Material Escalation: A Difficult Road to Recover Costs

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The annual inflation rate in the United States rose 7% in 2021, its highest rate since 1982.  The construction industry has not been immune from this general trend, with steel prices rising 200% and lumber prices soaring as high as 288% at different points in 2021.  Usually when confronted with such an extreme economic situation, businesses generally pass on at least some of the additional costs to consumers.  Federal contractors performing on a firm-fixed-price contract don’t usually have the same option.  This article discusses options for federal contractors performing on firm-fixed-price contracts, including three exceptions to the general rule.

The General Rule and Three Exceptions

The FAR explains that “[a] firm-fixed-price contract provides for a price that is not subject to any adjustment on the basis of the contractor’s cost experience in performing the contract. This contract type places upon the contractor maximum risk and full responsibility for all costs and resulting profit or loss.”  FAR 16.202-1.  Thus, the general rule is that a contractor assumes the risk of increased costs in a firm-fixed-price contract.  Exceptions to this rule include: (1) the contract contains an economic price adjustment clause (EPA); (2) government-caused delay forces performance of the contract into a period of increased material costs; or (3) the contract contains a force majeure clause permitting additional time

1. Economic Price Adjustment Clause

Under a firm-fixed-price contract, the general rule is that the risk of increased costs is attributable to the contractor, unless the contract contains an EPA clause.  Such a clause, “provides for upward and downward revision of the stated contract price upon the occurrence of specified contingencies.”  FAR 16.203-1.

Recently, in Appeal of KF&S Corp., ASBCA No. 62223, 21-1 B.C.A. ¶ 37759 (Dec. 9, 2020), the Armed Services Board of Contract Appeals (ASBCA) found that a contracting officer’s (CO) “intentional exclusion” of an EPA clause precluded recovery of increased labor costs due to an increase of the minimum wage in Korea.  The ASBCA rejected the contractor’s argument that the CO was required to include an escalation clause noting it is, “well-settled that the contractor assumes the risk of cost increases in firm, fixed-price contracts, except as specifically provided for in the contract.”

Recovery for labor and materials is limited even in contracts that contain EPA clauses.  Under FAR 52.216-4(a), a contractor must notify the CO of a price change within 60 days by submitting a proposal for “an adjustment in the contract unit prices to be negotiated” along with “supporting data explaining the cause, effective date, and amount of the increase or decrease and the amount of the Contractor’s adjustment proposal.”

To obtain an adjustment, the net change in rate of pay for labor or materials must be at least 3% of then-current total contract price.  FAR 52.216-4(c)(3).  While the contractor may request multiple increases over time, there is an aggregate limit on the adjustments that may be granted in the amount of 10% of the original unit price.  Any adjustments are limited to labor rates and material unit prices listed in the contract Schedule.  In other words, a contractor is not entitled to an increase under FAR 52.216-4 without a unit price for the subject material in the Schedule.

2. Delay

Even without an EPA clause, a contractor may recover for increased material costs if government-caused delay forced performance of the contract into a period of higher costs.  For instance, in Appeal of — ADT Constr. Grp., Inc. by Timothy S. Cory, Chapter 7 Tr., ASBCA No. 57322, 15-1 B.C.A. ¶ 35893 (Feb. 12, 2015), the Board noted that “[t]he lack of an economic price escalation clause in the contract does not preclude a contractor from recovering damages for cost escalation incurred due to government-caused delays.”

Should a dispute end up in litigation, any recovery will depend on whether the contractor has adequately documented its costs.  The Boards of Contract Appeals and Court of Federal Claims will very carefully analyze cost documentation, and estimates are typically not sufficient to prove costs.  These cases are highly fact-specific, so it is important for contractors to provide proper notice to the government regarding its responsibility for delay.  The burden is on contractors to prove both that the government caused the delay and to document its costs for recovery.

3. Force Majeure and Doctrine of Impracticality

The FAR force majeure clause only allows contractors to obtain additional time and not additional costs.  FAR 52.249-10(b) provides that where a “delay in completing the work arises from unforeseeable causes beyond the control and without the fault or negligence of the Contractor,” then “[t]he Contractor’s right to proceed shall not be terminated nor the Contractor charged with damages.”  Courts generally reject attempts by contractors to rely on a force majeure clause to excuse performance due to increased costs.  For example, in Seaboard Lumber Co. v. United States, 308 F.3d 1283, 1294 (Fed. Cir. 2002), the court declined to excuse the contractor’s performance under a force majeure clause where a slump in the timber market made the contract unprofitable.

While courts generally reject attempts by contractors to rely on a force majeure clause to excuse performance due to increased costs, in rare cases, contractors have obtained relief for increased costs under the doctrine of impracticability of performance.  Courts and boards impose stringent standards for relief, and the basic test is whether the costs of performance of the work are so much greater than anticipated as to render the performance “commercially senseless.”  For instance, in GAI Consultants, Inc., ENGBCA 6030, 95-2 BCA ¶ 27,620 (Apr. 4, 1995), the board found commercial impracticability where excavation in the winter would have required “commercially unacceptable costs and time input far beyond that contemplated in the contract.”

Compare that to Jalaprathan Cement Co., ASBCA 21248, 79-2 BCA ¶ 13,927, where the board declined to find commercial impracticability when the contractor lost $208,408.59 on a fixed-price contract of $639,993.08.  In that case, the board analyzed impracticability not only in terms of the loss on the contract, but also the total loss on the contractor’s business, and found that the impact was not so crippling as to constitute commercial impracticability.  Courts and boards of contract tend to reject claims of commercial impracticability where they find the contractor assumed the risk of price increases.  In Brazier Lumber Co., ASBCA 18601, 76-2 BCA ¶ 12,207 (Nov. 12, 1976), the board noted that lumber price increases of between 130% and 155% after contract award were deemed normal business risks that contractor assumed.

Key Takeaways

In conclusion, without an EPA clause, contractors performing a firm-fixed-price contract face a difficult road to recover increased material or labor costs.  Notably, courts find that where there is no EPA clause, there is an assumption that the contractor assumed the risk for increases.  In these volatile times, contractors should carefully investigate whether an EPA clause is included in a firm-fixed-price contract prior to bidding.  Simply put, outside of extraordinary circumstances like government-caused delays, there will be no recovery for material or labor increases. 

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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