Navigating Trade Wars: Perspectives from Australia

Insolvency Risk

During the previous US-China trade war, a large number of Chinese businesses were forced to either drastically alter their operations, by moving production and assembly abroad (to places like Vietnam, Malaysia or Cambodia), or to file for bankruptcy due to the impact of tariffs and the additional costs of doing business. For example, China’s largest importer of soybeans, the Shandong Sunrise Group, was forced to file for bankruptcy in 2018, due to a combination of a 25 percent retaliatory tariff and policy changes introduced by the Chinese government aimed at reducing the import of US soybeans.

Whilst global trade wars may appear to create opportunities for third parties such as Australian exporters to profit from selling non-tariffed goods with the opening up of new markets (as discussed in our third insight), there is however, an increased risk of insolvency for Australian customers and importers of tariffed goods.

Another risk for Australian commodity companies is demonstrated by the fact that whilst, as of the date of this article, it is currently 20 percent more expensive to import Chinese manufactured goods (which use Australian raw materials) into the US, President Trump has threatened levies as high as 60 percent on Chinese products. As such, there is a clear possibility that we will see a decrease in demand for Chinese manufactured goods, with an increased risk of credit issues and insolvency of importers.

Recent history has taught us that commodities and shipping clients may experience the following problems with insolvent importers:

1. As with any financially impecunious commodity purchaser, there is a risk that they will default on the underlying sales contract, as they are: a) unable to fulfil their payment obligations in respect of the goods; or b) have breached another term of the contract (by becoming insolvent or filing for bankruptcy).
    
2. As credit lines start to tighten and large import tariffs need to be paid, commodity sellers can find themselves in a position where goods have been shipped, but there is no payment security in place as a result of changes in the commercial bargain and the increased strain on a buyer’s cashflow, as highlighted in our third insight. In such situations, a seller/shipper may not be willing to deliver the goods to the receiver who has not yet paid, which can lead to a delay in the vessel being called into port. In the case of The MV “YANGTZE XING HUA”[2], which we discuss further below, the charterers ordered the vessel to wait off the discharge port for a period of over four months as they had not been paid for the cargo.
    
3. Historically, claims have then been brought against shipowners for deterioration and/or cargo damage, which the shipowner will likely try and pass on through the charterparty chain to the FOB Buyer/CIF Seller. This is, of course, however, subject to any provision within the sale contract which sets out who is responsible for the deterioration of cargo and/or delays in transit, such as a demurrage clause (as discussed in our third insight).
   
   The MV “YANGTZE XING HUA” concerned an appeal by the charterers of the vessel, who sought to challenge the decision of an arbitration award that it bore 100 percent of the cargo claim brought by the shipowners under the NYPE Inter-Club Agreement 1996 (ICA). The appeal was dismissed, with the court upholding the tribunal’s decision that the shipowners were not to blame for the damage by not monitoring the cargo. Instead, the cause of the damage was a combination of the inherent nature of the cargo, together with the ‘act’ of the charterers falling within clause 8(d) of the ICA, in ordering the vessel to wait for a prolonged period at the discharge port. Accordingly, charterers (qua shippers/exporters) had to bear responsibility for the cargo damage claim.
    

4. The delay in the vessel being called into the port also heightens the chances of demurrage, and as discussed in our first insight, will then force shipowners to consider whether the charter has automatically come to an end as a result of frustration.

Letter of Credit issues

As commodity sellers will be alive to counterparty risks, parties often only ship goods after a Letter of Credit (L/C) has been opened. With the unpredictability of the imposition of tariffs and financial uncertainty of their counterparts, it will be particularly important for shipping and commodities clients to ensure that they can comply with all requirements in any L/C issued in respect of a sale.

Whilst an importer/buyer will have opened an L/C in favour of the seller for the agreed sale value, the issue now, however, is that the importer/buyer will have to pay an additional percentage by way of tariff, for the goods to be imported and discharged.

The importer will usually make payment to the issuing bank through a subsequent sale of the commodity, or the final product which used the raw material (a “self-liquidating” facility). However, if the importer cannot sell the tariffed goods quickly enough or becomes insolvent and cannot make payment due to the financial impact of tariffs, the issuing bank will have to cover the purchase and may have no guarantee of repayment.  In such circumstances, an issuing bank may look to bring a misdelivery or other claim to recover its losses or avoid making payment in the first place.

It is therefore crucial for shipping and commodities clients to ensure that the L/C can be complied with, as the issuing bank is going to look for discrepancies, either in the L/C terms itself, or in the presentation of the documents, if they have a concern that their customer (the applicant) cannot comply with the terms of the credit they have opened, due to their obligation to pay additional levies/taxes prior to importing the goods.

Conclusion

A major issue in a global trade war is guaranteeing the financial certainty of your counterparty, particularly if that counterpart is in a country affected by US tariffs.  

Accordingly, whilst Australian exports to China may not be the subject of direct tariffs, history has taught us that the implications for commodity sellers and shippers could still be substantial, as tariffs will have a substantial knock-on effect on businesses in any export-driven economy.

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