Contract frustration claims from virus likely to lead trade credit losses: Kennedys

The Covid-19 pandemic will deliver insured losses in the trade credit market, mainly from falling commodity prices, increased governmental intervention and rising insolvencies of businesses that do not have enough capital to withstand enforced closedowns or supply chain disruptions, according to the insurance team at law firm Kennedys in Singapore. The team, led by Julian Wallace, warns insurance company claims handlers that they must understand the insurers’ timing requirements for political risk and trade credit claims, because such timing requirements vary by policy. “Although political risk and credit policies typically provide for insurers’ liability to be deferred until a specified ‘waiting period’ has expired, many such policies contain prescriptive timetables for the adjustment of the claim, including requests for further information and the provision of a coverage determination,” the team points in a recently issued note. The Singapore-based lawyers say claims could emerge under contract frustration policies in particular. Contract frustration insurance covers the risk of default under contracts with sovereign entities and state-owned obligors. The coverage is for non-payment and non-delivery by the obligor and can cover risks such as licence cancellation, import and export embargo, and non-certification of invoices. They point out that the contract frustration market, both in Singapore and elsewhere, sustained heavy losses following the crash in commodities prices between 2014 and 2016. At that time, many emerging market governments, particularly in sub-Saharan Africa, which were heavily dependent on revenues earned from the sale of commodities, started to default on their contractual obligations. National budgets shrank and governments prioritised essential services over projects financed by international investors. This led to a failure to meet payment obligations for those projects, explained the team. “The sharp contraction in demand caused by the pandemic, initially from China but now from western economies as well, has led to another slump in commodities prices. The situation has been exacerbated by Saudi Arabia’s decision to increase oil production at a time of falling demand, which has led to a collapse in oil prices from about $60 per barrel in January 2020 to less than $20 per barrel in April 2020,” points out the Kennedys team. The International Energy Agency (IEA) warns in a recent report that the collapse in oil prices threatens to cut the revenues of oil-producing states such as Ecuador, Iraq and Nigeria by between 50% and 85%. Nigeria’s economy is less prepared to tackle a “price shock” than five years ago, because per capita GDP had shrunk by almost a third, says the IEA. The Kennedys team points out that the single-situation credit market also saw a large number of claims following the 2014-2016 commodities crash from commodities traders and banks, following defaults under contracts with local traders and commodity producers. The steel sector in India and the UAE was particularly hard hit. “We would again expect to see pressures in those sectors as companies struggle to cope with the impact of the demand shock and falling prices prompted by the Covid-19 pandemic,” the Kennedys team observes. Singapore has been by no means immune to the crisis and subsequent dramatic fall in commodity prices, says the Kennedys team. One of Singapore’s biggest oil traders, Hin Leong Trading, collapsed in April and this in turn threatened a severe liquidity crunch in the city-state’s commodities sector. The company admitted to $800m in undisclosed losses, as well as the sale of pledged collateral, and is now the subject of a police investigation. It is the second high-profile insolvency of a Singapore commodities trader in recent months, with Agritrade International also being accused of fraud by at least 20 banks following its collapse in February 2020. “As governments around the world take a more interventionist role in regulating commercial activity, we may also see an increase in claims under contract frustration and other political risk policies for losses arising from import or export embargos or other government measures that prevent the performance of contracts,” states the note. “For example, in China the government responded to the disruption to trade and supply chains by issuing force majeure certificates to Chinese companies to protect them from liabilities arising from their inability to perform contractual obligations. This has had knock-on consequences for traders supplying commodities to China and for their contracts with mining companies,” the lawyers state. Trade credit insurers are also expecting an uptick in claims activity, warns the Kennedys Singapore team. “Despite aid packages for business announced by various governments around the world, it is expected that the shutting of service and manufacturing operations as a result of the pandemic will lead to a steep rise in insolvencies and, in turn, claims under trade credit insurance policies,” they add. The timing issue is critical for claims handlers, according to the team. “We have seen policies issued to banks in which the insurer is required to notify the insured within as few as 14 days if it requires further information in connection with its review of the claim, and to notify the insured of its coverage determination within 30 days after receipt of the claim or, if later, 14 days after receipt of any requested information. If the insurer fails to request information relevant to the claim within the specified timeframe, it may be at risk of waiving its rights to investigate the claim,” the lawyers point out. To ensure no rights are waived, it is important for claims handlers immediately to review and diarise the policy’s relevant deadlines, advise the Kennedys lawyers. “When faced with tight timescales, the insurer should consider appointing a loss adjuster as soon as possible. If potential coverage or validity issues are already apparent from an initial review of the claims materials, then it may be necessary for the insurer to impose a reservation of rights in order to protect its position,” they state. Claims handlers also need to review the policy wording carefully to familiarise themselves with the scope of the cover under the insuring clause and any potentially applicable exclusions, conditions or warranties, they add. For example, contract frustration and credit policies typically contain exclusions, warranties or conditions that seek to protect the insurer’s position if the underlying transaction turns out to be illegal or unenforceable, or if the insured has acted in breach of local laws. “It can, therefore, be important to check whether, under the laws of the host country, the insured contract was properly authorised by the relevant government officials or parliamentary bodies. If it was not and the insurers proceed to pay the claim, this could adversely affect their ability to make recoveries if and when they and/or the insured seek to enforce the debt,” the Kennedys team notes. Contract frustration and credit policies will also often contain “disputes exclusions” that suspend the insurers’ liability under the policy until any dispute between the insured and the obligor in relation to the insured debt has been settled or resolved in the insured’s favour. “Accordingly, it is always important to investigate whether the debt is disputed by the obligor and to obtain full details from the insured on the nature of any such dispute,” the lawyers add. “Given the scope of the potential economic impact of the Covid-19 crisis, insurers and claims professionals may face unique and challenging claim scenarios. As always, preparation and timely investigation will be key,” concludes the team.

Contract frustration claims from virus likely to lead trade credit losses: Kennedys

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