Key Details: On January 16, 2026, the Secretary of War announced a sweeping audit of the 8(a) Business Development Program and other small-business set-aside contracts valued at $20 million or more. This follows the DoW’s crackdown on waste, fraud, and pass-through schemes in 8(a) and other small business contracts. As such, contracts deemed non-essential to the warfighter or found non-compliant with small business rules could face terminations for convenience, with potential follow-on DOJ investigations. Small business contractors are encouraged to fully understand the audit scope and audit steps, and to contact their legal counsel before potential terminations.
DoW’s Audit Scope, Steps, and Red Flags
The official memorandum dated January 16, 2026, expanded the scope of the audit. Initially noted as a check of 8(a) sole-source contracts over $20 million, the memorandum expanded applicability to all covered contracts over $20 million. This includes the following:
- Sole source awards to 8(a) businesses over $20 million
- Set-aside awards to 8(a) businesses over $20 million
- Set-aside award to a small business over $20 million
Contractors should note that only active contracts are targeted. As such, ongoing projects that meet the criteria above are being audited, whereas completed awards are presumably excluded from the audit.
The memorandum details two stages to this audit:
Stage 1: Identification & Mission Alignment
Each DoW component was required to identify all active contracts in the categories listed above. By January 31, leadership was required to review this list to determine if each contract is mission-critical and supports warfighting efforts. Secretary Hegseth’s May 27, 2025, efficiency memo informed this mission-criticality review. Contracts deemed non-essential to the defense mission were slated for termination for convenience. In effect, programs or services that are not directly tied to enhancing the warfighter effort are at a high risk of cancellation.
Stage 2: Compliance & Performance
Stage 2 required DoW components to complete a deeper review of the remaining covered contracts by February 28, 2026. This stage scrutinizes contract performance data to verify two things:
- Compliance with limitations on subcontracting.
- Pricing at or below market rates.
Performed to ensure that the prime contractor is performing at least the required share of work.
Reviewers will examine invoices, payroll and payment records, staffing and labor hour reports, Contracting Officer’s Representative logs, deliverables, and confirm key personnel assignments.
The goal of stage 2 is to detect excessive pass-through charges or other signs that a small business contractor may be improperly allowing large subcontractors to perform substantive or specialized work. Additionally, reviewers were required to compare contract costs to benchmarks and flag any that exceeded market rates. Contracts in which prime contractor personnel are not performing the technical work, or in which subcontractors take an outsized share of the effort, will draw scrutiny for potential violations of the limitation on subcontractor rule. Likewise, if a contract’s billing rates or total prices seem high relative to typical industry rates, it may be flagged as wasteful.
The timeline for this DoW audit was very compressed, but the message was clear: if a contract is not mission-critical, compliant, and cost-effective, it is at risk.
Continued Awareness is a Must
The DoW memorandum instructs agency leaders that, after they finish the Feb. 28 compliance review, they must provide a list of any “covered” contracts priced above market rates that the department cannot terminate immediately. For these contracts, officials must include a plan to terminate the contract “within 90 days while still maintaining necessary services”. In other words, even if a contract is temporarily spared, it may still face cancellation within three months. As such, contractors should not assume that no news by early March means they are in the clear. It is critical to keep tracking communications from your Contracting Officer, SBA officials, and legal counsel. Maintain documentation, update your readiness plans, and stay alert for any follow-up requests or notices.
Note on Termination Types
Federal contracts can end in different ways. A termination for convenience occurs when the government decides to end a contract not because the contractor did anything wrong, but because it no longer needs the goods or services. In those cases, contractors are typically entitled to recover costs incurred up to the date of termination, plus a reasonable profit on work performed. By contrast, a termination for default arises when the government believes the contractor has materially failed to meet its obligations—such as falling behind schedule or delivering non-conforming work. If a contract is terminated for default, the contractor can lose its right to compensation for some of the work, and the termination may entitle the government to recover re-procurement costs. Both types of terminations are governed by provisions in the Federal Acquisition Regulation (FAR) and can affect a contractor’s performance record and future eligibility for contracts. Given the potential financial and reputational consequences, contractors should consult with qualified legal counsel promptly if they receive any termination notice or if they foresee performance issues on a covered contract.
Conclusion and Action Plan
For small business contractors, especially those participating in the 8(a) Business Development Program and other set-aside awards, this audit represents a call to action. Even if your business’s contracts are not immediately impacted, the era of heightened oversight is here. Contractors are encouraged to speak with their trusted advisors, consult legal counsel, and follow the steps below to prepare for potential contract and performance scrutiny.
- Inventory high-value DoW-funded contracts over $20 million that are under an 8(a) award or other small business set-aside award.
- Ensure subcontracting compliance by proactively calculating the percentage of work your business performs. Ensure adequate documentation of calculations, including any unique justifications.
- Gather and organize performance documentation.
- Substantiate fair pricing and compare pricing to market rates.
- If any notice of termination is received, speak with your legal counsel to develop a comprehensive response strategy.
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About Peter Ryan
Partner, Co-founder, & CPA
Peter T. Ryan co-founded Ryan & Wetmore in 1988 with business partner Michael J. Wetmore. Peter provides clients with the best strategies for success. His expertise extends across various industries. Peter obtained a Master of Business Administration in Finance from the University of Baltimore and a Bachelor of Arts in Accounting from the Catholic University of America.
