Jeremy Drew Danielle Lodge December 18 2012 IT consultants beware: take-or-pay clauses may be unenforceable penalties RPC | Tech, Data, Telecoms & Media - United Kingdom Jeremy Drew, Danielle Lodge Tech, Data, Telecoms & Media Introduction Background Key provisions Key questions Minimum commitment? Construction Debt or damages Unenforceable as a penalty Comment IntroductionIn granting summary judgment to an IT consultancy in a dispute over unpaid invoices under an IT services agreement, the judge in E-Nik Ltd v Department for Communities and Local Government ( EWHC 3027 (Comm), November 2 2012) found that a take-or-pay clause requiring the defendant to take a "minimum" 500 days of consultancy did not constitute an unenforceable penalty. In the circumstances of this case, he considered the clause commercially justifiable. Nonetheless, the judge accepted that, in principle, such a clause could constitute a penalty.BackgroundThe claimant was an IT services company that had entered into a contract with the defendant on April 1 2009. The contract was for a period of two-and-a-half years, but terminable with 12 months' written notice by either party.Neither party terminated the contract, but an argument arose when the defendant failed to pay invoices for the balance of 500 "minimum" days of consultancy services per year, which the defendant had not used. The claimant alleged that the fees remained payable, as the contract was intended to reflect a minimum commitment (ie, a take-or-pay agreement).The contract was not drafted by lawyers, and in the words of the judge, the language was not always "elegant or apt".Key provisionsClause 2 of the contract read:"2.1 The Authority hereby undertakes to purchase minimum of 500 days of Consultancy from the Supplier per year based on project requirement, additional days will be required once the purchased days have been exhausted.2.2 The Authority shall issue an Assignment Note to requisition Services from the Supplier.2.3 The Authority shall pay the Supplier fees at the rate of not less than £850 per day but subject to mutually agreed assignment notes for each change request."Invoices were payable on an upfront basis.Key questionsThe key issues to be considered in the case were as follows:Did Clause 2.1 allow the defendant to refrain from purchasing a minimum of 500 days of consultancy if those consultancy days were not required?If the answer to the above question was no and the defendant was bound by a minimum commitment, was the claim for outstanding invoices unenforceable, as a penalty?Minimum commitment?In relation to the first issue, the claimant relied on a number of arguments:The reference to the minimum of 500 days meant what it said. The 'project requirement' element of Clause 2.1 became relevant only if the defendant decided that it required additional days.An 'assignment note' (defined as "a mutually agreed document…detailing the precise purpose of work to be carried out by the Supplier") never came into existence. The absence of such further document did not, therefore, affect the minimum commitment.The ability to terminate with 12 months' notice would have been pointless if there was in fact no obligation to call off any consultancy services.Clause 3.8 of the document obliged the defendant to provide a spreadsheet detailing 'days remaining' – which must have referred, by its context, to the balance of the 500-day commitment – at any given time.The defendant relied instead on the words "based on project requirement" and argued that 'based on' meant 'dependent on' project requirements. On this basis, as the project did not require 500 days of consultancy, the defendant needed neither to purchase nor pay for them. On the defendant's construction, the defendant was not required to purchase any days.ConstructionIn respect of this first issue, the judge found that the defendant's view of events would deprive the word "minimum" at Clause 2.1 of any meaning. Further, the words "based on project requirements" neither meant nor said "subject to project requirements". To construe otherwise would not be a commercial or common-sense construction of this particular commercial contract. Accordingly, the 500 days was found to be a minimum commitment on the part of the defendant.Debt or damagesThe judge then considered whether the claim should be framed as a debt (the moneys were just due) or whether the services had to be specifically demanded before moneys were owing, in which case the defendant's failure to call off the 500 days would be a breach of contract that triggered a damages claim.The defendant contended that a request for such services was necessary before any moneys were owing and put the claimant to proof that the consultancy services actually remained available, if needed, throughout the contract term.The claimant's view was that the defendant's obligation was not dependent upon a request. The claimant had been ready to perform services as and when needed and had made sure that it was available to deliver throughout the term of the contract. The provision for the 500 days to be paid upfront also made it plain that payment was not dependent on a request.On this issue, the judge again found in favour of the claimant. The defendant plainly undertook to purchase and pay for a minimum of 500 days of consultancy services (without the need to further request them) and, on the evidence presented, the claimant continued to keep the services available.The moneys due in respect of the balance of the 500 consultancy days were therefore due as a debt.Unenforceable as a penaltySince the court determined that the moneys owed were recoverable as a debt, the claimant argued that the moneys were due and owing, as the rule against penalties does not apply to a claim for a debt (relying on Jervis v Harris  Ch 195).The defendant's contrary view relied on the judge's earlier decision in M&J Polymers Ltd v Imerys Minerals Ltd ( EWHC 344 (Comm)), in which he determined that a take-or-pay clause could in principle constitute a penalty.The judge again accepted that such a clause could constitute a penalty and that it could do so regardless of whether the claim under it was for a debt. He also accepted that the court should not be too keen to characterise a clause as a penalty clause. In the current case the judge stated:"I am entirely satisfied that in the context where the Claimant had to, and did, keep available the wherewithal to provide the consultancy services as called off throughout the entire term, at rates which…were at or below the rates regularly charged by the Claimant to the Defendant, these clauses were commercially justifiable, did not amount to oppression, were negotiated and freely entered into between parties of comparable bargaining power and did not amount to a provision in terrorem [ie, by way of threat]."The court therefore found in favour of the claimant, in that the terms were commercially justifiable and therefore not a penalty. No appeal has been made.CommentThe case reaffirms the principle that a take-or-pay clause, under which a customer is obliged either to use or to pay for a set number of consultancy days, can in principle qualify as a penalty clause and thus be unenforceable.However, it is unfortunate that the judge did not expand on why, having determined that moneys were recoverable as a debt, any test of commercial justifiability should apply, as this test was thought to apply only to damages provisions.Until the rationale for the application of the justifiability test to a debt claim is confirmed or clarified, it makes sense for potential claimants to make clear, when drafting take-or-pay clauses, that:payment is not dependent on further request by the customer;a minimum commitment means precisely that – a minimum commitment;moneys owing will be recoverable by the claimant as a debt;the contract is internally consistent in treating the relevant minimum commitment provision as precisely that; andon the chance that case law continues to blur the lines as to how and when a justifiability test should be applied to debt claims, the above principles have been expressly agreed between the parties on a commercial basis, based on the consideration granted by the claimant.For further information on this topic please contact Jeremy Drew or Danielle Lodge at RPC by telephone (+44 20 3060 6000), fax (+44 20 3060 7000) or email ([email protected] or [email protected]).