As we see the new Administration begin to lay out more information regarding budget reform, the nonprofit world, like every other market, is beginning to navigate the new budgetary demands, and, in some cases, is merging entities to leverage resources. Such an approach may have the added benefit of reducing a nonprofit's indirect rates by increasing their total programmatic dollar spend, but if this approach is one you are contemplating, there are several critical aspects that must be considered. This month's newsletter dives into these topics and provides an update on some important developments out of the U.S. Office of Management and Budget.

Key Considerations for Nonprofits Looking to Acquire or Reduce Federal Awards

The first half of 2017 has seen a noticeable pickup in nonprofit mergers and acquisitions, including of nonprofits that are government contractors or grantees. As the volume of these transactions increases, so does the importance of anticipating and addressing merger and acquisition strategy. While each deal requires customized considerations, we highlight several key elements that are often practically significant in the merger or acquisition of a nonprofit contractor or grantee.

The Big Picture and Deal Terms. Preliminary acquisition discussions tend to focus on strategic fit, compatibility of organizational cultures, and various elements of the combination that would create value for both sides. However, the precise deal terms of any transaction are crucial. While discovering potential long-term synergies in the abstract is exciting, it is common for prospective partners to have different views on the post-transaction structure in practice, which can make it difficult to nail down a definitive agreement. The parties must be candid and realistic, not only about opportunities, but also about growing pains. One common way to bridge the gap is to affirmatively engage a committee of stakeholders from each organization who can take ownership of the transaction on behalf of each party. The more clarity and specificity that is brought to the process prior to finalization of the transaction documents, the better the chance for a successful transaction and long-term transition rather than a short-lived marriage.

Conduct Thorough Due Diligence. Once an appropriate non-disclosure agreement is in place after early talks, diligent data gathering and thorough analysis on multiple issues are critical to assessing the full range of operations, assets, and liabilities that may be assumed in connection with a proposed transaction. In order to fulfill their fiduciary duties, directors of nonprofit organizations must be reasonably informed of the assets, operations, and liabilities that will be assumed in connection with a merger or acquisition. However, fulfillment of this duty does not require individual directors to review each diligence document. It is permissible for board members to rely on information and guidance provided by legal counsel and other professionals when obtaining and analyzing such information. That said, directors should be diligent and vigilant in examining and thoroughly discussing material issues.

Assignment and Novation. Federal contracts and grants are typically transferable to a third party only with government consent; however, each is addressed quite differently by the federal government. Federal contracts are subject to the procedures set forth at Subpart 42.12 of Federal Acquisition Regulation (FAR) (48 C.F.R. Subpart 42.12) (note: under the FAR, stock deals do not normally require formal consent), whereas the Uniform Guidance is silent on the assignment of federal grants and cooperative agreements. As a result, regarding the latter, grant recipients should closely review the terms of their grant for specific requirements. Similarly, most commercial contracts contain anti-assignment or change of control clauses, which give each party certain rights, such as approval or a right of termination in the event the other party to the agreement undergoes a change in ownership or management. In our experience, as long as the other party to the agreement receives and will continue to receive its goods or services, it typically will not be motivated to object to the assignment or terminate the agreement. However, the formal novation or assignment process can take a considerable amount of time, and in the case of the federal government, it is only done post-transaction. As a consequence, to the extent that key contracts require consents for a change of control transaction, those consents should be identified early, and a plan should be put in place for obtaining those consents, as well as performance during the pendency of such approval.

Beware of Conflicts of Interest. Mergers and acquisitions of a government contractor or grantee may generate new organizational conflicts of interest that can drastically impair the acquiring nonprofit's receipt of future awards or threaten its existing grants or contracts. Aside from individual conflicts of interest that may arise for directors because of simultaneous board service or outside interests, certain laws prohibit the federal government from awarding a grant or contract to an organization with organizational conflicts of interest. These are conflicts that arise as a result of the organization's current or previous work with the federal government. For FAR-based contracts, organizational conflicts of interest are governed by FAR Part 9.5. The Uniform Guidance makes organizational conflicts of interest relevant to grants in 2 CFR § 200.318. For example, an organization that provided guidance to the agency on how to set up a particular study cannot then be awarded that work as part of an effective mitigation plan. Thus, any novation or assignment would need to include information related to potential conflicts of interest that would affect any pending or existing awards. Failure to provide such notice could result in significant liability under the federal False Claims Act. For that reason, it critical for the parties to identify and evaluate potential organizational conflicts of interest which may result from a merger or acquisition – because of either the activities of individual directors and officers or the activities of the target, the acquirer, and their affiliates – as early in diligence as possible, and implement a mitigation plan if needed. For additional information on organizational conflicts of interest, please review our previous publications on the subject.

Preparing for Closing Matters. As the ink dries on the transaction documents, the parties must turn to integration planning for the combined organizations and satisfaction of closing conditions. Typical closing obligations include regulatory filings or amendments to governing documents, obtaining third-party consents, notifying key business partners, amending or terminating contracts, and coordinating press releases. Beware that closing a transaction in the government contracting space attaches a number of additional and unique regulatory strings. As closing obligations include many administrative and operational tasks, the parties should anticipate potential delays. Although closing is a critical milestone, it is crucial to be well prepared to overcome and navigate the potential pitfalls of this transition period.

OMB Issues Guidance Aimed at Reducing Agency Burden, Including Grant-Related Requirements for Federal Agencies

On June 15, 2017, Mick Mulvaney, the Director at the U.S. Office of Management and Budget (OMB), issued a memorandum to all heads of Executive departments and agencies titled "Reducing Burden for Federal Agencies by Rescinding and Modifying OMB Memoranda." This memorandum is the "first phase" of an extensive review process, whereby OMB will identify low-value, duplicative, and obsolete activities that can be eliminated. "Through this Memorandum, OMB begins providing relief to agencies by rolling back these requirements and allowing … [agencies to] manage operations, adopt best practices, and find the best way possible to reduce costs and minimize staff hours responding to duplicative and burdensome reporting requirements."

With respect to federal grants and cooperative agreements for nonprofits, this memorandum eliminates:

  1. Agency requirements to report the metrics measuring the impact of the Uniform Guidance as instructed by OMB Memorandum M-14-17; and
  2. The mandate that agencies prepare for an expanded Catalog of Federal Domestic Assistance numbering schematic, as informed by OMB's Controller Alert of December 2016.

While the elimination of these requirements may well prove beneficial as it frees up agency resources from such tasks, the memorandum also disbands the Council on Financial Assistance Reform (COFAR), an interagency group of Executive Branch officials that was established by OMB Memorandum M-12-01. COFAR was one of the principal organizations for developing and rolling out the Uniform Guidance. "Moving forward, financial assistance priorities will be considered by the Chief Financial Officers Council (CFOC), consistent with the goal of involving a broader community of grant-making agencies to participate in developing priorities for reforming federal grants management." It is unclear at this time how the CFOC will handle these additional tasks.