The use of 'take or pay' clauses

Money iStock 000008683901XSmall 146x219The High Court has provided further confirmation that a “take or pay” clause can be a penalty, writes Mark Alsop.

The case of E-Nik Limited v Department for Communities and Local Government [2012] EWHC 3027(Comm) concerned a clause in a contract (not drafted by lawyers) which stated that: “The [Department] hereby undertakes to purchase a minimum of 500 days of Consultancy from [E-Nik] per year based on project requirement…”.

The question arose as to whether the Department was required in all circumstances to purchase 500 days, or whether it was only required to do so if the relevant project so required. This in turn gave rise to questions as to whether E-Nik could claim any shortfall in days purchased as a debt (rather than damages for breach of contract) and whether the provision was an unenforceable penalty.

The High Court (Mr Justice Burton) found in favour of E-Nik:

  • On the evidence, the construction of the clause was such that the Department had agreed to take at least 500 days per year.
  • On the debt point, the issue was whether the services had to be “specifically demanded” or whether they simply had to be made and remain available. The judge found that there was no need for a request. E-Nik kept the services available, and there was provision for the services to be paid for upfront. These factors pointed in favour of a debt.  
  • On the penalty point, the judge referred to his previous decision in M&J Polymers v Emerys Minerals Limited [2008] (noted in a previous bulletin) where an agreement to pay for minimum quantities could qualify as a penalty clause, even though in that case there was plainly commercial justification for it. Similarly in this case, the minimum payment clause was potentially a penalty, but commercially justifiable since E-Nik had to, and did, keep available the wherewithal to provide the consultancy services as called off throughout the entire term. This did not amount to oppression, the term was negotiated and freely entered into between the parties of comparable bargaining power.  

Comment

The courts generally try to uphold contractual terms which fix the level of damages for breach. It has been stated that a genuine pre-estimate of damages will not be unreasonable unless there is a “substantial discrepancy” between the level of damages stipulated and the level of damages which is likely to be suffered. Take or pay clauses are generally drafted to give the supplier no more than it would receive anyway, rather than giving a supplier an element of undeserved uplift, so one would expect the clauses generally to be commercially justifiable and thus not a penalty.

But…. one wonders why the judge considered the penalty point at all, having found that the failure to pay for 500 days gave rise to a debt, rather than breach of contract. The generally held view is that the rule against penalties does not apply to debts. There are indications that the judge considered that there was a parallel debt and damages claim.

Mark Alsop is a Professional Support Consultant at Charles Russell. He can be contacted on 020 7203 5355 or byThis email address is being protected from spambots. You need JavaScript enabled to view it..

There have been two more rulings in this area - a further article will follow.