Assignment of Claims

Assignment of claims is the government-contract-specific mechanism by which a contractor pledges its rights to receive future contract payments to a bank or financing institution as collateral for a loan, subject to specific procedural requirements and limitations under the Assignment of Claims Act of 1940.

What is Assignment of Claims?

The Assignment of Claims Act (31 U.S.C. § 3727) governs the assignment of payment rights under government contracts. As a general rule, rights under government contracts cannot be freely transferred, this is a core restriction that protects the government's ability to assert claims, setoffs, and defenses against the contractor. The Assignment of Claims Act creates a limited exception: a contractor may assign its right to receive future payments under a government contract to a financial institution (bank, trust company, or Federal Reserve Bank) as collateral for financing, provided specific procedural requirements are met.

The requirements for a valid assignment of claims are: the assignment must be in writing; the assignee must be a recognized financial institution; the contract must be for at least $1,000; the contractor must provide written notice of the assignment to the contracting officer, surety (if any), and disbursing officer; and the contractor must provide a copy of the assignment instrument. Once properly executed and notice is given, the government must make payments directly to the assignee rather than the contractor.

The assignment covers only future payments, it cannot cover amounts already due or claims that have already been settled. It does not transfer the contractor's performance obligations, which remain with the original contractor. The government retains all of its rights to assert claims, setoffs, and defenses against the contractor, the assignee bank takes subject to those existing government defenses.

Assignment of claims is commonly used by smaller government contractors who need working capital financing for contract performance but cannot qualify for unsecured commercial credit. Factoring companies and specialized government contract lenders use assignment of claims as the legal mechanism to lend against government contract receivables.

Why Assignment of Claims matters for government contractors

Assignment of claims is one of the few working capital financing tools available to government contractors. Companies performing large, long-duration contracts, particularly in construction, manufacturing, or IT, may face significant cash flow gaps between when costs are incurred and when the government pays invoices. Assignment of claims allows contractors to use their government receivables as collateral for lines of credit, reducing the need for equity capital.

Example

A small defense manufacturer wins a $4.5M contract to produce 200 specialized sensors over 18 months. The manufacturer's bank reviews the contract and agrees to provide a $1.5M revolving line of credit collateralized by the assignment of the manufacturer's payment rights under the contract. The manufacturer executes a written assignment of claims, provides the required notices to the contracting officer, the surety bond company, and the disbursing officer, and receives a copy of the government's acknowledgment. Going forward, the contracting officer directs all payment disbursements to the bank's lockbox account, and the bank applies payments against the outstanding credit line balance.

Frequently Asked Questions

Can the government refuse to recognize an assignment of claims?

The government is required to honor a properly executed assignment of claims that meets the Act's requirements. However, the government retains all its existing defenses and offsets, if the contractor owes the government money on another contract, the government may assert a setoff against the assigned payments. The bank/assignee takes subject to these government rights.

Does assigning claims under a contract mean the financing institution must perform the contract?

No. Assignment of claims transfers only the right to receive payments, it does not transfer any performance obligations. The contractor remains solely responsible for performance. If the contractor defaults, the bank has no obligation to complete the work.

Can a contractor assign claims under all of its government contracts?

Technically yes, subject to meeting the Act's requirements for each assignment. However, banks and lenders typically evaluate the specific contract's payment stream and performance risk when deciding whether to lend against it. Assigning all receivables to multiple lenders creates complexity in payment administration.

What happens to the assignment if the contract is terminated for convenience?

If the contract is terminated for convenience, the government's payment obligation becomes the termination settlement rather than the original contract price. The assignment of claims typically covers the settlement payment as well, though the financing institution should review the assignment instrument to confirm the T4C settlement is covered by its lien.