Coronavirus: managing CPI-linked price increases in commercial contracts

Out-Law Analysis | 02 Apr 2020 | 4:22 pm | 4 min. read

Contractual price increase mechanisms linked to the UK consumer prices index (CPI) may become more difficult to exercise in the coming weeks if restrictions linked to the coronavirus pandemic make it more difficult to produce consumer price data.

Suppliers with existing contracts which contain a CPI-linked price increase mechanism should consider agreeing an alternative with their customers. Alternative drafting options should be considered for new contracts.

The UK Office for National Statistics (ONS) published CPI data for February on 25 March, with data for March due to follow on 22 April. In a statement dated 27 March, it said that it had stopped collecting data directly by visiting shops and businesses, and was putting in place arrangements to allow price data to be collected remotely as well as methods for dealing with goods and services that are in limited supply or not currently available.

For suppliers, questions over the reliability of CPI published during the pandemic may impact on their ability to increase prices, and therefore their profit margins.

Depending on the approach the ONS takes to the adjustments to weightings of items, we may see CPI falling to a lower level than expected or some elements which traditionally feature in the 'basket' of goods and services used to calculate CPI disappearing altogether. Businesses should monitor future ONS releases for updates.

What is CPI?

CPI is the main measure of inflation in the UK. It measures the weighted average of prices of a 'basket' of consumer goods and services. It uses a geometric average, meaning it can continually capture the effects of changes in consumer spending patterns. The ONS publishes monthly changes to the CPI, as well as the annual CPI each calendar year.

CPI is calculated by taking the price changes of 650 predetermined items and averaging them in accordance with their weighting. The basket of goods and services is reviewed every year to reflect UK shopping and purchasing patterns, and the weight given to the various items in the basket is chosen to reflect their importance in the typical household budget.

How is CPI used in commercial contracts?

CPI is often used as a measurement for price increases in commercial contracts, particularly in long-term contracts, to ensure that these remain profitable for suppliers.

The application of CPI as a price adjusting mechanism depends on the specific drafting of the price adjustment clause. Typically, a clause will allow a price increase in line with CPI to occur no more than once in a 12 month period. It may be that only certain payments are subject to CPI adjustments, or that CPI is included as part of an indexation formula. There is no 'one size fits all' approach to referencing CPI as a price adjustment mechanism and it is a point of negotiation between the supplier and the customer.

How might Covid-19 impact on the calculation of CPI?

Social distancing and 'lockdown' measures currently in place in the UK are likely to have an effect on the ONS' ability to physically collect price information, as well as a lack of data for particular items. For example, the closure of pubs, bars and restaurants and hotels will mean that data for these items simply won't be available.

The impact on parties to commercial contracts will depend on whether they are suppliers or customers. For suppliers, questions over the reliability of CPI published during the pandemic may impact on their ability to increase prices, and therefore their profit margins. Customers may seek to rely on unreliability of the measure to contest price increases, particularly in light of the commercial pressures businesses are currently under.

What options are available for existing contracts?

Options available to suppliers whose existing price increase mechanisms rely on CPI include:

  • deciding not to exercise any right to a price increase;
  • seeking to exercise a right to a price increase with reference to the latest CPI figures, if published; or
  • reaching agreement with customers on an alternative mechanism - for example an agreed percentage, an average of the previous 12 months where CPI data has been published, or use of an alternative benchmark.

What options are available for future contracts?

Suppliers may wish to consider alternative drafting options for future price increase mechanisms, such as:

  • whether an annual increase by reference to CPI can be caveated so as to exclude months where figures are not published and take an average of the last 12 months published; or
  • including a fall back mechanism for price increases, such as a set percentage.

Are there any alternative price mechanisms?

Other indices by which to measure inflation are available, although these will be subject to the same pressures as CPI as a result of Covid-19. The main difference between each index is the calculation method used, rather than the underlying 'basket' of goods and services.

The most common alternative indices are:

  • retail prices index (RPI) - this was the headline measure of price inflation for many decades and is likely to still be referenced in many contracts. However, it is now considered by the ONS to be a poor measure of general inflation, and changes to the calculation method have been proposed so that it becomes more like CPIH (below). The UK government published a consultation on the changes, which could take effect from 2025 onwards, alongside the 2020 Budget;
  • CPIH – this is a variant of CPI that includes owner occupiers' housing costs;
  • harmonised index of consumer prices (HICP) – the CPI's international equivalent, which is calculated in each EU member state according to rules specified in a series of European regulations developed by Eurostat in conjunction with the EU member states. While likely to be impacted in the same way as CPI, HICP may provide an alternative benchmark for parties to consider in the event of a price increase dispute.

Additional research by Kim Perry of Pinsent Masons, the law firm behind Out-Law.