Hedging costs recoverable as damages in commodities transactions

It is a common practice for traders dealing in physical commodities trades to hedge their position in the paper market. This has been recognized as a form of risk management to avoid the risk of either price or currency fluctuations, depending on what is being hedged.

The Singapore High Court had to deal with a case recently where the facts would have been quite unremarkable to most traders for the reason that this is something that happens quite so often. And very often, traders would have to decide on their best course of action once their counterparty repudiates the contract.

The High Court in Apex Energy International Pte Ltd v Wanxiang Resources (Singapore) Pte Ltd [2020] SGHC 138 provides a helpful guide as to the calculation of damages that are recoverable by the seller when the buyer breaches the contract of sale.

Facts of the case

Apex Energy was the seller of a cargo of Light Cycle Oil (“LCO”) and Wanxiang was the buyer. Apex Energy bought the cargo from S-Oil. The intent was for Apex Energy to sell the cargo to Wanxiang at a margin of US$0.10 per barrel. Wanxiang in turn was going to sell it to its buyer down the line.

The contract price between Apex Energy and Wanxiang was based on the monthly average of the MOPS GO for December 2017 plus a premium of US$11.90 FOB.

After the deal recap between Apex Energy and Wanxiang was sent, Wanxiang’s buyer backed out of the deal. On 29 November 2017, Wanxiang took the position that there was no legally binding contract between Apex Energy and Wanxiang.

After Wanxiang denied that there was a legally binding contract, Apex Energy reached an agreement for the sale of the cargo to Shanghai Rui Run on 1 December 2017. Shanghai Rui Run nominated Ningbo Youngor International as the contracting party for this contract with Apex Energy.

On 6 December 2017, a formal contract was entered into between Apex Energy and Ningbo Youngor International. The sale price in the contract with Ningbo Youngor International was the monthly average of MOPS GO for January 2018 plus a premium of US$9 FOB.

As the contract with Ningbo Youngor International was pegged to the MOPS GO January 2019 average, it meant that Apex Energy was now exposed to potential adverse price movements between December 2018 and January 2019, bearing in mind its contract with S-Oil was pegged to the December 2018 average. Therefore, Apex Energy entered into a hedging arrangement with ICE to hedge any potential downside in price movements.

While the hedging arrangement meant that it would completely remove Apex Energy to any exposure to any price movements, it also meant that it guaranteed a loss of US$0.40 per barrel of the gasoil hedged.

Wanxiang’s argument was that Apex Energy acted unreasonably by entering into the hedging arrangement. As matters turned out, there was a rise in the index prices between December 2018 and January 2019. If Apex Energy did not enter into the hedging arrangement, the sale to Ningbo Youngor International would have resulted in Apex Energy making a handsome profit of US$711,180 compared with the original contract price between Apex Energy and Wanxiang.

Apex Energy claimed against Wanxiang for the following heads of losses;

(a) The difference in the premium between the contract with Wanxiang (US$11.90) and that in the contract with Ningbo Youngor International (US$9).

(b) The freight cost in performing the sale to Ningbo Youngor International.

(d) Cost of the hedging arrangement.

(e) Commission paid for the hedging arrangement.

The Court’s Decision

The Court held that the starting point for assessment of damages is that the innocent party should be put in as good a position as if the contract had been performed. And in a case where the Sale of Goods Act applies, the first issue to be determined is whether or not there was an available market. If there was an available market, then Section 50(3) of the Sale of Goods Act would apply in ascertaining damages.

The Singapore High Court cited the decision of the UK Supreme Court in Bunge SA v. Nidera BV [2015] UKSC 43;

“… [W]here there is an available market for the goods, the market price is determined as at the contractual date of delivery, unless the buyer should have mitigated by going into the market and entering into a substitute contract at some earlier stage: Garnac Grain Co Inc v HMF Faure & Fairclough Ltd [1968] AC 1130, 1168 and Tai Hing Cotton Mill Ltd v Kamsing Knitting Factory [1979] AC 91, 102. Normally, however, the injured party will be required to mitigate his loss by going into the market for a substitute contract as soon as is reasonable after the original contract was terminated. Damages will then be assessed by reference to the price which he obtained. If he chooses not to do so, damages will generally be assessed by reference to the market price at the time when he should have done: Koch Marine Inc v d’Amica Societa di Navigazione (The Elena d’Amico) [1980] 1 Lloyd’s 75, 87, 89. The result is that in practice where there is a renunciation and an available market, the relevant market price for the purposes of assessing damages will generally be determined not by the prima facie measure but by the principles of mitigation.”

On the facts of this case, the question therefore is whether Apex Energy acted reasonably in mitigating its losses when it sold the cargo to Ningbo Youngor International at the price that it did, and whether Apex Energy acted reasonably in entering into the hedging arrangement.

The Court held that the reasonableness of mitigation is assessed objectively, taking into account subjective circumstances such as the aggrieved party’s financial position.

“… Ultimately, the reasonableness inquiry reflects commercial and fact-sensitive fairness at the remedial stage of a legal inquiry into the extent of liability on the defaulting party’s part, and bars an aggrieved party from profiting or behaving unreasonably at the expense of the defaulting party…”

With regards to the selling price in the contract with Ningbo Youngor International, the Court held that there was no obligation to make any effort to obtain the best price available. The view of the Court was that there were many factors which influenced the price, including the balance of bargaining powers between the parties. The Court recognized that it was not unreasonable for potential buyers to drive a hard bargain from a seller in Apex Energy’s position.

As for the decision by Apex Energy to hedge its position, Wanxiang appeared to have led evidence to show that there was a rising trend in the prices based on historical data. Based on the historical data, Wanxiang appeared to have argued that in view of the upward trend in the prices, the decision to hedge was unreasonable.

The Court rejected that argument. Apex Energy did nothing more than to act out of an abundance of caution. The very purpose of hedging was to avoid any speculative risk in price movements, and therefore, there was nothing unreasonable about it.

The Court proceeded to award Apex Energy damages based on the five heads of claim as described above.

Our Comments

Disputes of the nature as set out in this case happens all too frequently in the real world. It is however rather uncommon for a claim of this nature to be fought all the way to trial. This judgment is therefore a useful guide for traders and legal practitioners who have to deal with such problems on a regular basis.

It is also reassuring to know that the courts take a commercial approach to commercial problems and sees the commercial realities on the ground. In particular, the court recognises that hedging of risks is a commonplace commercial practice and should form part of the heads of damages recoverable by the party not in breach.

In addition, in every case where the buyer fails to take delivery and the seller sells the cargo to some other third party at a loss, a common refrain from the buyer in default would be that the seller should have sold the cargo at a higher price.

The Court in this case also expressly recognised that it is impracticable to expect the seller to sell at the highest price possible, and recognising at the same time, that for a trader in the same position as Apex Energy, sometimes the most reasonable and logical thing to do, is to sell the cargo at a lower price to avoid other complications.

Traders should take heart that so long as they are acting reasonably in mitigation of their losses, the costs incurred would likely be recoverable.