Driver Trett Digest | Issue 20 - Magazine - Page 15
DIGEST | ISSUE 20
What is ‘take or pay’?
Take or pay clauses operate to the benefit of
both buyer and supplier.
There is a well-understood commercial justification for
including such a provision in a supply contract: a buyer
may require the flexibility to take delivery or not to take
delivery of workers, materials or gas commensurate
with needs; a seller could give the buyer an option on
whether or not to take delivery or call-off the services,
on condition that the seller would still require the buyer
to make payment to the seller of a certain value for the
quantities of gas, resource or services not delivered.
Such a payment is an option fee which is payable for
the buyer’s election not to take delivery. This take or
pay payment creates an obligation in debt in the seller’s
favour. This is different to a liability in damages (typically
found in a take and pay clause) because under a take
and pay clause, the buyer’s “non-off-take” is a breach
of contract, whereas under a take or pay provision the
buyer’s “non-off-take” is an exercise of a contractual
right to do so.
The distinction is an important pleading point. Whether
the supplier runs a damages claim or a claim in debt
affects not only procedure but can also open up wider
debates about the enforceability of pre-agreed amounts
and, in particular, if the law of penalties applies or if such
amounts can be reduced.
Does the law of penalties apply?
M&J Polymers Ltd. v. Imerys Minerals Ltd.1 and E-Nik Ltd.
v. Department for Communities and Local Government2
are two English High Court Judgements decided by
Mr. Justice Burton. The same judge in a third case of
Cavendish Square Holdings BV & Anor v. El Makdessi3
made clear that he considered that “take or pay” clauses
despite creating a debt claim could nevertheless qualify
as a penalty clause.4 This clarification was important.
Mr. Justice Burton stated:
Thus I concluded in M&J Polymers Ltd. v. Imerys
Minerals Ltd. [2008] 1 AER (Comm) 893 that a “take or
pay clause” might qualify as a penalty clause, i.e., that
the concept of penalty could apply to a debt claim as
much as to a damages claim (contrary to the previous
understanding in Jervis v. Harris [1996] Ch. 195).
The provenance of Mr. Justice Burton’s “expansion”
of the concept of penalty is open to exploration. The
learned judge stated “…the way in which in more
modern times the concept of penalty, while remaining
a rara avis, has, at least in principle, moved outside the
original province of a clause providing for an extravagant
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assessment of (liquidated) damages. One development,
to which I have referred, was to expand its operation,
although in the event unsuccessfully, into what was
otherwise a claim in debt…”5
In M&J Polymers the learned judge considered that the
House of Lords approach in White & Carter (Councils)
Ltd. v. McGregor6 and its citation in Chitty on Contracts
– “The law on penalties ... is not relevant where the
claimant claims an agreed sum (a debt) which is
due from the defendant in return for the claimant’s
performance of his obligations” was “too simplistic”.
Burton relied on Lord Roskill’s speech in Export
Credits Guarantee Dept. v. Universal Oil Products Co.
where it was said “the clause was not a penalty clause
because it provided for payment of money upon the
happening of a specified event other than a breach of
a contractual duty owed by the contemplated payor
to the contemplated payee.”7 However, Lord Roskill
was summarizing Slade LJ’s judgment in the Court of
Appeal which in turn relied on Diplock LJ’s judgment
in the Court of Appeal in Philip Bernstein (Successors)
Ltd. v. Lydiate Textiles Ltd.8
In that case, Diplock LJ (as he then was) confirmed
that the “penalty area” is restricted to the “narrow field”
where there has been “a prior agreement by the parties
to the contract as to an amount to be paid by a party in
breach to the other party in respect of that breach.” Such
is the beauty of the common law and jurisprudence that
a supplier could argue that the law of penalties does not
apply and cite back to the House of Lords in White &
Carter (Councils) Ltd. Should a tribunal find otherwise,
then one needs to look at how liquidated damages are
Should a tribunal find that take or
pay relates to breach and damages,
then the international debate will
focus on whether the sums claimed
can be reduced.
Nature of penalties under English law
The Supreme Court reviewed comprehensively the
nature of penalties in Cavendish Square Holdings BV v.
Makdessi and ParkingEye Ltd. v. Beavis.9 In their joint
judgment, Lord Neuberger and Lord Sumption pointed
to the distinction between a primary contractual
obligation and a secondary obligation which arises
only on breach of a primary obligation and made clear,
“The true test is whether the impugned provision is a
secondary obligation which imposes a detriment on the
contract-breaker out of all proportion to any legitimate
interest of the innocent party in the enforcement of the
primary obligation…”
The comments of Lord Mance add further weight to
the proposition that the Courts are unlikely to set
aside the pre-agreed or liquidated amounts. Supply
agreements that invoke “take or pay” provisions are
complex and negotiated at arm’s length based on
legal advice. Lord Mance said:10 “In judging what is
extravagant, exorbitant or unconscionable, I consider
(despite contrary expressions of view) that the extent
to which the parties were negotiating at arm’s length
on the basis of legal advice and had every opportunity
to appreciate what they were agreeing must at least be
a relevant factor.”
Liquidated damages under civil codes
Should a tribunal find that take or pay relates to
breach and damages, then the international debate will
focus on whether the sums claimed can be reduced.
By way of example, pursuant to Article 390(2) of the UAE
Civil Code the court holds a discretion to adjust the preagreed amount of compensation to ensure the damages
are equal to the loss suffered. Similar provisions are
found in the Civil Code of the Republic of Uzbekistan
at Article 326 which may allow a penalty to be reduced
in case where it is manifestly incommensurate to the
consequences of breach of obligation. Article 1231-5 of
the French Civil Code may also be relevant. It provides:
When an agreement provides that the party who fails to
perform it will pay a certain sum as damages, the other
party may not be awarded a greater or lesser amount.
Nevertheless, the judge may, even on his own motion,
moderate or increase the penalty agreed upon
when it is manifestly excessive or ridiculously low.
Where the obligation has been performed in part, the
agreed penalty may be reduced by the judge, even ex
officio, in proportion to the interest that the partial
performance has provided the creditor, without
prejudice to the application of the preceding paragraph.
Any stipulation contrary to the two preceding
paragraphs shall be deemed unwritten.
Except in the case of final non-performance, the penalty
shall only be incurred when the debtor is given notice.
Three key points
M&J Polymers Ltd. v. Imerys Minerals Ltd. and
E-Nik Ltd v. Department for Communities tend to
the conclusion that a failure by the buyer to “take
or pay” is a breach giving rise to damages such that
the law on penalties is activated.
However, English law authority also concludes
that a failure to “take or pay” is a debt claim (not
a claim in damages) and so not subject to the rule
on penalties, for example White & Carter (Councils)
Ltd. v. McGregor and Euro London Appointments v.
Claessens International.
The jurisprudence indicates that take or pay
clauses ought not fall into the law on penalties. If
a Tribunal decides otherwise, the UK Supreme
Court in Cavendish Square Holdings BV v. Makdessi
has reinforced the point that English Courts will
be reluctant to disturb the parties’ agreement.
Internationally, buyers keen to assert that the
harm to the supplier is lower than that set in the
agreement may attempt to seize upon Civil Codes.
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