Inflation and rising interest rates can have a serious impact on contracts. Yulia Barnes, Managing Partner, Barnes Law, highlights the key points of law that can help or hinder contractual relationships.
In an attempt to curb rising inflation, the Bank of England – like many other central banks – is raising interest rates. With UK inflation at a 40-year high of 10.1% at the time of writing, the knock-on effect can be detrimental to businesses and legal contracts. Those who entered a long-term contract before this may find themselves facing challenges in regard to contractual obligations and performance. They may even find themselves in a position where they or their contracted party can no longer adhere to the obligations they have legally agreed to. With that in mind, here’s what needs to be considered.
TMI: Does force majeure cover inflation?
Yulia Barnes (YB): Contracts are usually rather lengthy because we need to look to the future to foresee what can possibly go wrong and provide a way to protect ourselves. For the events that can’t be predicted, force majeure comes into play. This is a provision that seeks to free both parties from their obligations if an extraordinary event directly prevents one or both from performing as agreed. While it may seem like a legitimate reason, there’s no concept of force majeure in English law. If a party wishes to rely upon it, it needs to be included in the contract and drafted in a way that captures the situation that is covered by that particular event of force majeure.
TMI: Can a price change clause be inserted into an existing contract?
YB: Some commercial contracts can address price changes enabling suppliers to adjust the prices in order to fit the elevated cost of manufacturing and supplying the products. These clauses are in the favour of the seller because they provide assurance they will not be at a loss in the event of economic change.
However, these clauses can be detrimental to the buyer, and they create a considerable amount of uncertainty over prices. To help alleviate this unpredictability, the clause should be negotiated to reflect a fair understanding of how the price of goods may increase over time.
TMI: Will a court allow terms to be implied in a contract?
YB: When a UK court is considering whether to imply a term into the contract, it will either apply the business efficacy or the officious bystander test. The business efficacy test will allow a proposed term to come into play if the contract will lack commercial coherence. Whereas the officious bystander test looks at whether an objective person would conclude that the term is so obvious that it must be included.
However, it’s unlikely that either test would permit prices to increase with inflation, especially for those in long-term contracts, as it’s difficult to predict the effect on inflation in the distant future.
There’s a long-held principle that under UK law, as much as possible, parties should be left to determine the content of their contracts.
TMI: Can a contract be terminated because of inflation?
YB: Under English law, the courts expect parties to fulfill 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 permits parties to terminate the contract without any cause, e.g., for convenience. If such a clause exists in the contract, this route can be considered as a means to discharge any obligations that either party can’t comply with. Using this can help a party to avoid any breach of contract claim being made against them.
TMI: Are high rates of inflation classed as a frustrating event?
YB: Contracts can effectively come to an end when unforeseen circumstances that happen outside of our control, such as war or a change in legislation or statutory prohibition of a product or service, lead to the performance of the contract being impossible.
While the list of what constitutes a frustrating event is non-exhaustive, it’s unlikely that high inflation rates would fall into this category and contracts cannot be frustrated purely because the performance has become too expensive.
TMI: Can an existing contract be renegotiated?
YB: Those who are in existing commercial contracts with no price change clause are in a difficult position. When faced with this challenge, the party/parties involved in the contract want to renegotiate the terms.
In this case, the party that wishes to incorporate a price change should set out their reasons for the increase along with the evidence to support it. As part of this, the party should demonstrate they have considered alternative options to deal with the effects of the high inflation rate. The other party can then use the renegotiation to voice any concerns over the price rates.
It’s important in this scenario for both parties to not be pressured into accepting price variations that are unworkable. If an agreement can’t be reached, consider cutting the losses and terminating the contract, if the contract allows this without breaching its terms.
TMI: What can we learn from this?
YB: While renegotiations have a place and can, in some cases, be a good solution, it’s important to note that not all parties reach an agreement. The challenges that businesses have faced, and continue to face, can provide insight to how to deal with drafting provisions for the future. For future contracts, consider what protections are necessary against further economic changes such as inflation rates rising again.