Price Explosion for Raw Materials – Suppliers entitled to (Price) Adjustments?

by Dr. Heiko Franke

Trade & Distribution

Price Explosion for Raw Materials – Suppliers entitled to (Price) Adjustments?

The German as well as the international economy has had to deal with serious obstacles in recent years, particularly as a result of the Corona crisis. As a result of the war in Ukraine and the associated political developments, further obstacles have come up, in particular raw material shortages and considerable increases in raw material prices, which can make the manufacture of products significantly more expensive. There are a variety of issues in this context. In this blog post, we will shed light on whether and on what legal basis suppliers can demand or achieve payment of higher prices than those agreed between them in the medium or long term from their customers with regard to increased raw material prices.

1. Contractual Provisions

1.1 Price Adjustment Clauses

The supplier concerned should first check whether it can rely on contractual agreements for dealing with increases in the prices of raw materials, in particular specific price adjustment clauses. Corresponding clauses are a much more secure legal basis compared to supplementary contract interpretation (see below under 2.) and the doctrine of fundamental change of circumstances (see below under 3.), provided that the respective clause has been validly agreed. Several types of clauses are distinguished:

  • Prices may be linked to the change in certain cost elements as part of the costs incurred by the supplier, such as the cost of raw materials or labor costs (so-called cost element clause).
  • They may be linked to reference values such as statistical indices (so-called index clause).
  • They may be linked to the price development of similar or comparable goods (so-called tension clause).
  • In addition, the supplier may be permitted to increase prices at its discretion (so-called reservation clause).

1.2 Attention to the Laws on General Terms and Conditions

Anyone wishing to rely on such clauses should bear in mind the risk of potential invalidity of the respective clause. Since many companies work with standard clauses, the requirements of the law governing general terms and conditions (sections 305 et seq. of the German Civil Code, BGB) should typically be considered first (insofar as the supplier and not the customer has used the respective standard clause). The requirements of German laws on general terms and conditions should not be underestimated, even in b2b business transactions. Also in b2b business transactions, in general, with regard to maintaining the appropriateness of the clause and thus its validity under the laws on general terms and conditions, the respective clause should not allow the supplier to unilaterally increase its profit retrospectively - on the occasion of the cost increases - instead of simply compensating for cost increases. This should also not be done, for example, by only linking to increases in certain costs without taking into account whether the total costs have increased at all. Furthermore, in general, the criteria for the price adjustment should be comprehensible to the customer, so that he can verify the allegation that costs have increased. However, these are merely general guidelines for evaluation under the laws on general terms and conditions that do not apply without restriction, as is so often the case under such laws; i.e., certain deviations from these general guidelines are permissible and each clause must be examined in detail. For example, with regard to price reservation clauses, the German Federal Court of Justice (BGH) has recognized that their users may have a legitimate interest in not having to disclose certain cost calculations on which the price adjustment is based, i.e. certain compromises in transparency are tolerated here.

1.3 Price Clause Act

In addition to requirements under the laws on general terms and conditions, the requirements of the Price Clause Act (for index clauses) may have to be observed depending on the form of the adjustment clause. However, this law provides for the invalidity of a clause that is inadmissible according to its rules only at the time of the (judicially) legally established violation of the law, unless an earlier invalidity is agreed (which is usually not the case).

1.4 Force Majeure

It should be added that in addition to the typical price adjustment clauses, "force majeure" clauses may sometimes serve as another basis for a claim for contract adjustment. However, force majeure clauses typically have a different case in mind than the increase of raw material prices, namely that a party is prevented from performing by an external event (and is then released from its performance obligation for a certain period of time according to the respective clause). Overall, typically, force majeure clauses therefore do not cover the case of price increase that is of interest here, as at the same time the supplier is still able to perform. Nevertheless, it is worthwhile to at least briefly check this in individual cases.

2. Supplementary Interpretation of the Contract

If there are no contractual agreements regarding a price adjustment, a so-called "supplementary interpretation of the contract" must be considered. In simple terms, this involves closing a possible loophole in the contract by recourse to the other contents of the contract and the valuations expressed therein as well as objective aspects (custom of the trade, standard of good faith). In this respect, the question is what the parties would have agreed in good faith if they had foreseen the case that occurred, i.e. in this case a serious increase in raw material prices.

It is already clear from the above that recourse to supplementary contract interpretation is fraught with considerable uncertainties. If the supplier wishes to rely on this legal institution, he must likely make considerable effort during the proceedings to convince the court of his point of view. In this context, a supplementary interpretation of the contract in favor of a price increase may be supported by the fact that, according to the text of the contract, the parties had already recognized the risk of increases in prices for production at the time of conclusion of the contract and had made certain provisions for this purpose, even if these are not applicable to the specific case. E.g., the parties have expressly made a provision for the case of an increase in wage costs, but not for the case of an increase in raw material costs. Any discussions of the parties on the occasion of or as evidenced by the drafts exchanged by the parties may also be used in this respect.

In contrast, a supplementary interpretation of the contract is not possible, in particular, if it would contradict the intention of the parties. If, for example, it turns out that the parties deliberately imposed the risk of possible increases in raw material prices on the supplier or did not want to allow an adjustment of the prices in this case, there is no room for a supplementary interpretation of the contract.

3. Fundamental Change of Circumstances

3.1 Starting Point

If there are no relevant contractual provisions and a supplementary interpretation of the contract is also out of question, the law may give rise to a claim for price adjustment. This is not from the provisions on the so-called "impossibility" of performance (sec. 275 German Civil Code, BGB). These are neither relevant on the factual side (performance is still possible) nor on the legal consequence side (a contract adjustment is not provided for as a legal consequence). However, a claim for adjustment of the contract due to "fundamental change of circumstances" pursuant to sec. 313 (1) BGB may exist. Nevertheless, a fundamental change of circumstances only exists in exceptional cases, namely if it is unreasonable for one party to adhere to the contract unchanged, taking into account all individual circumstances and in particular the contractual or statutory distribution of risk. In this case, there is a claim against the contractual partner for adjustment to the changed circumstances (i.e., there is no automatic adjustment by law). In view of the price problem considered here, the relevant group of cases of fundamental change of circumstances will have to be the so-called "disruption of equivalence", which involves a (significant) imbalance between performance and consideration. According to case law, it is to be assumed that the parties assume an (at least approximate) equivalence of performance and consideration, even if this equivalence was "not specifically addressed or considered" during the contract negotiations.

However, since the relevant agreements on conditions and prices are in the hands of the parties, only very exceptional circumstances can require an adjustment with regard to the criterion of unreasonableness of the unchanged adherence to the contract. Whether such extraordinary circumstances exist is a question of the individual case and cannot be assessed schematically. In the past, case law has, for example, assumed a disruption of equivalence in the event of an increase in production costs by a factor of 15 or (even) by 60%. Even if this does not seem to fit together at first glance, it must be considered that a multiplication of costs with overall very low costs may have less strong effects than an increase by 60% with already high costs (with possibly ruinous consequences for the company). The decisive factor must be how significantly the respective cost item affected by the price increase increases the costs when viewed as a whole and how the relationship to the service in return is presented as a result.

In principle, the risk of an increase in the price of raw materials lies with the supplier. However, if the so-called "sacrifice limit" is exceeded, i.e. the price increase exceeds (by far) the limit of the typically foreseeable risk assumed by the supplier, an adjustment of the contract may nevertheless be considered. It is essential that the relevant circumstances must lie outside the supplier's sphere of influence or risk. In this context, it is not only a cause that can be considered in favor of an adjustment of the contract (e.g., war and consequences of war) that has to be taken into account. A claim for adjustment on the basis of fundamental change of circumstances may be excluded if the supplier, despite the possibility and foreseeability of such change, has not adequately safeguarded itself, for example by maintaining adequate stocks of the respective raw materials.

3.2 War in Ukraine

In the case of the Russian attack on Ukraine, significant circumstances were probably not foreseeable, even on the basis of the public statements made by various actors. This applies to the attack itself as well as the comprehensive sanctions imposed on Russia and the course of the war so far as well as the resulting supply shortages from Ukraine and Russia and the corresponding shortage of raw materials and their price increase. It is not likely that a supplier could have foreseen these aspects in advance. In some cases, the impact on prices is also considerable in conjunction with other factors. For example, the gas price at the end of February/beginning of March 2022 was around 200 euros per megawatt hour; in contrast, the long-term average was between ten and 25 euros, according to press reports; however, the increase was not solely due to the start of the war but we will not go into details here.

However, this remains a question for each individual case, and the supplier will need good arguments to justify the unreasonableness of sticking to the unchanged contract, especially in view of the strict requirements for fundamental change of circumstances. As a result, only those cases will probably be successful in which, in the event of non-adjustment of the respective contract(s), demonstrably serious, lasting consequences for the respective supplier or its company can be shown; these could be, for example, a threat to the supplier's existence or the circumstance that, within the framework of a permanent contractual relationship, the supplier's expenses necessary for the fulfillment of the contractual performance permanently and significantly exceed the agreed remuneration (assessment of such constellations for lack of relevance to the decision left open in earlier BGH decisions, for example on the 1973 oil crisis).

Against this background, too, suppliers will normally have to assume that it will be very difficult to demonstrate a disruption of the business basis. In view of the developments, which are generally perceived as extremely surprising, and the serious effects on the raw material situation and the corresponding prices, this nevertheless does not appear impossible, at least in the case of demonstrably serious economic effects (see above).

3.3 Adjustment Claim

The content of the fundamental change of circumstances claim may be the restoration of a certain balance between performance and consideration. Considering that typically the risk regarding the costs for production lies with the supplier, this will regularly result in a (delivery) price increase. This may only go so far as is necessary to relieve the risk and thus does not lead to a complete equivalence of performance and consideration (sec. 313 (1) BGB: "[...] adjustment of the contract may be demanded insofar as [...]"). The circumstances of the individual case must be taken into account here; schematic solutions are not appropriate.

4. Summary and Recommendations

The supplier concerned should first check whether it can rely on contractual agreements for dealing with increases in the prices of raw materials, in particular specific price adjustment clauses. They regularly provide the safest basis for corresponding adjustments, whereby risks regarding the invalidity of the respective clause may arise in particular from the law governing general terms and conditions (in the case of standard clauses).

In contrast, the supplementary interpretation of the contract and the doctrine of fundamental change of circumstances are significantly more uncertain as a basis for a possible adjustment of the contract; however, if there is no promising contractual basis for an adjustment, suppliers should consider these two instruments and examine their respective argumentation prospects.

Irrespective of this, it may make sense to seek an exchange with the respective customer despite rather low legal prospects of success. Since it is quite possible that other suppliers in the relevant industry have already had to cease operations, and since the price increases, some of which are considerable, are probably already known in the relevant market, the relevant customer may be willing to accommodate the supplier in terms of prices, at least for a certain period.

In addition, suppliers should consider other aspects, such as that, depending on the individual circumstances and in particular on the contractual provisions, they may not be obligated to accept orders from the respective customer or to supply the customer only under certain conditions; this may be the case, for example, because a comprehensive supply to all customers may not necessarily be guaranteed due to shortages in the purchase of raw materials (which in turn raises complex legal issues). The respective customer may have a considerable interest in securing its own supply or at least not to jeopardize it. In this respect, too, a closer examination of the individual case is, ultimately, unavoidable and clearly recommended.

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