Legal Rights and Remedies in FFA Disputes: Managing Market Volatility

1. When Market Volatility Overtakes Counterparty Expectations: Legal Rights and Remedies in FFA Disputes Bruce G. PaulsenSeward & Kissel LLPOne Battery Park PlazaNew York, New York 10004(212) 574-1200 Shipping 2009 ● Connecticut Maritime Association ● March 25, 2009

2. The Economic Context Daily Chart For Cape/Panamax/Handy4 TC AVERAGE Values (March 2004-March 2009) Source: DryShips Inc., Daily Market Report, http://www.dryships.com/pages/report.asp (last visited Feb. 28, 2009).

3. Forward Freight Agreements Are Freight Derivatives A Forward Freight Agreement is: A forward swap agreement Fixing the parties’ obligations to buy or sell at dates in the future A derivative financial instrument Referencing prevailing shipping rates and routes (e.g., BPI, BCI, BHMI) An individually negotiated contract Although facilitated by the members of the Forward Freight Agreement Brokers’ Association (FFABA), it is a principal-to-principal transaction That means counterparty risk A maritime contract Brave Bulk Transport Ltd. v. Spot On Shipping Ltd., 2007 U.S. Dist. LEXIS 81137 (S.D.N.Y. Oct. 30, 2007) A risk management tool

4. Connecting Ship Owners and Merchants (Alongside Speculators) • Forward Freight Agreements lock in the future price to ship goods over a certain trade route for a certain number of days. • The agreement protects the parties against the price of shipping going up (or down) in the future, depending on which side of the contract the parties are on, as Buyer or Seller.

5. Connecting Ship Owners and Merchants (Alongside Speculators) Forward Freight Agreements lock in the future price to ship goods over a certain trade route for a certain number of days. The agreement protects the parties against the price of shipping going up (or down) in the future, depending on which side of the contract the parties are on, as Buyer or Seller. FFAs are cash-settled Speculators may exist alongside hedgers, betting on the market and divorced from any physical position.

6. Connecting Ship Owners and Merchants (Alongside Speculators) Forward Freight Agreements lock in the future price to ship goods over a certain trade route for a certain number of days. The agreement protects the parties against the price of shipping going up (or down) in the future, depending on which side of the contract the parties are on, as Buyer or Seller. FFAs are cash-settled Speculators may exist alongside hedgers, betting on the market and divorced from any physical position. Unhedged volatility or bad bets can lead to default or bankruptcy – and in both of those cases, to disputes under an FFA.

7. Elements of a Typical FFA: FFABA 2007 Terms • Parameters of the Trade • Contract Route(s), Contract Rate, Contract Quantity, Contract Month(s)

8. Elements of a Typical FFA: FFABA 2007 Terms • Settlement Procedures Fix the Parties’ Obligations (i.e., who pays?) • Settlement Dates, Settlement Rate, Settlement Sum

9. Elements of a Typical FFA: FFABA 2007 Terms • Payment Procedure and Obligations

10. The ISDA Ground Rules • The FFABA 2007 Terms constitute and incorporate by reference the detailed provisions of the 1992 ISDA Master Agreement (Multicurrency – Cross Border) (without Schedule), with specific modifications and elections:

11. Declaring an Event of Default On Failure To Pay A Four Step Process… Failure to pay the Settlement Sum On the later of (a) two (2) London business days after presentation of an invoice or (b) five (5) London business days after the Settlement Date (the last Baltic Exchange Index publication day of each Contract Month). Notice of Failure to Pay; Cure Period Under Section 5(a)(i) of the Master Agreement, failure to pay ripens into an Event of Default after notice of such failure is given and three business days have passed without remedy. Notice of Event of Default; Fixing of Early Termination Date Upon a continuing Event of Default (i.e., continued non-payment), the Non-defaulting Party has the option to declare an Event of Default and give between 1 and 20 days’ notice to fix an Early Termination Date as to all outstanding Transactions. Calculation of Loss; Fixing of Damages Loss is measured on the Early Termination Date and for all outstanding Transactions (e.g., all FFAs) between the parties.

12. Declaring an Event of Default On Failure To Pay A Four Step Process… Failure to pay the Settlement Sum On the later of (a) two (2) London business days after presentation of an invoice or (b) five (5) London business days after the Settlement Date (the last Baltic Exchange Index publication day of each Contract Month). Notice of Failure to Pay; Cure Period Under Section 5(a)(i) of the Master Agreement, failure to pay ripens into an Event of Default after notice of such failure is given and three business days have passed without remedy. Notice of Event of Default; Fixing of Early Termination Date Upon a continuing Event of Default (i.e., continued non-payment), the Non-defaulting Party has the option to declare an Event of Default and give between 1 and 20 days’ notice to fix an Early Termination Date as to all outstanding Transactions. Calculation of Loss; Fixing of Damages Loss is measured on the Early Termination Date and for all outstanding Transactions (e.g., all FFAs) between the parties.

13. Declaring an Event of Default On Failure To Pay A Four Step Process… Failure to pay the Settlement Sum On the later of (a) two (2) London business days after presentation of an invoice or (b) five (5) London business days after the Settlement Date (the last Baltic Exchange Index publication day of each Contract Month). Notice of Failure to Pay; Cure Period Under Section 5(a)(i) of the Master Agreement, failure to pay ripens into an Event of Default after notice of such failure is given and three business days have passed without remedy. Notice of Event of Default; Fixing of Early Termination Date Upon a continuing Event of Default (i.e., continued non-payment), the Non-defaulting Party has the option to declare an Event of Default and give between 1 and 20 days’ notice to fix an Early Termination Date as to all outstanding Transactions. Calculation of Loss; Fixing of Damages Loss is measured on the Early Termination Date and for all outstanding Transactions (e.g., all FFAs) between the parties.

14. Declaring an Event of Default On Failure To Pay A Four Step Process… Failure to pay the Settlement Sum On the later of (a) two (2) London business days after presentation of an invoice or (b) five (5) London business days after the Settlement Date (the last Baltic Exchange Index publication day of each Contract Month). Notice of Failure to Pay; Cure Period Under Section 5(a)(i) of the Master Agreement, failure to pay ripens into an Event of Default after notice of such failure is given and three business days have passed without remedy. Notice of Event of Default; Fixing of Early Termination Date Upon a continuing Event of Default (i.e., continued non-payment), the Non-defaulting Party has the option to declare an Event of Default and give between 1 and 20 days’ notice to fix an Early Termination Date as to all outstanding Transactions. Calculation of Loss; Fixing of Damages Loss is measured on the Early Termination Date and for all outstanding Transactions (e.g., all FFAs) between the parties.

15. What Are My Damages? • Under FFABA 2007 and the Master Agreement,there are several considerations: • Bilateral Netting • Netting for all outstanding Transactions between two parties; multiple Transaction netting is allowed • Mitigation • Generally by reference to prevailing market prices • Dampskibbelskabet ‘Norden’ A/S v. Andre & Cie SA, [2003] EWHC 84 (Comm) (30 January 2003) • Set-off • Or, other reasons to withhold payment. A matter of English common law arising only upon Early Termination. • Interest • “One month USD-LIBOR plus 2%, reset daily and compounded monthly.” • Attorneys’ Fees • Attorneys’ fees and expenses are generally recoverable under English law. • All payments and the Termination Currency are set to U.S. Dollars

16. Avoiding (U.S.) Bankruptcy Proceedings • “Automatic Early Termination” Applies • In the event of certain bankruptcy-related Events of Default, all outstanding Transactions are automatically accelerated and an Early Termination Date is immediately set. • FFA parties are therefore pre-petition creditors with a fixed amount owed immediately prior to the filing of a U.S. bankruptcy proceeding. • FFAs are “swap agreements.” Payments made (or assets attached) in connection with FFAs and prior to the bankruptcy filing cannot be avoided as preferences under the Bankruptcy Code. • It was not always this way…

17. The Saga of Section 546(g)Or, Attaching Assets Prior to Bankruptcy Proceedings“Under” (And/Or) “In Connection With” FFAs • In re Interbulk, Ltd. (Interbulk, Ltd. v. Louis Dreyfus Corp.), 240 B.R. 195 (Bankr. S.D.N.Y. 1999) • Dreyfus attached assets prior to the bankruptcy filing; the Debtor sought to avoid the transfer as a preference • At that time, Section 546(g) read: • “…the trustee may not avoid a transfer under a swap agreement, made by or to a swap participant, in connection with a swap agreement and that is made before the commencement of the case…” • In re Casa de Cambio Majapara S.A. de C.V. (Casa de Cambio v. Wachovia Bank, N.A.), 390 B.R. 595 (Bankr. N.D. Ill. July 9, 2008) • Wachovia attached assets prior to the bankruptcy filing; the Debtor sought to avoid the transfer as a preference • Following amendments to the Bankruptcy Code, Section 546(g) now reads: • “…the trustee may not avoid a transfer, made by or to a swap participant or financial participant, under or in connection with any swap agreement and that is made before the commencement of the case...” • Conclusion: Courts should view pre-bankruptcy attachments of assets in connection with FFAs as “transfers in connection with a swap agreement” which should not be avoidable as preferences in U.S. bankruptcy proceedings.

18. International Complexities • AWB (Geneva) SA v. North America Steamships Ltd. [2007] EWCA Civ 739 (18 July 2007) • Trustee commenced Canadian restructuring proceedings under Canada’s Companies’ Creditors Arrangement Act (CCAA), and sought to enforce payments due under FFAs, despite the Debtor’s prior failure to pay and insolvency. • Non-defaulting Parties to the FFAs: • (1) sought to invoke the “Exclusive Jurisdiction” provision of the FFAs – that these contracts should be governed by English law, and that the Canadian proceeding was absolutely invalid – and • (2) sought to determine the effectiveness of the FFAs under English law. • Held: (1) The insolvency proceedings could go forward and were not barred by the exclusive jurisdiction provision; but (2) the English courts could properly rule on the effectiveness of the FFAs. • Outcome? Settlement. • Takeaway? Be aware of the risks arising from international legal regimes and complexities. Different jurisdictions have different insolvency and netting regimes.

19. Alternatives -- Clearing Systems: Multilateral Netting As an Alternative To Bilateral Disputes • Individually-negotiated FFAs traded OTC allow for bilateral netting, but not multilateral netting • Lack of assignability can be a stumbling block: • Effect of this clause is that Assignment of a claim can technically only occur following an Event of Default and fixing of the amount owed as of the Early Termination Date, absent contrary agreement. • Since October 2008, stresses in the dry bulk market have led NOS Clearing ASA to offer a multilateral netting service in order to match and close out trades to ease pressure on the market. • In December 2008, NOS reported that “40 participants delivered 512 trades to the service, and the netting effect was USD 512 million. Instead of financing USD 600 million, only USD 88 million was needed to settle the contracts.” • Most recently, Lloyd’s List reports more than 90% of FFAs are now settled using clearing houses, whereas a year ago OTC trades made up approximately half of the FFA market. There has been a corresponding drop in use of the netting facility in January 2009. Source: NOS Clearing ASA, General News, http://www.nos.no/general-news/category619.html (last visited Mar. 5, 2009). Source: Lloyd’s List, January Derivatives Netting Down 94%, Feb. 23, 2009, at 12.