United States: Under Long-Term Supply Contracts, Can A Manufacturer Pass On Dramatic Increases In Power Or Raw Materials Costs?

Dramatic increases in the cost of electricity in California and Washington, and in the cost of natural gas there and elsewhere in the United States, highlighted the difficulty that manufacturers with long term supply contracts may have in passing on even substantial increases in raw material and power costs to their customers. A manufacturer confronting such a situation must carefully review its supply contracts to determine whether the manufacturer (a) is expressly permitted to pass on such cost increases, or (b) is excused from performing under the contract if its costs increase dramatically (a so-called force majeure clause). Assuming the manufacturer cannot pass the increased costs on and is not excused from performing, but nevertheless attempts unilaterally to impose increases in the contract price for its goods or to suspend performance altogether, the manufacturer’s supply contracts must be examined to determine whether liability for a breach of the contract is limited or whether consequential or other types of damages for which it might be liable to its customers are excluded.

Under the Uniform Commercial Code, which regulates the sale of goods, "delay in the delivery or non-delivery [of goods]… by a seller … is not a breach of his duty under a contract for sale if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made." Commentary to the Code states that "increased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency that alters the essential nature of the performance. Neither is a rise or collapse in the market itself a justification, for that is exactly the type of business risk which business contracts made at fixed prices are intended to cover."

In what appear to be a substantial majority of commercial impracticability cases, even dramatic price shifts and other events - such as the closing of the Suez Canal or the Arab oil embargo - that have made contracts unprofitable for one of the parties have not resulted in findings of commercial impracticability.

The moral of this story for a manufacturer is clear: Strive to negotiate long-term supply contracts that let you pass through significant raw material or power price increases to your customers, or that permit you to suspend performance under the contracts while the price increases are in effect. Supply contracts that do not include such pro-visions may open you to substantial, unavoidable and unrecoverable losses.