Implications Of Price Adjustment For Iron Ore Cargoes On Letter Of Credit Payment

The quality characteristics of iron ore cargoes must comply with the standard specifications of the benchmark used as reference for the calculation of the base price. If the cargo`s quality characteristics differ from the quality specifications of the benchmark (i.e. Base Specifications), the Base Price calculated based on the average of the benchmark price quotations published for the reference price will have to be adjusted proportionately in accordance with the contract provisions.
If the cargo`s iron content is higher than the contract specification and the cargo has a smaller content of impurities and moisture than the maximum permissible limits for impurities and moisture, the Base Price will be adjusted upwards.
If the cargo`s iron content is lesser than the contract specification and the cargo has a greater content of impurities and/or moisture than the maximum permissible limits for impurities and moisture and/or the iron ore does not comply with the physical specifications, the Base Price will be adjusted downwards.
For iron ore cargoes sold on CFR basis to Chinese buyers, the sellers will make an initial drawing under letter of credit for the provisional price calculated based on the cargo`s net weight and quality characteristics certified by the surveyors at loading port and then wait for the results of the ship`s draft survey and sample`s moisture, chemical and physical analysis performed by CIQ at the discharge port for the final settlement.

Initial Drawing Under Letter Of Credit

The banks issuing the letters of credit for the payment of iron ore cargoes calculate the L/C amount based on the average of price quotations published on the days preceding the date of issuance of LC for the benchmark used as reference. After shipment of the iron ore cargo, the sellers calculate the base price in the provisional invoice based on the average of the benchmark price quotations on the five days preceding the Bill of Lading date and the quality differentials between the benchmark and iron ore cargo.
The letters of credit issued for iron ore cargoes stipulate a tolerance limit of +/- 10% for both the cargo quantity and amount available for payment. It may happen that the amount of provisional invoice is more or less than the 10% tolerance limit due to the benchmark price rising or fall during the reference period or the upward or downward adjustment of the base price. Article 18(b) of UCP600 stipulates that the banks may accept a commercial invoice issued for an amount in excess of the amount permitted by the letter of credit, provided they will not pay an amount in excess of that permitted by the letter of credit.
UCP600 does not say anything about the situation when the invoice value is less than the amount of the letter of credit. Therefore, the letters of credit issued for iron ore cargoes should include a special condition to address this matter.
An example of such condition is the Special Condition 27 of BP Letter of Credit format¹ which has the following provisions:

"Any discrepancy resulting from the invoice value exceeding or falling below the US dollar range allowed in this letter of credit is acceptable. In the event that the invoice amount does not exceed the LC value, payment will be effected on the invoice amount. In the event that the invoice value exceeds the maximum value of the LC, the bank will pay on the maximum value allowed under this Letter of Credit."

Final Settlement

The final settlement shall be made on the basis of the results of the ship`s draft survey and sample`s moisture, chemical and physical analysis performed by CIQ at the discharge port.
If the dry weight figure certified by CIQ based on the vessel`s draft readings and moisture analysis results is within 0.5% of the dry weight figure certified by the surveyors at the loading port, the dry weight figure certified by CIQ shall be final and binding upon the seller and buyer.
If the difference between the dry weight figure certified by the surveyors at the loading port and the dry weight figure certified by CIQ at the discharge port exceeds 0.5% and the seller and buyer cannot reconcile the difference, the average between the two figures shall be used for the calculation of final price.
If there is a difference of less than or equal to 0.50% in iron content between the figure certified by the surveyors at the loading port and the figure certified by CIQ, the iron content certified by CIQ shall govern and shall be the basis for the calculation of the final price.
If the difference in percentage in iron content between the figure certified by the surveyors at the loading port and the figure certified by CIQ is more than 0.50% but less than or equal to 1%, the average of the two figures shall be final and binding and shall be the basis for the calculation of the final price.
If there is a difference in percentage in iron content by more than 1% or there is a significant difference between the analysis results certified by the surveyors at loading port and those certified by CIQ at discharge port in respect of any other chemical or physical characteristics, the seller and buyer shall consult to reconcile the difference and if the difference cannot be reconciled, then, at the request of either the seller or the buyer, the umpire sample shall be analysed by an independent umpire inspection company mutually agreed by the seller and buyer and the results of the umpire analysis shall be final and binding upon the parties and shall be the basis for the calculation of final price.
If the base price in the final invoice will be higher than the base price in the provisional invoice due to the price adjustments and thereby the final price will be higher than the provisional price, the buyer shall have to remit the difference between the final price and provisional price along with any balance of the provisional price left unpaid.
If the base price in the final invoice will be lesser than the base price in the provisional invoice due to the price adjustments and thereby the final price will be lesser than the provisional price, the seller shall have to remit the difference between the provisional price or amount of the provisional payment and the final price.

by Vlad Cioarec, International Trade Consultant

This article has been published in Commoditylaw`s Coal Trade Review Edition No. 4.

Endnotes:

1. See Schedule B of BP Oil International Limited General Terms & Conditions for Sales and Purchases of Crude Oil and Petroleum Products – 2015 Edition