Inflation Adjustment Clauses in Contracts: Providing Post-Diligence Value to Clients
Using artificial intelligence-based tools to analyze contracts as part of an M&A due diligence process is becoming a standard practice. It has revolutionized due diligence. But there are other tangible side benefits to using AI-based tools in M&A, as we have documented before (see our recent ebook, The Unexpected Benefits of AI in Transactional Law).
One example of the value that AI-based diligence adds is that the process of analyzing a target company’s contracts creates a well-structured data set that a purchaser can leverage for other purposes after closing. Lawyers advising on such transactions have an opportunity to provide additional post-deal value by helping clients find insights in that data.
Finding and Understanding the Impact of Inflation Adjustment Clauses
An example of such insight is highly relevant in today’s high-inflation environment: inflation adjustment clauses. These clauses require pricing adjustments in certain situations, such as when a price index such as the Consumer Price Index (CPI) moves up or down. Such a clause automatically protects pricing from value erosion in inflationary times without requiring a new price negotiation.
Quickly identifying inflation protection clauses found in an acquired company’s contract scan help the purchaser understand the pricing risks and develop strategies to manage them.
Contract review software such as Litera’s Kira can be used to identify and understand the inflation adjustment clauses in a set of contracts, including the following aspects:
- When can the adjustment be made, and how often
- The direction of the adjustment: whether the clause limits adjustments to increases only or whether lower inflation can trigger downward price adjustments
- Any applicable caps on adjustments that might limit the size of an inflation-based price change
- The relevant reference index governing any inflation adjustment, whether it be the CPI, the U.S. Producer Price Index, or some other local or regional index
- Any specific formulas the contract applies for computing the size of inflation adjustment
Providing Post-Transaction Value
If the due diligence analysis on a transaction included a comprehensive automated contract review, the acquiring company will be left with a structured data set that will give good visibility into the acquired company’s rights and obligations with regard to inflation-based price changes.
Aggregating and synthesizing that data is a valuable service that M&A lawyers can provide to clients post-closing. In periods of high inflation, the data will provide insights on which specific contracts can be adjusted and, beyond that, can provide better insight into the future revenue potential of the contracts in the aggregate. The data can also help the client understand whether the clauses need to be adjusted in future contract negotiations, such as determining whether a given contract uses the appropriate inflation reference index for the given market and products.
Supporting Clients During Times of Inflation
Some firms might consider providing this kind of analysis as a goodwill measure to build client loyalty and demonstrate expertise. It shows that the firm understands the financial stresses on a company in the current inflationary environment and opens the door to further discussion on how inflation clauses should be structured in the future.
To learn how Litera supports business and practice in law, schedule a quick demo to learn more about our ecosystem of solutions.