The Department of Defense (DoD) has released guidance to the contractor community on how to handle cost differences under different contract agreements as rising inflation rates have led to increased costs for contractors under existing agreements, and what the Pentagon is looking for in economic price adjustment clauses that reflect inflationary pressures.
DoD explained that with cost reimbursement-type contracts, the government bears most of the risk of increased costs, including those caused by inflation. On the other hand, contractors performing under firm-fixed-price (FFP) contracts must bear the risk of cost increases.
“For contracts being developed or negotiated during this period of unusually high inflation, an EPA [economic price adjustment] clause may be an appropriate tool to equitably balance the risk of inflation between the government and contractor,” DoD wrote in the latest guidance.
This 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” due to an EPA’s built-in mechanism to mitigate that risk, the Pentagon said.
Because the impacts of inflation vary widely, DoD suggested that contracting officers (COs) be mindful of that when crafting an EPA clause. Additionally, the agency said, COs should limit the scope of the EPA to those costs most likely to be impacted by inflation, and exclude costs that are not likely to be impacted.
According to the guidance, an appropriate EPA clause will be equitable for both parties and will:
- Allow for upward and downward revision of the contract price upon the occurrence of specified contingencies;
- Use the same index in establishing the negotiated price and to adjust the negotiated price under the terms of the clause; and
- Incorporate a ceiling and a floor on adjustments of the same magnitude.
“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,” wrote DoD. “The guidance contained in this memo is applicable to any clause that results in cost or price changes due to changed economic conditions.”
