DoD Issues Memo on Inflation and Economic Price Adjustments
On May 25, 2022, the Department of Defense ("DoD") issued a memorandum entitled, Guidance on Inflation and Economic Price Adjustments, to help contracting officers ("CO") "understand whether it is appropriate to recognize cost increases due to inflation under existing contracts as well as offer considerations for the proper use of [economic price adjustment or EPA] when entering into new contracts." Contractors should heed this memo and take action where appropriate.
For DoD contracts, the memo says that the treatment of inflationary cost or price increases will depend on the contract type. For example, the memo provides the following guidance:
Cost reimbursement – the Government bears the risk of increased costs, including those due to inflation.
Fixed-price incentive (firm target) (FPIF) – the contractor’s actual (allowable and allocable) costs are recognized up to the contract ceiling.
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).
Firm-fixed-price (FFP) – contractors generally must bear the risk of cost increases, including those due to inflation. In 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.
Notably, under FFP contracts, the memo provides that COs should not agree to contractor REAs submitted in response to changed economic conditions because increased inflationary costs aren't the result of a CO-directed change. For contracts that are being developed or negotiated, the memo states that an "EPA clause may be an appropriate tool to equitably balance the risk of inflation between the Government and contractor." The memo likewise provides that "COs must be cognizant that any clause addressing potential contract cost or price changes due to economic conditions, e.g. inflation, is effectively an EPA clause, whether or not the term EPA appears in the clause."
Takeaway
The DoD memo is welcome news for contractors as it provides a roadmap on how DoD intends on handling inflationary impacts in defense contracts. To that end, contractors should review their contracts for EPA clauses (or other similar language) and seek modifications where such language is absent. Similarly, contractors may also look to changes and delays clauses for potential relief. Prospective offerors, on the other hand, should request that procuring officials – through the Q&A process, email, etc. – insert EPA clauses in solicitations for upcoming procurements.
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