Can a ''take or pay'' clause be an unenforceable liability?

The recent case of E-Nik Ltd v Department for Communities and Local Governments [2012] EWHC 3027 (Comm) turned on whether a "take or pay" clause in the contract could in principle be an unenforceable penalty.

What is a "take or pay" clause?

A take or pay clause in a contract obliges a supplier to make a minimum amount of their product available to a buyer over a specified period of time. In return, the buyer undertakes to either take delivery of the product or pay for a minimum amount at an agreed price. The phrase "take or pay" is a slight misnomer however as the central idea is that the buyer pays regardless of whether it takes the product or not.

E-Nik Ltd v Department for Communities and Local Governments

The case concerned the supply of IT consulting services by E-Nik Ltd (E) to the Department for Communities and Local Government (D) under a "take or pay" clause in the governing contract. D undertook to purchase a "minimum of 500 days of Consultancy" from E "based on project requirements" over a contract term of two and a half years. D also undertook to pay E a fee of "not less than £850 per day but subject to mutually agreed assignment notes for each change request.".

When D failed to use the set number of consultancy days, E invoiced D for the unused balance. D disputed the invoices. The basis for D's argument was that there was no obligation to purchase the minimum amount because it was dependent on project requirements and the project did not require any consultancy services. The Court did not agree. It was held that the interpretation put forward by D deprived the word 'minimum' of any meaning and that the phrase 'based on project requirements' simply explained how the 500 days specified was arrived at.

Mr Justice Burton referred to his decision in the 2008 case of M & J Polymers Ltd v Imerys Minerals Ltd and held that, although in principle a "take or pay" provision could be interpreted as a penalty clause, in this instance, it was not. This was because the provisions were commercially justifiable, negotiated and freely entered into between parties of comparable bargaining power.

E was also able to provide evidence that it continued to keep its services available to D until the termination of the contract, even though they were not called upon. The fact that the daily rate charged was at or below the rates regularly charged by E to D was also a factor in the judgement.

What does the decision mean in the long term?

While the E-Nik decision confirms that a take or pay clause may in principle, amount to a penalty clause, its impact may be limited due to Mr Justice Burton's conclusion that the clause should be upheld because it was commercially justifiable. In reality, most suppliers should be able to demonstrate a business justification for the existence of a "take or pay" clause such as the requirement for certainty on their minimum income stream from the buyer in question.

However, when considering using a "take or pay" clause you should:

Finally, as ever, precise drafting is key. The judge in the E-Nik case specifically highlighted the fact that the contract had not been drafted by lawyers and was not always 'elegant or apt'!