As the price of Brent crude has plunged to its lowest point in years and energy bond yields have risen dramatically over the past few days, and as the potential for a so-called oil war threatens to cause losses and disruption to the industry, buyers and sellers of hydrocarbons may be increasingly nervous as to the creditworthiness of their counterparties. What happens if a counterparty enters into an insolvency event before deliveries and payments under an offtake contract are completed? Can a party ring-fence the hydrocarbons or purchase price, or otherwise insist on performance of the contract?
In a recent decision1 concerning the sale of hydrocarbons, the English Court of Appeal has considered whether the remedy of specific performance of a contract for the supply of goods is available where a party has sold the same goods twice, to two different buyers, in flagrant breach of contract. Although the decision concerned a number of complex and inter-related procedural orders relating to arbitral proceedings under LCIA Rules, this Legal Update focuses on the Court's judgment as it concerns specific performance as a remedy for breach of contract under English law.
Under three offtake contracts entered into in late 2018 and early 2019, VTB agreed to purchase quantities of High Sulphur Vacuum Gasoil ("VGO") from Antipinsky. VTB prepaid for the VGO, which was due to be delivered between April and July 2019. In April 2019, VTB learned that cargoes of VGO were being delivered by Antipinsky to another party, Petraco. VTB feared that, despite having prepaid for delivery of effectively all of Antipinsky's VGO, the VGO was being sold by Antipinsky to other buyers, in breach of Antipinsky's obligations under the offtake contracts.
In late April 2019, therefore, VTB served a notice of default under the offtake contracts and exercised its rights to accelerate Antipinsky's obligations to repay all outstanding prepayments with interest. VTB also sought and obtained various injunctions from the High Court against Antipinsky. One such injunction restrained Antipinsky from disposing of VGO to anyone save to the extent that this would not inhibit Antipinsky's ability to supply that VGO to VTB.
In December 2019, Antipinsky was declared insolvent and entered into a formal liquidation procedure.
By the time of the hearing, it was common ground that the injunction which VTB sought, i.e. restraining Antipinsky from selling VGO to third parties without the consent of VTB, was tantamount to an order for specific performance of the offtake contracts. The question was therefore whether VTB was entitled to an interim injunction for the specific performance of the offtake contracts. The Court noted that VGO belonging to Antipinsky was the subject of numerous competing claims, both proprietary and contractual, pursuant to the insolvency of Antipinsky.
The Court referred to section 52 of the Sale of Goods Act 1979, which expressly permits an order for the specific performance of a contract for the sale of goods where those goods are "specific" or "ascertained".
The Court considered a case decided during the 1973 oil crisis, Sky Petroleum2, which was the only known case where specific performance of a contract for the supply of oil was granted.
The Court noted the general rule that damages are an adequate remedy, and in effect the default remedy, for a breach of contract. The Court also noted that the specific performance sought by VTB, which is an inherently discretionary remedy, would effectively turn a contractual claim to the VGO into a quasi-proprietary right in the VGO, in circumstances where specific parcels of VGO had not been allocated to VTB under the offtake contracts.
After considering the case authorities, the Court of Appeal concluded that there was a strong presumption that specific performance will be limited to cases of specific or ascertained goods, i.e. goods which are in effect unique.
The Court held that the fact that VTB had prepaid for its purchases of VGO did not take the matter out of the ordinary, and did not justify the injunction sought i.e. specific performance. Unlike in Sky Petroleum, this case did not involve a general failure in the market, and there may also be creditors with equal or better claims than VTB to the preservation and ultimate distribution of Antipinsky's assets and in particular its VGO.
This decision involves the Court of Appeal applying the usual principles of English contract law. Unless specific parcels of goods are allocated to a buyer, or a proprietary interest is granted to the buyer on prepayment, it will not be easy for the buyer to obtain specific performance of an offtake contract unless there are special circumstances at play, such as a general failure in the market which renders the goods in effect unique. It appears that the 1973 oil crisis was deemed in Sky Petroleum to be such a general failure in the market, and was sufficient to render specific performance appropriate because the price of oil had risen by so much (400%) that the oil which supplied under that contract was in effect unique on account of the state of the market at that time.
Buyers of hydrocarbons, therefore, should take note of this decision, especially if entering into offtake contracts requiring prepayment with sellers whose solvency may be in question. Without specific performance, a proprietary remedy, or some form of proprietary right or security to exercise in the event that the hydrocarbons are not delivered, the buyer will only stand as an unsecured creditor of the insolvent seller, and have no rights to the hydrocarbons purchased or the monies prepaid.