Legal Problems of Countertrade

Countertrade activity has given rise to a number of public law concerns regarding its com- 16.15 patibility with competition, anti-dumping, taxation, and fair-trading principles,^[1827] as well as policy concerns over accountability when countertrade is used as a development tool.

A. The Nature and Effectiveness of the Transactional ‘Link'

For a countertrade transaction to achieve its commercial purpose, there must be an ef- 16.16 fective ‘link' between the matching, but opposite, transactions. The strongest form of ‘link' is one that arises automatically between the parties as a matter of law. An example would be the situation where there are mutual debts that arise under matching sales transactions, so that one liquidated sum will automatically reduce or extinguish the amount of the other, provided that there is the requisite mutuality between the parties. Whilst equitable set-off extends the reach of that doctrine beyond mutual liquidated debts, this type of legal ‘link' is not, however, a panacea: there are limits upon the types of claim that may be subject to an equitable set-off and the circumstances in which such a right might be asserted.

A more common (albeit weaker) form of ‘link' is one that depends upon the parties taking 16.17 action to establish it, rather than the ‘link' arising automatically. In the countertrade con­text, the ‘linking' mechanism will generally be contractual in nature.^[1828] As regards its form, there are three broad options. First, where the two sale agreements are concluded simultan­eously and the goods supplied at the same time,^[1829] each contract may contain a provision linking the supply of goods in one direction to the equivalent obligation in the other direc­tion.

16.18 Whatever the precise form of the contractual ‘link’, its content will depend upon the drafting process. At one end of the scale, the closest possible link is when the two sale contracts are made interdependent. Whilst UNCITRAL has certainly encouraged trading parties ‘to include in the countertrade agreement clauses indicating the extent of interdependence of obligations’,^[1835] care must be taken.

obviously seek to map out the nature and contents of any subsequent contract as closely as possible, a mere undertaking to enter into future transactions must inevitably represent a weaker form of ‘linkage’ than when the parties have actually entered into the matching transaction already.^[1841] Indeed, assuming that such a commitment is valid at all, the remedies for breach would only ever sound in damages, as no English court would be likely to specif­ically enforce such a framework arrangement given the need for ongoing supervision.^[1842] It is because of the relative legal weakness of such future commitments that countertrade par­ties frequently seek to strengthen their legal protection by also concluding a co-operation agreement,^[1843] by inserting a liquidated damages clause,^[1844] or by demanding a performance bond as security.^[1845]

16.19

The difficulty in drafting an effective contractual ‘link’ in countertrade transactions is high­lighted by the decision of the Court of Appeal in The State Trading Corporation of India v M Golodetz Ltd (‘Golodetz’),^[1846] which concerned a contract for the sale of 12,600 metric tons of South Korean sugar by M Golodetz Ltd (‘Golodetz’) to the State Trading Corporation of India Ltd (‘STC’) on C&F terms to an Indian Port.

16.20

Golodetz submitted its damages claim to arbitration by the Council of the Refined Sugar Association. In its turn, STC sought to rely upon Golodetz’s failure to issue the Countertrade Performance Bond as excusing its own failure to open the letter of credit. As the sale con­tract was largely silent as to the inter-relationship between the Countertrade Performance Bond and the principal letter of credit, the issue arose as to whether the former was a condition precedent of the latter, so as to excuse STC what would otherwise constitute a breach of contract. The arbitrators decided that this was not the case, as the sale contract did not expressly subject the letter of credit's opening to the existence of the Countertrade Performance Bond. Moreover, the sale contract was largely silent as to the form of the Countertrade Performance Bond, the bank at which it was to be opened, and its precise terms.^[1848] This decision was reversed by Evans J,^[1849] who concluded that ‘the obligation of [STC] to open the credit was conditional on [Golodetz] taking “appropriate steps” to ask the bank to issue the [Countertrade Performance Bond]’.^[1850] Schmitthoff has expressed his disagreement with this conclusion: given that the parties' respective obligations to open the Countertrade Performance Bond and the letter of credit were in fact to be performed sim­ultaneously, he has suggested that ‘[t]he correct answer would have been that each financial obligation was conditional on the other, and, that in the this simultaneous situation both parties were in default’^[1851]

16.21 No doubt as a consequence of this academic critique, there was a further appeal.

[The Countertrade Performance Bond] was not a condition precedent to anything under the express terms of the contract, and I can see no reason for concluding that it had this character by implication. It did not relate to the main and immediate transaction, but to another one which did not fall to be performed for a further six months. It was rela­tively unimportant in terms of money.... [T]here was no similar agreed proforma for the [Countertrade Performance Bond]. Its terms might well have required negotiation quite apart from those of the countertrade transaction itself.... STC required the [Countertrade Performance Bond] as a security to ensure that the export contract would in fact ma­terialise. But... this is not an argument in favour of treating the timeous opening of the [Countertrade Performance Bond] as a condition of the sugar contract. On the contrary, the undefined nature of the countertrade transaction may well militate against this con­tention. But in any event, the commercial significance of the [Countertrade Performance Bond] was only a matter of a relatively small sum of money.... For all these reasons I can see no basis for concluding that the sellers' obligation concerning the [Countertrade Performance Bond] had the character of a condition, let alone of a condition precedent to STC's obligation to open the letter of credit. Indeed, since the prescribed time limits for both obligations were the same, viz ‘not later than seven days after the conclusion of the

contract' in the case of the letter of credit and ‘within seven days of finalisation of import contract' in relation to the [Countertrade Performance Bond], it seems unarguable that the parties could have intended that performance of either obligation was to be a condition precedent to the performance of the other.

16.22

Given the range of differing views in Golodetz, the salutary lesson to draw is that, what­ever the nature of the contractual ‘link' between the opposite and matching transactions, its terms need to be clearly drafted, not only with respect to the content of each party's coun­tertrade obligation, but also the time-frame within which those obligations must be dis­charged, the sequence of each party's performance, and ideally the consequences of breach.

B. Certainty and Completeness

16.23

Whilst Golodetz highlights the commercial and practical consequences of failing to specify the parties' countertrade obligations with sufficient clarity in on-going barter, counter-pur­chase, and direct off-set transactions,^[1854] there may come a tipping point where the drafting failures are so extensive that they impact upon the countertrade's legal validity.^[1855] It is horn­book law that in order to constitute a valid contractual commitment, an agreement must be sufficiently certain in its undertakings, and sufficiently complete in its coverage, to be enforceable by the courts. Accordingly, vague, meaningless, or contradictory terms in a contract risk falling afoul of the former concern^[1856] and a failure to agree on essential or material matters the latter.^[1857] In the countertrade context, UNCITRAL has recognised the dangers of the commitments in countertrade operations not being held enforceable by na­tional courts and has warned about the need to ensure that the matching contract is defined closely enough.^[1858] That said, the problems are not necessarily always associated with drafting failures, but may be the product of the parties deliberately leaving matters vague, such as the quantity and type of goods to be supplied in the future;^[1859] the relative value to be ascribed to the goods passing between the parties;^[1860] and the time-frame within which the relevant goods are to be delivered. These are not mere matters of detail that can legitimately be left open, but relate to core contractual matters.^[1861]

16.24        This legal risk is apparent from the subtext in Golodetz. Whilst the appeal in that case was focused on the narrow question of whether Golodetzs obligation was a condition prece­dent to STC’s obligation, Kerr LJ was alive to the significant uncertainty in the counter­trade provision when he indicated that ‘the [terms of the Countertrade Performance Bond] might well have required negotiation quite apart from those of the countertrade transac­tion itself’.^[1862] Accordingly, his Lordship observed that counsel had ‘rightly accepted... that [Golodetz’s] commitment to the countertrade transaction might not be enforceable in law, but only as a matter of commercial morality, because a number of essential terms would clearly require negotiation and agreement, in particular the description and price of the goods to be exported’.^[1863] Given that Golodetz arguably represents the leading countertrade decision in English law, it is a matter of some concern that this fundamental issue has been left hanging in this way.

16.25        Increasingly, however, English law has recognised that commercial parties may wish to regulate their long-term relationships by concluding framework contracts that are surpris­ingly light on detail in order to maximise flexibility as the trading relationship develops.^[1864] Accordingly the English courts have shown a degree of tolerance in this regard,^[1865] no longer insisting on absolute clarity or certainty and being prepared to enforce agreements in which the details may be supplied at some future stage.^[1866] UNCITRAL has similarly expressed the desire that countertrade arrangements should be enforced by national courts, despite those transactions being relatively open-textured.^[1867] To this end, in RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Co KG,^[1868] the United Kingdom Supreme Court emphasised that, provided there is at least agreement ‘upon all the terms which [the parties] regarded or the law requires as essential for the formation of legally binding relations’, it is not fatal that ‘certain terms of economic or other significance have not been finalised’.^[1869] This approach has been endorsed by the Supreme Court even more recently in Wells v Devani.^[1870] Despite this more liberal modern approach and the English courts’ traditional reluctance to condemn commercial transactions as being too uncertain,^[1871] it is not at all clear that the contractual

‘link’ in countertrade transactions would necessarily pass the requisite legal threshold: as Golodetz highlights, without the price or the goods having been identified, there is little to enforce. Whilst the fact that the parties have acted on an alleged agreement,^[1872] or have pro­vided some objective benchmark^[1873] or machinery^[1874] to resolve any uncertainty, will point against an agreement being uncertain or incomplete, Golodetz shows that this is not an ab­solute truth. Accordingly, the mere fact that commercial persons wish to embrace contrac­tual fluidity does not per se remove the legal risk that an English court might strike down an agreement on grounds of uncertainty or incompleteness;^[1875] there comes a tipping point when doctrinal matters can no longer simply be sacrificed on the altar of commercial ex­pediency. This is not contractual paternalism, but simply the pragmatic recognition that contractual remedies will be limited in what they can achieve if it is unclear what the court is being asked to enforce. Indeed, what separates a contract from an agreement is the will­ingness of a court to deploy its judicial armoury in its support. That said, given that coun­tertrade transactions are not always concluded for purely commercial reasons, but may be concluded by state actors in order to achieve high-level development, political, or military goals, agreements may instead take the form of an international treaty (and so not be sub­ject to domestic contractual principles) or may be susceptible to sovereign immunity claims (which would take the agreement outside judicial purview in any event). Indeed, unless countertrade can provide the necessary legal certainty, it may become states alone, rather than commercial parties, that employ this mechanism in the future.

16.26

Those forms of countertrade that employ a bridging or framework structure for their sale contracts may also be susceptible to a related form of legal vulnerability, namely that the ‘link’ mechanism is nothing more than an ‘agreement to agree’ or a ‘contract to contract’. The reason for treating this as a separate concern from certainty and completeness is that an agreement can be invalidated on this ground, even if it would otherwise be sufficiently certain and complete to be enforced. For example, in the counter-purchase context, there might be a very straightforward concluded trade agreement, which contains a provision to the effect that a clearly defined matching trade transaction for specified goods at a spe­cified price will be entered into at some future date. In terms of its content and the obliga­tions created, this agreement would appear to be sufficiently certain and complete;^[1876] and yet English law has always had a deep-seated hostility to agreements to agree.^[1877] As Lord Ackner stated, in Walford v Miles,^[1878] ‘[t]he reason why an agreement to negotiate, like an agreement to agree, is unenforceable, is simply because it lacks the necessary certainty’.

16.27

That said, there seems to be an increasing recognition that any such uncertainty can be cured by inserting a provision indicating an objective standard against which the under­taking to make a further agreement can be measured, whether a standard of ‘reasonable endeavours'^[1879] or potentially ‘best efforts', or ‘best endeavours’. Even where no explicit standard is stipulated, there are growing signs that English law may finally be ready to rec­ognise the utility of good faith as a standard against which contractual performance might be measured;^[1880] if the performance of an ‘agreement to agree' can be measured against an implicit good faith standard, then these become far less objectionable. Such a notion of good faith is more likely to be implied into ‘certain categories of long-term contract',^[1881] where the parties have made a substantial, longer-term commitment to one another involving a high degree of communication and co-operation based upon mutual trust and confidence. As this category of ‘relational' contract seems apt to cover countertrade transactions, it is pos­sible that English courts in future will use notions of good faith to avoid striking down such transactions.

16.28        Alternatively, if English law were to persist in the view that all countertrade transactions (or at least certain categories) are likely to be too uncertain, it might nevertheless be possible to treat countertrade transactions as belonging to an intermediate category of arrangement that has commercial (albeit not legal) force. Examples of such arrangements include let­ters of intent^[1882] and comfort letters,^[1883] upon which commercial parties are accustomed to rely, despite such arrangements being unenforceable in legal terms. Whilst such a classifica­tion would be cold comfort to parties who are forced to litigate a dispute, analogising some countertrade transactions to comfort letters might at least explain why they operate effect­ively in the market, despite uncertainties over their legal enforceability.^[1884]

C.   Nature and Effect of ‘Blocked Accounts'

16.29        As explained above, rather than using a contractual provision or framework arrangement to ‘link' the sale contracts or the delivery obligations thereunder, the parties may seek to ‘link' the payment obligations arising under matching sales. This may be achieved by way of an express set-off arrangement: if a clause in the parties' arrangement makes clear that sums should be set-off against each other, even if English law would not ordinarily recognise such a set-off, then the courts will nevertheless give effect to that arrangement.^[1885] Such a con­tractual set-off is equally likely to be recognised abroad. Alternatively, the parties might ‘link' their respective payment undertakings through the mechanism of a ‘blocked account' into which the proceeds of any sale must be paid and out of which the funds may only be withdrawn by either party when defined conditions have been satisfied. Whilst this mech­anism is commonly used for a range of commercial transactions, care needs to be taken to ensure that the conditions for withdrawal are sufficiently clearly stated. Moreover, as it is

possible for the ‘blocked account' to be established and operated in a number of different ways, care must be taken to define the nature of the parties' rights to the account funds. For example, it is necessary to determine whether the legal title to the chose in action repre­senting the account is held in joint names or only one parties' name. In the latter case, it will also need to be determined whether the legal accountholder also holds the equitable title to the account-funds on trust for the parties (and, if so, in what proportions); whether the legal accountholder also holds the entire beneficial interest, subject to defined contractual drawing rights in favour of the other party; or whether the accountholder's rights are sub­ject to a charge or ‘flawed-asset' arrangement in favour of the other party.

16.30

Indeed, the difficulty in characterising the nature of the parties' rights under a joint- account arrangement, when it is not properly documented, was highlighted in Whitlock v Moree:^[1886] the issue concerned whether the beneficial interest in an account, which was held solely in the name of the party who had contributed all the funds, was held entirely for himself pursuant to a presumed resulting trust or was held jointly with his friend, so that rights of survivorship arose. Ultimately, the Privy Council resolved the difficulty by focusing on the parties' indications in the account-opening documents.

16.31

Even on the relatively straightforward facts of Moree, the legal issues were difficult; that is only likely to be magnified in the much more complex context of countertrade. Indeed, there are additional considerations that arise when a ‘blocked account' is used in the context of an international transaction. Where the ‘blocked account' is held with an English bank or the English branch of a foreign bank, then English law will determine whether the parties' rights are proprietary (whether arising under a trust or charge) or contractual in nature. Once one moves the account to a civilian jurisdiction, one faces the risk that an intended trust mechanism is either not respected^[1887] or morphs into a trust-like concept, such as the fiducie in French Law. Whilst none of this is insurmountable with careful thought about the nature of the parties' rights and the location of the account, there could be significant insolvency consequences of not paying sufficient attention to such issues from the outset.

D.   Choice of Law Issues

16.32

Besides the concerns relating to the nature and validity of the ‘link' mechanism in counter­trade transactions considered above and the issue of whether any disputes should be sub­mitted to arbitration or judicial determination (and, if so, where),^[1888] there may also be real choice of law difficulties. Some of the issues are likely to relate to the proper characterisation of the ‘link' mechanism in question for choice of law purposes. This was already considered above in relation to ‘blocked accounts', which can take a number of different juridical forms. Once the transaction has been properly characterised,^[1889] there are three particular choice of law issues that may arise in the countertrade context depending upon the nature of the ‘link’ employed.

16.33        First, where the ‘link’ between the sale contracts is contractual in nature (as in the case of a framework agreement), most of the difficulties in this area could be cured by the simple ex­pedient of expressly choosing an applicable law.^[1890] Given that each party will wish its own law to govern the transaction, it may not be possible to choose a law that governs each sale contract, as well as the bridging, framework or ‘link’ arrangement.^[1891] Accordingly, it is not beyond the realms of possibility that no law will have been chosen for all or some of the rele­vant transactions, or even that each independent transaction is governed by a separate law.^[1892]

16.34        As the various contractual relationships are by definition ‘linked’, one issue concerns the extent to which the law applicable to each independent contract does or should ‘infect’ that applicable to other contracts. Whilst the common law was prepared to submit related con­tracts to a similar legal system when the link in question was particularly close (as in the case of a performance bond and counter-guarantee),^[1893] it was certainly not the automatic judi­cial response and there had to be a clear commercial justification for subjecting the various contracts to a single law.^[1894] The English courts unsurprisingly continued the same broad ap­proach under the Rome Convention when determining the applicable law in the absence of choice: the presumptively applicable law under article 4(2) would be displaced under article 4(5), so that all networks of contracts, even those characterized as ‘autonomous’, tended to be subjected to a single law.^[1895] As recognised by the European Court of Justice,^[1896] the com­mercial imperative for subjecting contractual networks to a uniform law did not alter when the Rome Convention was introduced; nevertheless, the difference in structure between the choice of law principles at common law and under the Rome Convention did sometimes result in the English courts taking their willingness to displace the presumptively applic­able law too far.^[1897] Whilst article 4 of the Rome I Regulation^[1898] now makes clear that the presumptively applicable law should not be displaced on a whim, but only when there is a ‘manifestly’ more closely connected legal system,^[1899] it is clear that such displacement is still likely to occur when there is a contractual network (albeit potentially less frequently than under the Rome Convention).^[1900] Indeed, Recital 20 of the Rome I Regulation states

that ‘account should be taken, inter alia, of whether the contract in question has a very close relationship with another contract or contracts’. For obvious reasons, this possibility has particular relevance to countertrade involving ‘linked’ transactions: in the absence of any clearly expressed choice that different parts of the contractual network should be governed by different laws, there is a real risk that they will all be subjected to some uniform law. Accordingly, countertrade parties should think carefully about the choice of law implica­tions of ‘linking’ their otherwise independent transactions.

16.35

Secondly, where the relevant ‘link’ involves a set-off between the parties’ payment ob­ligations, the contractual choice of law principles discussed above may also potentially be significant. According to article 17 of the Rome I Regulation, ‘[w]here the right to set-off is not agreed by the parties, set-off shall be governed by the law applicable to the claim against which the right to set-off is asserted’. This suggests that the parties are free to choose the law applicable to any set-off, although it is not clear how this possibility will assist countertrade parties who are at odds over the law governing their relationship more generally. Where there is no express choice, article 17 provides that the law applic­able to the set-off is the same as that applicable to the underlying right; but, where two contractual claims governed by different laws are set-off against one another, article 17 will be difficult to apply, as the law applicable to the set- off ought not be determined solely by the identity of the party asserting the right of set-off. Otherwise, the set-off would be governed by the law of whichever party raised the argument first. Accordingly, an English court will likely fall back onto determining ‘the country with which [the contract] is most closely connected’ under article 4(4) of the Regulation. The uncertainty regarding how the Rome I Regulation applies to set-off, however, undermines countertrade transactions employing such a ‘linking’ device.

16.36

Thirdly, if the parties choose to ‘link’ their transaction through a ‘blocked account’, the dif­ferent possible characterisations of the account (as considered above) may alter the law ap­plicable to its operation. Where a party’s rights take the form of drawing rights or a ‘flawed asset arrangement’ over the account, the existence and scope of those rights is likely to be determined by the law applicable to the contract under which those rights were granted; whereas the enforceability of those rights against the bank in question will be determined by the law applicable to the account contract.^[1901] Where a party is granted a charge or some other form of security over the account, its validity, scope, and enforceability will similarly be determined by the law applicable to the account contract. Where a trust has, however, been created over the ‘blocked account’, the beneficiary’s rights under that trust will be gov­erned by the law chosen by the settlor,^[1902] or, in the absence of choice, by ‘the law with which a trust is most closely connected’.^[1903] In making that determination, a court should examine the place for the trust’s administration designated by the settlor, the situs of the trust assets, the trustee-bank’s place of business, and the place where the trust’s objects are to be fulfilled. These factors may point to the law applicable to the account contract, but that is not neces­sarily the case.

IV.