Marine Trade S.A. v Pioneer Freight Futures Co Ltd BVI  EWHC 2656 (Comm)
This case provides the inaugural UK decision on the application of Section 2 (a)(iii) of the
ISDA Master Agreement (MA) 1992. The High Court would determine two points:
(1) the provision was applicable to lawfully suspend payment.
(2) the potential for payment made under protest could be recovered on the grounds
The judgement can be found here.
Between May 2007 and September 2008, Marine Trade S.A. and Pioneer Freight Futures
entered into 14 forward freight agreements (FFA’s), a type of contract designed to aid ship
owners, charters, and speculators in hedging against fluctuations of freight rates. These
agreements fell under the governance of the 1992 ISDA MA from April 16th, 2008. During
the latter part of 2008, the freight market was subject to a significant downturn, leading to
notable disparities between the contracted (FFA) rates and settlement rates. As a result,
each FFA was substantially ‘in-the-money’ for whomever was the selling party. By the end of
January 2009, Pioneer found itself in a fortunate position, with net settlement sums totaling
just over $5 million in their favour.
As of the end of January 2009, Marine Trade held the belief that Pioneer had been subject
to an event of default according to Section 5(a)(vii). They interpreted the agreement in a
manner that disallowed netting, prompting them to demand just over $7 million from Pioneer
on January 30th, citing Pioneer’s default. Conversely, Pioneer invoiced Marine Trade for the
owed $5 million, reflecting the net balance of the forward agreement, on February 1st. While
the payment deadline was set for the 6th of February, Marine Trade attempted to utilise
Section 2(a)(iii) as a basis to withhold any obligations owed to Pioneer. Commonly referred
to as the ‘flawed asset’ provision, this clause outlines a condition precedent for both parties.
It requires the absence of an ongoing or potential event of default as well as no designation
of an early termination date. This provision facilitated the lawful suspension of payments to a
defaulting party in the Australian decision of Enron v TXU.
Despite Marine Trade’s suspension of payment, an action deemed an event of default, they
persisted in arguing their side. However, they feared that Pioneer’s position might be valid
and thus grant them the ability to initiate early termination under Section 6 (a), leading to
substantial compensation for Pioneer. Marine’s effort to secure an injunction to prevent this
was denied due to the potential impact on their cash flow. In retaliation, Marine Trade issued
their own notice to Pioneer under Section 5(a)(i) on February 17th.
To avoid potential liability should Pioneer’s claim succeed, Marine Trade chose to pay the $5
million net balance to Pioneer, even though the deadline had passed. This payment,
however, was accompanied by the clear assertion that it was made under protest, based on
Marine Trade’s belief that such a sum was not legitimately owed, and their intention was to
pursue its recovery.
Issue One: The initial significant concern revolved around whether Pioneer fell under an
Event of Default according to Section 2(a)(iii).
Issue Two: The subsequent issue centred on whether Marine Trade was also subject to an
event of default. Pioneer contended that Marine Trade entered default status around April or
May 2009. This position would have relieved Pioneer of the obligation to pay the $7 million
resulting from accepting their own default event, or at least suspended it until Marine Trade’s
default was resolved. Should this prove accurate and Pioneer gained the authority to set an
early termination date, regardless of the payment’s status, the repercussions for Marine’s
reputation alone would have been substantial – even if the legitimacy of such an event was
Issue Three: The final issue concerns Marine’s potential to recover the payment they made
while protesting the net aggregate settlement sums, assuming Pioneer did indeed fall under
an event of default. Marine Trade attempted to utilise the principle of mistake to reclaim their
losses which is something of a stretch given their earlier assertion that the payment was
being made under protest.
Addressing Issue One, simply, yes Pioneer did fall under an event of default and as a result
Marine could rely on Section 2(a)(iii) to essentially absolve themselves from an obligation to
pay. In obiter, the court observed that the 1992 ISDA MA did not explicitly indicate that the
termination of an event of default would automatically reactivate Marine’s payment
obligation. The court’s interpretation of Section 2(a)(iii) viewed it as a ‘one-time’ provision: if
the specified conditions aren’t met on the obligation’s due date, that obligation becomes
Concerning Issue Two, the court concluded that Marine Trade’ was not affected by an Event
of Default related to the February 6th settlement, which Pioneer eventually accepted.
Despite Pioneer’s argument that Marine became subject to a bankruptcy event under
Section 5 (a)(vii)(2) in April/May 2009, the lack of a default event on February 6th meant
Pioneer still had an obligation to fulfil that debt. Consequently, Flaux J maintained that the
conditions on the due date weren’t met for this event, rendering the payment unnecessary
and effectively cancelling it.
Turning to Issue Three and the potential recovery of the payment made under protest, the
court rejected this possibility. The payment was made to avert the risk that Pioneer was not
subject to an event of default and the resulting entitlement to a substantially larger sum. The
court deemed this incompatible with Marine’s attempt to utilise the concept of “mistake”. As
a result, their restitution claim was dismissed, with Flaux J asserting that no genuine
operative mistake existed.
Application and Significance
Clarity was provided that payment made under protest could, unsurprisingly, not be
recovered on the ground of mistake.The effect on the enforceability of Section 2 (a)(iii) bears
greater importance. In providing legal support for this provision, it would likely further
discourage a non-defaulting party from designating an early termination date and wrapping
up the agreement. This is because for as long as the counterparty’s event of default
persisted they were not obliged to pay anything. If such a date is subsequently appointed,
any payments withheld under Section 2 (a)(iii) factor into determining, and thereby likely
increasing the Section 6 (e) compensation owed.
Ultimately, the judgement provided the non-defaulting party with two choices: (1) set an early
termination date and pay their counterparty a significant sum or (2) suspend performance
and avoid payment for as long as their counterparty’s event of default persists. Thus, this left
a seemingly clear choice for the non-defaulting party which was considerably in their favour.
This can be contrasted with the US decision in Metavante which also left two options, yet both of these required payment, either in the form of continuing the agreement or through
designation of an early termination date after a reasonable time. Subsequently, the power of
this provision would eventually become limited as a result of the 2014 amendment which
would place a 90 day timeframe on setting an early termination date. Whilst the introduction
of margins would further limit this provision’s significance this judgement’s importance lies in
the UK’s interpretation of the provision giving it such influence in the first place.