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Whip Inflation Now: DoD Announces Guidance With Key Points for Contractors

By on June 9, 2022 | Posted in

On May 25, 2022, the Department of Defense (DoD) issued a memorandum to guide contracting officers and Government contractors on how to deal with the high inflation currently impacting the U.S economy.  See DoD Memo, “Guidance on Inflation and Economic Price Adjustments, (DoD Memo). Against the backdrop of rising fuel and materials prices, “DoD contractors and contracting officers (COs) alike have expressed renewed interest in using economic price adjustment (EPA) clauses.”  The DoD memo provides guidance on “whether it is appropriate to recognize cost increases due to inflation under existing contracts as well as offer considerations for the proper use of EPA when entering into new contracts.”

Key Takeaways

Importantly, the memo provides considerations for using EPA when the Government solicits new contracts.  The guidance is helpful and, while citing to the DFARS, reiterates the basic rules applicable to all Government contracts under the FAR.

  • Going forward, Contracting Officers should consider including an EPA clause in fixed-price contracts to combat the effects of inflation.
  • Contractors should consider requesting that the CO include an EPA clause in new solicitations for fixed-price contracts.
  • The DoD Memo specifically states that Requests for Equitable Adjustment (REAs) solely due to inflation will not be considered for current firm-fixed price contracts.
  • So for existing firm-fixed price contracts, Government contractors should seek REAs under existing contract clauses that allow for REAs and thereby capture inflation in an REA.

The Type of Contract is Key

The memo highlights the fundamental rule that treatment of inflationary costs depends on contract type.  For instance, for cost reimbursement contracts, contractors should inform the DoD that the costs incurred are closing in on the limits specified in the contract.  “Contractors are responsible for promptly notifying the CO that the costs incurred are approaching the limits specified in the applicable clause, as applicable under Federal Acquisition Regulation (FAR) clause 52.232-20, Limitation of Cost, or FAR clause 52.232-22, Limitation of Funds.”  Upon notification, the DoD may raise contract funding but the contractor is not obligated to continue contract performance beyond what can be carried out within the contract’s funded amount.  Naturally, these FAR clauses apply to non-DoD cost type contracts.

On the other hand, for fixed-price incentive (firm target) (FPIF) contracts, the memo explains that the Government may adjust the target profit in the event that the Government contractor’s costs differ from the target costs.

Under “fixed-price contracts with economic price adjustment (FPEPA), the EPA clause normally establishes a mechanism to mitigate specifically covered cost risks to both parties as a result of industry-wide contingencies beyond any individual contractor’s control; the Government will bear the cost risk up to the limit specified in the clause (if any).”

For firm-fixed-price contracts (FFP), the memo states Government contractors bear the risk of cost increases including those associated with inflation.  The DoD is currently “fielding questions about the possibility of using REAs under FFP contracts to address unanticipated inflation,” but the memo goes on to say Contracting Officers should “not to agree to contractor REAs submitted in response to changed economic conditions.”

Economic Price Adjustments

The DoD memo does address how EPAs can be used by the CO to balance the risk of inflation under FFP contracts.  “For contracts being developed or negotiated during this period of unusually high inflation, an EPA clause may be an appropriate tool to equitably balance the risk of inflation between the Government and contractor.”  The memo states:

Including an EPA clause may enable a contractor to accept a fixed-price contract without having to develop pricing based on worst case projections to cover the cost risk attributable to unstable market conditions because of the EPA clause’s built-in mechanism to mitigate such risk. COs should consider contract length as one of the primary considerations when deciding whether to use an EPA clause. Defense FAR Supplement (DFARS) 216.203-4(1)(ii) indicates EPA clauses based on established prices or on the actual cost of labor and material should only be used when delivery or performance will not be completed within six months after contract award. FAR 16.203-4(d)(1)(i) limits use of EPA clauses based on cost indices of labor and material to contracts with an extended period of performance, with significant costs to be incurred beyond one year after performance begins.

EPAs thus may allow contractors to whip inflation now and should be a consideration for COs following the new guidance, and contractors should raise the DoD Memo with the CO for upcoming procurement requirements.  If an EPA clause is not in the contract solicitation, contractors should consider asking the CO to include it.

What to Do on Existing Firm Fixed Price Contracts Without EPA

Unfortunately, the EPA is not an option on existing firm-fixed price contracts.  On existing FFP contracts, Government contractors should seek REAs under existing contract clauses such as the Changes or Suspension of Work clauses and thereby include inflation in that REA.  Therefore, knowledge of contract administration fundamentals like providing prompt notice to the Government that an REA will be sought under the appropriate contract clause is more important than ever.

For more information about DoD’s guidance on inflation and EPA clauses in contracts, please contact Howard Roth at (206.467.7461) or Jedidiah Blake at (206.667.0650) with the Oles Morrison Government Contracts law team.