Traditionally, a fixed price government contract is one in which the contractor absorbs the risks and costs of performance. Absent an economic price adjustment (EPA) clause in the contract, an unforeseeable event, such as a force majeure, or government imposed contract change, the contractor is stuck with the benefit or lack of benefit of the particular contractual bargain. In a cost reimbursement contract, while actual allowable, allocable and reasonable costs will be captured and paid, any fee contemplated to address the risks of performing that commitment are typically low.
However, the current landscape is not a normal one. It may be due to the COVID-19 pandemic sickness, restrictions and lockdowns, the war in Ukraine, China’s belt and road initiative, US spending of trillions of public dollars on entitlement programs, or something else, however, we see the impact in growing workforce, materials and product shortages. Economic theory aside, we know that so long as there is a continuing demand for limited services and supplies inflation will continue to grow. And, if price controls are instituted, they will not aid existing product shortages, and in fact may compound them.
No matter the cause, the public sector supply chain has been impacted by shortages of personnel, supplies, and services. Inflation has grown and the impacts on the public sector supply chain are multiplying. The result is that prices are increasing faster than normal and public sector contractors whose businesses traditionally do not command high profit returns on investment are finding that they cannot keep absorbing the costs of such unexpected increases without damage.
Contractors have voiced concern about the impacts of inflation to the Department of Defense (DoD) over recent months. Law360 reports that on May 25, 2022, John Tenaglia, Principal Director, DoD Defense Pricing and Contracting, issued guidance on addressing inflation and economic price adjustments in its government contracts. The three-page memorandum notes that “inflation is impacting several segments of our economy in varying degrees” and provides guidance on when EPA clauses can be used:
- For cost reimbursement contracts with Limitation of Cost or Limitation of Funding clauses, contractors are obligated to track and notify the Contracting Officer (CO) as they approach the limits of the contract’s funding. The contractor is not required to continue performance beyond what can be accomplished under that funding ceiling. The onus then is on the CO to determine whether to seek more funding in order to continue performance.
- For fixed price contracts with an EPA clause, increased costs covered by the clause will be addressed by the Government up to the limits set in the clause.
- The DoD memorandum provides that for current contracts “Since cost impacts due to unanticipated inflation are not a result of a contracting officer-directed change, COs should not agree to contractor REAs submitted in response to changed economic conditions.”
- The DoD memorandum does provide that COs may consider inclusion of an EPA clause in fixed price contracts “during this period of unusually high inflation” so that the contractor does not “develop pricing based on worst case projections to cover the cost risk attributable to unstable market conditions.” However, the memorandum provides that in crafting such a EPA clause, the CO should be “mindful that the impacts of inflation vary widely, depending on the nature of costs” and the appropriate EPA price index needs to be selected. The guidance also provides for adjustment up and down under the EPA clause.
- Any EPA clause placed in a contract will not apply to the profit portion of the contract.
The Government doesn’t want to pay more for existing fixed price contracts, even though it recognizes that there has been a change in circumstances. A careful read of the memorandum may provide contractors stuck with fixed price contracts and experiencing extreme impacts due to inflation and supply chain shortages some ideas for seeking relief. As noted above, the DoD recognizes the unusual nature of the current situation and its impacts on contract performance, costs and ability to perform. If these or other facts establish sufficient facts to seek cost, schedule, or other relief, an implied change might be considered.
We are following the various impacts of the current environment on the public sector supply chain. If you have questions on this advisory or other government contracts matters, contact Susan Warshaw Ebner or your Stinson counsel.