In the recent finding in Mercuria Energy Trading Pte Ltd and Mercuria Energy Group Ltd v. Citibank NA and Citigroup Global Markets Ltd [2015] EWHC 1481 (Comm) on 22 May 2015 the Commercial Court of London ruled on important principles of the sale and repurchase of commodities.

The principle consideration is whether the bank has complied with the principles of delivery in respect of repurchase transactions (ie. the transfer of title from one party to the other party by way of sale as opposed to an unsecured loan obligation) based on ‘deemed’ delivery without attornment.

In terms of the two Master Agreements concluded between Citibank and Mercuria, Mercuria sold quantities of metals to Citibank under a series of repurchase transactions and Mercuria repurchased “Equivalent Metal” at a specified future date at a higher price. The parties also entered into an aligned services agreement in terms of which Mercuria gave certain undertakings in regard to the storage and safekeeping of the metals.

This case supports the notion, and it was common ground that the repurchase arrangement between the parties were ‘true sales’ in the sense that Citibank took constructive possession of the metals on the initial purchase from Mercuria and that the title and risk in the metals passed to the Citibank (as security), even though the underlying commercial intention was to provide finance to the Mercuria.

In May 2014 large scale fraud in respect to metals stored at the Qingdoa and Penglai ports in China came to light, revealing that significant amounts of metals went missing and was possibly subject to multiple pledges. Due to the ongoing investigation, the ports have been closed down and the metals stored thereat are not accessible.

This led Citibank to call upon the sale date of a number of transactions to the value of US$ 271 million to be brought forward to one day after the delivery of a Bring Forward Event (“BFE”) notice. This entitles Citibank to accelerate the repurchase and payment date.

Mercuria in turn contended that Citibank could not effect delivery and that the situation at the ports materially affected Citibank’s ability to sell the metals and accordingly the non-delivery constituted a termination event in terms of the Master Agreement, which required Citibank to deliver the “Equivalent Metal” before Mercuria can be obliged to pay for the re-purchased metal.

Citibank claimed to have delivered the metal to Mercuria by furnishing warehouse receipts endorsed in blank, without any further instructions to the warehouse operator to release the metals to Mercuria.

The Sale of Goods Act 1979, Chapter 54 (“the SGA”) (applicable UK legislation) defines “delivery” as the “voluntary transfer of possession from one person to another” and continues to state that where delivery of the goods sold is in the possession of a third party:

… there is no delivery by the seller to the buyer unless and until the third person acknowledges to the buyer that he holds the goods on his behalf; but nothing in this section affects the operation of the issue or transfer of any document of title to goods.

It terms of English law a warehouse receipt does not constitute a document of title and therefore the warehouse operator must attorn to the buyer that delivery is effected before constructive possession can transfer.

Citibank acknowledged that the warehouse receipts tendered were not documents of title within the meaning the SGA and subsequently contended that the endorsed warehouse receipts was a “deemed” delivery based on the wording of the Master Agreements, “without the need for any confirmation from the owner/ operator of the Storage Facility”.

Citibank maintained that a lender should be able to deal with a transaction on a purely documentary basis without the responsibility for the storage of the commodities and the warehouse operator.

The court held that “delivery” cannot be read as to have two different interpretations. The Master Agreements required both parties to “deliver” the metal and there is no wording as to indicate that an endorsed warehoused receipt is acceptable as a “document of title”.

The Court accordingly held that in the absence of attornment, Citibank has made no valid constructive delivery. Should Citibank have requested the warehouse operator to issue a release confirmation, it would have sufficed to constitute attornment. Citibank is further not entitled to assign its rights to Mercuria after a Termination Event to effect delivery.

In terms of the Master Agreements Citibank represented and warranted that, the “Sale Date” of each sale transaction it has good title to and the right to possession of the metal; it has a full, unencumbered right to sell and deliver the metal A financier in this case should thus be wary of giving such warranties and representations as it can, as in Citibank’s case, be inconsistent (or possibly fraudulent) with the contended obligation that it only needs to deliver the documents of title for delivery to take place, irrespective of the status or existence of the metal.

Following the payment of one re-purchase transaction (Transaction 6), Mercuria claimed restitution for the amount paid on the basis of non-delivery. The Court held that should Mercuria wish to proceed on this basis, it would be deemed to accept Citibank’s breach and repudiation of the agreements and thus terminating Citibank’s obligation to deliver and Mercuria’s title to the metal. It was not the intention of Mercuria to relinquish its title to the metal and it was accordingly only limited to a claim for damages for failure to deliver the metal but cannot claim to be reimbursed as they have not terminated the transaction.

On the question of the validity of the BFE notices delivered on Mercuria, it was the opinion of the Court that, in the reasonable opinion of Citibank, the warehouse facilities were no longer safe and satisfactory for the storage of the metals and therefore Mercuria’s claim that the BFE notices were invalid and used as a tactical maneuver, was rejected.

Due the Court’s finding that the BFE notices was not only rational, but was also objectively reasonable and effective, Mercuria had committed a material breach of the Master Agreements by failing to pay the amounts due in terms of the BFE notice.

It was held however that Citibank was not entitled to judgment for the US$271million as its failure to deliver the metal would give Mercuria a right to repayment and thus a defense of circuity of action (the bringing of an action that gives rise to a cross-action). It should be highlighted that Mercuria’s payment obligation is not extinguished, but merely not granted to avoid a circuity of actions.

Mercuria’s contention that their delivery of a Termination Event suspended their accrued payment obligations in respect of the sales brought forward by the BFE Notices pending delivery of the metal, was rejected by the Court as the BFE notices was held to be valid and effective, but due to the reasons stated above Citibank was not entitled to judgment for such accrued payments.

Due to fact that Mercuria has materially breached the Master Agreements, Citibank is entitled in terms of contract and the common law to terminate the Master Agreement, irrespective of the fact that it has or hasn’t performed in terms of the contract. Citibank is therefore entitled to exercise its continuing rights to terminate the Master Agreements, even though it has not done so.

It is unlikely that we have seen the last of this case, as the parties have left some stoned unturned, namely Mercuria’s breach of its undertakings in terms of the services agreement for its failure to adequately secure the storage and safekeeping of the metals, akin Citibank’s breach of or false warranties provided in terms of the Master Agreements in respect to its good title to and the right to possession of the metal.

To summarize:

  • The tendering of endorsed warehouse receipts was not valid delivery and Citibank is accordingly not entitled to judgment for the payment of that metal due to Mercuria having a defense of circuity of action.
  • Citibank is not liable for damages for its failure to deliver because it was not under an obligation to make delivery
  • The BFE notices served by Citibank were valid and Mercuria is in continuing breach of the obligations thereof
  • Citibank is entitled to terminate the Master Agreements due to Mercuria’s material breach and its right of termination have not been relinquished by waiver or affirmation and are unaffected by Citibank’s inability to deliver the metal.

This case provided some insightful guidance on the structure of repurchase agreements under English law and is distinctly applicable to the South African legal position and serves as a lenient warning to financiers who rely on “deemed” possession as a means of transferring risk without attornment and the giving of boiler-plate representations and warranties to carefully consider the mitigation of risk and ownership in documenting and executing a sale and repurchase transaction.