The health of the Defense Industrial Base (DIB) has been brought to the fore as the United States responds to wars in Ukraine and Israel. Unfortunately, according to the National Defense Industrial Association's "Vital Signs" report, the U.S. DIB faces numerous challenges due to limited capacity to surge production, political obstacles to defense budgeting, and labor challenges.
Recently, the Government Accountability Office (GAO) has been active in assessing the health of the DIB and recommending policy tweaks to support it.
This month, the Government Watchdog found that the Department of Defense (DoD) lacks the necessary insight into the defense industry's mergers and acquisitions, impairing its ability to understand how consolidation affects the DIB. Notably, the report found that the DoD does little to monitor the effects of completed mergers & acquisitions (M&A) transactions on the DIB, there is inadequate coordination between antitrust agencies in the DoD when reviewing proposed transactions, and the DoD lacks the same information that antitrust officials have access to when completing their assessment.
To cure the problems identified, GAO recommends that the Secretary of Defense ensures the DoD does the following:
- Provide clear direction on which major defense suppliers should be prioritized for conducting M&A assessments.
- Assess whether its M&A office has sufficient resources to carry out its mission.
- Provide the Office of Industrial Base Policy with additional instructions on assessing the risks and benefits identified in DoD's M&A policy when developing new DoD guidance.
- Revise the Department's M&A policy to direct the Office of Industrial Base Policy to continually monitor for transactions that impact the DIB.
While the GAO's recommendations are in no way binding, the report does put a spotlight on a lack of oversight of the risks associated with the consolidation of DoD contractors. This comes as the Biden administration has ramped up antitrust scrutiny—albeit somewhat unsuccessfully—of proposed M&A, and a February 2022 DoD report highlighted the national security risks associated with contractor consolidation. With increased antitrust scrutiny of government contractor activities likely, it is incumbent upon contractors to take steps to reduce the likelihood of adverse actions.
Teaming Agreements
If antitrust officials want to bring enforcement actions against government contractors, teaming agreements could be a key area of concentration. These arrangements allow two or more contractors to enter into agreements allocating workshare under specific contracts. They can offer enormous efficiencies and competitive advantages to a bidder; however, without a well-crafted agreement, they can represent vectors of antitrust risk.
Teaming agreements can pose risks as they generally require contractors to commit to not submit bids independently or with another party. In addition, concerns especially mount when two leading bidders join forces or the agreement locks up a critical technology or capability, presenting vertical foreclosure concerns. To protect against bid rigging or anticompetitive enforcement actions, a contractor should clearly demonstrate the complementary skills bidders will combine for the benefit of the customer. Also, contractors should combine resources and activities to drive efficiencies. This will further evidence that the agreement is not simply an agreement not to compete—restraining competition—but a lawful pairing of contractor capabilities to better serve the government's needs. Lastly, while there is no mandatory notification for teaming agreements, in some circumstances where the agreements raise significant concerns, it may make sense to discuss with the Department of Justice's (DOJ) Antitrust Division or Federal Trade Commission before the agreement's implementation.
The Committee on Foreign Investment in the United States
In September 2023, at the Department of Treasury's Second Annual Committee on Foreign Investment in the United States (CFIUS) Conference, Assistant Secretary for Investment Security at the Department of Treasury, Paul Rosen, stressed a "renew[ed] [] focus on compliance and ensuring we have the resources to do so." He continued, "[t]his means parties can expect more compliance checks, questions, and site-visits." This renewed emphasis on compliance will include adding resources to detect and bring enforcement actions for non-notified transactions—those deals that didn't notify CFIUS of the transaction, however, should have—and enhanced oversight of compliance with mitigation agreements.
Given the current regulatory environment, M&A activity among DIB contractors will likely garner considerable attention from CFIUS. Contractors should ensure they understand their obligations under CFIUS when considering acquisition opportunities and following closing in the event certain mitigation agreements are agreed to. In addition, companies who have already completed transactions but inappropriately failed to notify CFIUS should prepare for compliance with potential future obligations.
Conclusion
Due to ongoing conflicts in Europe and the Middle East, an emerging concern over the health of the U.S. DIB, and the current posture of Biden administration antitrust officials, it is likely antitrust scrutiny of government contractor consolidation and M&A activities will increase. Contractors, strategic acquirers, and private equity investors should be aware of this increased scrutiny and be proactive when dealing with inquiries from DoD or DOJ on contractor consolidation or M&A activity.
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