The Trump administration's deluge of executive orders aimed at rooting out diversity, equity, and inclusion initiatives have made reviewing DEI programming a priority, particularly for federal contractors. The orders are making hiring decisions more complicated and are creating new challenges in the mergers and acquisitions context.
The new certifications the EOs require from federal contractors create risk. But this risk is amplified for parties in the M&A context, where risk must be evaluated to determine its scope, potential mitigation opportunities, and how—if at all—any deal-specific terms will address this fluid situation.
The new certifications also impose additional pressures, making it even more prudent to modify typical due diligence requests and potentially representations and warranties to account for these elevated (and in some cases, undefined) risks.
Federal Contractor Questions
Federal contractors provide goods or services to the federal government and are an important feature of the American business sector. Indeed, the Government Accountability Office reported the federal government spent $759 billion on contracts with private entities in 2023. And the Department of Labor reported that 25% of the entire Americanworkforce was employed by a federal government contractor that year.
The EOs require federal contractors to certify their compliance with applicable federal anti-discrimination laws is material to the government's payment decisions and that they don't operate any DEI programs that violate applicable federal anti-discrimination laws.
The failure to certify—or providing an inaccurate certification—can lead to serious penalties, including debarment from contracting, civil liability under the False Claims Act, or criminal penalties (to say nothing of inviting unwanted governmental scrutiny).
Despite the consequences of this far-reaching certification, the meaning and scope of "illegal DEI" remains undefined, even after the federal government offered a description in joint guidance from the Equal Employment Opportunity Commission and Department of Justice in March. That guidance, its interpretation, and legal challenges to these EOs remain in flux.
In the meantime, federal contractors must comply with an uncertain regulatory landscape. Given the lack of clarity regarding how workplace programs might illegally promote DEI, federal contractors (and their acquirers) face a magnified risk if they don't understand the scope of their DEI programming.
Dealmaking Risk Assessment
The risks associated with acquiring (or selling) a government contractor entity are well known in the M&A context, and representations and warranties regarding these terms—as well as due diligence to understand these risks—have long been a part of a deal team's risk assessment.
Such assessment typically includes reviewing the target's material contracts, analyzing financial information and performance, conducting interviews with key personnel, and other activities designed to inform the buyers of the target's operations and value. It also involves seeking and negotiating representations and warranties in deal documents to allocate risk among the parties and provide assurances to the buyer about the target and its business.
The information obtained from these assessments informs an allocation of risk between the buyer and seller regarding the business and the representations and warranties to be negotiated. It also affects the price an interested buyer might pay for the business (and the potential for any losses because of any inaccuracy in the representations and warranties provided by seller to buyer).
Risk Mitigation
The customary process for reviewing documents that disclose workplace and employee risk should ensure a review of DEI-related programs or processes by subject-matter experts as well as discussions with individuals at the business responsible for implementing these programs—typically the human resources team.
Simply reviewing the target's DEI statement is likely insufficient. Rather, robust DEI due diligence should extend to auditing the target's DEI-related policies and processes, such as its affinity groups or mentoring programming.
Buyers must focus their attention on the target's contracts with the federal government and should include a review of all the target's certifications to the federal government. If the target isn't currently a federal contractor, due diligence should include questions about whether the organization is considering becoming a federal contractor, is in the process of becoming one, or has other potential exposure based upon federal contracting (such as an affiliate, a supply chain source, or a vendor).
Finally, while customary "compliance with laws" and "material contracts" representations and warranties might capture any non-compliance, it remains prudent for the buyer and seller to understand these risks so they can appropriately assess, and allocate, the risk of any exposure. Sellers and buyers should consider whether appropriate indemnification provisions may address these risks.
Risk is inherent in the M&A context. But the changing legal DEI paradigm, together with the turmoil associated with abrupt changes to long-standing assumptions about how workplaces operate, counsel consideration of these DEI issues in the M&A process to evaluate and allocate any risk exposure.
Originally published by Bloomberg Law
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