High Court finds buyer not entitled to reject off-spec oil

A recent High Court decision has given a helpful analysis of the consequences that follow from delivering off-specification oil: Galtrade Limited v BP Oil International Limited [2021] EWHC 1796 (Comm).

The underlying facts of the case come up quite often in practice, although reported decisions are less frequent. A seller delivered off-spec hydrocarbons (in this case a cargo of fuel oil) to a buyer. The buyer rejected the cargo and claimed for its wasted demurrage and freight costs incurred in the transaction (around $1.1 million). The seller disputed the buyer's entitlement to reject, and brought its own counterclaim for losses it incurred when it re-took delivery of, and re-sold, the cargo ($500,000).

The High Court found that each side had proved breach of contract (the seller breached the quality clause; the buyer repudiated by wrongfully rejecting the cargo). But neither side proved loss and both were awarded nominal damages only.

Each case will, of course, turn on its own facts and the drafting of the particular sales contract. However, the decision is likely to provide some comfort to sellers with off-spec cargos of hydrocarbons. The judge concluded that the list of guaranteed specifications in the contract were not strict "conditions" of the contract, such that a breach would give rise to an automatic right to reject, but were intermediate or "innominate" terms. That meant the buyer was only entitled to reject the goods if the seller's breach deprived it of substantially the whole benefit of the contract – which in this case, by being slightly out as to its sulphur content, it did not.

The judgment provides some interesting pointers to parties drafting these contracts. If the precise specification of the product is of fundamental importance for the buyer, the buyer may want to reflect this in the drafting of the contract by specifying that the term as to quality is a "condition" or providing that the buyer's remedy for breach is rejection. This is not the default position in the BP General Terms and Conditions for Sales and Purchases of Crude Oil and Petroleum Products 2015, under which this sale was executed. Otherwise, the decision suggests, the court will "lean in favour" of the term being innominate, which may, subject to the breach, make it more difficult for a buyer to prove its entitlement to reject.

The judgment is also interesting for emphasising the care that a buyer must take when it first realises it has received off-spec goods. Here, the buyer had initially tried to negotiate a revised price with the seller, before subsequently rejecting the goods. The judge said that the buyer's decision to negotiate indicated that really the buyer's problem was one of value, rather than anything more substantial. A buyer in this position may therefore wish to be clear from the start that it is electing to reject the goods, with any negotiations for an alternative solution conducted on a "without prejudice" basis.

Background

The claimant ("Galtrade") and the defendant ("BOIL") were both oil trading companies. BOIL agreed to sell four cargos of low sulphur fuel oil to Galtrade. The "special provisions" of the contract contained certain "Guarantees" regarding the quality of the cargos. The transaction was also governed by BP's General Terms and Conditions for Sales and Purchases of Crude Oil and Petroleum Products 2015.

The first two cargos BOIL delivered were off-spec – but they were accepted by Galtrade and the parties agreed a discount to the contract price.

The third cargo was loaded on Galtrade's nominated vessel but, when on-board, was also found to be off-spec as to its: sulphur content (1.53% against a guaranteed maximum of 1.30%); vanadium content (59 mg.kg against a guaranteed maximum of 50 mg/kg); and P-value (2.0 against a guaranteed minimum of 2.5).

Galtrade rejected the cargo for being "drastically different" from the cargo it had contracted to buy.

BOIL said that Galtrade's rejection was wrongful, but nevertheless agreed to take back the cargo, after which it was blended with other oil products and sold intra-group to another BP entity for sale into the US. In the process, BOIL incurred certain costs making changes to its hedging arrangements for the original cargo of fuel oil.

BOIL admitted breach of contract as to quality. The dispute turned on the consequences of the breach.

Galtrade's position was that it was entitled to reject the cargo, on the basis that the terms as to quality were a strict condition of the contract, or this was a serious breach of an innominate term. Galtrade claimed its wasted expenditure as damages (around US$1.1 million in demurrage and freight costs).

BOIL's position was that Galtrade was not entitled to reject the cargo: the relevant term was not a condition and the breach was minor. BOIL argued that, in rejecting the cargo, Galtrade was itself in breach, and BOIL claimed damages of $500,000 (the difference between an adjusted contract price and the amount BOIL achieved for the fuel oil in the intra-group trade).

Decision

The High Court (Mr Adrian Beltrami QC, sitting as a Deputy Judge) decided that each party was entitled to nominal damages only.

Galtrade's claim

In relation to Galtrade's claim, the judge first held that the obligation to comply with the specifications as to quality was an innominate term not a condition. The following points were particularly important:

• The correct starting point, in the absence of clear agreement to the contrary, was for the court to "lean in favour" of construing a provision as an innominate term, especially in the area of quality deficiencies.
• The clauses were not described as conditions, and the contract did not state that there was an automatic right to reject if the specifications were not met.
• On Galtrade's case, it would have been entitled to reject the entire cargo for any deviation, however minor, from the guaranteed level of specification (other than perhaps something de minimis). In circumstances where fuel oil is a naturally occurring product, this would place so much commercial risk on the seller – and give so much commercial power to the buyer – that it would need to be expressly provided for in the contract. Here, the contract was silent as to the consequences of off-spec deliveries.
• There was a long list of quality specifications in the contract, and deviation from them may not necessarily cause any prejudice to the buyer. An off-spec cargo may be less marketable, but the industry can accommodate products of different specifications, whether into refineries, for blending, or for consumption.
• It was legitimate to have regard to the nature of the business the parties were conducting, which involved the upgrading or downgrading of parcels within larger blends. That made it less likely that the expectation would be that a single breach of a specification parameter would automatically allow rejection. It might or might not, depending on the severity of the breach; but that is the language of innominate terms, not conditions.

Having decided that the clause was an innominate term, the judge then went on to consider whether the breaches nevertheless gave rise to a right to reject (or, in the language of the cases, whether BOIL's breach deprived Galtrade of "substantially the whole benefit" of the contract). The judge decided that the breach did not give rise to a right to reject for the following reasons (amongst others):

• Fuel oil with a sulphur level of 1.53% is not a substantively different product to fuel oil at 1.30% sulphur. Both would be considered to be "low sulphur" fuel oil in the industry.
• Both experts agreed that the parcel remained marketable at a reduced price. That meant the nature and extent of the deviations could be assessed and a value placed on them. Once that had been established, it was difficult to avoid the conclusion that the claimant could be properly compensated for the financial effect of the breach, rather than it being a case where Galtrade had been deprived of the substantial benefit of its contract.
• The judge accepted that BOIL's breach placed Galtrade at a disadvantage in respect of its onward contracts for blended oil. But Galtrade had proved in its past dealings that it could trade – and indeed could profit from – off-spec cargo.
• Galtrade had initially tried to re-negotiate the price, rather than rejecting the cargo outright. The fact Galtrade was prepared to countenance a reduction in price provided a further indication that the problem was really one of value.

Galtrade nevertheless sought to maintain its claim for wrongful expenditure, on the basis that it had incurred costs in respect of a cargo which it never ended up buying. The judge held that this claim was analytically flawed: the wasted costs must genuinely be wasted, in the sense that they would not have been incurred in any event. But these costs would have been incurred in any event, because Galtrade should have accepted the cargo, and therefore would have shipped it (and in doing so, incurred the "wasted" costs). The only reason they were wasted was because of Galtrade's own breach in rejecting the cargo, and not BOIL's breach as to quality. The judge therefore rejected Galtrade's claim for damages.

BOIL's claim

As Galtrade's rejection was wrongful, and itself a repudiatory breach of contract, BOIL had a valid claim for damages. This claim fell under s.50 of the Sale of Goods Act, which provides that: damages should be in the amount of the loss directly and naturally resulting from the breach; and where there is an available market, that is prima facie to be ascertained by the difference between the contract price and the market price when the goods should have been accepted.

BOIL's claim was comprised as follows:

• the contract price less a discount to reflect the off-spec nature of the cargo

minus

• the net sum which BOIL recovered when it sold on the cargo, as part of the blended cargo, intra-group.

The most difficult question for the judge was what discount should be applied to the contract price to reflect the fact it was off-spec. The cargo had not simply been sold in the market directly by BOIL and so there was no reliable data regarding its market value. Both sides submitted expert evidence on this point. However, the judge ultimately found the most reliable evidence on which to base his assessment was the discount that the parties had agreed on an earlier off-spec cargo. They had previously agreed a discount of US$29.7/mt. The judge applied this discount again – and that extinguished BOIL's counterclaim entirely.