Key takeaways
Internal hedging not a valid defence
Court rules it doesn’t reduce damages
External hedges may affect compensation
Third-party contracts count in mitigation
Raise all arguments early in litigation
New points rarely accepted on appeal
In this case, the owner was in breach of the charterparty and faced a claim for damages from the charterer, an oil trader that had entered into sale and purchase contracts for the cargo of crude oil. The oil trader suffered losses under the sale contract due to a delay in the voyage caused by the owner’s breach.
The Commercial Court found that any reduction in the oil trader’s losses that was the result of the oil trader’s internal risk management system, a kind of internal “hedging”, should not be taken into account when assessing damages. The Court of Appeal has now declined to overturn that decision.
The Court of Appeal confirmed that a benefit from an external hedge with a third party should be taken into account as a step taken in mitigation. However, the internal arrangements in this case merely transferred the risk of loss or gain between the trader’s portfolios and did not make good its losses. Any benefit conferred on the trader by these internal arrangements was independent of and did not derive from any steps taken by the trader as a result of the owner’s breach of charter.
The decision provides reassurance for traders that, where they net off price risk exposure internally, that will not jeopardise a claim for market losses for breach of charter. It also serves as a reminder, both for trader charterers and owners, that external hedges should be taken into account when assessing a trader’s losses.
The background facts
The dispute arose out of a voyage charter between Rhine as owner and Vitol as charterer for the carriage of a cargo of crude oil from 1/2 West African ports to the Far East. The second cargo was loaded at Djeno, Congo-Brazzaville.
Vitol had contracted to purchase the Djeno cargo from TOTSA Total Oil Trading SA (TOTSA). Pursuant to that contract, Vitol was obliged to ensure that the vessel arrived at Djeno for loading within the vessel presentation range, 5 to 6 May 2020.
The charterparty
Under the charterparty, Rhine warranted that at the time of and immediately prior to fixing the charterparty, the vessel, owners, managers and disponent owners were free of any encumbrances and legal issues that might affect the vessel’s approvals or the performance of the charterparty.
The charterparty also provided for the following indemnity:
“In the event of arrest/detention or other sanction levied against the vessel through no fault of Charterer, Owners shall indemnify Charterer for any damages, penalties, costs and consequences…”
The voyage
At the first load port in Ghana, the vessel’s bunkers and stores were arrested by third parties in respect of claims against the bareboat charterer of the vessel, Al-Iraqia, a company that was connected to Rhine.
As a result, the vessel’s departure from Ghana was delayed while security was negotiated and posted. The vessel therefore only arrived at Djeno on 10 May, four days after the end of the vessel presentation range under the TOTSA contract. Loading of the cargo at Djeno was completed on 12 May, which was the date on which the bills of lading were issued.
The claim
Vitol brought a claim against Rhine in respect of this delay in loading, which resulted in Vitol paying a higher price (USD 24,562,783.57) under the TOTSA contract than it would otherwise have done (USD 20,887,949.35). The latter figure was based on a bill of lading date of 6 May 2020, which is when Vitol said loading of the cargo would have been completed had there been no arrest and no delay.
Vitol argued that, due to the arrest at Ghana, Rhine was in breach of the charterparty warranty and/or was liable to Vitol under the indemnity. Vitol therefore claimed USD 3,674,834.22 as the difference between the price that it actually paid TOTSA and the price that it would have paid had Rhine not been in breach of the charterparty.
Rhine denied the claim but also argued that even if it was in breach of the charterparty:
Vitol could not prove that, if the vessel had not been arrested, the vessel would have loaded the Djeno cargo in time for bills of lading to be issued on 6 May;
Vitol was not to entitled to recover USD 2,871,971 of the amount claimed because it had reduced any loss suffered by that amount by virtue of its internal hedging arrangements; and
Even if Vitol’s loss had not been reduced by USD 2,871,971 due to its internal hedging arrangements, it could not recover that amount where the sum could have been avoided by external hedging and was therefore too remote to be recoverable.
The Commercial Court decision
The Commercial Court concluded that the indemnity was engaged. The events in Ghana were clearly an “arrest/detention or other sanction levied against the vessel.” While the arrest was of property on board the vessel rather than the vessel itself, the indemnity did not require the vessel itself to be the primary target but only that the vessel had been arrested or detained or had some other sanction imposed on it. In any event, the vessel had been detained within the wording of the clause: the local authorities had prevented the vessel from leaving.
Rhine was also in breach of the warranty. On the evidence, Al-Iraqia were fairly described as managers of the vessel and the claims against them by the arresting third parties amounted to encumbrances or legal issues existing at the time of, or immediately prior to, the fixing of the charter that might affect the performance of the charter.
Also on the evidence, the Court concluded that the bills of lading would have borne the 6 May date.
As to “hedging”, Vitol’s internal arrangements were not legally binding contracts. They did not involve any external hedges or transactions entered into with any other legal entity and they did not affect its profit or loss. Vitol’s internal system was used to manage risk internally across its book of physical trades and to transfer risk between its portfolios. The process was not intended to mitigate or manage the specific price risk on any individual trade, such as the TOTSA contract. These arrangements were not, therefore, relevant to Vitol’s recoverable loss.
The Court went on to conclude that Vitol’s losses were not too remote to be recoverable as damages for breach of the charterparty. It was normal for an oil trader like Vitol to manage its risk internally in the way that it did, without hedging the specific transaction externally.
Rhine appealed, but only in respect of whether Vitol’s internal hedging should be taken into account in reducing Vitol’s damages.
The Court of Appeal decision
The Court of Appeal dismissed the appeal.
Rhine sought to appeal on the basis of a new argument, namely that Vitol’s internal risk management or hedging system was not lawfully or materially different from external swaps concluded with third parties and should, therefore, be taken into account in order to reduce Vitol’s recoverable losses.
In essence, Rhine sought to argue that:
Vitol’s policy was to regularly hedge risk where possible.
Within its internal risk management system, Vitol had managed the pricing risk arising from Rhine’s breach and the delayed issue of the bill of lading by matching the risk of an increase in the market price of the cargo with the risk of a decrease in the market price.
If there had been no breach and the bill of lading had been issued on 6 May, Vitol’s trading book would have shown a risk of a drop in the market price but with no matching market increase risk.
Vitol would not have retained this risk on its books without hedging it externally.
Vitol’s external hedge would have resulted in a loss to Vitol.
Rhine’s breach meant that Vitol avoided this loss on an external hedge.
This argument raised new legal, factual and expert issues. In the Commercial Court, the case had depended entirely on the scenario in which Rhine was in breach, whereas Rhine’s new argument on appeal addressed what would have happened had there been no breach.
The Court of Appeal concluded that Rhine should not be allowed to raise the new point on appeal because determination of the point would require further factual findings, not made by the Commercial Court.
As it did not need to decide the issue, the Court of Appeal left open the question of whether an avoided book hedge loss was a step taken in mitigation of loss (and relevant to quantum of damages) or a collateral benefit (and irrelevant). The Court of Appeal did, however, consider that the principles of collateral benefit would place formidable difficulties in the way of Rhine’s new argument.
Comment
The decision provides guidance to owners and trader charterers on the extent to which hedging or similar arrangements will be relevant to the quantification of damages for breach of a charterparty.
It also highlights the importance of raising all relevant arguments at trial because new points will rarely be allowed on appeal.
