On April 12, 2016, the Department of Justice (DOJ) and the Federal Trade Commission (FTC) issued a joint statement explaining their standard of review under the antitrust statutes of proposed transactions (mergers, teaming agreements, and other joint business arrangements) acquisitions, within the defense industry. The DOJ and FTC are responsible for reviewing mergers in the defense industry under Section 7 of the Clayton Act, which prohibits mergers whose effect “may be substantially to lessen competition, or to tend to create a monopoly.”
The DOJ and FTC rely heavily on DoD's expertise to evaluate the potential impact of mergers and acquisitions within the defense industry. The DOJ and FTC "are especially focused on ensuring that defense mergers will not adversely affect short- and long-term innovation crucial to our national security and that a sufficient number of competitors, including both prime and subcontractors, remain to ensure that current, planned, and future procurement competition is robust." The statement indicates that "if a transaction threatens to harm innovation, reduce the number of competitive options needed by DoD, or otherwise lessen competition, and therefore has the potential to adversely affect our national security," the DOJ and FTC will not hesitate to block it.
Of passing interest, DOD objected to the Lockheed-Martin 2015 acquisition of Sikorsky which DOJ and FTC did not block; hence the current DOJ-FTC joint statement’s focus on defense contractors as a means to placate DOD.
With the increase in defense industry consolidations due to "sequester" and other budgetary constraints and the renewed focus on merger and acquisition activities by the DOJ and FTC, this is a good time to revisit some of the regulatory requirements related to these activities.
Organization costs are specifically unallowable under the provisions of FAR 31.205-27; however, certain external restructuring costs are allowable under specific circumstances. Let's start with a couple of definitions:
Organization costs are defined by 31.205-27 (a) as "expenditures in connection with (1) planning or executing the organization or reorganization of the corporate structure of a business, including mergers and acquisitions, (2) resisting or planning to resist the reorganization of the corporate structure of a business or a change in the controlling interest in the ownership of a business, and (3) raising capital (net worth plus long-term liabilities)"…. Such expenditures include but are not limited to incorporation fees and costs of attorneys, accountants, brokers, promoters and organizers, management consultants and investment counselors, whether or not employees of the contractor. "All of these costs are unallowable.
Restructuring activities are defined by DFARS 231.205-70 (b)(3) as are defined as "nonroutine, nonrecurring, or extraordinary activities to combine facilities, operations, or the workforce, to eliminate redundant capabilities, improve future operations, and reduce overall costs. Restructuring activities do not include routine or ongoing repositionings and redeployments of a contractor’s productive facilities or workforce (e.g., normal plant rearrangement or employee relocation), nor do they include other routine or ordinary activities charged as indirect costs that would otherwise have been incurred (e.g., planning and analysis, contract administration and oversight, or recurring financial and administrative support)."
External restructuring activities are defined by DFARS 231.205-70 (b)(2) as " restructuring activities occurring after a business combination that affects the operation of companies not previously under common ownership or control. They do not include restructuring activities occurring after a business combination that affects the operation of only one of the companies not previously under common ownership or control, or when there has been no business combination, restructuring activities are undertaken within one company. External restructuring activities are a direct outgrowth of a business combination. They normally will be initiated within three years of the business combination."
Allowable Costs
Restructuring costs are defined by DFARS 231.205-70 (b)(4) as the "costs, including both direct and indirect, of restructuring activities. Restructuring costs that may be allowed include, but are not limited to, severance pay for employees, early retirement incentive payments for employees, employee retraining costs, relocation expense for retained employees, and relocation and rearrangement of plant and equipment. For purposes of this definition, if restructuring costs associated with external restructuring activities allocated to DoD contracts are less than $2.5 million, the costs shall not be subject to the audit, review, and determination requirements of paragraph (c)(4) of this subsection; instead, the normal rules for determining cost allowability in accordance with FAR Part 31 shall apply."
The primary difference between organization costs which are unallowable and restructuring costs that may be allowable is that restructuring costs occur subsequent to the merger and are nonrecurring.
For external restructuring costs to be considered allowable, the contractor must submit a restructuring proposal identifying projected restructuring costs and restructuring savings for audit. All costs must be allowable in accordance with FAR Part 31 and DFARS Part 231, and an advance agreement must be negotiated with the ACO. In addition, one of the following conditions must be met:
- Cost savings must exceed restructuring costs by a factor of at least 2 to 1; or
- The costs allowed, and the business combination will result in the preservation of a critical capability that might otherwise be lost to DoD.
Redstone Government Consulting stands ready to assist with restructuring proposal preparation and identification and calculation of restructuring costs and savings as needed.
