Oil & Gas: Hydrocarbon sales - risk of loss of pre-payment and without delivery of goods

In VTB Commodities Trading DAC v JSC Antipinsky Refinery [2020] EWHC 72 (Comm) the Commercial Court refused to continue an order for specific performance relating to the delivery of gasoil that had been pre-paid by the buyer. As a result, the buyer was left ranking equal with all other unsecured creditors in asserting a debt claim for return of sums paid and/or any damages awarded by an arbitral tribunal.

Background

VTB Commodities Trading DAC (“VTB”) agreed to buy quantities of gasoil from a refinery in Russia, JSC Antipinsky Refinery (“Antipinsky”). The agreement was contained in an offtake contract (the “Offtake Contract”) and a prepayment agreement (the “Prepayment Agreement”). These contracts set out that VTB would pre-pay gas, up to 120 days in advance, and in exchange, Antipinsky would deliver gasoil to VTB; if the gasoil deliveries were insufficient to amortise the pre-payments, Antipinsky would pay the difference in cash. The contracts were governed by English law and provided for arbitration under the London Court of International Arbitration (“LCIA”).

After Antipinsky failed to deliver gasoil to VTB, allegedly selling it instead to a third party (Petraco Oil Company SA), VTB commenced arbitration proceedings in London. VTB obtained, without notice, pursuant to Section 44 of the AA 1996, a worldwide freezing order (“Freezing Order”) and an order (“the Cargo Injunction”): (i) restraining Antipinsky from selling, transferring or otherwise disposing of High Sulphur Vacuum Gasoil (“VGO”) to third parties (save with third parties entered before the contractual arrangements in dispute); and (ii) requiring Antipinsky to comply with its delivery obligations under the contractual arrangements in respect of shipments of VGO. In effect, the Cargo Injunction amounted to an order for specific performance.

At an adjourned return date, the Commercial Court considered whether the Freezing Order and the Cargo Injunction should be continued.

Decision

The Cargo Injunction

VTB argued that damages were not an adequate remedy in the present case, not least because VTB had entered sub-sales in respect of VGO to be shipped from Murmansk of a specification only available, in practical terms, from Antipinsky’s refinery. Further, exclusion clauses in the Offtake Contract might have well precluded VTB from recovering losses incurred in the sub-sale contract from Antipinsky, which was in any event not likely to be good for any damages due to VTB.

In discharging the Cargo Injunction, Commercial Court decided that specific performance could be granted where:

1. Section 52 of the Sale of Goods Act 1979 (the “Act”) applies, as the goods falls within the definition of the Act and are “specific” or “ascertained”; or
2. in equity.

In relation to orders for specific performance in equity, the Commercial Court accepted the position set out in Snell’s Equity (33rd ed) at [17-009] that: “In practice, the courts are reluctant to exercise this discretion [to grant specific performance outside of s.52] unless the goods are effectively unique. However, in very exceptional circumstances in which the normal market is not functioning, the courts may be more flexible about specific remedies, even for goods that are not specific or ascertained.”

An example of a normal market not functioning is Sky Petroleum Ltd. v V.I.P. Petroleum Ltd [1974] 1 WLR 576 where, during the oil crisis of the 1970s, a seller was refusing to carry out an existing contractual obligation to supply petrol, except “at prices which… would not be serious prices from a commercial point of view”, endangering the financial viability of the buyers business.

The Commercial Court decided that the fact that Antipinsky was in financial trouble and was double-selling its production of VGO, notwithstanding that VTB had prepaid to purchase that production, did not take the matter out of the ordinary, let alone justify granting an injunction which gave priority to VTB over other purchasers of Antipinsky’s goods. The Cargo Injunction in effect ran directly counter to the position in English law that, even where the seller is dishonest in taking prepayment and has sold its entire production to a third party, the innocent purchaser does not acquire any form of equitable or other proprietary interest in that production and is not entitled to orders which would have that effect.

Further, in the present case there is no question of a more general failure in the market, which is being exploited by a large supplier, putting a purchaser out of business, as was the position in Sky Petroleum.

For the above reasons the Commercial Court refused to continue the Cargo Injunction on the basis that this is not an exceptional case where the discretion to grant such an injunction arises. But even if it was such a case, the Commercial Court would decline to exercise its discretion in circumstances where:

1. There are multiple claimants to Antipinsky’s production of VGO, both contractual claims (in the case of Petraco) and proprietary claims; and
2. it appears that Antipinsky was in deep financial difficulties and might well have creditors with equal if not better claims than VTB to the preservation and ultimate distribution of its assets.

The Commercial Court was not able to deal with the issue of whether the Act might apply as some of the VGO was “ascertained”, as there were numerous competing claims to the cargo, both proprietary and contractual.

Freezing Order

Notwithstanding allegations of material non-disclosure due to an agreement being entered into for the novation of certain rights arising from the Pre-Payment Agreement (not disclosed at the first injunction hearing), the Freezing Order was maintained.

The matters VTB failed to disclose were, at most, of peripheral relevance, relating to only part of its debt claim and to a possible future problem which was well known to Antipinsky and would not arise until after the return date. It is unlikely that disclosure of the deed of novation would have affected the granting of the Freezing Order.

Whilst such matters in no way excused the non-disclosure, they did justify the Commercial Court in exercising its discretion to continue the Freezing Order notwithstanding that failure. An additional powerful factor is that the arbitral tribunal in the underlying dispute had since the granting of the Freezing Order awarded VTB the full amount of its claim, changing VTB’s status from claimant to, in effect, judgment creditor.

Comment

For oil and gas practitioners, the most salient element of the Commercial Court’s decision is likely the refusal to maintain the Cargo Injunction. As explained above, the Cargo Injunction was, in effect, an order to perform the delivery obligations in the hydrocarbon sale and purchase contract. As such, it was an order for specific performance.

It is apparent from the decision of the Commercial Court that in the event the Act does not apply, English law will be reluctant to grant an order for specific performance in equity in relation to a hydrocarbon sale and purchase agreement. The reason being that this would amount to granting a proprietary (or equitable) remedy when the sales arrangement is not a property transaction.

Unlike the granting of interim injunctions restraining termination, in considering specific performance, the Commercial Court did not seem to place any weight on the argument that exclusion provisions that would likely limit damages available to VTB arising from on-sale agreements, in the Offtake Agreement and Pre-Payment Agreement (presumably for ‘consequential loss’), may mitigate in favour of granting interim measures (see AB v CD [2014] EWCA Civ 229). As such, unlike other circumstances, the wide scope of ‘consequential loss’ exclusion clauses in many hydrocarbon sale contracts may not assist in obtaining specific performance against a seller.

In addition, the structure of many hydrocarbons sales and purchase arrangements will mean that the remedies under the section 52 of the Act may not apply – as here. The problems include:

1. In many arrangements for the sale of hydrocarbons the goods will be neither “specific” (“… goods identified and agreed on at the time a contract of sale is made and includes an undivided share, specified as a fraction or percentage, of goods identified and agreed on as aforesaid”) or “ascertained” (“probably means identified in accordance with the agreement after the time a contract of sale is made” - Re Wait [1927] 1 Ch. 606 at 630).
2. In addition, some bunker contracts would not be sales under the Act for the reasons identified by the Supreme Court in The Res Cogitans [2016] UKSC 23.

In practical terms, this means that hydrocarbon sale contracts that require pre-payment, without security, may expose a buyer to the risk that a seller in a financially weak position may ‘double-sell’ a cargo and leave the innocent, wronged, buyer with a claim for damages that ranks equal with other unsecured creditors. As a result, if any concerns exist relating to the financial viability of the seller or any ability to enforce a debt/damages award against them, buyers should be cautious of agreeing any form of pre-payment without security for that sum. Whilst the buyer will doubtless seek to recover the cost of security in the sales price, absent security the buyer may be exposed to a total loss of pre-payment.