On May 25, 2022, the Department of Defense (DOD) issued Guidance on Inflation and Economic Price Adjustment (Guidance Memorandum). It was long overdue. Inflation is steadily rising and, as a result, contractors with fixed-price contracts are forced to shoulder skyrocketing supply costs since fixed-price contractors bear the risk of increased costs. As these cost increases erode profit margins and continue to drive contracts into loss positions, contractors are seeking some type of relief. PilieroMazza recently hosted a webinar, Supply Chain Pain: How Contractors Can Get Relief from a Supply Chain-Related Claim, detailing relief options and best practices when a contractor faces inflation and supply chain delays. DOD previously provided some high-level thoughts about inflationary problems facing contractors in a letter to Congress. But now, DOD has added policy-level direction to contracting officers detailing the agency position on allocating inflation risks in ongoing contracts and new contracts. Contractors affected by inflation on their federal contracts should pay close attention to this guidance as they negotiate and enter new government contracts.
DOD Confirms Willingness to Include EPA Clauses in New Contracts
The Guidance Memorandum offers hope to contractors currently negotiating contracts. It highlights that “DOD contractors and contracting officers (COs) alike have expressed renewed interest in using economic price adjustment (EPA) clauses.” Beyond that, it confirms that “an EPA clause may be an appropriate tool to equitably balance the risk of inflation between the Government and contractor.” In particular, DOD notes that an EPA clause might be appropriate in contracts that will not be performed within the next six months. This direction provides COs with no new authority; FAR 16.3203-2 already allows adding an economic price adjustment clause when (i) there is serious doubt about the stability of market or labor conditions that will exist during an extended period of contract performance, and (ii) contingencies that would otherwise be included in the contract price can be identified and covered separately in the contract. Nonetheless, the Guidance Memorandum will likely make convincing COs to use that authority an easier proposition.
Beyond encouraging the use of an EPA clause, the Guidance Memorandum also offers direction to COs regarding how to appropriately craft an EPA clause. It stresses several key factors, including:
- considerations for selecting an index to measure inflation that is linked to cost components that are most unstable;
- limitations on the scope of the EPA to exclude costs that are unlikely to be affected by inflation;
- allowance for both upward and downward adjustments in price; and
- establishing formulas for calculating the new pricing instead of merely reopening price negotiations.
DOD Signals Unwillingness to Adjust Existing Contracts
On the other hand, the Guidance Memorandum offers sobering advice for contractors with existing fixed-price contracts. It parrots the position used by many contracting officers that “[i]n the absence of an applicable contract clause, such as an EPA clause authorizing a contract price adjustment as a result of inflation, there is no authority for providing contractual relief for unanticipated inflation under an FFP contract.” Based on that policy, the Guidance Memorandum reinforces that without an applicable contract clause or change, contracting officers may not agree to a contractor’s requests for equitable adjustment. This unfortunate decree aligns with the advice provided during our webinar, telling contractors that they should ground any demands for adjustments in either (a) an economic price adjustment clause; (b) an alternative contract clause that authorizes price adjustments; or (c) by identifying some government direction that can be construed as a change or government-caused delay.
This guidance comes across as disingenuous given the statements DOD previously made to Congress. In early May, DOD responded to a list of Congressional questions. In that response, DOD attempted to obfuscate the problem of contractors facing inflation, claiming that contractors had filed few requests for equitable adjustment due to inflation. But it is unclear why DOD expected contractors to file such adjustment requests given that DOD previewed—and now in the Guidance Memorandum, officially confirmed—that contracting officers should not grant equitable adjustments without EPA clauses. Instead of providing relief under the current contract, DOD told Congress that it expects contractors to raise prices on future contracts to make up for those losses—separate from any price increases needed to accommodate risk.
As mentioned earlier, government contractors should review and understand the implications of the Guidance Memorandum prior to bidding for their next contract and pursuing relief under current contracts. There are at least three key takeaways:
- Contractors should push contracting officers to add EPA clauses to any solicitation but may want to target those requests to adjustments for the component(s) with the most instability.
- Contractors should couch any request for adjustments of current contracts on a contractual provision or other government action that entitles contractors to relief (i.e., changes/delay).
- Contractors should consider raising prices for future contracts to make up for the increased inflationary costs incurred on current contracts.