Effective pricing clauses in your contracts

Volatility in international markets and the rising cost of living may be forcing you to consider increasing the prices of your goods or services. However, getting your customers onboard with any increases will be a lot easier if your contract already allows you to do this in a reasonable and smooth manner.

Many commercial contract disputes arise from pricing issues, ranging from contracts being silent on pricing and payment terms, or unilateral changes made by the product or service provider, or increases being deemed unreasonable by the customer. Such disputes can be avoided, and it makes for a far easier business relationship, if a pricing clause is agreed by both parties and included in the contract at the outset. However, all is not lost even if one is missing. Amendments to contracts are still possible and highly advisable.

In this blog, we highlight a few key considerations on how to approach price increases if you already have a clause in your contract, and what should be included if you are looking to add or amend such a clause.

What should a pricing clause cover?

If your contract does not currently have a pricing clause or you are negotiating a new contract, here are some of the key components that a strong pricing clause should include or cover:

Frequency

How often can you increase the prices during the contract term? The answer to this will depend on many external factors such as how often you are subject to price increases from your suppliers, market conditions, interest rates if they affect any of your borrowing, and other overhead increases you may face throughout the contract term. It is plausible that the customer may ask for price increases to be limited to a certain amount per year or for the contract term. It is a fine balance to accommodate the risks faced by both sides and so careful negotiation will be required.

Limits

Should you limit how much of an increase you can apply? It is typical for customers to request a cap to be applied so that they can manage their own expense budgets. However, no one has a crystal ball and foreseeing fluctuations in markets can make committing to a cap hard. In the worst case, you could suffer losses if any cap which you agree to is underestimated. If a cap is something you do agree on, it is advisable to add in some language that allows you to revisit the cap should market conditions change or to revisit it each year.

Calculation

If the pricing structure has to include incentives for performance, volume discounts or staggered discounts over a certain tenure, these pricing calculations, formulae or tables showing the pricing should be incorporated into your pricing clauses.

Payment terms

Tied in with pricing terms are payment terms as you need to get paid for any increases. Any clause that deals with a price increase should be clear on how a price increase should be communicated and when it will come into effect. This can be tied into the payment clause too. For example, if invoices are sent on the first of the month, it would make invoicing simpler if price increases come into effect on the first of the month. Whether this is appropriate will, of course, depend on looking at all the risks facing the parties.

Striking a balance

Not only do pricing clauses need to be reasonable in order to address the risks and concerns of both parties for the health of the business relationship, but reasonableness is also a legal requirement. If payment or pricing clauses are deemed to be overly unfair, there is a risk they can be contested in court and deemed invalid.

However, this does not mean you cannot aim for flexibility to change the terms in line with market conditions. For example, if you agree to a cap on how much of a price increase happens, you do not have to agree that for each year of the contract. It may be prudent to negotiate a steady increase year on year for that cap. Alternatively, if considered appropriate for your situation, it may prove beneficial to exclude certain costs from the cap. This is where seeking legal advice and having a team that understands the commercial risks your business is exposed to can help get you the best terms possible in any contract.

Additionally, aligned with the concept of reasonableness, pricing clauses should not be dealt with in isolation. If, for example, it is harder to achieve a well-balanced clause or one that does not afford you the future flexibility you seek, adding a suitable amendment clause could help – one that allows you to propose changes to the pricing clause where consent cannot be unreasonably withheld by the customer. In other words, if markets unexpectedly force you to increase pricing in a manner that is outside the scope of your pricing clause and you can reasonably prove that not doing so would be detrimental, an amendment clause could allow you to do this and the customer would have limited scope to disagree. Of course, even this term would require careful negotiation between the respective parties.

Already have a pricing clause but not sure if it is effective?

So far, we have discussed how to add pricing provisions into a contract, but what if you already have one and you are not sure how strong it is, how to activate it, or even how to amend it?

Much of what has been outlined above would still apply in this instance. However, questions such as the following would be considered before further advice could be provided:

• Does the contract allow for amendments to pricing?
• Does the customer have a veto on such changes?
• Are there other clauses that could be impacted by an amendment?
• Is the current clause reasonable?
• Are there clear mechanisms stipulated within any existing pricing clause which give you the confidence to apply an increase? For example, are there clear notice provisions and clear effective dates outlined for any increase?

This is not an exhaustive list and each contract will be different as will the sensitivities within the commercial relationship. Our team of solicitors is experienced in analysing, negotiating and advising on commercial contracts, especially ensuring there are effective pricing clauses.

For company commercial legal advice, please contact Ian Barnard or Richard Wrightson in our corporate and commercial team on 01653 600070.

This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.