Take-or-pay clauses in the natural gas sales contracts and potential claims against buyers


1. Introduction

Take-or-pay clauses are common in long-term supply contracts in the energy sector, the most typical example being the contracts for the sale of natural gas between a supplier and its customers. Under the take-or-pay clauses, the customer – buyer of a supplier – seller is required to either pay the price corresponding to certain agreed-upon quantities of natural gas and take delivery of the pre-agreed quantities or pay the price regardless of whether it takes delivery or not. On its part, the seller commits towards the buyer to have available the agreed-upon quantity of natural gas.

2. Theoretical approach

The rationale behind the take-or-pay clauses is based on the very nature of the energy projects, because the required investment funds for research, design and construction are significant. In this context, the conclusion of long-term contracts between a supplier and a customer ensures guaranteed income to suppliers, even on predefined terms. In that sense, these clauses act as a risk sharing mechanism between the supplier that, having invested significant funds, often funded by banks, seeks assurance for guaranteed income and the customer that seeks stability in supply and some flexibility on prices. It also follows from the above that take-or-pay clauses operate as an implied guarantee for the financing of a project by the banks, for which they are, indeed, often the primary collateral.

Therefore, the original concept and the purpose of the clause is the balanced satisfaction of both parties, i.e. supplier and seller (and seller and consumer, respectively). The take-or-pay clause is activated when the buyer does not take delivery of the entire quantity of the natural gas ordered. In many cases, the latter is required to pay the price for a minimum quantity of natural gas (make up quantity), which is defined in advance, even if it has not taken delivery of it in the respective year. Usually, the buyer may take delivery of the make-up quantity in future contractual years either by paying a special price fixed anew or without any obligation to pay for the second time.

3. Historical Approach

Take-or-pay clauses are common worldwide in long-term Natural Gas Sales Contracts, both in the US and the Continental Europe.

In the US, the clause already applied in natural gas contracts in the 1960s aiming to balance the trade relations between producers and pipeline management companies.

Take-or-pay clauses ensure that the buyer will not and may not use the contract for freezing natural gas quantities without obligation to compensate the seller. Furthermore, the seller ensures an annual fixed income, regardless of whether the natural gas market is eventually profitable for the seller, thus the downside risk in the natural gas market is passed on to the buyer[1].

Indeed, during the period of the world industrial crisis in the early 1980s, the take-or-pay clauses led to renegotiation of contracts and became the subject of legal disputes, as the buyers had assumed the obligation to purchase, regardless of taking delivery of, quantities far exceeding demand, whilst the prices had fallen to levels far below the value of the contract. In general, however, the validity of such clauses is not disputed in the US, as the courts validate, in theory, such agreements [2].

In the past, the Supreme Court of England and Wales also addressed the question of whether these clauses are prohibited as excessive penalty, not compensatory, clauses, since the rule does not permit the enforcement of a contractual penalty on a party that has breached the agreement. On the dilemma, the Court ruled in favour of the validity of the clause, provided that it does not create contractual and economic imbalance to the detriment of one party and (provided that) the amount of damages or even the price imposed on the parties depends on the amount of the actual and specifically defined (specific) damage occurred[3].

4. The nature of the clause and the legislative regulation under national and EU law

The nature of the take-or-pay clauses is compensatory. In principle, they are clauses of agreed-upon compensation, where the buyer is in mora creditoris, which otherwise under the general provisions – Art. 349 et seq. of the Greek Civil Code particularly in conjunction with Art. 381 of the Greek Civil Code – would lead to compensation of the seller, upon conditions, but not to payment of the entire agreed-upon counter performance.

Moreover, due to the nature of the clause and its impact on the natural gas market which is, in any case, a particular market internationally requiring regulation by mandatory rules, given the monopolistic or oligopolistic position of the participants (mainly suppliers), it is proper to apply specific arrangements of mandatory law to avoid distortions of competition.

More specifically, in Greece, Law 3175/2003[4] provides that:

(a) The natural gas supply contracts of power generation licence holders concluded with DEPA (Public Gas Corporation of Greece S.A.) or third parties cannot contain terms more onerous than those laid down in the respective contracts of DEPA or third parties with their own suppliers, in particular with respect to take-or-pay clauses.

(b) The above contracts cannot contain take-or-pay clauses that, when added up as to the Customers of each party, exceed the sum of its obligations towards its own suppliers, and

(c) Claims for payment of the price based on the above clauses can only be made if the respective claim arises against the other party according to its contracts with its own suppliers.

(d) Implementation issues regarding this paragraph shall be determined by decision of the Minister for Development, following recommendation by Regulatory Authority of Energy (RAE).

(e) RAE, as part of its powers to monitor and control the operation of all energy market sectors, controls the implementation of the above obligations, in a way that promotes healthy competition and ensures consumer protection, and collects all necessary information.

The Ministerial Decision regarding the terms, restrictions and conditions laid down in paragraph 3 of Article 24 of Law 3175/2003 was never issued[5] probably because the statutory provision was deemed sufficiently certain and the interpretation and implementation guidelines remained in the direction given in the explanatory report, namely towards consumer protection.

Indeed, according to the explanatory report, “with respect to the take-or-pay clauses, there are regulations so as to avoid passing on the costs resulting from these clauses to the above natural gas consumers, when such costs are not incurred by their suppliers. As a common practice, the take-or-pay clauses in natural gas contracts are imposed individually on each customer and activated, i.e. the customer incurs charges when it cannot absorb the minimum contractual quantity even where its supplier is not required to pay the respective clause to a third supplier, because other customers have absorbed natural gas quantities exceeding the threshold.

Further, the same explanatory report, referring specifically to the limitations of the Law[6], specifies that “Paragraph 3 of Article 25 of the proposed draft law introduces provisions seeking to safeguard power producers concluding natural gas supply contracts with suppliers of their choice. In this context, it is provided that the natural gas supply contracts of the power generation licence holders concluded with DEPA or third parties should not contain terms more onerous than those laid down in the respective contracts of DEPA or third parties with their own suppliers, in particular with respect to take-or-pay clauses. Therefore, it is provided that DEPA or third parties, cannot impose take-or-pay clauses which in the aggregate exceed the sum of obligations of DEPA or third parties to their own suppliers. Further, DEPA or third parties cannot demand payment of the price of the compulsory purchase, regardless of taking delivery by the natural gas consumers, whom they supply themselves, except where DEPA or the third parties are required to pay the price provided for respectively in the take-or-pay clauses in their own supply contracts. In the latter case, DEPA or the third parties shall charge only the defaulting consumers, whom they supply themselves, proportionally to the participation of each one in the corresponding cost of DEPA or the third parties, as follows from the supply contract between them.”

The above provisions of the Law are now also applicable to the supply contracts concluded between the Eligible Customers (industrial customers) and the Suppliers[7].

Nevertheless, in the light of the EU law, the legal assessment of the contractually undertaken purchase obligations regardless of taking delivery should result in their compatibility with the rules contained both in the specific sectoral regulatory framework and the competition law provisions.

More specifically, one of the fundamental principles of Directive 2009/73/EC[8] is the possibility to provide third party access to the natural gas transmission system, i.e. every supplier is entitled to access it. In this context, derogations from this rule may be requested where another natural gas undertaking that already has access to the network proves that it encounters economic and financial difficulties because of the assumed take-or-pay clause[9].

Further, it is equally important to assess the compatibility of these clauses, when contained in long-term natural gas supply contracts, with Articles 101 and 102 TFEU. Specifically, the inclusion of that clause in supply contracts should not lead to a distortion of the competition conditions by creating or strengthening a dominant position of certain suppliers or binding excessively the transactional freedom of their counterparties. The EU Commission has acknowledged that these clauses are not forbidden per se; however, their impact on the European market should be evaluated on a case by case basis, especially taking into account criteria, such as the location of the supplier in the relevant market and the general structure of the relevant market, the existence of alternative suppliers and the duration of the contract[10].

4.1. Drafting the terms of the Contract to comply with mandatory law

The provision of Article 24 is, by reason of its purpose, mandatory law. Gas sales contracts should adopt the statutory requirements to define the obligation from the take-or-pay clause and to set specific conditions for raising claims under that clause. In any case, the arrangements and claims cannot lead to a breach of the parameters of Article 24.

4.1.1. Ratio between the terms of the contract between seller and buyer (customer) and the contract between seller and its supplier. The prohibition to impose more onerous terms in the Contract in comparison with the Contract between Seller-Supplier [11]

More onerous terms are considered not only the terms regarding the price of the take-or-pay quantity but also those regarding the manner of supply and cost of the make-up quantity. As to the latter, the resulting total cost for the customer should not exceed that for the seller. Namely, the take-or-pay clause in the contract between the seller and its supplier cannot be more favourable as to its key elements, in comparison with the Clause agreed between the seller and the buyer in the Contract. The meaning of the “more onerous terms” is not merely limited to the wording of such terms but also extends to how they are eventually implemented and what economic results derive from their implementation. This examination should take place where appropriate.

4.1.2. Balancing the quantities of natural gas delivered to all of the seller’s customers and the quantities delivered to the seller from its supplier[12]

Take-or-pay clauses, added up as to the customers of each counterparty, should not exceed the sum of its obligations towards its own suppliers.

In that sense, the seller, in order to be able to demand from each buyer thereof to cover the cost incurred by reason of the activation of its own take-or-pay clause against its supplier, must have exhausted its own supply terms and taken the make-up quantities to which it is entitled, whilst providing a detailed breakdown of the actual activation cost of that clause. This is so because, if in fact its cost was zero or less than what actually corresponds to each buyer, its claim should be adjusted only by that amount.

4.1.3. The correlation between the seller’s claim against the buyer compared to the claim of the seller’s supplier against it[13]

There should be a causal link between the seller’s claim and the breach of the corresponding obligation by its customer (buyer), not any other reason (e.g. because the seller opted to by supplied with gas from another supplier).

In order to lawfully raise the claims concerned of the seller against the buyer, it is necessary to impose a prior take-or-pay clause on the seller by its supplier, solely for failure of that particular customer to take delivery of the annual minimum quantity (take-or-pay quantity) and not for selection, on the part of the seller, of another supplier or a lower cost solution (e.g. purchase of LNG spot loads).

4.2. Aggregation of loss and profit

Given the compensatory nature of the take-or-pay clauses, the general principles of damages are applicable and, in particular, the restrictions on the scope of damages, such as the inclusion of the loss suffered by the injured party (in this case the claiming seller) and any profit gained from the harmful event.

Given that the purpose of the damages is to compensate for the loss of the injured party, not the enrichment thereof, any profit gained by the person alleging the loss from the harmful event should be taken into account and included in the loss caused and reduce it, so that the liable party be required to pay only for the actual loss suffered by the injured party. The inclusion is imposed by the very concept of loss, under the theory of the difference, according to which the loss is the difference between the actual economic position of the injured party and the economic position, if the harmful event had not occurred.

This means that, in order to establish the damages, the entire economic position of the injured party should be taken into account, i.e. both negative and positive consequences of the harmful event[14].

The issue of offsetting profit and loss includes any profit of the seller obtained during the operation of the contract and the parallel contract with its supplier, from arbitrage, i.e. speculative buying and selling based on the criterion of price difference between pipeline gas and liquefied natural gas (LNG). The seller, during the operation of the contract, may have taken delivery of lesser amounts of its own obligation towards the supplier, in order to buy LNG at more favourable prices. Provided that this is proved, the profits from this practice should be deducted from the amounts sought by its customers as to its loss from the activation of the take-or-pay clauses.

Another expression of this principle on offsetting are the common terms found in supply contracts, under which the seller should provide evidence and documentation regarding its total Annual Deficit Amounts, which under the relevant take-or-pay clause has created claims against the seller by its suppliers[15].

Therefore, the seller is obliged to invoke and prove that after settlement of the contracts with its customers regarding the take-or-pay clause, it continues to suffer loss in connection with its contract with the supplier.

5. Concluding remarks

From the methodology imposed by Article 24, it follows that the right of the seller to raise claims against its buyers under the take-or-pay clauses is subject to restrictions of mandatory law. Such claims can be raised if the conditions of the relevant terms of the supply contract are adapted to the mandatory nature of the statutory conditions.[16]

In particular the seller must establish:

(a) That the loss to its assets is due to the failure to balance it with natural gas quantities delivered to other customers thereof and by inclusion of any profit thereof. When including the seller’s loss and profit, the calculation of profit will take into account any positive adjustments of the selling prices of natural gas quantities to the seller from its supplier.

(b) That the extent of the seller’s loss to be recovered by the buyer corresponds to loss to the same extent of its supplier, the satisfaction of which the seller’s supplier has already requested in the sense that it is in a direct causal relationship with the failure of that particular buyer to take delivery of the natural gas quantities, namely it is its direct result.

(c) That when calculating the seller’s loss and raising the relevant claim, the seller has taken account of any more favourable conditions it enjoys or provides to other buyers thereof.

(d) That, under the above calculation, the seller has re-adjusted the price for taking delivery of the make-up quantities, depending on the price finally paid to its supplier.

[1] (Reading & Bates Pet. Co. v. Transok, Inc., No. CJ-85-1992 (Tulsa Cty. Dist. Ct., Okla. Jan. 27, 1987)“Take-Or-Pay Oklahoma Style”, J. Michael Medina, Vol. 60-No. 12-3/25/89, The Oklahoma Bar Journal

[2] The Take or Pay Wars: A Cautionary Analysis for the Future, J.M. Medina, 27 Tulsa L.J. 283 (1191-1992), p. 287-288

[3] M & J Polymers Limited v Imerys Minerals Limited (2008) EHWC 344 (Comm.)

[4] See paragraph 3, Article 24.

[5] According to paragraph 11 of Article 196 of Law 4001/2011, as replaced with paragraph 9 of Article 55 of Law 4223/2013, the above sentence 4 applied until 31 December 2015.

[6] Article 24 para. 3 of Law 3175/2003.

[7] Paragraph 4, Article 28 of Law 3428/2005.

[8] This directive replaced Directive 2003/55/EC

[9] Articles 35 and 48 of Directive 2009/73/EC

[10] See Distrigas, MEMO/07/407, 11.10.2007

[11] Article 24 para. 3 sentence 1 of Law 3175/2003

[12] Article 24 para. 3 sentence 2 of Law 3175/2003

[13] See Article 24 para. 3 sentence 3 of Law 3175/2003

[14] Law of Obligations, General Part, Ap. Georgiades, Sakkoulas editions (1999), p. 152 et seq.

[15] See Art. 24 para. 3 sentences 2, 3 of Law 3175/2003

[16] See conditions laid down in paragraph 3 of Article 24 of Law 3175/2003