On May 25, 2022, the Department of Defense (“DoD”) issued a memorandum recognizing that contractors are not exempt from “exceptionally high” inflation. The memorandum titled “Guidance on Inflation and Economic Price Adjustments” provides guidelines on when compensation is appropriate for cost increases due to inflation and considerations for the proper use of economic price adjustment (“EPA”) conditions when entering into new contracts.
For existing DoD contracts, whether a contractor can get relief from inflation depends on the type of contract.
- Cost reimbursement agreements: As the government bears the risk of increased costs under cost reimbursement agreements, the government must increase the risk of inflation costs and, on notice, increase the contract money to allow for continued performance. Moreover, the contractor has no duty to continue the performance after the shortage of funds.
- Fixed price incentive contracts: DoD states that the contractor’s actual costs are recognized to the extent of the lease and that the actual cost is different from the target cost, the target profit margin is adjusted by applying the contract share ratio to costs over or under the target cost. .
- Fixed price contracts with financial price adjustment: The EPA clause provides a mechanism to mitigate costs involved 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 describing three scenarios in which DoD contractors may be able to recover inflation costs, DoD states that “contractors who work under fixed-price (FFP) contracts should generally have a risk of cost increases due to inflation.” This is not a surprise take from DoD. However, contractors with existing FFP contracts will be able to claim increased costs from any government-directed changes or delays, among other conditions, such as a change clause, a government delayed work clause, or a work suspension clause.
For new contracts currently under development or negotiated, the DoD says the inclusion of an EPA clause is an appropriate way to balance risks between the government and the contractor. Instead of limiting the inclusion of EPA clauses to cost-type contracts, the DOD says, adding an EPA clause in an otherwise fixed-price contract helps balance out inflation risks, encouraging contractors to accept fixed-price transactions. Unstable market conditions as proposals. DoD noted four additional guidelines for using EPA clauses in contracts.
- FirstIndexes for any EPA stipulation must be followed by “cost components that are assessed as highly unstable” because industries do not equally experience the effects of inflation.
- SecondEPAs should not affect the profitability of the contract.
- ThirdDoD should not use EPA stipulations on short-term transactions for a year or less.
- FourthEPA stipulations “are not one-sided, but fair to both parties. [and will] Allow the contract price to be revised upward and downward with the specified ceiling and the same amount of floor.
DoD says these guidelines are important to ensure that contract price adjustments are based on “pre-established formulas rather than simply reopening price negotiations.”
Thus, although contractors with existing fixed-price contracts may not be able to compensate for the increase in cost due to inflation, contractors must insist on adding an EPA clause to balance inflation risks during the process of negotiating their contracts.