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Costly increases

Adam Bernstein asks: what can a firm do to protect its position in respect of difficult markets –
especially where they sell to trade rather than retail?

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.

So, what can a firm do to protect its position in respect of difficult markets – especially where they sell to trade rather than retail?

James Crayton, partner and head of commercial at Walker Morris, says that to combat energy bills and material and labour shortages, firms should initially conduct an assessment of their current commercial arrangements – including considering their own supplier relationships as well as their relationships with customer – ‘to understand whether there are any contractual or common law remedies which can provide them with flexibility or assistance to maintain good relationships, whilst not detrimentally impacting their finances’.

The aim of the process is to get a fix on the current position. And this starts, clearly, with the current contractual position on pricing, especially where the firm is party to long-term supply contracts. He says that ‘while the simplest price mechanism is a fixed price, often more detailed mechanisms to determine price are included in longer term agreements and firms should assess if this price is broken down into components which may be able to be changed’.

This is particularly the case in circumstances where the firm can demonstrate the cost of supply has significantly increased.

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 Crayton, ‘the contract will provide for the price to increase in relation to an index, such as the Retail Price Index (RPI) or the Consumer Price Index (CPI).’

However, without an express provision, Crayton says ‘the price specified in the contract won’t adjust in line with either of these indexes, or any other method for measuring inflation’.

Similarly, with general price reviews or adjustments, there needs to be an express clause in the agreement providing for the right to do so. Here Crayton warns ‘vague statements that variations may be agreed are unlikely to be enforceable’.

He 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.

Crayton says that these events are often listed within the clause or definition. He notes, however, that ‘the supplier would need to be able to demonstrate that circumstances beyond its control prohibit it from complying. A general change in the economic climate or market conditions affecting the profitability of a contract is not likely to be considered a force majeure event.’

And where there’s no force majeure clause, Crayton says 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 Crayton advises looking at are ‘the basis of the agreement, and whether a firm is bound to supply pursuant to it, or whether it acts as a framework under which call-off orders/purchase orders are issued and subject to acceptance’.

Of course, refusal means no revenue and may risk damaging customer relationships. However, as Crayton says, it allows a pause in supply ‘in circumstances where cost price rises are making it unprofitable for continued supply… and it may also be helpful leverage in discussions with customers requesting a price increase’.

Then there’s a material adverse change which Crayton defines as ‘an event or circumstances which have a material adverse effect on the ability of the parties to perform their obligations’. He says while this isn’t something typically seen in short-form standard terms and conditions, ‘it may be included in a long form, negotiated 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. It’s the least favourable option and carries risks. As Crayton points out, ‘care should be taken to properly assess the contractual right to terminate in accordance with the terms of the contract; it’s likely the firm will need to continue to supply up to the expiry of any notice period’ – even if it’s possible to terminate.

The absence of contractual provisions
So, if with careful review of the contract it’s found 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.

Crayton says the obvious, and most effective and co-operative, approach is to maintain an open dialogue with customers. He says ‘they’re unlikely to be surprised by requests for price increases and it’s something we’re seeing a large number of our clients undertaking across various market sectors’. 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 the 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.’

Interestingly, Crayton highlights the fact it’s likely that alternative suppliers the customer might turn to will be facing the same challenges, and the customer may therefore have limited options to find an alternative. Regardless, he advises that ‘any commercial discussions should be documented, and the formal contractual variation procedure followed if applicable’.

Where a firm is able to renegotiate, and certainly for any new agreements entered into, as Crayton emphasises, ‘firms should ensure their contractual provisions provide adequate protection for any ongoing or new challenges faced owing to cost price increases’.

He explains 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.

That said, he adds a proviso: ‘While we’ve not seen evidence of these types of provisions being tested recently and there is of course the risk that there is a challenge regarding contract formation or a battle of the forms scenario, it’s likely to be more beneficial than not to include such wording.’
Another tack is to add wording to quotes that states that quotes only remain open for acceptance for a short time period, and future supply will be subject to updated quotes, to reflect the market at that time.

Looking to the future, Crayton 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. And the market is moving in his experience. As he says, ‘we’re 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 whether to commit to supplying ‘a certain volume’ for a certain price, or whether the firm wants to work on a purchase order basis. The advantage of having a predetermined volume of business detailed in the contract is that it provides certainty for both seller and their customer. However, 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’.

In summary
As with any finely balanced negotiation, seeking good advice to help steer the conversation can help avoid inadvertent pitfalls while inserting sufficient flexibility to ensure contracts help, rather than hinder, the long-term business relationship between supplier and customer. Now is the time for firms to address contractual issues.
Adam Bernstein is an independent columnist

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