New DEI Restrictions In Federal Contracting

Federal contractors face a rapidly shifting regulatory landscape on diversity, equity, and inclusion. Through a series of executive orders, agency directives, and proposed rulemaking, the administration has built a layered enforcement framework to prohibit or restrict DEI-related activities by government contractors. Compliance deadlines are imminent, enforcement is already underway, and pending litigation is unlikely to provide near-term relief. Below is what contractors need to know.

The OMB proposed rule

On May 29, 2026, the Office of Management and Budget (OMB) published a proposed rule that would substantially revise 2 C.F.R. Part 200—the government-wide framework for federal financial assistance. Two provisions are most significant for contractors:

• The “Unlawful DEI Provision” (Proposed § 200.300) would prohibit federal awards from being used to “fund, promote, encourage, subsidize, or facilitate” DEI policies that violate federal anti-discrimination laws—including racial preferences and activities where race or intentional proxies for race are used as selection criteria.

• The “Disparate-Impact Provision” (Proposed § 200.218) would bar the use of federal funds to promote or support theories of disparate-impact liability—defined as an “automatic or near-insurmountable presumption” that discrimination exists solely because outcomes differ among groups, even without discriminatory intent. Recipients could not use federal funds to impose race-balancing requirements or presume discrimination based solely on statistical disparities. A narrow exception exists for internal analyses not funded by the award.

Noncompliance would constitute a material breach, giving agencies grounds to terminate awards or recover funds. Comments are due July 13, 2026, with a proposed effective date of October 1, 2026. The timeline is aggressive, and contractors should begin preparing now rather than waiting for a final rule.

Tracing the proposed rule to earlier executive orders and guidance

The OMB proposed rule did not emerge in a vacuum. It codifies a series of executive orders and federal guidance issued since January 2025:

Executive Order 14151 (Ending Radical and Wasteful Government DEI Programs and Preferencing, January 20, 2025) terminated all federal DEI programs and directed agencies to identify contractors and grantees involved in DEI activities.

Executive Order 14173 (Ending Illegal Discrimination and Restoring Merit-Based Opportunity, January 21, 2025) required that every federal contract include a clause requiring the contractor to certify that it does not operate DEI programs violating federal anti-discrimination laws. Importantly, EO 14173 was tethered to existing civil rights statutes and expressly preserved First Amendment-protected speech.

DOJ Memorandum of July 29, 2025 (Guidance for Recipients of Federal Funding Regarding Unlawful Discrimination) offered a non-binding framework identifying practices that may violate federal law and best practices for compliance. Examples of unlawful activities include race-based preferences, unlawful proxies for race (such as “cultural competence” requirements or geographic targeting based on racial composition), segregation of training sessions by race, and training programs that stereotype individuals based on protected characteristics. The OMB proposed rule references this guidance as illustrative of prohibited conduct.

EO 14398, its enforcement, and legal challenges

The proposed rule also builds on Executive Order 14398, “Addressing DEI Discrimination by Federal Contractors” (March 26, 2026), which goes further than any prior directive. Unlike EO 14173, it is not limited to programs that violate existing law. It independently defines “racially discriminatory DEI activities” as any disparate treatment based on race or ethnicity in:

• recruitment and employment (hiring, promotions)

• contracting (vendor agreements)

• program participation (training, mentoring, leadership development, clubs, associations)

• allocation or deployment of resources.

All contracts and “contract-like instruments” (including subcontracts) must incorporate a clause where contractors agree to refrain from “racially discriminatory DEI activities.”

The FAR Council codified EO 14398 as FAR 52.222-90 and issued guidance on implementation. Agencies must insert the clause into new solicitations immediately and bilaterally modify all existing contracts by July 24, 2026. Contractors who refuse the modification risk a termination for convenience. Penalties for noncompliance include contract cancellation, suspension, debarment, and False Claims Act liability.

Prime contractors face a heightened obligation: they must report any subcontractor conduct that violates the clause that is “known or reasonably knowable” and may face the same consequences—including debarment—for subcontractor violations.

The government has not waited for the rulemaking process to conclude.

• Just two weeks after EO 14398 was signed, the DOJ announced its first settlement: a major technology company agreed to pay over USD17M to resolve allegations that it falsely certified compliance while tying bonuses to demographic targets and using race and sex as factors in hiring decisions. The alleged conduct dated to 2019, signaling the government’s willingness to look backward. DOJ officials have indicated they expect additional settlements to follow.

• At least 10 federal agencies, including the Departments of Justice, Homeland Security, Transportation, Commerce, and Education, have issued class deviations adopting the FAR 52.222-90 clause, and contracting officers are actively approaching contractors to add the clause to existing contracts.

But the Order is not without scrutiny. An amended complaint filed May 22, 2026 in the U.S. District Court for the District of Maryland (Case No. 8:26-cv-01532) challenges EO 14398 on multiple grounds. The plaintiffs—including the National Association of Diversity Officers in Higher Education and the National Association of Minority Contractors—brought seven claims, arguing that the Order: (1) violates the First Amendment by prohibiting lawful expression about race and diversity; (2) imposes unconstitutional conditions on the receipt of government contracts; (3) exceeds presidential authority under the Federal Property and Administrative Services Act by invoking False Claims Act enforcement; (4) is unconstitutionally vague; and (5–7) that the FAR Council’s implementation violated the Administrative Procedure Act.

Critically, no motion for a temporary restraining order or preliminary injunction is currently pending. As no near-term judicial relief is expected, contractors cannot rely on the litigation to delay compliance.

Examples of conduct that may constitute unlawful DEI

Based on the OMB Proposed Rule and the July 2025 AG Guidance, the following are a non-exhaustive list of examples of activities that may be considered unlawful:

• Race-based scholarships or programs that reserve spots exclusively for members of a particular racial group

• Preferential hiring or promotion practices that prioritize candidates from “underrepresented groups” defined by race

• “Diverse slate” policies requiring a minimum number of candidates from specific racial groups on interview panels

• Use of intentional proxies for race, such as “cultural competence” requirements, geographic targeting based on racial composition, or mandatory “diversity statements”

• Segregated training sessions that separate participants by race, or training content that stereotypes individuals based on protected characteristics

• Programs promoting disparate-impact theories—for example, using statistical disparities alone to presume discrimination and mandating race-conscious remediation

What contractors should do now

• Conduct a privileged assessment. Evaluate current programs—mentoring, affinity groups, supplier diversity, recruitment activities, and training—against EO 14398’s definitions and the July 2025 AG Guidance, ideally under attorney-client privilege.

• Prepare for contract modifications. Contracting officers must modify existing contracts by July 24, 2026. Understand what accepting the clause means for your organization and develop a plan for compliance.

• Address subcontractor risk. Prime contractors must report known or reasonably knowable violations and may face debarment for subcontractor noncompliance. Flow-down requirements and compliance monitoring programs should be established or updated.

• Understand your False Claims Act exposure. EO 14398 explicitly provides that compliance is material to the government’s payment decisions for FCA purposes—meaning qui tam relators and the DOJ can pursue contractors for violations.

• Consider submitting comments on the OMB proposed rule. Comments are due July 13, 2026. This is an opportunity to shape the final rule’s scope and application to contractors.

• Do not wait for the litigation. Without a pending injunction, the Maryland lawsuit will not provide near-term relief. Compliance obligations are enforceable now.

If you have any questions about this subject or related subjects, or if you need assistance, please contact the authors of this article or your Winston Taylor relationship lawyer.