by William Panlilio
The COVID-19 pandemic that gripped the world for over two years was a phenomenon of historic proportions. Countries closed their borders, and global trade halted almost to a standstill. In 2020 and 2021 (and up to parts of 2022), the world saw reductions in trade that were not seen since World War II.
The effects of that unprecedented disruption in global supply chains continue to reverberate, including in cross-border disputes, especially in disputes arising from commodity trade finance. These disputes have started to arise in jurisdictions such as Australia, Singapore, and the United Kingdom, and are being pursued in both court litigation and arbitration.
What is commodity trade finance?
Commodity trade finance is the provision by a lender company of financing to support a commodity sales transaction where, typically, an underlying seller enters into a sales contract with an underlying buyer for the sale of any various “commodities.” These commodities are usually in the form of high-volume raw materials that are used in various production processes, and which power the global supply chain. These commodities can be many things – Ukrainian wheat, Argentinean corn, paraffin wax from China, basically, any raw material needed in many economies.
Commodity trading is a capital-intensive industry that presents its own unique risks such as payment delays and disruptions in delivery, and requires efficient and timely cashflow management, which is why many commodity traders seek commodity trade financing (both for the obvious reason of obtaining finance for the underlying trades, but also to mitigate/transfer risk).
In the usual commodity trade financing transaction, funders or lenders would extend financing typically in exchange for the receivables from the underlying commodity sales transaction. The lender would then either require the borrower to obtain trade credit insurance with the lender designated as an insured or joint insured, or the lender would obtain trade credit insurance itself. That trade credit insurance covers instances where either the underlying buyer goes bankrupt, or for various reasons, is unable to pay the invoices in the underlying commodities trade.
In the ordinary course of trade, commodities are purchased and delivered; invoices are paid; cashflow is refreshed; and premiums are paid to the insurance companies that provide trade credit insurance coverage. However, the COVID-19 pandemic caused a seismic disruption to that process.
Trade credit insurance disputes have risen.
Because of the obvious fact that the COVID-19 pandemic caused many commodity buyers to go bankrupt or unable to make timely payments on invoices (if at all), defaults in commodity trades arguably then triggered indemnification provisions in trade credit insurance policies that covered those underlying trades.
Many companies such as Insurance Australia Limited, The Bond & Credit Co., and Tokio Marine have therefore found themselves facing claims in the magnitude of several hundred millions of dollars. Likewise, companies such as Marsh, that brokered many trade credit insurance policies, have also been sued for various alleged breaches including by purportedly providing lenders incomplete or inaccurate information about the insurance policies.
The claims against insurance companies and trade credit insurance brokers will undoubtedly run into the hundreds of millions of dollars. Whilst actions have been filed in Australian and English courts, as well as in some arbitrations, these cases are likely only the start of a tidal wave of claims.
Lenders on the other hand have now found themselves at the receiving end of delay tactics by insurance companies, and even adamant refusal to make payment on the trade credit insurance policies. This is why disputes arising from trade credit insurance have increased, and will continue to rise.
Lenders and their investors should consider disputes finance.
In litigating disputes against insurers (or brokers), lenders or their investors should consider utilising disputes finance, also known as litigation or third-party funding. Disputes finance is a product where a funder assumes, on a non-recourse basis, a percentage of the financial risk of a legal claim in exchange for a share of the amount recovered.
There are a number of reasons why claimants in trade credit insurance cases, in particular, should consider disputes finance.
Firstly, litigation funders can step in and finance trade credit insurance cases where the underlying lender or its investors either do not have the capital to finance the cases themselves, or little appetite for injecting additional funds into cases connected to what are otherwise already defaulted transactions.
Even where funding may not really be needed because the claimant is not impecunious or has an otherwise healthy balance sheet, funding has the important effect of freeing up capital, affording the claimant flexibility to devote its capital to its core business of providing trade credit for commodities transactions.
Secondly, if a lender in trade finance has multiple disputes, a litigation funder can provide a portfolio solution where the trade finance lender’s cases are funded. Lenders with trade credit insurance claims could have potential cases arising out of different policies, against different insurers located in any number of jurisdictions, and subject to varying dispute resolution provisions. Those claims could be heard either in court or before an arbitral tribunal.
Trade credit insurance claims are good candidates for portfolio financing, which has the effect of reducing the cost of the financing for the lender (because a diversified portfolio of claims spreads the risk for a litigation funder).
Thirdly, funding from established litigation funders can ensure that the claimants against the insurance companies have the necessary financial backing to endure litigation where delay tactics by the insurance companies are expected. Insurance companies are likely to delay claim assessment processes by seeking endless rounds of information and documents, often rejecting claims for indemnity under the trade credit insurance policy. On top of that, insurance companies will robustly defend themselves in court to delay payment of the hundreds of millions in claims they are facing. This includes attempts to bleed claimants dry of the financial capability to litigate. The backing of an established litigation funder, in part, minimises the effects of these tactics by insurance companies.
To the extent that the presence of disputes finance is disclosed in the case, it also sends a message to respondent insurance companies that tactics seeking to capitalise on an opponent’s weak financial position are unlikely to be successful. In the usual case, funders will finance a case until its conclusion.
Fourthly, disputes finance can promote settlement. Because a funded party now has sufficient resources to litigate its claims, it can weigh any potential settlement based on its merits and the strength of its case, minimising any financial pressure to compromise. The presence of disputes finance affords a claimant more room to assess settlement on its own merits.
Finally, established litigation funders, such as Litigation Capital Management (LCM) are able to provide efficient project management. Investment Managers at LCM, by way of example, have a minimum of a decade of experience in litigating and managing complex disputes in courts and before arbitral tribunals. LCM can assist with management of costs and implementation of effective dispute strategies.
Trade credit insurance cases in courts and arbitration will only continue to rise. There are hundreds of millions of claims against insurance companies that have provided trade credit insurance coverage. Disputes finance provides crucial assistance, financial and otherwise, in litigating those claims.