In the relations between large suppliers and buyers, various types of risks are possible. Among them, a fairly common situation is when it is not possible to sell all planned goods in connection with the refusal of a transaction by one of the parties to the contract. This results in significant financial losses to the supplier company. In order to prevent such cases, in a number of contracts for the supply of products (usually expensive and in large volumes), the principle called “take or pay” is applied. What does this mean, what is it and how did this mechanism appear? How and does it always work? You will learn about this by reading the article.
The essence of the principle
The “take or pay” condition is a fairly common mechanism in relations between large, including international, corporations. It consists in the following: when concluding a contract for the supply of an agreed volume of products, the supplier and the buyer assume certain obligations. The first is to ensure, within the period stipulated by the contract, the maximum quantity of goods in accordance with the volume agreements fixed by both parties. The second is to pay the indicated quantity of products, regardless of how much was actually purchased in the corresponding period.
The meaning of the terms "take or pay"
Application of this principle allows minimizing the risk of financial losses associated with the inability to market the planned volume of products. Even if the buyer refuses to purchase the goods in the maximum quantity (fixed in the contract), he will have to pay the full cost. This can be considered a fine for failure to comply with the terms of the contract. In a business environment, this is called the take-or-pay principle. If such a risk mitigation mechanism were not used, the supplier would have to include it in the pricing formula.
The story of the take-or-pay principle
For the first time, this system of building relationships between parties to a supply agreement was introduced in the late 1950s in the Netherlands. This was due to the development of the Groningen gas field, which turned out to be a very expensive event, which required the investment of public funds in the gas transportation and production infrastructure . The money spent was required to be returned, and this could only be done in one way - by ensuring the uninterrupted supply of large volumes of gas and their full payment. So the “take or pay” principle was actively invented today.
The state of the Netherlands has entered into multi-year contracts. They provided for maximum volumes of goods that counterparties pledged to purchase within a certain period of time. If they refused to fulfill the conditions, then they paid a fine. At present, one of the most famous followers of this principle is the Russian company Gazprom.
If the condition did not work: a good example
Gazprom, in its relations with Chinese and European partners, is actively applying the take-or-pay principle. Many of the intergovernmental gas supply agreements entered into by the company have a validity period of 25 years or more. Usually everything works successfully, but once a mistake happened.
The terms of the agreement on the contract concluded on the basis of this principle with the Czech company RWE Transgas were violated. The buyer refused to purchase gas in the maximum amount that was stipulated by the contract, and did not want to pay a fine. As a result of litigation (in connection with a violation of the “take or pay” principle), Gazprom was the loser. The Vienna Arbitration Court recognized the right of a Czech company to withdraw less gas than stipulated by the terms of the contract, without the need to pay any fines.
Dissatisfaction with the condition among international partners
Despite the fact that the principle of "take or pay" is actively applied in the export policy of Russian companies, many counterparties have repeatedly expressed dissatisfaction with them. Such stringent conditions of international gas supply contracts did not please, in particular, Italian and Ukrainian partners.
For example, Eni threatened Gazprom with refusing to renew the contract if the take-or-pay principle was not excluded from its terms. The discontent of the Italian partners can be understood, because in connection with the shortage of gas volumes, it lost 1.5 billion euros (for 2009-2011).
Ukrainian counterparties also complain. So, under the contract between Gazprom and Naftogaz (valid until 2019), gas is supplied to Ukraine in the amount of 52 billion cubic meters annually. For 2013, an application from partners was submitted for only 27 billion cubic meters. In this case, the company will have to pay at least 33 billion cubic meters. meters, as well as possible fines for the shortfall in the amount of two billion dollars.
Some analysts have argued that the era of dominance of contracts with such harsh conditions is gradually ending. This applies not only to Russian Gazprom, but also to other world corporations. Only events will show how events will develop.
Conclusion
The “take or pay” principle can be called a very effective tool to reduce the risk of financial losses. For suppliers, this is an opportunity to sell their products in full, and otherwise reduce losses from "under-procurement". But, as it turned out, not all buyers like this condition (and can afford it). Some experts consider the principle too rigid and predict the rejection of its application. In any case, it is still working (albeit with obstacles), and many companies are very pleased with this state of affairs.