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Common sense prevails – Circular trades deemed not inherently fraudulent1 October 2024

Overview

The Singapore High Court’s decision in Banque de Commerce et de Placements SA, DIFC Branch and another v China Aviation Oil (Singapore) Corp Ltd and others [2024] SGHC 145, another dispute arising out of the collapse of ZenRock Commodities Trading Pte Ltd (“ZenRock”), adds to the recent judicial trend in which lenders have attempted to resist making payment, or sought recovery of payments made, under letters of credit on the purported basis that the underlying trading contracts are fraudulent in nature.

"BCP alleged that CAO did not sell any physical cargo to ZenRock; instead, the physical Cargo had been purchased and sold by ZenRock to third parties under a separate chain of transactions, which it termed 'Series A'."

In its decision, the Court upheld the legitimacy of the underlying sale transaction between China Aviation Oil (Singapore) Corporation Ltd (“CAO”) and ZenRock, rejecting Banque de Commerce et de Placements SA’s (“BCP”) allegations of fraud and misrepresentation relating to a letter of indemnity presented to facilitate payment under a letter of credit, and dismissing BCP’s related claims of deceit, breach of contract, negligent misrepresentation, unjust enrichment and conspiracy.

Facts

ZenRock (now in liquidation) purchased approximately 260,000 barrels (+/-5%) of gasoil 500 ppm sulphur (the “Cargo”) from CAO, the defendant, in January 2020. CAO had purchased the Cargo in turn, on materially back-to-back terms, from Shandong Energy International (Singapore) Pte Ltd (“SEIS”), on ZenRock’s request for it to act as an intermediary. Such request was premised on SEIS declining to offer ZenRock 45-day credit terms. By bridging this gap, CAO earned a modest profit of approximately US$62,000.

BCP agreed to offer ZenRock financing for the purchase of the Cargo and, to this end, issued a letter of credit for the sum of US$20.5m (the “LC”) to the benefit of CAO. BCP agreed to do so based on, amongst others, ZenRock’s representation that the Cargo would be sold onward to PetroChina International (East China) Co Ltd (“PetroChina”) and that BCP’s exposure under the LC would be secured by an assignment of the receivables due to ZenRock and payable by PetroChina.

The LC provided that in the event the specified original shipping documents were not available at the time of presentation, CAO could claim payment thereunder by presenting its invoice and a letter of indemnity in a certain form. The LC was confirmed by UBS Switzerland AG (“UBS”).

After the sale of the Cargo to ZenRock was completed, CAO received SEIS’s invoice and letter of indemnity, which stated that SEIS had been unable to provide CAO with the full set of 3/3 original BLs and other shipping documents. Despite this, CAO believed that SEIS had sold and transferred title in the Cargo to CAO, and therefore duly presented its invoice and letter of indemnity to UBS. Thereafter, UBS made payment to CAO and BCP reimbursed UBS.

Given BCP’s expectation that it would, in turn, be reimbursed by PetroChina, it wrote to PetroChina to request payment. However, on or around 29 April 2020, PetroChina informed BCP that the sale contract between ZenRock and PetroChina had been “cancelled”, such that PetroChina was under “no obligation to make payment”.

Consequently, BCP filed a claim to recover the LC payment sum from CAO.

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"The Court noted that a number of Singapore cases have recognized the legitimacy of circular trades and was persuaded that there exist legitimate commercial reasons for them."

BCP’s case

The crux of BCP’s case against CAO was that the contract between CAO and ZenRock was a sham and/or fraudulent transaction. BCP alleged that CAO did not sell any physical cargo to ZenRock; instead, the physical Cargo had been purchased and sold by ZenRock to third parties under a separate chain of transactions, which it termed “Series A”.

BCP alleged that the second/separate chain of transactions involving CAO, which it termed “Series B”, did not deal with the physical Cargo at all and formed a circular trade, the purpose of which was “merely a financial arrangement for the benefit of, inter alia, [CAO]”.

A graphical representation of Series A and Series B is as follows:

“Series A”: Series A: Petco – ZenRock – Petrolimex

“Series B”: ZenRock – GBE – SEIS – CAO – ZenRock

BCP also asserted various other causes of action against CAO, including under the ‘fraud exception’, deceit, negligent misrepresentation, breach of contract, unjust enrichment and conspiracy.

CAO’s case

CAO’s position was that it reasonably believed that there was physical shipment and delivery of the Cargo, and that the representations and warranties made in its letter of indemnity in relation thereto were true.

It further argued that the transactions formed a single chain, which it had entered into at ZenRock’s request for legitimate commercial reasons, and that it was unknown to CAO at the time of contracting with ZenRock that ZenRock had engineered a circular transaction.

Finally, it took the position that the “Series A” and “Series” B chains co-existed. Thus, title to the Cargo passed through the circular “Series B” before vesting back in ZenRock, to be passed down later to Petrolimex under “Series A”.

As such, CAO denied that it was liable under the various causes of action.

The High Court’s decision

The Court dismissed BCP’s arguments on their merits, holding that the contract between CAO and ZenRock was not a sham or fraudulent transaction. It found that:

  • CAO clearly intended to enter into genuine transactions, which was evidenced by its risk management measures, the conduct of its personnel, and its appointment of independent cargo surveyors. Furthermore, even if an individual at CAO had tried to perpetuate the contract with ZenRock as a sham or fraudulent transaction, BCP had not pleaded the identity of the specific human actor whose allegedly fraudulent state of mind should be attributed to CAO, without which it was not possible to find that CAO had entered into a sham or fraudulent transaction with ZenRock;
  • It preferred CAO’s argument that the contract between CAO and ZenRock co-existed with the “Series A” transactions. It held that, based on the facts at hand, the “Series A” and “Series B” transactions were not mutually exclusive and were in fact a single chain of transactions, or a chain containing a “circle-out”;
  • The fact that the contract between CAO and ZenRock was part of a circular trade did not mean that it was, by that very fact, a sham transaction. The Court noted that a number of Singapore cases have recognized the legitimacy of circular trades and was persuaded that there exist legitimate commercial reasons for them.
  • Occasionally documentation relating to trades may not be available due to issues on the ground and/or as a matter of practice, and that this does not indicate in and of itself that there was a lack of intention on the part of the parties to enter into genuine contracts; and
  • the identification of alleged operational lapses/shortcomings in the underlying trade documentation by BCP’s expert, even if proved, would not indicate that the contract between CAO and ZenRock was a sham or fraudulent transaction. In this regard, the Court was unable to accept that a genuine transaction must, among other things, be one carried out without any operational lapses whatsoever, particularly in the fast-moving world in which a trader operates.

"The Court’s common-sense and practical approach in this matter should reassure commodity traders and provide certainty to lenders."

BCP also attempted to raise the ‘fraud exception’ by way of its closing submissions, which was disregarded by the Court on the ground that the same was not pleaded and, further, on the ground that BCP in any event failed to satisfy the elements of the ‘fraud exception’ as advanced in Winson Oil Trading Pte Ltd v Oversea-Chinese Banking Corp Ltd and another suit [2023] SGHC 220. In particular, the Court held that the steps taken by CAO leading to the issuance of the letter of indemnity indicate that its representations, if at all to BCP, could not be said to have been reckless.

The Court further held, referring to UniCredit Bank AG v Glencore Singapore Pte Ltd [2023] 2 SLR 587, that CAO’s letter of indemnity and invoice were addressed to ZenRock and not BCP, and that this would have made it clear to any reasonable bank in BCP’s position that “not only what the nature of the document was, but also that its contents were not directed at and promised to” BCP. The Court therefore held that BCP could not invoke the ‘fraud exception’ on the basis of a document that was neither addressed nor presented to it (having been presented by CAO to UBS, as the confirming bank).

It was noted that BCP, as the issuing bank, could have relied on the ‘fraud exception’ to refuse reimbursement to UBS or to recover payment therefrom if there was fraud on the face of the documents presented to it. It added that the protection afforded by the ‘fraud exception’ is not illusory simply because BCP’s recourse lay other than with CAO.

Finally, the Court decided that BCP failed to persuade it in relation to its claims for breach of contract (holding that there was no contract between CAO and BCP), deceit, negligent misrepresentation, unjust enrichment and conspiracy.

Comments

The foregoing adds to the body of cases that have been decided by the Singapore courts on issues relating to purportedly sham trades and reinforces the position that, under Singapore law, circular transactions are not inherently fraudulent. Notably, the position has been firmly reiterated that there exist legitimate reasons for circular trades, which may include parties seeking to make arbitrage profits, brokerage fees or for arranging liquidity of funds whilst trading.

Furthermore, this decision affirms that, where fraud is alleged, the courts will undertake an extensive investigation into the facts of the underlying transactions and the contracting parties’ conduct, against the backdrop of the realities of international trade, and will require strong and authentic evidence to arrive at a positive determination of fraud.

The Court’s common-sense and practical approach in this matter should reassure commodity traders and provide certainty to lenders; in particular, the Court’s recognition of the various legitimate commercial reasons that parties may enter into circular trades and, separately, that a lack of complete underlying trade documentation and/or certain discrepancies in the same are not inherently sinister. Indeed, with regard to the latter, we agree that it is the rare transaction that takes place without any so-called ‘operational lapses’ whatsoever, given the fast-paced and high-pressure environment of international commodity trading.

Please do get in touch if you would like to discuss any of the issues canvassed in this article further.

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