Introduction: Role of Take or Pay Clauses in Energy Sector Contracts
In the landscape of energy contracts—notably in gas supply agreements, power purchase agreements, and LNG transactions—”Take or Pay Clauses” (TOPCs) serve a pivotal role. These contractual provisions originated in the United States during the 1960s, when fluctuating seasonal gas demands made revenue predictability difficult for energy producers. Over time, TOPCs became a mechanism for sellers to secure certainty in long-term supply commitments, shielding them from losses due to under-lifting or price volatility.
In India, the use of TOPCs gained momentum in the 2000s and is now a prevalent feature in commercial arrangements within the energy sector. These clauses are closely mirrored by “Send or Pay” and “Ship or Pay” clauses in transportation contracts. Across all these forms, the principle is the same: the buyer commits to either take delivery of a minimum quantity or pay the agreed price regardless of actual offtake.
As corporate law firms in Ahmedabad and top legal firms across India frequently advise clients in the energy and infrastructure sectors, understanding the enforceability of TOPCs is crucial. In this article, we examine their legal standing under Indian Contract Law, practical drafting considerations, and judicial interpretations.
Importance of TOPCs: Commercial Certainty and Risk Allocation
TOPCs are designed to safeguard the seller’s investment, which is often capital-intensive, involving exploration, extraction, and infrastructure development. Without such clauses, upstream players lack assurance on cost recovery, deterring exploration and production investments. Since energy commodities like natural gas and crude oil cannot be stored economically in large quantities, unutilized supplies translate into immediate losses.
To illustrate, suppose a buyer enters into a gas sales agreement pegged at a fixed rate for a multi-year term. If global spot prices subsequently fall, the buyer might be tempted to reduce offtake. A well-drafted TOPC ensures that the seller is compensated even if the buyer defaults on the committed offtake volume. Legal firms in Ahmedabad and across India are increasingly advising energy clients to structure these clauses to provide enforceability and mitigate performance risks.
Common Structure of TOPCs
A standard Take or Pay Clause reads as follows:
“The Buyer shall, during each Contract Year, take delivery of not less than [X]% of the Contract Quantity. In the event of failure to take such quantity, the Buyer shall pay to the Seller an amount equivalent to the price of the undelivered quantity, unless otherwise agreed under the provisions of this agreement.”
Typically, such clauses allow for ‘make-up gas/oil’ wherein the buyer, having paid for undelivered quantities in a prior period, is allowed to lift such quantities in future periods. Disputes generally arise when buyers contest their obligation to pay under TOPCs without corresponding delivery.
Given the high-value nature of these contracts, disputes often go to arbitration. Leading arbitration lawyers in Ahmedabad and PAN India regularly assist in such proceedings, where enforceability often turns on interpretation under Section 74 of the Indian Contract Act, 1872.
Legal Position in India: TOPC and Section 74 of Indian Contract Act
While Take or Pay Clauses are frequently challenged under competition law as anti-competitive, their enforceability primarily hinges on the Indian Contract Act. Courts evaluate whether the clause constitutes a genuine pre-estimate of damages or a penalty. This is significant since Section 74 allows recovery of reasonable compensation for breach, not exceeding the amount stipulated in the contract.
Let us examine two illustrative Indian decisions.
Case Study 1: PTC India Ltd. v. Gujarat Electricity Regulatory Commission
In this case, PTC India had committed to offtake 200 MW of power but failed to do so. Gujarat Urja Vikas Nigam Ltd. (GUVNL) sought compensation under the TOPC. PTC challenged the award, arguing that the clause violated Indian Contract Law.
The Appellate Tribunal applied liquidated damages principles laid down by the Supreme Court. It held that if the sum stipulated in the contract was a genuine pre-estimate of damages known to the parties, then no additional proof of loss was necessary. The Tribunal emphasized the context at the time of contract formation as the basis for validating the clause.
Case Study 2: HPCL v. Dhampur Sugar Mills Ltd. (DSM)
In O.M.P. (COMM) 164/2020, DSM challenged an arbitral award granting INR 18,14,785 to HPCL under a TOPC. DSM argued that HPCL had failed to plead actual loss and could not claim damages merely on the basis of the clause.
The Delhi High Court accepted DSM’s contention. It observed that HPCL had neither proved actual loss nor established that loss was impossible to determine. It reinforced the requirement under Section 74 that compensation must reflect either real loss or a genuine pre-estimate. In absence of this, the court refused to uphold the award solely based on the TOPC.
Implications for Contract Drafting and Risk Allocation
These judicial trends underscore that while TOPCs are not unenforceable per se, they must be framed with legal precision. Clauses should:
- Clearly establish the commercial rationale for minimum offtake.
- Reflect a genuine pre-estimate of damages.
- Include supporting evidence or reasoning to justify fixed compensation amounts.
- Provide make-up period flexibility to mitigate buyer hardship.
Firms considered among the best law firms in Ahmedabad and top corporate law firms in India frequently assist in tailoring such clauses. Moreover, involving experienced arbitration lawyers in India early during contract drafting reduces future litigation risks.
Conclusion: Takeaways for Stakeholders in Energy Contracts
In the Indian legal context, enforceability of Take or Pay Clauses is contingent upon the principles laid down under Section 74 of the Indian Contract Act. Indian courts look beyond the clause’s text to evaluate its fairness, intent, and evidentiary support. As energy contracts continue to grow in complexity and scale, engaging reputed legal firms in Ahmedabad or international law firms in India with sectoral expertise is becoming indispensable.
Whether you are an energy developer, utility, or infrastructure investor, consult with the best lawyers in Ahmedabad or specialized contract advisory teams PAN India to ensure your agreements are future-proof.
Upcoming in Part II: We will explore whether it is possible to claim compensation under a Take or Pay Clause without satisfying the conventional test of liquidated damages under Indian law.
*The content of this article is intended to provide general information. No reader or user should act or refrain from acting on the basis of the information written above without first seeking legal advice from a qualified law practitioner.