Take-or-Pay contracts are fundamental to the effective operation of contracts across the mining and energy sectors, but times change and what seemed a good deal may look very different when you are on the wrong end of the bargain. Matthew Saunders and David Harley suggest ways for buyers and sellers to protect themselves in a dynamic market.

Take-or-pay contracts are fundamental to the effective operation of contracts across the mining and energy sectors, providing certainty of income to sellers, a crucial feature for projects with very large initial capital investment. They are vital for project proponents who have invested large amounts of capital into a project for start-up purposes, and now need the commercial certainty of guaranteed income in order to finance project loans – indeed, lenders will often not fund projects without take or pay commitments in place to provide certainty of the ability to repay financing loans.

So far, so commercially prudent. But for every seller of a commodity or of a service such as rail haulage, there is a buyer – and times change; what seemed a good deal in the context of a certain competitive dynamic in a given market may change profoundly, or a market may shrink in size, sometimes overnight. Recent negative changes, especially in the Chinese economy, have led to falling demand for minerals across the board. All of a sudden take or pay obligations look different; for buyers they are excessively onerous where a market has disappeared and for sellers they may be a lifeline where products can no longer be sold on the "open market". Either way, the relevant contractual clauses will come under greater scrutiny, with those on the "wrong" end seeking to find a way of removing, or at least mitigating the burden. So what should parties be bearing in mind with such obligations?

The problem with take-or-pay clauses is that they are inherently vulnerable in times of economic difficulty and both sides are at risk if the take-or-pay commitment becomes too far removed from the reality of the current market.

On the buyer's side, clearly if markets are falling the obligation to pay for a commodity or service which is now over-priced, unsellable or simply economically burdensome is a significant draw-back. Sellers however should be alive to the fact that if prices crash, the most obvious consequence is a dispute caused by non-payment. Even if the legal solution to a dispute is relatively straightforward, it can still be costly in both time and money to bring the necessary legal proceedings to force a buyer to comply with their obligations. The added problem with take-orpay contracts is that more often than not the legal issues they raise are extremely complicated.


A take-or-pay obligation is effectively pointless if the buyer is going to become insolvent because of the weight of its take/pay obligations. Sellers should:

  • Investigate the buyerfs ability to pay before the clause is agreed
  • Consider the complexity of the relevant insolvency laws that will apply
  • Require sufficient payment security for a year. Where a buyer chooses not to take delivery, in some sectors it is often not required to make interim payments and can wait until the end of the relevant period to pay the amount specified.

Given the scale of burden that such clauses can impose, it is hardly surprising that ingenious (or desperate) counterparties are running novel legal arguments seeking to undermine the critical obligations of take-or-pay contracts.


Recent cour t decisions in Australia and the United Kingdom leave miners open to a potential legal challenge on the basis that take-or-pay obligations amount to a penalty and are unenforceable.

To avoid this risk, sellers should take care to ensure that take-or-pay arrangements are commercially justifiable and, to the extent possible, achieved through arms-length commercial negotiations. They should consider including a provision for re-pricing of the commodity depending on the prevailing market conditions. This has long been a feature of long-term gas supply contracts, and the attractiveness of the flexibility it provides is clear.

In the gas sector, clauses generally give a right to seek negotiation of revised pricing if over a stipulated period of time there is change in the relevant defined market such that the gas can no longer be "economically marketed". Of course, this does not avoid disputes (scores of arbitration lawyers, including the authors, have spent many months arbitrating such clauses) but they do render workable against changed market conditions what are often very long term take-or-pay obligations.

Interestingly though, such clauses are less common in commodities contracts outside of the gas sector. Why such re-pricing provisions have not spread widely into other commodity sectors is unclear, not least because the sustainability they lend to contractual bargains would seem to have advantages for both sides to the bargain.


Most business people will be familiar with the expression 'force majeure'- a standard clause in contracts that allows one party to cancel/suspend the contract or be excused from its performance on the basis of an event occurring that is beyond its control.

English law does not recognise a doctrine of force majeure outside of the wording of the contract itself so it is entirely up to the parties themselves to specify what constitutes 'force majeure' in relation to their agreement. (In stark contrast to many civil law regimes, where it does have an agreed meaning.)

The risk, of course, is that if it is not in the contract, it is not covered.

Let us imagine that a buyer is prevented from taking delivery because an earthquake has destroyed its processing plant and it cannot receive, store or process the commodity it is still committed to purchase. It could be argued by a seller that a buyer's real obligation under the take-or-pay contract is to pay for the commodity or service. The actual ability to pay will not be affected by its factory being destroyed. All that would do is make it very difficult (but not physically or commercially impossible) for them to pay (because of the likely adverse financial consequences). Unless the contract specifically refers to such a situation, these parties are in for a protracted legal dispute.

It is important to note that in English law economic hardship, even very severe economic hardship, will not be considered a force majeure event.

If such an "escape route" is wanted then express "economic hardship" provisions must be drafted, but such clauses are often vague and there is always the difficulty of objectively assessing when sufficiently severe "economic hardship" has arisen. And that means the lawyers get involved.

This, in brief terms, is a clause which excuses a party from performance where it has become unduly economically onerous for them to do so. Usually though there is a requirement for the parties to renegotiate their agreement, rather than simply letting one side "off the hook".

A problem with these clauses is that they are also open to quite different interpretation in civil and common law jurisdictions. Because economic hardship clauses are seen as a type of force majeure clause, all the risks and difficulties inherent in that doctrine apply to economic hardship clauses as well. In a common law system, everything will turn on the definition of "hardship" used in the contract. There is a good deal of unavoidable uncertainty, making this an especially fertile area for litigation and arbitration lawyers (hence, this article!).

For both buyer and seller, the key point is to consider whether the take-or-pay obligation is absolute or whether it is qualified in certain circumstances, such as in the event of force majeure or failure to supply.


Another consideration for parties to a take-or-pay contract is the law of the place of dispute resolution ("lex fora") they have agreed and whether they have chosen litigation or international arbitration.

The lex fora may often not be the same as the law which governs the contract. For instance, a Chinese company could contract with an Australian company concerning commodities being mined in Australia. The law chosen for the take-or-pay contract is English law, but England would clearly not be a convenient location for hearing any dispute. Hence the parties choose Australia as the place of dispute resolution (or perhaps Singapore as a seat for arbitration). This means that the Australian/ Singaporean courts will be asked to apply English law. This is fairly common and courts are used to doing so, but it is just another consideration to bear in mind (not least because "sophisticated" courts may find this easier to achieve than others). The law of the place of dispute resolution will also affect the procedure of any dispute process which may be relevant as to how various issues are proven by use of expert and factual evidence.

A final consideration with take-or-pay contracts is that the dispute resolution process may also be affected by "mandatory" local laws, usually of the place where the contract is being performed. These are laws which cannot be contracted out of in a domestic situation through parties deliberately choosing a different governing law in order to circumvent them. The issue becomes very complicated when the contract is not domestic because it has an international element and legal doctrine in this area is far from clear or settled across different jurisdictions. Cynics (including the authors) observe that resort to mandatory law can sometimes represent little more than a "fig leaf" covering a court seeking to give a party "home player advantage" through negating the otherwise valid choice of a neutral foreign law. Clearly, this is an area in which it is prudent to seek specialist legal advice.

© DLA Piper

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