Federal Securities Law Considerations for Public Company Government Contractors After a Federal Government Shutdown
We’ve seen it before. Our team is out of time outs. There’s very little time left on the clock, and, absent a miraculous play, the home team is going down in defeat.
That’s where the nation was on April 8, 2011. Many went home late that Friday night fully expecting to wake up Saturday morning to the first federal government shutdown since 1996 and wondering what would happen next. We all know what happened. Very late that evening – at literally the 11th hour – congressional leaders and the Obama Administration forged an agreement that prevented a federal government shutdown.
In March 2011, many government contractors were preparing their businesses, employees, subcontractors and team members for the looming shutdown. Even though the nation has a budget for fiscal year 2011, that doesn’t mean that government contractors can put those contingency plans away until next September. The reality is that we may face another shutdown sooner than expected.
May 16, 2011, came and went without much fanfare, but it was nonetheless an important day. The Treasury issued about $72 billion in securities that day which would have eclipsed the federal debt ceiling – a statutorily imposed maximum amount the government may borrow at any one time – absent some maneuvers by the Treasury to suspend certain federal retirement fund payments to use that money to finance the nation’s general obligations.
Trick plays sometimes work, but Administration officials will have exhausted their play book by the time the clock expires on August 2, 2011, which is when Treasury Department officials believe they no longer can suspend those payments. Absent an agreement to raise the federal debt ceiling by then, the United States would begin to default on its interest payments for the first time in our nation’s history. The consequences could include an initial slow down in payments to federal government contractors. Delayed payments to government contractors could expose the government to interest charges under the Prompt Payment Act or other statutes. Government agencies may then need to refrain from making new contract awards or ordering additional work under existing contracts and, at some point, the government may need to terminate or significantly downsize some of its existing contracts. A slow trickle eventually could lead to turning the faucet off completely, and the nation could again face a government shutdown – even during a budget year.
In light of another looming federal government shutdown, public company government contractors need to examine their businesses and their disclosure and consider whether, and to what extent, they need to include disclosure about a government shutdown in filings they make with the Securities and Exchange Commission (SEC). Reporting companies should consider whether (i) as a result of a shutdown they should file new disclosure in order to correct material misstatements or to make what they said not misleading, and (ii) the government shutdown will trigger any new disclosure required by federal securities law.
In Many Cases No Immediate Action Required
The good news is that for most public company government contractors, news of the shutdown won’t surprise investors, and most public companies should not have to file a Form 8-K or issue a press release the next morning just because of a shutdown. However, the consequences of the government shutdown could cause public company government contractors to file a Form 8-K if the shutdown indirectly leads to a Form 8-K triggering event. Also, any public company government contractors in registration (meaning in the process of having the SEC declare effective a previously filed registration statement) and any other government contractors who are about to file a registration statement or initiate a private placement of securities should carefully examine the disclosure in their registration statement or private placement offering memorandum to ensure that it meets the 10(b)-5 standard in light of the shutdown. This means that it must lack any material misstatements of fact and that it does not fail to disclosure anything needed to make what is disclosed elsewhere in the offering material not misleading in light of the shutdown.
Updating Prior Statements
Public company government contractors generally do not have to update prior statements just because an investor would want to know of a changed circumstance. However, public company government contractors need to consider whether subsequent events, such as a government shutdown, render misleading a prior statement made to the investing public.
A public company government contractor has a duty to update:
- a prior forward-looking statement that
- lacked an accompanying cautionary statement about a specific risk (boilerplate forward-looking statement cautionary text will not suffice) which has come to pass, and
- was likely to remain alive in the minds of reasonable investors.
A public company government contractor should of course review its prior SEC filings to see whether any of its prior forward-looking statements lacked specific risk disclosure and were of a type likely to remain “alive” in the minds of reasonable investors. Public company government contractors should also review the transcripts of prior investor conference calls because these prior statements are not confined to filings with the SEC. A public company government contractor in Illinois State Bd. of Inv. v. Authentidate Holding Corp., 2010 WL 889294 (2nd Cir. Mar. 12, 2010) learned the hard way that it should have updated an investor conference call statement that “we hope to have an amendment to our original agreement within the next few weeks” when the amendment to that particular material agreement with the United States Postal Service never came. A Form 8-K making a simple Reg. FD disclosure of the failure to amend the government contract could have averted litigation.
There are other occasions when public company government contractors should review prior statements including if they have a shelf registration statement on file, if they are in the midst of an offering which hasn’t closed, if they know that investors will rely on prior filings such as prior Exchange Act reports when making an investment decision in a private placement and if prior disclosure otherwise fails the 10(b)-5 standard. Also, in light of the Supreme Court’s recent decision in Matrixx Initiatives, Inc. v. Siracusano, No. 09-1156, 2011 WL 977060, slip op. at 1 (Mar. 22, 2011), public company government contractors may want to ensure that the total mix of information about the shutdown, which some investors could deem a material adverse event, is sufficient to disclose to investors the risks inherent in investing in public company government contractors even if the company hasn’t made a prior statement which the shutdown might affect.
Focus on Backlog, Liquidity and Risk Factors in Prior Disclosure and MD&A Generally for Prospective Disclosure
Backlog. Public company government contractors should clearly distinguish between funded and unfunded backlog. Termination for convenience and the annual federal budget process, among many other things, distinguishes government contracts from typical commercial contracts and makes investing in government contractors different than investing in purely commercial enterprises. Investors want to project future revenue and earnings, and investors analyze long-term contracts when modeling revenue and earnings, but investors in government contractors need to understand that a five-year contract does not guarantee a five-year revenue stream, and public company government contractors should distinguish their funded and unfunded backlog and explain to investors how backlog becomes funded over time. Doing so will provide investors with a better sense of the degree to which revenue from federal customers is contingent.
- Liquidity. As the August 2, 2011 debt ceiling deadline approaches, public company government contractors may plan for a significant decrease in cash flow and the consequential effect it may have on overall liquidity in the event of a government shutdown. Public company government contractors may have access to forms of liquidity other than cash from operations such as a line of credit. In some cases, government contractors will have sufficient borrowing capacity to carry them through the shutdown depending on how long it lasts. In response to the liquidity crisis in 2009, through its review and comment of annual reports on Form 10-K, the SEC has asked an increasing number of registrants to disclose whether the company believes it has sufficient liquidity for a given time period, typically through the end of its next fiscal year. If a public company government contractor believes that absent payment from government customers, its liquidity will decrease materially, then the company should examine its prior disclosure concerning liquidity. If the company has given comfort on liquidity as the SEC has requested of a number of registrants, then the company may need to temper that comfort, and if the company has not affirmatively disclosed whether it believes it has sufficient liquidity, and if the loss of liquidity is material, disclosure may be required in order to make the total mix of information available to investors not misleading.
- Risk Factors. There are risks inherent in investing in government contractors not present with purely commercial enterprises. Public company government contractors should ensure that their risk factors warn investors that the spending and mission priorities of the federal government may change and that the failure of Congress to approve a budget could both delay the company’s opportunity to provide contracted services and the company’s ability to collect on services already performed, both leading to a loss in future revenue. In addition, for many services-based government contractors, some of their most valuable assets walk out the door each evening. Services-based registrants should consider a risk factor disclosing that furloughs and other employment maneuvers could cause critical employees to seek employment elsewhere. Companies that may have already disclosed these risks generally should ensure that their risk factors in their next filing are sufficiently tailored to disclose these risks specifically.
- Management’s Discussion and Analysis. With respect to accounting periods after a shutdown, public company government contractors need to begin to think now about whether the shutdown will create an uncertainty reasonably likely to result in the company’s liquidity decreasing or an uncertainty that the company reasonably expects will have a material unfavorable impact on revenue or income from continuing operations. Regulation S-K requires registrants to provide a narrative description of these kinds of uncertainties in their MD&A, and it is certainly possible for many public company government contractors – especially for those not providing essential services or those who have already received progress payments – that a shutdown will create exactly this type of uncertainty.
Would a Shutdown Trigger Any Current Disclosure Requirements?
While it would appear that, in many cases, a public company government contractor should not need to file a Current Report on Form 8-K solely as a result of a shutdown, public company government contractors should nevertheless consider whether any of the triggering events of Form 8-K apply as a consequence of a shutdown. Because application of the triggering events will depend on the terms of a company’s actual contract with the government, each company’s situation is unique and may differ from the general trends. As a result, public company government contractors should examine their contracts to see if they contain terms which could trigger a filing requirement based on the items below.
- Amendment to a Material Agreement. While a government contract may not automatically be amended as a result of the government shutdown, the government could issue a formal stop work order to the contractor. Although not common, the government could do this in the form of a formal contract modification or letter which could be considered an “amendment” to the original agreement. If this is the case, and if the agreement is material to the public company government contractor, the company would be required to disclose this amendment on Form 8-K within four business days.
- Termination of a Material Agreement. Depending on the length of the government shutdown, the federal government may, but is not required to, terminate a contract once funding expires. Alternatively, if a government contractor requests a termination upon the expiration of funding, the federal government must grant the request. If a material contract has been terminated in either case, the public company government contractor would be required to disclose the termination in its Form 8-K within four business days.
- Triggering Events Leading to Acceleration. Many public company government contractors carry bank or other debt which may contain financial covenants based on EBITDA or other earnings metrics. Undoubtedly, public company treasuries should carefully analyze their projected financial covenant compliance in light of a shutdown. The good news is that projected covenant non-compliance is not a trigger for the filing of a Form 8-K. Moreover, in some cases actual non-compliance and even a default itself are not triggering events. However, if the credit agreement or indenture increases interest payments as a result of non-compliance, and that increase is material, or if the lenders actually accelerate the debt after default, then the filing of a Form 8-K is required.
- Material Impairments. It is possible that a government shutdown could materially impair the carrying value of a registrant’s subsidiary. If a public company government contractor has a subsidiary carried on its balance sheet, it should consider whether the shutdown impairs its value. If the board, a committee of the board or an authorized officer concludes that a material change for impairment is required to the balance sheet, the company would need to disclose this on a Form 8-K when it made that conclusion. It would then need to disclose a description of the impaired asset (the affected subsidiary), an estimate of the range of impairment and an estimated range of future cash expenditures which might be necessary as a result of the impairment.
When Would a Public Company Government Contractor Make Corrective or Other Disclosure?
Absent a triggering event for the filing of a Form 8-K, public company government contractors should consider making the appropriate disclosure in their next quarterly report or annual report if due prior to their next quarterly report. A public company may want to disclose information concerning the effect of a shutdown on it prior to the time for filing the next required quarterly or annual report if, for example, officers of the company were about to meet with existing shareholders or bondholders. Compliance with Regulation FD could require the filing of a Form 8-K to disclose that information to other investors not present at such a meeting. A company may also want to disclose voluntarily on Form 8-K certain information it feels might be helpful to avoid threatened litigation.
During a shutdown, public company government contractors should not expect their ongoing communications with the SEC to proceed at a customary pace. Many SEC employees could be furloughed. Undoubtedly, this would slow the closing of offerings then in registration.