The effect of inflation on contractual relationships

The UK economy has been relatively stable over the last ten years, however recently the UK has experienced soaring inflation rates. In May 2022, the Office of National Statistics reported that the UK inflation rate had reached a record-breaking 9.1%. The UK has not seen rates like this since 1982, over 40 years ago. High inflation rates have a knock-on effect on everyday life from the cost of living to legal contracts.

Long-term contracts that were entered into before the increase in inflation may now be facing many challenges with regards to contractual obligations and performance. Some parties to commercial contracts might find themselves in positions where they can no longer afford to adhere to their obligations under the contract. In such situations, how may contracting parties mitigate the effect of the rising inflation?

Price change clause

A commercial contract such as one dealing with the supply of goods may contain provisions that allow suppliers to adjust the prices in order to fit the cost of manufacturing and supplying the products. Such clauses are in favour of the seller as they provide assurance that they will not be at a loss, in the event of an economic change in the market. However, the same cannot be said for the buyer. Such clauses create a considerable amount of uncertainty for the buyer in terms of the price of goods. To help alleviate this unpredictability, the clause should be negotiated to reflect a fair understanding of how the price of the goods is likely to increase over time.

Implied terms in the contract

When considering whether to imply a term into the contact the courts will either apply the business efficacy or the officious bystander test. Under the business efficacy test, the  proposed term will only be implied if without it, the contract will lack commercial coherence. The officious bystander test looks at whether an objective person would conclude that the term is so obvious that it ought to be included. It is unlikely that a term that permits prices to increase in line with inflation would pass either tests, especially those pertaining to long-term contracts. It would be difficult to predict the effect of inflation over a long period of time, therefore any terms relating to inflation would not be considered obvious nor would it prevent a contract from being coherent.

Termination

Under English law, the courts expect parties to fulfil their commitments under the contract and are unlikely to provide any relief to parties due to high inflation rates. However, a contract may contain a provision that allows parties to terminate the contract without any cause, i.e. for convenience. If such a clause exists in the contract, it may be useful for parties to consider taking this route to discharge any obligations they may have under the contract that they cannot comply with. This also helps parties to avoid any claims for breach of contract being made against them.

The doctrine of frustration arises where an unforeseen event which is out of the parties’ control takes place. This event automatically renders performance of the contract impossible. Any obligations that the parties have will be discharged as the contract effectively comes to an end.  While examples of what constitutes a frustrating event are non-exhaustive, they typically tend to cover things such as; an outbreak of war, a change in legislation or statutory prohibition of a product or service. With these examples in mind, it is hard to see how high inflation rates could also fall into this category. It is also a well-known fact that a contract cannot be frustrated purely because performance has become too expensive.

Negotiations 

Parties to commercial contracts may consider negotiations to be a good option, especially where there are no provisions or clauses in the contract that permit a price change. Of course, both parties to the contract need to be willing to engage. The party who wishes to incorporate a price change might want to set out their reasons for the increase along with the evidence to support it. It would be a good practice to also demonstrate that they have considered alternative options to deal with the effects of the high inflation rate. The other party can voice any concerns that they may have and to suggest price rates that would work well for them. Parties should not be placed under any pressure to accept price variations and if parties cannot reach an agreement, it may be best for them to cut their losses and terminate the contract whether or not there is a right to do so.

Looking at the effects of high inflation rates on commercial contracts, it is clear that it is more challenging to deal with contracts that already exist and have no price change clause. While negotiations may appear to be a good solution in such cases, it is also evident that parties do not always come to an agreement. Therefore, it is advisable that parties who are looking to enter into contracts in the future should consider including provisions into their contracts that deal with economic changes such as inflation rates.

Please contact our team for any existing contract enquiries or if you need assistance with a new contract.

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