ABL for Government Contractors: Assignment of Claims, Set-Off Risk, and Borrowing Base Mechanics

Why Government Contractors Are Both Easy and Hard to Finance

From a credit perspective, the federal government is one of the best account debtors in the world. Payment is mandated by appropriated funds. Default risk is effectively zero. Disputes over completed and accepted work are rare. For a working-capital lender, a federal receivable looks like a near-perfect collateral asset.

And yet many federal contractors -- particularly the small and middle-market firms that hold a meaningful share of federal contract dollars -- struggle to finance their growth. The reason is mechanical. Federal receivables come with a specific legal and procedural overlay that shapes how they can be pledged, what protections a lender requires before advancing against them, and how the borrowing base actually behaves through the contract lifecycle. Borrowers who do not understand that overlay end up with facilities sized too small, structured too conservatively, or refused outright.

At Don Clarke Enterprises, we place asset-based facilities for federal, state, and local government contractors and run the legal and operational mechanics that make these deals work. Donald Clarke -- SFNet Hall of Fame inductee, author of Asset Based Lending Disciplines (the industry's first textbook), and advisor who has trained more than 5,000 lending professionals at institutions including GE Capital, JP Morgan Chase, Lloyds, and Barclays -- has been structuring government-contractor ABL since 1986. Here is how these facilities actually work.

The Core Issue: The Anti-Assignment Acts

Federal contracts have historically been governed by two related statutes: the Anti-Assignment Acts (31 U.S.C. Section 3727 and 41 U.S.C. Section 6305), which broadly prohibit a contractor from assigning amounts due under a federal contract to a third party. The intent of the statutes was to prevent claims trafficking and protect the government from set-off complications.

If those statutes operated without exception, federal contracts would be effectively unfinanceable. A lender taking a UCC-1 lien on the contractor's receivables would have no enforceable right against the government for payment of those receivables. The government would be free to pay only the contractor, and a contractor that collected and did not remit would leave the lender with no remedy against the obligor.

The Assignment of Claims Act of 1940

The Assignment of Claims Act (FACA), codified at 31 U.S.C. Section 3727 and implemented through Federal Acquisition Regulation Subpart 32.8, carves out a critical exception. Under FACA, a contractor may assign monies due or to become due under a federal contract to a financing institution if the following conditions are met:

• The contract specifies payments aggregating $1,000 or more.
• The assignment is made to a bank, trust company, or other financing institution.
• The contract does not prohibit assignment.
• The assignment covers all unpaid amounts under the contract (not a partial assignment).
• The assignment is made to only one party (or to one agent/trustee for multiple participants in a financing).
• Written notice of assignment, with a true copy of the assignment instrument, is filed with the contracting officer, the disbursing officer, and any surety on bonds applicable to the contract.

When all conditions are met and the assignment has been properly filed and acknowledged, three things change. First, the government is obligated to direct payment to the assignee (the lender). Second, the contractor cannot redirect that payment without the lender's consent. Third, the lender obtains a direct collection right against the government -- a remedy that does not exist for any other category of account debtor in commercial finance.

That third point is what turns federal receivables from collateral that is technically not lendable into collateral that is among the most reliable in the market. But the FACA filing has to actually happen. Federal receivables that have not been assigned remain ineligible in nearly every ABL credit agreement, as we covered in our broader discussion of eligible versus ineligible receivables.

The Mechanical Reality of FACA Filings

Filing FACA assignments sounds straightforward. In practice, it requires discipline. Several practical issues arise on every government-contractor ABL facility.

Per-Contract Filings

FACA assignments operate at the contract level, not the contractor level. A contractor with thirty active prime contracts needs thirty FACA filings. Each filing has to be served on the contracting officer, the disbursing officer, and any bond surety. Each acknowledgement comes back on its own schedule. Federal agencies vary widely in how quickly they process FACA notices -- some return acknowledgements in two weeks, some in two months. Borrowers who plan to use ABL should build FACA workflow into the contract administration function from day one.

The Contract Itself Has to Permit Assignment

FAR 32.803 allows agencies to insert clauses prohibiting assignment when the agency determines a prohibition is in the government's interest. Those prohibitions exist on a meaningful minority of contracts -- particularly classified work, certain DOD program contracts, and some intelligence community work. Before counting on a contract to support availability, both contractor and lender confirm the contract does not include the prohibition clause (FAR 52.232-24).

No-Setoff Commitments Are Better Than Standard Filings

Without a no-setoff commitment, the government can apply payment owed on the assigned contract against any independent liability the contractor owes the government -- unpaid taxes, social security contributions, defaulted prior obligations -- even after the FACA assignment is on file. With a no-setoff commitment (FAR 52.232-23 with Alternate I), the government waives that right within statutory limits and is obligated to remit to the lender free of unrelated set-off claims. No-setoff commitments require an agency-head determination of need under presidential delegation, and they are not standard. When they are available -- typically on defense production contracts and certain large agency programs -- they materially strengthen the lender's position.

Borrowing Base Mechanics for Federal Receivables

Once FACA mechanics are in place, federal receivables typically receive favorable treatment in the borrowing base. Standard advance rates of 80 to 85 percent on eligible AR apply, and credit-rated federal counterparties -- the largest cabinet departments and major defense agencies -- often qualify for elevated concentration limits or are exempted from the standard concentration cap entirely. This matters because federal contractors often have a single customer (one agency) representing the vast majority of revenue, which would otherwise blow through any standard concentration limit.

Several federal-specific borrowing base issues need careful structuring:

Cost-Reimbursement Contracts

On cost-reimbursement contracts (cost-plus-fixed-fee, cost-plus-incentive-fee, etc.), receivables arise as costs are incurred and submitted on monthly public vouchers (SF-1034 / SF-1035 series). These billed receivables are typically eligible upon submission. Indirect cost rate true-ups create complications -- year-end retroactive rate adjustments can claw back availability if the rate adjustment is unfavorable. Lenders price for that volatility through dilution reserves on cost-type contracts.

Time-and-Materials and Labor-Hour Contracts

T&M and labor-hour contracts work similarly to commercial billing -- a fixed labor rate times hours worked, plus reimbursable materials. Eligibility is generally clean once the invoice is approved and submitted.

Firm-Fixed-Price Progress Payments

Progress payments under FAR 52.232-16 work on fixed-price contracts when costs are being incurred ahead of delivery and final payment. These are unique because the government takes title to inventory paid for under progress payments -- which complicates the lender's collateral position on inventory and requires careful intercreditor analysis. Lenders sometimes exclude progress payment recoveries from the borrowing base or apply a reserve.

Performance-Based Payments

Performance-based payment (PBP) contracts under FAR 32.10 trigger payment on milestone completion rather than cost incurrence. The contractor either has a billable receivable (milestone met) or does not. Eligibility is binary and clean.

Retainage and Holdbacks

Many federal contracts include retainage -- typically 10 percent of progress payments or final invoice -- held by the agency until completion or final inspection. Retainage receivables are usually excluded from the borrowing base entirely or eligible at significantly reduced advance rates because the underlying obligation is contingent on contract completion. Borrowers with high-retainage contracts should model availability accordingly.

Set-Off Risk Beyond the Government

Government set-off is one form of set-off risk. Two others affect government contractors specifically.

Subcontractor and Vendor Set-Off

Federal contractors often have payable obligations to subcontractors and vendors performing on the same contract. Those vendors sometimes have their own UCC filings, materialmen's lien rights, or Miller Act bond claims. A lender financing the prime contractor's receivables has to think about subordination of those secondary claims and whether vendor liens could attach to government payments before they reach the lender.

Termination for Convenience

The government retains the right to terminate any contract for convenience, in which case the contractor receives a settlement based on costs incurred plus a reasonable profit on work performed -- but unbilled receivables on terminated contracts may shift in value, and the dispute over the termination settlement can take months. Lenders factor termination risk into eligibility on long-term contracts and sometimes apply specific reserves.

State and Local Government Receivables

Receivables from state and local government agencies face similar but jurisdiction-specific issues. State assignment-of-claims statutes (and equivalent municipal procurement rules) vary widely. Some states have FACA-equivalent regimes that work cleanly. Others require approvals from the state treasurer or attorney general before an assignment is enforceable. A few prohibit assignment outright. Lenders financing state and local receivables work jurisdiction-by-jurisdiction with the contractor's legal counsel to confirm enforceability before advancing.

How to Structure a Workable Government-Contractor Facility

Five elements separate a facility that actually supports a government contractor from one that frustrates them.

Build the FACA Workflow Before Closing

Identify all active contracts that will support the borrowing base. Confirm none contain prohibition clauses. Prepare FACA notices in template form and queue them for filing as soon as the lender's closing certificate is issued. Borrowers that come to closing with this work already mapped out activate the borrowing base in days rather than weeks.

Negotiate Custom Concentration Treatment

A federal contractor with 80 percent of revenue from a single agency cannot live under a 25 percent concentration cap. Negotiate at the term sheet stage for elevated concentration limits or full exclusion from concentration testing for credit-rated federal counterparties. This is one of the highest-leverage parts of ABL term sheet negotiation for federal contractors.

Address Cost-Type Volatility Explicitly

If meaningful revenue is on cost-reimbursement contracts, model indirect rate true-up risk into projected availability. Negotiate dilution reserves that reflect actual historical rate adjustments, not a generic punitive haircut. Submit clean, audit-ready cost data to support the case for tighter reserves.

Build Termination-for-Convenience Reserves Carefully

Lenders will want to apply reserves on long-term contracts to address termination risk. The reserve methodology should be specific and quantified, not discretionary. Reasonable credit judgment standards with defined caps protect the contractor against availability swings.

Match the Lender to the Sector

Not every ABL lender has experience with federal contractors. The mechanics described here -- FACA filings, no-setoff commitments, retainage treatment, indirect rate true-ups, termination risk -- require lender desks that understand them. Borrowers who place deals with generalist lenders sometimes find themselves educating the lender mid-deal, which costs time and produces conservative terms. Our guide to choosing the right ABL lender walks through how we map sector specialization.

Why DCE

We place ABL facilities for federal, state, and local government contractors, including prime contractors, subcontractors, IT services firms, defense suppliers, professional services contractors, and construction contractors with meaningful federal exposure. We understand FACA mechanics, we know which lenders have actual government-contractor desks, and we structure facilities that work through the contract lifecycle rather than around it.

Don Clarke has been doing this work for four decades. He founded Asset Based Lending Consultants in 1986 and has trained the senior underwriters at most major government-contractor ABL lenders on the discipline. That is the difference between a deal that closes and a deal that fits the business.

We do not consult. We execute.