What are Novation Agreements?

Contractors are precluded by law from selling off, transferring, or otherwise disposing of their Government contracts. Every once in awhile however, Government contractors are acquired by another company through acquisition or merger or a Government contractor decides to divest itself of a division that is performing a Government contract.  In those situations, the Government may, but is not required to, recognize a third party as a "successor in interest" to a Government contract. These situations are generally limited to cases where there has been a transfer of all of the original contractor's assets (or the entire portion of the contractor's operations involved in the performance of the contract) to a third party.

When the Government recognizes a successor in interest, there must be a novation agreement. Novation agreements are generally discussed in FAR (Federal Acquisition Regulations) 42.12 and is defined in FAR 2.101 as follows:

Novation agreement” means a legal instrument
    (1) Executed by the--
        (i) Contractor (transferor);
        (ii) Successor in interest (transferee); and
        (iii) Government; and
    (2) By which, among other things, the transferor guarantees performance of the contract, the transferee assumes all obligations under the contract, and the Government recognizes the transfer of the contract and related assets.

To begin the process of novating a contract, the contractor must submit a written request to the contracting officer. The request must include the following information:

1. Three signed copies of the novation agreement (sample wording for such an agreement is contained in FAR 42.1204(i)).
2. A description of the proposed transaction.
3. A detailed listing of all affected contracts.
4. Evidence of the transferee's capability to perform the contract (sometimes this can be a stumbling block).
5. Any other relevant information requested by the contracting officer.

Additional, as the following information becomes available, the contractor must supplement the initial request with the following:

1. An authenticated copy of the instrument effecting the transfer of assets.
2. A certified copy of each resolution of the corporate parties' boards of directors authorizing the transfer of assets.
3. A certified copy of the minutes of each corporate party's stockholder meeting necessary to approve the transfer of assets.
4. An authenticated copy of the new entity's certificate and articles of incorporation.
5. Opinions of legal counsel for the transferor and transferee stating that the transfer was properly effected under applicable law and the effective date of transfer.
6. Balance sheets for the transferor and the transferee as of the dates immediately before and after the transfer of assets.

If the Government does not accept the novation agreement, the original contracting party is still on the hook for performance. Failure to do so will most likely lead to a termination for default.