UK: Trader´s Guide: How To Manage Risk And Reduce Exposure

Last Updated: 2 April 2009
Article by Eurof Lloyd-Lewis

Since September 2008, and the collapse of Lehman Brothers, not a day seems to pass without news of the impact of the global financial crisis upon markets. In this article, Eurof Lloyd-Lewis looks at how international trade contracts may be affected by the current crisis.

Earlier this year, however, in contrast to the equities sector, the credit crunch had appeared to bypass the commodity markets which were putting in a stellar performance with prices hitting historic highs.

However, the Bull Run came to a sudden and abrupt end in late July/early August 2008. The resulting turmoil has been further exacerbated by the liquidity problems encountered by many banks, some of which provide trade finance. Prices have gone into freefall and the spectre of counterparty default and insolvency appears to haunt every transaction. Few traders have been unaffected by the turmoil; transactions have been restructured or renegotiated or there has been the complete failure of performance. Such a severe change in economic circumstances probably constitutes the most rigorous and sternest of tests in a contractual relationship.

The aim of this article is to provide an aide-mémoire of some of the issues traders may wish to consider when negotiating their contracts to withstand the current economic turmoil.

Standard form contracts

These can be used in their entirety or as a platform upon which to base bespoke terms and conditions. Many commodities traded internationally are traded using standard form contracts, for example grain, vegoil and fats, sugar and coal. These forms have been formulated by trade associations, for example GAFTA, FOSFA, RSA and other organisations, specifically with a view to simplifying the trade of these commodities so that everyone in a particular trade is familiar with the terms on which the goods are traded. Many of these contracts have a long history and, as a consequence, they have undergone a process of continuous development over 150 years. Accordingly, they have the benefit of being well tested. In addition, many trade associations have contract drafting committees who continually review the latest developments in the trade, both commercially and legally, to ensure that new editions remain relevant.


Cash in advance, letter of credit, cash against documents or open account. From a seller's perspective, cash in advance offers the securest form of payment but, from a buyer's, the least convenient and attractive. An alternative is to require the buyer to provide a letter of credit. By insisting upon a letter of credit, a seller is substituting his buyer's credit risk for that of a hopefully creditworthy third party, i.e. a bank. A seller must appreciate, however, that to operate the credit they must be able to procure and present the documents required under the terms of the instrument otherwise they will not be paid. Other issues are that the credit must be opened in time - at the latest by the beginning of the shipment period - otherwise the seller will be entitled to cancel the contract, walk away and claim damages. The seller must be careful, however, that if they fail to hold the buyer in default for failing to open the letter of credit on time, they may have waived the right.


A well drafted commodity contract should have a clause addressing counterparty insolvency. The definition of what constitutes an act of insolvency for these purposes should be very broad so as to include suspension of payments, i.e. it is not necessary for a receiver or liquidator to be appointed or for there to be court intervention. Such a clause should stipulate the effect of an act of insolvency on the parties' rights; for example, the party who commits an act of insolvency is obliged to notify its counterparty and the contract is then automatically "closed out" at the market price ruling on the business day following the service of the notice; in the absence of a notice, a solvent counterparty will have the option to close out the contract. The effect of such a provision is to "wash out" the contract thus making it one for differences, i.e. there is no requirement to make and accept delivery but whoever is not in the money will be obliged to pay the difference. This might, of course, not be such an attractive position for a non-insolvent party if it is the one who has to pay and it does not have the goods.

Price variation and/or price fixing

It should also be appreciated that, unless a contract says so expressly, the fact that it becomes less profitable to perform will not constitute a force majeure event as a matter of English law. Accordingly, if the parties want to allow for price variations during the contract term, it will require a price variation clause and/or provide that the price is to be fixed by reference to an index, for example CBOT.


If the parties want to exercise the right of set-off, i.e. set off sums due under one contract against sums due under another contract, it should say so expressly. This is because, as a matter of English law, commodity sale contracts do not usually give rise to an automatic right to set off. From a commercial perspective, there is nothing more frustrating than being legally obliged to pay money when you are also owed money by the same counterparty. Accordingly, if you are entering into a contract which may entail a number of shipments or deliveries or a number of separate contracts, you may wish to consider incorporating a clause which will grant such an express right.

The current economic crisis exposes everyone in business to all nature of pressures. Whilst it is impossible to legislate for every eventuality which may arise, a well drafted contract should enable a trader to manage the risks inherent in transactions of this nature.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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