Choil Trading v Sahara Energy Resources
DMC/SandT/2011/12
England
Choil Trading SA v Sahara Energy Resources Limited (The “Prem Mala”) English Commercial Court: Christopher Clarke J: [2010] EWHC 374 (Comm): 26 February 2010
Available on BAILII @ http://www.bailii.org/ew/cases/EWHC/Comm/2010/374.html
Chirag Karia (instructed by Davies Johnson & Company) for the claimant buyer, Choil
Mark Smith (instructed by Spenser Underhill Newmark LLP) for the defendant seller, Sahara
SALE OF GOODS CARRIED BY SEA: FOB SALE CONTRACT: CIF ON-SALE CONTRACTS: QUANTIFICATION OF DAMAGES FOR DELIVERY OF CONTAMINATED GOODS IN BREACH OF FOB CONTRACT: RECOVERABILITY OF HEDGING LOSSES INCURRED IN MITIGATION IN RELATION TO CIF CONTRACTS: WHETHER TRUE CONSTRUCTION OF FOB CONTRACT EXEMPTION CLAUSE EXCLUDED RECOVERY OF HEDGING AND ADDITIONAL EXPENSES/COSTS INCURRED AS A RESULT OF BREACH OF CONTRACT
Summary
Quantum – date of assessment: where the buyer of dated (volatile) price-indexed FOB goods had bought for general on-sale on dated (volatile) price-indexed CIF terms but, as a result of breach of FOB contract as to description, the CIF on-buyer rejected the goods, necessitating CIF salvage on-sale to another party by the FOB buyer, quantum was to be assessed as at the date the goods were rejected by the original CIF on-buyer, rather than at the date of delivery (shipment) under section 53(3) of the Sale of Goods Act 1979.
Quantum – measure of damages: damages would include not only any loss of market value for the off-specification goods as against sound goods assessed at the date of rejection of the goods by the original on-buyer (on the facts no such loss occurred due to a rise in market value) but also the additional expenses/costs that naturally and ordinarily resulted from having to on-sell the goods to another party, including:
- the net costs of hedging arrangements closed out and created in mitigation of exposure to the dated price differentials of the FOB contract and the original and new CIF contracts;
- additional freight and deviation costs incurred under the contract of carriage; and
- additional surveying and insurance costs incurred in relation to the goods.
Exclusion – consequential loss: clause 13 of the FOB contract did not exclude recoverability of the FOB buyer’s claim for hedging losses and the additional expenses/costs incurred, because that provision only excluded liability for special damages under the second limb of Hadley v Baxendale, whereas the losses suffered by the FOB buyer were of the kind that flowed directly and naturally from and were likely to arise on breach of the FOB contract by the seller under the first limb of Hadley v Baxendale.
Case note contributed by Jim Leighton, BSc (Hons), LLB (Hons), LLM (Maritime Law), Solicitor of England & Wales / Registered Foreign Lawyer (Practising Foreign Law) in Singapore at Kennedys Singapore LLP and International Contributor to DMC’s CaseNotes
Background
Choil bought 28,290 MT of naphtha FOB Port Harcourt from Sahara to on-sell to a sub-buyer. Sahara had in turn bought the naphtha from Pipelines and Products Marketing Company Limited, a subsidiary of the Nigerian National Petroleum Corporation, which also owned the Port Harcourt loading terminal. The dispute arose out of what Choil alleged was a significant quality defect in the naphtha. The naphtha contained an abnormally high quantity of Methyl Tertiair Buthyl Ether (“MTBE”), a man made substance which is not a by-product of naphtha production. This probably arose as a result of gasoline contamination in shore tanks at Port Harcourt. After the dispute arose, the parties came to an arrangement whereby Choil would accept delivery of the naphtha and make a payment of the purchase price less US$1,200,000 on the basis that this should be without prejudice to the legal position of the parties.
Choil was to on-sell the cargo to Petrogal (the original on-sale) for US$18,838,358 or US$665.90 per MT (in accordance with the terms of the contract price formula - average Platt’s during 13–17 August 2007 plus $17). The original on-sale did not go ahead, because on 28 August 2007, when SGS released its surveyor’s report of the composite cargo samples taken on board the vessel during loading, Petrogal rejected the cargo as being off contractual specification. Choil instead re-sold the cargo to Blue Ocean (the salvage on-sale) for US$20,225,579 or US$741.93 per MT (in accordance with the terms of the contract price formula - average Platt’s during 1-31 October 2007 minus US$31.50).
Choil claimed from Sahara the difference between the plus US$17 on Platt’s average reported market price (for the original on-sale) and the minus US$31.50 on Platt’s average reported market price (for the salvage on-sale), being US$48.50 x 28,290MT, i.e. US$1,372,068. Choil took this position because the prima facie difference in sale prices, that is, the difference between the original on-sale contract and the salvage on-sale contract, showed that Choil had made a profit on the cargo as a result of the steps taken to mitigate losses on rejection of the cargo by Petrogal. Choil also claimed for additional expenses/costs resulting from taking the vessel to Amsterdam (per the salvage on-sale) instead of Leixoes (per the original on-sale) and certain hedging losses that resulted from the change of date for the contract price formula period.
Sahara took the position that (1) Choil was seeking to rely on evidence/figures that was/were not a proper measure of the difference in value between sound and contaminated cargo on 13 August 2007 (delivery on board the vessel), on 28 August 2007 (rejection by Petrogal) or any other date, and (2) Sahara had not warranted the quality of the cargo on delivery or any other time. On either basis, Choil would have suffered no provable loss of profit on the salvage on-sale to Blue Ocean.
The judge held, on the basis of the facts and expert evidence, that Sahara had warranted the maximum MTBE content of the cargo and was in breach of that warranty because the naphtha exceeded the MTBE limit. This note deals with the quantum and exclusion clause aspects of the dispute. The law report also deals with demurrage and short delivery claims under the sale contract, but for the sake of brevity these aspects are not dealt with here.
Judgment
Quantum - Date of Assessment
Both parties agreed that section 53(3) of the Sale of Goods Act 1979 was relevant to the assessment of damages but the correct approach to its application was disputed. That section reads:
“In the case of breach of a warranty of quality such loss is prima facie the difference between the value of the goods at the time of delivery to the buyer and the value they would have had if they had answered the warranty”.
Choil submitted that the measure of loss should be the difference between the sound arrived value of uncontaminated cargo and the actual arrived value of the actual cargo as of 28 August 2007 (the day on which SGS communicated the cargo survey report and Petrogal rejected the cargo). Damages on this basis would have been US$1,372,068 (as detailed above). This was the earliest date on which Choil and Petrogal could reasonably have been expected to understand the true extent of the cargo contamination on board the vessel and to respond to it.
Sahara submitted that the prima facie measure of damages in section 53(3) was not displaced; accordingly, section 53(3) applied and any sub-sale was irrelevant. This was because (a) Sahara’s sale to Choil was not on the same or similar warranties as to the condition and description of the naphtha as Choil’s sale to Petrogal, and (b) the practice in the trade was for the seller to sell FOB Nigeria, without warranty, and, when the quality of the naphtha had been determined, for the buyer to sell on CIF or similar terms. Sahara argued that the relevant date for measuring damages was therefore the date of shipment (13 August 2007).
Choil’s approach was, stated the judge, not a precise application of section 53(3) because it did “not involve taking the market value of the contaminated naphtha at the place and time of delivery under the contract” (that is, at Port Harcourt when the cargo was loaded on board the vessel). However, the judge accepted that the starting point was to consider the value of the MTBE contaminated naphtha on or about 28 August 2008 for the reasons given by Choil. This was also close to the time when the vessel was at her intended discharge port.
Quantum - Measure of Damages
Choil’s case was that its loss was the difference between the plus US$17 and minus US$31.50 on the average Platt’s market rate and that because both the purchase and on-sale contracts were based on the average Platt’s market rate, even though taken from different periods, this was not to be taken into account. As 28,290MT had been shipped, according to the bill of lading, damages payable would be US$1,372,068. Choil also claimed additional expenses/costs of US$505,160 that they had incurred consequent upon Sahara’s breach – consisting of US$204,930 (additional freight), US$281,399 (deviation costs), US$9,831 (additional survey costs) and US$9,000 (additional insurance costs).
The judge determined that the validity of Choil’s approach depended on three factors, the most critical of which was whether the difference between plus US$17 and minus US$31.50 was properly to be regarded as representing the difference between the sound and actual arrived value of the cargo.
On this point, Sahara’s position was that the plus US$17/minus US$31.50 comparison was no guide to the difference between sound and MTBE contaminated naphtha on 28 August or any other date. The judge accepted this position on the basis that, firstly, he was not convinced that the premium or discount over Platt’s reflected only the difference in quality (other relevant factors included timing of the sale, quality specifications of the cargo, price differentials between naphthenic naphtha and paraffinic naphtha, which are used for different purposes, the Platt’s rate being based on paraffinic naphtha) and, secondly, it was impossible to infer that the differences in the quality provisions in the original on-sale contract and the salvage on-sale contract made no difference to the price.
Under those circumstances it was necessary to consider what should be regarded as the market value of naphtha of PHRC quality CIF NWE (“North West Europe”) on about 28 August. In applying Glencore Energy v Transworld Oil (fn.1), the judge held that the correct figure to take for the sound market value on 28 August, if such a figure were available, would be the price on that date of a cargo of the contract quality on a vessel which would in ordinary course arrive in NWE in very early September, by which time PREM MALA was sitting off Portugal. In default of that, the judge considered it would be appropriate to take the average Platt’s CIF NWE for 28 August, which was US$652 plus a premium to reflect the fact that Platt’s relates to paraffinic, not naphthenic, naphtha, which would have to be assessed.
As the expert evidence before the judge did not reveal an appropriate figure for such a premium at that date, the judge adjusted a naphtha swap price premium of US$10 per MT (based on naphthenic naphtha) from that date to a premium of US$7 per MT. This made for a price of US$659 per MT, representing a sound cargo value of US$18,646,156.13. As the judge had determined, on the evidence available, that the value of the cargo as delivered was US$20,255,579 (namely, under the salvage on-sale contract), he held that Choil on the face of it had suffered no loss.
Hedging Losses
As the judge noted, trading companies like Choil habitually hedge in order not to be caught out with an open positions in a volatile market. The evidence highlighted that Choil’s trade finance bank required this to be done. The rejection of the cargo by Petrogal left Choil with a long open position, and Choil took what the judge described as “a reasonable attempt at mitigation” by buying and selling lots of dated Brent crude to close out the open position, given that the naphtha market, which had no live index for hedging purposes, was likely to follow the Brent crude market, which did have a live index.
On the evidence, and in following Addax v Arcadia Petroleum (fn.2), the judge determined that Choil were entitled to recover a total of US$1,208,157, comprising hedging losses of US$702,997 (US$2,285,428 hedging paper loss less US$1,582,431 physical on-sale gain), together with the additional expenses/costs (of US$505,160) incurred by Choil as a result of Sahara’s breach of contract. This was subject to the issue of whether or not clause 13 of the 20 July terms excluded Choil’s right to recover such damages.
Loss Exclusion Clause
The clause in question read:
“Neither party shall be liable for any consequential, indirect or special losses or special damages of any kind arising out of or in any way connected with the performance of or failure to perform the agreement.”
While referring to Watford Electronics v Sanderson CFJ (fn.3), the judge did not consider the present losses to be consequential, indirect or special losses/damages, because such losses/damages were limited to those under the second limb of Hadley v Baxendale (fn.4).
In specifically considering the hedging loss, the judge noted that Morison J. in Addax v Arcadia had held that a limitation to consequential damages would not apply to hedging costs which were part and parcel of the claimant’s position with its suppliers. By extension, the judge considered that a similar result should apply here, where the hedging in question was part and parcel of the claimant’s dealings in respect of cargo unexpectedly left on its hands. Further, given that in the trade in which the parties participated operating hedging was an every day occurrence and regarded as a normal and necessary part of the trade, and anyone in the position of Choil would have been expected to hedge, no special knowledge was required at the time of entering the contract to realise that hedging was what Choil was likely to do to mitigate a breach.
It followed that Choil were entitled to judgment in the sum of US$1,208,157.
Comment
This case is useful on the issue of whether hedging arrangements put in place by a buyer should be taken into account in determining its recoverable loss in the context of an international sale of goods contract. While Glencore v Transworld focused on closing out hedging that had been commenced before breach, where the goods could not be on-sold due to non-delivery of the goods by the seller, the present case focused on the situation where additional hedging had become required/necessary and was specifically created as a result of the need to on-sell the goods in mitigation of the breach of contract by the seller where the buyer was left with goods on its hands.
In both situations, the integral nature of hedging against exposure to date/price differentials for goods sold against a volatile price index meant that gains/losses flowing from a breach of contract by the counterparty are to be taken into account in determining quantum. The result of a breach will create an outright paper or physical market position which necessitates a hedging arrangement (such as closing out an existing paper position, buying in a replacement cargo against an open paper position and/or creating a paper position against a physical position) to be taken to mitigate against the uncapped exposure created by the outright position. Losses resulting from such mitigation are considered to be a direct and natural result of the breach of contract by the counterparty. This is so whether hedging arrangements were made as a matter of course (before breach) where breach necessitated closing of that position or the opening of further positions was only necessitated by the need to mitigate (following breach).
Footnote (1): The “Narmada Spirit” [2010] EWHC 141 (Comm); see the case note at http://www.onlinedmc.co.uk/index.php/Glencore_Energy_v_Transworld_Oil.
Footnote (2): [2000] 1 Lloyd’s Rep 496, where Morison J stated that in principle there was “no sensible or commercial reason why the court should not take into account the costs of the hedging instruments” in mitigation of breach of oil trading contracts.
Footnote (3): [2002] FSR 19.
Footnote (4): (1854) 9 Exch 3411.
