After decades of low inflation, UK inflation has leapt by 7.9% as at May 2022 (Office of National Statistics), and it has been reported that leading economies are close to “tipping” into a high-inflation world where rapid price rises are normal, dominate daily life and are difficult to quell. Many longer-term contracts will have been negotiated with little thought about the possibility of high inflation. Some will become difficult or uneconomic to perform. What can contracting parties do?
Price change clause
Some long-term supply contracts may contain a price change clause, which allows for a price adjustment if there are changes in the cost of manufacturing and supplying the products or the services. Although such clauses introduce an element of uncertainty on price into a contract, they can be sensible to include where a single item forms a major essential part of a product. Price change clauses can provide for an automatic change to the product price, or provide a right for a supplier to request a change to the product price.
Courts can allow a term to be implied into a contract, but it is extremely unlikely that they would allow an implied term that prices would be increased in line with inflation. A term can only be implied if objectively either the implied term is so obvious that it goes without saying, or it is needed for business efficacy, in that without the implied term the contract would lack commercial or practical coherence, and it is extremely doubtful that such a clause would pass either test.
Parties should check the contract for termination rights. There may be a right to terminate the contract without fault, but care should be taken to comply with any procedural requirements contained in the termination clause. It may be that even if there is no right to terminate, it may make more economic sense to do so in any event if a potential damages claim will be less than the cost of performance.
It is extremely unlikely parties will be able to rely on a force majeure clause for non-performance of a contract due to high inflation. Generally speaking, force majeure clauses protect a party from a breach of contract claim if it was unable to perform its contractual obligations due to an event that was outside its control. What is a force majeure event depends on the wording of the clause, which normally includes events such as acts of God, extreme weather events, riot, war or invasion, or action taken by a government or public authority. However it is well established under English law that a change in economic or market circumstances that affect the profitability of a contract or the ease with which the parties' obligations can be performed, will not be regarded as being a force majeure event.
A commercial negotiation is likely to be the most sensible option for all parties. Even if the party facing a request for a price increase is not required to consider one under the terms of the contract, it will want to avoid a situation where its supplier is unable to supply on time or to the correct quality, or otherwise faces insolvency. To maximise the chances of successfully obtaining a price increase, a party should be able to justify the increase sought with supporting evidence, show that it has considered other ways to mitigate the inflationary effect and that it has taken into account the potential effect of a price increase on the whole of the supply chain.
Does the party seeking an increase need to be careful about how much pressure it puts on the other to agree to its terms? There is a tort of lawful act economic duress, where an illegitimate threat or pressure is put on a party causing it to enter a contract. In some circumstances if that party has no reasonable alternative other than giving in to that threat or pressure, the English courts will step in. The courts will not lightly conclude that a commercial party has made an illegitimate threat in the context of negotiating a commercial contract. If the contract is a relational one, however, that is one involving a high level of collaboration on a long-term basis, such as a joint venture agreement or franchise agreement, then this could potentially be something to be wary about.