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 an Attorney 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 and gas 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 the Energy Institute. Email:
[email protected]
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
5.
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
CONCLUSION ……………………………………………………….........18
BIBLIOGRAPHY
ii
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
iii
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 commercial 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 2
Hodges, P., and J. Rogers, Take or Pay Clause Tested in English Courts, I.E.L.R. 3 (2008), p. 60 M & J Polymers Limited v Imerys Minerals Limited (2008) EHWC 344 (Comm.) 1
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 2
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 revenue 5 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 Takeor-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 3
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 Roberts, P., Supra note 5 p. 153 8 Greenwald, G. B., Natural Gas Contracts under Stress: Price, Quantity and Take or Pay, 5(1) J.E.N.R.L (1987), p. 1 9 Namikawa, R., Take or Pay under the Japanese Energy Policy, Energy Policy, Vol. 31 (2003), p. 1328 10 Namikawa, R., Ibid. 7
4
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. 129 13 Roberts, P., Supra 4 p. 153 5
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. 1328 16 Roberts, P., Supra note 4 at, p. 167 17 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 6
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. Roberts, P., Supra note 10 at, p. 162. 22 Roberts, P., Supra note 10 at, p. 162. 21
7
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 taking 23
M & J Polymers Limited v Imerys Minerals Limited (2008) EWHC 344 (Comm.) 8
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. 9
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 McGregor27 where it was stated that: “The law on penalties … is not relevant where
25
M & J Polymers Limited v Imerys Minerals Limited (Supra). Hugh, B., 29th Edition, 2004, Vol. 1 at Para. 26-118. 27 (1962) AC 413 26
10
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 11
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 Blank33 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, (29th Ed.), (London, United Kingdom: Sweet & Maxwell, 2004), Vol. 1 at Para 26-109. 31 Holland, B., and P. Ashley, Supra note 27 p. 610 32 Hodges, P., and J. Roger, Supra note 1 p. 61. 33 (1966) 3 All E.R. 128 C.A. 12
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. Limited 34 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). 13
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. 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 cited in Roberts, P., Supra. p. 163 38 Hodges, P. and J. Rogers, Supra. 36
14
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. 611 Beale, H., Supra. note 29 at, para. 26-009 cited in Holland, B., and P. Ashley, Ibid. 41 M & J Polymers v Imerys (Supra). 40
15
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 43
Holland, B. and P. Ashley, Supra. note 27 p. 12 Roberts, P., Supra. note 10 p. 163 16
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 17
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. 18
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).
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