Piliero Mazza &
Pargament, PLLC

Vol. IV, Issue 5
July-August 1999

An Update for Federal Contractors and Commercial Businesses


Proposes Linking
Contract Awards to
Labor Law Compliance

Congress Passes Bill
to Limit Y2K Liability

Businesses Should
Be Aware of

"Preemptive Rights"
When Offering Stock

Exclusive Teaming
Arrangements May
Be Scrutinized by
DCAA and DoD for
Anticompetitive Effects



Administration Proposes Linking
Contract Awards to Labor Law Compliance

On July 9, 1999, the Clinton Administration published in the Federal Register proposed changes to the Federal Acquisition Regulation ("FAR") to require that in awarding federal contracts, agencies take into account contractors’ compliance with federal labor laws. Enactment of these proposed regulations would fulfill a promise made by Vice President Al Gore to the AFL-CIO in February 1997.

Under current regulations, contractors must have "a satisfactory record of integrity and business ethics" in order to be considered "responsible" under the FAR. The proposed regulations would provide examples of an "unsatisfactory record." One such example would be "substantial noncompliance" with labor and employment laws. The proposed regulations would also require that, to meet "responsibility" criteria, contractors must have "necessary workplace practices addressing matters such as training, worker retention, and legal compliance to assure a skilled, stable and productive workforce."

The Administration’s rationale for the proposed changes is that the government should do business only with law-abiding contractors. Determinations as to whether a contractor has a pattern of violating federal laws would be made based on the "whole picture," thus requiring a federal agency to use its judgment to determine what constitutes patterns of substantial violations.

Congressional Republicans are opposed to the linkage of contract awards to labor law compliance because they fear that the proposed regulations will give the Administration too much power to discriminate against non-unionized contractors. Rep. Peter Hoekstra (R-MI), who chairs the House Subcommittee on Education and the Workforce, characterizes the proposed regulations as "blacklisting" and has vowed to thwart their implementation.

Another provision in the proposed regulation would disallow the costs of "attempting to influence employee decisions respecting unionization" and "legal expenses related to defense of judicial or administrative proceedings brought by the federal government when a contractor is found to have violated a law or regulation, or where the proceeding is settled by consent or compromise."

The U.S. Chamber of Commerce and other business organizations are strongly opposed to the proposed changes. They claim that the proposed regulations would be a veiled effort to give labor unions a tremendous amount of influence in the awarding of government contracts. Also, some argue that since many companies have had at least minor violations of labor and employment laws at some point, agencies would have virtually unlimited discretion in applying the regulation. To emphasize the potential for abuse, opponents of the proposed changes note that ever since Vice President Gore made his promise to the AFL-CIO two years ago, organized labor leaders have been promising their members that the Clinton Administration would promulgate regulations to enable agencies to withhold federal contracts from companies that resist unions.

The Federal Acquisition Regulatory Council is accepting comments on the proposed regulations through November 8, 1999. Companies may wish to comment on the need for greater specificity as to what is meant by terms in the proposed regulations such as "substantial noncompliance," "necessary workplace practices," and "legal compliance." Without such guidance, the proposed regulations would introduce greater subjectivity to responsibility determinations.

If you have any questions about how these proposed changes could affect your business, or if you would like assistance in commenting on the proposed regulations, please do not hesitate to contact us.


Congress Passes Bill to Limit Y2K Liability

As we enter the second half of 1999, there is a growing emphasis on the "Year 2000"/"Y2K" problem, which involves older computer software and hardware that use only two digits to indicate a year (e.g. "99" instead of "1999"). On such systems, the year 2000 will register as 1900, thus causing obvious problems that could be expensive to correct. It is imperative that contractors, if they have not already done so, confront this problem. In addition to determining the extent of the problem, businesses should review their license and maintenance agreements, keep Y2K in mind when negotiating new agreements, and consider insurance to cover Y2K problems.

Businesses should also take note of legislation that was recently passed by Congress to address liability issues arising from the Y2K problem. On July 1, 1999, both houses of Congress passed H.R.775, the Year 2000 Readiness and Responsibility Act. The bill was approved by a vote of 404-24 in the House of Representatives and 81-14 in the Senate. President Clinton signed the bill into law on July 21, 1999.

H.R.775 would require a plaintiff who wishes to file a Y2K action for monetary damages to give the defendant notice of the problem and 90 days to fix it. Any damages awarded for a Y2K claim would exclude compensation for damages that the plaintiff reasonably could have avoided based on disclosures and other information of which the plaintiff was or reasonably should have been aware. The bill also limits punitive damages which could be awarded in Y2K suits to $250,000 for businesses with fewer than 50 employees. Furthermore, the bill prohibits punitive damages from being awarded to government entities.

The Y2K bill appears to be an attempt to avert the anticipated flood of Y2K-related lawsuits that could be filed next year. This bill could prove to be important to certain contractors and other small businesses who would otherwise be liable for Y2K problems, despite having made good faith efforts to be prepared. In addition, placing reasonable limits on Y2K liability might help avert price increases in computer products by companies who could otherwise be forced to raise their prices to offset large damage awards resulting from Y2K problems.

We will report any significant developments on the Y2K issue in future issues of the Legal Advisor.


Businesses Should Be Aware of "Preemptive Rights" When Offering Stock Incentives

As the nation continues to hover near record low unemployment, more and more companies are offering incentive packages to lure skilled workers. As part of these incentive packages, many companies are offering prospective employees stock in the company. While such stock incentives might be effective inducements to attract skilled workers, stock incentives can also create unintended long-term obligations for the company. Therefore, prior to making an offer of stock, employers should know what, if any, preemptive rights are available to shareholders, either by operation of state law or through the company’s articles of incorporation, bylaws, or agreements.

If a company grants a percentage of its stock to an employee, the company could be required to maintain the employee’s percentage if the company issues stock to others in the future. In such a case, it could be determined, as a matter of contract, that the company is required to issue the employee, at no cost, a sufficient number of additional shares to maintain the employee’s percentage of the total number of shares that are issued and outstanding. In other words, the employee’s percentage is being diluted by the new ownership structure and the employee may have a breach of contract action against the employer. This outcome might occur even though it is contrary to the company’s intentions at the time it offered the stock incentive. To avoid this problem, the employer’s agreement with the employee should grant a specified number of shares, rather than a percentage of ownership in the company. Such agreement should be written and could take the form of an employment agreement or a stock bonus/incentive agreement.

Furthermore, even if the employment contract provides for issuance of a specified number of shares, rather than a percentage of the business, the employee might have a "preemptive right" to maintain his/her ownership interest in the business. Corporation codes in some states grant existing shareholders "preemptive rights." In general, a shareholder who possesses such rights may require the company to offer him/her the right to purchase those additional shares required to maintain his/her percentage of ownership. Not every issuance of stock triggers the preemptive rights of other shareholders, and state law should be consulted in this regard. Even if not granted by state law, companies sometimes grant preemptive rights in their articles of incorporation and/or bylaws. Employers should know what those documents require before offering stock to prospective employees.

Preemptive rights may come into play not only in structuring incentive packages for prospective employees, but whenever the company issues stock to third parties. Therefore, whenever a company contemplates issuing stock, it should determine whether existing shareholders have preemptive rights. In addition, the company should always ensure that it has a sufficient number of authorized shares of stock to cover obligations it might have to offer stock to existing shareholders by virtue of their preemptive rights. If a company does not have a sufficient number of authorized shares needed to meet its obligations, an amendment of its articles of incorporation and/or bylaws might be required.

To avoid unintended consequences stemming from the issuance of stock to new employees and other third parties, companies should exercise caution in this regard and seek the assistance of counsel.


Exclusive Teaming Arrangements May Be
Scrutinized by DCAA and DoD for Anticompetitive Effects

A recent memorandum of the Defense Contract Audit Agency ("DCAA") expresses concern over the potential anticompetitive effects of "exclusive teaming agreements." According to the DCAA, an "exclusive teaming arrangement" is created when two or more companies team together for a DoD requirement, and further agree not to team with any other competitors for that requirement.

The DCAA’s memorandum is based on an earlier memorandum from the Under Secretary of Defense, which stated that, although the Department of Defense ("DoD") preference is to permit teaming relationships and subcontracting without DoD involvement, there are some circumstances under which DoD intervention is necessary to ensure adequate competition. According to the DoD memorandum, anticompetitive effects can result where the proposed subcontractor/supplier is the sole provider of a product or service, or has unique capabilities. According to the DoD, in such circumstances, the contracting officer can insist that such product, service or capability be made available to other competitors.

The DCAA, therefore, recommends that auditors notify contracting officers if they suspect that a contractor has an exclusive teaming arrangement with a proposed subcontractor so that the arrangement can be scrutinized for anticompetitive effects.

The government’s concerns over anticompetitive teaming relationships do not necessarily prohibit prime contractors from securing covenants from their teaming partners that they will not work for another competitor for the same requirement. Contractors often have a legitimate interest in ensuring that, should the teaming relationship break down, their confidential and proprietary information will not be revealed to competitors by their teaming partner. The recent concerns of the DCAA and the DoD emphasize the need to balance these legitimate business interests against the overall impact that such restrictions might have on competition in that particular procurement. As noted, contractors should ordinarily avoid exclusive teaming arrangements where proposed subcontractors have unique capabilities, or are sole providers of goods or services.

If a contractor has a concern about the permissibility of an exclusive teaming arrangement in a particular acquisition, it may wish to raise the issue during the pre-proposal conference. If any doubt remains, contractors should seek legal advice.

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