SECURITY OF SUPPLY: GEOPOLITICAL INSTABILITY AND LEGAL ISSUES

AUSTRALIAN GRAINS INDUSTRY CONFERENCE

29 JULY 2014

Brian Perrott, Partner Peter Murphy, Partner T: +44 (0)20 7264 8184 T: +852 3983 7700 Brian.Perrott@hfw.com Peter.Murphy@hfw.com

2014 – A volatile start for Black Sea producers?

2014 – A volatile start for Black Sea producers?

2014 – Broader market volatility

Force Majeure ("FM")

§  A contractual provision which operates to: §  cancel the contract or to excuse performance of the contract; or §  suspend performance or allow more time for performance

if a specified event or events beyond a party's control occurs.

§  A party seeking to rely on a FM clause needs to show that: §  the FM event is covered by the clause and that the FM event has

prevented or delayed the performance of the contract;

§  delay or non-performance is due to circumstances beyond his control; §  FM event was not reasonably foreseeable at the time that the contract

was made; and §  that no reasonable means to avoid or mitigate the FM event(s) exist.

Force Majeure – General position

§  General principle is that a change of economic circumstances will not frustrate a contract even if the effect is that the contract becomes significantly more expensive for one party to perform than was anticipated at time of entry into contract.

§  Same position under majority of FM clauses.

§  There is a long line of cases in which courts have been unwilling to relieve parties from imprudent bargains.

§  Rationale - well known that freight and commodity markets fluctuate and traders take these risks.

§  To be covered, market movements etc would need to be specifically referred to as FM events.

Force Majeure – Beware general definitions

Thames Valley Power Ltd v Total Gas & Power Ltd

[2006] 1 Lloyd's Rep. 441

§  Price of the commodity being supplied (gas) rose sharply, until not economic to supply under contract. Total issued a FM notice stating that they would cease supplying gas until the price fell.

§  FM clause was very general:

"If either party is by reason of force majeure rendered unable wholly or in part to carry out any of its obligations ..."

§  Wide general drafting was not enough for the increase to be FM:

"This conclusion is consistent with a line of cases, both on force majeure clauses and on frustration, …, to the effect that the fact that a contract has become expensive to perform, even dramatically more expensive, is not a ground to relieve a party on the grounds of force majeure or frustration…”

Force Majeure – Key points

§  General words are not sufficient to protect against a "price majeure" situation!

§  Do pay attention to the wording of any clause §  e.g. a supplier prefers "hindering supply" over "preventing delivery"

§  Do include specific pricing mechanisms §  e.g. hardship clauses, fixing an exchange rate, or even an exclusion

clause

§  Intend an FM clause for 'unforeseen' events not simply price fluctuations.

§  Tactical - Commercial considerations §  Be alert to the notice provisions in the contract.

§  What do you have to do to comply, and by when? Is this feasible?

EU and US sanctions – Pre-MH17

EU and US sanctions – Russia increasingly isolated

Sanctions – Black Sea-related measures

Date Event 6 March EU Regulation 208/2014 and associated EU designations

– 18 individuals 17 March EU Regulation 269/2014 and associated EU designations

– 21 individuals 20 March US EO 13662 and US designations under EO 13661

– 20 individuals, Bank Rossiya 21 March EU Regulation 284/2014 and associated EU designations

– 12 individuals 23 June EU Regulation 692/2014

– Prohibits the importation of goods originating from the Crimea or Sevastopol (excluding contracts made before 25 June)

17 July US EO 13662 sectoral sanctions identification list – 5 individuals, Rosneft, Gazprombank

So trend is from targeting regime-connected individuals to broader economic sanctions.

Sanctions – what measures?

EU measures: asset freeze §  All funds and economic resources belonging to, owned, held or

controlled by the natural or legal persons, entities and bodies listed in the relevant annex shall be frozen.

§  The participation, knowingly and intentionally, in activities the object or effect of which is, directly or indirectly, to circumvent the measures is prohibited.

US measures: blocking §  Prohibitions include: the receipt of any contribution or provision of funds,

goods, or services from any person whose property and interests in property are blocked.

§  Restricts access of Russian companies to the U.S. equity or debt markets for new financing with a maturity beyond 90 days, raising borrowing costs and effectively cutting off medium- and long-term U.S. financing.

Sanctions – effects and compliance Risks

§  Inability to make or receive payment

§  Fines/imprisonment and reputational/commercial damage

§  Costs of investigating and dealing with regulators

Dealing with current restrictions:

§  Counterparty selection and due diligence

§  Currency and banking issues

Dealing with future restrictions:

§  Understand the scope and extent of performance obligations

§  Identify suspension and termination rights

§  Discuss with banks and insurers

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CBOT: 2014 September Wheat

2014 – Affect on pricing?

Ukrainian President flees Kiev (Time.com)

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CBOT: 2014 September Wheat

2014 – Good news?

Supply environment – global trends

Supply environment – Black Sea

Source: USDA. Data based on numbers for Russia, Ukraine and Kazakhstan www.cmegroup.com

Grain Trade Australia – Force Majeure

GTA FOB Contract No.1 Grain and Oilseeds in Bulk §  Clause 22: Strikes, Etc/Force Majeure

"[If the parties' performance is prevented] by reason of fire, strikes, lockouts, riots, differences with or between work-men, accidents to or breakdown of machinery, plant or equipment, civil commotions, policies or restrictions of governments, including restrictions of export and other licenses, or any cause comprehended in the term Force Majeure…"

GTA Trade Rules June 2014 §  Rule 21.0 Force Majeure

"Neither the Buyer nor the Seller shall be responsible for delay in Delivery or Shipment of goods […] occasioned by any act of God, fire, flood, wind, explosion, power failure, war, embargo, act of government, strike, […] lock-out, combination of workers, or civil commotion which is not due to said party's own acts or negligence, which constitute Force Majeure."

GTA – Force Majeure - Consequences

GTA FOB Contract No.1 Grain and Oilseeds in Bulk Clause 22: Strikes, Etc/Force Majeure §  Performance of the Seller's obligations suspended for duration of FM event.

§  Sellers must use best endeavours to minimise/remove effects of FM event.

§  If the FM situation continues for 30 days = Buyers have the right to extend the shipment period by a further 30 days.

§  If the FM situation continues after the expiry of the further 30 days = contract automatically terminated.

GTA Trade Rules Rule 21.3: Extension of Contract due to Force Majeure §  Unless otherwise agreed, a party invoking FM is entitled to a contract extension

of not more than 30 days from the end of the delivery period.

§  If after 30 days delivery is still prevented, option on other party of cancelling the contract or agreeing a further extension of not more than 30 days.

§  If at the conclusion of the second extension period delivery is still prevented, the contract or any unfulfilled part shall be considered in Default per Rule 17

Grain Trade Australia – Prohibition Clause

GTA FOB Contract No.1 Grain and Oilseeds in Bulk Clause 23: Prohibition

§  Applies to situations where there is an executive or legislative prohibition on export, or a blockade or hostilities restricting export.

§  Event will be deemed by both parties to prevent fulfillment of the contract.

§  To the extent of the restriction (total or partial) on fulfillment – the unfulfilled element of the contract will be extended 30 days beyond the end of the prohibition event.

§  If the prohibition event continues for more than 30 days after the expiry of the delivery period the contract, and any unfulfilled part, will be cancelled.

GAFTA – 'Old regime' similar to current GTA

Prior to 1 June 2014: GAFTA Prohibition Clause

§  Applied in cases where act of government of the country of origin or shipment restricting export, whether partially or otherwise.

§  Restriction was deemed to prevent fulfilment of the contract and allowed the contract or any unfulfilled portion to be cancelled.

§  c.f. GTA FOB – if continues >30 days after end of delivery period, cancelled.

GAFTA Force Majeure clause: §  Sellers not to be responsible for delay in shipment of the goods occasioned

by Act of God, strike, lockout, riot or civil commotion [etc.] or any cause comprehended in the term "force majeure".

§  If shipment delayed by more than 30 consecutive days, Buyers gained option to cancel; else after 60 days contract considered void.

§  c.f. GTA FOB – no option to cancel but if FM event continues for 60 days, contract terminated.

GAFTA – 'Old regime' in context

§  In summer 2010, Russia and Ukraine suffered severe droughts. §  Russia imposed grain export ban in August 2010.

§  Ukraine issued grain export quotas in October 2010 (lifted in June 2011 but replaced by high export duties).

§  GAFTA Prohibition Clause simpler than Force Majeure clause: §  No extensions of time leading to prolonged uncertainty. If clause applied,

contract automatically cancelled. §  Contract was cancelled and not terminated – meaning no damages payable

for non-performance.

§  Under the 'old regime', the Russian grain export ban lead to more contract cancellations under Prohibition Clause than FM Declarations.

§  New GAFTA regime!

New GAFTA regime - "Prevention of Shipment" clause

"Event of Force Majeure" means

(a) prohibition of export or other executive or legislative act done by or on behalf of the government of the country of origin or of the territory where the port or ports named herein is/are situate, restricting export, whether partially or otherwise, or

(b) blockade, or

(c) acts of terrorism, or

(d) hostilities, or

(e) strike, lockout or combination or workmen, or

(f) riot or civil commotion, or

(g) breakdown of machinery, or

(h) fire, or

(i) ice, or

(j) Act of god, or

(k) unforeseeable and unavoidable impediments to transportation or navigation, or

(l) any other event comprehended in the term "force majeure"."

New GAFTA regime - "Prevention of Shipment"

§  A new unified concept of 'Force Majeure' applying to all FOB, C&F and CIF GAFTA contracts entered into after 1 June 2014.

§  Contract will be suspended if a force majeure event ("FM Event") prevents the sellers from performing and adequate notice is served on the buyers.

§  GAFTA new clause expressly lists events such as prohibition on exports, fire, machinery breakdown and acts of terrorism.

§  Notice of the FM Event must be given:

§  within seven consecutive days of the occurrence; or §  not later than 21 consecutive days before commencement of the

shipment period, whichever is later.

New GAFTA regime - "Prevention of Shipment"

§  Prohibition on export will no longer result in the contract being automatically terminated.

§  Instead the contract will be suspended for the duration of the FM Event, initially up to 21 days from the end of the shipment period.

§  After this 21 day period, the contract will only be terminated either by: §  (1) notice of cancellation from the buyers; or §  (2) following a further 14 consecutive days of force majeure.

"Prevention of Shipment" – Key points

§  The new GAFTA clause expressly states that it is the seller who must prove that an FM Event has occurred and that seller's performance was prevented by the FM Event.

§  Sellers should note that when an FM Event has ceased before the contract could be cancelled, they are obliged to notify buyers without delay.

§  Sellers then get (a minimum of) 14 days to make shipment. §  If the FM event continues 21 days past the end of the shipment

period, failing buyer's notice of cancellation, the contract will automatically continue for 14 consecutive days (previously 30 days).

GAFTA – 'hot off the press' cases

Nidera B.V. v Venus International Free Zone for Trading & Ors

[2014] EWHC 2013 (Comm)

§  Background – interpretation of clauses 6 & 8 of 'GAFTA 49': §  Sellers cancelled the contract relying on a prohibition of export clause. §  Buyers argued that they had validly extended the contract delivery

period: sellers' cancellation was premature and sellers were in repudiatory breach of contract, entitling buyers to damages.

§  GAFTA arbitration decided in favour of buyers and sellers appealed to the English High Court.

§  Decision: Buyers construction of clause 8 prevailed. §  Court held that "where a timely notice is served, there is an unqualified

right of extension under clause 8".

§  HFW acted for Buyers.

GAFTA – 'hot off the press' cases

Bunge S.A. v Nidera S.A. [2013] EWHC Civ 1628

§  Case concerns interpretation of GAFTA Prohibition clause.

§  On appeal from GAFTA arbitration, the English Court of Appeal held: §  that the prohibition clause required a causal link between the event in

question and the seller's inability to perform the contract; and

§  the contractual GAFTA default clause applied as the parties' agreement on the applicable measure of damages.

§  N.B. the Supreme Court has granted permission to appeal in respect of the default clause issue.

Counter-party insolvency risk?

Situation GTA GAFTA

SELLER INSOLVENT ü ü BUYER INSOLVENT ü ü SHIPOWNER INSOLVENT û û

SHIPOWNER LOSES VESSEL û û

Counter-party insolvency risk?

Defend against counterparty insolvency risk

HEAD CHARTERERS (DISPONENT OWNER)

OWNERS

SUB CHARTERERS

SUB-SUB CHARTERERS

LENDER FINANCING

C/P

C/P

C/P

REPOSSESSION RISK

How to protect your position?

Limiting liability in a sub-charterparty

§  "Disponent Owner's liability in respect of any proved damages for non-performance of this charterparty is limited to the amount of freight paid or payable pursuant to the terms of this charterparty. This clause shall not be incorporated into any bill of lading contract."

§  Historically concerned clause might be penal and hence unenforceable under English law.

§  Modern analysis is that the penalty doctrine should not prevent charterers limiting their liability under a sub-charter by reference to the amount of freight payable.

§  Hence clause is drafted in the least controversial way possible, limiting only "proved damages for non-performance".

How to protect your position?

Defend against counterparty insolvency risk

§  "Automatic termination" mechanism:

"If at any time a Bankruptcy Event occurs in relation to either of them (the “Defaulting Party”), the other party (the “Non-Defaulting Party”) may by not more than 20 days’ notice to the Defaulting Party designate a close-out date in respect of all Transactions then outstanding between them on which the process set out in paragraph (b) shall occur [...].

(b) As of the close-out date

(i) all performance obligations of the parties under outstanding Transactions shall terminate

(ii) the Non- Defaulting Party shall promptly calculate its Loss in respect of each Transaction

(iii) the Losses so calculated shall be aggregated and netted to the greatest extent possible [...] and

(iv) the net resulting amount, if positive, shall be paid by the Defaulting Party to the Non-Defaulting Party within 3 days of the close-out date.

How to protect your position?

Defend against counterparty insolvency risk

"(c) A close-out date [...] shall occur automatically as of the time immediately before the start of a Bankruptcy Event [...]."

§  Aim is to effect a quick and clean break from an insolvent counterparty.

§  The clause on certain events applies automatically, rather than providing an option to terminate.

§  A Bankruptcy Event under 1992 ISDA Master Agreement does not expressly include the repossession of a vessel, but we expect that such an event would come within the clause and trigger the termination.

§  Drafted by HFW and tested by the Court, saving one client in excess of US$200m.

Insurance cover – trade credit risk

§  What is it? Protection against §  Non-payment due to commercial risks (insolvency of customer) §  Late payment (protracted default) of trade debts

§  Political risks – associated with exporting

§  Protecting balance sheet from impact of loss

§  Covers trade in goods and services - does not cover individuals

Insurance cover – trade credit risk

§  Pre Qualifying requirements §  Credit limits §  Retention of title §  Exclusion of selling to buyers in certain territories

§  Notification obligations §  Where a circumstance or event may occur suggesting likelihood of loss §  Where payments are overdue by 60/90 days

§  Obligation to prevent or minimise losses §  Take all reasonable steps §  Contribution to costs §  Settlement agreements with buyers –

§  Re-issuing invoices §  Full and final settlements (preserve subrogation rights)

Insurance cover – political risk

§  Two main types of policy §  Asset cover §  Trade-related cover

§  Asset cover may include: §  Confiscation – deprivation, nationalisation, creeping expropriation, forced

abandonment and forced divestiture

§  Political violence – war on land and terrorism

§  Inability to convert or transfer currency §  Aircraft repossession

§  Trade-related cover may include: §  Events before shipment §  Events after shipment

§  Unfair calling of own demand contract bonds

Conclusions:

§  Trends in the Black Sea market: §  Increased volatility with contract periods down from 18 months to 6 months. §  Relatively limited effect on production levels and supply (but will it last?).

§  Impact of Ukrainian shipping restrictions limited to local trade flows. §  Situation may escalate.

§  Areas to watch : §  Default, Force Majeure and counter-party risk §  Impact of the new GAFTA provisions

§  Sanctions and any extended regime imposed by EU / USA §  Revisit insurance cover i.e. political risk – credit risk insurance

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