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Price Variation – What’s The Problem?

A business needing to reconsider pricing during the term of a contract is an issue which can affect any commercial organisation and is something that we have noticed is coming to the forefront for many of our commercial clients.

A lot can happen during the term of a contract, whether at a local level or as a result of larger international developments, to all inform what a company needs to charge for its goods and/or services to make a profit or, sometimes, to keep going as a viable commercial entity. One party needing to change the price after the contract is signed may not be the ideal situation for either party, but it is something that should be considered when entering into a supply contract. Reasons to vary prices can be many but in recent years a few have been of particular note – the price of raw materials, Covid, and Brexit.

As an example, imagine a company which requires steel to complete a long-term infrastructure project with a customer. The price of steel rose 200% between March 2020 and July 2021 and during this period, the company’s overheads will have increased substantially as a result. If the contract did not provide for this then this puts the impact of those price rises back onto the supplier could lead to the company making a loss on the project or even more severe consequences. A well drafted price variation clause would help the parties navigate potential rises and come to a mutually convenient solution.

Unilateral right to amend – Audit rights – RPI/Link to raw Material – Right to review

A unilateral right to amend the price is certainly something to consider if your supply chain is closely linked to economic shocks.

These can be drafted in several different ways to satisfy different parties, but some commercially sensible (and reasonable) approaches may be as follows:

  • the price variation could be triggered at a specific point in the term of the agreement. For example, every 12 months;
  • the increase or decrease could be linked to certain prices or indexes;
  • parties can agree a cap of the variation of the price; and
  • notice will be given to allow the client to review the variation and, potentially, a termination right offered if the increase is not acceptable.

One of the more common mechanisms for these clauses would be to link any variation to the Retail Price Index (RPI) / Consumer Price Index (CPI) or to the price of a certain raw material. These are updated on an on-going basis and are calculated in line with market variations. Parties can also agree for the variation to be capped so that the increase or decrease does not affect the margins of the supplier.

Example 1

“The Supplier may adjust the Product Prices once per year in line with the percentage increase or decrease in the Consumer Price Index during the previous year.”

Another option would be to include audit or benchmarking rights which would conclude in a price review which is binding on the parties. This effectively means that the parties agree certain parameters, margins or volumes (normally set out in a schedule) for the agreement and elect a party, usually an independent expert, to review the pricing against these review criteria at set intervals of the agreement. The price will then be varied where certain conditions/margins/volumes have been met.

Example 2

“Once the Independent Expert determines the appropriate adjustment, the adjusted Product Prices shall be deemed to apply with effect from [Date]”

Price is fixed if not – need to speak to other side – may need to vary the contract

If there is no mechanism in the agreement, then it becomes more difficult to vary the price of a contract. In this situation, a party who wants to vary the price will need to obtain the consent of the other party and should review the contract to see what formalities there may be for varying the contract.  It is usually best to discuss the matter between the parties informally to see if an agreement can be reached. This can then be negotiated, and the contract varied to amend the original price. It may also be best to include a price variation clause at this stage, so this is more easily negotiated in future.

Although this is not the ideal situation for either party, it may be the best option. Without a variation to the price, there may be a risk to the supply chain (i.e. if they can no longer afford to complete the contract and end up breaching the contract and, in the worst case scenario, going insolvent). This can then lead to the customer needing to find a new supplier and paying an increased price of the product (i.e. as a new supplier will price at the point the contract is made). This is an extreme example, but this scenario can easily be avoided by planning ahead at the point the contract is made.

Please contact one of the Commercial Contracts Team if you require any assistance.