Impending Tariffs Could Increase Cost of Performance, but Remedy-Granting Clauses May Allow for Price Adjustments

Federal ProcurementAs talk of a trade war escalates, government contractors should be alert to the possibility that the recently imposed steel and aluminum tariffs could increase their cost of performance.  The orders, signed March 8, 2018, impose a 25 percent tariff on imported steel and a 10 percent tariff on imported aluminum, with exemptions for imports from Canada and Mexico.  The tariffs took effect March 23.  Increasing the cost of imported materials will in varying degrees lead to price increases when manufacturers of finished goods who rely on those materials are able to pass their increased material costs to consumers.  But this may not be feasible for government contractors with firm fixed-price contracts and options, and it also could affect certain flexibly priced contracts, including cost-type contracts with incentive fee provisions.  The tariffs may also indirectly increase the price of domestically produced steel and aluminum by reducing competition from foreign sources.  In addition, the tariffs may lead to temporary shortages while foreign suppliers sell their products overseas on more favorable terms and domestic suppliers are still ramping up their production to fill the gap.  With these potential effects looming, contractors have to consider the remedies they may be entitled to pursue.

To protect themselves, contractors should first consider whether the new tariffs will affect their contracts.  If so, they should evaluate the terms of their contracts to determine whether they contain clauses that will allow them to recover.  If not, contractors should weigh other available options.  If the tariffs lead to shortages, contractors may also need to seek appropriate schedule relief.  Going forward, contractors may need to factor increased cost and performance risk into their bids and proposals.

Consider Whether and How Tariffs Affect Your Contract Tax Provisions

The FAR’s tax provisions may provide the best solution to the tariff issue, at least in the first instance.  FAR 52.229-3 – “Federal, State and Local Taxes” provides for a price increase for after-imposed taxes that a contractor is “required to pay or bear as the result of legislative, judicial, or administrative action taking effect after the contract date.”  Covered taxes include “any new or increased Federal excise tax or duty,” FAR 52.229-3(a), which likely includes the new tariffs.  FAR 29.401-3 calls for the inclusion of FAR 52.229-3 in solicitations and contracts if (1) the contract is to be performed in the United States; (2) a fixed-price contract is contemplated; and (3) the contract is expected to exceed the simplified acquisition threshold.  This may eliminate the risk under at least some fixed-price contracts.  However, contractors should keep in mind that FAR 52.229-3(g) requires contractors to “promptly notify the Contracting Officer of all matters relating to any Federal excise tax or duty that reasonably may be expected to result in either an increase or decrease in the contract price and shall take appropriate action as the Contracting Officer directs.”  Thus, if and when a contractor determines that the new tariffs “reasonably may” affect its pricing, it should provide prompt notice to the relevant contracting officer.

Economic Price Adjustment Clauses

If the tax clauses are unavailing – for example, where a contractor experiences increased costs from domestic suppliers due to secondary market effects – the FAR’s Economic Price Adjustment (“EPA”) clauses might provide an alternative remedy.  Those clauses are included in fixed-price contracts “for upward and downward revision of the stated contract price upon the occurrence of specified contingencies.”  FAR 16.203-1(a).  There are several types of economic price adjustments, each with its own contract clause, so it is essential to determine which – if any – is included in a given contract.  For example, the typical clause for “Labor and Material” calls for the Contracting Officer to negotiate a price adjustment upon receiving notice of a price change.  FAR 52.216-4(b).  Because contractors normally must provide that notice within 60 days, it is essential to be on the alert for any price increases and to provide prompt notice to the government to avoid timeliness or waiver problems.  FAR 52.296-4(a).  Even where relief is available under one of the EPA clauses, upward adjustments usually are limited to 10 percent of the unit price.  FAR 52.216-4(c)(4).  Thus, these clauses may not provide complete relief if the new tariffs lead to major price hikes by domestic suppliers who now face reduced competition.

For Department of Defense contractors, the Department of Defense FAR Supplement provides additional guidance on price adjustments for basic steel and aluminum products and for nonstandard steel items.  See DFARS 216.203-4-70; 252.216-7000; 252-216-7001.  As with the FAR clauses, the DFARS clauses require prompt notice to the Contracting Officer and impose a 10 percent maximum on the price increases.  A contractor seeking a price adjustment may also be required to show its math, including by making available all relevant records used in the computation.  See DFARS 252.216-7001(f)(3).

Although EPA clauses may offer a solution for some contractors, not all contracts contain them.  Contractors should carefully review their contracts for EPA clauses that may allow a price increase in light of escalating material costs.

Other Remedies

Other remedies are limited.  In particular, any claim based on a changes clause or breach of contract theory is unlikely to succeed.  Contractors frequently turn to the changes clauses when government action interferes with their ability to perform the contract as agreed.  Those remedy-granting clauses recognize that the government has extraordinary power to unilaterally change the terms of its contracts, and, in return, contractors are entitled to an equitable adjustment in the contract price or schedule.

Here, the government has not formally changed the contract.  Instead, government conduct has had the effect of indirectly increasing the cost of performance; therefore, contractors considering this path must show that a “constructive change” has occurred.  A constructive change occurs when the government has taken actions that have the same effect as a written change order signed by the contracting officer.  However, the imposition of new tariffs likely does not fit within the language of the changes clauses.  See FAR 52.243-1 to 7.

The changes clauses identify the possible modifications or events that could qualify as a constructive change.  For example, FAR 52.243-1 applies to fixed-price contracts when government action has the effect of modifying the specifications, the method of shipment or packing, or the place of delivery.  Similarly, FAR 52.243-3 applies to time-and-materials or labor-hours contracts when government action modifies the description of services to be performed, the time of performance, the place of performance of the services, specifications for supplies, the method of shipment or packing of supplies, the place of delivery, or the amount of government-furnished property.  None of the modifications identified in the changes clauses address the imposition of new tariffs.  Therefore, it is unlikely that the new tariffs would qualify as a constructive change.

Moreover, under the Sovereign Acts Doctrine, the United States Government is not liable for breach of a contract made by a public and general act within its sovereign power.  The enactment of a tariff likely falls under this doctrine, which stems from the Court of Claims’ venerable decision in Deming v. United States, 1 Ct. Cl. 190 (1865).  In Deming, the court held that the United States is not liable for losses caused by duties imposed by Congress after the contract was formed.  The facts of the case are relatively straightforward.  Deming entered into a contract to provide rations to the Marine Corps.  After the contract was formed, Congress imposed an additional duty on some of the supplies needed to perform the contract.  As a result, Deming performed the contract at a loss.  He claimed that the government’s action imposed new conditions upon his performance of the contract, which caused him to suffer monetary damages.  The court differentiated between the government acting as a party to a contract and the government “exercising its sovereign power of providing laws for the welfare of the State.”  Deming, 1 Ct. Cl. at 191.  In dismissing the case, the court explained that “[a] contract between the government and a private party cannot be specially affected by the enactment of a general law.  The statute bears upon it as it bears upon all similar contracts between citizens, and affects it in no other way.  In form, the claimant brings this action against the United States for imposing new conditions upon his contract; in fact he brings it for exercising their sovereign right of enacting laws.”  Id.  The upshot is that – in the absence of contract provisions such as the Federal, State, and Local Taxes clause or the Economic Price Adjustment clause – the government cannot be made to pay for the financial consequences of a generally applicable tax or duty.

Side Effects:  Shortages and Schedule Delays

In addition to the obvious financial consequences, one potential side effect of the tariffs may be shortages and resulting schedule delays.  While the tariffs are intended to bolster domestic steel and aluminum production, they may create a temporary reduction in the availability of steel and aluminum as foreign suppliers look elsewhere to sell their products on more favorable terms, and domestic suppliers have not yet increased their production capacity to supply domestic needs.  If so, contractors may face schedule delays due to an inability to acquire necessary materials.  Fortunately, those delays may be excusable.

 Excusable delays in fixed-price supply and service contracts are governed by the Default clause contained in FAR 52.249-8(c), which states that “the Contractor shall not be liable for any excess costs if the failure to perform the contract arises from causes beyond the control and without the fault or negligence of the Contractor.”  The clause provides a list of examples that would entitle a contractor to an excusable delay, which includes “acts of Government in either its sovereign or contractual capacity.” FAR 52.249-8(c)(2).  Similarly, excusable delays in fixed‑price construction contracts are dealt with in the Default clause in FAR 52.249-10(b), which states that “[t]he Contractor’s right to proceed shall not be terminated nor the Contractor charged with damages under this clause if – (1) the delay in completing the work arises from unforeseeable causes beyond the control and without the fault or negligence of the Contractor.” Such causes may include “acts of the Government in either its sovereign or contractual capacity.”  FAR 52.249-10(b)(1)(ii).

Consistent with these clauses, the courts and boards have recognized that a contractor that experiences supply shortages beyond its control is entitled to a schedule extension.  For example, in J.D. Hedin Construction Co. v. United States, 408 F.2d 424, 428-30 (Ct. Cl. 1969), the Court of Claims decided that a delay  caused by an unforeseeable cement shortage may give rise to an excusable delay.  And in Maverick Diversified, Inc., ASBCA No. 19454, 75-1 B.C.A. (CCH) ¶ 11114 (Feb. 12, 1975), the Armed Services Board of Contract Appeals recognized that, where a contractor establishes that a steel shortage is the cause of its delay, that delay is excusable.

What the Future Holds

 To quote the Magic Eight Ball, the picture is cloudy for the future of the tariffs, with any number of consequences both intended and unintended.  Given this uncertainty, contractors not only should stay alert for possible effects on their existing contracts, they also should weigh the price and performance risks posed by their new proposals and closely examine the remedy‑granting clauses included in the resulting contracts.

Even contractors who use no steel or aluminum in their products may see ricochet effects if the new tariffs lead to retaliatory measures such as reductions in foreign government purchases of U.S. defense and aerospace technology and platforms.  If a tariff squabble becomes a trade war, those purchases may become one of the front lines.  That unintended consequence might eventually become the tariffs’ most significant effect on U.S. defense and aerospace contractors.  Unfortunately, it is also an effect for which the FAR offers little or no recourse.