This post uses hypothetical scenarios for illustrative purposes only. It does not describe any actual client, transaction, or representation, and is not legal advice.
Picture a founder-owned services company whose three biggest customers are federal agencies. The buyer’s model assumes the government revenue transfers at closing like any other contract. Then, somewhere in diligence, a lawyer says the quiet part: you cannot assign a federal contract. Not with consent language, not with a well-drafted assignment clause, not at all — a statute prohibits it. The room goes quiet, the timeline slips, and the deal team discovers a federal process with its own paperwork, its own timing, and its own leverage dynamics that nobody priced into the letter of intent.
The statute is 41 U.S.C. § 6305, the Anti-Assignment Act, and the process is the novation procedure in FAR 42.1204. If you buy or sell a business that holds federal contracts — defense, space, IT services, logistics, construction, health — this regulation quietly reorganizes your deal structure, your closing mechanics, and your post-closing risk allocation. Here’s how it actually works, and where deals go sideways.
Asset deals need the government’s blessing; stock deals mostly don’t.
The Anti-Assignment Act flatly prohibits transferring a government contract to a third party. The safety valve is that the government may — the word is permissive — recognize a third party as the successor in interest when the third party’s interest arises from a transfer of all the contractor’s assets, or the entire portion of the assets involved in performing the contract. FAR 42.1204(a) lists the qualifying transactions: an asset sale with assumption of liabilities, an asset transfer incident to a merger or consolidation, the incorporation of a proprietorship. That recognition happens through a trilateral novation agreement among transferor, transferee, and the United States, signed by the responsible contracting officer.
The structural fork comes in FAR 42.1204(b): a novation agreement is unnecessary when ownership changes through a stock purchase, with no legal change in the contracting party, where that party keeps control of the assets and keeps performing. Buy the equity, leave the legal entity intact, and the contract never moves — the same principle that makes reverse triangular mergers attractive under ordinary commercial anti-assignment clauses, which we unpacked in our post on anti-assignment clauses and the Meso Scale line of cases. For a government contractor, this single regulation often decides the threshold question that usually turns on tax and liability factors — the tradeoffs in our asset-versus-stock decision framework. Sellers of federal-heavy businesses have a structural argument for equity deals that has nothing to do with capital gain: the buyer avoids months of novation exposure. A change of ownership still gets reported and may prompt the government to address related issues in a formal agreement, but the contract itself stays put.
The novation package is a diligence exercise the government runs on your deal.
When an asset structure is unavoidable — carve-outs, divisional sales, liability-driven structures — the contractor must submit a package under FAR 42.1204(e) and (f) that reads like a second closing checklist. Three signed copies of the proposed novation agreement. The purchase agreement itself. A list of every affected contract with dollar values and unpaid balances. Evidence of the transferee’s capability to perform. Then, as they become available: the authenticated bill of sale or certificate of merger, certified board resolutions from each party, an opinion of counsel for both transferor and transferee that the transfer was properly effected, balance sheets of both parties immediately before and after the transfer audited by independent accountants, evidence that security clearance requirements have been met, and surety consents where bonds are required.
Read that list again as a deal lawyer and three consequences jump out. First, the government sees your transaction documents. The purchase agreement goes to the contracting officer, so draft with that audience in mind. Second, the audited before-and-after balance sheets are a real cost and a real timeline item that first-time sellers never anticipate — order them early. Third, the package can’t even be finalized until closing has happened, which means the novation is almost always executed after the deal closes. You close into uncertainty. The contracting officer has discretion, takes weeks or months, and under FAR 42.1204(c), if the government declines to concur, the original contractor remains obligated to the government — and the contract can be terminated for default if that original contractor, now an empty shell that sold its operating assets, fails to perform.
The interim period runs on subcontracts, and the seller stays on the hook.
Deals bridge the gap with performance mechanics: the seller remains the contractor of record while the buyer performs behind the scenes, through a subcontract or back-to-back agreement, until the novation is executed. That interim arrangement deserves as much drafting attention as the purchase agreement’s reps — it’s where invoicing, payment flow, compliance responsibility, and audit exposure actually live for months. Pair it with covenants requiring both parties to pursue the novation diligently, to submit the package promptly, and to maintain the seller entity’s existence until execution. A seller who wants to dissolve, distribute, and disappear at closing cannot — winding up the transferor before novation is a self-inflicted default risk. The same interim logic shows up in the operating covenants between signing and closing generally, where buyers police the business they’ve priced but don’t yet own — see our post on material contract covenants and buyer consent rights.
Now the provision sellers underestimate most. The standard-form novation agreement in FAR 42.1204(h) and (i) — reproduced verbatim in the regulation — requires that the transferee assume all obligations, that the transferor waive its claims against the government, and that the transferor guarantee performance of the contract by the transferee. A performance bond may be accepted instead. Sit with that: the founder who just sold the business remains a guarantor of the buyer’s performance to the United States, indefinitely, on contracts the founder no longer controls. Sophisticated sellers negotiate for the bond alternative, or extract a back-to-back indemnity from the buyer covering any liability under the guarantee, sized and secured with the same seriousness as any special indemnity. Sellers who skip this discover their exit has a tail.
Price the process, don’t just paper it.
A few allocation questions belong in the LOI, not the eleventh-hour markup. Whether novation execution is a closing condition (almost never achievable, since the government generally won’t act until after transfer) or a post-closing covenant with an escrow or holdback against non-recognition. Who bears the revenue risk if an agency declines to novate a particular contract — a purchase price adjustment, a clawback, or buyer’s risk. How change-of-control notices, clearance issues for classified work, and organizational conflict-of-interest reviews under FAR subpart 9.5 sequence against the closing date. And for set-aside work, whether the buyer’s size or status jeopardizes contracts priced into the model — small business eligibility does not automatically travel with an acquisition, and that diligence belongs at the term sheet stage. Regulated-transfer choreography isn’t unique to federal work — state-regulated industries have their own versions, like the FMCSA and tax-clearance sequencing in our post on buying or selling a Florida trucking company — but the federal version is distinctive in one respect: the counterparty whose consent you need is also a sovereign with discretion, a form it will not negotiate much, and no closing deadline but yours. In a defense-heavy state like Florida, with its concentration of contractors around the Space Coast, the Panhandle bases, and the ports, this process shows up in lower-middle-market deals far more often than founders expect.
The government contractor M&A market prices these mechanics fluently at the top end. In founder deals, they surface late, get handled in a rushed amendment, and leave someone holding a guarantee they didn’t understand. The regulation is public, the form agreement is printed in it, and the traps are all avoidable with sequencing and candor about who bears which risk.
If you are buying or selling a business that holds federal government contracts, feel free to reach out to our firm manager, Magda, at Magda@montague.law, or fill out our contact form. Mention you read this post.
