On granting summary judgment to an IT consultancy in a dispute over unpaid invoices under an IT services agreement, Mr Justice Burton has found that a ‘take or pay’ clause requiring the defendant to take a ‘minimum’ 500 days of consultancy did not constitute an unenforceable penalty. In the circumstances of this case, he considered the clause commercially justifiable. The judge accepted nonetheless that, in principle, such a clause could constitute a penalty. IT consultants beware: ‘take or pay’ clauses could be unenforceable penalties.
For the full judgment, see E-Nik Ltd v Department for Communities and Local Government [2012] EWHC 3027 (Comm).
Background
The claimant is an information technology services company, which entered into a contract with the defendant dated 1 April 2009. The contract was for a period of two and a half years, but terminable on 12 months’ written notice by either party.
Neither party terminated the contract, but an argument arose when the defendant failed to pay invoices for the balance of 500 ‘minimum’ days of consultancy services per year, which the defendant had not utilised. The claimant alleged that the fees remained payable, as the contract was intended to reflect a minimum commitment, or a ‘take or pay’ agreement.
The contract was not drafted by lawyers and, in the words of Burton J, the language was not always ‘elegant or apt’.
Key provisions
Clause 2 of the contract read as follows:
‘2.1 The Authority hereby undertakes to purchase 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.
2.2 The Authority shall issue an Assignment Note to requisition Services from the Supplier.
2.3 The Authority shall pay the Supplier fees at the rate of not less than £850 per day but subject to mutually agreed assignment notes for each change request…’
Invoices were payable on an upfront basis.
Key questions
Two of the key issues to be considered in the case were as follows. First, whether clause 2.1 allowed the defendant not to purchase a minimum of 500 days of consultancy, if those consultancy days were not required. Second, if the answer to that question was ‘no’, and the defendant was bound by a minimum commitment, was the claim for outstanding invoices unenforceable, as a penalty?
Minimum commitment?
In relation to the first issue, the claimant relied upon a number of arguments, namely:
- The reference to the minimum of 500 days meant what it said. The ‘project requirement’ element of clause 2.1 only became relevant if the defendant decided that it required ‘additional days’
- An ‘Assignment Note’ (defined as meaning ‘a mutually agreed document… detailing the precise purpose of work to be carried out by the Supplier‘) never came into existence. The absence of such further document did not therefore affect the minimum commitment
- The ability to terminate on 12 months’ notice would have been pointless, if there was in fact no obligation to call off any consultancy services at all
- Clause 3.8 of the document obliged the defendant to provide a spreadsheet detailing ‘days remaining’, which must, by its context, have referred to the balance of the 500 days commitment, at any given time.
The defendant relied instead on the words, ‘based on project requirement’ and argued that ‘based on’, meant ‘dependent on’, project requirements. On this basis, as the project did not require 500 days of consultancy, the defendant need neither purchase nor pay for them. Indeed, on the defendant’s construction, the defendant need not purchase any days at all.
Construction
In respect of this first issue, Burton J found that the defendant’s view of events would deprive the word ‘minimum’ at clause 2.1 of any meaning. Further, the words ‘based on project requirements’ neither meant nor said ‘subject to project requirements’. To construe otherwise would not be a commercial or common sense construction of this particular commercial contract.
Accordingly, the 500 hours was found to be a minimum commitment on the part of the defendant.
Debt or damages
Burton J then considered whether the claim should be framed as a debt (the monies are just due), or whether the services had to be specifically demanded before monies were owing, and therefore the defendant’s failure to actually call off the 500 days was a breach of contract, which triggered a damages claim.
The defendant contended that a request for such services was necessary before any monies were owing, and put the claimant to proof that the consultancy services actually remained available, if needed, throughout the contract term.
The claimant’s view was that the defendant’s obligation was not dependent upon a request. The claimant was ready to perform services as and when needed – and indeed made sure it was available to so deliver throughout the term of the contract. The provision for the 500 days to be paid for upfront also made it plain that payment was not dependent upon a request.
On this issue, Burton J again found in favour of the claimant. The defendant plainly undertook to purchase and to pay for a minimum of 500 days of consultancy services (without the need to further request them) and, on the evidence presented, the claimant continued to keep the services available.
The monies due in respect of the balance of the 500 consultancy days were therefore due as a debt.
Unenforceable as a penalty
The court having determined that the monies owed were recoverable as a debt, the claimant argued that the monies were due and owing, as the rule against penalties does not apply to a claim for a debt (relying on Jervis v Harris [1996] Ch 195).
The defendant’s contrary view relied upon Burton J’s earlier decision in M&J Polymers Ltd v Imerys Minerals Ltd [2008] EWHc 344 (Comm), in which he determined that a take or pay clause could, in principle, constitute a penalty.
Burton J again accepted that such a clause could constitute a penalty and indeed that it could do so regardless of whether the claim under it was for a debt. He also accepted that the court should not be too keen to characterise a clause as a penalty clause. In the current case Burton J stated: ‘I am entirely satisfied that in the context where the claimant had to, and did, keep available the wherewithal to provide the consultancy services as called off throughout the entire term, at rates which… were at or below the rates regularly charged by the claimant to the defendant, these clauses were commercially justifiable, did not amount to oppression, were negotiated and freely entered into between parties of comparable bargaining power and did not amount to a provision in terrorem‘. For non-Latin speakers, ‘in terrorem’ means ‘by way of threat’.
The court therefore found in favour of the claimant – in that the terms were commercially justifiable, and therefore not a penalty. No appeal has been made.
Comment
The case reaffirms the principle that a ‘take or pay’ clause, under which a customer is obliged to either use or pay for a set number of consultancy days, can, in principle, qualify as a penalty clause and so be unenforceable. It is, however, unfortunate that Burton J did not expand on why, having determined that monies were recoverable as a debt, any test of commercial justifiability should apply at all – as this test was thought only to apply to damages provisions.
Until such time as the rationale for the application of the justifiability test to a debt claim is confirmed/clarified, it makes sense for potential claimants to make it clear, when drafting their take-or-pay clauses, that:
- payment is not dependent upon any further request by the customer
- minimum commitment means just that, a minimum commitment
- monies owing shall be recoverable by the claimant as a debt
- the contract is internally consistent in treating the relevant minimum commitment provision as being just that
- on the chance that case law continues to blur the lines as to how/when a justifiability test should be applied to a debt claim, the principles above have been expressly agreed between the parties, on a commercial basis, based on the consideration granted by the claimant.
Danielle Lodge is a Senior Associate, Projects & Outsourcing at RPC (Reynolds Porter Chamberlain LLP): Danielle.Lodge@rpc.co.uk
