Take or pay: does a breach of capacity obligation cause loss?

Insights / / Take or pay: does a breach of capacity obligation cause loss?

You can listen to this article in podcast format here:

British Gas Trading Limited v Shell UK Limited, Esso Exploration & Production UK Limited [2020] EWCA Civ 2349

The recent Court of Appeal ruling in British Gas Trading Limited v Shell UK Limited, Esso Exploration & Production UK Limited [2020] EWCA Civ 2349concerned a “take or pay” arrangement, in which the buyers, British Gas, were only entitled to nominal damagesdespite Shell’s breach of their capacity obligations as sellers.

This case is another reminder, following our recent podcast on Apache v Euroil, that the Court may look at two separate but related agreements to construe a provision in one of them.

Under “take or pay” arrangements the seller agrees to maintain supply of an agreed volume of a commodity, and the buyer commits to either:

  1. Take delivery and pay the price of the agreed volume over a given period; or
  2. Reject delivery but pay a minimum price to the seller.

Such terms are popular in long-term energy supply contracts where buyers and sellers wish to share a degree of the risk in the movement of price and demand.

In this case, Shell and British Gas entered into an agreement (the Principal Agreement) for the supply of natural gas from 1988 until at least 2025. This Principal Agreement included a “take or pay” provision, under which the Shell agreed to:

  1. Supply daily quantities of natural gas to British Gas; and
  2. Constantly maintain certain delivery capacity at the gas field reservoirs.

British Gas agreed to either take delivery or, in the event they could not take delivery, pay for a minimum amount of gas every year.

The quantity of gas British Gas were required to take every year was calculated by reference to a percentage of the total daily quantity of the Reservoirs (the “TRDQ”). The TRDQ also determined the delivery capacity rates which Shell were obliged to maintain.

The parties anticipated that the TRDQ would change over the life of the contract, so they agreed that, after a certain stage of production, Shell would be entitled, but would not have, to reduce the TRDQ if they thought that production levels could not be maintained. Needless to say, any reduction in the TRDQ would reduce the quantity of the gas which British Gas were required to take.

Separately, British Gas and Shell were parties to a different agreement (the Separate Agreement) entered into with other producers. Under this agreement, Shell were required to lend gas produced from the Reservoirs to other producers on the basis that those producers would repay the lent gas to Shell.

Production volumes at the Reservoirs declined over time and Shell subsequently served variation notices reducing the TRDQ. However, after 2009 Shell were able to meet their supply obligations without having to reduce the TRDQ by using a significant balance of gas that was owed by other producers under the Separate Agreement.

British Gas complained, not of a failure by Shell to deliver the nominated volumes, but of their failure to maintain capacity to deliver gas at the agreed rates from the Reservoirs.

In fact, British Gas complained, because the market price of gas had for some time fallen below the price agreed under the Principal Agreement with Shell. They contended that Shell ought to have reduced the TDRQ which would have had the effect of reducing the amounts that they were obliged to take and pay for above market price.

The British Gas claim was based upon three arguments:

1) When determining Shell’s capacity obligations the gas owed by other producers under the Separate Agreement should not be taken into account.

The High Court rejected this proposition, so British Gas appealed.

The Court of Appeal interpreted the language of Shell’s capacity obligation clause, and then tested this construction against the terms of the two agreements. It also considered the “commercial common sense” invoked by Shell. It was however doubted this would have much of a role to play in the interpretation of detailed and complex contracts.

The Court of Appeal found that Shell’s capacity obligation was concerned with gas provided from the Reservoirs alone, so gas owed by other producers should not be taken into account for the purpose of determining whether Shell had maintained their delivery capacity.

2) Shell were under an implied duty to exercise their entitlement to reduce the TRDQ in good faith.

This was rejected by the High Court. British Gas appealed but their application was also rejected.

3) The assessment of damages.

The British Gas case was that in order for Shell to avoid being in breach of their capacity obligation, they would have served variation notices reducing the TRDQ, which, in turn, would have reduced the amounts that British Gas were obliged to pay for under the Principal Agreement. It therefore claimed the difference between the price of gas which it could have purchased on the market and the price which it actually paid to Shell (which was estimated at over £61 million).

However, the Court rejected British Gas’ arguments emphasising that damages should be assessed on the basis that the party in breach had performed its obligations (that is, if Shell maintained delivery capacity throughout the duration of the Principal Agreement). On this basis, Shell would have provided the same gas volumes, so British Gas suffered no loss.


The Court of Appeal’s approach on interpretation of the Shell’s capacity obligation serves as a reminder of how important the agreed language in complex contracts can be.

On the assessment of damages, the Court’s conclusion that British Gas suffered no loss despite Shell’s breach, could be “surprising” and seemed to run contrary to the “conventional expectation that parties who break contracts should face consequences”. However, this was reached on a proper application of law on what was described as an “unusual” agreement “giving one party the prerogative to set the parameters of an obligation that binds both parties”.

Chris Kidd

Chris Kidd Head of Shipbuilding and Offshore Construction, Joint Head of Energy & Infrastructure, Partner

Tarek Taha

Tarek Taha Associate

Related sectors:

Related news & insights

News / Climate change litigation update: Derivative claim dismissed

06-07-2022 / Energy & Infrastructure

McGaughey & Anor v Universities Superannuation Scheme Ltd & Anor [2022] EWHC 1233 (Ch) On 24 May 2022, the High Court refused a claim brought against the directors of the Universities Superannuation Scheme (the “USS”), the largest private pension scheme in the UK, for inaction around climate change commitments.

Climate change litigation update: Derivative claim dismissed

News / Refund guarantees – avoiding drafting pitfalls

12-05-2022 / Energy & Infrastructure

Refund guarantees are often described as the cornerstones to shipbuilding projects and the buyer’s main security. Although they do not strictly form part of the shipbuilding contract, a shipbuilding project is unlikely to go ahead at all without one. It is therefore important to understand the different types of guarantee instruments, and the impact each has in practice on the guarantor’s obligations to pay and the buyer’s entitlement to recovery. A well-drafted guarantee provides certainty to the parties and strikes a balance between their respective entitlements and obligations.

Refund guarantees – avoiding drafting pitfalls

News / You will be estopped if you cross the line

04-04-2022 / Energy & Infrastructure

Estoppel is a useful tool in litigation, which is usually used to bind one party to a statement or a promise that it has previously expressed causing another to accept or adopt it for the purpose of their legal relations. The Court’s recent ruling in Geoquip Marine Operations AG v (1) Tower Resources Cameroon SA (2) Tower Resources PLC addresses estoppel by convention and recognises the requirement for the common assumption created between the parties to be clear and unequivocal. In this article, we focus on the specifics of the Court decision.

You will be estopped if you cross the line

News / Court of Appeal overturns second Unaoil bribery conviction

29-03-2022 / Energy & Infrastructure

On 24 March 2022, the Court of Appeal overturned the conviction of a second man, Paul Bond, prosecuted by the Serious Fraud Office (SFO) in relation to alleged wrongdoing by Unaoil. 

Court of Appeal overturns second Unaoil bribery conviction

News / The Court grapples with impact of Covid-19 on European rugby

08-03-2022 / Energy & Infrastructure

As we approach the second anniversary of Covid-19 being declared a pandemic by the World Health Organisation on 11 March 2020, a number of judgments are coming out of the English Courts which are providing useful guidance on how the English Courts are treating claims concerning Covid-19, especially in a force majeure context.

The Court grapples with impact of Covid-19 on European rugby

News / Climate change litigation: Courts decide the law, not political policies

02-03-2022 / Energy & Infrastructure

R (Finch) v Surrey County Council CA (Civ Div) [2022] EWCA Civ 187 “The task of the court in a claim such as this is only to decide the issues of law. Those issues cannot extend into the realm of political judgment – which is the responsibility of the executive, not the courts …”

Climate change litigation: Courts decide the law, not political policies