between Romania and the rest of the world has been steadily increasing
annually. As in any emerging market with occasional volatile economic,
social and political fluctuations, both foreign and domestic trading
partners must seek ways in which to minimize the risks attendant to such
fluctuations. Romania’s accession to the European Union in January is
expected to substantially enlarge its annual trade with EU member
states, affording business partners with both unique opportunities as
well as with the archetypal risks associated with international trade.
This article reviews the steps that such parties can take to protect
themselves from price risks in international trade agreements involving
Romanian partners - risks incurred from outside factors such as exchange
rate fluctuations in different currencies, the increase in the price of
raw materials and of energy, and sudden changes in the economy. These
risks all influence the extent of the obligations of parties who must
pay more or less than what they agreed to pay when they concluded their
agreement. They are risks that affect the contractual balance between
the parties; and, most importantly, they are risks that can easily be
avoided by introducing certain provisions into the contract. (Risks of
nonperformance of contractual obligations including nonpayment are not
the subject of this article.)
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Romania’s major trading partner is, of course, the European Union, with
a total balance of €37.9 billion in 2005 of imports and exports
representing 68.9% of Romania’s overall foreign trade. Other important
trading partners include the NAFTA countries - the US, Mexico and Canada
- with a total balance of trade of €1.8 billion representing 3.3% of
overall trade; the EU candidate states and Bulgaria (in 2005) with €4
billion at 7.2%; and the ASEAN countries with €344 million at 0.6%.
Trading partners in all of these countries continually assess the
commercial risks associated with business opportunities in Romania such
as the possibility that a future and probable event might cause negative
pecuniary consequences to one of the parties. Such risks include
economic, political, administrative, and natural risks. Economic risks
are determined by the evolution of the company and the quality of the
services and commodities it provides. They are, in turn, divided into
currency risks incurred by changes in exchange rates or the official
parity of the payment currency in comparison with the reference
currency, and non-currency risks. The latter include: inflation, changes
in the bank interest rate, changes in the price of the raw materials,
equipment, labor, transportation, insurance premiums, commissions,
interest, technology, the balance between supply and demand, and
financial and investment risks. Price risk is included in this category,
since all of these factors influence the cost of production and,
consequently, the obligations of the contractual parties.
An example of currency risk is the way changes in the currency exchange
rate of the leu have affected long term international transactions. The
leu appreciated in real terms by 11% against the euro from September
2004 up to December 2005, and by a further 5% in the first three months
of 2006. Therefore, all the long term international agreements that had
as object the supply of certain products or services in Romania or to
Romanian companies that had prices expressed in US dollars or in euro
were affected by the changes in the exchange rate. The Romanian buyers
gained from the change since they were now paying in a currency that had
depreciated at a price that had been settled before the depreciation
and, thus, they were paying less for the same product or service. The
foreign sellers incurred certain loses since they now received the same
amount in a currency that in the meantime had lost value. Thus, they
were receiving less for the same product or service. At present, due to
the National Bank of Romania’s disinflation efforts and large foreign
cash inflows, the leu is expected to remain strong over the next year
and the exchange rate is expected to remain stable. Therefore there is
currently no perceived currency risk which might influence the extent of
long term contractual obligations.
Other risks that might affect prices are those incurred from the
situation the Romanian economy finds itself in right now. Therefore an
analysis of monetary policy and the evolution of the inflation rate
should be made when considering the conclusion of a long term
transaction. The authorities face a dilemma imposed by EU constraints on
inflation since a tightening of monetary policy to reduce inflation will
detrimentally affect Romania’s external competitiveness which needs to
be preserved in order for the country’s economy to expand. For the
latter to happen, the exchange rate of the leu is bound to be subjected
to further pressure since capital inflows will increase due to higher
domestic interest rates. Experts predict that with a significant
loosening of the fiscal policy in 2007, year-end inflation will run
about 6.8% and the current-account deficit is forecast to rise to about
10% of GDP.
country risk combines political with economic and social elements that
are heightened by the nation’s current internal political situation in
which the two senior government coalition parties, the National Liberal
Party (NLP) and the Democratic Party (DP), and the President and Prime
Minister, trade angry accusations back and forth at each other each day
– a situation that could lead to a breakup of the ruling coalition and
new elections influencing the economy and business transactions.
Prices are closely linked to changes in the economy and in the general
social, environmental and political situation in Romania. Recent changes
in climate that have subjected Romania to certain natural
weather-related risks have indirectly influenced the level of prices.
There has been a 12.6% decrease in agricultural output caused by recent
floods. The prices of agricultural products could also be affected in
2007 by the droughts that have been predicted.
Developments in 2005 can serve as an example of the impact on prices, as
consumer prices increased by 8.6%, exceeding the 7.5% inflation target.
This increase was mainly due to price adjustments for utilities, as well
as the unfavorable impact of some incidental factors like floods on the
price of food. For example, if a long term transaction involving
agricultural products had been in place during this increase in the
costs of production and in the prices, the seller would have incurred
losses from the deal since he agreed to supply the products for a
certain price, but due to floods or drought the crops were not the
expected ones and his costs increased a great deal. The increase in
costs should have been covered by an increase in the price of the
transaction, but this could not have happened unless the agreement
contained a price adjustment clause.
Legal risks incurred due to changes in national and international
provisions of relevant commercial legislation can be devastating to a
long-term international trade agreement that lacks suitable protections.
Such risks relate to new taxes and levies, property loss and so on.
Among the legal risks that affect prices, troublesome and
non-transparent bureaucratic procedures remain a major problem in
Romania. International experts point to the excessive time it takes to
secure necessary zoning permits, property titles, licenses, and utility
hook-ups, causing the skyrocketing of construction costs. Moreover,
there are frequent changes in legislation and regulations, especially
fiscal rules, often without prior notice and without a transition
period. These changes significantly add to the costs of doing business
in Romania, create difficulties for investors, and can cause increases
in the prices provided for in long term agreements.
All these risks can be covered through special clauses inserted into
international trade agreements. There are specific clauses for currency
risks, non-currency risks and force majeure, and for political, social,
administrative and natural risks. These clauses can also be categorized
as: clauses for the maintenance of the value of the agreement as the
parties had initially agreed and clauses for the adaptation of the
agreement to the new conditions on the market. The different varieties
of clauses are, of course relative, since there are some which could be
included under more than one category.
Clauses used to cover price risks are briefly described below.
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Price Risk Protection
Price is a strategically important element in a sale-purchase, licensing
or distribution agreement as it sets forth the most important obligation
for a party - the pecuniary side of the transaction. In an international
trade agreement, the price can be fixed. This is used most often in one
time transaction agreements. In respect to long term deals, agreements
are usually concluded containing variable price clauses as the
relationship between the business partners is deemed to be a strong one
- otherwise they would not enter into such agreements.
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Contractual Clauses that Prevent Price Risks
Long term trade agreements usually incorporate a special provision
showing the price of the transaction. This price can be a fixed one or
it can be conveyed through a price determination formula.
Price-protection clauses that should be included in international trade
agreements are either currency adjustment clauses - gold clauses
and currency clauses; or non-currency clauses,
such as price adjustment clauses, depending on the type of risk they
The gold clauses, i.e. the gold-value clause and the gold-coin clause,
use gold as a reference for the value of the currency in which the price
is expressed or express the price directly in gold. Other currency
clauses use as reference an internationally tradable currency other than
the one from the agreement, the conjunction of two or more tradable
currencies in previously determined percents or an institutional
currency combination (for example: the Special Drawing Rights of the
International Monetary Fund and the Asian Monetary Unity of the Clearing
non-currency clauses refer to price adjustment. The most important one
is the escalator clause, also called the escalation
clause. It is a provision in an agreement stipulating an
increase or a decrease of a price based upon increased costs of wages,
benefits, or other prices, under certain conditions, i.e. changes in the
cost of living, energy and raw materials, such as in an unstable,
volatile market like Romania. Escalator clauses frequently appear in
business contracts in order for them to raise prices if the supplier of
a particular service or type of merchandise is forced to pay more for
labor or materials. They are inserted after careful consideration and
evaluation of the market determining that it is in fact more likely for
it to shift than remain the same. When a raw material with a volatile
value is a major cost component for an asset that is the subject of a
transaction, risk identification is required. Understanding the risk
factor is essential to any entrepreneur or executive manager concluding
an agreement for the future when the costs are not determinate.
This risk-neutral position in an agreement could also be accomplished
through concluding a Cost-Plus agreement through the use of an escalator
There are several variations of a Cost-Plus agreement, but the guiding
principle is to determine amongst the parties a percentage or mark-up
margin against the price of a raw material that fluctuates regularly and
significantly on the basis of a previously published Price Index.
Therefore, the automatic adjustment in payments based on an economic
index that is independent of the will of any of the parties involved
becomes effective. The clause, thus, provides for a price increase
mechanism. The result is that, no matter what the price of the asset is
today, tomorrow or three months from now, the buyer will pay the same
amount (i.e. percentage) over the seller’s prices for that period.
Nowadays, Cost-Plus agreements are used in transactions that involve
technology products, equipment, gasoline and other petroleum products,
and certain food products, which are all traded on highly volatile
markets with pricing changing every hour on the hour.
The most common way in which an escalator clause acts is by a mechanism
through which only if the increase or decrease in the costs is greater
than a certain percentage, previously determined by the parties, does
the adjustment of the price become operable.
Another way in which escalator clauses operate is by a notification that
the seller/vendor sends to the other party showing that he desires an
increase in the price due to the change of the price of raw materials
and/ or energy on the market. If the escalator clause is operational by
a notification, than the buyer has the benefit of a period of time prior
up to the moment in which the price increase enters into force. During
this period, the buyer is entitled to place orders at the original
price. The same mechanisms apply in case of a price decrease on the
market for raw materials and/or energy.
Another price clause commonly used to avoid risks is the price
re-determination clause. This gives either party the right to
ask for a recalculation or renegotiation of the price from the agreement
at intervals which have been previously established by the parties.
Usually an adjustment of the price is done once a year. The common
procedure for a price re-determination is to average three or more of
the prices of other competitors on the market.
Agreements could also contain a clause for the post calculation of the
price, the Cost and Fee clause. In this case the price of
the agreement is determined after the performance of the obligations by
calculating the production costs with other expenses, like the cost of
Price risk can also be covered by clauses for the adaptation of the
agreement, by way of including it amongst the other obligations
undertaken by the parties to the agreement. These clauses do not refer
only to the pecuniary value of the agreement, but to the entire
performance of the agreement (transportation, packaging, quality and so
on); however, price plays, yet again, a crucial role since it represents
the most important obligation.
Such provisions are: “the most favored customer”, “the
most favored nation” and the “best price” clauses.
In all these, the seller undertakes to provide the buyer with the lowest
price and the best trade conditions he would offer his most favored
customer. In this way the buyer is never at a disadvantage towards that
The hardship clause is also included in this category. It
has been defined by the UNIDROIT Principles of International Commercial
Contracts under Section 2, Article 6.2.2. as “the occurrence of events
fundamentally altering the equilibrium of the contract either because
the cost of a party’s performance has increased or because the value of
the performance a party receives diminished.” In case hardship occurs
the party that has become disadvantaged has the right to request the
renegotiation of the agreement and, consequently, of the price.
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Price Risks in the Future
practice, price adjustment clauses are widely used and have been used
for some time in long term international trade agreements concluded in
Romania or with Romanian companies. This is demonstrated in the annual
reports of some Romanian companies which show that price risk has been
covered either by the fact that the raw materials had prices expressed
in euro or by the adjustment of prices with inflation and by their
escalation according to the cost of the raw materials.
Price risks, currency exchange risks and interest risks can also be
covered by the use of different derivative financial instruments like:
futures, options, swaps, hedging. Companies often cover
price risk by concluding futures agreements through which
they establish with a certain buyer the sale-purchase terms, including
the price, of a transaction that will take place in the future, for some
products they do not yet own.
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Because the Romanian market is at all times quite volatile, risks can
never be fully perceived and companies need to pay close attention to
risk management as well as make efforts at risk avoidance, such as the
aforementioned clauses covering price risk and financial instruments.
This is necessary for diminishing the effect of risks that may still be
incurred. Risks should be handled, and controlled as far as possible.
As a transitional emerging economy, the Romanian economy still has a
long road ahead before reaching a reasonable state of stability.
Moreover, as not even stable economies offer complete protection against
the risks incurred in long term transactions, changes in the economic,
political and social environment should be expected in Romania. Indeed,
this is the very purpose of the clauses covering price risk and of all
the risk protection mechanisms, i.e., to bring about the desired
stability of long term agreements and the desired results from
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Editors Note: It is our policy not to mention our clients by name in
The Romanian Digest™ or discuss their business unless it is a matter of
public record and our clients approve. The information herein is correct
to the best of our knowledge and belief at press time. Specific advice
should be sought from us, however, before investment or other decisions
Copyright 2007 Rubin Meyer Doru & Trandafir, societate civila de avocati.
All rights reserved. No part of The Romanian Digest™ may be reproduced,
reused or redistributed in any form without prior written permission
from the publisher.
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