Enforceability of Take-or-Pay Provision in Offtake Agreements Post Cavendish

by R. Choudhury, Advocate and Barrister

Executive Summary

[Addendum to the OGEL 4 (2017) LNG Special Issue - April 2018] In the capital-intensive business of liquefied natural gas ("LNG"), developers of greenfield LNG projects seek participation of consortia of lenders to provide debt financing. To enhance bankability of such projects, and to mitigate their revenue risk, LNG project developers seek customers who commit to paying the developer for a minimum quantity of LNG annually for a fixed term. Such payment needs to be mandatory in order to fulfil the basic purpose of the agreement - providing visibility over the project's income stream so as to assure lenders of the manner in which repayment of the project's substantial debt will take place. Determining the quantity of LNG for which a buyer should be obligated to make payment is itself an intricate exercise as there are numerous components to the formula for its determination. Thus, an LNG project's prospects of securing financing hinges largely on the sanctity of provisions known as "take-or-pay" which require the buyer to make payment, irrespective of whether it elects to take delivery of the LNG or not. Two decisions of the English High Court had subjected such revenue risk mitigation provisions to the penalty rule, thereby rendering take-or-pay provisions susceptible to being held unenforceable on the basis that amounts payable under such provisions may not represent a genuine pre-estimate of the damage that the seller would suffer as a result of the buyer's failure to take delivery of the LNG. The confusion caused by this had rattled the LNG industry - until a decision in 2015 of the Supreme Court of the United Kingdom when the confusion was cleared up in a manner that reinstates the utility of take-or-pay provisions in enhancing the bankability of LNG projects.

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