This article has been originally published by Lex Spectrum, a legal magazine of Oil and Natural Gas Corporation Ltd.

Introduction

India’s energy landscape is rapidly evolving, with natural gas playing an increasingly vital role in meeting the country’s growing energy demands. Liquefied Natural Gas (LNG) has emerged as a crucial component in India’s energy mix, offering flexibility, cleaner emissions compared to coal and oil, and the ability to bridge the gap between domestic production and consumption. As India continues to expand its LNG import infrastructure and seeks to secure reliable supplies, the structuring of spot LNG Sale and Purchase Agreements (SPAs) becomes ever more significant.

Key Points

Take or pay clauses: addressing downstream risk: Take or pay clauses are fundamental in LNG SPAs, obligating the buyer to pay for a minimum quantity of LNG, regardless of whether it is taken. These clauses also obligate the Seller to deliver the agreed quantity of LNG and if such delivery is not made, the Seller is obligated to pay for a minimum quantity of LNG. In the context of spot LNG transactions, it is critical that these clauses explicitly address downstream risks of buyers. This means the contract should clearly define what constitutes a downstream risk (such as disruptions in the buyer’s regasification or distribution network) and specify how such risks impact the buyer’s take or pay obligations.

Off-Spec LNG: Seller’s delivery obligations: Quality assurance is paramount in LNG transactions. The SPA should include a clear provision stating that if off-specification LNG is delivered without prior notice to the buyer, such delivery will be treated as a failure by the seller to deliver under the contract in addition to all costs that the Seller would be liable to pay for damages caused to the Buyer’s facilities due to such off-spec LNG. Typically, seller’s try to limit their liability by introducing caps on such damages. However, Buyer’s should always endeavor to have uncapped liability for such scenarios or at the very least, a 100% damages cap.

Credit support: clarity in confirmation memorandum: Credit support mechanisms are essential to mitigate counterparty risk in spot LNG SPAs. The confirmation memorandum should explicitly set out the duration, amount, and timing for providing such credit support. Importantly, the provision of credit support should not be based solely on the credit rating of a company. Instead, it should only be required if specifically stipulated in the confirmation memorandum.

Delivery Terms: demarcating EEZ and in-country delivery: The delivery point is a critical commercial and legal consideration in LNG SPAs. The contract should clearly distinguish between delivery within the Exclusive Economic Zone (EEZ) and delivery at an in-country terminal. This demarcation affects risk transfer, taxes, customs obligations, and logistical arrangements.

Governing Law: excluding the UN convention on sale of goods: The choice of governing law has significant implications for the rights and obligations of the parties. It is advisable to expressly exclude the application of the United Nations Convention on Contracts for the International Sale of Goods (CISG) in the SPA. The CISG contains certain warranties for fitness and imposes a buyer’s caveat emptor (buyer beware) obligation, which may not align with the commercial intentions of the parties in an LNG transaction. By excluding the CISG, parties can rely on a legal framework that better reflects their negotiated terms.

Conclusion

LNG contracts, particularly spot SPAs, are inherently complex and require careful structuring to address the unique risks and commercial realities of the LNG market. By paying close attention to key clauses such as take or pay, off-spec LNG, credit support, delivery terms, and governing law, parties can create robust agreements that support successful and reliable LNG transactions. As India’s reliance on LNG continues to grow, the importance of well-drafted SPAs cannot be overstated.