What Things Can Go Wrong When Banks And Commodity Traders Finance The Procurement Of Oil Cargoes Based On Sellers` Letters Of Indemnity Instead Of Bills Of Lading
Unless the sale contract allows the issuance and transmission of shipping documents, including Bills of Lading, electronically, the oil cargoes are traded on the basis of the sellers` letter of indemnity rather than the Bills of Lading due to the time necessary to pass the Bills of Lading down the chain of sellers, banks and buyers. In the letter of indemnity the seller warrants to the buyer that he has the title to the cargo and the right to transfer such title and undertakes to send the Bills of Lading to the buyer as soon as possible.
Things can go wrong for the buyers in CFR and CIF purchases where the sellers are also the charterers of the carrying vessel. The CFR and CIF sellers can sell the same oil cargo twice, get the money from both buyers, request the shipowners to discharge the cargo against a letter of indemnity to one of the buyers and then disappear, leaving the other buyer with empty hands. This is the reason why the letters of indemnity issued by small traders are required to be endorsed by a bank1.
The CFR and CIF buyers can also take advantage of the prolonged time needed to transfer the original shipping documents along the chain of sellers and banks, when they purchase the oil cargoes with money provided by third parties, banks or commodity traders. The CFR and CIF buyers can on-sell the oil cargoes to third parties and then disappear and leave the credit provider the unpleasant task of trying to recover the money lost from the suppliers.
Case study: Fortune Hong Kong Trading Ltd. v. Cosco-Feoso (Singapore) Pte Ltd., [2002] EWHC 79 (Comm)
In that case, a Chinese oil trader, Pacific Fond Ltd. asked another trading company, Fortune Hong Kong Trading Ltd. to finance the purchase by the former of two gas oil cargoes for delivery in China.
The financing agreements between Fortune Hong Kong Trading Ltd. and Pacific Fond Ltd. required the lender to obtain the issuance of L/Cs for the payment of oil cargoes and the borrower to provide 20% of the L/C amount before the opening of each L/C as a security deposit and the balance no later than two days before the payment due date under L/C. If Pacific Fond Ltd. did not fulfil its reimbursement obligation, the lender was entitled to forfeit the security deposit and recover the balance of the loan by seizing the oil cargoes.
Pacific Fond Ltd. bought two cargoes of gas oil from Cosco-Feoso (Singapore) Pte Ltd. on CIF terms for delivery in the port of Hainan. Unbeknown to the credit-providing company, Fortune Hong Kong Trading Ltd., Pacific Fond Ltd. on-sold the gas oil cargoes to another company, Sinochem Hainan Co. Ltd. and then asked the seller, Cosco-Feoso (Singapore) Pte Ltd. to arrange the discharge of cargoes against letters of indemnity.
On 7 August 1997, Cosco-Feoso (Singapore) Pte Ltd. issued a letter of indemnity to the shipowners asking them to deliver the cargoes to Sinochem Hainan Co. Ltd. and then on 28 August 1997, it issued a letter of indemnity addressed to Fortune Hong Kong Trading Ltd. to get the money under the letters of credit.
The CIF buyer, Pacific Fond Ltd. repaid only the amount due under the financing agreement for the procurement of the first cargo and the 20% advance required for the issuance of the second L/C and then disappeared.
When Fortune Hong Kong Trading Ltd. found out from shipowners that the gas oil cargoes were delivered to another company on the seller`s request, it brought a claim against the seller, Cosco-Feoso (Singapore) Pte Ltd. for breach of the warranties provided in the letters of indemnity.
Fortune Hong Kong Trading Ltd. contended that the seller was liable in deceit by the fact that in the letter of indemnity issued on 28 August 1997 the seller represented that it had free title to the first cargo and the right to transfer title to the cargo and had the intention of obtaining and surrendering the Bills of Lading to Fortune Hong Kong Trading Ltd., whereas in fact by providing a letter of indemnity on 7 August 1997 to shipowners to deliver the cargo to another company, the seller did not have free title to the cargo, nor a right to possession of it, nor the capacity to transfer title in or effect delivery of it to the buyer, nor the intention to obtain and surrender the Bills of Lading to buyer.
The English Commercial Court upheld the claim saying that that if those misrepresentations had not been made, Fortune`s bank would not have paid under the letter of credit.
Case study: Trafigura Beheer BV v. Kookmin Bank Co., [2006] EWHC 1450
In that case, a Korean oil trader, Huron, asked Kookmin Bank to finance the purchase of an oil cargo by issuing a letter of credit in favour of the commodity supplier, Trafigura following that Huron to reimburse the bank from the proceeds obtained from re-selling the cargo in the local market.
Trafigura which sold the oil cargo to Huron basis “CFR one safe port Kunsan, Korea” chartered the vessel “Shanghai” for the carriage of oil cargo from Indonesia to Korea.
The letter of credit issued by Kookmin Bank in favour of Trafigura required the presentation of Bills of Lading “issued to or endorsed to the order of Kookmin Bank” evidencing a shipment from Balongan, Indonesia to “one safe port/berth in South Korea”, marked “freight payable as per charterparty”. The letter of credit provided that in the absence of original Bills of Lading, Trafigura could present a letter of indemnity addressed to Huron.
Trafigura bought the oil cargo from an Indonesian oil company, Pertamina PT on FOB terms but failed to give proper instructions to shippers and shipowners as to information to be inserted in the Bills of Lading. As the Bills of Lading issued to Pertamina did not conform with the requirements of Kookmin Bank`s letter of credit, Trafigura asked the ship managers to replace them with a new set of Bills of Lading showing the details required by the letter of credit.
In the meantime, the vessel arrived the port of discharge nominated by Huron and discharged the cargo into a bonded storage terminal and held there to Trafigura`s order.
Trafigura did not wait for the replacement of Bills of Lading and obtained the payment from negotiating bank presenting the commercial invoice and a letter of indemnity addressed to Huron. Then Trafigura authorised the storage company to release the oil cargo to Huron.
When Kookmin Bank received the commercial invoice and letter of indemnity from the negotiating bank, it asked for the original Bills of Lading, it received the replacement set of Bills of Lading marked “Voyage accomplished. Null and void” because the cargo had long been delivered to the buyer.
Huron on-sold the cargo but the sale proceeds vanished in other pockets without reimbursing Kookmin Bank. In a couple of days after Huron`s managers obtained the cargo they arranged the sale of cargo through another company and sent Huron into liquidation.
Kookmin Bank sought to recover the financial loss from Trafigura for breach of the warranties and undertaking provided in the letter of indemnity presented for payment, claiming that by authorising the release of cargo to Huron, Trafigura deprived Kookmin Bank of its security interest in the cargo and by agreeing with the marking of the second set of Bills of Lading with the words “Voyage accomplished. Null and void”, Trafigura invalidated the second set of Bills of Lading as documents of title, despite the fact that it knew that Kookmin Bank was entitled to delivery of cargo through the Bills of Lading. Given that the letter of indemnity presented by Trafigura to negotiating bank and then transmitted to Kookmin Bank was subject to English law and had an exclusive jurisdiction clause, the legal action was brought in the English Commercial Court.
The English Commercial Court held that:
“The sale contract provided for property to pass to the Buyer at the ship`s flange at the load port and at the time when discharge instructions and delivery to Huron took place, the shipping documents were still in the control of the shippers who were entitled to change their delivery instructions to the shipowners. No conversion could take place at either point because Kookmin had no entitlement to the cargo, no entitlement to any B/L and no interest in the cargo. Kookmin had agreed to pay against the LOI. Once payment was made under the L/C on presentation of the LOI, there could not be any issue as to who was entitled to the cargo, as between Trafigura and Huron and the ship owners were entitled to deliver the cargo to Huron on Trafigura`s and Pertamina`s instructions.
It is Kookmin`s misfortune that it failed to make appropriate arrangements which gave it a contractual right against the carriers or some form of security against its customer in respect of reimbursement of the sum which it had paid under the L/C, whether by requiring the LOI to provide for delivery of original B/Ls to it, rather than its customer or by some other means.”
The Court noted that in the letter of indemnity addressed to Huron, Trafigura committed to send the Bills of Lading to Huron, and not to Kookmin Bank. There was no provision in the letter of indemnity issued by Trafigura that Kookmin Bank was to receive any Bills of Lading at all, so that Kookmin Bank had no legal basis to ask for the original set of Bills of Lading after making the payment against a letter of indemnity addressed to Huron.
In order to have been entitled to the original set of Bills of Lading required in the letter of credit, the issuing bank should have stipulated in the letter of credit that the letter of indemnity be addressed to itself, and not to Huron, and the letter of indemnity should have contained the undertaking that the Bills of Lading be sent to the issuing bank. Had the L/C issuing bank asked the seller to provide a letter of indemnity to itself, then the seller would have been aware of the bank`s interest in the cargo and would have instructed the shipowner to deliver the cargo to the bank`s order and not to the buyer. In case of the seller`s failure to do that, the issuing bank could have recovered the amount paid under letter of credit based on the letter of indemnity addressed to it.
Case study: Euro-Asian Oil S.A. v. Credit Suisse AG & Ors, [2018] EWCA Civ 1720
In that case, a Romanian oil trader, Dan Igniska, who needed regular shipments of 30,000 MT of gas oil for distribution in Romania but could not afford to buy gas oil quantities larger than 10,000 MT asked his former business partners from the Swiss company Euro-Asian Oil S.A. to help him purchase the additional quantities of 20,000 MT. The financing structure proposed by Igniska to Euro-Asian Oil executives involved three back-to-back purchase contracts and two back-to-back LCs.
Igniska bought through one of his companies, Abilo Ltd. gas oil cargoes of 30,000 MT +/-5% of which he on-sold quantities of 20,000 MT +/-10% to Euro-Asian Oil for further sale to another company he owned, Neptune Energy SA or Real Oil Development. Igniska procured the gas oil cargoes of 30,000 MT from suppliers such as Glencore and Select Energy. The procurement of gas oil cargoes by Igniska, through Abilo, was financed by Credit Suisse with L/Cs payable to suppliers initially at 10 days after the vessel`s NOR date at the port of discharge (L/Cs issued in favour of Glencore) and then at 30 days after the Bill of Lading date (L/Cs issued in favour of Select Energy), based on the L/Cs issued in favour of Abilo by BNP Paribas and Credit Agricole, on Euro-Asian Oil`s request.
The sale contracts between Abilo and Euro-Asian Oil and the sub-sale contracts between Euro-Asian Oil and Neptune Energy and Real Oil Development provided initially a credit period of 90 days, later extended to 120 days after the Bill of Lading date. The L/Cs issued in favour of Abilo by BNP Paribas and Credit Agricole had similar payment terms. During the 120 days` credit period, Abilo was financed by Credit Suisse which paid the commodity suppliers.
The first sub-sale contract between Euro-Asian Oil and Igniska`s companies was concluded on 9 November 2009 with Neptune Energy for a gas oil quantity of 19,100 MT. The contract provided initially a credit period of 90 days to Neptune Energy.
Igniska`s obligation under Euro-Asian Oil/ Neptune Energy sale contract was to provide a certificate issued by Constanta Oil Terminal S.A. confirming that it held in storage to Euro-Asian Oil`s order the quantity of 19,100 MT of gas oil pledged to BNP Paribas. The holding certificate had to provide security to Euro-Asian Oil and its financing bank, BNP Paribas during the 90 days` credit period until the sub-purchaser, Neptune Energy paid for the gas oil. The gas oil quantity of 19,100 MT was to be released in parcels following the payment of eight instalments.
Euro-Asian Oil`s executives expected to receive the holding certificate soon after the discharge of gas oil cargo by the carrying vessel at Constantza Oil Terminal S.A. on 13 November 2009, but Igniska who arranged the Customs clearance for the gas oil cargo through another company he owned, DG Petrol2, took the entire cargo of 31,443 MT he bought from Glencore without leaving any cargo in storage and providing the holding certificate to Euro-Asian Oil`s bank, BNP Paribas.
In January 2010, Igniska asked and obtained an extension of credit period from 90 to 120 days. The extension of credit period to 120 days allowed Igniska sufficient time to obtain a second L/C and procure a second cargo of 30,000 MT from Glencore. On 12 February 2010, Igniska concluded a second sale contract on Abilo`s behalf with Euro-Asian Oil for a gas oil quantity of 20,000 MT
+/-10% and replaced Neptune Energy with another company, Real Oil Development, as final buyer.
On the same day, Credit Agricole issued, at Euro-Asian Oil`s request, a deferred payment L/C in favour of Abilo and on 2 March, Credit Suisse issued a second back-to-back LC in favour of Glencore.
As the payment due date under the first deferred payment L/C (120 days after 6 November 2009, Bill of Lading date for the first cargo delivered by Glencore) was closing by, Igniska left in storage at Constantza Oil Terminal S.A. a quantity of 19,100 MT of gas oil from the second cargo and asked the storage company to issue a certificate confirming that it held that quantity to the order of Euro-Asian Oil and pledged to BNP Paribas, the bank which issued the first deferred payment L/C in favour of Abilo. Then on, Igniska started to operate a carousel wherein the holding certificates provided as security for payment during the 120 days` credit period were in fact issued for gas oil cargoes delivered under the next contracts.
Despite the fact that Igniska breached his contractual obligations under the first transaction and provided the holding certificate with a delay of 110 days after the discharge of the first cargo, practically extending further on the credit period of 120 days, BNP Paribas had to pay his company Abilo on the payment due date (at 120 days after the Bill of Lading date) of the first deferred payment L/C. The documents were presented to BNP Paribas by Credit Suisse which purchased Abilo`s claim under the deferred payment L/C. The documents presented by Credit Suisse to BNP Paribas consisted of a commercial invoice and a letter of indemnity issued by Abilo and endorsed by Credit Suisse. Credit Suisse endorsed Abilo`s letter of indemnity without making inquiries about the fate of the first cargo, relying on the warranty of title from the letter of indemnity provided by the commodity supplier, Glencore with four months ago.
In May 2010, Euro-Asian Oil`s executives became aware that Igniska was running a carousel but they expected that Igniska would ultimately close the circle and end the carousel. That did not happen. Between November 2009 and December 2010, Euro-Asian Oil financed the procurement of four gas oil cargoes of 20,000 MT +/-10% by Igniska`s companies but when the time came to provide a holding certificate as payment security for the fourth cargo, Igniska was unable to purchase in due time a fifth cargo and thereby to reimburse Euro-Asian Oil for the fourth cargo.
The fourth gas oil cargo paid for by Euro-Asian Oil, a quantity of 22,000 MT that was part of a cargo of 31,570 MT purchased by Igniska through Abilo Ltd. from Select Energy, was used by Igniska to provide security under the third sale contract between Euro-Asian Oil and Real Oil Development and by the end of the 120 days` credit period after the date of Bill of Lading issued for the fourth cargo, 11 September 2010, there was no more cargo left in storage at Constantza Oil Terminal S.A.
Credit Suisse L/C Officers had their part of the blame in what happened. Igniska used Credit Suisse as front cover to procure the gas oil cargoes from the suppliers and get the money from Euro-Asian Oil`s banks. During the judgment, it emerged that Credit Suisse L/C Officers did not examine the sale contracts concluded by Igniska through Abilo with Euro-Asian Oil and did not know about the financing arrangement Igniska had with Euro-Asian Oil to procure the gas oil cargoes and about the carousel. By dealing solely with the shipping documents pursuant to UCP Bible and not making inquiries to shipowners about the fate of the four cargoes, Credit Suisse L/C officers did not even know whether and what cargoes Abilo delivered to Euro-Asian Oil.
Euro-Asian Oil`s executives had their part of the blame too in what happened. They relied entirely on Igniska to provide the holding certificates in due time without taking any active steps to make that happen.
Euro-Asian Oil`s executives had no involvement in the procurement contracts made by Igniska with the commodity suppliers, Glencore and Select Energy. Only Igniska`s companies were mentioned as Notify Party in the Bills of Lading so that Euro-Asian Oil`s executives and banks that issued the back-to-back L/Cs did not know when and whether the gas oil cargoes were delivered at the port of Constantza. Furthermore, Igniska did not give to Euro-Asian Oil`s executives ETA Notices about the vessels` arrival at the port of Constantza.
The gas oil cargoes were sold on CIF Constantza terms by the commodity suppliers to Abilo and then by Abilo to Euro-Asian Oil and were discharged at Constantza Oil Terminal against the letters of indemnity provided to shipowners by the commodity suppliers who chartered the carrying vessels. Euro-Asian Oil should not have accepted Igniska`s company, Abilo as intermediary in the purchase of gas oil cargoes.
The simple rule for the credit providers in commodity trade finance is to keep control over the goods through documents of title until the borrower reimburses the loan required for the procurement of goods. In Euro-Asian Oil case, a prudent company would have purchased the gas oil cargoes directly from the suppliers on ex ship terms, DAP in INCOTERMS 2010, and then deliver the gas oil to Igniska`s company In Situ by way of stock transfer effected and confirmed by the storage company after each payment made by Igniska`s company. The ex ship deliveries do not require the presentation of Bills of Lading or seller`s letter of indemnity but only certificates of quantity and quality issued at the time of delivery at discharge port and thereby, the trick and trouble with the Abilo`s letters of indemnity would have been avoided.
Igniska drafted the Abilo/ Euro-Asian Oil sale contracts and deferred payment L/C conditions like a blank cheque. It is obvious that he had in mind to take advantage of that. The deferred payment L/Cs issued by Euro-Asian Oil`s banks provided that the shipping documents can be presented later than 21 days after the Bill of Lading date but there was no time limit for their presentation. Instead, the L/Cs provided that if the shipping documents (Bills of Lading and certificates of quantity, quality and origin) were not available not even on the payment due date, at 120 days after the Bill of Lading date, the payment was to be made against the presentation of the commercial invoice and Abilo`s letter of indemnity endorsed by a bank.
Euro-Asian Oil`s executives relied on Abilo`s letter of indemnity because it was endorsed by Credit Suisse and when Igniska`s carousel ended, they sought to recover the financial loss from Credit Suisse through a claim for breach of warranties and undertaking provided in the letter of indemnity presented by Credit Suisse for the payment of the fourth cargo.
Euro-Asian Oil contended that Credit Suisse, as an endorser of Abilo`s letter of indemnity, was jointly and severally liable for the breach of the warranties provided therein: i.e.
- that Abilo had free marketable title, clear of any encumbrance, on a cargo of 22,000 MT of gas oil sold by Abilo to Euro-Asian Oil on 1 October 2010 (the fourth cargo), that was declared in the letter of indemnity to have been shipped on board the vessel “Ariadne” on 10 September 2010 at Puerto La Cruz, in Venezuela;
- that Abilo had authority to transfer the title to the cargo and effect delivery of the cargo to Euro-Asian Oil.
In fact, the warranties provided in the letter of indemnity were false because the cargo referred to in the letter of indemnity had, by the time of the presentation of letter of indemnity for payment in early January 2011, been released to Igniska`s company Real Oil Development after the latter paid the instalments under the third purchase contract with Euro-Asian Oil.
The English Commercial Court and English Court of Appeal upheld Euro-Asian Oil`s claim against Credit Suisse who, by endorsing Abilo`s letter of indemnity, assumed the same contractual responsibilities as Abilo and became jointly and severally liable for breach of the warranties provided therein. The English Commercial Court held that Abilo and Credit Suisse`s liabilities were the same as they would have been if Abilo had sold and delivered the cargo shipped on board the vessel “Ariadne” to a third party before demanding the payment with the letter of indemnity from Crédit Agricole in January 2011 under the letter of credit3. The relevant passage from the Court decision is quoted below:
“the Fourth letter of indemnity related to the position when it was presented with the commercial invoice on 6 January 2011 to Euro-Asian`s bank, Crédit Agricole. It was on that date that the Ariadne shipment was nominated under the Fourth sale contract. The representations and warranties took effect on that date.
The warranties were breached and Euro-Asian suffered loss because Abilo did not have the right to deliver the cargo, since it had been already been delivered and paid for by Euro-Asian with the Third transaction. Euro-Asian suffered loss in that it effectively paid a second time for the Ariadne cargo.”
by Vlad Cioarec, International Trade Consultant
This article has been published in Commoditylaw`s Oil Trade Review Edition No. 2.
Endnotes:
1. For examples of bank`s endorsed letters of indemnity see the Shell`s General Terms & Conditions for Sales and Purchases of Crude Oil – 2010 Edition, Part Six, Schedule A – Seller`s Indemnity format and BP Oil International Limited General Terms & Conditions for Sales and Purchases of Crude Oil and Petroleum Products – 2015 Edition, Part Nine, Schedule A – Seller`s Indemnity format.
2. DG Petrol SRL was owned at the time by Dan Igniska through the off-shore companies Abilo Ltd. which held 90% of the shares and Real Oil Development which held 10% of the shares.
3. See Euro-Asian Oil SA v. Abilo (UK) Ltd & Ors, [2017] 1 Lloyd`s Rep 287, [2016] EWHC 3340 (Comm)