Defense Contractors Face New Scrutiny Under the Trump Administration

The White House on January 7, 2026, issued an executive order (EO) titled "Prioritizing the Warfighter in Defense Contracting," which aims to accelerate defense procurement and enhance the defense industrial base by shifting contractor priorities from investor returns to production and performance, including by limiting stock buybacks, dividends and executive compensation. This Holland & Knight alert breaks down the EO, as well as potential implications for industry.

Core Policy and Prohibitions

According to the EO, some contractors have prioritized "newer, more lucrative contracts, stock buy-backs, and excessive dividends" while underperforming on existing contracts or investing in increased capacity and innovation.

In response, the EO provides that the stated policy of the U.S. government is to revitalize the defense industrial base to "maintain peace through strength." To achieve this, the EO establishes a new policy preventing major defense contractors from conducting stock buybacks or issuing dividends if doing so comes at the expense of accelerated procurement and increased production capacity. The EO states that, "[e]ffective immediately" contractors who fail to remedy government-identified deficiencies are not permitted to pay dividends or buy back stock until they can deliver a "superior product, on time and on budget."

Contractor Review and Identification Process

The EO establishes a formal review process led by the U.S. Department of War (DOW) secretary (the Secretary) to identify and address contractor performance issues.

Coverage, Timeline and Scope

Within 30 days of the order, and on an ongoing basis, the Secretary is directed to identify defense contractors for critical weapons and supplies that are underperforming.

In terms of which contractors are subject of the EO, the EO mentions "large contractors" and "major defense contractors," but neither of those terms is defined. Further, Section 3 of the EO mentions contractors that provide "critical weapons, supplies, and equipment," which potentially limits coverage and may exclude contractors providing services, for example. Moreover, the proposed remedies related to stock buybacks and dividends suggest that coverage may be limited to publicly traded companies, but the EO is not entirely clear in this regard.

Criteria for Identification

A contractor may be identified if it is found to be:

• underperforming on its contracts
• not investing its own capital into necessary production capacity
• not sufficiently prioritizing U.S. government contracts, or
• demonstrating insufficient production speed as determined by the Secretary

Importantly, a critical component for this "identification" is that the contractor must have also engaged in stock buybacks or other corporate distributions during this period of underperformance.

Notification and Remediation

Once identified, a contractor will receive a notice describing the deficiencies. The contractor then has a 15-day period to submit a board-approved remediation plan for the Secretary's review. Contractors that have already been reviewed by the Secretary for these issues may not require an additional review.

Enforcement and Announced Future Contractual Mandates

The EO grants the Secretary several enforcement powers in the event that a contractor's submitted remediation plan is deemed insufficient. When deciding whether to initiate these actions, the Secretary is directed to take into account the contractor's financial condition, economic viability of the programs in question and potential mutual benefits from sustained government growth opportunities paired with contractor capital investments.

Direct Statutory and Regulatory Enforcement

The EO announces that the Secretary may use available enforcement actions under the Defense Production Act (50 U.S.C. 4501 et seq.), as well as contract enforcement mechanisms found within the Federal Acquisition Regulation (FAR) and Defense Federal Acquisition Regulation Supplement (DFARS). The EO does not reference specific FAR or DFARS clauses and instead refers to these regulations generally. Industry should anticipate forthcoming DFARS and FAR deviations to implement.

Voluntary Agreements

The EO notes that the Secretary can also secure remedies through a voluntary agreement with the contractor.

Impact on Foreign Sales

Additionally, the Secretary is directed to consider ceasing ongoing advocacy or denying new advocacy for an underperforming contractor's efforts to secure international Foreign Military or Direct Commercial Sales (in consultation with the secretaries of the U.S. Departments of State and Commerce).

The EO further directs the chairman of the U.S. Securities and Exchange Commission (SEC) to consider adopting amended regulations that would prohibit an underperforming defense contractor from using the "safe harbor" provisions of Rule 10b-18 for stock buyback.

Mandatory Clauses in Future Contracts

Within 60 days of the order, the Secretary is required to take steps to include new provisions in all future defense contracts, including renewals. The EO provides that these clauses will:

• prohibit any stock buybacks and corporate distributions during a period of underperformance, noncompliance or insufficient investment, as determined by the Secretary.
• link executive incentive compensation to performance metrics such as on-time delivery and increased production, rather than short-term financial metrics driven by stock buybacks
• allow the Secretary to cap executive base salaries at current levels (with adjustments for inflation) for underperforming contractors for a period sufficient to ensure incentive pay is properly aligned with performance metrics

Key Takeaways for the Defense Industry

The EO signals a potentially significant shift in the government's expectations for the defense industrial base. The focus is moving away from rewarding short-term financial metrics and toward mandating production, performance and internal investment. Contractors should prepare for a new era of heightened scrutiny and government influence over corporate decision-making. Below are a few critical takeaways for the industry.

• Performance Metrics Supersede Shareholder Returns: The core policy of the EO is to stop contractors from prioritizing stock buybacks and dividends at the expense of production capacity and on-time delivery. The administration's stated view is that though contractors are entitled to profit, that right is secondary to the responsibility of equipping the military. Contractors must now consider a reevaluation of their capital allocation strategies to align with these new priorities.
• Capital Distributions as Contingent on Performance: The EO creates a direct link between performance and a company's ability to conduct stock buybacks or issue dividends. An "underperformance" designation by the Secretary could trigger an immediate prohibition on these activities until the contractor can prove it is delivering a "superior product, on time and on budget."
• A New and Subjective Review Process: The Secretary is tasked with identifying underperforming "major" contractors on an ongoing basis. It remains unclear which defense contractors will qualify as "major" or how such a determination will be reached. Further, the metrics to be used for this designation are undefined and subjective – including "insufficient production speed" or "not sufficiently prioritizing" government contracts, as determined by the Secretary. Once identified, contractors have only 15 days to submit a board-approved remediation plan, creating a very short window to respond to government concerns.
• Future Contracts Will Include New Restrictive Clauses: Within 60 days, the Secretary must begin incorporating new mandatory clauses into all future defense contracts and renewals. These clauses will:
• formalize the prohibition on stock buybacks and dividends during periods of underperformance
• mandate that executive incentive pay be tied to operational performance metrics such as on-time delivery and increased production, rather than financial metrics driven by buybacks – although not specified in the text of the EO, on January 7, 2025, President Donald Trump posted on social media that "no Executive should be allowed to make in excess of $5 Million Dollars" unless their companies invest in additional production capacity
• grant the Secretary the authority to cap executive base salaries for underperforming contractors
• Consequences Extend Beyond Contract Performance: The penalties for an underperformance designation are not limited to contract enforcement. The Secretary can recommend ceasing advocacy for a contractor's Foreign Military Sales (FMS) or Direct Commercial Sales (DCS). Furthermore, the EO directs the SEC to consider rule changes that would prevent underperforming contractors from using the Rule 10b-18 "safe harbor" for stock buybacks. In addition, the Defense Production Act could be used to further increase pressure on defense contractors, including prioritization of certain DOW contracts related to commercial and non-DOW contracts.
• Proactive Self-Assessment Is Essential: Given the subjective nature of the review criteria and speed of the remediation timeline, contractors should not wait to be identified. It is critical for companies to proactively assess their contract performance, production capacity, internal investment plans and executive compensation structures to ensure they align with the order's directives and prepare for potential scrutiny.
• Impact on the Supply Chain and Lower-Tier Subcontractors: Contracts for "critical weapons, supplies, and equipment," which are the focus of the EO, often involve substantial and complex supply chain issues, as well as multilayered subcontracting arrangements. Contractors, subcontractors, suppliers and vendors should expect the production pressures to flow down through the supply chain and subcontracting tiers, with primes and higher-tier subcontractors potentially making greater demands and increasing enforcement of agreement terms. This will likely lead to stricter deal terms in sub-agreements and heightened enforcement of deal terms in those agreements.

Conclusion

This EO represents a significant shift in the relationship between the government and defense industrial base. It moves beyond traditional performance oversight and into direct intervention in corporate governance, capital allocation and executive compensation. The speed, subjectivity and severity of the new regime require immediate attention from every defense contractor. As the landscape of compliance and government expectations is being reshaped, navigating these changes will be critical.

For guidance on how this EO may impact your specific operations and to develop a proactive strategy, please reach out to the authors.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.