Originally published by Law360 Government Contracts, Law360 Mergers & Acquisitions, and Law360 Private Equity, December 2016
When acquiring a government contractor, review and analysis of the target's current government contracts is a central focus of due diligence for purposes of assessing the legal and business risks. Pending bids and proposals, however, also present unique issues and challenges and could have a significant impact on the anticipated value of the business. Post-acquisition, the loss of resources from a former parent company or affiliated company may jeopardize the target company's pending proposals. This situation could arise both where the proposal is successful and a protester challenges the award to the successor contractor, and where the successor contractor is not the successful awardee and itself seeks to challenge the procuring agency's award decision. This article discusses recent decisions issued by the U.S. Government Accountability Office and the U.S. Court of Federal Claims and highlights key issues for both sellers and buyers arising from pending proposals. The decisions highlight the potential impact a merger or acquisition may have on a target company's outstanding proposals and the importance of careful review of these proposals during due diligence.
The issues presented by pending proposals, like all issues presented in a due diligence review and risk assessment, must be considered in the context of the broader deal. Typically, this will involve negotiation of key provisions in the acquisition and ancillary agreements, U.S. Securities and Exchange Commission filings in the context of a public deal, Hart-Scott-Rodino reviews, and approvals by the U.S. Department of Justice or the Federal Trade Commission and avoidance of "gun-jumping" under the antitrust laws. Additionally, there is often the need to maintain secrecy and limit knowledge of the deal to a confined, manageable deal team with a "need to know."
For a publicly traded company, prior to a public announcement of an acquisition, it would be unlawful for the company to share information about the proposed transaction with the procuring agency or others in advance of the public announcement or the required filing with the SEC. Regulation FD (Fair Disclosure) prevents a public company from selectively disclosing material nonpublic information to certain individuals or entities without making public disclosure of such information. The upshot is that when a target has a significant portfolio of pending proposals that could be material to the deal and the future value, and sustainability of the acquired business, the acquirer should appoint a team to review each pending proposal and, based on its terms, decide what needs to be disclosed to the contracting agencies, or risk disqualification or loss of a contract in a post-award protest. This also means that notice to agencies must be coordinated with notices to the SEC and public announcements. Risks concerning pending proposals may, of course, also arise in acquisitions of privately held companies.
A central question in conducting a government contracts due diligence is whether the target company, as the original offeror that submitted the proposal, will be the same company that receives the award and performs the contract in key material respects. This is a fact-intensive analysis. Companies run into trouble when the target relied, either explicitly or implicitly, on the resources of its former corporate parent or affiliates in its proposal. These resources can include corporate organizational resources, processes and support functions; the management team; proposed contract personnel or key personnel; corporate experience; past performance references; and technical, financial and other assets, such as facilities, licenses in intellectual property, or research and development capabilities.
Lessons From Recent Cases
Recent bid protest decisions involving corporate transactions and pending proposals offer a cautionary warning to buyers and sellers as they consider these issues. Indeed, reports on the sale earlier this year by Lockheed Martin of its Information Systems & Global Solutions business to Leidos indicated that the combination has resulted in the loss of $5 billion in business. See GAO Denies Lockheed Protest of $500M Tech Contract, Law360, (Oct. 6, 2016). How can similar results be avoided?
In Lockheed Martin Integrated Systems Inc., B-410189.5; B-410189.6 (Sept. 27, 2016), GAO upheld the exclusion of protester LMIS from consideration for award of a task order contract for technical services based on "unquantifiable cost and risk associated with [its] planned spin-off of its information business segment" and sale to Leidos Holdings. GAO relied on press releases and a "Cautionary Statement Regarding Forward Looking Statements," which is standard disclaimer language used by publicly traded companies to avoid liability under federal securities laws for nondisclosure. GAO latched on to statements in the disclaimers that there were "many uncertainties that could affect [protester's] and Leidos Holdings' operations, markets, products, services, prices and other factors" and that material differences "could include business disruption, operational problems, financial loss, legal liability to third parties, and similar risks, any of which could have a material adverse effect on [protester's] consolidated financial condition, results of operations or liquidity." GAO found that these risks and uncertainties could create "an environment of risk for costs," a probable change in proposed direct labor and indirect cost rates, "unquantifiable cost risks," and a new corporate structure that could impact future performance, among other findings. Based on these findings, GAO questioned whether past performance would still be a predictor of future performance. According to GAO, where a transaction is "imminent and essentially certain," it will be incumbent upon offerors to advise procuring agencies of the effect of a proposed transaction, to avoid potential for elimination from the competition.
In a footnote in the Lockheed Martin case, GAO noted that the SEC filings referred to the transaction as a "merger" and questioned whether in view of the "merger,"even if the agency had considered the SEC filings, "it would have reached a different conclusion as to the nature of the transaction." In fact, the transaction took the form of a deal structure known as a "reverse Morris trust," which is essentially a reorganization and stock acquisition. While it is unclear whether educating the agency on the deal structure would have made a difference to the outcome of the protest case, GAO's footnote nonetheless suggests that disclosure of the deal structure and the impact of the transaction on essential elements of the offeror's proposal is critical.
Similarly, an offeror's failure to notify the agency of a change in its ownership and control led to the Department of Energy's National Nuclear Security Administration(NNSA) decision in August 2016 to rescind award of a management and operation contract to Nevada Site Sciences Support and Technologies Corp. (NVS3T), identified as a subsidiary of Lockheed Martin in its proposal. Following the award, NNSA learned that Leidos Innovation Corp. had acquired NVS3T from Lockheed Martin, but NVS3T had failed to notify the contracting officer of its ownership change, contrary to request-for-proposal (RFP) requirements. According to NNSA's press release regarding the rescinded award to NVS3T, the change in ownership "raises substantial questions about the information in the NVS3T proposal, which could significantly impact the evaluation of the proposal and award decision." NNSA announced that the procurement would continue and that, "in the interest of fairness," it would reconsider all offers previously received in response to the RFP. Thereafter, NVS3T filed a complaint at the U.S. Court of Federal Claims challenging the agency's action as arbitrary and capricious. Ultimately, in October 2016, the parties filed a joint motion to dismiss the complaint, which reflected that NNSA would take corrective action and establish a competitive range, including NVS3T, and proceed to hold discussions, request revised final proposals and make a new award based on the revised proposals from offerors.
On a related note, in Universal Protection Service LP v. United States, 126 Fed. Cl. 173 (Fed. Cl. 2016), the COFC held that the new owner of the original offeror that had previously submitted a proposal could not pursue a post-award bid protest because it was not the complete successor-in-interest to the offeror, which it acquired through an asset purchase. And, GAO has sustained protests against an award made to a company whose corporate structure had changed since the submission of a bid, Wyle Laboratories Inc., B-408112.2 (Dec. 27, 2013), 2014 CPD ¶ 16, and when the agency failed to consider the impact the acquisition had on the outstanding bid, FCi Federal Inc., B-408558.7, B-408558.8 (Aug. 5, 2015), 2015 CPD ¶ 245.
In Wyle Laboratories, GAO sustained a protest over a NASA award of a cost-reimbursement contract to "new" SAIC, based on a proposal submitted by "old" SAIC, which is now called Leidos. GAO found that the offeror (old SAIC) never intended to perform as the prime contractor on the NASA contract, "but rather intended that a smaller entity with substantially fewer resources, that was completely separate from 'old' SAIC, would perform the contract as prime contractor." B-408112.2 (Dec. 27, 2013), 2014 CPD ¶ 16. GAO also considered several critical and distinguishing facts: the new SAIC was only "one-third" of old SAIC; the award involved a cost-reimbursement contract, which raised risks of increased costs to the government with a substitution of a new prime contractor; and the agency "gave no meaningful consideration" to new SAIC's technical approach or the probable costs associated with that approach. Id. GAO found that the new SAIC was a far smaller entity, with fewer personnel and a changed technical approach. On this record, GAO found that the agency's evaluation failed to reflect the manner in which the contract actually would be performed and the level of costs likely associated with performance, and on that basis found "no reasonable basis for award." Id.
In FCi Federal Inc., B-408558.7, B-408558.8 (Aug. 5, 2015), GAO, in a prior proceeding, sustained a protest against an award initially made to USIS PSD, based on what it found to be an unreasonable determination of the awardee's responsibility, and ordered the Department of Homeland Security, U.S. Citizenship and Immigration Services, to take corrective action. See FCi Federal, Inc. B-408558.4 et al. (Oct. 20, 2014). Thereafter, PAE acquired USIS PSD and created a new entity called PAE/USIS PSD. The agency found PAE/USIS PSD responsible and affirmed the earlier award. In a second protest to GAO, FCi Federal again challenged the agency's award, claiming that the agency's evaluation failed to consider that the awardee's proposal no longer reflected the manner in which it would perform the contract. Relying on Wyle Laboratories, GAO found that, in addition to making a new responsibility determination resulting from the sale of USIS PSD to PAE, the agency also was required to consider whether the original USIS PSD proposal still reflected the intended approach to performance and the resources, experience and past performance to be relied upon by PAE/USIS PSD. GAO found that the record indicated that the awardee's proposal, and the agency's evaluation of it, no longer reflected the manner in which the awardee would perform the contract and the resources, experience and past performance on which the awardee would rely. But see Honeywell Technology Solutions Inc., B-413317 et al. (Oct. 5, 2016) (Air Force obtained information prior to submission of final proposals about the awardee's sale to CACI and ability to perform contract independent of its former parent; no indication that the awardee would be unable to perform contract in the manner described in its proposal).
Each of these decisions is highly fact-specific but the common thread is that the agency must be found to have considered the effect of acquisition on the offeror's proposal and its ability to perform the contract in accordance with the proposal that the agency evaluated.
Due Diligence Considerations
Although the analyses in the protest decisions have been highly fact-specific, the cases suggest that buyers evaluate the following factors in a target company's significant pending proposals. An acquirer should carefully examine the contents of any pending proposals to determine the extent to which the target is relying on existing corporate resources and capabilities of the selling entity or an affiliated entity. This list is not exhaustive, but is intended to highlight some of the issues typically identified by the GAO and the COFC in the protest decisions involving proposals of an acquired company.
1. Corporate/Technical Assets: Key corporate assets identified in a proposal must be transferred as part of an acquisition in order for the proposal to remain valid. These assets may include specific facilities, such as cleared facilities, equipment, and intangible assets such as licenses for intellectual property. For example, in Universal Protection, the proposal relied on a software license that was specifically excluded from the asset purchase agreement. The court was not persuaded by the argument that the new parent could simply purchase a license to the commercially available third-party web-based data collection and analytics system.
2. Method of Contract Performance: In reviewing the target's pending proposals, an acquirer should assess the target's proposed methods of contract performance to determine if its planned performance post-award will be the same as it would have been absent the acquisition. If the target's "intended approach to performance" changes as a result of the acquisition, a protest challenging the award on this ground may be successful. FCi Federal Inc., supra. As the GAO stated in FCi Federal Inc.:
Where an offeror's proposal represents that it will perform the contract in a manner materially different from the offeror's actual intent, an award based on such a proposal cannot stand, since both the offeror's representations, and the agency's reliance on such, have an adverse impact on the integrity of the procurement process.
Post-acquisition, the successful awardee should intend to perform the contract using the same technical approach, with the same resources, and using the same personnel and management capability as originally proposed, and as evaluated and selected for award by the procuring agency.
Note that if the contract does not expressly prohibit subcontracting, it may be possible to subcontract specific tasks to the former parent company and thereby satisfy this requirement. See IBM U.S. Federal, supra.
3. Organizational Resources: The more a target company relies on, or "reaches back" to, the former parent company's organizational resources and support functions, such as contract and subcontract administration, finance, facility services, quality assurance, security, staffing and training, legal and compliance resources, the greater the susceptibility to challenge or disqualification. See FCI Federal, B-408558.4 et al. at 7 (USIS PSD's proposal relied in material respects on the corporate resources and back-office support of its former parent, USIS LLC, and of Altegrity, USIS LLC's parent); and Universal Protection, 126 Fed. Cl. 173 (proposal mentioned its former parent's "record of integrity and business ethics"). In AIU North America Inc., B-283743.2 (Feb. 16, 2000), 2000 CPD ¶ 39, GAO sustained a protest where the corporate entity submitting the successful proposal was acquired by another corporation after submission of final proposals but before the source selection determination was made, and where the agency's evaluation failed to consider the "availability of corporate resources" as required by the RFP evaluation criteria. The offeror's proposal described the corporate resources of the prior parent corporation that were not transferred to the acquirer, the entity awarded the contract by the agency.
4. Differences in Pricing and Evaluated Costs, Including Changes in Indirect Cost Rates: In IBM U.S. Federal, B-409806, B-409806.2 et al. (Aug. 15, 2014), 2014 CPD ¶ 241, GAO dismissed a protest involving a fixed-price/fixed-labor contract awarded to SAIC/Leidos following its split, because "it d[id] not appear that SAIC's corporate restructuring is likely to have any significant cost or technical impact on performance of the requirements." GAO found that the labor rates submitted in the proposal were still applicable to the new company post-corporate reorganization. Similarly, in an FAA protest, ODRA found that where a firm fixed-price contract is involved, there will be no cost impact to the government resulting from the risk of increased costs of performance. See Protest of Data Transformation Corporation, FAA Order No. ODRA-15-762 in Docket No. 15-ODRA-00732 (Feb. 8, 2016) (protest denied challenging award of contract to Computer Sciences Corporation following corporate reorganization and transfer of contract).
Conversely, where a cost reimbursement contract is involved, GAO may find that the government bears the risk that the new company performing may not be able to achieve the anticipated cost goals and, on that basis, sustain a protest. In Wyle Laboratories, NASA evaluators failed to take into account the cost-reimbursable nature of the contract and the fact that the substituted company was substantially smaller and had fewer resources than the company that was evaluated and awarded the contract. See also Nat'l Aeronautics and Space Admin.-Recon., B-408112.3, May 14, 2014, 2014 CPD ¶ 155.
5. Financial Resources: References in a proposal to the parent company's financial resources also can spell trouble, if the acquirer is a smaller company or not as dominant in the field. In Wyle, GAO specifically noted references by the original offeror in its proposal to its parent company's "over 40,000 employees and $10.6 billion in annual revenue." If financial statements are required under the terms of the RFP, an offeror should consider providing its own certified financial statements rather than a consolidated statement of its corporate parent. This was a specific finding in Universal Protection (offeror's submission of consolidated financial statements could be viewed as reliance on the resources of a former parent company to the offeror's advantage in the evaluation of its proposal). But, even more benign references can raise concerns. In FCi Federal, GAO found that the awardee's proposal relied on the financial resources, including lines of credit, of its parent, USIS LLC, and the parent company's parent, Altegrity. Conversely, L-3 National Security Solutions was able to defeat a protest when it demonstrated access to its own credit facility and that of its new parent following a purchase. See Honeywell Technology Solutions, B 413317, B 413317.2 (Oct. 5, 2016).
6. Proposed Management Resources and Contract Personnel: Where specific employees or a management team are referenced in a proposal, the acquirer should confirm that such personnel will be available post-acquisition to perform the contract. A key issue identified in Universal Protection was that, of the 17 key personnel identified in the proposal, at least six were employees of the former parent company and not employed by the new owner by the time of the protest. In CBIS Federal Inc., B-245844 et al. (Mar. 27, 1992), 92-1 CPD ¶ 308, GAO sustained a protest where the awardee proposed key personnel in its best and final offer whom it could not reasonably expect to be available to work on a project. GAO held that an offeror has a responsibility to propose persons whom it reasonably may expect will be available for contractor performance. According to GAO, "where the offeror provides firm letters of commitment and the names are submitted in good faith with the consent of the respective individuals (that is, the offeror is not proposing personnel it has no intention of providing), the fact that the offeror, after award, provides substitute personnel does not itself make the award improper."
7. Past Performance: A corporate subsidiary's past performance references may include the past performance of its corporate parent or other affiliates. These references will not be relevant post-acquisition, if the business units that are the subject of such past performance references are not transferred as part of the acquisition. See FCi Federal Inc., supra. Even arguably stray references to a corporate parent could result in problems down the road. In Universal Protection, 127 Fed. Cl. at 193, the court found that each reference to the former parent company "was designed to bolster the proposal" and thus should no longer be considered. The court rejected the protester's claim that each reference "was only coloration and not relevant to the merits of the evaluation," and concluded that "there are simply too many references to support from, or reliance on, the parent company." Id.
8. Small Business Status: Potential loss of small business status is always a concern in acquisitions of companies that identify themselves as small businesses. The Small Business Administration determines a contractor's small-business status based on annual receipts or number of employees, depending on size standards established under North American Industry Classification System (NAICS) codes applicable to the contractor and specified in a particular solicitation. See FAR 19.102. However, under the SBA's rules on affiliation, SBA counts not only the annual receipts or number of employees for the contractor, but also the receipts or employees of each of its domestic and foreign affiliates. Concerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party (or parties) controls or has the power to control both. It does not matter whether control is exercised, so long as the power to control (whether affirmative or negative) exists. See 13 CFR § 121.103. SBA considers factors such as stock ownership, common management, previous relationship with or ties to another concern, and contractual relationships in determining whether affiliation exists. Id. An acquirer may try to structure the transaction with the small business government contractor in a manner to avoid affiliation, such as by having the target retain majority ownership and management control of itself. Often, however, the target and acquirer will be deemed to be affiliates, and the target will no longer qualify as a small business under the SBA affiliation rules. Where a private equity firm is involved, the target can be deemed to be affiliated with all other portfolio companies held by the PE firm, resulting in loss of small business status.
New SBA regulations impose additional recertification requirements on a small business concern if a merger or acquisition occurs after the small business concern submits its proposal but prior to contract award. See 13 CFR § 121.404(g)(2)(ii)(D); 81 Fed. Reg. 34243 (May 31, 2016).
9. Classified Contracts and Security Clearances: When a target is involved in performance of contracts requiring access to classified information, it can be difficult for the acquirer to gain access to bids, proposals or contracts for the due diligence review. Retention of employees with personnel security clearances who are necessary for continued performance of classified contracts, either at the contractor's facility or offsite at government facilities, also will be a consideration. Where the target has a facility security clearance, the National Industrial Security Program Operating Manual (NISPOM), DOD 5220.22-M requires that a foreign ownership, control and influence (FOCI) analysis be performed of the acquiring entity to ensure compliance with any FOCI restrictions that may be necessary. Where a private equity firm is the acquirer, this can require an assessment of potential FOCI issues involving the PE firm and its fund investors; depending on the results of that analysis, disclosures to the Defense Security Service (DSS) may be required, along with implementation of appropriate FOCI restrictions and mitigation measures.
10. Organizational Conflicts of Interest: From a diligence and business perspective, careful analysis of the organizational conflict of interest (OCI), exclusivity or similar provisions included in the target's contracts is necessary to assure that they do not undercut pending bids and proposals. An OCI analysis should be performed, consistent with the requirements of FAR Subpart 9.5 and any applicable agency requirements to determine whether the target's work under any of its contracts could be deemed to conflict with work under other present and future contracts or business opportunities of the acquirer, its subsidiaries or affiliates, or any portfolio companies, where private equity buyers are involved. Of course, the acquirer's present contracts and pending bids or proposals could present the same issues for the target's pending bids and proposals. The OCI analysis should identify any lines of business or programs in which both the target and acquirer, its subsidiaries or affiliates, or any portfolio companies share a presence and where ownership of, or investment in, the target could result in actual or potential OCIs and, if so, the steps that can be taken to avoid or mitigate such OCIs. On a going-forward basis, continued compliance with any exclusivity provisions, OCI limitations or restrictions, OCI mitigation plans or similar provisions will be critical.
Keep the Government Informed
A key takeaway from the foregoing discussion is the criticality of keeping the government, and particularly the contracting officer, well-informed about any planned acquisition – to the extent parties can do so consistent with securities laws, including Regulation FD, and the antitrust laws. Open communication will facilitate the agency's evaluation of pending bids and proposals based on the most up-to-date and accurate information. FCi Federal Inc., supra (sustaining protest where agency did not conduct reevaluation when awardee was acquired between initial evaluation and award decision) and Lockheed Martin Integrated Systems Inc., supra (agency should evaluate effect of possible corporate restructuring where a transaction is "imminent and essentially certain").
An agency, GAO or court evaluation of the impact that an acquisition has on a target company's pending bids and proposals will be specific to the circumstances and will depend on how the deal is structured, regulatory requirements, and the details of the target's proposals. Where the value of a target depends at least in part on sustaining its government business, careful review of pending proposals should be a key component of the government contracts due diligence process.
Steven S. Diamond is a partner and Joan G. Ochs is a counsel in the government contracts and national security practice at Arnold & Porter LLP. Based in Washington, D.C., they regularly advise strategic and financial buyers in acquisitions of government contractors.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.