Trade disputes on the rise
February 09, 2009
by Meyer Sosland
Most of the world’s grain trade is done under the Grain and Feed Trade Association’s (GAFTA) long standing system of contracts. With a system of arbitration, relying on the experience of experts with many years in the trade to achieve fairness, grain trade around the world is largely self-policing. GAFTA’s proud boast is "My Word is My Bond." But one lawyer specializing in trade disputes believes that the current international financial crisis will put the system under pressure as parties find themselves in increasingly difficult situations.
It’s no coincidence that specialist Damian Honey of global law firm Holman Fenwick Willan is based in London, since the contracts are written under English law. "English Law is one of the great exports of this country," he told World Grain. "A lot of international contracts are written under English Law."
That means to understand the full ramifications of the contracts, you have to understand English law. Like the legal system of the United States, with which it has many similarities, English law is what is known as a "Common Law" system, based on judges following the decisions of their predecessors. It contrasts with the codified systems used in many other countries. It’s not British law, incidentally. Scotland has its own legal system.
There are exceptions. "In North America, grain is traded under NAEGA contracts which are governed by U.S. law,"
Honey explained. "In the rest of the world it’s GAFTA, which is the standard. GAFTA also includes an arbitration process. Arbitration is generally held in London."
GAFTA contracts are used worldwide. "The rise in trade with China is mostly done under GAFTA contracts," he said. "In the former Soviet Union, trade is mostly done under GAFTA contracts.
The international reach of English law is not confined to grains. "It’s not unusual to the grain trade," he said. "It happens in a lot of commodities. Shipping contracts are also done under English law. In general, in international trade you’ve got to move the commodity."
Pamela Kirby Johnson, director general of GAFTA, which has been in existence for 130 years, put the proportion of international grain trade covered by GAFTA contracts at over 80%.
According to Honey, the GAFTA system means that outsiders are rarely aware of trade disputes. "GAFTA arbitrations are private and confidential," he said. "The reality is that the press and public are nine times out of 10 not aware of the big fights."
Honey said arbitration rulings can be appealed to the High Court in London, but under the United Kingdom’s Arbitration Act of 1996, the right to appeal is limited. He said such appeals have been rare but are increasing.
GAFTA arbitrators deal with most disputes. "Most of the disputes in grain are in arbitration," he said. "They are behind closed doors."
However, the financial downturn has meant more arguments to be settled. "There has been a rise in disputes, not only in grain, simply because of the fall in prices," he said. "Where a buyer has paid a price and there is a fall in the price, rather than honor contracts, some people will try to rip them up or restructure them. The fall in prices has been across the board."
Further problems are created by the lack of available credit. "Buyers are finding it difficult to obtain credit from the banks, so they look to restructure or simply don’t perform," he said. "There’s been a lot of that. That’s symptomatic of recession."
Freight prices, which have dropped 95% from their highs, have created their own problems. "That has had a huge impact on the business," he said.
PIRACY The legal problems facing grain traders go beyond the downturn and everyday contract disputes. Honey was one of the speakers at the 2008 Global Grain Conference in November, a time when the threat of piracy was in the forefront of many people’s minds because of the hijacking of a ship carrying 36,000 tonnes of grain to Iran by pirates in the Gulf of Aden.
"At the moment, ransoms are considered legal payments and can be paid," he said. "From a trader’s perspective, a ransom payment is something that can be recovered in general average. The owner will declare general average and require general average from you," he said, referring to the principle in maritime law under which losses are shared out.
He also stressed the need to be careful about relying on, or spreading, market rumors about the solvency or otherwise of a trading organization. "Market rumor has been driving performance," he said. "It’s always important to be careful if you rely on a rumor. There have been some actions in defamation."
Although there is a clause on insolvency in the GAFTA 100 contract, which covers bulk feeding stuffs, it doesn’t mean you can get out of a contract if you merely think the other party is insolvent. "That particular insolvency clause only works on insolvency," he said. "If you only think your counter party is insolvent, it’s not going to help you."
Another idea which he identified as creating some confusion is "force majeure," which states: "Sellers shall not be responsible for delay in shipment of the goods or any part thereof occasioned by any Act of God, strike, lockout, riot or civil commotion, combination of workmen, breakdown of machinery, fire, or any cause comprehended in the term ‘force majeure.’ "
"If you’re going to try to rely on a force majeure situation, you have to look at the wording of your contract," he said. "The GAFTA 100 force majeure clause is quite technical in its requirement that if you’re going to have to rely on it, you have to give notice."
He stressed that what it does not cover is a change in economic circumstances. "Can an extreme change in contract price constitute force majeure? That is the common question at the moment," he said. "The answer is no."
Other markets have their own ways of dealing with sharp price changes. "It’s quite common in the oil and gas market for there to be a price escalator clause," he said, wondering if such provisions could become common in the grain trade for term, rather than spot, contracts.
He also told conference delegates that if they wanted to have arrangements where payments owed between two parties under different contracts offset each other, they needed an agreement in writing. "Set off is particularly relevant where payments are due where you have a longstanding customer who you buy from and sell to," he said. "It’s quite difficult to achieve in GAFTA contracts."
GAFTA contracts are designed to cover a single agreement. "If you want a proper set-off clause, you need to enter into a master contract," he said.
He predicted an increased tendency for grain traders to negotiate master contracts in the future.
LAWYERS’ ROLE Although the GAFTA arbitration system does not involve lawyers, they do have a role. "A lot of what we do as lawyers is firefighting," he told World Grain. "It’s advising clients on existing contracts. We look at them and interpret them. Do they have to perform?"
What they can’t do is argue a case in the arbitration. "GAFTA does not allow lawyers to go into the room," he said. "Lawyers are very heavily involved, but they are not allowed to be advocates."
Even though there are more disputes, Honey was keen to stress the effectiveness of the system. "People have been happy trading for years under the contracts," he said. "You can go for years without having any issues."
In good times people just muddle through, said Honey, pointing out that there had not been a financial shock to compare with the current situation since the early 1990s. "In terms of the volume of disputes, this hasn’t been seen for some time," he said.
Johnson said that GAFTA had not yet seen an increase in disputes. "We tend to lag behind. People have a dispute before we hear about it," she said. "The number of disputes has plateaued in the last few years for the simple reason that the contracts are very clear. Rarely is there a dispute because of the contract. There’s usually some course of action that should not have been taken."
The GAFTA arbitration process limits the scope for taking disputes to court. "When you choose arbitration, you go to arbitration," Johnson said.
Although GAFTA contracts have been around for a long time, they do change to suit the needs of the time. "The contracts are continuously under review by an international group of experts," she said.
When he spoke in November, Honey predicted a lot more strife over contracts.
"We think that we’re going to be quite a lot busier (this) year simply because of the volatility of prices and the collapse of prices and people arguing among themselves," he said.
He also predicted that more of the complicated clauses found in oil and gas contracts would be coming into grain trading, noting that, because of biofuels, more traders are now involved in both sectors. He also speculated that governments would be more involved.
"We also think there’s going to be greater regulation for us all," he said.
Chris Lyddon is World Grain’s European editor. He may be contacted at: email@example.com.