can take or pay clause in gas contract be considered a contractual penalty

8/9/2019 Can Take or Pay Clause in Gas Contract Be Considered a Contractual Penalty

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M & J POLYMERS LTD v. IMERYS MINERAL

LIMITED: CAN TAKE OR PAY CLAUSE IN GAS

CONTRACT BE CONSIDERED A CONTRACTUAL

PENALTY?

Ayeni Oladotun*

ABSTRACT: The recent case of M & J Polymers Limited v. Imerys Minerals Limited (Polymer‟s

case) is the first test of English case to have explicitly considered the question of whether a take or pay

clause constitutes a penalty and whether it falls short of the English Law Rule which prohibits

contractual penalties. The Polymers‟ case raises so many questions as to whether take or pay clauses

can be considered as contractual penalties, its effect; if its deemed a penalty, whether a failure to take

or pay a minimum under a supply gas contract constitutes a debt and what principles should be

considered when preparing a long-term gas contract in view of the rule against penalties.

This research paper shall seek to address the above questions by examining its implication on the

future of take or pay clause in gas contracts.

* The author is currently completing his LL.M in Petroleum Law and Policy at the Centre for Energy,

Petroleum, Mineral Law and Policy (CEPMLP), University of Dundee. He holds an LL.B (Hons)Degree and was called to the Nigerian Bar in 2006. Prior to his study at the CEPMLP, he worked as anAttorney in the law firm of G. Elias & Co. (Barristers & Solicitors) in Lagos specialising in corporate

and commercial law, litigation and dispute resolution. His main interests are project finance, oil andgas contracts and international business transactions. He is a member of the Nigerian Bar Association,

Association of International Petroleum Negotiators (AIPN), Society of Petroleum Engineers and theEnergy Institute. Email: [email protected]


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TABLE OF CONTENTS

ABBREVIATIONS……………………………………………..…………….…...iii

1. INTRODUCTION………………………………….………….…………...1

2. TAKE OR PAY CLAUSE IN GAS CONTRACTS: AN OVERVIEW….2

2.1. Defining Take or Pay Clause as used in Gas Contracts……………....2

2.2 Rationale for Take or Pay Clause in Gas Contract …………………..3

2.3 Mitigating and Restricting the risk of Take or Pay in Gas

Contracts ……………………………………………………………..5

3. BACKGROUND TO THE POLYMERS’ CASE……………………….....8

3.1. The Facts: The Case before the Court ………………………..............8

3.2. The Legal Issues ……………………………………………………...9

3.3. The Argument and Judgment ………………………………………..10

3.4. The Rule Against Penalties ………………………………………….12

3.5. The Polymers‟ Case in relation to Take or Pay Clause ………...........14

4. IMPLICATION OF THE POLYMERS’ CASE TO GAS CONTRACT.16

4.1. Implication to the Buyer of Gas ……………………………………..17

4.2 Implication to the Seller of Gas ……………………………………...17

4.3 Future of Take or Pay Clause to Gas Contracts ………………..........17

5. CONCLUSION ……………………………………………………….........18

BIBLIOGRAPHY


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ABBREVIATIONS

A.C. Appeal Cases

All E.R All England Reports

C.A. Court of Appeal

CAR CEPMLP Annual Review

EHWC (Comm.) England and Wales High Court (Commercial Division)

GSA Gas Sales Agreement

HL House of Lords

IELR International Energy Law Review

JENRL Journal of Energy and Natural Resources Law

LNG Liquefied Natural Gas

OGLTR Oil & Gas Law and Taxation Review

PPA Power Purchase Agreement

SPA Share Purchase Agreement


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1. INTRODUCTION

The Take or pay clause is commonly used within the energy and mining sectors in

long term Offtake Contracts, Power Purchase Agreements (PPAs) and long term Gas

Sales Agreements (GSAs). The enormous financial commitment involved in

developing the infrastructure for energy and mining projects leads the parties to such

contracts to secure the level of supply and demand throughout the life of the supply

arrangement so as to guarantee future returns on their investment. The take or pay

clause has however evolved to protect the interest of both the buyer and seller

(producer and supplier) as it guarantees a minimum income to the seller while the

buyer is assured of regular supply.1

Despite the fact that the “take or pay” clause is widely used in supply contracts of

various shades and forms most especially in high risk investments in the energy

sector , the High Court of Justice, Queen‟s Bench Division Commercial Court,

England and Wales on the 29th of February, 2008 in the recent case of M & J

Polymers Limited v Imerys Minerals Limited („Polymers case‟)2 considered for the

first time whether or not a “take or pay” provision in a commercia l agreement was

unenforceable on the basis that it amounted to a penalty; whether or not it contravenes

the English Law rule against penalties and whether or not it amounted to an action in

damages or a debt claim. In M & J Polymers Limited („M & J Polymers‟) v Imerys

Minerals Limited („Imerys‟), the High Court held that as a matter of principle, the

rules against penalties could apply to a take or pay clause in certain circumstances.

Given the frequent usage of the take or pay clause in Gas Sales Agreements (GSAs)

and in Sale and Purchase Agreements (SPAs) (where it is the sale of LNG) in the

1 Hodges, P., and J. Rogers, Take or Pay Clause Tested in English Courts, I.E.L.R. 3 (2008), p. 602 M & J Polymers Limited v Imerys Minerals Limited (2008) EHWC 344 (Comm.)


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energy sector, the Polymers‟ case raises so many questions as to whether or not take

or pay clauses can be considered as contractual penalties, its effect, if is deemed a

penalty?; whether a failure to take or pay a minimum under a supply gas contract

constitutes a debt?; what the English rule against penalties is?; what principles should

be considered when preparing a long-term gas contract in view of the rule against

penalties?; and what the effect of the Polymers‟ case will be on gas contracts.

In addressing the above questions, an analytical approach is adopted. This research

paper shall in section 2 provide a brief overview of take or pay clauses in general,

rationale for take or pay clauses, its implications, how it is mitigated and its

restrictions. Section 3 gives a background to the Polymers case, identifies the legal

issues arising, the findings of the court, the rule against penalties and whether the take

or pay clause in a gas sales contract could be a contractual penalty? Section 4 analyses

the implications of the decision of Polymers to a seller and buyer of gas in a Gas Sales

Contract and the energy industry and the future of take or pay clauses in GSAs. This

paper shall conclude based on the legal issues discussed in the body of this research.

2. TAKE OR PAY CLAUSE IN GAS CONTRACTS: AN OVERVIEW

2.1 Defining Take or Pay Clause as used in Gas Contracts

A Take or pay clause is often contained in long-term contracts for the sale of natural

gas. Take or pay clause can be defined as a clause that requires the buyer of gas to

receive and pay for, or (if available) pay for whether taken or not, a minimum

quantity of gas. It is a clause that “obligates a purchaser to pay for a percentage of the

gas which a seller can produce, whether or not the purchaser actually takes the gas”. 3

3 Lowe, J. S., The Take-or-Pay Wars – Is Peace at Hand? 1 O.G.L.T.R (1989/90) p. 3


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It entitles the buyer either to pay for the quantity of gas contracted to be taken in a

specified period (e.g., a day, month, quarter or year) or, if it does not take delivery of

that quantity or only part of it, to pay for the quantity not taken. The vast majority of

long-tern gas purchase contracts contains provisions which obligates the buyer to take

a minimum quantity of gas on an annual basis (“minimum contract quantity‟), or if

the buyer is unable to take all the minimum contract quantity, to pay the producer for

the difference between the minimum contract quantity and the volume of gas actually

taken by the buyer. The payment made by the buyer to the seller pursuant thereto is

commonly referred to a “take or pay payments”.4

2.2 Rationale for Take or Pay Clause in Gas Contracts

The question that should be asked at this juncture is why the need for a take or pay

clause in gas contracts or why should a buyer agree or be made to pay for gas even if

it is not used or supplied?. The reason for subjecting a buyer of gas to the take or pay

obligation is because, in the structuring of a GSA (or SPA), the seller is usually

reluctant in relying on the merchant formulation of delivering and being paid for gas

only when the buyer requests gas for delivery, because of the risk that the buyer might

not want gas and the seller will not earn any revenue5 coupled with the sensitivity of

natural gas demand to weather conditions and economic downturns. The attendant

reluctance of the seller in relying on the market formulation of the buyer is due to the

peculiar feature of gas from oil; gas cannot be stored and transported easily in large

quantity like oil and consequently gas is more typically produced in order to meet a

demand in a specifically identified or created market. Therefore, gas is often sold and

4 Pearson, M. P., and R.D. Watt, To Share or Not To Share: Royalty Obligations Arising out of Take-

or-Pay or Similar Gas Contract Litigation, 42nd

Annual Institute on Oil and Gas Law and Taxation,

(Dallas, USA: Matthew Bender, 1991), pp. 11-5.5 Roberts, P., Gas Sales and Gas Transportation Agreements: Principles and Practice, (2nd Edition),

(London, UK: Sweet and Maxwell 2008), p. 153


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transported under a clear contractual arrangement which seeks to match up the market

demands of the buyer with the production, storage and transportation constraints of

the seller.6

Due to the above reasons, the seller will seek to protect itself from the inherent risk of

the market formulations of the buyer by obliging the buyer to take and pay for a

certain quantity of gas at any time (take and pay) or by an assured revenue through a

take or pay commitment.7 Therefore, the take or pay clause in gas contracts is a viable

tool for ensuring a steady cash flow to the sellers and collateral security to the lenders

for the enormous investment in the energy sector.8 As a viable economic tool for

enhancing gas contract, the take or pay by virtue of guaranteeing a regular cash flow

amortizes the huge initial investment of gas projects and secures the financing of the

project.9. Take or pay clause benefits the buyer as the buyer commits to pay for a

minimum quantity to guarantee a regular but flexible supply thereby meeting delivery

obligations to end users.10

One of the fundamental reasons for the inclusion of a take or pay clause in a gas

contract is to allocate the risks of the production and sales of natural gas between the

seller and buyer. The take or pay clause moves the risk of market failure from the

seller to the buyer. The seller bears the risk of production; to compensate the seller for

that risk, the buyer agrees to take, or pay for it if not taken, a minimum quantity of

gas, thus the buyer bears the risk of market demand. The sharing of price risk and

6 Roberts, P., Supra note 5 p. v

7 Roberts, P., Supra note 5 p. 1538 Greenwald, G. B., Natural Gas Contracts under Stress: Price, Quantity and Take or Pay, 5(1)

J.E.N.R.L (1987), p. 19

Namikawa, R., Take or Pay under the Japanese Energy Policy , Energy Policy, Vol. 31 (2003), p.132810

Namikawa, R., Ibid.


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quantity risk is a common feature of long-term take or pay gas contracts11. The seller

is compensated at all times for being ready to deliver the maximum amount of gas to

the buyer and avoids the risk that he would usually have faced were the buyer‟s

demands drop too low.12

2.3. Mitigating and Restricting the Risk of Take or Pay Clause in Gas

Contract

The inclusion of take or pay clause in gas contracts could be onerous and unfair to a

buyer who might object to the take or pay clause on the ground that, the seller should

be free to sell its gas elsewhere if the buyer elects not to request gas for delivery.

However, the view of the buyer in this instance may not be economically justified

where the seller had dedicated gas reserves to the buyer such that they cannot be

freely sold elsewhere, or where the seller may not have access to unutilised gas

transportation capacity in order to facilitate the sale of gas to other party.13

The take or pay clause has also been criticized for reducing the effect of competition

in the sale of natural gas by negativing the aims of competition to provide the best

service to the consumer at the lowest price because the buyer is bound by the GSA (or

SPA). The take or pay clause in gas contracts do not generally make the GSA easily

amenable to changes to reflect prevailing market situations as buyer is at a

11 Glachant, J., and Hallack, M., Take-or-pay contract robustness: A three step story told by the Brazil –

Bolivia gas case? Energy Policy, Vol. 37 (2009), pp. 651 – 657.12

Marseglia, E. A., Take-or-Pay Litigation – The Producer Perspective: Part 2, 5 0.G.L.T.R.(19987/88) p. 12913

Roberts, P., Supra 4 p. 153


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disadvantage where the demand volume for gas falls below the contracted price

coupled with the developments of spot market.14

The above enumerated risk of a take or pay clause in a gas contract could be mitigated

by amending the terms of the GSA to reflect the prevailing economic circumstances

by making the term of the GSA short, lengthening the take or pay obligation and

decreasing the percentage of the take or pay obligation.15 The GSA could also be

made flexible by a make up clause which will cater for the possibility that the buyer

will take less gas and a carry forward clause which will cater for the possibility that

the buyer will take more gas.16

(“The make up and carry forward clause are vital

tools available to the buyer to modulate its take or pay commitment in the light of

unpredictable operational and/or commercial requirements”).17

Renegotiation clauses could be included in the GSA in a bid to allow the parties

materially revisit their economic interest, clarify any ambiguity or uncertainty and

redraft the basis of the GSA to reflect the present economic climate.18

This serves to

put the disadvantaged party in a better stance commercially and to reach consensus.

Furthermore, price review clauses could be included in the GSA to oblige both parties

to renegotiate the market price of gas changes viz – a-viz the contract price.19

Given the difficulties encountered by many buyers of gas as a result of the take or pay

clauses, the seller may to her advantage, in the long term, afford to the buyer what is

14 Glachant, J., and Hallack, M., supra note 11 at, p. 1328; Osikilo, Y., How are the Problems of Buyer

in Long-Term Take or Pay Contracts in the Gas Industry Mitigated? CEPMLP Annual Review (CAR),

2004/2005.15

Glachant, J., and M. Hallack, supra note 11 p. 132816 Roberts, P., Supra note 4 at, p. 16717

Roberts, P., Ibid.18

Phillips, B., Examining the Future of long term Take or Pay contracts, O.G.L.T.R Vol. 3 (1997), pp.

73 – 74.19 Davey, H., “Take or Pay” and “Send or Pay”: A Legal Review and Long -Term Prognosis,

O.G.L.T.R. Vol. 11 (1997), p. 421


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in effect a take or pay “holiday”, so that the effective date or pay rate is reduced in

earlier years but compensated for “at an appropriate rate” in subsequent years of the

life of the contract.20

Despite the mitigation of the risk of take or pay contacts in the GSA, it is imperative

to state that the above explained mitigation could be restricted in a number of ways;

for example, the seller in a GSA may wish to limit or exclude completely the buyer‟s

access to carry forward the payment for the gas; the seller could also seek for

limitations on the amount and timing of the make up quantities. The seller may also

through a mechanism called “infidelity clause”21

penalise the buyer for its desire to

buy further volumes of gas (or LNG) from the spot market or from someone other

than the seller by increasing the buyer‟s take or pay liability under the GSA (SPA) but

the buyer may posit that such infidelity clause falls foul of any competition provisions

to which the GSA (SPA) may be subject or argue that the clause unjustly restricts the

freedom of the buyer to buy gas from other sources in its bid not to be bound by the

take or pay provisions.22

From the above analysis, it can be inferred that long-term obligations relating to take

or pay is an essential term for stabilising GSA (or SPA). Having discussed the

concept of take or pay clause in a GSA, including its mitigation and restrictions, it is

necessary to proceed to the crux of this research paper for a better appreciation of the

analysis.

20 Phillips, B., Supra note 18 p. 78.

21

Roberts, P., Supra note 10 at, p. 162.22 Roberts, P., Supra note 10 at, p. 162.


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3. BACKGROUND OF POLYMERS’ CASE: THE RULE AGAINST

PENALTIES AND TAKE OR PAY CLAUSE

3.1 The Facts: The Case before the Court

“Under a supply contract dated 25th January, 2005, M & J Polymers (“claimant”)

agreed to supply chemical dispersants to Imerys, subject to various provisions for

termination, the supply agreement had a three-year minimum term and a take or pay

provision. Under Article 5.3 of the supply contract, the Imerys (“defendant”) agreed

to buy specified minimum quantities of the products, and under Article 5.5 of the

supply contract (the “take or pay” clause) the defendant agreed to pay for the

minimum quantities of the products even if the defendant had not ordered the

indicated quantities during the relevant monthly period. Under Article 10.1, the

claimant warranted that the products would be “(i) of the specified and ordered

quality, (ii) free from defects, (iii) in strict accordance with any specifications or

standards attached to this Agreement or to any Buyer Order , and (iv) free from any

and all liens and encumbrances” and under Article 10.3, the defendant was to make

known to the claimant the purposes for which the product was required and the

claimant, based on the then state of the art, was to make sure that the product was

compatible with those purposes.”23

A dispute subsequently arose between the parties as to the quality of the products

being supplied under the supply contract and that Imerys (“the purchaser”) neither

took nor paid for the stipulated minimum quantities. Imerys later terminated the

supply contract claiming that the product was defective and not within the agreed

specification. M & J Polymers accepted Imerys termination but treated is as unlawful

repudiation of the contract. In the period preceding the termination, Imerys was taking23

M & J Polymers Limited v Imerys Minerals Limited (2008) EWHC 344 (Comm.)


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less than the required minimum quantity of product and was not paying the minimum

amount specified for such minimum quantity under the contract. M& J Polymer sued

Imerys claiming payment for the minimum amount, stipulated by the contract, as a

debt.24

3.2 The Legal Issues

The legal issues that arose for determination from the facts before the Commercial

Court included: (i) whether the dispersants delivered by the claimant was fit for its

purpose under Article 10.3 of the supply contract and whether the defendant company

was entitled to refuse to accept any further deliveries of it; (ii) (a) whether the sums

due to be paid by Imerys to the M & J Polymers for a shortfall in orders for the period

prior to the repudiatory breach of the supply contract by the defendant, were

recoverable as a debt rather than damages in respect of the price of the minimum

quantities of product which the defendant was to purchase (or pay for) under the

supply contract; and (ii) (b) whether the take-or-pay clause constituted a penalty and

that the claimant should be limited to a general claim in damages for breach of the

defendant‟s obligation to order the specific minimum quantities; and (iii) whether the

defendant has breached the supply contract by not ordering the required minimum

amount of goods. It should be noted that legal issue (ii) is the main crux of this

research paper, therefore, I shall briefly state the decision of the court on issue (i) and

(iii) while I will dwell more on issue (ii).

24 Ibid .


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3.3 The Argument and The Judgement

On the first issue, based on the evidence presented by M & J Polymers and Imerys

coupled with internal investigations and independent tests, the court rejected Imerys‟

argument that it was entitled to refuse to accept any further deliveries of dispersants

by M & J Polymers on the ground that it was not fit for the purpose in breach of

Article 10(3). The court held that M & J Polymers was not in breach of Article 10(3)

of the supply contract because M & J Polymers produced the dispersants in

accordance with its contractually provided specification and the supplied dispersants

were compatible with the purpose for which Imerys required it. 25 The court also held

that Imerys was in breach of the contract by ordering less than the minimum

quantities.

In connection with legal issue (ii) above, M & J Polymer argued that the failure by the

defendant to make the minimum payment under the supply contract constituted a debt

and a breach of contract and consequently, the law of penalties did not apply. The

defendant further asserted that the claimant‟s claim pursuant to the take or pay clause

amounted to a penalty and that the claimant must be limited to a claim for breach of

the defendant‟s obligation under Article 5.3 of the supply contract. M & J Polymers

further buttressed its argument that its claim under the take or pay provision was a

debt by referring Burton J. (the presiding judge) to the citation in Chitty on

Contracts26 that discussed the principle of law in White & Carter (Councils) Limited v

McGregor 27

where it was stated that: “The law on penalties … is not relevant where

25

M & J Polymers Limited v Imerys Minerals Limited (Supra).26 Hugh, B., 29th Edition, 2004, Vol. 1 at Para. 26-118.27

(1962) AC 413


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the claimant claims an agreed sum (a debt) from the defendant in return for the

claimant‟s performance of his obligations.”28

M & J Polymers also relied upon the decision of the House of Lords in Export Credit

Guarantee Dept. v Universal Oil Products Co.,29

wherein a payment to take place on a

specified event was held not to be susceptible to the law of penalties. M & J Polymers

argued that the sum was due as a price irrespective of whether Imerys had ordered the

minimum quantities or as it might alternatively be stated “whether or not they have

ordered the quantities” or indeed “whether or not there has been a breach of clause ?

and concluded that the amount due was a debt and not as damages and the rule of

penalties did not apply.

Burton J. disagreed with M & J Polymers‟ argument and held that the sum due under

the take or pay proviso arose as damages for failure to order the minimum quantity

and therefore it was not a claim for debt but for damages and therefore the rule of

penalties might apply to take or pay clause. The court held that on the evidence, it was

clear that the take or pay clause was commercially justifiable, did not amount to

oppression, was negotiated and freely entered into between parties of comparable

bargaining power, and did not have the predominant purpose of deterring a breach of

contract nor amount to a provision "in terrorem" and therefore the take or pay clause

in Article 5.3 was not a penalty and the rule against penalties does not apply.

28

Holland, B., and P. Ashley, Enforceability of Take-or-Pay Provisions in English Law Contracts,26(4) JENRL, (2008)29

(1983) 1 WLR 399


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3.4 The Rule Against Penalties

The rules against rule against penalties do not permit the enforcement of a contractual

provision which imposes a penalty on a party in default. The law does however permit

the recovery of liquidated damages. Two parties to a contract may (and within the

scope of the parties‟ freedom of contract) as part of the agreement between them, fix

the amount which is to be paid by way of damages in the event of breach. Whether

such sum is or is not in fact recoverable from the party in breach depends on whether

the amount provided for in the agreement constitutes liquidated damages (which are

recoverable) or a penalty (which are irrecoverable).30

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 (in order to frighten). Clauses of this

nature are considered to be unjust and courts will usually not enforce them.

The English law rule against penalties prohibits the enforcement of contractual

provisions which operate as a penalty against a defaulting party.31

For example, the

rule renders unenforceable, a provision which states that upon a breach of a contract

by one party, a sum shall become payable to the non-defaulting party in circumstances

where the amount due is not a genuine pre-estimate of loss suffered due to the

breach.32

The English law on penalties was upheld in the case of Robophone Facilities

Limited v Blank 33

wherein it was stated that a provision which has the object or effect

of acting as a penalty against a party in order to secure the performance of an

obligation under an agreement will be rendered unenforceable.

30 Beale, H., Chitty on Contracts, (29

th Ed.), (London, United Kingdom: Sweet & Maxwell, 2004), Vol.

1 at Para 26-109.31

Holland, B., and P. Ashley, Supra note 27 p. 61032 Hodges, P., and J. Roger, Supra note 1 p. 61.33

(1966) 3 All E.R. 128 C.A.


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The question whether an express clause which states a sum to be recovered on breach

is an enforceable liquidated damages clause or is unenforceable as a penalty rests

essentially on whether it is a genuine pre-estimate of loss. This question was

examined in the leading case of Dunlop Pneumatic Tyre Co. Limited v New Garage

and Motor Co. Limited34

wherein Lord Dunedin summed up the law as follows;

1. “the Parties‟ use of the words „penalty‟ or liquidated damages does not

conclusively decide the issue;

2. the case must be judged according to circumstances at the time of the

contract was made and not at the time of breach;

3. the sum will be held to be a penalty if it is „extravagant and

unconscionable in amount in comparison with the greatest loss that could

conceivably be proved to have followed from the breach;

4.

the sum will be held to be a penalty if the breach consists only in not

paying a sum of money, and the sum stipulated is a sum greater than the

sum which ought to have been paid;

5. there is a presumption (but no more) that it is penalty when „a single lump

sum is made payable by way of compensation, on the occurrence of one or

more or all of several events, some of which may occasion serious and

others but trifling damage, and on the other hand it is no obstacle to the

sum stipulated being a genuine pre-estimate of damage, that the

consequences of the breach are such as to make precise pre-estimation

almost an impossibility. On the contrary, that is just the situation when it

34 (1915) A.C. 79, pp. 86-88. (Please see this case for a fuller explanation).


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is probable that pre-estimated damage was the true bargain between the

parties.”35

In respect of the above, the rule against penalties in English law therefore means that

a party is free to breach its contractual obligations provided damages would be paid

based on the value to be determined by the court based on established principles.36

The adverse effects of the penalty rule is that it runs against the principle of freedom

of contract not to enforce the fairly bargained agreements and the allocation of risk

agreed by the parties and should not be extended at the expense of freedom of

contract and simply to afford relief against onerous bargains.37

(“The courts are

generally reluctant to invoke it and will do so only in circumstances of undue

oppression (for example, where there exists an inequality of bargaining power and/or

the provision is not commercially justifiable”).38

3.5 The Polymers’ Case in relation to Take or Pay Clause and Penalty

Burton J. stated that “as a matter of principle, the rule against penalties may apply”.

However, on the facts of the case under review, it was held that the take or pay

provision was not a penalty because it was commercially justifiable and did not

amount to oppression, it was negotiated and freely entered into between parties of

comparable bargaining power and did not have the predominant purpose of deterring

breach of contract nor amount to a provision “in terrorem”.

35 (1915) A.C. 79, 86-88 as cited in Beale, H., in Chitty on Contracts, Supra. note 27 Page 26-109.

36 Holland, B and P Ashley, Supra. note 27 p. 611.

37

Exports Credits Guarantee Department v Universal Oil Products Co. (1983) 2 All E.R. 205 HL citedin Roberts, P., Supra. p. 16338

Hodges, P. and J. Rogers, Supra.


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The Polymers‟ case is important in respect of the take and pay clause as it appears to

open the take or pay provisions to attack because it found that a breach of any take or

pay clause similar to the one examined by the judge, represents an action in damages

(and consequently a penalty) not a debt coupled with the judge‟s interpretation as to

when take or pay clauses could be treated as a penalty and consequently

unenforceable.39

To appreciate this judgement in relation to take or pay provisions, it

is imperative to describe the distinction between a claim for a debt and for damages.

A debt is a definite sum of money fixed by the agreement of the parties as a payment

by one party in return for the performance of a specified obligation by the other party

or upon the occurrence of some specified event or condition; damages may be

claimed from a party who has broken his contractual obligation in some way other

than a failure to pay such debt.”40

According to Burton J., the seller‟s claim was a damages claim because the obligation

of the buyer to pay under a take or pay clause arose as a result of the breach of the

duty to order the minimum quantity so the claim was subject to the rule against

penalties. He stated further that he did not see how a payment obligation can arise

under the take or pay provision except than a breach of the obligation to request for

the minimum quantity.41 The implication of Burton J.‟s reasoning is that most take or

pay obligations would be a penalty given the fact that it usually involves an obligation

on the buyer to order a minimum quantity of a product. However, take or pay clauses

should not be interpreted as a clause that functions only because of the breach of an

obligation to order the minimum quantity neither is it necessary to interpret the

39

Holland, B. and P. Ashley, Supra. note 27 p. 61140 Beale, H., Supra. note 29 at, para. 26-009 cited in Holland, B., and P. Ashley, Ibid.41

M & J Polymers v Imerys (Supra).


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interrelation of the minimum order clause and the take or pay in a manner that makes

a claim by a seller under the take or pay clause a damage claim.42

Despite Burton J.‟s reasoning for its judgment, a take or pay clause does impose an

obligation on the seller to deliver goods to the buyer while the buyer has an obligation

to take up and / or pay for the goods; the sum due being a debt. It should be noted that

take or pay payment is not payable as a penal consequence of a failure of the buyer to

take delivery of a quantity of gas equal to the buyer‟s take or pay commitment but an

alternative method of contractual performance for the buyer, which has the option to

take the delivery of gas and to pay for it or not to take delivery of gas but still to

pay.43

The supply contract in Polymers‟ case did not contain a „make up‟ provision that

would have made it difficult for the buyer to argue that the take or pay provision was

oppressive and unenforceable as a penalty.

4. IMPLICATION OF THE POLYMERS’ CASE TO GAS CONTRACTS

Given 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.

Having said this, the finding that take or pay clauses could, in principle, be a penalty

has some important implications.

42 Holland, B. and P. Ashley, Supra. note 27 p. 1243

Roberts, P., Supra. note 10 p. 163


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4.1 Implication to the Buyer of Gas

The reasoning by Burton J. that take or pay may constitute a penalty could be

attractive to a buyer under a GSA (or SPA) which contains a take or pay obligation

resulting in the buyer being bound to buy gas (or LNG) at a price which is greater

than the price at which the gas could be bought elsewhere in another market.44

The

Polymers‟ case also appears to give a buyer a plausible (though difficult) argument to

avoid liability under a take or pay clause.

4.2 Implication to the Seller of Gas

The seller can take confidence in using take or pay provisions and enforcing

payments. In order to protect the interest of the seller and to guard against a take or

pay clause been deemed a penalty, 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 which has been incurred

by the seller as a result of setting aside the gas for the specific buyer. Particular care

must be taken where it might be suggested that the seller has greater knowledge and

bargaining power .

4.3 Future of Take or Pay Clause to Gas Contracts

The positive impact of take or pay clause in ensuring security of a revenue for a seller

is important in enhancing the growth of new gas (or LNG) production and

transportation infrastructure coupled with the take or pay commitment which has been

shown to be a vital mechanism in the evolution of a growing gas (LNG ) markets.

However, the marriage of a long-term GSA with a take or pay obligation and a fixed

44 Roberts, P., Supra note 10 p. 163


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contract price could be challenged by the buyer or make the buyer refuse to perform

its obligations in view of the cost of competing gas or other fuels and buyer‟s

commitment becoming commercially unfair in view of the comparative opportunities

to buy and sell gas in the gas market. This situation was clearly demonstrated when

the rigid application of and the high commitments of the take or pay provisions in

contracts for the purchase and sale of natural gas wreaked havoc in the US gas

industry in the late 1980s and early 1990s. A similar scenario was played out in the

United Kingdom as a result the combination of the effects of deregulation,

introduction of competition, and downward pressure on gas prices which exposed

pipeline company gas buyers, who were acting effectively as middlemen in the

purchase of gas from gas producers and excess supply of gas over demand in the gas

market.

To avoid take or pay commitments from losing its viability, there is the need to revisit

the economic and legal regime of take or pay clauses by infusing flexibility into GSA

(SPA) by transcending from long-term GSAs (SPAs) to short-term GSA agreements,

inserting a price review clause in the GSA so as to mitigate the price risk or volume

risk of take or pay obligations and to make provision for the possibility of

renegotiation of GSA or (SPA) so as to ensure a balance between its mitigation and

restrictions.

5. CONCLUSION

The benefits of a take or pay to both the buyer and seller of gas coupled with balance

between the mitigation and restriction of the risk of take or pay clauses in GSAs and

the commercial justification for its inclusion in gas contracts would most unlikely

make take or pay clauses to be unenforceable as a contractual penalty.


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BIBLIOGRAPHY

PRIMARY SOURCES

Cases

Dunlop Pneumatic Tyre Co. Limited v New Garage and Motor Co. Limited (1915)

A.C. 79.

Exports Credits Guarantee Department v Universal Oil Products Co. (1983) 2 All E.R.

205 HL.

M & J Polymers Limited v Imerys Minerals Limited (2008) EHWC 344 (Comm.)

Robophone Facilities Limited v Blank (1966) 3 All E.R. 128 C.A.

White & Carter (Councils) Limited v McGregor (1962) AC 413.

SECONDARY SOURCES

Books

Roberts, P., Gas Sales and Gas Transportation Agreements: Principles and Practice,

2nd

Edition, (London, United Kingdom: Sweet and Maxwell, 2008).

Articles

Glachant, J., and M. Hallack, Take-or-pay contract robustness: A three step story told

by the Brazil – Bolivia gas case? Energy Policy, Vol. 37 (2009)

Greenwald, G. B., Natural Gas Contracts under Stress: Price, Quantity and Take or

Pay, 5(1) J.E.N.R.L (1987)


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Hodges, P., and Rogers, J., Take or Pay Clause Tested in English Courts, Vol. 3

I.E.L.R. (2008)

Holland, B., and P. Ashley, Enforceability of Take-or-Pay Provisions in English Law

Contracts, 26(4) JENRL, (2008)

Lowe, J. S., The Take-or-Pay Wars – Is Peace at Hand? 1 O.G.L.T.R (1989/90)

Marseglia, E. A., Take-or-Pay Litigation – The Producer Perspective: Part 2, 5

O.G.L.T.R. (1987/88)

Namikawa, R., Take or Pay under the Japanese Energy Policy, Energy Policy, Vol.

31 (2003)

Osikilo, Y., How are the Problems of Buyer in Long-Term Take or Pay Contracts in

the Gas Industry Mitigated? CEPMLP Annual Review (CAR), 2004/2005.

Pearson, M. P., and Watt, R. D., To Share or Not To Share: Royalty Obligations

Arising out of Take-or-Pay or Similar Gas Contract Litigation, 42nd Annual Institute

on Oil and Gas Law and Taxation, (Dallas, USA: Matthew Bender, 1991).

can take or pay clause in gas contract be considered a contractual penalty

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