Contract pricing in commercial agreements – pitfalls to avoid

The key areas to consider

If you are a fan of Marmite or Hellman’s mayonnaise, you may recall a brief dispute that broke out between Tesco and Unilever in late 2016 which led to the supermarket temporarily suspending the sale of a range of popular branded products. The dispute arose following the UK’s decision to leave the EU when the value of the pound tumbled, the cost of imported goods rose, and Unilever increased UK wholesale prices to Tesco.

That dispute highlighted the need for contractual pricing provisions to always be given careful consideration and for sufficient flexibility to be built into commercial agreements to cater for currency fluctuations and other variables that may impact on contractual pricing arrangements.

The need to pay attention to pricing provisions remains of fundamental importance and something that should be high on every business owner’s agenda.

The easiest way to ensure that your commercial agreements are up to scratch is to have them drafted and then regularly reviewed by an experienced contracts lawyer. They will understand the pitfalls of pricing arrangements and can help you to create pricing provisions that shield your business from the risk of commercially unacceptable price variations.

Here is a checklist of just some of the things to consider.

VAT

It may sound obvious, but you need to make sure that any contract you propose to enter into clearly states whether the price to be charged or the price to be paid is inclusive or exclusive of VAT. Be aware that if the contract is silent on this point, then the presumption will be that the price is VAT inclusive. Also take extra care where a contract is made up of several documents, such as a main contract with supporting schedules, as inconsistencies in the way pricing obligations are expressed could lead to unintended consequences.

Remember you need to think about VAT in the context of:

• the nature of what is being supplied, i.e. goods, services, intellectual property rights etc., and whether the transaction in question attracts a charge to VAT (or may do at some point in the future) or if it is VAT exempt or zero rated;
• the place in which supply will occur, i.e. within the UK, the EU or some other jurisdiction, which will be crucial in determining whether a domestic VAT charge will apply;
• how payment is to be made, i.e. via cash or some sort of payment in kind – remembering that even where no money changes hands, a charge to VAT may still arise; and
• the time of supply, and therefore the point at which VAT will be payable.

In a fixed price VAT inclusive contract, you also need to ensure that you build in flexibility to cater for any changes to the applicable VAT rate.

Import and export costs

Moving goods into and out of the UK has become increasingly burdensome and expensive and unless your contracts cater for any additional costs associated with this to be borne by your counterparty, or at the very least to be shared between you equally, then you could find that your business is left out of pocket.

To guard against this risk, you should ensure that pricing provisions are clear about how increased import and export costs will be dealt with; and, in the context of contracts with businesses in the EU, you need to ensure that your contracts are clear about:

• who will be responsible for paying any import duty that may now be levied;
• what happens where import duty is not paid, particularly when it comes to refund rights; and
• who will pay for the cost of goods being returned, including any VAT charge that may now be due under post-Brexit rules.

It is also advisable to stipulate whether any given prices are inclusive or exclusive of domestic or international delivery costs.

Currency fluctuations

If your business deals internationally, then it is important that any contracts you enter into include an appropriate provision to deal with the impact that currency fluctuations may have on your pricing arrangements. There are a number of ways in which this could be achieved, including via the insertion of a clause which enables the price to be adjusted where there has been a change in the applicable exchange rate which is in excess of an agreed percentage level of tolerance.

You could alternatively look to include a clause which provides for the price to be based on a specified exchange rate (e.g. US dollar to UK sterling), but with provision built in for the price to be reviewed at regular intervals and to be increased by a set amount where, at the time of the review, the value of the pound has fallen by (or above) an agreed percentage.

Formula and calculations

In contracts where the price to be paid for goods or services will be based on one or more calculations, great care needs to be taken to ensure that there is clarity about the formula that should be used to enable those calculations to be carried out. The same is true where pricing arrangements include the application of a performance bonus or penalty, or a pricing discount, for example for delivering goods or services ahead of schedule or below a pre-agreed target cost.

Mistakes in the way contractual pricing calculations are expressed can be extremely costly, as the following fictitious example shows.

Assume that a contract provides that the price to be paid for a shipment of goods is £100,000, minus £1,000 for every day that the supplier manages to shave off the target delivery date. Let us then assume that the supplier delivers ten days early.

When the parties were negotiating the contract, if they agreed that the BODMAS formula (Brackets, Order, Division, Multiplication, Addition, then Subtraction) should be used to calculate the final price payable, it might be shown like this:

• • £100,000 – (£1,000 x days shaved off target)

But compare the different outcome if the brackets were typed incorrectly:

• • (£100,000 – £1,000) x days shaved off target.

A cost of £90,000 becomes a staggering £990,000!

In this scenario there would be grounds to challenge the price provision on the basis of an obvious mistake, but it goes to show how something as simple as misplacing a bracket in a formula can lead to unintended and very costly consequences. It is therefore extremely important to double check that contractual formulae are expressed correctly.

For advice on any commercial contract, please contact Olivia Chalmers on 01733 882800 or email [email protected].

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