RGCI - Employee Stock Ownership Plan (ESOP) is the Gift That Keeps on Giving

Besides the potential tax benefits of an Employee Stock Ownership Plan (ESOP), the National Defense Authorization Act (NDAA) for Fiscal Years 2022 and 2024 has introduced an additional benefit for employee-owned businesses contracting with the Department of Defense (DoD). A pilot program that will allow for the award of follow-on contracts without competition.

The Congressional intent was for the pilot program to run for 5 years. Yes, from the 2022 NDAA enactment. To support this intent, Defense Pricing and Contracting issued a memorandum dated November 8, 2022, to initiate the pilot prior to any regulatory actions. The 2024 NDAA extended the pilot program to 8 years. In Section VI of the Federal Register, it states: "To date, eight businesses are participating in the pilot, six of which are small entities." With the fairly large number of employee-owned businesses doing business with DoD, this appears rather disappointing.

What is the New Benefit?

Based on Congress's direction, DoD is implementing a pilot program to award follow-on contracts to employee-owned contractors on a non-competitive basis.

DoD has issued a proposed rule under DFARS Case 2024-D004 soliciting public comments on or before July 29, 2024. The proposed rule will add a new DFARS part 270, Defense Contracting Programs, including subpart 270.X, Pilot Program to Incentivize Contracting with Employee-Owned Businesses. Subpart 270.X will provide the scope, definition, policy, limitations, procedures, solicitation provisions, and contract clause associated with the pilot program.

What are the Details?

A contracting officer will be allowed "to award one sole-source, follow-on contract for the continued development, production, or provision of products or services that are the same or substantially similar to those procured under previous contracts awarded by or for DoD to contractors that meet the definition of a qualified business." (Emphasis added) Congress set this single follow-on contract limitation in the 2022 NDAA Section 874 (b)(3). This limitation is on a program basis, not a contractor basis. So, a contractor with two different programs could get a non-competitive follow-on contract under each program – allowing the contractor to get two non-competitive follow-on contracts.

The contracting officer will still be required to complete a written justification and approval required by FAR 6.303 and FAR 6.304. Sometimes, you just have to love the thinking of the rule makers – never give up an opportunity to require the creation of a useless document.

The contractor must also be a "qualified business." The rule will define a qualified business as "An S corporation as defined in 26 U.S.C. 1361(a)(1) for which 100 percent of the outstanding stock is held through an employee stock ownership plan as defined in 26 U.S.C. 4975(e)(7).

What are the Limitations?

  • Only a contracting officer may submit an application to participate in the pilot program;
  • Contracting officers may only award contracts to contractors that meet the definition of a qualified business;
  • Contracting officers may only award one sole-source, follow-on contract to a qualified business for each predecessor contract unless a waiver is obtained; and
  • Unless waived, a qualified business shall not pay more than 50 percent of the amount paid by the Government for contract performance to subcontractors that are not qualified businesses, except when the contract is for a product and subcontracts for materials are not available from another qualified business.

What are the Reporting Requirements?

Within 30 days after the completion of the follow-on contract, the contractor will be required to submit the following information in writing to the contracting officer:

  • The number of years the contractor has been wholly-owned by its employee stock ownership plan;
  • Challenges the contractor experienced in attracting and retaining a talented workforce in a competitive market;
  • Challenges the contractor experienced that hinder its ability to contract with DoD to scale its technologies and capabilities due to the contractor's corporate ownership structure; and
  • Challenges the contractor experienced due to its corporate ownership structure in obtaining the capital necessary to bridge funding gaps, for example, between prototype demonstration and full-scale development.

While the 2022 NDAA did require some analysis and reporting to the Comptroller General by DoD, I am not sure how these reporting requirements related to challenges of the contractor tie to the 2022 NDAA Section 874 (f)(D) intent to find "[a]cquisition authorities that could incentivize businesses to become qualified businesses wholly-owned through an Employee Stock Ownership Plan."

Did you really think it was all going to be good news?

Does the Pilot include Simplified Acquisition Threshold (SAT) and Commercial Contracts?

The pilot will not be extended to contracts below the SAT threshold.

After extensive discussion about whether the law at 10 U.S.C. 3452 exempts contracts and subcontracts for the acquisition of commercial products, including COTS items and commercial services, the Principal Director of Defense Pricing and Contracting determined that commercial should be included in the pilot.

My Take

Reading between the lines, it appears to me that the DoD is not truly supportive of Congress's initiative to increase the number of defense contractors moving to ESOPs. As I see it, there is no need for the contracting officer to draft a justification and approval – the pilot has already addressed that. Additionally, the contracting officer still has to support a fair and reasonable price (yes, even in a non-competitive award), so the risk to DoD has been addressed by existing requirements in FAR part 15. I also see no need for the reporting requirements being placed on the contractor.

If you see it the way I do, or for that matter, you see anything that DoD should consider changing – now is the time to make your voices heard through the public comments process.

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Written by John C. Shire, CPA

John C. Shire, CPA John is a Director with Redstone Government Consulting, Inc. providing government contract consulting services to our clients primarily related to the DFARS business systems, CAS Disclosure Statements, and DCAA/DCMA compliance preparation, advisory, and defense. Prior to joining Redstone Government Consulting, John served in a number of capacities with DCAA/DCMA for more than 30 years. Upon his retirement, he was based in Texas as an SES-level Corporate Audit Director for DCAA, managing a staff of 300 auditors at one of the largest DOD programs. Professional Experience John began his career in the late 80s working in the Clearwater, FL audit office and over the next three decades he progressed through a number of positions within both DCAA and DCMA with career highlights as DCAA Program Manager at Ft. Belvoir, Chief of Technical Programs Division, Deputy Assistant Director-Policy, Director of the DCMA Cost and Pricing Center, the SES-level Lockheed Martin Corporate Audit Director, and Director of Integrity and Quality Assurance. John’s three decades of experience in performing and leading DCAA auditors and DCMA reviewers provides a wealth of expertise to our clients. John’s role, not only in the performance of audits, but also in the development of audit policy affords him unique insights into the defense of audit findings and the linkage of audit program steps to the underlying regulatory framework. He is an expert in FAR, DFARS, and other agency acquisition regulation, as well as a subject matter expert in the Cost Accounting Standards having reviewed and provided audit feedback on many of the largest and most complex cost accounting practices during his tenure with the DCAA. John’s tenure with DCAA and DCMA came at a critical time during each agency’s history where a number of changes were occurring such as the response to the ICS backlog, development of audit approaches to the DFARS Business Systems and implementation of new audit initiatives as a result of Congressional oversight through the NDAA process. John’s leadership at the DCMA Cost & Pricing center saw oversight of all major DOD pricing actions, leadership of should cost review teams, the Commercial Pricing group and many other areas of strategic value to our clients. His involvement in these and other Agency initiatives is of great value to our clients due to his in depth understanding of DCAA and DCMA’s internal policy directives. Education John holds a Master of Business Administration and a B.A. in Accounting from the University of South Florida. Certifications Certified Information Systems Auditor State of Alabama Certified Public Accountant

About Redstone GCI

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Topics: Compliant Accounting Infrastructure, Employee & Contractor Compensation, Contracts & Subcontracts Administration, Government Regulations, Federal Acquisition Regulation (FAR)