BY THOMAS KADING
Legal Planning for Inflation As of January 2022, the Bureau of Labor Statics (BLS) released a metric indicating that inflation over the last 12 months was 7.5%. BLS's referenced metric is the Consumer Price Index (CPI). Since 1913, the average inflation as per the CPI has been 3.2% per year. At 7.5%, we are seeing the highest inflation rate since the early '80s. The purpose of this article isn't to consider the causes of this inflation; rather, it is to look at how the business community can plan for the potential of inflation (and deflation) in their contract strategies.
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Contract clauses may be an important part of planning for inflation, but they certainly cannot be the only planning. Planning for inflation includes a comprehensive look into the operation of a business and an understanding of how inflation may affect the business. An appropriate holistic approach may consider adjusting business strategies, hedging and drafting contracts that account for potential inflation. In addition, maintaining accurate accounting and reporting practices is important when considering inflation. If you don't know your numbers, it may be exceedingly difficult to identify which inflationary factors impact your business. Accurate accounting is also a good practice in general and often may be helpful if legal disputes ever arise. Each business may be affected uniquely by inflation. For example, a manufacturing business that relies on metal inputs may have its bottom line significantly impacted by inflation on materials. On the other hand, a restaurant may be more impacted by the inflation of food products. One reasonable approach for these examples might be locking prices for a period of time or
Thomas Kading Attorney at Fargo Patent & Business Law, PLLC Josiah Kopp
building an escalation clause into a vendor agreement. An escalation clause is a term added to an agreement that stipulates a change in price based on a predetermined set of conditions. Escalation clauses may be used with customers, vendors, and other parties. An exemplary escalation clause may stipulate that the contract price may increase in relation to the CPI as put out by BLS. A good escalation clause will select an appropriate index, determine how often the repricing applies and set a pricing floor and ceiling.
Appropriate Index Virtually any metric may be chosen when drafting an escalation clause. One of the more common metrics is the CPI. There are many variations of the CPI as put out by the BLS. For example, the BLS issues CPI metrics based on energy prices, food prices, new vehicles and many others. Further, the BLS breaks down the CPI metrics by geographic areas, population types, specific categories and so forth.