Government Contract Restructuring Task Force

A multi-practice task force to advise clients about common restructuring issues that may arise from government contract cancellations.

Haynes Boone recommends Contractors and Counterparties review rights, options, and develop action items to enhance positioning in any bankruptcy case. There may be opportunities to resolve matters without a bankruptcy, or to enhance creditor positioning if a counterparty files a bankruptcy. This contingency planning plainly differs if the Contractor or Counterparty is itself in distress or does business with the impacted counterparty having its contracts and cash flow interdicted by contract cancellations.

For the distressed Contractor or Counterparty, the most immediate need is to bridge the cash flow interruption caused by an abrupt contract cancellation. Options range from renegotiating financing arrangements with existing lenders, to securing alternate financing to assist in maintaining operations. Necessarily, these distressed Contractors or Counterparties should also immediately consider operational adjustments and engage outside business professionals to coordinate business operations and legal strategies.

For creditors of Contractors, a timely risk assessment, including an immediate review of contractual and legal rights concerning the shipment of goods, is essential. Obtaining updated financial information and evaluating options for action whether in the form of lien filings, suspension or termination of deliveries, demands for adequate assurance, commencement of litigation, the exercise of setoff and recoupment rights, and closely monitoring the Contractor’s financial health, are all options that should be thoughtfully considered. A creditor should also review agreements for bankruptcy-related defaults and remedies and take steps where possible to collateralize the contract position. Moreover, creditors should be aware of the risks of (and any potential to mitigate) debtor-owned causes of action if a bankruptcy is filed so they can seek to minimize the risks of avoided transfers or payments (called avoidance action litigation).

Yes, a government contractor that relies upon some or all of its revenue to come from the government may default on its contracts with Counterparties unrelated to the cancelled government contracts. Be it lease obligations, labor and employment agreements, or loan covenants, a government contractor may default and must develop an understanding of how that risk may be important to all commercial parties.

Restructuring can be important to any business impacted by a government contract cancellation. Whether a company is (i) highly dependent on the continuation of government contracts or recovery of damages from a cancellation of government contracts or (ii) a counterparty to a principal government contractor that itself gives rise to substantial credit risk exposures, clients may benefit from understanding the options and risks a restructuring process can bring.

For the troubled direct government Contractor, restructuring strategies may allow a company to secure interim assistance and expertise to rapidly address a changed financial environment. Restructuring professionals can assist the Contractor with obtaining new financing, rapidly reducing costs consistent with corresponding laws, regulations and legal requirements, and positioning the Contractor for longer term collection efforts as the fallout from these cancellations take effect. In a restructuring, the Contractor can take steps to improve its deteriorating capital structure, adapt to new circumstances, or undertake organizational changes.

Restructurings can occur in or out of court. Out of court, a business can renegotiate key agreements (such as contracts and loans) with lenders and counterparties. It also provides opportunities to retain third-party business advisors that bring a fresh perspectives and relationships to evaluate different possibilities to restructure a business faced with a sudden cancellation of key contracts.

In court, a Contractor can file a Chapter 11 bankruptcy and continue operating in the ordinary course while gaining breathing room from creditor collection efforts and pending litigation claims through the automatic stay. A Contractor can also use Chapter 11 to restructure their business, through, among other things, operational changes, contract re-negotiations, asset sales, or a combination thereof.

The automatic stay is effectively a worldwide injunction against creditors acting on pending claims, contracts, or collection of debts of a debtor Contractor. It goes into place immediately upon a bankruptcy filing. The automatic stay is a broad injunction that stops creditors from taking certain actions against a debtor and its property. It prevents precipitous creditor action and a race to the courthouse. The automatic stay is applicable to all creditors and counterparties, including the government, subject to some limited exceptions associated with the enforcement of police or regulatory power to protect the public interest.

The U.S. Bankruptcy Code broadly defines what is included as the debtor’s property (defined as the “estate”), capturing essentially every right, asset and interest of the debtor, whether tangible or intangible. Thus, one key benefit of the automatic stay is that it may prevent the government or other nongovernment counterparties from terminating executory contracts, without first obtaining bankruptcy court relief.

Executory contracts are essentially all contracts that a Contractor has, and which prior to the moment the bankruptcy is filed, are not already terminated, and which have some measure of material performance still due on both sides of the contract. Contractors can assume, and in many cases assume and assign, or reject unprofitable executory contracts in bankruptcy, although government contracts may have some restrictions on assignment that require particularized review.

Executory contracts are property of the estate, and the automatic stay generally stops contract-counterparty termination without bankruptcy court relief. Importantly, terminations that are not fully effective can be intercepted by a bankruptcy filing, with the debtor retaining rights. Counter-parties—including the government—cannot terminate contracts solely because of a bankruptcy filing (FAR § 52.249-8; 11 U.S.C. § 525(a)).

Bankruptcy also gives the debtor tools to renegotiate executory contracts that may be burdensome through assumption, assignment, and rejection. Assignment allows a debtor to transfer an executory contract either to itself as a reorganized debtor or a third-party. To assign an executory contract, the debtor must cure any defaults. After assumption, debtors can assign contracts to themselves (reorganized debtor) or to third-parties, subject to certain exceptions. Rejection is a breach occurring immediately before the bankruptcy filing and entitles counterparties to damages arising from the breach, although the non-debtor’s damages are likely relegated to general unsecured claim status absent action to enhance priorities.

Contracts with the federal government do have special regulations and laws impacting their treatment. The DOGE cancellations may impact the ability to assign contract rights. The Anti-Assignment Act (41 U.S.C. § 6305) places some restrictions on debtors seeking to assign government contracts to third parties without government consent, even if the cancellation is not final and complete at the time a bankruptcy is filed. Some courts allow assignment, and others require the government’s consent prior to assignment. If a business is considering bankruptcy as a protection from government contract cancellation, the underlying facts involved, the exact terms of the contract, and applicable case law in the expected venue will be key considerations.