Sixth Circuit Interprets Take Or Pay Contract

Sixth Circuit Interprets Take Or Pay Contract

      In the decision rendered earlier this month, the Sixth Circuit Court of Appeals was called upon to characterize a “take or pay” provision in a supply contract. In this instance, the court found that the agreement was to be characterized as one offering either performance or a liquidated damages provision. Hemlock Semiconductor Corp v. Kyocera Corp., No. 172276, 2018 WL 3949110 (6^th Cir. August 16, 2018).

      Kyocera entered into a contract with Hemlock pursuant to which Hemlock would sell to Kyocera polysilicon to be used in the construction of solar panels. The contract they entered into contained a so-called “take-or-pay” provision under which Kyocera was required to purchase a specified quantity of polysilicon each year or, in the alternative, pay full price for the product not taken. In effect, Kyocera was required to buy the fixed quantity irrespective of whether it needed the product. The contract as well contained an acceleration provision providing that, in the event of Kyocera’s default, it would be required to pay to Hemlock the total amount that would be paid over the contract’s remaining term.

      The contract fell victim to macroeconomic developments.

Several years into Kyocera and Hemlock’ deal, the Chinese government disrupted the solar-panel market by subsidizing Chinese solar-panel companies. This intervention reduced the market price of polysilicon such that the price Kyocera agreed to pay Hemlock was far greater than the going rate.

      Efforts to renegotiate the agreement were ultimately unavailing, and Hemlock filed suit seeking a declaratory judgment that Kyocera had repudiated the contracts by indicating it would no longer perform under the take or pay provision. Kyocera counterclaimed, arguing that the “pay” aspect of the take or pay provision is an unlawful penalty as is the acceleration provision. The trial court dismissed Kyocera’s claims, and this appeal followed. The Sixth Circuit characterized the question as follows:

[T]he key question is whether the take-or-pay provision offer Kyocera two viable performance options, on the one hand, or one performance option coupled with a liquidated damages provision, on the other. If the former, the take-or-pay provisions are enforceable as written. If the latter, the question becomes whether the “pay” option quantifies lawful liquidated damages or an unlawful penalty. If the payment obligation is a penalty, it is unenforceable - regardless of what the parties’ contract labels it. 2018 WL 3949110, *2 (citations omitted).

      The court would find that contract should be characterized as one involving a performance option coupled with a liquidated damages provision. From there, it assessed the “pay” option under liquidated damage jurisprudence, assessing whether it truly is liquidated damages or the nature of a penalty. It would ultimately determine that the “pay” should be characterized as an impermissible contract penalty. That determination was based largely upon the economics of the transaction. For example, under the “pay” option, while Hemlock would receive 100% of the contract amount, it would never incur the costs of production.

      Kyocera’s challenge to the acceleration clause, which had likewise been dismissed by the trial court, was dismissed as well by the Sixth Circuit, it finding a lack of ripeness.