Enforceability of ‘take or pay’ commitments
E-NIK v DEPARTMENT FOR LOCAL GOVERNMENT [2012]
As in this case, commercial contracts often contain a commitment by the customer to purchase on a ‘take or pay’ basis ie to buy a minimum quantity of goods and/or services within a defined period. When those commitments are not complied with, questions then arise as to what the supplier’s entitlement is and the extent to which the supplier is under an obligation to mitigate its loss.
Facts:
- E, an IT services company, entered into a contract with DLG for a two and a half year term but terminable upon 12 months’ notice by either party during that period. No notice of termination was served and the contract ran for its full period.
- DLG committed to “purchase [a] 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".
Decision:
The Court had to address a number of questions which arose out of the arrangements when DLG did not commission the minimum stated volume of services:
- DLG committed to pay for the Consultancy at a minimum cost of £850 per day. Could DLG claim that the “based on project requirement” wording made the commitment to purchase conditional and that if project requirements did not necessitate 500 days per year, there was no such obligation? This argument was dismissed although the Judge did seem to indicate that had the clause said “subject to project requirements” the result may have been different.
- In the final 6 months of the contract term DLG claimed that there was no minimum commitment at all. On the other hand, could E claim that in these 6 months the 500 day commitment should be halved to reflect a pro-rata apportionment even though the language of the contract made no express provision for pro-rating? The Judge agreed with E that a proportionate 250 day commitment applied in the last 6 months.
- E claimed that the sum of £850 per day (x500) was claimable as a debt (a fixed amount due and owing) simply in return for being prepared (‘ready, willing and able’) to make the services of its consultants available if called upon, irrespective of whether DLG actually called off the services or not. Importantly, it maintained that it was not a simple claim for damages which would depend upon E being able to demonstrate exactly what loss it had suffered. Importantly a damages claim would be subject to a duty to mitigate whereas a debt claim is not subject to such a duty. Could E claim there was a debt? Again the Judge decided in favour of E which was crucial as E was then able to avoid difficult issues about the extent to which one contract replaces another.
- Was the £850 inclusive or exclusive of VAT? The contract was not explicit on this. Because of the failure to make this clear, the Court held that the daily rate was inclusive of VAT.
- Was the claim for unused services an unenforceable penalty? It was argued that the obligation to pay for the services when they had not been called-off and when they had not been provided was a penalty. However, the Judge dismissed that argument. Although accepting that in principle such a provision could constitute a penalty, he decided that in context it was not. Given that E had to and did keep available the resources to provide the consultancy services as and when called off, the clauses were commercially justifiable and did not amount to oppression.
Points to Note:
- The finding that the sums payable in respect of the minimum call-off commitment were claimable as a debt is an important one particularly in the current climate. Customers who seek to terminate a contract part way through an initial minimum term in breach of contract often argue that they have no resulting financial liability to compensate the supplier because the supplier must mitigate its loss by obtaining a replacement contract. This decision makes such a position much more difficult to argue because a debt is a debt and does not impose an obligation to mitigate. Even if there was an obligation to mitigate, it is arguable that one contract for services is not a direct replacement for another and therefore mitigation is almost impossible in any event.
- It has to be said that this case was an interim application to the Court without a full trial (known as a ‘summary judgment’ hearing) and therefore of relatively limited precedent value. There seems to be have been little or no evidence as to exactly what E did by way of having resource available throughout the term to meet any possible call-offs. It also seems slightly strange that the Judge thought that the question of whether this provision amounts to a penalty applies at all since it is difficult to see what the breach by DLG was since it was not obliged to make the call-off but could do so if it wished. Its only obligation was to make the payment.
- Ultimately, however, the end result is largely the same and reflects the fact that very rarely in a commercial contract between two business entities will the Courts hold a provision to be a penalty. Notably the Judge used the term ‘oppression’ when considering whether a provision amounts to a penalty (a term which has been used by the Courts before), which suggests that any provision must be very extreme indeed before it will be so categorised and deemed therefore unenforceable.
- Take care to make it crystal clear whether the stated charges are inclusive or exclusive of VAT. In this case E failed to do so and therefore effectively had to bear the VAT element itself.