Climate and inflation come home to roost on federal contractors

Contractors have only a couple more weeks to comment on a so-called climate risk rule. If it becomes final, the rule would impose big reporting and operational costs. This as the Pentagon and the industry are trying to figure out how to deal with inflation-related upswings in costs. To help sort it all out, the Federal Drive with Tom Temin  spoke with Haynes Boone procurement attorney Zach Prince.

Interview transcript:

Tom Temin
Let’s get into this issue of this climate rule. This is for everybody. And it’s not just necessarily reporting, but also you might have to do things differently. Tell us about it.

Zach Prince
That’s right, Tom. So there are two categories of contractor that this rule would apply to. There are significant contractors and major contractors. It’s challenging to define, exactly, what either of these two are, because the rule is not very well written. A significant contractor is, a contractor that’s received $7.5 million to $50 million in federal contract obligations, in the prior federal fiscal year. I’m not sure what a federal contract obligation is. It’s not a well defined term. So whether that means that a contractor has actually received payment of those amounts. Or it means the contractor has received contract awards, that are valued up to those thresholds, like it would be for the cost accounting standards or similar far rules. It’s totally unknown.

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Tom Temin
All right, so we don’t know precisely who it would affect at the two levels. But what would it do once that’s figured out?

Zach Prince
So once that’s figured out, on an annual basis, significant contractors, that is the ones that receive 7.5 to $50 million the prior year in whatever that means. They would have to report their scope one and scope two greenhouse gas emissions, it’s going to be challenging for them to figure out exactly what that entails. But it’s something that they’ll have to get a handle of fairly quickly.

Tom Temin
Yes, because I keep asking this question, if you are a services contractor and you are providing our labor based types of contracts, what are you doing? People driving to work? Is that what it is? Or maybe the boss had too many beans for lunch? What do they mean by these emissions, in that context? It’s not like you’re pouring steel and delivering it by diesel truck to a train.

Zach Prince
So it seems that the rule applies to manufacturers, not to serve as contractors. But that’s one of the points that the fire council needs to clarify in it’s the next step before there’s any final rule.

Tom Temin
And what about those that are neither service contractors nor manufacturer? Suppose you are a reseller and there is some delivery component and you represent manufacturers, that’s how a lot of product gets into the government. What about those people? We have to wait and see?

Zach Prince
We have to wait and see. These are some of the many questions that the comments should be raising with the agency.

Tom Temin
And with respect to those different levels of reporting of CO2 and emissions. What do those entail, say, if you are a manufacturer? What do we know about, what it is you’re going to have to do?

Zach Prince
Scope one and two looks at your own emissions. Scope three is a much more challenging issue to get a handle on. And scope three reporting is going to be applicable to major contractors, that is entities with 50 million or more. And that requires going into your supply chain and figuring out emissions that are as a consequence of your activities. And that begs the question of, how do you get that information from your supply chain? Are you going to have to flow down clauses? How are you going to have to flow those down? How do the subs figure out how they’re allocating greenhouse gas emissions to a particular purchaser? None of these are easy to answer.

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Tom Temin
Or how do you know what they are from any source, at all in the first place?

Zach Prince
That’s right.

Tom Temin
And what about any consequential actions? Suppose you are able to figure out well, this contract and this deliverable is emitting 6.2 tons of CO2 per quarter? So what?

Zach Prince
if you’re a major contractor, that means you have to establish targets for reductions that align with the Paris Agreement?

Tom Temin
I see. So you can’t say well, next month, it’s going to be seven tons, it’s got to go down.

Zach Prince
Well, you have to establish target. But the rule is unclear about what happens if you don’t start meeting those targets.

Tom Temin
At this point, then what should, in your opinion, contractors be doing? Just following step by step, what’s going on and probably, I would say comment.

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Zach Prince
That’s exactly right. And I’d say get involved with an organization, that’s going to be submitting comments. National Defense Industrial Association and Professional Services Council, for example and others and the [American Bar Association (ABA)] is going to be submitting comments. Pretty much every major organization that’s involved in this area is going to submit comments, because this is really critical.

Tom Temin
And if you go through the associations, they’ll take all the swear words out and keep you honest there. Were speaking with Zach Prince. He’s a partner at the law firm, Haynes and Boone. And another matter I wanted to ask you about is, this unclear issue, section 822, of the most recent National Defense Authorization bill for 2023. And the idea of compensating contractors for inflation induced rises in cost. There’s some question as to, How widespread that will be? and What kinds of contracts it applies to?

Zach Prince
That’s right. And inflation relief is something that we’ve talked about a few times already in the past year, it’s on everybody’s mind, who’s in this space. Historic levels of inflation, they seem to be coming down a bit. But if you’re operating under a fixed price contract, where the pricing was established years ago, you didn’t build in contingency for, completely, ahistorical inflation pressures. Last year, [Department of Defense (DoD)] came out with two memos. One said, you’re out of luck, if you want to get any relief. There’s no basis for it. The second one said, actually, maybe there’s some relief that can be granted, in exchange for some quid pro quo. It wasn’t clear what that entailed. Or contractors could always apply for extraordinary contract relief, under Public Law 84 805. But that is, really, rarely granted. So in response, Congress heard the complaints of industry. They added the Section A 22, to the National Defense Authorization Act last year, that would allow DoD discretion to grant contractors and subcontractors under fixed price contracts, some relief, to the extent that inflationary pressures increase their costs beyond price. But it’s dependent on a couple factors. One, it’s totally discretional. Two, the NDAA is not an appropriations bill. So it expressly says, this depends on there being appropriated funding available for use by DoD. And it has a time period, it only runs through the end of next year. And it can’t be implemented until DoD puts out guidance, which they have to do within 90 days.

Tom Temin
Right. This raises a lot of questions surrounding DoD. One, is their money for that? Just as a parallel question in a different domain, the replacement munitions and systems for delivery from the extraction of our stockpiles that have gone to Ukraine. Nobody knows where that money is coming from, or whether they’ll replenish and so forth. So really, the increase in the budget for DoD in the coming year, it hasn’t really sifted out to where that money’s precisely going to go.

Zach Prince
It’s an unfortunate problem. And it’s a disconnect that often happens in the space where you have authorization on the one hand, for laudable policy goals, but it doesn’t come with money. And you can’t commit the government to anything without available appropriations, it’s actually a crime by the agency person who does it.

Tom Temin
And I guess it’s fair to say then, here too, that if you’re a contractor, if you’re worried about this, the least you should be documenting your costs and cost increases that seem inflationary. So you’re prepared for what might come down the pike.

Zach Prince
Get ready, because the money for this is going to be limited, and the time is limited. So you want to be engaging with your customer early, to try to make sure you can be one of the lucky few who actually get relief under the statute.

Tom Temin
I guess, if you’re the person who supplies the omelet breakfasts, in the Pentagon and what we’ve seen with the cost of eggs, you’ve probably got a pretty good case for a price escalator, given what a dozen eggs cost nowadays.

Zach Prince
That’s right.

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