Oil & Gas – You reject if you want to, the Product is not for rejection!

International

The Commercial Court has decided that a Buyer under the BP General Terms and Conditions for Sales and Purchases of Crude Oil and Petroleum Products 2015 Edition was not entitled to reject off-spec Product and, in so rejecting, was itself in breach of contract.  The Buyer’s remedy was limited to a right (in principle) to damages for the diminution in value of the Product. Galtrade Ltd v BP Oil International Ltd [2021] EWHC 1796 (Comm) is a significant case for oil traders.

Facts

By a contract for sale dated 10 October 2018 (the “Contract”), BP Oil International Ltd (“BPOI”) agreed to sell four Parcels of SRFO (the “Product”) to Galtrade Ltd (“Galtrade”). SRFO is “the residual fuel oil which emerges from the primary refining of crude oil”.  Its quality and value can be affected by, amongst other things, the concentration of pollutants found in it, in particular vanadium and sulphur, which is undesirable because refineries have to incur additional cost to remove these elements during the refining process.

Galtrade raised concerns that the SRFO specifications of the third Parcel might not be as specified in the Contract.  The test results would not be available until after the vessel had loaded and sailed. 

The test results revealed that the sulphur content was 1.53% rather than the agreed maximum of 1.30%.  Subsequently, Parcel 3 did not comply with the contractual specifications. Galtrade rejected and refused to pay for Parcel 3. When the cargo arrived in Malta, BPOI agreed to take possession of Parcel 3 via ship to ship transfer, blended it with other parcels and sold it to the US instead.

The parties agreed that the Product in Parcel 3 did not comply with the specifications in the Contract. Galtrade claimed damages of over USD 1 million in wasted expenditure.

BPOI admitted a breach of contract.  However, BPOI contended that Galtrade had no right to reject the Product and that Galtrade was itself in breach by refusing to pay for Parcel 3.

Decision

The decision of the Commercial Court covers a number of areas of law but for present purposes the key issue was whether Galtrade was entitled to reject Parcel 3.  If it was not, Galtrade would itself be in breach for wrongful rejection.

Galtrade’s right to reject Parcel 3 was dependent on whether BPOI’s obligation to provide Product of a certain quality was a “condition” or an “intermediate term” under English law.  The significance of this distinction is that if the quality requirement was a condition, Galtrade would have had a right to terminate (or, in this case, reject the Product) for breach.  With an intermediate term, the ability of Galtrade to terminate (or reject) for breach was a matter of interpretation of the contract and a matter of assessing the effect of the breach at the time it took place.

Were the Quality Requirements Conditions of the Contract?

The quality clause, from BP’s General Terms, read:

59.1 Quality

59.1.1 Unless otherwise stated in the Special Provisions, the quality of Product delivered hereunder shall not be inferior to the specification (if any) set out in the Special Provisions. Whether set out in these General Terms and Conditions or in the Special Provisions neither typicals nor any stipulation as to time of delivery shall form part of the Product's description, quality or fitness for purpose. This sub-section constitutes the whole of the Seller's obligations with respect to the description, quality and fitness for purpose of the Product and all statutory or other conditions or warranties, express or implied, with respect to the description or satisfactory quality of the Product or its fitness for any particular purpose or otherwise are hereby excluded” (our emphasis).

Galtrade argued, amongst other things:

  1. That the quality requirements of the Contract were conditions.  Any deviation from the guaranteed levels of quality (whether maximum or minimum) would entitle Galtrade to reject the cargo in its entirety.

  2. A provision in the Contract to deliver Product meeting the agreed specification would, under the Sale of Goods Act, have been considered, in its entirety, a “term of description” rather than quality, and therefore would – but for Clause 59.1.1 – have been a statutory condition.   If the intention had been to change the usual regime for a sale by description so fundamentally, Clause 59.1.1 would need to say so (and it did not).

The Commercial Court rejected these arguments for a number of reasons, including:

  1. The relevant obligations were not described in the Contract as conditions, nor did they specify an automatic right to reject.

  2. The quality parameters in the Contract were, on the expert evidence, “pretty normal…for that type of product”, which pointed to the provisions being standard quality specifications of the Product, not part of a sale by description. 

  3. The specifications did not mark some clear watershed between the acceptable and the unacceptable. On the contrary, on the evidence Parcel 3 remained “usable as a blend stock” and still marketable (albeit less so).

  4. A consideration of the commercial effect of classifying the specifications as conditions would be that it would “place significant risk on the seller and accord corresponding commercial power to the buyer”. The commercial imbalance between the parties would be great and the consequences were sufficiently striking for the absence of an express provision entitling rejection to be of significance. 

As a result, the relevant obligations were held not to be conditions; they were intermediate terms.  The question then became whether the breach was sufficiently serious to generate a right to reject.

Was BPOI’s Breach “Sufficiently Serious”?

It was significant that both of Galtrade’s expert witnesses agreed that Parcel 3 remained marketable at an appropriate price, notwithstanding its off-specification form.  This strongly undermined the case that Galtrade was deprived of either substantially the whole benefit or a substantial part of the benefit of the Contract.

Galtrade also had alternative remedies available to it in cases where there were deviations from the contractual specifications.  It was held that if differences in specification affected the price rather than whether the Product can be used at all for all or any of its intended purposes, then that was where the remedy ought in principle to lie. 

As a result, it was held that BPOI’s contractual breach was not of sufficient seriousness to justify the rejection.  It did not “go to the root of the contract”.

Result

The quality requirements were intermediate terms, the breach of which were insufficiently serious to entitle Galtrade to reject the Product.  As a result, Galtrade’s claim for wasted expenditure was rejected. Its losses did not directly result from BPOI’s breach of the Contract, rather, it resulted from Galtrade’s own “unreasonable conduct” in “wrongfully” rejecting and not paying for Parcel 3. 

That conduct on the part of Galtrade was itself a breach of Contract.

Comment

The Buyer’s Conundrum

The case highlights the conundrum facing a buyer of product when faced with a quality issue, particularly so on the widely used BP General Terms. 

As the quality requirements of the BP General Terms were not, in this case, viewed as conditions, a total rejection of a cargo or a batch could expose a buyer to a claim for wrongful rejection.  Before rejecting product, a buyer should consider whether other contractual remedies, such as damages or a price adjustment mechanism (if available), would be a sufficient remedy.

Whether a right to reject accrues would be a question of contractual interpretation and an assessment of the effects of the breach.

On the facts of this case, Galtrade sought to reject a batch of SRFO with a sulphur content of 1.53%, which was above the requirement of 1.3%.  On the expert evidence, the Commercial Court rejected the assertion that the higher sulphur content made the Product “substantively different” (indeed 1.53% and 1.3% would both have been viewed as “intermediate sulphur” content).    

The case may have been decided differently had the Product delivered been substantively different to that required by the Contract.  On the specific issue of sulphur content, on the evidence that might have been the case if the sulphur content was in excess of 3.5%.

Desirability of Flexibility in the Product Sales Market

BPOI had submitted that Galtrade’s case was “commercially absurd and would have a chilling effect on the commodities market if it were correct.”

The Commercial Court did not endorse, nor reject, that particular submission but it did accept that the effect of Galtrade’s case, as regards the balance of commercial risk between the parties, was “simply too severe and wide-ranging for it to be left unsaid” in the Contract.

The judgment reflects English law’s hostility to classifying provisions in a contract as conditions, unless the provision is clearly to that effect.  The guidance of the existing case law leant in favour of intermediate terms rather than conditions, and especially so in the area of quality deficiencies.

In line with previous product sale cases, the judgment demonstrates that it is legitimate to have regard to the nature of the business which the parties were conducting and were known to be conducting.  It was significant that the very business in which the parties engaged might involve the upgrading or downgrading of parcels within larger blends. This made it less likely that, within such a market, the expectation would be that a single breach of a specification parameter would automatically make the cargo vulnerable to rejection. 

The Commercial Court was cognisant of the fact that in the market in which the parties operated, deviations from specification were viewed as having remediable economic consequences.

Indeed, the judgment emphasises the desirability of protecting the important attributes in the market of “flexibility and agility”, when it comes to making the most out of cargoes which are off specification (and indeed higher than specification).

Link to the case: Galtrade Ltd v BP Oil International Ltd [2021] EWHC 1796 (Comm) (5 July 2021) (bailii.org)