Assessment of damages: Internal hedging did not reduce loss

Rhine Shipping DMCC v Vitol SA [2023] EWHC 1265 (Comm) was a complex case in which the Commercial Court considered the relevance of hedging to the assessment of damages.

Key takeaways

• Rhine was distinguished from previous cases where the courts have found that profits and losses from external hedges entered into (or closed out) to mitigate loss as a consequence of breach of contract may be taken into account in the assessment of damages.
• This was on the basis that these were internal hedges entered into through the defendant’s risk management system, independently of the breach and were therefore res inter alios acta.
• The Court also found that losses arising as a result of the breaching party not having entered into external hedges were not too remote to be recovered as:
  • failing to hedge was not outside the reasonable contemplation of the parties; and
  • the non-breaching party had assumed responsibility for such losses.
• This case highlights that the courts will look at the specific details of hedging arrangements and their connection to the breach of contract giving rise to the loss before determining whether losses or gains made through those hedges should be factored into the assessment of damages. Internal hedges entered into through a portfolio management system may be insufficiently linked to the breach to be relevant to the assessment of damages.

Key facts

This dispute arose out of a voyage charter for a crude tanker between the Claimant (Rhine), as owner, and the Defendant (Vitol), as voyage charterer. Rhine’s claim was for unpaid demurrage, which, by the time of the trial, had been agreed. The trial was therefore only concerned with Vitol’s counterclaim, which was a claim for breach of the charterparty arising as a result of delay to the vessel in proceeding to one of the load ports due to detention of the vessel in Ghana where an arrest of property had been made in support of a separate London arbitration. The resultant delay in the loading of the vessel at its next port, Djeno, in Congo, caused a significant increase in the sale contract price as compared to the price had there been no detention. Vitol claimed the difference in price from Rhine as damages for breach of warranty and under an indemnity in the charterparty.

Vitol’s risk management system

Central to this case was Vitol’s risk management system. It used a “group trade capture” system called Vista to manage its trading portfolio. When a physical sale or purchase was made, the transaction is recorded in Vista by Vitol brokers. This physical deal would often then be matched with a corresponding deal, so that where Vitol entered a contract to purchase a cargo, and another contract to sell on that cargo, the purchase and sale will be grouped together on the Vista system. After it became apparent that the Vessel’s arrival at Djeno would be delayed, and the pricing dates were going to be later than anticipated, the internal swaps were “rolled” so the pricing dates of the internal hedge matched the delayed anticipation dates for pricing under the contract and this generated a pricing gain for Vitol.

Issues

The key issues for determination were:

1. Whether Vitol was entitled to an indemnity under clause 13 of the charter.
2. Whether there was a breach of warranty.
3. If the Vessel had not been detained, whether the bills of lading for the Djeno cargo would have borne the date of 6 May 2020 and the price difference would not have arisen.
4. Whether the system of “hedging” entered into by Vitol should be taken into account as reducing its losses.
5. If the losses were not reduced, whether they were too remote to be recoverable, either (a) because they was outside the reasonable contemplation of the parties, or (b) because, even if within their reasonable contemplation, Rhine had not assumed responsibility for them.

Judgment

Issues 1, 2 and 3

This case summary focuses on the quantum issues. With regard to the first, second and third issues, the Court held that there had been a breach of warranty and the indemnity was engaged. The Court also found that the likelihood of the Vessel meeting the originally anticipated loading date was sufficiently certain that damages were to be assessed on the basis of that date.

Issue 4

Rhine alleged that Vitol’s Vista system had the same effect as external hedging. It relied on Glencore Energy UK Ltd v Transworld Oil Ltd [2010] EWHC 141 (Comm) and Choil Trading SA v Sahara Energy Resources Ltd [2010] EWHC 374 (Comm) in which the Court found that external hedging may be taken into account, at least if undertaken in a reasonable attempt to mitigate loss, both as something that has reduced the loss suffered and as something that might generate costs which themselves are recoverable as loss.

However, in this case, the Court noted that hedging can take various forms and that, here, Vitol’s Vista system was not equivalent to the position where external hedges had been entered into (or closed out) as a result of a breach of contract. Instead, the hedges were res inter alios acta as, to the extent they gave rise to a gain for Vitol, they did so independently of the circumstances giving rise to the loss on the Djeno transaction. Therefore the gains neither derived from steps taken by Vitol in consequence of the breach of charterparty nor derived from a contract entered into in order to bring benefit to Rhine.

Issue 5

With regards to remoteness, Rhine argued that if Vitol’s risk management system did not operate to reduce its loss, then the amount of the loss suffered which would not have been suffered if the hedging arrangements had reduced the loss, was too remote to be recoverable. Effectively, the argument was a back door to mitigation using remoteness; Rhine would have expected there to be mitigating hedges and so losses that would otherwise have been mitigated were too remote.

In addition, Rhine contended that the loss suffered by Vitol was not in its reasonable contemplation at the point of contracting and that, even if it were, it was not the type of loss for which Rhine had assumed responsibility. This “reasonable contemplation argument” was based on the fact that Rhine had certain established commercial expectations that Vitol would engage in hedging in order to reduce its exposure to market movements and that the activities discussed above and undertaken by Vitol, were unusual and not within the parties’ reasonable contemplation. However, while the experts said that it would be unusual for an oil trader not to hedge the price risk, they said it was usual for a large trading house, like Vitol, to hedge internally.

Both limbs of their remoteness argument were unsuccessful with the Court finding that the losses caused by failing to enter into external hedges were not too remote to be recovered and that the failure to hedge was not outside the reasonable contemplation of the parties and the breaching party had not failed to assume responsibility for such losses.

With thanks to Bea Byrne Hill and Mike Gledhill for their assistance in preparing this article.