As more players enter the LNG market, it is increasingly likely that an LNG Master Sale and Purchase Agreement (MSPA) will land on your desk sooner or later. MSPAs can be intimidating at first glance and it is helpful to have some guidance.
This client alert provides a brief introduction to LNG MSPAs, outlines their key provisions and identifies issues to look out for. It is aimed at in-house lawyers and specialist negotiators who are new to the LNG market.
Nature of an LNG MSPA
An MSPA is a long and complex framework agreement agreed between two parties. It sets out all the terms which apply to LNG sales and purchases between them. Parties are not bound to enter into any transactions by virtue of signing an MSPA alone. The benefit of agreeing an MSPA up front, is that each time the parties wish to agree a trade, the bulk of the work (from a legal perspective!) has already been done and the parties can focus on the commercial terms.
When a trade is agreed, the commercial terms and any deviations from the MSPA terms are set out in a Confirmation Notice (CN). The CN will expressly incorporate the MSPA terms – see more below on the CN.
Although various trade bodies and organisations have attempted to provide standardised MSPAs for the market to use, uptake is low. Most market participants will prepare their own preferred form of MSPA and then seek to agree terms with each counterparty. Arguably, there are three main categories of MSPAs which you may come across, each of which deal with different scenarios:
- Trader MSPA – these are bilateral documents which are usually balanced between buyer and seller. Parties are generally prepared to both buy and sell under the same agreement. Caution should be had if a counterparty presents different forms depending on whether it is a buyer or seller – such versions are usually biased in favour of your counterparty;
- Producer/Consumer MSPA – these are typically one sided, and can be of a more technical nature as they can deal with the specifics of the ports involved. Governing law is likely that of the country in which the LNG facility is located; and
- Tender MSPA – these are usually a hybrid of the two above, they are more akin to the trader MSPA but will commonly bake in specifics relating to the tendered cargos. Going a step further, if a party has a long term off take arrangement with a producer, then the form of tender MSPA will likely mirror that agreement to allow the parties to be back-to-back. This is the case even if you already have a trader MSPA in place with that counterparty.
Both producer/consumer and tender MSPAs are usually presented as a take it or leave it agreement whereas trader MSPAs are usually negotiated.
The Key Clauses
An MSPA is typically split into several different sections:
- Main body of key clauses and boilerplate;
- Delivery schedules (DES/DAP and FOB);
- Measurement and testing schedule; and
- Annexes – confirmation notice format, credit support templates.
The key clauses common to all MSPAs (no matter the form or counterparty type) are considered briefly below:
When parties agree a transaction, they both sign a CN which sets out the commercial terms of the deal and will sometimes contain additional legal provisions. In the case of an inconsistency between the CN and the MSPA terms, the terms of the CN will prevail. As such, it is always essential that the CN is reviewed thoroughly. Parties will frequently use the CN to amend the MSPA terms (for that deal only).
Failure to Deliver/Accept
The failure to deliver/accept provisions of an MSPA are always negotiated and there can be big differences between contracts. This is an area to keep an eye on in the context of back-to-back risk when trading in a string.
Recognising that a failure to deliver/accept may be due to operational constraints and is not necessarily indicative of anything more sinister (such as looming insolvency), MSPAs do not consider such a situation as an event of default. Instead MSPAs always contain a contractual mechanism which sets out the practical steps which should be taken to remedy the situation, and how costs should be allocated.
Typically the provisions allow the relevant party to either go out into the market and sell (if the buyer has failed to accept) or purchase (if the seller has failed to deliver) a cargo of LNG to/from a third party. Any costs/losses associated with that transaction are then passed on to the party which failed to perform. Parties tend to negotiate what loses are recoverable, what should happen if a replacement sale/purchase cannot be made or if a replacement is made and that trade is in the money – i.e. should any gains made be passed on or split?
It is vital that LNG meets the contractual quality specified in the CN. If off-spec LNG is injected into an LNG facility or LNG ship, it can have serious consequences and remedial costs can be large. The mechanics dealing with quality issues are typically usually split into two scenarios:
Off-Spec Prior to Delivery
If the seller becomes aware that the LNG is off-spec prior to delivery, then the seller is usually required to notify the buyer ASAP who must in turn work with the LNG facility to try to accept the off-spec LNG (subject to a reimbursement of costs capped at 20% – 50% of the LNG value). So long as the buyer uses reasonable endeavours to try to accept the LNG, if it cannot do so, then it may reject the LNG and the failure to deliver provisions will apply.
Off-Spec LNG is Delivered
The situation is more problematic if off-spec LNG is delivered to the Buyer as serious damage may occur at the LNG facility and/or to the LNG ship.
If the buyer can treat the LNG so as to make it meet the contractual specification or become marketable then the Seller is usually required to reimburse treatment costs and any ancillary losses or expenses (including to the LNG ship or the LNG facility itself). Where the buyer is unable to treat the LNG, the seller is usually deemed to have failed to deliver the cargo and the seller is required to reimburse for any costs, including for disposal of the LNG. Sometimes a 100% cap will be included in the latter scenario, but usually this liability is left uncapped.
Audit rights are often weaved through the fabric of an MSPA – especially in relation to quality and the failure to deliver/accept provisions. Care should be taken to limit such rights to what is proportionate to the issue at hand. Most parties are comfortable with agreeing to include audit rights so long as the party auditing is an independent third party.
Transfer of Title & Risk
Title and risk transfer provisions are found in all MSPAs. They will usually mirror the applicable Incoterm provisions. Increasingly provisions are included to permit title transfer in international waters instead of at the flange at the loading (FOB) or discharge port (DES/DAP). This may be due to taxation issues, or sometimes regulatory issues. In any event, provisions are largely similar across all MSPAs.
Every MSPA contains physical force majeure provisions including a non-exhaustive list of specific situations – after the Fukushima disaster in Japan, it is now common to include radioactive contamination in this list. These provisions are standard across the market, though again certain MSPAs linked to specific ports or projects may contain additional provisions relevant to those to address specific issues. Parties in long and complicated back-to-back strings of deals may attempt to reference events occurring in other contacts. Such a reference should be resisted unless that party is willing to share the wording of the trigger in the underlying contract.
A typical area of negotiation in the context of force majeure is how many days should pass for force majeure to be considered as ‘long term force majeure‘. Usually a 10 – 21 day trigger is agreed for a long term force majeure with the consequence being a walk away right for both parties from that trade.
Events of Default
Standard events of default are included in an MSPA and usually cover (1) non-payment; (2) non-performance (though excluding failure to deliver or accept); (3) insolvency; and (4) misrepresentation. During negotiations, it is usually the grace periods rather than triggers themselves which are the points of contention.
A developing area involves the consequences of an event of default. Generally, upon an event of default, the non-defaulting party may terminate the MSPA and all outstanding CNs, then calculating damages. There are moves from time to time to align with the natural gas world (i.e. EFET/ISDA positions) and provide for a gains, losses and costs calculation across all open CNs – this approach is traditionally favoured by financial institutions but has so far seen little take up in the market.
Compliance, Sanctions & Immunity
Most MSPAs contain compliance provisions dealing with anti-corruption and sanctions. There are some MSPAs which contain extensive compliance provisions running onto multiple pages. Generally, the spirit of these provisions are well thought through however parties should look out for intrusive audit provisions which are above and beyond market practice. People familiar with oil GTCs will recognise the sanctions language which tends to be used.
Given the number of sovereign parties in the LNG market, most MSPAs include immunity waiver provisions. Parties should always check, however if such a provision is valid under local law of the sovereign entity – for example, in certain jurisdiction (especially in the Gulf) it is not possible for a sovereign entity to agree to such a waiver.
Governing Law and Dispute Resolution
It is rare to see a governing law other than England & Wales for standard bi-lateral MSPAs. Where the MSPA has been designed in relation to a tender for a specific facility, or is a producer form MSPA, another governing law will be set. Difficulties often arise during tenders which don’t have England & Wales as the governing law as its often difficult to obtain robust local law advice on enforceability during the short tender window.
Arbitration is the dispute resolution forum of choice, with LCIA arbitration being the most common choice followed by SIAC.
As mentioned above, LNG trades are usually made on an FOB or a DES/DAP basis. For MSPAs dealing with trades on both sets of Incoterms, separate schedules will be included to outline the specific operational provisions. These schedules should always be reviewed by the operational shipping teams. Where the MSPA only covers trades for one Incoterm, the delivery specifics will likely be included in the main body of the MSPA rather than in a schedule.
Frequently, additional knock-for-knock liability provisions are slipped into these schedules and can be missed in a time pressured review. These provisions seek to limit liability by setting out in advance which heads of liability will be covered by which party regardless of which party is at fault. For example, it is common to see that each party is liable for any damage claims for death or personal injury of any of their own employees (even if it was caused by the other party or indeed, a third party).
The market is evenly split on whether to include these provisions or not – some like the certainty, whereas others are uncomfortable with a liability regime which is not linked to fault based triggers. Due to the split in approach by the market this is a potential area for back-to-back risk to arise.
There will usually be a provision in the measurement and testing schedule to ensure that terminal rules will typically overrule anything in the MSPA regarding measurement and testing. It is therefore essential for your in-house team to review and vet the terminal rules in advance of any trade.
As the market matures, it is likely that there will be further convergence of the key terms, this is already starting to happen in relation to the trader MSPAs. In the meantime, LNG MSPA reviews remain an arduous and time consuming undertaking. We are on hand to assist with your MSPA negotiations.
Nic Horsfield, Partner
Nic has personally negotiated in excess of 200 MSPAs and Confirmation Notices (vanilla and structured) and has been active in the LNG market for over 10 years. We offer clients a highly competitive and bespoke LNG MSPA review and negotiation service.
Please call Nic on +65 8792 9080 or email him to discuss anything contained in this article or our LNG practice and services in more detail.
This client alert does not constitute nor is it intended to be legal advice.