What Is a Take-or-Pay Contract?

A take-or-pay contract is a commercial agreement between a supplier and a buyer where the latter commits to a fixed quantity of goods over a set period. If they cannot accept the agreed-upon quantity, they must pay a deficiency payment or penalty. This sort of agreement is common in volatile industries where the seller requires some sort of stable income and return on upfront investment, like energy or raw materials.

The buyer promises a minimum payment per month or year, whether or not they actually take delivery. This way, sellers guarantee revenue, while buyers secure long-term supply.

What does it include?

A take-or-pay agreement typically lays out some specific components that make the contract enforceable and clear for both sides.

Minimum purchase obligation

At the heart of the contract is a minimum volume of goods (somewhat like MOQs) that the buyer agrees to acquire during a set period. Let’s say this is 50 barrels of oil per month at $60 each, guaranteeing the seller a baseline income of $3,000. Even if they don’t take all the barrels, they must still pay the full price. 

Payment terms

The agreement specifies when and how to make payments. The pay is typically due upon delivery or per the normal payment cycle. If the buyer does not collect their contracted amount, the seller invoices them for the shortfall. This payment may be expected within standard commercial timeframes, typically 30 calendar days.

Delivery flexibility

Some contracts offer leeway in terms of when the buyer collects the goods to accommodate demand changes. For example, LNG power plants might not need daily deliveries but only twice or three times a week. In any case, the total contracted volume must still be honored.

Penalty clauses

If the buyer repeatedly fails to take or pay, additional penalties may apply. These could be financial (interest or fees) or contractual (loss of future supply rights). For the seller, penalties like contract price reduction can apply if they fail to deliver the agreed volume.

Make-up provisions

To soften the blow for buyers, some take-or-pay contracts include a make-up clause. This lets the buyer collect any previously paid-for but undelivered goods within a set period, anywhere from six months to two years. Think of it as a credit system that reduces waste and supports obsolescence management, as buyers have a longer window to utilize stock.

Common use cases

A take-or-pay contract is especially useful where the seller needs heavy upfront investment and where supply and demand can fluctuate. Here are some example industries:

Energy supply

These contracts are common in the CNG and LNG industries. Suppliers gain confidence that their production and infrastructure costs will be recovered, while buyers (typically, utility companies) get supply security.

Manufacturing supply

A factory relying on a steady stream of materials, like steel and cement, might enter into a take-or-pay contract to avoid price volatility and supply delays. The supplier gets predictability, and the buyer avoids costly interruptions.

Infrastructure

In large projects, like pipelines and ports, developers often rely on take-or-pay agreements with future users to justify financing. Banks want to see that revenue is guaranteed, even before operations begin.

Transport and logistics

Freight forwarders or third-party logistics (3PL) providers may secure long-term volume commitments from shippers. For example, a mining company might sign a take-or-pay contract with a rail operator to reserve train capacity for transporting ore. It will pay for the reserved slots even if it ships less than expected. 

Benefits for sellers and buyers

For sellers, the benefits are pretty clear:

• Stable revenue stream, even if demand drops.

• Easier access to financing due to predictable cash flows.

• Reduced business risk due to guaranteed upfront cost recovery.

• Long-term collaboration, leading to stronger partnerships.

Buyers also gain quite a bit, including:

• Long-term supply security, with priority access during shortages.

• Stable pricing over time, less susceptible to price hikes.

• Predictable costs simplify financial planning.

• Streamlines procurement operations with fewer renegotiations.

So while initially it may seem like buyers are taking a hit, the trade-off is often worth it. Particularly in volatile or high-demand industries, buyers secure reliable access to essential goods and services and earn leverage in supply planning.

Risks and considerations

Take-or-pay contracts do come with their share of risks. For buyers, the biggest concern is overcommitting. If market demand drops significantly or they overestimate their needs, they will be stuck paying for unused goods for a long time. And unless there’s a generous make-up clause, that money is gone.

For sellers, the risk lies in performance obligations. If they can’t produce or deliver what’s promised, perhaps due to operational issues, regulatory changes, or force majeure, they could face penalties, lawsuits, or loss of credibility.

Additionally, poorly worded contracts can lead to disputes over what counts as “non-performance” or how make-up rights are applied. That is why these contracts are often carefully negotiated and reviewed by legal teams and major stakeholders on both sides.

Example scenario

Let’s say a cement company signs a take-or-pay contract with a coal supplier. The agreement requires the cement company to buy 50,000 tons of coal per year at a fixed price. If, due to lower production, the cement plant only uses 40,000 tons, they still have to pay for the full 50,000.

However, the contract includes a make-up clause allowing them to claim the unused 10,000 tons within the next calendar year. This gives the buyer some flexibility while still honouring the financial commitment.

From the supplier’s point of view, this setup guarantees revenue even during slow production years. It helps them maintain operations and plan ahead — a win for both cash flow stability and supplier risk management.