Tuesday Insight – June 7th, 2022: How the Pentagon Plans to Manage Inflation Costs in Contracts

Jun 13, 2022

The Defense Department urged contracting officers to “be mindful” of the varying impacts of inflation and “limit the scope” of equity pay adjustment clauses, according to new guidance.

The Defense Department knows cost increases due to inflation may begin to affect contracts. But, according to recent guidance, defense contracting officers are urged to “limit the scope” when using clauses for pay adjustments.

“The current economic environment requires we understand the impacts of inflation to existing contracts and consider various approaches to manage risk of inflation to prospective Department of Defense (DOD) contracts,” John Tenaglia, the principal director for Defense Pricing and Contracting, wrote in a memo dated May 25.

“Against this backdrop, DOD contractors and contracting officers (COs) alike have expressed renewed interest in using economic price adjustment (EPA) clauses.”

Handling cost increases for existing contracts depends on the contract type and contractors are responsible for notifying DOD when costs are approaching the limits laid out in those agreements, the memo states. But an EPA clause could be a solution, when approached with care, for developing contracts or those in negotiation.

“For contracts being developed or negotiated during this period of unusually high inflation, an EPA clause may be an appropriate tool to equitably balance the risk of inflation between the Government and contractor,” Tenaglia wrote. “In crafting an EPA clause, COs must be mindful that the impacts of inflation vary widely, depending on the nature of costs…the CO should take care to use an index that is closely related to the cost components judged to be most unstable.”

The document also stresses 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.” Also, contracting officers should “limit the scope” of such clauses to “costs most likely to be impacted by economic fluctuations and should exclude costs that are not likely to be impacted by inflation from adjustment under the clause,” such as depreciation, or labor costs where a union agreement exists.

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