Key Considerations for Pricing Disputes
Among the most common disputes in the manufacturing industry are disputes over price changes. Most often, such disputes involve a supplier seeking higher prices from its customer. However, there also are instances in which a buyer seeks price reductions from its suppliers. These disputes can arise for many reasons, such as increases for raw materials or other costs, programs extending beyond original expectations, or simply through miscalculations in the initial quote. Whatever the cause, such disputes have existed for as long as the manufacturing supply chain itself. While many of these disputes are resolved amicably through commercial discussions, they have the potential to destroy long-standing relationships and cause significant disruption to the supply chain.
In recent months, as fiscal years turn over, budgets are prepared, and rumblings increase regarding a potential economic slowdown, we have seen a marked increase in the number of these pricing disputes. Against this backdrop, this article is intended to provide a summary of some of the key contractual issues that both buyers and sellers should consider as part of any dispute over pricing:
Does the contract have a fixed price? – One of the first and most basic questions a party must consider is whether the contract includes a fixed price. Most contracts, on their face, provide for a specific fixed price. However, it is not uncommon for contracts to include provisions that allow (or even require) changes in the price under certain circumstances. For example, an indexing provision that allows for price changes based on changes in raw material costs is common in some industries. Oftentimes, a seller’s documents will include a right to increase prices while the buyer’s documents state that the prices are fixed and are not subject to change, requiring the parties to engage in a “battle of the forms” analysis to determine what the contract actually requires regarding price.
Does the contract have a specific term or is the term indefinite? – In addition to price, the parties must consider the term of the contract. In other words, if the contract requires supply at a fixed price, how long is the supplier bound to this obligation? If the contract does not include a specified term, it likely will be considered a contract of indefinite duration. Under Section 2-309 of the Uniform Commercial Code (“UCC”), a contract of indefinite duration may be terminated by either party upon “reasonable notice.” Although what constitutes “reasonable notice” may be the subject of debate, the ability to terminate a contract of indefinite duration gives suppliers an ability to terminate the current agreement and require higher prices under any new agreement.
When does the contract expire? – Assuming that the contract is not one of indefinite duration, when does it expire? If the relevant contract is expiring in the near future, a seller may be able to leverage its right to refuse to extend the contract in order to increase prices. Conversely, a buyer that knows its seller is unhappy with the current arrangement and unlikely to renew the agreement should make sure it has a contingency plan in place.
Renewal rights/obligations? – As a corollary to understanding the expiration date of the contract, the parties must consider any provisions under which a contract may be renewed and any related requirements. For example, a contract may renew automatically unless one party or the other gives formal written notice that it will not renew the agreement. Many contracts also give one party (usually the buyer) some measure of power to unilaterally renew the term. Both buyers and sellers should be aware of these terms and make sure that they comply with any notice or other requirements. Failure to give notice that a party will not renew may result in the party being locked into a contract that otherwise would have expired, and therefore losing the ability to demand a different price for any new contract. Conversely, a party that wishes to keep current pricing in place may lose that ability if it fails to take any steps necessary to renew the agreement.
Does the contract allow early termination? – Even if a contract is not about to expire, the parties should be aware of any rights to terminate the agreement before its natural expiration. In the manufacturing supply chain, rights to terminate “for convenience” usually are limited to the buyer. However, it is not unheard of for contracts to include a mutual right to terminate upon giving a specified notice period. Upon termination of an existing contract, the parties usually are free to demand new pricing as a condition for entering a new agreement.
Does the contract include a specific quantity? – Under Section 2-201 of the UCC, a contract for the sale of goods cannot be enforced beyond the quantity of goods specified in writing. For example, if a contract specifies that it is for five widgets, the buyer cannot force the seller to supply ten widgets, just as the seller cannot force the buyer to purchase ten. A quantity may be measured by the buyer’s requirements or by the seller’s output. However, where a contract contains no quantity term at all, it cannot be enforced to require further shipments by the seller (or purchases by the buyer).
What other commercial considerations exist? – Finally, regardless of their respective contractual rights, buyers and sellers should take care to consider the full picture of their relationship and all other commercial considerations that are involved. For example, a seller that succeeds in obtaining a price increase worth a few hundred thousand dollars may have won the battle, but will lose the proverbial war if, in doing so, it so angers a key customer that it misses out on millions of dollars in future business. Similarly, a buyer that succeeds in holding the line on prices may find that the supplier is not interested in taking on new business from the customer, resulting in less competition for future programs, which can lead to higher prices.
While all disputes must be addressed in light of the specific contracts and circumstances involved, the issues addressed above represent some of the most important considerations that are common to most pricing disputes. Buyers and sellers should consider these issues as part of their strategy for seeking, or opposing, any requested changes in price.