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On May 25, 2022, the Department of Defense (“DoD”) issued a memorandum recognizing that contractors are not immune from the “period of unusually high” inflation. The memorandum, titled “Guidance on Inflation and Economic Price Adjustments,” provides guidelines on when relief from cost increases due to inflation is appropriate and provides considerations for the proper use of economic price adjustment (“EPA”) clauses when entering into new contracts.
For existing DoD contracts, whether contractors can get relief from inflation depends on the type of contract.
- Cost Reimbursement Contracts: Because the Government bears the risk of increased costs under cost reimbursement contracts, the Government must bear the risk of the inflation costs and, upon notice, the Government may increase the contract funding to allow for continued performance. Further, the contractor has no duty to continue performance once it runs out of funding.
- Fixed-Price Incentive Contracts: DoD states that the contractor’s actual costs are recognized up to the contract ceiling and to the extent the actual cost differs from the target cost, the target profit will be adjusted by application of the contract share ratio to the costs over or under the target cost.
- Fixed-Price Contracts with Economic Price Adjustment: The EPA clause provides a mechanism to mitigate covered costs for both parties outside of the contractor’s control. For this type of contract, the Government will bear the cost risk up to the limit specified in the EPA clause.
After explaining the three situations where DoD contractors may be able to recover inflation costs, DoD states that “contractors performing under firm-fixed-price (FFP) contracts generally must bear the risk of cost increases, including those due to inflation.” This is not a surprising take from DoD. However, contractors with existing FFP contracts may be able to seek increased costs from any Government-directed changes or delays under, among other clauses, the Changes clause, Government Delay of Work clause, or the Suspension of Work clause.
For new contracts currently being developed or negotiated, DoD states that inclusion of an EPA clause may be an appropriate way to equitably balance risks between the government and the contractor. Rather than limiting the inclusion of EPA clauses to cost-type contracts, DoD states that including an EPA clause in an otherwise fixed-price contract can help balance inflation risks, encouraging contractors to accept fixed-price deals without factoring the worst-case projections about the unstable market conditions into proposals. DoD noted four additional guidelines for using EPA clauses in contracts.
- First, indexes for any EPA clauses should follow “the cost components judged to be the most unstable” as industries are not feeling impacts of inflation equally.
- Second, EPAs should not affect the contract profit.
- Third, DoD should not use EPA clauses in short-term deals of a year or less.
- Fourth, EPA clauses “will not be one-sided, but will be fair to both parties . . . [and will] allow for both upward and downward revision of the contract price with a specified ceiling and floor of the same magnitude.
DoD states that these guidelines are important to ensure that contract price adjustments are based on “pre-established formulas rather than simply reopening price negotiations.”
Thus, while contractors with existing firm-fixed-price contracts likely cannot get relief from cost increases due to inflation alone, contractors in the process of negotiating their contracts should push for inclusion of an EPA clause to balance the risks of inflation during performance.