It is now 12 months since news broke of wide-scale fraud operations linked to the financing of metals in Qingdao, China. The authorities in Qingdao have prohibited access to the port warehouses, and it remains unclear how much metal was stored in those warehouses at the time. The problem is said to have arisen from the activities of a Chinese trading company, Decheng Mining, which used warehouse receipts to obtain multiple loans secured against small quantities of metal. The apparent purpose of the scheme was to utilise trade finance from foreign banks at much lower interest rates than were available from banks in the PRC mainland. Several foreign banks and large trading companies are facing claims, and are engaged in disputes over who should bear the losses.

The first significant decision from a non-Chinese court on one such claim was delivered by Mr Justice Phillips in the English High Court, on 22 May 2015, in the case of Mercuria Energy Trading Pte Ltd and another v Citibank NA and another [2015] EWHC 1481 (Comm). The focus of the dispute was the operation of “repo agreements" (repurchasing agreements) under which Mercuria sold metal that it had purchased from Decheng, to Citibank NA, on the basis that Citi would re-sell the same or equivalent metal back to Mercuria at an agreed future date, at a fixed higher price, the difference in the price being in effect the cost of the finance1. These repo agreements were subject to English law and the jurisdiction of the High Court in London. The judgment contains a useful discussion on potential problems in the drafting of repo agreements, but it also covers points of more general application to the sale of goods and warehouse financing.

Each repo agreement comprised three categories of document:

  • the Master Agreement, which governed the terms of the transaction
  • the Sale Confirmation for the sale from Mercuria to Citi, and
  • the Forward Sale Confirmation for the re-sale by Citi to Mercuria.

At the time the fraud came to light, Citi was holding warehouse receipts issued to itself by international warehousing companies pursuant to the Sale Confirmations. These receipts had in turn been issued on the strength of "rukudans" (port receipts) issued by the port company to the warehouse companies. On 9 June 2014, Citi served notices (known as BFE notices2) to bring forward the Forward Sale date to the next banking day following receipt of the notice. On 11 July, Mercuria served its own notice declaring a termination event, which had the effect of requiring Citi to deliver equivalent metal before Mercuria was obliged to pay the price. On 22 July, Citi purported to deliver to Mercuria the warehouse receipts endorsed in blank.

Mercuria commenced the High Court action seeking a declaration that Citi’s notices were invalid, and that the tender of the endorsed warehouse receipts was not effective delivery of the metal. Citi counterclaimed for the price specified in the Forward Sales Confirmations, totalling approximately US$ 271 million.

Much of the argument focused on the terms of the Master Agreement, the Sale Confirmations and the Forward Sale Confirmations, but several points are worth noting.

  1. The Court accepted the position adopted by both parties that the repo agreements involved a true sale of goods, under which it was intended that title to the metal would pass from Mercuria to Citi and, subsequently, from Citi to Mercuria. 
  2. Since each transaction was a true sale, the Sale of Goods Act 1979 applied. Section 29(4) of the Act applies where goods at the time of sale are in the possession of a third party, such as a warehousekeeper. Unless the seller is able to transfer a document of title to the buyer, there can be no delivery by the seller to the buyer unless, and until, the third party acknowledges to the buyer that he holds the goods on his behalf. This acknowledgement is known as an attornment. In the present case, there was no attornment by the warehousekeeper following Citi's endorsement of the warehouse receipts to Mercuria.
  3. Under English law, warehouse receipts (unlike LME Warrants) are not documents of title.
  4. Citi's tender of the endorsed warehouse receipts to Mercuria was not good delivery of metal to Mercuria; nor was Citi entitled to assign its rights to the metal to Mercuria. Citi was, therefore, not entitled to judgment for the unpaid price of the metal (Mercuria would have an ongoing liability to pay for the metal following the service by Citi of the BFE notices, but Mercuria would have a defence by way of circuity of action as a result of Citi's failure to transfer tittle to the metal to Mercuria.)

Several other issues between the parties were considered by the judge or held over for future proceedings. This was only the first round in a potentially lengthy battle to decide who bears the losses in Qingdao. In the meantime, for other banks and traders involved in warehouse financing, it is worth considering the status of warehouse receipts under English law and the nature of repo agreements.