DAMILOLA holds a degree in Law from the Obafemi Awolowo University and an LLM in Environmental Law and Policy from the prestigious Centre for Energy, Petroleum, Mineral Law and Policy (CEPMLP) University of Dundee. An exceptionally driven individual with a track record of academic and professional excellence, She graduated with a Second Class Upper Division from both the university and the Nigerian Law School. She is currently a partner at Essien Ogunniyi Legal Practitioners, a firm whose primary area of interest is the Natural Resources Sector.
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A Take or pay contract is a form of off take agreement used mainly in the energy industry. It is a contract whereby one party is under an obligation to take delivery of a specified amount of goods or pay a specified amount. Often times it is inserted as a clause in a wider agreement. The aim of this provision is that the supplier will receive a guaranteed amount of income under the agreement irrespective of whether the buyer takes the commodity or not. A properly constructed take or pay clause gives the seller an assured revenue stream that ensures an adequate return on the capital invested on the project.[1] Furthermore, a take or pay clause could be a key consideration for securing an external debt financing. This form of financing is commonly used in the energy industry because it of its capital intensive nature. It usually serves as collateral in an off balance sheet financing (project finance). It is also a risk allocation mechanism used by sellers of commodities.[2] A take or pay clause or agreement usually shifts the market demand risks (also known as volume risk) from the buyer to the seller. It is pertinent to note that a seller is usually confronted with two forms of risks: Market demand risks and the price risks. Where a seller then enters into a take or pay contract, his volume risks becomes minimized leaving him with only the price risks which in certain cases might be hedged.[3]
Essentially, in a take or pay contract, a buyer’s obligation is always described as being in the ‘alternative’. This connotes that a buyer either agrees to (a) take and pay the contract price for a minimum contract quantity of commodity each year (TOP quantity) or (b) pay the applicable contract price for the TOP quantity if it’s not taken within the applicable year. Often times, The Take or pay Obligation is usually determined on a yearly basis.[4] Please note that these obligations must be conveyed in a take or pay contract to achieve the commercial/desired result of the contract. Furthermore, a TOP quantity could be varied by the following events in the course of the year: the quantity which (a) the seller failed to make available (shortfall), (b) were rejected because they did not meet quality specifications and (c) the buyer could not take because of force majeure.[5] A buyer is only obliged under the contract to take deliveries of commodity that meet quality specifications or even those off specification but which the buyer agrees to accept. Also a force majeure event must operate fully to relieve a buyer of her obligation under the contract. [6]
VALIDITY OF TAKE OR PAY CONDITIONS IN DIFFERENT JURISDICTIONS
Under the English Law, the general rule is that the courts will not enforce a contractual provision which imposes a penalty on a party who has breached a contract.[7] In distinguishing the TOP contract from a penalty, the criteria for its enforceability were laid down in the case of M&J Polymers v. Imerys Minerals ltd. The contract was for the supply of chemicals, subject to a take or pay obligation. In determining this case the court examined whether the TOP obligation infringed the rules on contractual penalties. In conducting this test, the court considered the following :[8]
Essentially, in a take or pay contract, a buyer’s obligation is always described as being in the ‘alternative’. This connotes that a buyer either agrees to (a) take and pay the contract price for a minimum contract quantity of commodity each year (TOP quantity) or (b) pay the applicable contract price for the TOP quantity if it’s not taken within the applicable year. Often times, The Take or pay Obligation is usually determined on a yearly basis.[4] Please note that these obligations must be conveyed in a take or pay contract to achieve the commercial/desired result of the contract. Furthermore, a TOP quantity could be varied by the following events in the course of the year: the quantity which (a) the seller failed to make available (shortfall), (b) were rejected because they did not meet quality specifications and (c) the buyer could not take because of force majeure.[5] A buyer is only obliged under the contract to take deliveries of commodity that meet quality specifications or even those off specification but which the buyer agrees to accept. Also a force majeure event must operate fully to relieve a buyer of her obligation under the contract. [6]
VALIDITY OF TAKE OR PAY CONDITIONS IN DIFFERENT JURISDICTIONS
Under the English Law, the general rule is that the courts will not enforce a contractual provision which imposes a penalty on a party who has breached a contract.[7] In distinguishing the TOP contract from a penalty, the criteria for its enforceability were laid down in the case of M&J Polymers v. Imerys Minerals ltd. The contract was for the supply of chemicals, subject to a take or pay obligation. In determining this case the court examined whether the TOP obligation infringed the rules on contractual penalties. In conducting this test, the court considered the following :[8]
(a) Whether the TOP clause was
oppressive;
(b) Whether the TOP clause was
commercially justifiable;
(c) Whether the primary purpose of the
TOP was to deter breach of contract;
(d) Whether the parties enjoyed equal
bargaining power.
Based on these four criteria, the court held that the clause in the contract was reasonable and did not amount to a penalty. This reasoning was also applied years later by the same judge in the case of E-Nik Limited V. Department for communities and local government. The clause in question read:
"The Authority hereby undertakes to purchase [a] minimum of 500 days of Consultancy from the Supplier per year based on project requirement; additional days will be required once the purchased days have been exhausted".
Burton J. Again held that, a TOP clause may as a matter of principle, be considered a penalty clause. However in the present case, the judge held that the clause in question was a TOP clause because it was commercially justifiable, did not amount to oppression, were negotiated and freely entered into between parties of comparable bargaining powers and did not amount to a provision in terrorem.[9]
The validity of the take or pay clause in the United States (US) are often times not disputed. It is important to note that take or pay clauses were first included in US gas contracts in the 1960s. However, the possibility of the seller recovering the full amount under the take or pay clause has been subject to varying decisions of the courts.[10] This is attributed largely to the provisions of The Uniform Commercial Code (UCC) in force in most US States and which is generally accepted as applying to gas sale contracts. Section 2-708 of the UCC provides that in the event that the buyer refuses to take delivery of the goods, the seller is entitled to “the difference between the market price at the time and place of tender and the unpaid contract price together with any incidental damages”
While some courts have enforced this provision of the UCC Strictu sensu thus enabling the seller to recover only the difference between the market price and the contract price, other courts have found that take or pay clauses are a derogation from the general rule, hence the payment obligation being enforceable in full.
One of the mechanisms used to mitigate the hardship the TOP may cause a buyer is the right to receive a makeup quantity in later years. This often applies to gas contracts and the makeup quantities can only be taken after the buyer has taken full delivery of the TOP for the year, thus ensuring that the seller’s revenue for the year accrues to him.[11] This right is subject to a deadline after which the buyer loses the right.
In the Australian Jurisdiction, the take or pay clause is rarely featured in long term energy contracts.[12] However, the decision of the Australian court in the case of Andrews v. Australian and New Zealand Banking Group Ltd (Andrews) has widened the scope for the enforceability of the penalty doctrine. Clauses which imposes and obligation on the occurrence or non occurrence of an event, which do not involve a breach of contract, shall be enforceable. In this case, a representative action was commenced against ANZ by a group of 38,000 customers in the Federal Court of Australia. The applicants challenged the legal efficacy of various fees charged by ANZ to its customers, alleging in particular that certain provisions in their contracts with ANZ were void or unenforceable on the basis that they were to be characterized as penalties. The court held that relief against penalties may be available even if the obligation is not triggered by a breach of contract. The implication of this judgement is that Australian courts would be reluctant to strike out take or pay clauses. The High Court provided guidance for determining whether a clause will be classified as a penalty, highlighting in particular that a distinction exists between:
The validity of the take or pay clause in the United States (US) are often times not disputed. It is important to note that take or pay clauses were first included in US gas contracts in the 1960s. However, the possibility of the seller recovering the full amount under the take or pay clause has been subject to varying decisions of the courts.[10] This is attributed largely to the provisions of The Uniform Commercial Code (UCC) in force in most US States and which is generally accepted as applying to gas sale contracts. Section 2-708 of the UCC provides that in the event that the buyer refuses to take delivery of the goods, the seller is entitled to “the difference between the market price at the time and place of tender and the unpaid contract price together with any incidental damages”
While some courts have enforced this provision of the UCC Strictu sensu thus enabling the seller to recover only the difference between the market price and the contract price, other courts have found that take or pay clauses are a derogation from the general rule, hence the payment obligation being enforceable in full.
One of the mechanisms used to mitigate the hardship the TOP may cause a buyer is the right to receive a makeup quantity in later years. This often applies to gas contracts and the makeup quantities can only be taken after the buyer has taken full delivery of the TOP for the year, thus ensuring that the seller’s revenue for the year accrues to him.[11] This right is subject to a deadline after which the buyer loses the right.
In the Australian Jurisdiction, the take or pay clause is rarely featured in long term energy contracts.[12] However, the decision of the Australian court in the case of Andrews v. Australian and New Zealand Banking Group Ltd (Andrews) has widened the scope for the enforceability of the penalty doctrine. Clauses which imposes and obligation on the occurrence or non occurrence of an event, which do not involve a breach of contract, shall be enforceable. In this case, a representative action was commenced against ANZ by a group of 38,000 customers in the Federal Court of Australia. The applicants challenged the legal efficacy of various fees charged by ANZ to its customers, alleging in particular that certain provisions in their contracts with ANZ were void or unenforceable on the basis that they were to be characterized as penalties. The court held that relief against penalties may be available even if the obligation is not triggered by a breach of contract. The implication of this judgement is that Australian courts would be reluctant to strike out take or pay clauses. The High Court provided guidance for determining whether a clause will be classified as a penalty, highlighting in particular that a distinction exists between:
· a payment that is to secure performance of a primary obligation; and
· a payment for further services or accommodation.
· Where the payment is to secure a performance of a primary obligation, it would amount to a penalty and unenforceable. Where it is a payment for further services or accommodation, it will not be classified as a penalty and is therefore enforceable.
In conclusion, the draftsman of a take or pay obligation must ensure that clauses which impose undue pressure on the buyer to perform the obligations under a contract will not amount to a take or pay clause but a penalty clause which is unenforceable by the courts.[13]
[1] King
& Spalding LLP: Key considerations in energy take or pay contracts, available
at http://www.lexology.com/library/detail.aspx?g=abec95b0-aec8-4c88-8bcb-f3e8a0ef451f,
last visited on 25th September 2013
[2] Micheal
Polkinghome: Take or pay conditions in Gas supply agreements,White
&Case Paris Energy Series No 7, Take
or Pay conditions in Gas Supply Agreements, available at http://www.whitecase.com/files/Publication/b14bafe5-f666-4802-a2d4-a5eb96ec6a5d/Presentation/PublicationAttachment/b2e11a77-2ead-47ee-8f88-aa5267b832c2/alert-Paris-Energy-Series-No7-Take-or-pay-Conditions-Gas-Supply-Agreements-April-2.PDF,
last visited on 26th September 2013
[9]
The enforceability of ‘take or pay
clauses’ by Walker Morris at http://www.walkermorris.co.uk/enforceability-take-or-pay-clauses,
last visited on 25th September 2013
[12]
Herbert Smith Freehills: High Court ruling impact take or pay clauses,
available at http://www.herbertsmithfreehills.com/insights/legal-briefings/high-court-ruling-impacts-take-or-pay-clauses,
last visited on 26th September 2013
[13] Is
your take or pay clause enforceable? Ian Mcdonald at http://www.lewissilkin.com/en/Journal/2013/February/Is-your-take-or-pay-clause-enforceable.aspx,
last visited on 26th September 2013
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