The Department of Defense (“DoD”) recently issued a memorandum to contracting officers (“COs”) providing guidance on the use of economic price adjustment (“EPA”) clauses to address inflation-related cost increases. The memorandum, entitled Guidance on Inflation and Economic Price Adjustments, comes as the year over year inflation rate rose to 8.6% for the month of May and contractors with fixed-price contracts seek ways to recover their rising costs. EPA clauses allow the parties to mitigate cost risks that present themselves as a result of circumstances beyond the contractor’s control, e.g., inflation and supply chain price fluctuations. Generally, an EPA clause will dictate that the Government bear the cost risk up to a mutually-agreed-upon ceiling. EPA clauses apply to the cost portion of a contract, but do not normally apply to the profit. DFARS PGI 216.203-4.

Memorandum: No CO Authority to Grant Contractual Relief Absent an EPA Clause

The memorandum states that, absent an existing EPA clause, COs do not have the authority to provide contractual relief for unanticipated inflation under a firm-fixed-price contract.

Some contractors who entered into contracts without EPA clauses have looked elsewhere in the FAR to solve their inflation woes. The FAR provides for equitable adjustments to contract terms based on government-directed changes to the contract through requests for equitable adjustment (“REAs”). However, the memorandum specifically disallows the use of REAs to address unanticipated inflation. The DoD reasons that inflation is not a CO-directed change to the contract and, therefore, REAs are not appropriate.

Although the memorandum does not have the force of law on these points, it will influence the actions of COs who are considering contractors’ attempts to recover for price increases.

Considerations for Use of EPA Clauses

The memorandum advises COs on when and how to include an EPA clause into a prospective contract. EPA clauses cannot be integrated into all government contracts. The memorandum advises COs that EPA clauses based on established prices or on the actual cost of labor and material may only be used when the contract term extends at least six months past the date of award. DFARS 216.203-4(1)(ii).

EPA clauses that are based on cost indices of labor and material (such as the Bureau of Labor Statistics Producer Price Index or the Employment Cost Index) may only be used when the contract demands that significant costs be incurred beyond one year after the start of performance. When a cost index is used to negotiate the price of the contract, the same index should be used to adjust the price under an EPA clause. The memorandum further advises COs to limit the scope of EPA clauses to those costs most likely to be impacted by inflation and to select narrow indices that are specifically relevant to contract performance, such as the North American Industry Classification System (“NAICS”) Product Codes.

The memorandum stresses that any EPA clause should be fair to both parties. Contractors should be mindful to ensure that an agreed-upon EPA clause include both a formula for the computation of authorized upward and downward adjustments, as well as a list that clearly identifies the events that trigger the EPA clause.

For more information, please contact Jennifer Harris at 202.293.8815.