As we enter the third year of the global Covid-19 pandemic, contract law practitioners have become aware of the need to insert innovative risk management provisions in long-term agreements to help their clients foresee the “unforeseeable” in times of crisis.

In effect, we are witnessing the emergence of new contractual provisions aiming at ensuring the continuity of affected businesses as well as the evolution of traditional concepts such as Force Majeure, Hardship and Frustration which seem to have evolved in a direction that takes new unexpected risks into consideration.

Amongst the contractual instruments that were rediscovered following the global pandemic, we are noticing the resurgence of the practice of inserting price variation clauses in long term agreements.

These price variation clauses raise two questions:

• What are price variation clauses?

• Are they efficient risk management instruments?

1-WHAT ARE PRICE VARIATION CLAUSES?

Price variation clauses are contractual provisions that cause the increase or decrease of the price owed to one of the parties as soon as an event described in the contract arises.

Where the contract provides for the increase of the price, the clause is called a price escalation clause. 

Where the contract provides for the increase of the price, the clause is called a price de-escalation clause.

These clauses are characterized by the following four elements:

First, these clauses are inserted in contracts that provide for the payment of a sum of money by one party to the other. In effect, these clauses only affect monetary obligations.

Second, these clauses are triggered by the occurrence of a specific event described in the agreement.

In some instances, the triggering event is independent from the will of the parties (a natural disaster such as the global pandemic, a variation in an index or a verified shortage of certain goods, etc.). 

In other instances, the event is intimately related to the will of the parties. For instance, certain contracts provide for the possibility of the creditor to decide on an increase in price or for the debtor to decide on a decrease in price. In these instances, the variation of the price is at the discretion of one of the parties[1].

Third, these clauses are characterized by their effect, which is the increase or decrease of the price.

In some instances, the variation of the price is automatic. In this case, the price automatically varies as soon as the event is triggered.

In other instances, the variation is triggered by the will of one of the parties. In this case, it is one of the parties that can increase or decrease the price. However, the right to increase or decrease the party is only available when the event described in the clause has occurred.

Fourth, the clause may specify the level of variation.

In some instances, the variation is indexed objectively and varies according to an objective element.

In other instances, the variation is already provided for in the contract. For example, the contract may provide for a 10% increase when a specific event occurs.

2-ARE PRICE VARIATION CLAUSES EFFICIENT RISK MANAGEMENT INSTRUMENTS?

 Price Variation Clauses present three advantages:

• They allow for a variation of the price without the need for a court decision or an agreement between the parties.
• They allow the parties to recalibrate their contracts whenever the initial equilibrium has been broken.
• They can be indexed to an objective parameter which decreases the risks of one party deciding on the variation of the price unilaterally.

However, these clauses are not always efficient.

In effect, two factors may tend to decrease the efficiency of these clauses.

The first factor pertains to the deficiency of the index that is chosen to determine the increase or decrease of the price. Unless the parties have provided a safeguard in the contract, the price variation clause becomes useless whenever the index used by the parties becomes defective.

The second factor pertains to the existence of provisions in the applicable law to the contract which negate the efficiency of the clause. In this case, the price variation clause may be deemed null and void or neutralized by the lex contractus.

 CONCLUSION

Price variation clauses are a useful contractual risk management tool that is making a comeback in cross-border transactions.

Amidst the emergence of new contractual risk management instruments, a question arises as to whether the insertion of such clauses may prove useful in domestic contracts in light of the current Lebanese crisis which has led to the depreciation of the local currency and the emergence of multiple foreign currency exchange rates.

Although it is not always possible to foresee the unforeseeable, it is strongly advised to consider inserting provisions that allow for a variation of the price or that determine alternative terms of payment.