Michigan Court of Appeals Enforces Take-or-Pay Contract, Highlighting Importance of Careful Drafting of Contractual Terms
Foster Swift Business & Corporate Law News
December 17, 2015
Allocating the risk of loss between parties is a key consideration in the negotiation and drafting of commercial contracts. Contractual tools such as indemnity and hold harmless provisions are used to shift risk of loss from one party to another. “Take-or-Pay” contracts, typically used in connection with the purchase and sale of commodities, allocate risk concerning the rise or fall of market prices between a purchaser and seller.
A take-or-pay contract was at issue in a recent case before the Michigan Court of Appeals. The case involved Kyocera Corporation (“Plaintiff”), a Japanese producer of solar panels, and Hemlock Semiconductor, LLC (“Defendant”), a Michigan manufacturer of polycrystalline silicon (“poly”) which is used in the manufacture of solar panels.
The parties entered into a series of long-term take-or-pay contracts requiring Plaintiff to purchase a certain quantity of poly annually over a ten-year period, and Defendant to supply it for certain prices. Thus Plaintiff insulated itself from risk of the price of polysilicon going up, and Defendant hedged against the price going down. Due to fluctuations in the market, primarily due to China’s aggressive, arguably anti-competitive, move into the solar panel market, the price of solar panels dropped dramatically, as did the price of poly.
After attempts to amend the contracts failed, Plaintiff sent notice to Defendant in 2015 that it would be exercising its right under a “force majeure” clause to discontinue its contractual obligations because of the alleged anti-competitive actions of the Chinese government.
A force majeure clause is a contract provision that relieves the parties from performing their obligations when certain agreed upon circumstances arise that are beyond their control. In the contract at issue, force majeure events include things such as “natural disasters,” “fire,” “strikes,” and “acts of the Government.”
Plaintiff filed a complaint seeking a declaration that the acts of the Chinese or United States governments constituted a force majeure event, consequently relieving it of its obligations under the contracts. Defendant filed a motion to dismiss, asserting the force majeure clause did not relieve Plaintiff of its obligations. The trial court granted defendant’s motion to dismiss and Plaintiff appealed.
The Court of Appeals upheld the lower court’s decision, rejecting Plaintiff’s argument that the “acts of the Government” provision of force majeure clause released it from its obligations. In short, the alleged market manipulation activity engaged in by the Chinese government “did not constitute a force majeure event under the parties’ contract.”
The Court of Appeals further explained that the deflation of prices for poly which rendered Plaintiff’s contract unprofitable was a risk that was expressly assumed by Plaintiff through its take-or-pay contract with Defendant:
“Plaintiff opted not to protect itself with a contractual limitation on the degree of market price risk that it would assume. It cannot now, by judicial action, manufacture a contractual limitation that it may in hindsight desire, by broadly interpreting the force majeure clause to say something that it does not.”
This case is another example of the importance of carefully reviewing and negotiating every term of a contract, even routine ”boilerplate” provisions like a force majeure clause. Moreover, parties should think long and hard before entering into long-term take-or-pay contracts, as commodities prices often take unexpected turns, and courts are not hesitant to enforce such contracts. (After all, who ever thought we would be paying $1.70/gallon for gasoline in 2016!)