|
|
 |
 |
|
|
 |
|
|
|
|
|
Focus: Energy – March 2008Endorsing 'take or pay' clausesIn brief: The
High Court of England and Wales recently considered whether a 'take or pay'
provision is unenforceable because it is essentially a penalty. Although the
final ruling maintained the status quo, it could have implications for
Australian energy contracts which commonly use 'take or pay' clauses. Partner
Angus Jones
BackgroundM & J Polymers supplied Imerys Minerals with chemicals that were used for, among other things, the production of paper. The contract under which the chemicals were supplied contained a take or pay clause requiring Imerys to make a minimum purchase; and even if they did not order the minimum amount they would still have to pay as if they had. Similar clauses are common within the energy sector, in long-term gas sales contracts and other offtake or commodity contracts. Imerys later terminated the contract, claiming that the product was defective (the court found this to be a wrongful termination). In the period leading up to the termination, Imerys was taking less than the required minimum purchase, and not paying the required minimum amount. M & J Polymers sued Imerys claiming payment for the minimum amount as a debt. Imerys argued that the take or pay clause was a penalty provision, and so unenforceable.
What is a penalty provision?A penalty provision is a clause in a contract that 'intimidates' a party into complying with the contract by specifying an additional liability for a breach of the contract. It is sometimes referred to as a sum in terrorem. Clauses of this nature are considered to be unjust and courts will not enforce them. Penalties are often confused with liquidated damages clauses, which are allowed by the courts. A liquidated damages clause is a genuine attempt at estimating loss caused by the breach, that may otherwise be difficult to quantify.
The High Court's decisionThe judge was surprised that neither he, nor counsel, were able to find any previous cases considering whether take or pay clauses were penalties. The court said that not ordering the minimum quantity could be seen as a breach of contract, and forcing payment for the minimum amount could be seen as a punishment for that breach. This means that, in principle, a take or pay provision could be considered a penalty. However, the court went on to explain that rendering a clause unenforceable should not be done lightly. A provision estimating damages, or put in for some other commercial reason, should only be considered a penalty if it is oppressive. The court found that, given the shortage in supply of the relevant chemicals, it was commercially justifiable for M & J Polymers to require payment for a minimum amount that they set aside for Imerys. Flowing from this, the court found that the take or pay clause was not oppressive and did not have the predominant purpose of deterring a breach of contract. Also relevant was that the parties freely entered into the contract with comparable bargaining power and experience. From this, the court determined that the take or pay provision was not unjust or designed to intimidate Imerys into complying with the contract. This meant the provision was not a penalty and was enforceable.
Implications of the decisionGiven the widespread and common usage of take or pay clauses, had the court found them unenforceable it would have caused major problems. By deciding they are likely to be enforceable in all but extreme cases, the court has maintained the status quo. From this, sellers can take confidence in using take or pay clauses and enforcing payment. Having said this, the finding that take or pay clauses could, in principle, be a penalty has some important implications. It does give buyers a plausible (though difficult) argument to avoid liability under a take or pay clause. To guard against this, sellers must ensure that their take or pay clauses are negotiated in a manner that confirms they are not oppressive or framed as a deterrent to breach, but rather as an estimation of damages or a commercially justified trade-off for setting aside a certain amount of product for a specific buyer. Particular care must be taken where it might be suggested that the seller has greater knowledge and bargaining power. Finally, we note that there were two features of the take or pay clause in this case which made it potentially more like a penalty than the take or pay clauses commonly seen in energy contracts, such as long-term gas sales contracts, in Australia. The first feature is a separate obligation to purchase a minimum amount. Many take or pay clauses simply require that the buyer pay a minimum amount, with no separate requirement to order a minimum amount. As a result, not ordering the minimum amount would therefore not be a breach of contract (it just triggers the minimum payment obligation), so the requirement to pay is not a penalty for a breach. As there is still no authority on this aspect, a court may still find the clause could be a penalty since the requirement that the buyer pay for a minimum amount practically means there is an implied requirement that they order a minimum quantity. The second distinguishable feature of this case is that payment of a take or pay amount did not entitle the buyer to any future inventory or 'make-up' rights. We believe that the existence of such rights (ie where the take or pay payment can be characterised as a pre-payment for future product, provided subsequent minimum thresholds are met) are likely to make it even more difficult for a buyer to successfully argue that the take or pay clause is oppressive and unenforceable as a penalty.
For further information, please contact:
|
|
|
 |
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
 |
 |
|
|
||
|
|
|
|
|
 |
|
|
|
|
|
|
|
|
top of page
download pdf version (103KB)
