What Is a Take or Pay Agreement

Although take-or-pay is not the only way to manage delivery obligations in long-term contracts for the sale of goods, it remains the most common form. However, although the take-or-pay clause is common in practice, it is still often poorly worded. Parties entering into contracts for the unconditional assumption of obligations related to energy raw materials should be aware of the essential characteristics and limitations of the fundamental obligation to cease unconditionally and to ensure that they manage the significant differences between an unconditional or unconditional obligation to pay and an unconditional obligation to pay or a formal notice obligation. The main distinguishing feature of a “take and pay” contract is that any failure by the buyer to take the minimum contractual quantity is a separate breach of contract for which the seller must make a corresponding claim for damages, and if the buyer actively objects to the seller`s claim, it can take a long time for the seller to claim its damage. Unless the contract contains a provision on lump sum damages covering this type of breach, the seller must, in seeking compensation for such breach, provide proof of its actual damage and proof of its efforts to mitigate such loss, among other things. All this will usually take a long time. Arrangements for taking or payment are usually included between companies and their suppliers, which require the purchasing company to accept an agreed delivery of the supplier`s goods on a certain date, at the risk of paying a fine to the supplier if it fails to do so. This type of agreement benefits the supplier by reducing the risk of losing money on the capital spent to make the product they want to sell. It benefits the buyer by allowing him to demand a lower negotiated price because he assumes part of the supplier`s risk. This can be an overall net gain to the economy, as it facilitates transactions that might not have taken place otherwise, as well as the benefits associated with trade, through better risk sharing between buyers and suppliers. Outside the oil and gas context, “take or pay” contractual clauses are often rejected by the courts as unenforceable penalties. The courts consider these to be “lump sum damages” clauses, which must be based on a reasonable approximation of the actual harm that one party would suffer as a result of the other party`s breach.

“Take or pay” generally does not meet this standard. The provision of article 24 is mandatory in view of the objective it seeks to achieve. Gas sales contracts should adopt the legal requirements to define the obligations arising from the clauses to be invoked and to establish specific conditions for the claim of claims under that clause. In any event, such agreements and claims shall not result in a violation of the parameters set out in Article 24. Many LNG and gas sales contracts give the buyer the right to receive a recharge quantity equal to the amount for which a “take or pay” payment was made in subsequent years (in some cases, even for a short period after the expiry of the contractual period). As a rule, this makeup can only be taken after the buyer has first taken the TOP quantity for that year, thus maintaining the seller`s guaranteed annual income source. In addition, there are often restrictions on the period of time during which the buyer`s right to wear makeup exists. Makeup is sometimes lacking in other types of contracts for taking or paying for goods. Therefore, the initial concept and purpose of the clause is to balance the interests of both parties, i.e.

suppliers and sellers (seller or consumer). The take-or-pay clause is activated if the buyer does not purchase the entire quantity of natural gas ordered by him. In many cases, the latter is required to pay the purchase price for a predetermined minimum quantity of natural gas (recharge quantity), even if he did not purchase this quantity during the year concerned. As a general rule, the buyer can accept the catch-up quantity in future contract years, either by paying a newly determined special price or without any obligation to refund. For the buyer, such contracts are also useful, since there is no obligation to accept delivery. In the above case, suppose company A finds another buyer who offers a lower price than company B. In this case, Company A will use the take-or-pay contract to terminate the contract and pay the fine. Another key element of an take or payment clause is that the TOP amount is not fixed, but is adjusted to reflect events that occur throughout the year. As a general rule, the TOP quantity is reduced by quantities that: (a) the Seller has not made them available for delivery; (b) have been rejected on the grounds that they do not meet the quality specifications; and (c) Buyer has not been able to act due to force majeure. These standard deductions reflect the basic principles that a buyer does not have to pay for goods that could not be delivered; The obligation to take or pay applies only to goods that meet the required specifications (or that the buyer accepts even if they do not conform to the specifications); and that force majeure should fully release some of the obligations affected by force majeure. Three factors explain the need for “take or pay” clauses in energy supplier contracts: An important area of risk in take-or-pay contracts occurs at the beginning of contractual deliveries.

If the buyer is in default of putting into service the equipment he needs to receive and use the goods, the seller always expects that the obligation to take or pay will begin on the first date of contractual delivery: deliveries may not begin, but the obligation to take or pay begins to occur. However, the Seller must be able to prove that, despite the Buyer`s delay, the Seller is available to make the goods available for delivery. Otherwise, if the buyer can prove that the seller cannot complete the delivery, he can argue that the TOP quantity will be reduced, thus eliminating the provision of taking or payment. Faced with this problem, the seller still has to do everything in his power to prove his ability to deliver the goods. In practice, this meant that sellers would complete the wells and fully equip the production facilities, although it was clear that their buyer would be several months or years late in commissioning the buyer`s facilities. In this situation, both parties benefit from the “take or pay” clause. Company A receives from Company C only the quantity of gas it needs, at a lower total cost than it would have paid; Company B receives the penalty price from Company A, instead of earning nothing, if Company A simply changes supplier if the determination of income or payment is missing. For example, contracts to take or pay encourage energy suppliers to invest in the business. Such agreements serve as an assurance to suppliers that they would recover costs.

If such a contract is not concluded, the supplier bears all risks, including the cancellation of an order by the buyer due to price fluctuations. The “take or pay” provisions of a contract are intended to allow for predictable results from a financial point of view, especially when it comes to debts. If a supplier needs a loan to finance the production of an order from the buyer, the lender may not be willing to offer the necessary funds without a provision of taking or payment in the contract. This provision ensures that the supplier is able to repay the loan as intended. For Company A, the agreement is profitable only if the price difference it receives from Company C is greater than the amount of the fine it would pay to Company B. The damages available to the seller if the buyer does not accept the goods may be of the nature of unspecified general damages, or they may consist of agreed lump sum damages, but in most cases they will not be the total price of the contract for the quantity not accepted. When recovering general damage, the seller is often obliged to take steps to reduce its losses, which may require a seller to resell the goods not taken to the buyer and to offset the proceeds of the resale with the seller`s claim for damages. In a take-or-pay contract, the seller is not subject to any mitigation or resale obligation, and if he succeeds in reselling the quantity not taken by the buyer, the seller is entitled to retain all the proceeds of the sale and is not obliged to invoice this product to the buyer. The exact definition of the buyer`s request (e.g. B what facilities? which area? what period? maximum demand levels?) can be somewhat complex in establishing a requirements contract.

If the Buyer fails in its obligation to take only its claims for goods from the Seller, then the Seller`s loss is the profit it would have made from the Buyer for the goods it would otherwise have sold (less any resale proceeds received by the Seller from a mitigating sale) and, as such, the damages available to the Seller, and the seller`s obligation to mitigate the loss is similar to those that apply to a breach of an obligation to take and pay. In fact, according to the explanatory report, “rules will be introduced with regard to `take or pay` clauses in order to avoid passing on the costs arising from these clauses to the aforementioned natural gas consumers if these costs are not borne by their suppliers.