An arbitration panel comprising Lord Millet, Michael Hwang and V.V. Veeder (President) appointed by the London Court of International Arbitration issued an arbitration order in the case filed by Citibank N.A. against the Ceylon Petroleum Corporation (CPC) for non payment of dues in the oil hedging deals. The case was heard in Singapore. The panel in a judgment (award) dismissed the claim against the CPC. Here are extracts of the ruling:
|November 16, 2008 File pic: Officials briefing the media denying the CPC's hedging agreements were wrong. L to R: Clive Haswell – CEO Standard Chartered Bank, Dennis Hussey – CEO Citibank, Amitha Gooneratne – Managing Director Commercial Bank, Asantha De Mel – Chairman CPC. Pic by J. Weerasekera
The Parties’ Dispute
1.8 Citibank’s claim first arose from two of the 16 derivative transactions between July 2007 and July 2008 made by reference to a Master Agreement dated 11 July 2007 (the “Master Agreement”), the remaining 14 transactions having been unwound or closed out without any contractual claim by Citibank against CPC.
1.9 Two Disputed Transactions: The first of these two disputed transactions, “Transaction No 15”, was made on 13 June 2008, resulting (according to Citibank) in a contractual obligation by CPC to pay the principal sum of US$ 18,429,950 on 5 December 2008. The second, “Transaction No 16”, was made on 16 July 2008, resulting (according to Citibank) in a contractual obligation by CPC to the principal sum of US$ 3,240,240 on 5 December 2008. CPC did not pay these principal sums, totalling US $21,670, 190.
1.10 -8 .12. 2008 Notice : By letter dated 8 December 2008 to CPC, Citibank claimed the right to terminate the Master Agreement following “Events of Default” (namely non-payment of the two principal sums due on 5 December 2008) and an “Illegality Termination Event” under Section 5(b)(i) of the Master Agreement occurring on November 2008 (namely interim orders made by the Supreme Court of Sri Lanka suspending all payments from CPC to Citibank under these disputed transactions).
1.11 15.12.2008 Notice: By letter dated 15 December 2008 to CPC (as later supplemented), Citibank gave notice of its “Close-Out Amount and Unpaid Amounts” under Section 6(d) of the Master Agreement, being respectively (according to Citibank) the principal sums of US$ 172,829,200 and US$ 21,670,190, together with interest.
1.12 CPC did not pay the amounts claimed by Citibank; and it denied any liability for such contractual claims.
Formal Claims for Relief
1.47 Citibank: As originally pleaded in Paragraph 6 of its Statement of Case, modified from Part 4 of its Request, Citibank sought the following relief from the Tribunal (modified from its claim as first made to CPC):
(i) A declaration that the [ Nos 15 and 16] are valid and enforceable;
(ii) An award of (i) US$ 194,505,771 being the Termination Amount (or such other amount as the Tribunal determines to be the Termination Amount) and (ii) interest up to the due date of 26 March 2009 of USS 952,321.03, amounting to a total of US$ 195,458,092.67;
(iii) An award of interest (a) from the due date to the date of the Tribunals award and (b) from the date of the award to payment in full, at the contractual rate or at a reasonable commercial rate;
(iv) An award of its costs in the arbitration; and
(v) Such other relief as the Tribunal determines appropriate.
2.5 As a result of concerns by the Government of Sri Lanka and the Sri Lankan Central Bank over the price of imported oil (as regards both future price increases and the increasing strain on foreign currency reserves) in mid-2006, an internal “Study Group” recommended that CPC (wholly-owned by the Sri Lankan State) should start hedging its foreign oil purchases using certain derivative transactions.
2.6 The Study Group’s report of 16 November 2006 concluded with Five Recommendations, as follows:
“(1) CPC to hedge purchase of petroleum products, both crude oil and refined products in the international marker, ( 2] Use Zero Cost Collar as thè hedging instrument with the upper bound based on market developments, (3) Commence hedging with smaller quantities for a shorter period and gradually increase the quantity and the duration, (4) Grant authority to the CPC to call for quotations for oil hedging decide on future pnces and purchase kedging instruments from reputed banks, (5) Grant authority to CPC to change instruments based on the developments in the market.”
2.7 The Study Group did not recommend that CPC should pay premiums for hedging its costs of oil purchases, hence the reference to “Zero-Cost Collar” in Recommendation No 2 (subject to Recommendation No 5).
2.8 The Sri Lanka Cabinet issued a decision confirming the implementation of the Study Group Recommendations by CPC, without delay, on 24 January 2007.
2.9 CPC’s senior officers were already holding discussions with a number of financial’ institutions, including Citibank in Sri Lanka.
• 2.10 CPC’s first derivative transaction was made with another bank (not Citibank) on 7 February 2007.
2.11 Citibank had insisted on CPC first negotiating and signing the Master Agreement. On 26 March 2007, CPC’s board of directors passed a resolution approving the signing of the Master Agreement and authorising CPC’s Chairman (Mr de Mel) and CPC’s General Manager—Finance (Mr Karunaratne) to enter into Transactions under this Master Agreement, which was signed by the Parties on 11 July 2007.
2:12 From 11 July 2007 onwards, by reference to the Master Agreement, CPC’s senior officers and Citibank entered into 16 Transactions, six in 2007 and ten in 2008 (“TransactionsNos 01 to 16”). Over this same period, CPC entered into other derivative transactions with several other banks.
2.15 On 28 November 2008, in public interest litigation brought by third parties, the Sri Lankan Supreme Court issued interim orders intended to prevent Citibank from demanding and CPC from making any further payments under Transactions Nos 15 and 16, including the payments for November 2008 which were due on 5 December 2008. CPC did not make those payments to Citibank; nor did it make or tender any other payment to Citibank relevant to the 16 Transactions before the commencement of or during these arbitration proceedings.
2.16 In December 2008, Citibank took contractual steps under the Master Agreement to close out Transactions Nos 15 and 16, resulting in Citibank’s contractual claims for the Termination Amount (plus interest) for approximately US$ 195 million (plus interest), made by Citibank’s letters to CPC dated 8 December 2008, 15 December 2008, 6 March 2009, 24 March 2009 and 21 April 2009. Citibank also commenced these arbitration proceedings against CPC on 19 December 2008.
2.17 After this arbitration was commenced by Citibank, CPC raised several defences and counterclaims for the first time, including the defence that CPC did.not have capacity to enter into Transactions Nos 15 and 16 (or any of the 16 Transactions with Citibank), being ultra vires as speculations.
2.27 In summary, CPC denies any contractual liability under Transactions Nos I5 and 16, under a number of alternative defences, several operating by way of counterclaim.
2.28 Ultra Vires & Capacity: CPC submits first that its contractual capacity is determined by Sri Lankan law under English conflict rules (as the lex loci arbitrii). CPC also submits that the Sri Lankan courts will have regard to English legal authorities when determining the capacity of a corporation such as CPC to enterinto a contract; and that the Tribunal should do likewise in these arbitration proceedings in applying Sri Lankan law.
2.29 CPC submits, both as a matter of Sri Lankan and English law, that if a statutory corporation such as CPC enters into a transaction that is beyond its objects, or exceeds its powers, that transaction is null and void.
2.30 CPC contends that Transactions Nos 15 and 16 fell outside the objects of CPC as defined by the Sri Lankan statute incorporating CPC, namely Section 5 of The Ceylon Petroleum Corporatiori Act, No 28 of 1961 as amended (the “1961 Act”) and were therefore both null and void. Alternatively, CPC submits that these Transactions Nos 15 and 16 fell outside the limits on CPC’s powers imposed by the direction given to
CPC pursuant to Section 7(1) of the 1961 Act, made by letter dated 29 January 2007 from the Additional Secretary to the Ministry of Petroleum acting for the Minister.
CPC submits that Transactions Nos 15 and 16 were ultra vires because they fell outside CPCI &objects set out in Section 5 of the 1961 Act, which provides as follows:- -
“5(a) to carry on business as an importer, exporter, seller, supplier or distributor of petroleum;
5(b) to carry on the business of exploring for, and exploiting, producing and refining of petroleum; and
5(c) to carry on any such other business as may be incidental or conducive to the attainment of the objects referred to in paragraphs (a) and (b).
2.32 CPC submits that the issue of ultra vires (or capacity) in this case is whether Transactions Nos 15 and 16 fell within Section 5(c) or (as later formulated) within an implied power to do anything incidental or conducive to CPC s main objects under Section 5 of the 1961 Act, and CPC answers that issue in the negative.
2.33 CPC accepts that derivative transactions forming part of a hedging strategy for the purpose of managing CPC’s financial risks would fall within Section 5 of the CPC Act. However, CPC contends that Transaction Nos 15 and 16 were not made for the purpose of managing CPC’s financial risks and should be regarded as speculations; and, accordingly, that they were therefore neither incidental nor conducive to CPC’s business of importing Oil and thus fall outside Section of the 1961 Act.
CPC submits, it was obliged to comply with these Study Group Recommendations; and that it is clear that Transaction Nos 15 and 16 failed to comply with both the strict terms of these Recommendations and also their spirit and purpose.
2.37 CPC submits, in particular, that Recommendation No 1 required CPC to hedge its purchases of crude oil and refined products in the international market, but that Transactions Nos 15 and 16 were incapable of meeting this hedging objective, were not entered into for the purpose of achieving this objective and were speculative; that Recommendation No 2 required CPC to use zero-cost collars, but these Transactions were not zero-cost collars; and that Recommendation No 5 granted authority to CPC to “change the instrument based on market developments”, but read in the appropriate context (namely CPC’s need to manage the risks of rising and volatile oil prices as an importer and refiner), this Recommendation still required CPC to enter into Transactions that were capable of meeting the hedging objective, which both Transactions failed to do. CPC also submits that these Transactions were in breach of Recommendations Nos 3 and 4 because they had been made without CPC’s officers going through a process of obtaining competitive quotations for the same transaction from several banks.
2.38 Accordingly, CPC submits that Transactions Nos 15 and 16, invoked by Citibank for its contractual claims, were and remain legally nullities.
2.39 Authority:CPC also submits that Transactions Nos 15 and 16 were made without CPC’s authority.
2.46 CPC also submits that Citibank cannot rely on the representations contained in Sections 3(a)(ii), (iv) and (v) of the Master Agreement and Representation (a) of the Confirmations, because those were no more than representations made by CPC’ s agents (Mr de Mel and Mr Karunaratne) to Citibank as to CPC’s power to enter into derivative transaction: an agent cannot pull himself up by his own bootstraps and unilaterally hold himself out as having an authority which he does not have; and accordingly, so CPC submits, those representations do not bind CPC, particularly if those Transactions were ultra vires.
2.47 Illegal Performance: CPC submits, in the further alternative, that the performance of its obligations under Transactions Nos 15 and 16 / became illegal because, after conducting an investigation into these Transactions the Sri Lankan Monetary Board sent a letter to Citibank dated 16 December 2008 directing it not to proceed with, or give effect to, these Transactions. CPC contends\ that this direction made the demands for payment claimed by Citibank and payment\by CPC illegal in Sri Lanka, as the place of performance; it being well established under English and Sri Lankan law that a transaction that is illegal at the place of performance cannot be enforced by a party.
2.48 CPC submits that the Monetary Board exercised this power of direction under Section 46(1) of the Banking Act No. 30 of 1988 (the “1988 Act”), which permits it to issue directions to licensed commercial banks as to the conduct of any aspect of their business; that such directions have the force of Sri Lankan law; and that failure to comply with such directions can lead to criminal sanctions in Sri lanka. CPC contends that the Monetary Board’s direction was a valid exercise of this statutory power by the Monetary Board; and that, accordingly, even if (which CPC denies) the Transactions Nos 15 and 16 bound CPC, these Transactions cannot be enforced by Citibank.
CPC submits that Citibank breached its duty to CPC by recommending derivative transactions that were incapable of meeting CPC’s hedging objective, by downplaying the Transactions risks, by failing to explain to CPC that if the oil price was on a downward trend, it might not he possible to restructure or unwind Transactions (not least because this would be subject to CPC’s credit limit at Citibank) and by failing to explain to CPC that Mr de Mel and M Karunaratne’s strategy was misconceived and imprudent.
2.54 Misrepresentation/Misstatement: CPC’s cases on misrepresentation and misstatement were alternative ways of pleading its case on an advisory duty of care owed by Citibank to CPC; and it is unnecessary here to describe these further.
The Tribunal addresses the issue of CPC’s capacity to agree the Transactions made in its name with Citibank in 2007 and 2008 under the Master Agreement; i.e. the Second Issue listed in Part III above. In consequence of deciding this Second Issue, the Tribunal here also decides Issues 6 and 7.
The Tribunal notes that this Capacity issue is raised as a positive defence by CPC as the Respondent to Citibank’s contractual claims as the Claimant under Transactions Nos 15 and 16. It was therefore for CPC to establish this defence.
CPC s Objects: It is a commercially unattractive feature of CPC’s case that CPC in these arbitration proceedings is asserting the legal ineffectiveness of its officers’ own actions in agreeing the impugned Transactions in order to resist Citibank’s contractual claims, notwithstanding several express terms of the Master Agreement and other contractual documentation agreed and signed by such officers designed specifically to prevent such a defence. It is even more unattractive in that the two loss-making Transactions, for which CPC is here seeking to avoid all contractual liability (namely Transaction Nos 15 and 16), were preceded by 14 similar Transactions over a long period, several of which produced substantial profits paid by the Claimant to CPC. which CPC was content to accept and retain.
However, CPC is a Sri Lankan public corporation; and, being a creature of statute, CPC can act only within the legal powers conferred on it by the statute.
Much of the argument before the Tribunal was directed to the interpretation of subsection 5(c) of the 1961 Act and to the question whether hedging the price of petroleum, or oil, was a business which could be said to be incidental or conducive to CPC’s business as an importer and refiner of oil. But while hedging the price of oil is a financial activity distinct from the actual purchase and import of oil and does not affect the price paid to the producer, CPC did not engage in hedging as a separate business on its own so as to fall within the words “such other business” in subsection.
It would, however, be an absurd interpretation of subsection 5(c) if CPC had the power to enter into the impugned Transactions only if it did so in the course of carrying on a separate business. The reason that subsection (c) is so circumscribed that, like an English corporation, a Sri Lankan corporation may do anything which “may fairly be described as incidental or conducive to or consequential on” its main objects (Amerasinghe, Public Corporations in Ceylon, p. 39). Although such a power is sometimes expressly stated in a statute or charter, its inclusion is superfluous, for it is implied by operation of law (ibid). Subsection (c) therefore extends the scope of subsection (a) by providing that CPC may do anything conducive to its main objects even if this entails carrying on a separate business of its own.
In the Tribunal’s view the crucial question is whether the relevant Transactions were calculated to manage thc commercial risks to which CPC was vulnerable as a buyer, importer and refiner of oil.
As regards this Capacity Issue (Issue 2), the Tribunal decides, accordingly that none of the 16 Transactions can be categonsed as risk management (or hedging), that all 16 Transactions were speculations by CPC’s officers; and that all 16 Transactions were beyond the capacity of CPC (or ultra vires) under Section 5 of the 1961 Act and the law of Sri Lanka. This Capacity Issue is therefore determined against Citibank and of a its contractual claims against CPC in these arbitration proceedings in respect of Transactions Nos 15 and 16.
Citibank is not entitled to the declarations that Transactions Nos 15 and 16 are valid and enforceable, to payment of the Termination Amount and to payment of interest on such Termination Amount.
- n In particular, the Tribunal declares that Transactions Numbered 15 and 16 were and remain ultra vires and beyond the Respondent’s capacity;
- n The Claimant’s contractual claims under Transactions Numbered I5 and 16 and the Master Agreement dated 11 July 2007 are hereby dismissed;
- n In particular, the Tribunal declares that the Claimant is not entitled to payment by the Respondent of the Termination Amount or to payment of interest on such Termination Amount under Transactions Numbered 15 and 16 and the Master Agreement dated 11 July 2007;