Commodities: when the contract price is much higher than the market price

The often dramatic falls in the prices of commodities in recent years has been well publicised and commented upon by market analysts.  The prices of oil, coal, petcoke and iron ore for instance, have fallen very significantly, well beyond what most traders expect as everyday market tolerances.  Where parties have entered into longer term supply contracts, this market situation can result in buyers being committed to pay prices that, at the time of delivery, are very much higher than prevailing market values.  Where the buyer is an end user – a plant or factory burning coal, for example – it is unlikely that it will have hedged its position, or have on-sale agreements at similarly high prices.  In these circumstance the pressure on end user buyers, or buyers without an adequate hedge, to avoid having to take delivery of and pay for the now ‘over-priced’ commodity can be irresistible, causing some buyers to look for any opportunity to reject a cargo, or cancel a contract.

In contrast, a seller in this situation does not want to be left with an unfulfilled shipment, which he has to then try and sell on the spot market at a considerable loss – all the more so if he purchased or locked-in the tonnage some time ago at a much higher price himself.  Furthermore, in CIF or CFR sales, a seller might also become exposed to the carrier if a buyer at the last minute refuses to take delivery of a shipment that is priced well in excess of the prevailing market.

We are seeing an increasing trend of disputes between sellers and buyers which are driven almost entirely by the fall in commodity prices.  Many buyers approach this situation by attempting to renegotiate the price at the time of delivery.  Often sellers will accommodate that if they can still achieve a reasonable profit at a reduced sale price, but that is not always possible if the discount requested is excessive, or the seller himself paid a high price for the tonnage and has little ‘wriggle room’ on his profit margin.  Understandably, some trader will just want the full price that has been agreed.  In some cases, buyers will scrutinize the terms of the contract looking for any ‘excuse’ to reject a cargo or cancel a contract – with or without real justification.  In extreme cases, we are seeing buyers, based in jurisdictions where it is notoriously hard to pursue a defaulter, just renege on their obligations to take delivery, calculating that, in practice, there is little that a seller will be able to do about it.

Buyers (and their lawyers) trying to escape their obligations in this way will often focus of the following areas of the relevant contract as a basis not to pay:

Is there a binding contract?

This might seem like a straightforward question, but in this context it can result in difficulties for a seller if, for example, there is no signed contract in existence.  Many trading partners regularly do business on unsigned agreements.  One party might draw up a written contract, sign it and send it to the other party to sign, which that party fails to do.  If a dispute arises over the agreed price, or the buyer refuses to take delivery of an agreed shipment, the seller will be left having to prove the contract terms on which he relies.  The absence of an unequivocal contract with the buyer can threaten that, leaving the seller having to argue that there is a course of dealing between the parties, or that the buyer partially acted in a manner which is consistent with the contract document even though it was not signed – which is a less certain position for the seller.  If parties choose to do business based upon a written contract, then it is advisable for sellers to ensure that such contracts are actually signed by their buyers.

Vessel nominations

In many CIF and CFR contracts, the seller is required to nominate to the buyer the vessel on which the cargo will be shipped, along with a variety of other information, within a specified timeframe.  This obligation will generally be regarded as a ‘condition’ of the contract, breach of which will enable the buyer to repudiate the contract and avoid having to take delivery of, and pay for, the cargo.  Sellers should therefore ensure that they have complied precisely with vessel nomination requirements as even a slight slippage beyond the agreed timeframe could enable a buyer to effectively cancel the contract and not have to pay for the cargo.

Payment by Letter of Credit

Where payment is by tender of documents under a letter of credit, a failure by the seller to either tender the documents within any agreed timeframe, or more commonly, where the tendered documents do not comply strictly with the requirements of the LC, will generally be a breach of a contractual condition enabling the buyer to reject the cargo, and thereby avoid having to pay for it. 

In fact, slightly discrepant documents are regularly tendered for payment under LCs throughout international trade.  Where the cargo has arrived and is in order, usually those discrepancies will be waived by a buyer who nevertheless wants the cargo.  However, even a seemingly minor discrepancy in a tendered document can become a real problem for a seller if the buyer is actively looking for a justification not to have to take delivery of a cargo - which at that point is priced well above its prevailing market value.  Under English law, this so called ‘Doctrine of Strict Compliance’ is particularly difficult to overcome if the physical cargo has been rejected and the seller is out of time to represent compliant documents.

Force Majeure clauses

Most international trade contracts will contain a force majeure clause that will excuse a party’s non-performance in specified circumstances.  Some clauses go so far as to excuse non-performance for ‘any reason beyond the control’ of a party.  It is worth remembering that under English law there is no common law concept of ‘force majeure’.  This is just a familiar label given to a particular sort of exclusion clause.  As such, as with any exclusion clause, the party relying on the exclusion must clearly fall within its terms.  It is most unlikely that a force majeure clause will expressly excuse non-performance due to changes in the market price of the commodity; no sensible trader of businessman would ever agree to such a clause.  Under English law, a general exclusion of performance in circumstances beyond a party’s control, would not cover market price volatility, so that despite force majeure clauses often being the natural place a buyer will look when trying to escape an obligation to purchase an over-priced cargo, this is usually one area that a seller need not be worried about.

Final comment

Whether you are a seller trying to enforce an obligation upon a buyer to take delivery of a cargo at a previously agreed price well in excess of the prevailing market price, or a disgruntled buyer who does not want to have to pay much above market, despite what was previously agreed, there are certain areas of the sales contract that have the potential to decide who gains and who loses in these circumstances – sometimes with unexpected results.

Andrew Iyer   IY LEGAL

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