On January 7, 2026, President Trump issued an executive order (EO) and fact sheet that, if fully implemented, will impose consequences on federal defense contractors determined to be "underperforming" or not in compliance with several government priorities (such as investing their own capital in production capacity, innovation, and on-time delivery), while at the same time engaging in stock buy-backs or corporate distributions of profit. The EO would also create a new contract clause permitting the government to cap executive compensation when a contractor is determined to be "underperforming" and prohibiting the use of short-term metrics for executive pay; instead, executive compensation will be linked to on-time delivery, increased production, and expanding stockpiles of critical defense items. The new policy raises a host of issues for contractors serving the U.S. Department of War (DOW), which are discussed in more detail below.
Why is this new policy being implemented?
In short, the EO identifies a perception that too many defense contractors have placed profits above "production capacity, innovation, and on-time delivery." The EO states that, "[a]fter years of misplaced priorities, traditional defense contractors have been incentivized to prioritize investor returns over the Nation's warfighters" and that "[w]hile the United States produces the best military equipment in the world, we do not make enough of it quickly enough to meet the needs of our military and our partners." The EO intends to ensure the timeliness, quality, and quantity of the defense items.
Does the EO apply to all contractors serving DOW?
Defense contractors may need to await additional guidance from DOW to learn the exact scope of the EO. Section 1 of the EO calls out "misplaced priorities" and other issues in relation to "traditional defense contractors" and "large contractors" (emphasis added). Section 3(a), which requires the Secretary of War to identify contractors for potential remediation, applies to "any defense contractors for critical weapons, supplies, and equipment" (emphasis added). However, Section 4(b) will require a new clause to be incorporated into "any future contract with any new or existing defense contractor" (emphasis added). It is therefore unclear how extensively the EO may be applied, for example, to contractors providing services as opposed to products, small businesses, or nontraditional defense contractors.
There does not appear to be an express exception for commercial providers or vendors of commercial off-the-shelf (COTS) items, although it is possible that subsequent guidance will also clarify this issue. The EO also states in multiple places that it must "be implemented consistent with applicable law," and so preexisting legal limits on the government's authority to apply new requirements to commercial providers may apply.
What are the reasons why DOW may identify a contractor as needing "remediation" under the EO?
The EO identifies several reasons why a defense contractor may be identified for "remediation." In short, the contractor may be identified if it has "engaged in any stock buy-back or corporate distribution" while at the same having one of the following apply:
- "underperforming on their contracts"
- "not investing their own capital into necessary production capacity"
- "not sufficiently prioritizing United States Government contracts"
- "production speed is insufficient"
Although the EO does not define these terms, it contains some indicators of how they may be applied. Some statements in the EO indicate that "underperforming" may be construed to mean that the contractor is not "produc[ing] a superior product, on time and on budget," is in "non-compliance with the contractor's contract," or has engaged in "insufficient prioritization of the contract[.]"
Similarly, the EO notes that "[a]lthough some contractors have made critical investments in increased production capacity and been responsive to our Nation's vital interests, far more have not" and discusses "necessary facilitation of investments … required to rapidly expand our United States stockpiles and capabilities." This suggests DOW may view increasing or expanding production capacity as "necessary."
Will there be an opportunity for a contractor to dispute a DOW determination under the EO?
The EO states that DOW must provide the contractor a "notice describing the nature of the underperformance or insufficient prioritization, investment, or production speed" and "then engage as needed with the relevant contractor to resolve the issues identified" during a "15-day negotiation period[.]"
After that period ends, the EO authorizes DOW to "initiate immediate actions to secure remedies for the Secretary that will expedite production, prioritize the United States military, and return the contractor to sufficient performance, investment, prioritization, and production, to the maximum extent permitted by law[.]" The EO notes, however, that DOW will "take into account the financial condition of the defense contractor, the economic viability of relevant programs, and the potential mutual benefits offered by robust and sustained growth opportunities from the United States Government coupled with capital investments by the contractor" when considering enforcement action.
While the EO does not create a new appeals process within DOW, depending on the action taken, it may be that preexisting procedures (e.g., disputing a Contractor Performance Assessment Report rating or submitting a claim under the Contract Disputes Act of 1978, 41 U.S.C. §§ 7101-7109) will apply.
What are the potential consequences of a DOW determination that a defense contractor is underperforming or unaligned with the other policy priorities in the EO?
Section 4 of the EO addresses enforcement. If the contractor's "remediation plan is insufficient" or the contractor and DOW "are unable to resolve the dispute as to underperformance within the relevant 15-day negotiation period," then DOW's options include the following, all "to the maximum extent permitted by law":
- "use of any voluntary agreement of the contractor," which the fact sheet notes includes "mutually agreeing to amend the underlying contract"
- "available enforcement actions under the Defense Production Act (50 U.S.C. 4501 et seq.)"
- "any available contract enforcement mechanisms within the Federal Acquisition Regulations and Defense Federal Acquisition Regulations Supplement"
Though not expressly stated, the available "enforcement mechanisms" in the last item above are wide-ranging and would include termination of a contract for default or for the government's own convenience, declining to exercise options, lower ratings in performance evaluations, or seeking reperformance of defective work at the contractor's expense. The U.S. Congressional Research Service's publication, "Selected Legal Tools for Maintaining Government Contractor Accountability," provides a summary.
In addition, DOW may work with other agencies to impose penalties, such as withholding Foreign Military Sales opportunities or safe harbors related to stock buy-backs:
- DOW may "in consultation with the Secretary of State and the Secretary of Commerce, consider whether it is appropriate to cease ongoing advocacy efforts or deny new advocacy cases for underperforming contractors competing for an international Foreign Military or Direct Commercial Sale"
- "The Chairman of the Securities and Exchange Commission shall consider whether to adopt amended regulations governing stock buy-backs under Rule 10b-18 that would prohibit use of the relevant safe harbor for defense contractors of the type identified by the Secretary pursuant to section 3 of this order."
What do defense contractors need to know about the new contract clause?
In addition to the identification and remediation procedures outlined above, Section 4(b) of the EO also directs DOW to include a new contract clause in future contracts accomplishing two things.
First, the clause will make it a contractual requirement not to buy back stock or make distributions when performance is inadequate or DOW's policy criteria (investment, prioritization, speed) are unmet. Specifically, the clause would "prohibit[] both any stock buy-back and corporate distributions by the contractor during a period of underperformance, non-compliance with the contractor's contract, insufficient prioritization of the contract, insufficient investment, or insufficient production speed as determined by the Secretary."
Second, the clause will limit executive compensation by restricting permissible incentives and even capping pay in some instances:
- It will "stipulate that executive incentive compensation for contractors will not be tied to short-term financial metrics, such as free cash flow or earnings per share driven by stock buy-backs[.]" Instead, compensation must "be linked to on-time delivery, increased production, and all necessary facilitation of investments and operating improvements required to rapidly expand our United States stockpiles and capabilities."
- The clause would "require that executive base salaries of the contractor be capped at current levels, with increases allowed for inflation, consistent with applicable law, for a time period sufficient to allow the Secretary to scrutinize the incentive portion of executive compensation to ensure it is directly, fairly, and tightly tied to the above metrics."
When does the new EO come into effect?
The EO states that, "[e]ffective immediately, [covered contractors] are not permitted in any way, shape, or form to pay dividends or buy back stock, until such time as they are able to produce a superior product, on time and on budget."
More specifically, DOW will identify contractors for remediation "[w]ithin 30 days of the date of [the EO], and on a continuing basis thereafter[.]" And DOW must "take steps to ensure" the new contract clause is incorporated into future contracts "[w]ithin 60 days of the date of" the EO.
Does the new EO raise any notable legal issues?
It is likely that both DOW and defense contractors are going to require time to fully understand and implement the EO, in part because it could pose some legal questions. Some items for consideration include:
- Whether any contractors will be exempt from application of one or more portions of the EO based on factors such as small business status, commerciality of offering, a distinction between services and products, or being a nontraditional defense contractor.
- Federal statute generally requires a procurement policy, regulation, procedure, or form to not take effect until 60 days after publication for comment in the Federal Register if it relates to expending appropriated funds and has either "a significant effect beyond the internal operating procedures of the agency" or "a significant cost or administrative impact on contractors or offerors." 41 U.S.C. § 1707(a)(1). But assuming it would apply here, the statute contains an exception for "compelling circumstances" and waiver authority for "urgent and compelling circumstances," upon which DOW may seek to rely. Other agencies have invoked these exceptions recently "to ensure alignment with recently issued EOs" and "to ensure [] solicitations and contracts consistently reflect the policies and priorities of the Administration."
- The EO requires DOW to "ensure that any future contract with any new or existing defense contractor, including any renewal, contains" the new contract clause (emphasis added). As we have previously written (briefly here and in detail here), options are not "new" contracts. Inserting new clauses into a contract at option exercise can render the option invalid and entitle the contractor to an equitable adjustment.
- The EO states it "shall be implemented consistent with applicable law." It may take time for DOW and contractors to identify the substantive limits on DOW's ability to "secure remedies" from contractors or otherwise implement the EO. For example, federal statute and regulations restrict what terms federal agencies may impose on providers of commercial products and services. See FAR Subpart 12.3. Similarly, some contractor accountability mechanisms, such as contractor performance evaluations, may not authorize DOW to sanction contractors for failing to meet policy criteria that are not contract requirements (e.g., the contractor's investment of its own capital in production capacity). See FAR Subpart 42.15.
Venable's Government Contracts Practice Group will continue to monitor developments in the defense contracting space and keep clients apprised of relevant information. To subscribe for alerts, please click here. For any questions about this alert and resulting impacts, contact Chris Griesedieck and Douglas Proxmire.