In Rhine Shipping DMCC v. Vitol SA,[1] the Commercial Court of England and Wales determined that the claimant’s internal risk management system, by which the risk of loss arising from physical trades was ‘hedged’ against opposite risks arising from other trades, could not be taken into account when assessing damages.
Background
The case concerned a charter (contract) between Rhine Shipping DMCC, the owner of an oil tanker, and Vitol SA, the charterer. Rhine claimed for unpaid demurrage (charges for delay in loading or unloading), which Vitol did not contest. The trial was therefore only concerned with Vitol’s counterclaim for Rhine’s late delivery of the tanker. Vitol claimed that the delay in delivery caused it to pay $3,674,834 more for its crude oil cargo, purchased from TOTSA Total Oil Trading SA, for which Rhine was liable under an indemnity.
Vitol’s internal risk management system, Vista, managed (or ‘hedged’) the risk of price fluctuation in respect of its transactions as a portfolio. The arrangements were designed to pool risk across a significant number of transactions internally, thereby allowing Vitol to assess and manage its net exposure instead of having to hedge each transaction. Given the size and diversity of Vitol’s book of business, it was not unusual for it to be able to entirely offset the risk arising from transactions through this process. In the event that that was not possible and surplus risk remained, Vitol would then determine whether to hedge that risk externally or to take a risk of an adverse price movement.
In this case, Vitol had hedged the potential risk arising from the TOTSA contract internally. When it became apparent that Rhine was going to deliver the tanker late, Vitol ‘rolled’ those hedges to later dates to keep the hedges in line with events. This process of rolling the hedges generated a ‘gain’ in the Vista system of approximately $2,871,971 in relation to the TOTSA contract. As the hedging in respect of this contract was entirely internal, so that any losses arising would be set off against corresponding internal gains, so too was this gain set off against corresponding losses.
Rhine argued that the $2,871,971 ‘gain’ made should be offset against the increase in the crude oil price paid by Vitol as a result of the delay.
Commercial Court’s judgment
Having determined that Rhine had breached the charter and that the indemnity was engaged, the court considered first whether the ‘gains’ made on the rolling of the swaps in Vitol’s risk management system should be brought into the calculation of the loss Vitol suffered and, second, whether the loss claimed by Vitol was too remote.
Should ‘gain’ made on rolling of swaps be taken into account?
The court determined that the authorities[2] suggest that hedging is capable of being taken into account when determining loss but noted that hedging can take various forms – and it is important to identify the nature of the particular transaction in question in each case.
The court was clear that where a party has entered into a hedging transaction with a third party and has done so in consequence of a breach of contract in order to mitigate its loss, any benefit received as a result would be taken into account in the assessment of damages.
The court was less clear regarding the position where a party has entered into a hedging transaction with a third party before a breach. The legal issue is whether any benefit arising from the transaction is sufficiently connected with the circumstances giving rise to the loss as to be taken into account, or whether the benefit should be deemed to be a collateral payment,[3] which the law treats as not making good the claimant’s loss. This question was not relevant to this case and was left unanswered.
In this case, while Vitol undertook the process of ‘rolling’ the hedges in consequence of Rhine’s breach, that process did not involve external transactions with third parties. Does this make a difference?
First, the court noted that a corporate entity, including different branches of the same corporate entity, cannot make a contract with itself. Second, to the extent that the risk was offset within Vista, that did not involve Vitol entering into a transaction for the purpose of either hedging risks or mitigating loss but was simply a matter of the Vista system identifying separate transactions entered into in the normal course of trading that happened to offset each other to manage the company’s overall risk.
Accordingly, the internal ‘transactions’:
- Were not enforceable contracts.
- Could not impact Vitol’s profit or loss.
The court decided that this meant that any apparent gain arising from the rolling of the swaps should not, therefore, be taken into account when determining Vitol’s loss.
Was Vitol’s loss too remote?
Rhine also argued that the loss claimed by Vitol was too remote to be recoverable: As it was reasonable for Rhine to believe that Vitol would have a process of external hedging, which would have reduced Vitol’s loss by the same amount as its internal hedging process, any loss not so hedged was outside the contemplation of the parties and was, therefore, not in the reasonable contemplation of the parties and/or of a type for which Rhine had not assumed responsibility.
The court dismissed these arguments, relying on the expert evidence that Vitol’s risk management system of internal hedging was entirely usual in the industry. Accordingly:
- The fact that Vitol may operate an internal hedging system should have been in the reasonable contemplation of the parties.
- There was nothing in ‘the context, surrounding circumstances or general understanding in the relevant market’ showing that Rhine would not reasonably have been regarded as assuming responsibility for this type of loss.
Takeaways
The case makes clear that while external hedging transactions entered into in consequence of a breach may be taken into account when determining losses, internal transactions cannot, regardless that the net result may ultimately be the same. This is a distinction that might be said to have more form than substance. Vitol pools risk through the internal hedging process to be able to manage it efficiently instead of having to externally hedge every physical transaction, but the net result from Vitol’s perspective is arguably the same (or at least similar) as if it did externally hedge every transaction. The question of whether external hedging before a breach may be taken into account in assessing loss remains unanswered and will be factually dependent.
[1] [2023] EWHC 1265 (Comm)
[2] Namely, Glencore Energy UK Ltd. v. Transworld Oil Ltd. [2010] EWHC 141 (Comm) and Choil Trading SA v. Sahara Energy Resources Ltd. [2010] EWHC 374 (Comm).
[3] This is sometimes referred to in the authorities with the Latin phrase res inter alios acta.
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