Three Important Elements of Offtake Agreements

By Richard L. Goldfarb and Jason R. Busch | August 27, 2007
An offtake agreement is a contract between an ethanol producer and the buyer of the ethanol or ethanol production coproducts, such as distillers grains. Offtake agreements are generally negotiated long before construction of the facility begins, because securing a market for the output is often necessary to secure financing for the facility. Even contracts for coproducts can be important, because distillers grains often represent 10 percent of an ethanol plant's revenues.

Like any sales contract, an offtake agreement serves two purposes: 1) it describes the terms of the agreement, and 2) it allocates the risks between buyer and seller. The following three contract terms are important to a good offtake agreement.

First, it is important to clarify whether the offtake agreement is a buy/sell agreement or a marketing agreement. That decision holds significant implications for the allocation of risk. For example, in a buy/sell agreement, once the buyer takes possession of the product (generally FOB plant), the risk of loss transfers to the buyer. If anything happens to the fuel or feed after it leaves the facility, such as contamination, the loss will be borne by the buyer. If these terms are not directly addressed in the agreement, the Uniform Commercial Code (UCC) Article 2 governs the transfer of the risk of loss. If the sale is FOB plant, the buyer will bear the risk. Credit risk from the buyer's customers will also be borne by the buyer. Conversely, if the contracting party is merely a broker for the producer through a marketing agreement, then risk of loss and credit risk typically remain with the producer. The type of agreement should be expressly specified, and it should specifically allocate both risk of loss and credit risk.

Closely related to the allocation of risk of loss is the force majeure clause. A force majeure clause is a contractual provision allocating the risk if performance becomes impossible or impracticable as a result of an event that the parties could not have anticipated or controlled, such as the breakdown of a locomotive that prevents delivery of feedstock. A force majeure clause typically excuses performance only as long as the condition exists that prevents performance. Although a force majeure clause typically applies equally to both parties, in an offtake agreement it is advantageous to draft the clause so that if the buyer cannot perform its obligations, the seller is permitted to find a new buyer. If force majeure affects only the buyer, the ethanol plant operator will still have ethanol to sell. The seller may need to enter into a new offtake agreement that extends beyond the pendency of force majeure. Accordingly, the clause should be drafted to allow the seller to sell outside the agreement for a commercially reasonable time period, regardless of the length of the force majeure event.

Finally, the default provisions of the typical agreement permit the remedy of cancellation of the agreement for any default. Offtake agreements are generally output or requirement contracts, which, in turn, are typically installment contracts. UCC 2-612 governs whether a breach of a single installment constitutes a breach of that installment only, or affects the whole contract. UCC 2-612 allows a cancellation provision to be enforced if that is what the parties desire. However, if the parties do not want such a brittle provision as the one contained in a standard contract, UCC 2-612 also provides standards for when cancellation is to be imposed. This is important because it is rarely in the interest of either party to cancel the whole contract. Financing parties, in particular, do not want to take the risk that a single default will result in the plant they finance losing its output agreement. A better remedy in the case of a late payment or a breach of quality standards is to provide for damages rather than complete cancellation.

Richard Goldfarb is a partner at Stoel Rives LLP. He practices primarily in the commercial, banking, corporate and securities law areas. Reach Goldfarb at [email protected] or (206) 386-7639. Jason Busch is an associate at Stoel Rives LLP. He practices in the firm's Resources, Development and Environment Group, focusing on land use. Reach Busch at [email protected] or (503) 294-9339.

This article is only a general summary for information purposes and does not constitute legal advice. Consult a qualified and experienced legal advisor for your specific situation or particular questions.