The Economic Price Adjustment Clause and Inflation

One of the hottest topics in defense contracting right now is the economic price adjustment clause and the effects this clause has on existing contracts due to inflation. Traditionally, subcontractors were required to go through their Prime to request price adjustment. But with the 2023 NDAA provision, this is no longer the case.

What does that look like? Let’s assume in 2017 you bid a 5 year contract at $100 with 3% annual escalation. In the fifth year, your cost is $112.55. Unfortunately, due to the rapid rate of inflation over the past several years, you are losing money. According to BLS’ CPI Inflation Calculator, that same $100 in 2017 is $122.22 in 2022. Imagine that difference multiplied on a multi-million-dollar effort? The loss of revenue is significant with major negative impact to your company. What are your options when the increase in your cost is due solely because of the recent rapid rate of inflation which could not have been predicted?

Cost-Type Contracts vs. Fixed-Price Contracts

Take a look at the type of contract you were issued. If you were fortunate enough to have a cost-type contract, the Government (or Prime if you’re a subcontractor with a cost-type subcontract) bears the risk of increased costs including those related to inflation.

If you have a fixed-price contract with an Economic Price Adjustment (EPA) clause, you likely have the mechanism at your disposal to mitigate your cost risk.

Typically, if you have a Firm Fixed Price (FFP) contract, you bear the risk of any cost increase, including an increase due to inflation. Memoranda issued by John Tenaglia, Principal Director, Defense Pricing and Contracting on May 25, 2022, and September 9, 2022, provide guidance to contracting officers regarding the range of options available to them to manage contractors’ ability to perform under firm-fixed-price contracts due to the impact inflation has had upon those in the Defense Industrial Base.

However, Section 822 of the National Defense Authorization Act (NDAA) for Fiscal Year 2023, Modification of Contracts to Provide Extraordinary Relief Due to Inflation Impacts, authorizes each DoD Secretary (Army, Navy, Air Force) pursuant to Public Law 85-804, Part 50, to afford Extraordinary Contractual Relief. This “relief”, however, does not come without certain requirements and is subject to “available funding”.

Public Law 85-804 was amended by Section 822 of NDAA FY2023 to temporarily permit contractors to request price adjustments when, “due solely to economic inflation”, the actual cost of performance exceeds the contract price. A significant provision is that a “covered subcontractor” may submit their requests directly to the contracting officer if a prime contractor does not.

The Downside

Don’t get too excited, there’s a “but” coming…this amendment is only effective if the Congress “specifically” appropriates funds to Section 822 of the NDAA. Presently, no funds have been appropriated. Additionally, any relief granted, if funds are appropriated, is at the discretion of the contracting officer.

The DoD is required to issue guidance by the end of March 2023 on how it plans to implement this temporary authority. We will post an update when this information becomes available.

Finally, this temporary authority expires December 31, 2023.

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