This is not the first time manufacturers have been put in this situation: the Covid lockdowns made it difficult for many manufacturers to deliver on contracts, and the energy price hikes at the start of the war in Ukraine placed pressures on supply chains, such as increased freight costs and protracted delivery times.
The sudden spike in oil and gas prices as a result of the conflict in the Gulf now threatens to ripple through higher energy prices and sustained inflation. While nobody can determine exactly how long the current situation and its effects will last, undoubtedly many affected businesses will be carefully reviewing their positions and commercial commitments.
So how can suppliers protect themselves by ensuring their contractual commitments don’t become commercially unworkable?
Force majeure clauses
While many people will be familiar with ‘force majeure’ clauses in contracts (as this was widely discussed during Covid) it would only be applicable in the current situation if, depending on the wording of the clause, performance of the contract would be delayed or impossible to perform – not just the mere fact the affected party would experience a financial “inconvenience” by performing its obligations under the contract.
Hardship clauses
These clauses are mostly seen in long-term supply contracts, where there are changes in markets that would result in the price being paid under the contract to cause a financial hardship on one of the parties. The affected business would typically seek to agree a new price, and if unable to agree would refer to an expert to decide (or possibly just have a right to terminate the agreement). The drafting of the clause would be crucial to identify what would amount to a hardship and what circumstances would qualify as leading to such hardship.
Termination and/or renegotiation
Some contracts have a provision to allow for termination by a party, such as providing a written notice, which a supplier may wish to rely on. While this may not be ideal, depending on the severity of the loss being incurred, it might be the only commercially realistic option where a supplier is locked into an unprofitable situation. Alternatively, the supplier could seek to renegotiate with the customer the price under the contract (including to allow for future price changes) – this may be particularly successful if the supplier might otherwise exercise its contractual right to terminate and the customer does not wish to lose the relationship with the supplier.
Price variation clauses
More commonly seen, and often more effective in practice, is to ensure the agreement has an adequate mechanism to allow for a price review and adjustment. This provides a greater degree of clarity and certainty for the supplier. There are a range of ways this can be incorporated into a commercial contract, with no one-size-fits-all approach, but some common examples include:
- The right to link prices to an appropriate price index, such as Consumer Prices Index or Retail Prices Index
- The right to change prices due to changes in law, currency fluctuations or labour costs
- The supplier to have the ability to adjust prices at fixed percentages, such as quarterly or annually
- The supplier to have the sole right to increase prices, such as on specific dates or at set milestones (this right would need to be reasonable in accordance with statutory requirements)
- The parties to meet on pre-determined dates to agree revised prices, based on a range of factors, often with an expert determination provision where the parties cannot agree (or where the parties cannot agree, the right to terminate).
The advantage of having a robust price review mechanism within your contract ensures that the right to change the price does not have to be tied to a particular type of event and allows for a degree of flexibility. It also allows for the contract to evolve according to the changing circumstances of the parties.
What should you do now?
The events of the last five years – including the return of inflation following the Gulf conflict and increased awareness of supply chain fragility – make it essential to review how your prices are determined within your contracts.
How TWM can help
At TWM Solicitors, our Commercial team advises businesses on managing contractual risk when market conditions change. We can help ensure that the contracts you sign with your commercial customers contain the most appropriate and effective provisions for your business.
We can support in preparing new agreements, reviewing and amending existing agreements, and assist in negotiations to ensure your contracts offer robust protection to reflect today’s economic conditions and your business objectives.
If your existing contracts are becoming commercially unviable, we can advise you on your options and support you in resolving any disputes.
To discuss your needs further, please contact our Commercial team for an initial, no-obligation conversation.