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Dealing with spiraling costs

In a fast-moving world where prices are rising at a pace not seen in decades, firms are
struggling to keep pace and, worryingly, stay in business. The natural reaction to rising
prices is to pass on cost directly to customers. However, that’s not always possible,
especially when dealing with commercial customers.

James Crayton, partner, and head of commercial at Walker Morris, says that firms should
initially assess their current commercial arrangements to get a fix on the current position.
He says that “while the simplest mechanism is a fixed price, often more detailed
mechanisms to determine price are included in longer term agreements and you should
assess if this price is broken down into components which may be able to be changed.”

Price indexation

But if the contract specifies a fixed price, then he advises considering if the contract contains provisions with regard to price indexation. “With such a clause,” says James, “the contract will provide for the price to increase in relation to an index, such RPI or CPI.”

And with general price reviews or adjustments, there needs to be an express clause in the
agreement that provides the right to do so. James adds that the contract may contain
provisions for an annual price review, but “these tend to be about setting a framework for
prices to be agreed, rather than a unilateral right to increase.”

Force Majeure
Next is the force Majeure clause. It is not a ‘get out of jail free’ card but may, in some
circumstances, suspend a party’s obligations when they are prevented from completing an
agreement by events outside of their control. Sometimes it includes rights to terminate.
James says that these events are often listed within the clause or definition. He notes,
however, that “the supplier would need to demonstrate that circumstances beyond its
control prohibit it from complying. A general change in the economic climate or market
conditions affecting profitability is not likely to be considered a force majeure event.”

And where there is no force majeure clause, James says that a supplier “may have to rely
on the doctrine of frustration, which is notoriously limited in its application.” In essence, this can set aside a contract where an unforeseen event either renders contractual obligations impossible, or radically changes the principal purpose for entering into the contract.

More contractual terms to examine
Other elements of the contract that James advises looking at are “the basis of the
agreement, and whether you are bound to supply, or whether it acts as a framework under
which call-off orders/purchase orders are issued and subject to your acceptance.”

Then there’s a material adverse change which James defines as “an event or
circumstances which have a material adverse effect on the ability of the parties to perform
their obligations.” He says that while this is not something typically seen in short-form
standard terms and conditions, “it may be included in a long form agreement and may allow for termination or suspension of obligations and a renegotiation of the contract.”

The fall-back position is termination of the agreement altogether. But care should be taken;
firms may need to continue to supply up to the expiry of any notice period.

The absence of contractual provisions
So, if with careful review of the contract it’s found that there are no suitable provisions
embedded in the agreements, or, worse, they offer little or insufficient protection from the
various price pressures the firm is facing. Are there any other options that can be
considered?

There are.

James says that the obvious approach is to maintain an open dialogue with customers. He
says that “they are unlikely to be surprised by requests for price increases.” He continues:
“Where the request is genuine, rather than exploitative, and particularly where it can be
backed up by evidence, there may be an opportunity to vary your agreement without the
need to terminate. Customers may be willing to accept this in order to guarantee continuity
of supply, or there are limited alternative suppliers.”

Renegotiate

Where a firm is able to renegotiate, and certainly for any new agreements entered into, as
James emphasises, “you should ensure your contractual provisions provide adequate
protection for any ongoing or new challenges faced due to cost price increases.”

He explains that his firm has assisted clients in many industries with preparing wording to
include in their quotes which reserves the right to amend prices in circumstances where
there are material increases in input costs, including energy, labour, and fuel.

Another tack is to add wording that states that quotes only remain open for acceptance for
a short time period, and future supply will be subject to updated quotes.

Pricing mechanisms

Looking to the future, James highly recommends detailed thought about the use of various pricing mechanisms and whether it would help to link them to inflation, or at the least, have price reviews at certain points throughout the contractual period where the parties can renegotiate the price. He says of this that “we are seeing a trend towards including indexes or pre-agreed price rises linked to certain commodities and a move away from the price being fixed for the term of the agreement.”

His last suggestion is to “consider working on a purchase order basis; as seen by the cost of living crisis, the economic climate is unpredictable, and a more flexible agreement may be more beneficial, such as supplying on an ‘order-by-order’ basis may be preferable.”

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