Introduction
Rising costs. Delayed timelines. Frustrated partners. These are just a few of the issues that can arise when a contract does not anticipate unexpected increases in the cost of materials, labour, or fuel. One of the most common oversights in commercial agreements- especially in sectors like construction, infrastructure, and manufacturing—is the absence of a clause that provides for price escalation.
When parties enter into a contract, they often focus on getting the deal done, assuming that current prices will remain stable. But as we've seen in recent years, economic conditions can shift rapidly—and dramatically. Since the COVID-19 pandemic, businesses in Nigeria and around the world have had to deal with rising inflation, supply chain disruptions, shifting global energy prices, labour shortages, and geopolitical uncertainties.1 Each of these factors can significantly affect the cost of delivering goods or completing projects.
In Nigeria, the impact of these global trends is compounded by local factors, such as infrastructure gaps and a high dependence on imported materials. These realities increase the exposure of businesses to volatile price movements. For example, the construction sector has seen costs soar due to spikes in the prices of cement, steel, and fuel. The result? Project delays, strained financing, and increased risks of contract disputes. This article explores how price escalation clauses work, why they matter, and how businesses can use them to manage financial risk and preserve contractual stability in uncertain economic times.
Understanding Price Escalation
Price escalation simply refers to a rise in the cost of delivering a product or service—often in a specific location and over a certain period. These increases can be driven by a variety of factors: inflation, rising labour or material costs, currency exchange fluctuations, customs duties, insurance, transportation, and even costs tied to warehousing and supply chain delays.2
A price escalation clause is a contract provision that allows parties—typically a project owner and a contractor—to adjust the contract price if certain cost inputs rise or fall beyond agreed thresholds. In short, it is a tool for sharing risk fairly between parties. Rather than placing all the risk on one party, the clause creates a more balanced pricing structure by accounting for fluctuations in key costs such as raw materials, fuel, or labour. This helps ensure that contractors can deliver as promised even when prices spike—and clients can better plan their financial commitments.
A well-drafted price escalation clause works both ways. If the cost of inputs decreases significantly, the contract price may be adjusted downward. This means that the client benefits from falling market prices, while still enjoying protection against unexpected price hikes. This two-way mechanism encourages transparency and trust. It also keeps the pricing of long-term or large-scale projects responsive to real market conditions, rather than locked into outdated assumptions.
Escalation Clauses in Contracts
There are several types of escalation clauses that can be incorporated depending on the nature of the project and its cost sensitivity. The most common include:
- Material-Specific Price Escalation Clauses: These clauses address cost changes for materials known to be volatile or central to the project—such as steel, petroleum products, cement, or other inputs. This ensures that parties are not unfairly exposed to sharp increases in essential material costs.
- Labour Rate Price Escalation Clause: Labour costs, especially in long-duration projects, may rise due to wage inflation, regulatory changes, or skill shortages. This clause allows contract pricing to reflect those changes without creating undue pressure on the contractor's ability to deliver.
- Fuel and Energy Price Escalation Clause: Given the wide-ranging impact of fuel and energy prices—not only on direct consumption but also on transportation and electricity—this clause protects against significant shifts in operating costs that could affect the overall project budget.
- Currency Exchange Escalation Clauses: These are used in contracts involving foreign currencies, especially where imported inputs or offshore services are involved. They protect against sharp fluctuations in exchange rates by adjusting the contract price based on agreed currency conversion thresholds.
- Subcontractor/Third-Party Escalation Clauses: In layered projects involving multiple subcontractors or external suppliers, these clauses account for cost increases passed on by third parties. They ensure the main contractor can adjust pricing based on upstream escalations in labour or materials.
- Government-Imposed Cost Escalation Clauses: These clauses address additional costs arising from changes in tax laws, tariffs, import duties, or regulatory compliance requirements imposed after contract execution. They are especially relevant in jurisdictions with volatile policy environments.
Ultimately, a well-drafted escalation clause should be tailored to the specific risks associated with a project. In many cases, a single clause can combine material, labour, fuel, and regulatory considerations, supported by a mutually agreed formula for price adjustments.
Key Elements: Adjustment Mechanisms
A well-drafted escalation clause should clearly define the mechanism for adjusting prices once a trigger event—such as a sharp cost increase—occurs. Two common adjustment models are:
- Index-Based Adjustments: This method references agreed indices (such as official inflation or commodity price indices) to calculate the change in price over time. It provides a transparent and standardized way to adjust contract values based on objective market data.
- Cost-Based Adjustments: This model uses the actual cost changes experienced by the contractor. It offers a more tailored and direct method of adjustment but requires the contractor to maintain detailed cost records and provide documentation of the increases. This approach is highly accurate when supported by transparent reporting.3
Why Price Escalation Clauses Matter: Insights from Sabru Motors Nigeria Ltd v. Rajab Enterprises Nigeria Ltd
One of the clearest reminders of why businesses need to plan for rising costs in their contracts comes from the case of Sabru Motors Nigeria Ltd v. Rajab Enterprises Nigeria Ltd.4 The dispute centered not just on a failed delivery, but on what happens when a contract fails to anticipate price increases—and a party tries to walk away from the deal when the market shifts.
Case Summary
Sabru Motors agreed to sell two Mercedes Benz trucks to Rajab Enterprises at a fixed total price of ₦1,692,519.40. Rajab paid the full amount. But before delivering the trucks, Sabru Motors sold them to someone else—explaining that the market price had gone up and it was no longer commercially sensible to proceed with the original deal.
Rajab took the matter to court, seeking a refund plus additional damages to cover the cost of buying the trucks at the new market price.
Courts' Decisions
- Trial Court: The court ordered a refund of the contract price (₦1,692,519.40) and awarded ₦300,000.00 in general damages to Rajab. However, the court rejected the claim for special damages, stating that the evidence provided was insufficient.
- Court of Appeal: Rajab appealed to the Court of Appeal, challenging the inadequacy of damages awarded by the Trial Court. On appeal, Rajab Enterprises succeeded. The Court held that they were entitled to recover the difference between the contract price and the increased market price at the time of the breach. The Court of Appeal increased damages to ₦3,000,000.00 in favour of Rajab.
- Supreme Court: Sabru Motors appealed to the Supreme Court, arguing that Rajab Enterprises had not sufficiently proven its loss. The apex court disagreed. Relying on Section 51(3) of the Sale of Goods Act, 1893, it held that where a seller wrongfully fails to deliver goods, the buyer is entitled to damages equal to the difference between the contract price and the market price at the time delivery was due. Based on Sabru Motors' own admission that the market price had increased to ₦1,500,000 per truck, the Supreme Court awarded ₦1,307,480.60 in damages- being the difference between the contract price for the two trucks (₦1,692,519.40) and their market value of ₦3,000,000.00 as at the date on which Sabru Motors failed to deliver the trucks.
The Real Issue: No Price Escalation Clause
At the heart of the dispute was a rigid, fixed-price contract that didn't provide a way to respond to market changes. If Sabru Motors had included a price escalation clause—one that allowed for renegotiation or price adjustments in the event of a sharp cost increase—they might have had a legal and commercial basis to revisit the pricing without breaching the agreement. Instead, their unilateral decision to sell to another buyer resulted in a finding of wrongful breach—and a costly damages award.
Why This Matters for Businesses
In today's volatile market conditions—where fuel prices, import costs, and currency fluctuations can change project economics overnight—fixed-price contracts without escalation provisions are risky. This case is a strong example of what can go wrong:
- Suppliers and contractors may feel compelled to breach when prices rise sharply, if no adjustment mechanism exists.
- Buyers can rightfully claim damages based on the market price at the time of non-performance.
- The absence of a price escalation clause limits flexibility and increases litigation risk.
- Key Takeaway: Build Flexibility Into Your Contracts
- For businesses and individuals, the lesson is clear:
- Fixed-price contracts must be approached with caution in industries vulnerable to cost volatility.
- Build in price escalation clauses, especially where materials, labour, or fuel are likely to fluctuate.
- Use index-based or cost-based adjustment mechanisms to ensure changes are handled fairly and transparently.
- Where appropriate, include notice periods or renegotiation triggers to give both parties time to respond to cost shifts.
Conclusion
Contracts that are built to adapt are contracts that endure. In an environment where material, labour, and energy costs are anything but predictable, price escalation clauses have become a critical part of sound contract management—not a luxury. As demonstrated by the Sabru Motors case and the ongoing economic realities facing businesses in Nigeria and globally, parties can no longer rely solely on fixed-price models without exposing themselves to significant financial and legal risks. Escalation clauses allow for measured, pre-agreed adjustments when costs shift beyond control, ensuring fairness, preserving relationships, and keeping projects on track.
For more information on structuring contracts that respond to today's market realities, reach out to John Ojelabi or Sharon Omoregie.
Footnotes
1. The Conversation, "Inflation in Nigeria is still climbing while it has slowed globally: here's why" https://theconversation.com/inflation-in-nigeria-is-still-climbing-while-it-has-slowed-globally-heres-why-222226 accessed 2nd October 2024
2. Thomas Benett, "What Is Price Escalation & How to Overcome It" https://priceva.com/blog/price-escalation accessed August 10th, 2024
3. Peter Ryan, Taylor Riso & Alex Benarroche, "Escalation Clauses in Construction Contracts: When and How They Apply" https://www.procore.com/library/escalation-clause accessed 2nd October 2024
4. Sabru Motors Nigeria Ltd v Rajab Enterprises Nigeria Ltd [SC.116/1997] http://www.nigeria-law.org/LawReporting/2002/April%202002/12th%20April%202002/Sabru%20Motors%20Nigeria%20Ltd%20v%20Rajab%20Enterprises%20Nigeria%20Ltd.pdf
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