Japan: Japan's Competition Regulator Questions Lng Destination Clauses

Last Updated: 18 September 2017
Article by Eric W. Sedlak, Steven C. Sparling and Tsuguhito Omagari
Most Popular Article in Japan, September 2017

The Japan Fair Trade Commission ("JFTC"), Japan's competition regulator, recently published results of an investigation into destination restrictions in liquefied natural gas ("LNG") supply contracts. The results of the investigation were published in a report on June 28, 2017, entitled "Survey on LNG Trades (Chapter 4E Ensuring of Fair Competition in LNG Trades)" (the "Report").1

JFTC appears to have undertaken the preparation of the Report in response to changing market conditions, where an increase in LNG supply (and suppliers) and the associated drop in prices could make inflexible long-term contracts unattractive to buyers, including in Japan, which consumed approximately 34% of the world's LNG in 2015.2 The market view, however, is that Japanese buyers probably have contracted for LNG in excess of their needs in the short and medium term, making the enforceability of destination clauses of paramount relevance.

Destination restriction clauses prohibit the buyer under an LNG sale and purchase agreement from redirecting or reselling the LNG in any particular cargo. Japanese electrical utilities in particular believe that the clauses unfairly disadvantage them, because they are less able to react quickly to changes in the domestic generation mix, where coal has taken over much of the baseload from nuclear, and where renewables, solar in particular, have an increasing market share. Destination restriction clauses also make the buyers less nimble in the face of price changes (which from the sellers' perspective, is precisely the point -- any windfall should accrue to the seller).

The Report, while not having the force of law, indicates that JFTC generally takes a dim view of arrangements whereby a seller limits the flexibility of a buyer to resell a product. Looked at cynically, the JFTC has signaled that it intends to treat LNG destination restriction clauses much like it does resale price maintenance undertakings for retail goods, notwithstanding the complexity, exceptionally high capital costs and peculiarities of the global LNG market.

JFTC's views, largely in its own words, as set forth in the approved but unofficial English version of the Report, are as follows:

Provision Specific Concepts Position Under the Antimonopoly Act
Destination clauses in Fixed-Term Free On Board ("FOB") Contracts Highly likely to be in violation
Providing profit share clause Not considered as reasonable; highly likely to be in violation
Destination clauses in Fixed-Term Deliver Ex Ship ("DES") Contracts If in order to define a delivery point Not in itself problematic
If a provision is included to require "seller's consent" to diversion or the provision of the requirements of "fairly necessity [sic]" and reasonableness to diversion Not in itself problematic
If seller's consent is required even if fair necessity and reasonableness are demonstrated A refusal is likely to be in violation
When a seller, on an operational or contractual basis, requests competition-restraining requirements for diversion Highly likely to be in violation
Providing a profit share clause when a seller requires from a buyer compensation in exchange for giving consent on a diversion of contract requirements (destination) according to a request from the buyer and for an agreement to allow them to resale Cannot be said that it is unreasonable; not in itself problematic
When a profit share clause contributes to unreasonable profit sharing with a seller: (i) by setting a high percentage of the resale profit without properly considering seller's actual contribution to resale or by using a gross profit as a resale profit; or (ii) when such clauses have some effects to prevent a buyer from reselling due to a seller's request for the disclosure of the profit or cost structure Likely to be in violation
Disclosure of information regarding resale When clauses requiring disclosure of information regarding resale have the effect of "prevent[ing] a buyer from reselling due to a seller's request for the disclosure of the profit or cost structure" Likely to be in violation
When seller does not require a breakdown of resale costs in detail and evidence therefor, and information sharing is minimized Therefore, it is desirable
Take or Pay When a seller's bargaining position is superior to that of a buyer and the seller unilaterally imposes Take or Pay clauses and strict minimum purchase obligation without sufficient negotiation with the buyer even after the seller has already got sufficient return for initial investment, strict minimum purchase obligation as well as providing Take or Pay clauses Likely to be in violation

Not surprisingly, much of the concern has revolved around whether JFTC's positions are intended to have retrospective effect, which could of course imply the possibility of forced renegotiation of LNG sale and purchase agreements.

Fixed-Term FOB Contracts

A key takeaway is that JFTC believes that no destination restriction in a fixed-term FOB contract is compliant. JFTC believes that the passage of title to the buyer at the flange at the port of loading strongly supports the position that any attempt to contractually restrict sales after that point is anticompetitive.

Fixed-Term DES Contracts

JFTC's views on destination restriction clauses in fixed-term DES contracts are more nuanced. JFTC believes that clauses whose purpose is to define a delivery point would be compliant, and if the provision requires seller's consent to diversion (as long as the seller's consent my not be unreasonably withheld), then the provision may be compliant.

If seller's consent is required even if buyer can demonstrate the need for the change and a reasonable basis fair necessity and reasonableness; however, then JFTC believes that the consent requirement could have an anticompetitive effect. In particular, if consent is conditioned on the buyer agreeing to or imposing competition-restraining requirements, then JFTC believes that the provision would be non-compliant.

Profit-Sharing Clauses

Profit-sharing clauses whereby a seller requires compensation in the form of a profit share from a resale of the cargo in exchange for the seller's consent to diversion are in principle permissible but may be questioned if the seller's share is particularly high (the commentary suggests that 50% would be appropriate, in particular if the seller contributed in some way to achieving the profit) or if the buyer will feel constrained from reselling because of a reluctance to disclose the cost structure or terms of sale. A contract that does not require the buyer to provide a breakdown of resale costs is "desirable."

Take or Pay

Take or pay provisions are very common in long-term supply contracts. Sellers often have high fixed costs and even variable costs that must be locked in for long periods of time, such as multiple year charter parties. Technical, efficiency, and yield considerations may dictate that production continue at predictable levels for extended periods of time.

ANNEX

JFTC's Key Findings

Fixed-Term FOB Contracts

"The restrictions on diversion as well as providing destination clauses are highly likely to be in violation of the Antimonopoly Act (Unfair Trade Practices: Trading on Restrictive Terms), because its necessity and reasonableness under an FOB contract is less likely to exist than that under a DES contract."

Fixed-Term DES Contracts

". . . providing destination clauses in a fixed-term DES contract in order to define a delivery point is not in itself problematic under the Antimonopoly Act."

" . . . under a fixed-term DES contract, the provision to require "seller's consent" to diversion or the provision of the requirements of fairly necessity [sic] and reasonableness to diversion are not in itself problematic under the Antimonopoly Act."

"However, in the operation of such requirements, even if a buyer's request meets any requirements of necessity and reasonableness from a seller, when the seller refuses its consent to diversion, such refusals are likely to be in violation of the Antimonopoly Act (Unfair Trade Practices: Trading on Restrictive Terms)."

"When a seller, on an operational or contractual basis, requests competition restraining requirements for diversion, such requirements are highly likely to be in violation of the Antimonopoly Act (Unfair Trade Practices: Trading on Restrictive Terms)."

Profit Share Clauses Under FOB Terms

". . . under a fixed-term FOB contract, in general, as providing profit share clauses is not considered as reasonable, providing profit share clauses is highly likely to be in violation of the Antimonopoly Act (Unfair Trade Practices: Trading on Restrictive Terms)."

Necessity and Reasonableness of Profit-Sharing Clauses Under DES Terms

". . . it cannot be said that it is unreasonable for a seller to require from a buyer compensation in exchange for giving consent on a diversion of contract requirements (destination) according to a request from the buyer and for an agreement to allow them to resale under a DES contract. Providing profit share clauses is not in itself problematic under the Antimonopoly Act."

"However, when such clauses contribute to unreasonable profit sharing with a seller, (i) by setting a high percentage of the resale profit without properly considering seller's actual contribution to resale or by using a gross profit as a resale profit ((A) below), or (ii) when such clauses have some effects to prevent a buyer from reselling due to a seller's request for the disclosure of the profit or cost structure ((B) below), these are likely to be in violation of the Antimonopoly Act (Unfair Trade Practices: Trading on Restrictive Terms)."

Disclosure of information regarding resale

". . . when clauses requiring disclosure of information regarding resale have the effect of "prevent[ing] a buyer from reselling due to a seller's request for the disclosure of the profit or cost structure, such a request is likely to be in violation of the Antimonopoly Act. (Unfair Trade Practices: Trading on Restrictive Terms).

"Therefore, it is desirable that, at least, a seller should not require a breakdown of resale costs in detail and its evidence, and sharing information should be minimized."

Take or Pay

". . . when a seller's bargaining position is superior to that of a buyer and the seller unilaterally imposes Take or Pay clauses and strict minimum purchase obligation without sufficient negotiation with the buyer even after the seller has already got sufficient return for initial investment, strict minimum purchase obligation as well as providing Take or Pay clauses are likely to be in violation of the Antimonopoly Act (Unfair Trade Practices: Abuse of Superior Bargaining Position)"

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Provision Specific Concepts Position Under the Antimonopoly Act

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