While tariff wars make for interesting politics, they can wreak havoc on a company that has signed a contract for the sale of goods or services, and later finds itself hit with unanticipated price increases. If a contract does not have an escalation clause, the company may be stuck with the increased costs they cannot collect from their end user.
While some companies attempt to use force majeure—"unforeseeable circumstances”—clauses to modify contracts, or, where the increase is so substantial, to get out of the contract, they do not typically protect against price increases or price fluctuations. Force majeure provisions are more commonly used to protect against acts of God or other significant natural and unavoidable catastrophes. As such, a company can rarely rely upon a force majeure clause to modify or terminate a contract due to a price increase.
One of the more effective ways for a company to protect against drastic price fluctuations due to tariffs or other unforeseen events is to include a price adjustment clause in the contract. A price adjustment or “escalator” clause, as it is more commonly known, is a mechanism used to protect against unpredictable or unforeseen cost increases. Escalator clauses are enforceable in most states and are commonly used in commercial contracts, as buyers may agree to change the price of the contract based on increases to the seller’s costs that occur after a contract is signed. There are some important considerations, however.
Adding an escalator clause in a contract alone may not get you the increase you want. A party to a contract who wants to adjust the contract prices using escalator clauses may have to prove actual cost increases and provide evidence of the following:
- the cost at the time the contract was signed,
- the cost increase after the contract was signed, and/or
- why there was an increase in costs after the parties signed the contract.
Buyers typically question or challenge cost increases. Sellers of the product subject to the increase will need to determine whether the cost increase will be based on increases in labor and overhead costs, as opposed to increases in material costs, due to a tariff, delay in production, delay in the buyer’s acceptance of goods or services, or some other similar event. The key to having an effective escalator clause is to clearly specify how the price increase will be calculated and to base the price adjustment on an objective or verifiable standard.
An escalator clause may be drafted in such a way as to permit cancellation of the contract if one of the parties does not agree to the increase in price, or it may require that both parties agree to the price increase or adjustment. The key is to negotiate the escalator clause before the contract is signed and specify as clearly as possible how to calculate the increase and when it will kick in.
Where there is no escalator clause or where it is not clearly spelled out, the contract will likely be enforced. However, in cases where the increase in costs is so high that performance under the contract will create significant financial hardship, litigation may be necessary to attempt to modify the contract and/or to attempt to terminate it.
Rescission (a remedy that terminates a contract) or reformation (a remedy that allows for a contract to be modified) may be available if litigation is unavoidable. Rescission cancels the contract and returns the parties to their original positions. Reformation allows courts to rewrite contracts to achieve the parties’ original intent. These remedies may be available in some circumstances where there is no escalator clause if an increase is so high that performance under the contract may cause financial devastation. If you find yourself in litigation, you may be able to invoke these remedies if there was a mistake, frustration, impossibility, and/or duress.
“Mistake” occurs when parties sign an agreement under a mistaken fact or where one party or both parties are mistaken about critical contract terms. These types of mistakes may allow for the contract to be reformed or terminated where the mistake is so material that to enforce the contract would be unconscionable. When the mistake derives from a party’s failure to exercise due care or diligence with respect to the transaction, reformation or termination of the contract will likely not be given.
In situations where performance of the contract may be impossible or impracticable due to the occurrence of an unforeseen event such as a tariff increase, a court may rescind the contract or reform its terms to allow for the price increase. These remedies are difficult to obtain and require litigation.
Thus, now that tariff wars are becoming the norm and delays in production are more and more commonplace, an escalator clause may be the best protection against unwanted price increases.
Negotiating an escalator clause at the inception of the contract can be beneficial to both parties and protects against litigation, a default, or the unexpected termination of a contract. Importantly, it also helps protect against a complete breakdown in the overall business relationship.
A business litigation attorney representing national and international companies, Rose A. Suriano is a member in the litigation practice at Brach Eichler LLC, a law firm in Roseland, New Jersey. She has nearly 30 years of trial and appellate court experience in state and federal courts across the country. Robyn Lym is an associate in the litigation practice of Brach Eichler LLC, and works closely with Rose A. Suriano on a number of business claims and disputes.