Commercial Court

Mr Justice Burton

Judgment delivered 29 February 2008

The Facts

M&J had been supplying dispersant chemicals to Imerys since 1991. In January 2005, the parties signed a new supply contract. The contract which had a three-year minimum term, contained a take or pay and termination clause which stated:

“5.5 Take or pay: the Buyers collectively will pay for the minimum quantities of Products as indicated in this Article...even if they together have not ordered the indicated quantities during the relevant monthly period.”

and

“16.3 The Buyer may at its option terminate this Agreement with immediate effect and without incurring any liability to the Supplier in the event that the Supplier (i) delivers Product which fail [sic] to meet the significant specification requirements…on more than two occasions in any given three month period, provided Supplier is informed timely [sic] of such breaches and such breaches are confirmed by an independent analytical laboratory”.

Imerys purportedly terminated the supply contract in May 2006 by a notice that M&J treated as an unlawful repudiation of contract, and which M&J accepted. M&J then made a claim pursuant to the take or pay clause in respect of a shortfall of deliveries of the dispersants up to the date of the termination. Imerys argued that the take or pay clause amounted to a penalty and refused to pay. M&J said that the effect of the take or pay clause was to establish a debt and so the law as to penalties did not arise.

Issue and Findings

Was the take or pay clause a penalty?

Whilst take or pay clauses are capable of being construed as penalties, this particular clause was not a penalty.

Commentary

There appears to be no previous authority as to whether a take or pay clause is a penalty. The Judge rejected the “simplistic” argument that the sum claimed was a debt for a price and that, accordingly, the law of penalties did not apply. In his view, whilst take or pay clauses were susceptible to the rule against penalties, here, the clause was commercially justifiable, did not amount to oppression, was negotiated and freely entered into between parties of comparable bargaining power and did not have the predominant purpose of deterring a breach of contract. Therefore the clause was enforceable. Given the broad commercial usage of such clauses, one might question to what extent, if ever, a court will find that that a take or pay clause is a penalty.