The Legal Implications Of Conflicting Provisions As To Amount Available Under Letters Of Credit Issued For The Payment Of Oil Cargoes
The banks issuing letters of credit for the payment of crude oil cargoes calculate the letter of credit amount in function of:
- the marker crude price quotation used as reference for pricing by the sellers and buyers in the underlying sale contract;
- the quality differentials between the marker crude oil and the crude oil sold in respect of density and sulphur content1; and
- the cargo quantity range agreed in the sale contract and provided in the letter of credit application.
The pricing period for crude oil cargoes is typically 5 days after the Bill of Lading date, but the price of cargo will be calculated only after the quality characteristics and final quantity of the cargo are certified by the independent inspectors.
The letters of credit issued for the payment of crude oil cargoes include the contractual price clause based on the marker crude price quotations published by Platts or Argus and a linked amount escalation/de-escalation clause stating that the letter of credit amount will automatically be adjusted for any price increase or decrease in accordance with Platts` or Argus` price quotations for the marker crude used as reference in the price clause.
In BP Letter of Credit format published in Schedule B of BP Sale Terms and Conditions, the drafters sought to cover both the possibility of price fluctuation and the possibility of overshipment of goods in CFR and CIF sales where the sellers may take advantage of price rising by shipping more than the contractual quantity range of 15%. BP Letter of Credit format stipulates a cargo quantity range within +/-15% of the mean contract quantity and a similar tolerance limit for the letter of credit amount. It also includes the following conditions:
“SPECIAL CONDITIONS:
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11. The value of this letter of credit may escalate/de-escalate above or below the tolerances allowed without any amendment on our behalf.
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15. Any discrepancy resulting from the invoiced quantity exceeding or falling below the quantity range allowed in this letter of credit is acceptable. Payment will be effected on the invoiced quantity in case the maximum quantity allowed in this letter of credit is not exceeded. In case the invoiced quantity exceeds the maximum quantity allowed in this letter of credit the bank will pay on the maximum quantity allowed in this letter of credit.
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27. 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 Credit2.”
The Special Condition 15 seems to be intended to prevent the CFR/CIF sellers from taking advantage of price rising by loading more oil than the contract quantity range. It provides that the sellers may load more than the maximum quantity stated in the letter of credit but if they do that the issuing bank will not pay for more than the maximum quantity stated in the letter of credit, i.e. 115% of the stated quantity.
The Special Condition 27 provides that the issuing bank will accept a commercial invoice issued for a price in excess of the letter of credit amount, but it will not pay an amount in excess of the maximum amount stated in the letter of credit. This may be in accordance with the provisions of article 18 (b) of UCP 600, but it is in contradiction with the Special Condition 11 which stipulates that the value of the letter of credit may escalate above the tolerances allowed (i.e. 15% margin) without any amendment. This means that in case of price rising, the letter of credit amount will automatically be increased to allow the payment in accordance with the new price, even if the invoice amount exceeds 115% of the letter of credit amount, but provided that the invoiced quantity does not exceed the maximum quantity allowed in the letter of credit, i.e. 115% of the stated quantity.
This matter should have been stated clearly in BP Letter of Credit format, because the conflicting provisions work in the disadvantage of the issuing bank in case of dispute.
The best known example is the Singapore law case Korea Exchange Bank v. Standard Chartered Bank3.
The case was a dispute between the confirming bank (Standard Chartered Bank) and issuing bank (Korea Exchange Bank) concerning the terms of two L/Cs issued for the payment of two gas oil cargoes sold by Trafigura to Petaco Petroleum Inc.. The first L/C had the following terms:
“50: Applicant Petaco Petroleum Inc.
59: Beneficiary Trafigura Beheer BV Amsterdam.
32B: Currency code, amount USD800000
39A: Percentage credit amount tolerance 10/10
41D: Available with By any bank by negotiation
42C: Drafts at Sight
42D: Drawee Korea Exchange Bank World Trade Center Branch
45A: Description of goods and/or services Origin: Japan
Gas oil 26,000 BBL +/– 10 pct.
Price term: CFR any port(s) in South Korea
47A: Additional conditions
Late presentation B/L acceptable.
Price: The price in US dollars per barrel based on the quantity as determined under clause 12 of the contract shall be on a ex tank price at Pyongtaek, Korea Basis shall be equal to the average of the mean quotations published in the Platt`s Asia Pacific/Arabian Gulf Marketscan for gasoil reg 0.5 pct quotations under the heading Singapore plus a premium of US dollars 3.38 per US BBL.
A. Availability by negotiation at sight against following documents:
- Seller`s commercial invoice (telex/telefax acceptable)
- Independent inspector`s quantity report at loadport (telex/fax acceptable)
- Copy of seller`s authorization for release of product to Petaco (telex/fax copy acceptable)
- Photo copy B/L (telex/telefax acceptable)
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E. The amount of this letter of credit shall automatically fluctuate to cover any increase/decrease according to the price clause without further amendment to this credit.
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J. Documents showing alterations without approval stamp or initials are acceptable.
49. Confirmation instructions May add.”
The terms of the second letter of credit were materially similar.
After paying the beneficiary (Trafigura), the confirming bank sent the documents to issuing bank claiming reimbursement under the two letters of credit. In the meantime, the buyer Petaco Petroleum Inc. became insolvent and the issuing bank had no longer the possibility to obtain reimbursement if it had paid under the two letters of credit. Therefore, the issuing bank sought to avoid payment alleging that there were discrepancies in documents.
One of the alleged discrepancies was that the letters of credit amount was overdrawn, because the commercial invoices for the two gas oil cargoes were for the amounts of USD 939,789.01, respectively USD 1,021,641.66, in excess of the L/Cs amount tolerance limit of USD 880,000 (USD 800,000 +10%).
The dispute reached to the High Court of Singapore where the issuing bank contended that:
- the Additional Condition E allowed for fluctuation in the price of gas oil without the need to amend the letter of credit provided that the price payable for the gas oil cargo was within the tolerance of +/-10% for the letter of credit amount stipulated for under the Field 39A;
- the letter of credit amount tolerance limit of 10% meant that the maximum amount that could be paid under letter of credit was USD 880,000 (i.e. USD 800,000 +10%);
- the confirming bank sought reimbursement for an amount in excess of USD 880,000 (the maximum amount payable under letter of credit).
In turn, the confirming bank argued that the 10% tolerance limit of the letter of credit amount was meant to cover the 10% tolerance limit for the cargo quantity, but the letter of credit amount tolerance limit was overriden by the letter of credit amount escalation clause which meant that the L/C amount tolerance limit of USD 880,000 could be exceeded without the need for amendment of the letter of credit.
The High Court of Singapore upheld the confirming bank`s claim for reimbursement on the ground that the condition referring to the 10% amount tolerance limit should not be read in isolation but should be considered in the context of the letter of credit as a whole. While there was an apparent conflict between the condition referring to the 10% amount tolerance limit and the automatic fluctuation clause, the latter prevailed because it stipulated that any fluctuation in the letter of credit amount to cover the price increase shall take effect automatically without further amendment of the letter of credit. The High Court of Singapore held that “that is as good as saying “Notwithstanding the credit tolerance limit provided under Fields 32B and 39A”4.
The L/C amount fluctuation was not stipulated to be subject to any tolerance limits. Therefore, a claim for reimbursement of an amount in excess of 110% L/C amount tolerance limit was not an overdrawing.
If the buyers and their banks wish to put a cap on the amount available for payment in letters of credit, they should amend the amount escalation / de-escalation clause to say that the letter of credit amount will automatically be adjusted for any price increase or decrease within the stated tolerance limits.
by Vlad Cioarec, International Trade Consultant
This article has been published in Commoditylaw`s Oil Trade Review Edition No. 2.
Endnotes:
1. For instance, in case of Azeri and Russian crude oil cargoes, the differential is established in function of the differences in density (API gravity at 60ºF) and sulphur content between these crude oils and the physical Brent crude oil, the marker crude for the European market where these crude oils are sold. The physical Brent crude oil has a density of 38.5 degrees API and a sulphur content of 0.36%. The Azeri Light Crude Oil has a density of 35 degrees API and a sulphur content of 0.20%. The Azeri Light Crude Oil is sold at a premium to Dated Brent price due to the lower sulphur content. The Russian Export Blend Crude Oil has a density of 32 degrees API and a sulphur content of 1.25%. The Russian Export Blend Crude Oil is sold at a discount to Dated Brent price due to the lower density and higher sulphur content. The price clause of contracts for the sale of Russian Export Blend Crude Oil provide that the price per net barrel (in fact, the discount to the Dated Brent price) is set based on a density of 32 – 32.09 degrees API. Then, the price clause stipulates that: “Should the actual density (gravity) of the crude oil cargo be above or below these limits of density, then the price shall escalate by USD 0.003 per net US barrel for each full 0.10 degree API above 32.00 degrees API or de-escalate by USD 0.003 per net US barrel for each full 0.10 degree API below 32.09 degrees API.”
2. See BP Oil International Limited General Terms & Conditions for Sales and Purchases of Crude Oil and Petroleum Products – 2015 Edition – Schedule B – Letter of Credit format.
3. [2006] 1 SLR 565, [2005] SGHC 220.
4. In this regard, the Special Condition 12 in the Shell`s Letter of Credit format has the following provisions: “The amount of this letter of credit will automatically escalate/de-escalate in accordance with the loaded quantity and above Price Clause, even above or below the stated limits, without any further amendment.” See Schedule B of the Shell`s General Terms and Conditions for Sales and Purchases of Crude Oil, 2010 Edition.