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The recent decision of Mercuria Energy Trading Pte Ltd. v. Citibank NA is another case that stems from the Qingdao port scandal (see also ANZ Bank (China) v. Ningbo Haitian Int’l Trade, Oct. 2014 DCW, p. 24). In this case, the underlying contract was for a repo transaction between Citi and Mercuria whereby Mercuria would initially sell Citi metals, aluminum and copper, and Citi would then sell the metals, or equivalent metals, back to Mercuria. The metals were located in bonded warehouses in China at the ports of Qingdao, Penglai, and Shanghai.

In May 2014, Mercuria informed Citi that there were reports of fraud emerging that a Chinese trader had colluded with a port company in Qingdao to issue fraudulent port receipts to warehouse operators, including the operators that had issued the warehouse receipts to Citi. It soon became apparent that there was only between 60,000 to 70,000 tonnes of aluminum held at the entire Qingdao port when Citi alone was supposed to have 73,000 tonnes stored there. Subsequently, similar problems were also discovered at Penglai.

In response, Citi, acting pursuant to a Master Agreement, served Mercuria with a Bring Forward Event Notice (BFE) which made the next banking day after the receipt of the notice the sale date. Mercuria challenged this action, claiming that the alleged fraud constituted Termination Events. Citi did not argue that the fraud marked a termination event, but believed the BFE notices were validly delivered and Mercuria’s payments obligations remained. Citi then delivered all of the warehouse receipts to Mercuria along with invoices totaling over USD 270 million.

The High Court of Justice, Queen’s Bench Division, Commercial Court, Phillips, J., concluded that Citi’s tender of the endorsed warehouse receipts did not constitute a good delivery of metal to Mercuria under the Master Agreements. The Judge determined that attornment by the warehouse operator was a necessary element in the transfer of constructive possession. Since that did not occur, Citi did not effect delivery of the metals to Mercuria. Therefore, the Judge ruled that Citi was not entitled to a judgment for the unpaid metal nor was Citi entitled to make delivery by assigning Mercuria its rights to the metal.

The Judge also concluded that the BFE notices delivered by Citi were valid and the payment obligations of Mercuria were not suspended when they claimed a termination event had occurred. The Judge agreed with Citi’s argument that all that was necessary to validate the BFE notices was a genuine and reasonable belief by Citi that they could no longer safely store the metal. The Judge determined that the facts, which included reports by Citi officials highlighting concerns and reports of the fraud at the Chinese ports, demonstrated Citi’s belief that it could no longer store the metal safely at the ports were both genuine and reasonable. Therefore Mercuria’s failure to make payment placed it in breach of its obligation.

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The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of the ICC or Coastline Solutions.