Take or Pay Obligations in Fuel Supply Agreements: An Overview

Contractual clauses that obligate the buyer to take delivery of a pre-determined quantity of natural gas or other fuel or pay the monetary equivalent of the pre-determined quantity of fuel in case of failure to take delivery are known as take or pay (TOP) clauses. TOPC (TOPC) have been justified from the seller’s point of view on the ground that these clauses help the seller recoup substantial capital investment.

TOPC have been in vogue in the natural gas industry for more than half a century. At the same time, they have been criticised as anti-competitive and anti-consumer. Consequently, the validity of TOPC has been challenged in judicial forums on numerous legal grounds.

The challenges have been more frequent when end-consumers, such as power-producers (using gas as the raw material), are unable to use the committed quantity of gas for consumption owing to circumstances beyond their control. TOPC have also been questioned especially when the prices of natural gas supplied are higher than those of alternative fuels or spot market prices, thereby encouraging buyers to go for such sources, and in economic rescission where demand for gas would be considerably lower than anticipated by the buyer.

Consonant with international practice, TOPC are prevalent in fuel supply agreements in India. In the forthcoming paper to be published in the Dr. Ram Manohar Lohiya National Law University Journal (2020), the manner in which these clauses have continued to be used in fuel sales agreements despite legal challenges under the rubrics of various laws in India has been analysed.

The paper first provides a brief overview of the history and the economic rationale for the continued use of TOPC. It describes the legal developments pertaining to the clause from competition law, contract law and electricity law perspectives. Considering the use of such clauses world over, an international perspective is also provided. The paper concludes by arguing that although TOPC are here to stay, various abuses surrounding TOPC have been, and are being, duly addressed in Indian law.

Padia Timbers & Contracting Through Tendering Process

A recent decision of the Supreme Court in Padia Timber v Vishakapatnam Port Trust is interesting on many counts. One, it is a rare decision by the Supreme Court construing general contract law (Sections 4 and 7 of the Indian Contract Act, 1872. Two, the Supreme Court overturned the decision of the trial court and the High Court notwithstanding that the case does not involve any new question of law that courts previously had not dealt with but that the lower courts (trial court and the High Court) did not deal with in this case. Three, the decision throws considerable light on government contracting practices and can act as a context in discussing such practices.  Four, this case relates to a notice inviting tender that was floated more than thirty years back (1990)! The matter was heard in the SC several times between 2007 and 2011 but it appears that the matter was not heard between 2011 and 2018.

The judgment reiterates the position that acceptance should be unconditional as per Section 7 and various decided cases. 

On facts, when  the appellant, Padia Timbers, submitted its bid, it made a revised quotation stating that inspection would have to be conducted at Padia Timber's depot an not otherwise. This is where government tendering practices are to be noted. Given the requirement of a rigorous and complaint free tendering process, government contracts usually state that the bidder must "accept" all the conditions stated in its offer.  If that is not the case, the Government entity generally rejects the bid if the non-acceptance pertains to a material provision. In this case, the error committed was that the Government entity went ahead with the tendering process and awarded the contract to the bidder despite deviation from the condition regarding inspection. What really happened making the port trust to proceed with the tendering process and awarding the contract is not clear and will be known if the tender file is perused.

The Court ultimately ordered the Port Trust to refund the earnest money to Padia Timber at an interest rate of 6% per annum from the date of institution of the suit (1994) till the date of refund. 

Vidya Drolia v DTC: Part II: Interesting Aspects- Contradiction between Patel Engineering & Booz Allen

Para 17-19 of Vidya Drolia v Durga Trading Corporation is the next interesting aspect we take up in this post. We had discussed the nature of an arbitration agreement and its relation to the law of contracts in the previous post on this subject. In this post, we will discuss the contradiction between Booz Allen and Patel Engineering on whether subject-matter arbitrability is to be decided by a court under Section 8 and11.

In Vidya Drolia, the Supreme Court observed:

" When public policy mandates and states that a case or a dispute is non-arbitrable, the court would not allow an application under Section 8 (or even Section 11 as observed supra) even if the parties have agreed upon arbitration as the mechanism for settlement of such disputes." (Para 19, P. 24).

Justice Ramana's opinion also touches on this topic in many places but does not explicitly note the contradiction between the approaches in these judgments (Patel Engineering &  Booz Allen) noted above. So what exactly is the issue?

The issue relates to whether power exercised under Sections 8 and 11 are similar. What turns on this question is the point whether a court hearing a petition under these sections has to decide subject-matter arbitrability.

In Patel Engineering, the SC held that Sections 8 and 11 were complementary in that the judicial authority under Section 8 or 11 has to decide the jurisdictional issues raised before it. This would logically include questions as to arbitrability of the subject-matter as well. In Booz Allen, however, a two-judge Bench of the Supreme Court held that the nature and scope of issues that arise for consideration in a Section 11 application were narrower than those under Section 8. The court held that arbitrability was not to be determined by the court under Section 11. It is this contradiction that the court in Vidya Drolia highlighted and held: 

"We are clearly bound by the dictum of the Constitutional Bench judgment in Patel Engineering Ltd. that the scope and ambit of court’s jurisdiction under Section 8 or 11 of the Arbitration Act is similar." (Para 17, p. 20).

We invite readers to access this post in this blog written almost a decade back where we argued that given the decision of the larger Bench in Patel Engineering, Booz Allen's approach as regards arbitrability question under Section 11 (that the same has to be decided by the arbitrator) was not consistent with Patel Engineering:

"The pertinent question for the purposes of this post would be whether Patel Engineering gives an indication of whether a decision under Section 11 included a decision on issues of Arbitrability. This blawgger’s view is that it would. Two reasons: (1) In line with the Patel Engg approach, Arbitrability of the dispute would be a jurisdictional fact/ condition precedent for the Chief Justice to exercise jurisdiction; (2) Supreme Court’s concern was for the party who had not agreed to an arbitration agreement but had to go through the entire process of arbitration (because the Act did not permit a court to interfere unless provided so in the Act) and could only challenge the award under Section 34. The same situation applies to Arbitrability as well. In a petition under Section 11, if the contention is that the dispute was not arbitrable, and if the court mechanically refers the parties to arbitration, the party which raised such a contention will be unnecessarily put to the trouble of going through the entire arbitration process...

Therefore, this blawgger is of the view that the obiter dicta of the Supreme Court in Booz Allen ought to be placed below the decision of the Seven Bench Supreme Court in Patel Engineering in terms of binding force."

However, this "contradiction" is a virtually an academic issue, given that Sections 8 and 11 have been amended. We will address Vidya Drolia on the implication of these amendments in another post. But we will conclude this post summarising the concluding observations in Vidya Drolia on this question:

• Judicial review and court's jurisdiction u/ss 8 and 11 are identical but extremely limited [Para 96(b)]
• Patel Engineering is no more good law in view of the 2015 and 2019 amendments to the 1996 Act. [96(a)]
• By virtue of separability and competence principles, arbitral tribunal is the "preferred first authority" to decide all aspects of non-arbitrability and courts can have a second look in terms of Sections 34(2)(a)(i), (ii), or (iv) or 34(2)(b)(i) of the 1996 Act. [96(c)]
• But courts can exercise its jurisdiction where the subject-matter of the dispute is "manifestly and ex facie" non-arbitrable. [96(d)].

[Note that Para 96(d) of the court's view confers very limited jurisdiction on the courts in respect of non-existence or invalidity of agreements as well but we did not deal with these aspects in this post.] 

The Law of the Arbitration Agreement: Enka Insat v OOO Insurance: UK Supreme Court

Enka Insaat Ve Sanayi AS v OOO Insurance Company Chubb [2020] UKSC 38 (09 October 2020) is an important decision which addresses the critical issue of the choice of law of the arbitration agreement. We had, in this blog, criticised, the pre-Enka English approach of giving priority to the law of the seat than the law of the contract where there is no express choice of the law of the arbitration agreement. 

Generally, we analyse such judgments in two parts, the first part deals with a detailed descriptive summary of the decision and the second part, usually in one or more posts, provides a critique of the decision. We will do so in this post but with a small change. We will not provide a detailed descriptive comment like we always do but refer readers to the (informal) press summary (pdf) provided by the UK Supreme Court, which is helpful in identifying the central aspects of the decision. In case readers wish to watch the summary rather than read it, please access this link. However, a brief idea about the judgment is provided in this post. 

The decision covers a situation where the law of the contract is different from that of the seat of arbitration. In this case, the English Court of Appeal had held that where there was no express choice of law of the arbitration agreement, the law of the arbitration agreement should be governed by the law of the seat as a matter of implied choice, subject only to any particular features of the case demonstrating power reasons to the contrary.

Readers who have read our post noted above will be familiar with the critique that preference to the law of the seat over the law of the contract is not the correct approach in the choice of the law of the arbitration agreement. Further, a look at the decision of the court of appeal noted in the above paragraph would reveal a test that is subjective and amorphous. 

In the Supreme Court, Lord Kerr, Lord Sales, Lord Hamblen, Lord Leggatt and Lord Burrows heard the matter.  There are three opinions: 

• the first opinion was of Lord Hamblen and Lord Leggatt with which Lord Kerr agreed, 
• the second one by Lord Sales (with whom Lord Sales agreed), and 
• also a separate opinion by Lord Sales. 

Between the opinions, the  judges agreed in principle that if the parties had agreed on the law of the contract, such law would also govern the law of the arbitration agreement. The judges also agreed that what is material in granting an anti-suit injunction under English law whether the pursuit of foreign proceedings was in violation of the arbitration agreement, and not on the law of the arbitration agreement [See, the Summary]. There is considerable significance in these propositions. 

However, the following issues were contentious between them:

• Where there is no express or implied choice of the law of the contract, whether the law with which the main contract is most closely connected should govern the arbitration agreement?
• Whether, on facts, parties chose Russian law to govern their construction contract?

In terms of relief, the majority dismissed the appeal while the dissenting judges remitted the question as to whether there was breach of the law of the arbitration agreement to the Commercial Court for determination.

More on the decision in another post.