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Analysis: Banks face trickier fights against shipowners to recover commodities losses

Singapore’s High Court has this year scuppered the plans of both Standard Chartered and the Overseas Chinese Banking Corporation (OCBC) to quickly recoup trade finance losses arising from the Hin Leong fraud scandal.

Both banks pursued misdelivery claims against shipowners, which have generally found such cases hard to defend because of the built-in legal protections for financial institutions.

But in deciding that both matters should go to trial, the court has suggested lenders that turn to a misdelivery claim when they are left unpaid may have to invest more time and energy into proving their case than previously thought.

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In the Standard Chartered case, a judge overturned a lower court’s decision to grant the bank summary judgement against Maersk for alleged misdelivery of US$6.1mn-worth of oil it financed for trading house Hin Leong, which collapsed in early 2020 amid fraud allegations. Among other points, the judge found that issues such as whether the bank ever intended to use bills of lading (BLs) as security and if it knew the cargo had already been delivered before it issued a letter of credit should be explored at trial.

Similarly, the same court decided that OCBC could not win a summary judgement against Scorpio Tankers, the owners of the vessel STI Orchard, for a separate alleged misdelivery involving Hin Leong. The judge found that whether the bank held the BLs in “good faith” and issues relating to the fact that Hin Leong blended the relevant cargo with another, should be explored at trial.

Along with other recent judgements in misdelivery cases in London, some of which ended badly for the banks, the developments in Singapore may spell trouble for finance providers litigating against vessel owners to recoup losses arising from the collapse of high-profile commodities traders in the city-state.

GTR speaks to Baldev Bhinder, managing director of law firm Blackstone & Gold, to find out more about the implications of the rulings.

 

GTR: Is there anything that these two judgements have in common in terms of their characteristics or lessons to be learned by banks and others?

Bhinder: These judgments share a number of features. Both involved misdelivery claims by financing banks – OCBC in the case against the owners of the STI Orchard and Standard Chartered vs Maersk who became holders of bills of lading pursuant to arrangements to finance cargo. Incidentally, the banks’ customer in both the cases was also the same: Hin Leong, whose collapse has been well documented.

In both cases, the banks tried to exercise their ‘security’ under the BLs only after discovering Hin Leong’s financial difficulties, and both lost their applications for summary judgment against shipowners for misdelivery. The two cases also have a similar overarching practical takeaway for banks: that the court would examine the precise financing arrangements between the financing bank and its customer, as well as the facts which the bank knew or should have known about the cargo in deciding whether it regarded the BLs as security.

More specifically, banks wishing to simplify their recourse against shipowners should ensure that their financing documents and conduct reflect the importance of their possession of the underlying BLs.

That can be achieved through methods such as requiring delivery of the BLs blank or endorsed to the order of the bank, using original bills of lading even in trust receipt mechanisms when practical, requiring new BLs for blended products made from an initial cargo and, if the BLs are to be provided by the debtor’s seller, securing a direct undertaking from the seller for the delivery of the BLs to the bank.

The key is not to treat the BL as a static document when trading is a dynamic process that involves the movement and blending of cargo. Likewise, financing might get extended or supplemented with other mechanisms like a trust receipt, and it is important to re-assess what is needed to maintain the BL as security.

 

GTR: Are there more attractive security alternatives for trade finance lenders than holding BLs?

Bhinder: There is little that is stronger by virtue of security for financed cargo than lawfully holding a BL in good faith – it effectively creates a pledge over the goods, allowing the holder to demand possession of the cargo, and failing that claim misdelivery against the shipowner.

What is needed is to strengthen reliance on the BLs, ensuring that the financing arrangements and parties’ conduct reflect the importance of the bank’s possession of the BL. As with any security, I think the critical question to be asked by lenders is whether they are in a position to enforce their security at any point in time.

 

GTR: Do you expect these judgements to embolden shipowners’ resolve to fight future misdelivery claims from banks, or make them less likely to agree to a settlement at an earlier stage?

Bhinder: Yes, that is a likely result. A BL holder has generally held a formidable position when it comes to misdelivery claims, hence the applications for summary judgment.

It is challenging to defend a misdelivery claim –there is a requirement for BL holders to be good faith holders. But this requirement connotes only honest conduct and not a broader concept of good faith, such as the observance of reasonable commercial standards of fair dealing in the conclusion and performance of the transaction concerned.

It is also well established that the defence of consent to delivery without the production of BLs is hard to prove against a financier – even where the bank knows that the underlying goods would be delivered against a letter of indemnity. Rather, banks are regarded as being entitled to rely on a shipowner’s contractual promise to deliver against production of BLs and expect the shipowner to have a letter of indemnity to protect itself.

The court in OCBC vs STI Orchard case found the financing arrangements and OCBC’s likely knowledge of Hin Leong blending the cargo into another product to raise a triable issue as to whether OCBC became a holder of the BLs in good faith.

The defence of consent was also not completely unarguable in the court’s view. This is because when OCBC granted a trust receipt loan to Hin Leong in respect of the on-sale, it knew or was put on notice that the cargo would be blended by Hin Leong and sold as a different product to Hin Leong’s buyer – which would require new BLs.

The shipowner therefore got unconditional leave to defend OCBC’s misdelivery claim. These findings will no doubt embolden shipowners, but the final word will come after the judgment after the trial.

 

GTR: When including three further misdelivery judgements in London this year (UniCredit vs Euronav, Fimbank vs KCH and the Miracle Hope) it’s been quite a bumper period for such cases. Why is that and does it tell us anything broader?

Bhinder: The collapse of a number of oil traders during the pandemic is the key driver. Defaults by their trader customers have left banks chasing any ‘security’ they believe they have in respect of the financing, including the BLs they end up in possession of.

As noted, the banks in the STI Orchard and SCB vs Maersk had financed Hin Leong – which, before its collapse, was one of Asia’s top oil traders. The financed party in Unicredit vs Euronav was Gulf Petrochem FZC, and in The Miracle Hope case, it was Hontop Energy – again, major traders that went under recently. The judgment in Fimbank vs KCH does not identify the underlying financed party, but it would not be surprising if it fits this broad description as well.

The Singapore High Court in the STI Orchard also alluded to this broader phenomenon when noting that the case arose out of the collapse of Hin Long, and is one of the many pending actions by a financing bank seeking to rely on the security apparently afforded to it by bills of lading in its possession. The fact that shipowners tend to be substantial companies makes them easy targets for enforcement, and has contributed to misdelivery litigation.

 

GTR: Do you expect these cases to subside somewhat as the bankruptcies of 2020 recede?

Bhinder: Such cases can indeed be expected to subside at least briefly as the insolvencies of major traders thrown up in the pandemic take their course. Trading, however, has become highly leveraged on credit and financing with multiple parties in a chain, so a liquidity event somewhere in the chain can easily topple the house of cards. Risk assessment really needs to be focussed on leverage.

In the longer term, the uptake of electronic BLs could significantly minimise misdelivery claims. These claims arise from the practical limitation of original, hardcopy BLs not being available by the time of discharge, necessitating discharge without presentation of BLs, a problem which eBLs hold the promise of effectively addressing.

 

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