Bank - Bank loan - derivative transaction

Standard Chartered Bank v Ceylon Petroleum Corporation: Queen's Bench Division, Commercial Court (Mr Justice Hamblen): 11 July 2011

The defendant (CPC) was Sri Lanka’s state-owned importer, refiner and retailer of oil. It was a major importer of crude oil and refined petroleum products on the international market. As it was required to buy oil on the international market in US dollars, in such significant amounts, it was inherent in CPC’s business that it had a price risk based on its need to buy physical oil.

In an attempt to protect itself from the rise in the oil price which took place from about 2003 to 2008, from February 2007 CPC began to enter into oil derivative transactions with the claimant (SCB) and other competing banks operating in Sri Lanka. In the period between February 2007 and October 2008, CPC entered into about 30 such transactions, including 10 transactions with SCB (the transactions).

The contentious transactions were the 8th and 9th such transactions entered into between CPC and SCB in May 2008 (T8) and July 2008 (T9). These transactions, required the banks to make payments to CPC when oil prices were high. Conversely, CPC was required to make payments to the banks if the price of oil fell below an agreed floor.

All CPC’s oil derivative transactions were executed on CPC’s behalf by its chairman, managing director and sole executive director, AM. The transactions were also often signed by LK, a chartered accountant who had been employed as the deputy general finance manager of CPC. The transactions were entered into under an ISDA Master Agreement (2002 version) dated 31 July 2006 (the master agreement).

In the period between February 2007 and July 2008, oil prices continued to rise in a previously unprecedented fashion, so that CPC was required to make ever-increasing US dollar payments for its physical oil imports. At the same time, CPC’s portfolio of derivative transactions generally required the banks to make payments to CPC when the oil price increased or remained high. In late July and August 2008, however, oil prices fell rapidly and continued to do so and, as physical oil prices fell, CPC also became 'out-of-the-money' on its derivative transactions, including T8 and T9.

In September, October and November 2008, CPC made the payments demanded by SCB under T8 and T9. From 12 December 2008, however, CPC failed to make any further monthly payments in respect of T8 and T9. SCB claimed US$161,733,500 plus interest, being the sum allegedly due under T8 and T9.

SCB’s submitted that it was entitled to the remaining payments which were due under the terms of the transactions. CPC had entered into the transactions as an arm’s length counter-party with SCB, knowing how it would respond to fluctuations in the oil price, wanting to acquire the benefits of the transactions, and aware of the risks and rewards that it entailed. CPC was always aware that a fall in oil prices would cause it to became liable to make payments to SCB and there was no basis upon which it could avoid its obligations.

CPC submitted that the instant case was a case concerning a publicly owned corporation, of critical importance to its national economy, with no experience in commodity derivative transactions, engaging in novel and sophisticated transactions for the first time in a country that itself had no previous experience of such trading.

On that basis, CPC contended that SCB had held itself out to CPC as advisor and encouraged it to enter into transactions that did not hedge its risks, but instead provided the prospect of insignificant up-front fixed profits in return for taking on vast and disproportionate downside risk.

CPC maintained that it should never have been sold those products, and it disputed their validity on four grounds namely: (i) lack of capacity: CPC, which was incorporated under the Ceylon Petroleum Corporation Act 1961 (the CPC Act), contended that it did not have capacity under the CPC Act to enter into the particular derivative contracts that it purported to enter into because: (a) they fell outside the scope of CPC’s 'general objects' as set out in s 5 of the CPC Act; and (b) they fell outside the terms of a letter dated 29 January 2007 (the Wijetunge letter) said to constitute a 'direction' given by the government to CPC pursuant to s 7(1) of the CPC Act;

(ii) lack of authority: CPC contended that (a) AM and LK lacked actual and ostensible authority from the CPC board to enter into the transactions because they were in breach of the terms of the relevant board resolution of March 2007; and (b) they fell outside the terms of the Wijetunge letter; (iii) supervening illegality: CPC contended that a letter dated 16 December 2008 from the secretary of the monetary board of the central bank of Sri Lanka (the CBSL) had the effect of rendering any further performance of CPC’s payment obligations under the transactions unlawful in Sri Lanka and so, it was said, unenforceable in England;

(iv) counterclaim: CPC contended that SCB owed a contractual and/or tortious duty to advise CPC which it had breached, and that it had made misrepresentations under s 2 of the Misrepresentation Act 1967 (the 1967 Act) to CPC, thereby causing CPC to enter into the transactions, and suffer loss constituted by the payments due under them. Consideration was given to Cassa di Risparmio della Repubblica di San Marino SpA v Barclays Bank Plc [2011] All ER (D) 189 (Mar) (San Marino) and Raiffeisen Zentralbank v RBS plc [2010] All ER (D) 111 (Jun) (RBS PLC)

The claim would be allowed: (1) Where a public corporation was created by an Act of Parliament from a particular country, that corporation's capacity to contract was therefore determined by the law of the relevant country (see [391] of the judgment).

In the instant case, the relevant law applicable was Sri Lankan law. CPC had capacity to enter into the transactions on the basis; (1) that they were incidental to or conducive to the attainment of the objects referred to in s 5(a) and (b) of the CPC Act and/or (2) that such transactions fell within the express powers contained in s 6 of the CPC Act and, even if those powers had been exercised for a purpose outside s 5 of the CPC Act.

That did not mean that such transactions had been beyond its capacity. Further, the Wijetunge letter was not a direction under s 7(1) of the CPC Act (see [398], [414] of the judgment). CPC's capacity defence failed (see [425] of the judgment).

(2) In the instant case, in relation to the transactions both AM and LK bona fide and reasonably believed that they had been acting within the authority conferred on them. AM and LK had had actual authority to enter into the transactions (see [446] of the judgment). CPC's authority defence failed (see [457] of the judgment).

(3) In the instant case, CBSL did not have a power, after a contract had been entered into, effectively to deprive a bank, by letter, of its accrued right to payment, for no compensation. Even assuming that such an extraordinary power could be granted consistently with the Sri Lankan constitution, for it to exist, it would need to be clearly spelt out in the relevant statute, and clearly exercised. Neither condition was satisfied (see [469] of the judgment).

CPC's illegality defence failed (see [470] of the judgment).

(4) A contract would only be implied from the parties’ conduct where it was necessary to do so. It would not be necessary to do so where the parties would or might have acted as they had done without any such contract. The test of any such implication was necessity (see [474]-[477] of the judgment). Aramis, The [1989] 1 Lloyd's Rep 213 considered; Blackpool and Fylde Aero Club Ltd v Blackpool Borough Council [1990] 3 All ER 25 considered; Mitsui & Co Ltd v Novorossiysk Shipping Co, The Gudermes [1993] 1 Lloyd's Rep 311 considered; Baird Textile Holdings Ltd v Marks and Spencer plc [2000] All ER (D) 895 considered.

(5) In considering whether a duty of care arose and, if so, its scope, case law had emphasised the importance of a pragmatic approach which concentrated on the exchanges and dealings between the parties considered in their context rather than the application of high level statements of principle.

Attention should be concentrated on 'the detailed circumstances of the particular case and the particular relationship between the parties in the context of their legal and factual situation as a whole'. There were three tests: (i) the assumption of responsibility test, coupled with reliance; (ii) the three-fold-test (whether the loss was reasonably foreseeable, whether the relationship between the parties was of sufficient proximity and whether in all the circumstances it was fair just and reasonable to impose such a duty); and (iii) the incremental test. There was no single common denominator, with all of the tests operating at a high level of abstraction.

However, what each test emphasised was the need to take into account all the relevant facts in the overall determination. Whatever the formulation of the test, it required an objective ascertainment of the relevant facts, the primary focus being on exchanges between the parties (see [478]-[480] of the judgment).

Bankers Trust v PT Dharmala Sakti Sejahtera [1996] CLC 518 applied; Williams v Natural Life Health Foods Ltd [1998] 1 WLR 830 considered; JP Morgan Chase Bank v Springwell Navigation Corp [2007] 1 All ER (Comm) 549 considered.

(6) The main elements of the law relating to misrepresentation were recently summarised in San Marino drawing on the judgment in RBS. To establish inducement for the purpose of a claim under s 2 of the 1967 Act, it was necessary to show that, but for the representation the claimant would not have entered into the contract that he had (see [552] of the judgment).

In the instant case, the alleged duty of care had not been owed on the facts in contract or in tort. Nor had the alleged misrepresentations been made out (see [550], [573] of the judgment). The counterclaims failed (see [574] of the judgment).

Raiffeisen Zentralbank Osterreich AG v Royal Bank of Scotland plc [2010] All ER (D) 111 (Jun) considered; Cassa di Risparmio della Repubblica di San Marino SpA v Barclays Bank Ltd [2011] All ER (D) 189 (Mar) considered.

Robin Dicker QC and Jonathan Goldring (instructed by Linklaters LLP) for the SCB. Ali Malek QC, Clive Freedman and James MacDonald (instructed by Gibson & Co) for the CPC.