President Obama issued a memorandum in late January directing the Internal Revenue Service (IRS) and Office of Management and Budget (OMB) to take steps to enforce existing tax delinquency laws against government contractors. (75 Fed. Reg. 3979). The memorandum directs the IRS to review non-delinquency certifications and report within 90 days on the overall accuracy of contractors’ certifications. The memorandum further directs OMB to work with the Treasury Department and other agencies to review the current practices of contracting officers and debarring officials to ensure that delinquent contractors do not receive additional government contracts, as well as generate a government-wide database of contractor certifications.

The president’s memorandum is the most recent step in a general tightening of enforcement of federal tax laws against government contractors. This heightened enforcement also raises concerns for financial institutions lending to government contractors.

Current FAR Tax Non-Delinquency Certification

While he was a senator, President Obama authored language in the 2008 appropriations bills that resulted in additional contractor certification requirements being added to the Federal Acquisition Regulation (FAR) regarding the contractors’ federal tax status.

Both the stand-alone Certification Regarding Responsibility Matters clause (FAR § 52.209-5) and the Offeror Representations and Certifications—Commercial Items clause (FAR § 52.212-3) require a government contractor making an offer to the federal government to certify “to the best of its knowledge and belief, that the Offeror and/or any of its Principals . . . (D) Have [], have not [], within a three-year period preceding this offer, been notified of any delinquent Federal taxes in an amount that exceeds $3,000 for which the liability remains unsatisfied.”

To be considered delinquent, (1) the tax liability must be finally determined; and (2) the taxpayer must be delinquent in making payment. (FAR §§ 52.209-5, 52.212-3). The provision then further defines both of these tests and provide examples.

Federal tax delinquency of a principal of a government contractor may also trigger delinquency with respect to the contracting entity. For purposes of the certification, a “principal” includes “an officer, director, owner, partner, or person having primary management or supervisory responsibilities within a business entity (e.g., general manager; plant manager; head of a subsidiary, division, or business segment; and similar positions).” (FAR § 52.209-5(a)(2)). The result is that an S corporation or limited liability company, which usually would not incur federal tax liability at the entity level, may still run afoul of this certification based on the tax delinquency of its principals.

Broader Implications for Financial Institutions

The verification of tax non-delinquency certifications does not directly affect the interests of lenders. However, this general trend of increased scrutiny and enforcement of government contractor tax liability could result in additional application of tax setoffs against government receivables used to secure loans to government contractors. There are two clauses providing for the assignment of payments from the government to financial institutions, in conformity with the Assignment of Claims Act, as amended (31 U.S.C. § 3727, 41 U.S.C. § 15). The first, the Contract Terms and Conditions—Commercial Items clause (FAR § 52.212-4), provides various terms and conditions that apply to commercial items contracts, including a clause providing for assignment of claims to lenders. The second, the Assignment of Claims clause (FAR § 52.232-23), is used in other contracts. This second clause also provides an alternative version, which allows for “no-setoff” language to be included. Both the Commercial Items clause and the standalone Assignment of Claims clause, without Alternative I selected, allow the government to take setoffs and reductions against amounts due under an assignment which decrease the value of a lender’s security.

Based on the government’s increased enforcement, financial institutions must be even more vigilant in obtaining counsel to review contractual documents before entering into an assignment.