Is there an ethical line being crossed?
Without more information, it is difficult to determine whether this creates an ethical violation, but it could give the appearance of a conflict of interest and may have the potential of becoming a conflict of interest.
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The terms of the contract and the specific nature of the event must be considered, and the contracting officer and ethics counselor should be consulted. If the Ethics Counselor is not your legal counsel, legal counsel should also be advised and asked to render an opinion regarding a potential conflict of interest. The government should determine that there is no conflict and that this is in the agency’s best interest.
Contractor employees must pay for their own expenses, fees, etc. The Government cannot pay the contractor for entertainment costs. (FAR 31.205-14)
Reimbursement of contractor employee morale and welfare expenses is also limited. (FAR 31.205-13)
The Government should be cautious about inviting contractor personnel to leave their place of employment for recreational events because it creates the expectation of payment.
Even when the contractor knows that it will not be paid for services not delivered during the absence of its employees, the contractor may feel obligated to attend. Agencies may permit contractor personnel working on-site to attend morale and welfare events when the agency believes that it would enhance performance.
However, the contractor personnel must make arrangements with their contractor supervisor for appropriate leave or other status under the contract.
Care must also be taken neither to permit the contractor to subsidize the DoD event, which would be a gift from a prohibited source, nor to allow Government funds to pay for the morale and welfare of unauthorized persons.
You should talk with you local ethics office as they will be able to act with more information than we can with the information provided here.