It is probably more insidious than that, John O. It sounds like the contractor was approached not by the DoD contracting officer, but by the DSS. Those guys control the clearances. If they question your fitness, or your company’s fitness (by extension) and pull clearances, jobs are lost.
Companies can challenge contracting officer’s actions in court. I do not know how you challenge clearance issues.
When it comes to clearances, contractors will jump and not even ask if they can come down, much less how high.