Buying a business that contracts with government? Key risks and due diligence considerations

Government contracts often include provisions that prohibit a change of control of the counterparty without prior government consent. This consent is usually subject to certain conditions, including the incoming party’s (or incoming controlling party’s) ability to meet certain eligibility requirements. 

Key considerations and recommendations:

• Identify each government contract during due diligence.
• Confirm which contracts require consent to change of control and on what terms.
• If those contracts are material to the business, include a condition precedent in the transaction documents requiring the relevant government party’s consent to the change of control and if applicable, satisfaction of any relevant conditions.

Government contracts often include stringent rights and obligations, including the right for the government party to terminate the contract without reason and audit rights. Understanding these rights and obligations is critical.

Key considerations:

• What are the termination rights of the government party under the relevant contract?
• Has the counterparty received any notice that such rights may be exercised? Is there any reason such rights may be exercised?
• Are there liquidated damages or penalties for non-performance?

Government contracts may be subject to public disclosure requirements, meaning contract details, financial terms and company performance may be publicly available.

Key considerations:

• Are there any sensitive contractual terms that could be disclosed under Freedom of Information (FOI) laws?
• Could negative disclosures impact the transaction or future business with government?

Some contracts allow the government party access to the supplier’s (or subcontractor’s) premises, personnel, computer systems, documents and other records for the purposes of ensuring performance under the contract.

Government contracts also may have more stringent requirements to maintain records, including with respect to the transfer, ownership or destruction of such records.

Key considerations: 

• Have all record-keeping obligations been complied with?
• Are there any sensitivities in providing access to records, if required?

Government contracts frequently include provisions granting the government party rights over intellectual property developed under the contract.

Key considerations: 

• Does the government party retain ownership or licencing rights over the intellectual property?
• Are those rights exclusive or non-exclusive?

Government contracts often require businesses to comply with strict rules regarding subcontractors and supply chains (including ethical sourcing, cybersecurity and anti-corruption compliance).

Subcontractors often require pre-approval by the government party and will be subject to the same obligations as the supplier (the supplier ultimately remaining liable for performance and compliance).

Key considerations:

• Has the business implemented policies to ensure subcontractor compliance with government requirements?
• Review all subcontractor agreements (if any) to ensure compliance with the relevant head contract.
• Consider including an indemnity in the transaction documents for any subcontractor non-compliance.

Many government contracts impose workplace obligations, such as compliance with modern slavery and fair work legislation, or specific workplace diversity and inclusions policies.

Key considerations:

• Is the business complying with all relevant employment obligations imposed by the government party?
• Does it meet government-mandated employment standards, such as employment quotas or local workforce requirements?

Some government contracts require a specified person (or a ‘key person’) who has particular skills, expertise or qualifications, perform a particular role in relation to the contract. In this case, a buyer will either need to ensure that person continues their employment with the business post-completion or, with the government party’s consent, find a suitable alternative to fulfil that role following completion.

Key considerations:

• Review the relevant government contracts for any key person requirements.
• If any material contracts have any key person requirements, either:
  • require a condition precedent that such person(s) accept employment with the buyer; or
  • locate a replacement to fulfil the relevant role from completion (with the prior consent of the government party).

Suppliers are often required to indemnify the government for any losses, damages or costs resulting from any breach of the contract, by subcontractors. Government contracts will also often include insurance requirements (depending on the nature of the contract).

Key considerations:

• Include an indemnity in the transaction documents for any pre-completion breach.
• Confirm the business has maintained and will, following completion maintain, the relevant insurances required under the contract.

Transactions involving defence-related businesses or critical national assets raise distinct regulatory and geopolitical considerations. If the subject matter of the contract raises national security concerns, the contract may attract increased government scrutiny and require considered management throughout the transaction.

The Defence Trade Controls Amendment Act 2024 introduced a licence-free trade environment with the UK and the US, while also creating three new criminal offences for supplying items or services listed on the Defence and Strategic Goods List (DSGL) to foreign persons (including within Australia). As a result of these changes, buyers will need to conduct thorough due diligence to assess both eligibility for licence-free trade and any increased exposure to compliance risks (including, for example, under the Australia-US Defence Trade Cooperation Treaty).

Foreign investment may also be subject to scrutiny. The Foreign Investment Review Board (FIRB) is a government body that has the power to review, block or unwind transactions on national security grounds – even if FIRB approval wasn’t required, the Treasurer has power to review or unwind a deal if national security concerns arise.

Key considerations:

• Does the transaction involve any goods, technology or services listed on the DSGL? If so, does the target or buyer qualify for the licence-free environment?
• Are there any risks of non-compliance with the Defence Trade Controls Amendment Act 2024 or other treaty obligations (ie the Australia-US Defence Trade Cooperation Treaty)?
• Have all relevant reporting, facility accreditation and export control obligations, including notification of ownership changes, been complied with and considered?
• Does the transaction involve a business that is a government contractor in a national security-sensitive sector? If so, has FIRB approval been obtained or considered to ensure contract continuity, tender eligibility and compliance with national security requirements under the Foreign Acquisitions and Takeovers Act 1975?

If the target supports Defence, defence-industry or classified government work, buyers should also consider additional compliance frameworks, including Defence Industry Security program (DISP) membership level and whether any special conditions have been imposed. 

Buyers not already DISP members should factor in up to 12-18 months for sponsorship, vetting and facility accreditation (depending on level). 

Key considerations:

• Are any existing DISP undertakings personal to the seller entity and non-transferrable on completion?
• Do the transaction documents require a post-completion remediation plan (ie uplift to a higher level DISP within 90 days)?