Intro 

In case you didn’t hear the term before, a clear-cut explanation is that a take-or-pay clause is a contractual provision that requires the buyer to make an unconditional payment to the seller. The buyer is required to either pay the price corresponding to pre-agreed quantities and take the delivery or pay their corresponding price regardless of whether it takes the delivery. Even though such clauses are used in contracts across a range of industries, they are commonly found in the energy business, namely in liquefied natural gas sale and purchase agreements (SPAs), natural gas SPAs, power purchase agreements and similar. 

Similarly, send-or-pay (aka ship-or-pay) clauses can be found in energy sector transportation contracts and capacity reservation agreements.

Origin  

Take-or-pay contracts have been used in the energy sector for several decades, particularly in the gas industry. The practice of including such provisions began back in the 1960s when natural gas started to be transported via pipeline. At first, these contracts were used to incentivize the construction of pipeline infrastructure by guaranteeing a predetermined level of demand for the gas that would be transported through the pipeline. Therefore, buyers were required to either take delivery of a determined amount of gas or pay for that amount regardless of whether they actually claimed delivery. 

In Serbian energy law, a take-or-pay agreement is a type of contract that is commonly used in the natural gas industry. Under this type of agreement, the seller of the gas is guaranteed a certain amount of revenue even if the buyer does not take the delivery of gas.

Understanding Pay-or-Take

What is the rationale behind such contractual clauses? This sort of agreement directly benefits the supplier by reducing the risk of losing money on any capital spent to produce the product. Take-or-pay agreements are common in the energy sector because of substantial overhead costs for suppliers to provide energy units and the volatility of prices in the energy market. 

 If there were no take-or-pay clauses, the supplier would not have an incentive to invest capital up front to provide energy units, and would bear all the risk. Without that clause, the buyer could decide to end the contract because its need for energy changed, dried up or a price swing shook the market.  

Even though they sound alike, take-to-pay differs from a take-and-pay contractual clause. The take-and-pay clause requires the buyer to both take the minimum contract quantity and pay the corresponding price. It is often referred to as the off-take agreement.

How both sides benefit from such clauses can be seen in a practical example that is usually used to describe a take-or-pay situation. Imagine two companies that are about to enter into a natural gas SPA. Company X wants to buy 10 billion cubic meters of natural gas from Company Y over 10 years at an agreed amount of 1 billion per year. After some time, Company X realizes that in the third year it will need less than 1 billion and declines to purchase the full amount. Instead, Company X is subjected to a fee that was agreed to in the initial contract.  

Imagine now the same contract but in different circumstances. For example, gas prices have fallen significantly after a few years, and Company X wants to change the supplier and decline the delivery from Company Y. Company X finds another supplier at a new, lower price of natural gas. Because of the pay-or-take clause, Company X has to pay the agreed amount to Company Y. 

Are Take-to-Pay (TOP) Clauses Renegotiable? 

One of main TOP’s features is its reviewing nature. Any TOP clause requires careful drafting in order to avoid the possibility that a buyer may be required to pay for a quantity that it failed to take due to, for example, a force majeure event that prevented contractual performance.  

A Force Majeure clause (aka Act of God clause) refers to the occurrence of events such as natural disasters or wars that make it difficult for one or both parties to maintain and uphold their obligations under the agreement. This clause is common in many energy agreements which include detail-oriented TOP provisions.  

The Serbian Law on Contracts and Torts examines such circumstances in the part about the terminating or amending a contract due to changed circumstances.

Other clauses that can be laid down in such agreements are, for instance, the Escalation clause and the Review clause. The Escalation clause is used to safeguard the interests of both parties in case of substantially high and unpredictable fluctuations of the product’s price on the market. As the name suggests, the Review clause encompasses the terms and conditions for timings of regular reviews of the agreement. 

The EU Perspective

Take-or-Pay clauses fall within the scope of the EU regulation of the gas sector which is presented by the Third Gas Directive (Directive No. 2009/73/EC) and the application of EU competition law in respect of the energy sector. The Second and Third Gas Directives do not address TOP clauses directly. Instead, the Third Directive lists them as one of possible justifications for derogations under Article 48.  

TOP conditions may be tackled from the angle of EU competition law. Being part of long-term gas supply contracts, they may fall within the scope of policies regarding restrictions of competition and market foreclosure. The main norm was provided in the 2007 Distrigas decision. The decision stated that, in the light of competition law, long-term gas supply agreements are not prohibited, yet their impact should be assessed on an individual basis to determine whether they restrict competition to an extent that cannot be accepted. 

‘Contractual Obligation or Penalty’ – Case Law

When the buyer declines the delivery, a certain amount has to be paid to the seller. It is widely comprehended that such a take-or-pay payment presents a contractual obligation, namely a debt. This differs from being liable in damages. For example, if you take a look at the take-and-pay clause, the buyer’s refusal to take the delivery amounts to a breach of contract. However, under a take-or-pay clause the buyer’s refusal to take presents a contractual right on the side of the buyer. 

This matter has been discussed within the Anglo-Saxon legal system. There are three often cited judgments by the English High Court on the nature of take-or-pay clauses: M&J Polymers Ltd v Imerys Minerals Ltd, E-Nik Ltd v. Department for Communities and Local Government and the case of Cavendish Square Holdings BV & Anor v El Makdessi. All these cases have one thing in common – the Court held that take-or-pay clauses, despite creating a debt claim, could also qualify as a penalty clause.  

You may wonder why we are discussing English case law on this matter. The cross-border nature of such contracts often leads to the assumption that national laws resolved issues that may arise. Legal uncertainty emerged in respect of widely used clauses in the global energy sector as the question of ‘debt or penalty’ appeared in few cases. The jeopardy can be found in a subsequent question: if they are penalties, are they even enforceable? 

However, the matter was resolved on appeal to the Supreme Court in Cavendish Square Holdings BV & Anor v El Makdessi. It was stated that there is no rationale for the doctrine of penalties to be applied in such commercial contracts. Namely, such clauses are commercially justifiable and have been negotiated between well-resourced commercial parties with equal bargaining power.