The Paris Energy Series No. 7: Take-or-pay Conditions in Gas Supply Agreements
This article was originally published in October 2014 by Michael Polkinghorne and has been amended to reflect additions and subsequent changes to the law.
Take-or-pay provisions are now fairly common in long-term offtake and supply agreements in the energy sector, a notable example being gas supply agreements.
In essence, take-or-pay provisions provide that a buyer must pay for specified quantities of energy (gas, for example) from a seller, even if the buyer is unwilling or unable to take such quantities. At the most basic level, take-or-pay clauses require the buyer either to purchase and take delivery of certain quantities of gas, or to pay for the gas regardless of whether it takes delivery.
The aim of these provisions is to ensure that the seller will receive a guaranteed stream of revenue under the agreement, irrespective of the quantities actually taken by the buyer. They often operate where the supplier has had to undertake substantial debt and capital commitments in order for the project to get off the ground in the first place. (At the same time of course, buyers have themselves often had to undertake commitments as well; consider re-gas facilities in an LNG project.)
Although take-or-pay clauses are widely used, the rules applicable to such clauses, under most national laws, are not fully settled. The concern frequently expressed is whether these provisions constitute a form of penalty which a court or arbitral tribunal should not enforce.
One need only take the (rare) situation where a buyer cannot take a quantity of gas but must still pay for it, and couple that with the (rarer) case where the seller is thereby able to sell that gas to someone else. Under a traditional take or pay scenario, the buyer will not be able to claim a credit for the other sale, and so the seller is in effect paid twice. The question then arises, is the fact that the buyer is being asked to pay an amount over and beyond the seller’s actual loss a matter for concern? And if so, should the provision be held unenforceable as a penalty clause?
One argument against this is that, in the context of gas contracts agreed between large and experienced companies on the basis of legal advice, take-or-pay provisions are not unreasonable and parties should be held to their commercial bargain. This argument is strengthened by the frequent mitigation of the potentially harsh effects of take-or-pay clauses by the use of one or more of the mechanisms. A second argument is based on the fact that one of these mechanisms which is often included is "make-up", where the buyer can reclaim the gas for which it paid at a later date. Where the buyer does eventually take the gas, the situation may (depending on the wording of the contract) no longer be a breach of contract and could instead be characterized as delayed performance. The initial payment should not therefore be viewed as a penalty for a breach of contract. Other technical arguments of a more legal nature seek to characterize the underlying obligation as a simple debt or an obligation subject to an order for specific performance. These arguments explain why courts and tribunals called upon to review take-or-pay clauses have generally tended to uphold them.
This article is intended to shed light on some of the uncertainties surrounding the legal treatment of take-or-pay clauses, by presenting an overview of the practice of take-or-pay conditions in gas supply contracts and reviewing how these clauses are interpreted and enforced in common law and civil law systems, as well as under European Union and certain Arabic laws.
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