Offtake agreements are legal contracts between two companies regarding specific amounts of goods to be delivered from one company to another. These contracts are quite common and are primarily used with energy producers like coal mines or power plants. Many times these agreements contain several protective clauses and may take months or years to complete.
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Companies use offtake agreements to ensure that a buyer is willing to purchase future goods produced by the supply company. Many times suppliers in the energy industry use offtake agreements to ensure that their investment in mines, wind turbines or coal power plants will earn a profit. Companies with offtake agreements are usually able to find outside financing to build their production facilities, allowing them to retain cash for normal operating uses.
Offtake agreements have benefits for both the sellers and buyers of goods in this type of legal contract. Sellers use offtake agreements to ensure that they have a buyer for future goods produced through their operations. Prices are agreed upon at the time of the contract, ensuring that sellers cannot offer a lower price in the future. Buyers use the agreement as a hedge against future prices in case of a future supply shortage. Additionally, any future supply shortages enable companies with offtake agreements to increase market share, raising their profits.
Offtake agreements should include three important statements. The first statement is whether the contract is a firm buy/sell agreement or an option contract. The buy/sell clause is important because it ensures that a future economic is guaranteed to take place unless one party breaches the contract. An option contract gives the buyer an option to exercise the agreement if the market provides a favourable environment for the buyer to execute the purchase.
A force majeure clause allows the offtake agreement to be cancelled with no penalty assessed to the buyer or seller listed in the contract. In order for the force majeure clause to take effect, something outside of the buyer's or seller's control must take place. This clause eliminates or mitigates the risk from the contract parties for items such as major weather disasters, government regulation or failure of a third party assisting with production.
The third most important clause of an offtake agreement is the ability of one party to cancel the contract through a default by the other party. Because offtake agreements are legal contracts, cancellation of the contract is usually not permitted. Default agreements will state what constitutes a default, such as the violation of one clause or multiple clauses that will result in penalties. Because legal agreements are difficult to cancel, companies usually build stiff financial penalties into the contract to ensure the agreement is strictly followed.
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