Drafting resilient transport contracts: will send-or-pay provisions become standard in a resilient supply chain?

By Simon Brady and Nicholas Fletcher
31 Mar 2022
Take-or-pay and send-or-pay arrangements – common in energy supply contracts – may become a standard feature of transport contracts as purchasers seek to build contingency into their otherwise volatile supply chains.

As shocks from the war in Ukraine and COVID-19 continue to buffet supply chains, the Federal Government has recently called for a pivot from "just-in-time" to "just-in-case" inventory practices. In a recent address to a business summit, the Prime Minister urged industry to consider a "just-in-case" model to support greater diversification and larger inventories of key goods, nominating semiconductors, agricultural chemicals, water treatment chemicals, telecommunications equipment, plastics, pharmaceuticals and PPE as supply chain priorities.

In this context of supply chain volatility, the Federal Government also announced the establishment of the National Intermodal Corporation Limited (formerly the Moorebank Intermodal Company), a government business enterprise tasked with developing nationally integrated intermodal terminals across the country's east coast to connect to the Inland Rail presently under construction. National Intermodal is responsible for creating open access terminals in Melbourne and Brisbane, to complement its existing facility at Moorebank in Western Sydney, with a view to encouraging equal access for above-rail operators. The Federal Government has committed $3.1b in new commitments in this year's budget to deliver the Melbourne intermodal terminal.

New intermodal terminals will enable business to diversify its logistics type and switch from road to rail and vice versa, constituting one element of a resilient supply chain.

Send-or-pay arrangements in transport contracts

Another element of a resilient supply chain may involve business and logistics service providers working together to develop new logistics offerings as a contingency for existing distribution channels. This may require substantial investment on the part of the logistics service provider, which it may seek to recoup from its customer via a guaranteed revenue stream in the form of a "send-or-pay" arrangement. Such arrangements ("take-or-pay") are common in the energy sector to ensure the seller makes an agreed rate of return in order to project finance its investment. They are also a feature of energy transport contracts and enable the shipper to use the transport service or pay for it.

Under a take-or-pay structure, the buyer is obliged (often on a monthly basis with an annual reconciliation process) to either take or pay a specified quantity of the relevant commodity or pay the seller for any amount of the specified quantity it has not taken. Such arrangements may offer the buyer some flexibility, including the right to make-up, in subsequent periods, any quantities of the commodity the buyer has purchased but not taken. A buyer may seek relief (1) if the seller is unable to make available the promised quantity of the commodity (whether due to force majeure or its own default) or (2) if the buyer is inability to accept delivery due to force majeure.

In the context of domestic logistics arrangements, an example may involve a logistics service provider agreeing to invest in a fleet of hydrogen-powered trucks in return for a guaranteed financial return from its customer. The customer elects to either use the service, or not use the service, but is obliged to pay for it anyway. The hydrogen-powered trucks supplement the service provider's fleet in the event of volatile oil prices. The joint announcement in March of the governments of NSW, Victoria and Queensland to install a hydrogen refuelling network between Melbourne and Brisbane further supports this diversification strategy.

Depending on the nature of the investment, send-or-pay arrangements will likely involve longer contract terms than those usually agreed between customers and logistics service providers. Longer term contracts may (depending on the nature of the market and the exclusivity of the arrangements) present competition law risk that will require careful consideration when drafting.

Further, the parties will need to ensure the send-or-pay arrangements could not be held unenforceable as a penalty. A clause which is found to be a "penalty" is unenforceable or void. The High Court has made it clear through Andrews' case that stipulated amounts which are out of all proportion with the loss caused are liable to be void, whether or not they arise on breach of contract. This case broadened the scope of commercial transactions that might be found to be void as penalties and parties must be mindful of its principles.

Finally, the negotiation of such arrangements will also require careful consideration of the costs of supply chain resilience the customer may ultimately pass on to consumers.

Is holding more inventory the answer?

The "just-in-time" inventory model involves keeping as little inventory on hand as possible and using short-term, flexible contracts capable of quickly adjusting to changes in demand. It ensures cash isn't tied up in inventory sitting in expensive warehouses and minimises obsolescence. As industry seeks greater resilience in its supply chains, building up inventory is much easier than developing localised production or pursuing other contingency plans.

Media outlets report a number of household name Australian brands are spending big on raw materials and semiconductor inventory to ride out future shocks in global supply chains.

A pivot to a just-in-case inventory model necessarily involves a build-up of inventory, however businesses should not overlook the terms of their underlying transport and logistics contracts to ensure they remain fit for purpose.

Fit-for-purpose contractual arrangements a key element of resilient supply chains

The first quarter of 2022 has seen ongoing, and worsening, disruption of global supply chains and such conditions are likely to continue. Business needs to ensure its logistics contracts have the flexibility to adapt to changing market conditions as a key element of developing a resilient supply chain.

We encourage service providers and users in the transport and logistics sector to adopt a review of their existing contractual arrangements to ensure they cater for the ongoing volatility arising from international conflict, COVID-19 and uncertain market conditions. As business builds contingency into its supply chains, issues such as send-or-pay arrangements will become more prevalent. Proper planning and preparation will ensure "resilience" becomes more than simply a post-pandemic buzzword.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.