Internal risk management systems subject to the scrutiny of the court when assessing damages

In the recent commercial court decision, the court was asked to consider whether internal risk management systems were the same as external hedging arrangement when considering quantum of loss. The findings are of particular relevance now, when shipments are increasingly subject to unexpected delays.

Background

The case concerned a dispute arising out of a contract between the Claimant disponent owner, Rhine and the Defendant voyage charterer, Vitol, regarding a delivery of crude oil at Djeno, Congo. The vessel was delayed in Ghana due to an arrest which resulted in her being detained for some days until security was posted.

Vitol claimed that during the delay in Ghana, there was a substantial increase in the price under the purchase contract. Vitol sought to recover the difference in price.

In the course of the proceedings, the Court was asked to consider two key quantum questions as to:

1. The role of Vitol’s internal risk management as a method of calculating loss.
2. Whether the loss was within the reasonable contemplation of the parties?

The role of Vitol’s internal risk management system

In relation to the first question, Vitol’s evidence was that under their internal risk management system when a physical sale or purchase was made, the transaction is recorded in Vitol’s system, Vista. The system would then match the purchase and sales contracts so that they were grouped together. In this case therefore, Vitol’s ‘sell position’ with Vitol Asia was matched with its ‘buy’ position under the TOTSA contract. This was referred to internally as a Vista Hedge.

When the M/T DIJILAH was delayed, the system “rolled” the dates that it would have used to price the cargo to match the later, delayed date. This resulted in a significant change of price.

Owners alleged that this had the same effect as external hedge -i.e. a hedging transaction with a third party. Owners sought to rely on Glencore Energy UK Ltd v Transworld Oil Ltd [2010] and Choil Trading SA v Sahara Energy Resources Ltd [2010] both of which suggest that hedging can be taken into account if “undertaken in a reasonable attempt to mitigate loss, both as something that has reduced the loss suffered and as something that might generate costs which are recoverable as loss.”

However, the court distinguished these cases and held that as the internal arrangements did not affect Vitol’s loss – their risk management system was not equivalent to external hedge.

Remoteness

The second question related to remoteness. Owners sought to argue that the loss Vitol sought to recover was not in the reasonable contemplation of the parties and therefore was not recoverable. However, the court found that the experts had agreed that such internal risk management systems were ‘usual’ in oil trading houses such as those the size of Vitol, as was offsetting price risks internally. As such, it was held that the loss claimed was reasonably within the contemplation of the parties at the time of contracting.

Comment

The Court held that internal risk management systems such as the one implemented by Vitol were not contracts for sale with separate entities. These internal hedging arrangements were, in effect, contracts with itself with no actual impact on profit and loss.

This case serves as a reminder that the court will examine the risk-management systems and hedging arrangements in determining the assessment of damages arising under sales contracts.

This is particularly relevant in the current climate, when shipments are subject to increasing delays as a result of supply chain disruption, geo-political influences and route changes due to extreme weather events.