It will help the reader to go through our articles titled – “Debt versus Damages and Significance thereof in various commercial contracts-Part I” and “Unliquidated damages, Liquidated Damages and Enforceability of Liquidated Damages Clauses under Indian Contract Act – Part II” as well while seeking to understand position of Take or Pay Clauses under Indian Contract Act.
Introduction and Need for Take or Pay Clauses
The take or pay clauses are a peculiar feature in gas sales contracts, LNG sales contracts, and power purchase agreements; they could also be found in other kinds of commercial contracts. The evolution of Take or pay Clauses [“TOPC:] can be traced back to the 1960s in the USA; demand for gas used to fluctuate depending on seasons in USA resulting in uncertainties in the volume of gas that may be purchased by buyers at different times and consequent loss of revenue for the operators/producers. This led to the genesis of TOPC mechanism in the fuel supply contracts. The TOPC have been utilized in the fuel supply industry for about more than 50 years and they have also been incorporated in various fuel and power supply agreements in India from the 2000s. Similar to the take or pay clauses, there are “Send or Pay Clauses” or “Ship or Pay Clauses” commonly used in the transportation contracts in the energy sector.
The TOPC is essential to secure the seller of the fuel/energy. Typically, the operators of gas/oil blocks or suppliers of power enter into a long-term contract with the buyer. Let us assume that the buyer entered into a gas sales agreement for the supply of gas at the rate of say 100 units and after a few months or few years the gas becomes available in the spot market at a cheaper rate following the international or domestic price movements. At this point, if the buyer who earlier obtained the benefit of having the gas at a rate lower than the spot market is allowed to wriggle out of the arrangement on a count of the availability of fuel at a lower rate in spot market now, the same will not provide the supplier with any kind of certainty. The supplier also does not have an option of storing the quantities of Natural gas or oil in large volumes. The gas and oil produced are made available to the buyers at a particular point, where it is transported to the buyers at different locations.
Absent any certainty in the form of TOPC, the upstream investments will be affected, as the players in this sector may not have incentives for exploration activities, geological surveys, obtaining land rights and various production activities for want of certainty.
Throughout the subsequent part dealing analysing legal position, we will be using the word “TOPC” while commenting on the enforceability and attendant matters to TOPC in the context of Indian contract law, the same rationale will apply to send or pay & ship or pay clauses.
Position under Indian Contract Act (ICA)
Apart from running in contravention of the provisions of ICA, TOPC are challenged on multiple occasions as being anti-competitive running contrary to the provisions of Competition Act, 2002. However, for the purpose of this article, we confine the discussion to position in context of Indian Contract Act.
Typical TOPC clause and Modalities
A typical TOPC will be something like-
“The buyer agrees to uplift/offtake at least x% of the awarded gas sales volume during the currency of the contract or pay for the price of x or y% of awarded sales volume if not off-taken in terms of the provisions of this agreement”
Under a typical TOPC, the buyer is obligated to offtake a defined minimum quantity of Gas/oil in a defined period which may be a quarter or full contract year and the clauses provide that in case of failure on the part of the buyer to offtake minimum quantity, the buyer will be required to pay for the full value of the minimum quantity or a specified percentage of the full value of the minimum quantity. The mechanism also typically provides that where buyer is required to pay for quantity not off taken it can offtake such quantity in a specified future period in the form of make-up gas/Oil.
Majority of the disputes arising out of these contracts and from the TOPC are normally settled through the mechanism of arbitration in India and therefore the judicial pronouncement on these issues is limited. However, we seek to illustrate the views of the judicial/quasi-judicial authorities in India on the TOPC from two decisions.
Judicial Pronouncements
- PTC India Ltd. v GERC
Brief Facts
In the case of PTC India Limited vs Gujarat Electricity Regulatory Commission, concerning the sale of 200-megawatt power, when PTC did not take the quantity of power in terms of the agreement after GUVNL having been awarded with necessary compensation by Gujarat electricity regulation, the same was challenged by PTC India Ltd. in Appellate tribunal on the grounds that the liability of the amount awarded under the TOPC ran in violation of the provisions of Indian contract act of 1872.
Decision of Tribunal
Appellate tribunal applied the principle pertaining to liquidated damages to TOPC as enshrined by the Supreme Court of India.
The appellate tribunal broadly held that if a particular sum named in the contract to be paid in case of breach of contract by party committing a breach to non-breaching is found to be genuine pre-estimate of losses within the knowledge of the parties while making the contract, there is no need to prove losses or provide evidence for that. Appellate tribunal also went into the question of whether the TOPC was penal or genuine pre-estimate of losses and held that the same was required to be decided based on the circumstances at the time of entering into the contract.
- HPCL v. Dhampur Sugar Mills Ltd.
In a more recent judgement regarding TOPC pronounced by the Delhi High Court in the case of HPCL vs. Dhampur Sugar Mills Ltd. (DSM) in O.M.P. (COMM) 164/2020, Delhi High Court dealt with enforceability of TOP.
Brief Facts
While this case had multiple issues involved for determination as it involved cross challenges to an arbitration award, we will seek to highlight the controversy and decision regarding the TOPC.
DSM challenged the award of compensation to HPCL in the amount of INR 18,14,785 under the TOPC. DSM argued that HPCL had not established any loss and that it had also not made any pleading that the loss was impossible or difficult to establish; ergo, no amount could be awarded to HPCL. DSM relied on multiple judgments pertaining to liquidated damages e.g. Fateh Chand v. Balkishan Dass, Maula Bux v. Union of India and Kailash Nath Associates v. Delhi Development Authority & Anr. Etc.
Decision of the Court
Court accepted the contention of DSM and found that HPCL failed to establish the actual loss or convincingly demonstrate that the liquidated damages represented a genuine pre-estimate of the loss suffered. The court emphasized that HPCL was required to establish the loss suffered if it was possible to do so with reasonable certainty. If it was not feasible to establish the actual loss, HPCL needed to demonstrate that the liquidated damages stipulated in the agreements were a genuine pre-estimation of the loss incurred. The court held that it could not agree with the contention of HPCL that it was not required to plead or prove any loss and that the amount should be awarded solely based on the TOPC contained in the agreement.
Conclusion on Enforceability of TOPC
It is thus clear that the Indian Courts and quasi-judicial bodies have been deciding the TOPC claims based on principles of liquidated damages contained in Section 74 of the Indian Contract Act of 1872.
As we have highlighted in our article on liquidated damages and enforceability of liquidated damages: –
- For a claim under the liquidated damages clause to succeed, breach of contract must be established.
- The liquidated damages clause must represent a genuine pre-estimate of the damages or loss.
- It must be established that the damage and loss have actually been suffered.
- In cases where damage and loss are difficult or impossible to prove, the liquidated amount named in the contract, if found to be a genuine pre-estimate of damages or loss, will be upheld by the court.
In the next part on the subject, we shall analyse whether it is possible to Claim the amount under a Take or Pay Clause(TOPC) without satisfying the conditions for liquidated damages.
Author: Ravish Bhatt, Managing Partner, R&D Law Chambers LLP
Email – info@rdlawchambers.com
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