Fal Oil v. Petronas (CofA)

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Fal Oil Co Limited and another v Petronas Trading Corporation
English Court of Appeal: Judge, Buxton and Mance LJJ.: 7 July 2004
Richard Millett QC and Edmund King, instructed by Ince & Co., for the claimants, Fal Oil
Stephen Males QC and Lawrence Akka, instructed by Holman Fenwick and Willan, for the defendants, Petronas

The Court of Appeal, upholding the decision of the High Court, held that Fal Oil, as sellers of a cargo of oil, were entitled to recover the sale price which buyers had refused to pay on the grounds that, on discharge, it had been found that water had been substituted for 1500 tonnes of oil. The buyers had been unable to establish, on the balance of probabilities, that the cargo had contained the excess water on delivery to them. On the further question whether the demurrage provision in the sale contract gave rise to an independent liability, or operated only to provide an indemnity if, and only if, the seller was liable for demurrage under the charterparty, the appeal judges held by a majority that it was an independent obligation.

DMC Category Rating: Developed

This case note is based on an Article in the August 2004 Edition of the ‘Bulletin’, published by the Marine and Insurance teams at the international firm of lawyers, DLA. DLA is an International Contributor to this website.

Under a contract of sale dated 29 November 2000, Fal Oil agreed to deliver four cargoes of 80,000 metric tonnes of fuel oil of "ex-Yanbu Standard Quality C and F one/two safe port(s) Singapore/Pasir Gudang range". To be of Yanbu standard quality the fuel had to be no more than 1% water and sediment. A variation was agreed for the first cargo, whereby it would be lifted from Yanbu in the Centaur but would be transferred on to the Devon off Port Sudan and delivered under the sale contract at that point.

The cargo was loaded on to the Centaur on 25 February 2001 and a ship-to-ship transfer made onto the Devon on 26 February. The Devon arrived at her first nominated discharge port of Singapore, on 17 March.

Samples taken from the Yanbu shore tanks on 20 and 22 February showed the percentage of water and sediment at 0.2%, which matched samples taken from the Centaur's tanks after loading at Yanbu. But on discharge of the Devon at Singapore, the cargo was found to contain about 1,700 tonnes of water, an excess of 1500 tonnes over the reported quantities at Yanbu. Discharge was delayed and eventually Petronas rejected the whole cargo. Fal Oil claimed for non-payment of the price and for demurrage.

The Mystery of the Excess Water
The unusual feature of the case was that there was no explanation for the presence of the water at unloading. No identifiable incident had taken place and the total quantity of liquid loaded on the Centaur and on the Devon closely corresponded with the total quantity discharged from the Devon. Where had 1500 tonnes of oil gone?

At first instance, the judge thought it was unlikely that it had been discharged into the sea, as this would have caused an international incident. He concluded there must have been a deliberate substitution of water for oil, but it was impossible to say whether this occurred on the Centaur or on the Devon. In any event, Petronas had failed to prove that the seawater had been loaded as cargo on to the Devon at the transfer point. Consequently, he concluded it was liable for the price of the cargo.

Petronas appealed. The more serious the misconduct alleged, the weightier the evidence needed to prove it on the balance of probabilities. The judge should have looked first for any other possible explanation rather than conclude that there had been a deliberate substitution by persons unknown.

Judgment on the Excess Water Issue
The critical question was whether the cargo transferred to the Devon contained some 1,700 tonnes of water. The judge had thought the answer to the question depended on whether Petronas could show that the presence of the water was more probably due to deliberate substitution of water for oil on the Centaur as opposed to on the Devon. The Court of Appeal thought the judge went too far in making everything depend on so stark a choice. Nevertheless, it was still necessary to consider whether Petronas had established, as a matter of probability, that the water was already present and was loaded on to the Devon during the transfer.

In the end, the Court of Appeal found itself driven to the same conclusion as the judge - that Petronas had simply failed to prove that the water was loaded on to the Devon by or at the transfer point. The suggestion that the water may have come on board during the loading of the Centaur was, according to the evidence, implausible. The possibility of loss of oil to the sea from either the Centaur or the Devon was, at best, very remote, and the possibility of deliberate substitution on either vessel was essentially speculative. The case was a mystery, but it was impossible to say as a matter of probability that the cargo loaded at the ship-to-ship transfer was 1,500 tonnes short of oil.

The second issue on appeal concerned the nature of Petronas' liability for demurrage. The sale contract dated 29 November 2000 allowed 36 hours' laytime, to commence 6 hours after Notice of Readiness was tendered or on berthing, whichever was earlier. Demurrage was "As per charterparty per day pro rata …". It also provided "Other terms and conditions: Where not in conflict with foregoing, Incoterms 2000 with latest amendments for CNF sales to apply." The relevant Incoterms simply provided that the seller must "contract on usual terms…"

No charterparty had been entered into at the time the sale contract was signed. Neither party could, therefore, have known its precise terms relating to laytime or demurrage.

In February 2001, Fal Oil chartered a vessel from an associated company, Fal Shipping. The charterparty was on the Asbatankvoy form and provided "Total laytime in Running Hours 72 HOURS SHINC … Demurrage per day USD 18,000 P.D.P.R". More detailed provisions provided that laytime would commence 6 hours after receipt of Notice of Readiness or on the vessel's arrival in berth, whichever first occurred. In certain circumstances (such as fire, explosion, storm or strike) the rate of demurrage would be reduced by one half.

Did the demurrage provision in the sale contract operate as an indemnity only - so that the liability to pay demurrage depended on whether Fal Oil had any liability to Fal Shipping? If so, then (Petronas argued) if Fal Oil had no liability, it had no right to an indemnity. Or did the provision operate independently of any such liability? The judge decided it was an indemnity.

Judgment on the Demurrage Issue
The Court of Appeal, by a majority, disagreed. The answer depended on the precise nature and effect of the provision in question, the wording used and the context - including any cross-reference to or incorporation of the demurrage provisions of a charterparty. In the absence of any cross-reference, the natural inference was that liability under a sale contract operated independently. Where there was a cross-reference, however, the effect of the reference was itself a matter of construction.

In the present case, the sale contract gave rise to an independent liability. It had been made independently of (and without knowledge of) the terms of the charterparty, which, as it turned out, did not match those in the sale contract. If the provisions in the sale contract operated as an indemnity, this would create problems in reconciling the different provisions.

Looking at the wording of the sale contract ("As per charterparty per day pro rata") two of the Appeal Court judges were satisfied that it incorporated a rate and no more. It was not a reference to the amount of demurrage paid pursuant to the charterparty. The parties had agreed to adopt that rate as an agreed approximation of the loss Fal Oil would be likely to suffer in the event of delay in discharging. A buyer in Petronas' situation was protected from paying over the odds by the general law on penalties, which prevents provisions for demurrage that are not a reasonable and genuine pre-estimate of loss.

Lord Justice Buxton dissented, concluding that the provision was in the nature of an indemnity. If it operated as an independent obligation and the seller had no liability to anyone else, the seller would get a windfall. Why would the buyer agree to an open-ended liability of that sort? Relying on the law against penalties was scant protection. In his view, once there was explicit reference in the sale contract to the demurrage provisions of the charterparty, the connection between the two was hard to resist.


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