|This article does not cite any references or sources. (July 2009)|
A take-or-pay contract is a rule structuring negotiations between companies and their suppliers. With this kind of contract, the company either takes the product from the supplier or pays the supplier a penalty. For any product the company takes, they agree to pay the supplier a certain price, say $50 a ton. Furthermore, up to an agreed-upon ceiling, the company has to pay the supplier even for products they do not take. This “penalty” price is lower, say $40 a ton.
Take or pay contracts are common in the energy industry and, in particular, for gas sales.
- Reduces risk to the company's supplier, in return for which they can ask to pay less.
- Reduces a rival’s incentive to come after the company's customers by making retaliation a near certainty.
- Increases severity of price war if deterrence fails.
- Increases risk of market foreclosure through a strong barrier for new entrants seeking to join the market — this reduces competition, raises prices for consumers and is likely to lead to a deadweight economic loss for society.
Outside the oil and gas context, "take or pay" contract terms are often rejected by courts as unenforceable penalties. Courts look at these as "liquidated damages" clauses that must be based on a reasonable approximation of the actual damage that a party would suffer due to the other party's breach. "Take or pay" generally does not meet that standard.