England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
QUEEN'S BENCH DIVISION
COMMERCIAL COURT
Mr. Justice Hamblen
[2011] EWHC 1785 (Comm)

		Royal Courts of Justice Strand, London, WC2A 2LL
		27 July 2012

Lord Justice Moore-Bick :

Background

1. This is the judgment of the Court to which all its members have contributed.
2. This is an appeal by Ceylon Petroleum Corporation ("CPC") against the order of Hamblen J giving judgment against it in favour of the respondent, Standard Chartered Bank ("SCB"), for the sum of US$166,476,281 under two derivative contracts designated "T8" and "T9" made between the parties in May and July 2008 respectively. The contracts were entered into under the terms of the 2002 version of the Master Agreement of the International Swaps and Derivatives Association Inc ("ISDA").
3. CPC is a corporate body established under the Ceylon Petroleum Corporation Act 1961 ("the Act") primarily for the purposes of supplying crude oil and petroleum products to the internal market of Ceylon, now Sri Lanka. Its governance is in the hands of a board of directors, the directors being also the members of the corporation. SCB is a commercial bank with branches in many countries, including Sri Lanka.
4. The circumstances which gave rise to these proceedings were described succinctly by the judge, whose account we gratefully adopt. He said:

"1. . . . CPC is a large commercial organisation, and a major importer of crude oil and refined petroleum products on the international market, importing some 26 million barrels per annum into Sri Lanka at a cost which had increased, by 2007, to about US$2 billion. Because it was required to buy oil on the international market in US dollars, in such significant amounts, it was inherent in CPC's business that it had a price risk based on its need to buy physical oil. In particular, in the present case CPC was exposed to the significant and unprecedented rise in the price of oil that occurred in the period from about 2003 up to late-July 2008.

2. In an attempt to protect itself from the rise in the oil price, from February 2007 CPC began to enter into oil derivative transactions with SCB and other competing banks operating in Sri Lanka, including Citibank NA ("Citi"), Deutsche Bank ("DB"), and two Sri Lankan banks, Commercial Bank of Ceylon and People's Bank (which is owned by the Sri Lankan Government). In the period between February 2007 and October 2008, CPC entered into about 30 such transactions, including 10 transactions with SCB.

3. The bulk of the derivative contracts entered into by CPC, including [T8 and T9], required the banks to make payments to CPC when oil prices were high. Conversely, CPC was required to make payments to the banks if the price of oil fell below an agreed floor.

. . .

6. In the period between February 2007 and July 2008, oil prices continued to rise in a previously unprecedented fashion, so that CPC was required to make ever-increasing US dollar payments for its physical oil imports. At the same time, CPC's portfolio of derivative transactions generally required the banks to make payments to CPC when the oil price increased or remained high.

7. In late July and August 2008, however, contrary to many industry forecasts, oil prices began to fall rapidly. This fall accelerated later in 2008 as the world financial crisis deepened, resulting in an unprecedented and almost complete collapse of the oil price. The price at which CPC was able to purchase oil in the international market and thus the amount that it needed to pay to do so therefore fell considerably. However, the derivative transactions that CPC had entered into were negatively correlated to the price of oil, which meant that, as physical oil prices fell, CPC also became "out-of-the-money" on its derivative transactions, including T8 and T9, being those which were outstanding with SCB, together with other such transactions with Citi, DB, Commercial Bank of Ceylon and People's Bank.

8. In September, October and November 2008, CPC made the payments demanded by SCB under T8 and T9 in respect of the relevant months. Since 12 December 2008, however, CPC has failed to make any further monthly payments in respect of T8 and T9. (It has also failed to make further payments under its outstanding derivative transactions with Citi and DB, which are the subject of arbitration proceedings, and with the local banks.)"

5. In due course SCB began proceedings against CPC seeking to recover the amounts due under T8 and T9. CPC resisted the claim on a number of grounds, all of which were rejected by the judge. Only one ground is pursued on this appeal, namely, that the contracts on which SCB sues are not binding on CPC because it did not have capacity to enter into them.

The nature of the transactions

6. It is unnecessary for present purposes to refer in detail to the terms of the ISDA Master Agreement 2002 because nothing turns on it so far as the present appeal is concerned. It is necessary, however, to describe the nature of the two transactions, T8 and T9, which CPC says were beyond its capacity. Both transactions were "derivatives", that is, synthetic contracts constructed as a reflection of forward dealing in a particular commodity, in this case Singapore Gasoil. Each transaction involved the purchase by CPC from SCB of a "call" option in respect of a specific quantity of for each month over the course of the ensuing year oil, that is, a right to buy that quantity of oil at a specified price (the "strike price"), and a sale to SCB of a "put" option, that is, an obligation to sell a specific quantity of oil to SCB at a specified price. If no premium is required for a pair of transactions of that kind, the call option is described as "zero cost". In effect, the purchase of the call option is financed by the sale of the put option. The cost of the call option and the value of the put option will depend on a range of factors such as the current underlying structure of and perceptions in the market, and the strike prices at which the options are arranged, as well as their other conditions. In paired transactions of this kind the strike price of the call option is often set higher than the strike price of the put option, in which case the strike price of the call option is often referred to as the "ceiling" and the strike price of the put option as the "floor". The effect is to establish a range of prices within which neither party incurs any liability. Outside that range one party is liable to pay the other a sum calculated by reference to the difference between the market price and the strike price. A pair of transactions of this kind are sometimes called a "zero cost collar", or "ZCC".
7. It is inherent in a transaction of this kind that each party assumes the risk of having to make a payment to the other and that the balance of risk must be acceptable to both parties. Accordingly, if the customer wishes to limit his potential liability under the put option (the "downside"), he will have to accept a limit on what he can recover from the bank under the call option (the "upside"). Various mechanisms have been devised to enable that to be achieved. They include a cap on the amount that the seller of the call option (here the bank) must pay on each notional barrel of oil, whatever the market price (sometimes called a "seagull"); another is to impose a cap on the total amount that the seller of the call option is liable to pay under the transaction as a whole (known as the "target"), after which it comes to an end, or "knocks out", without any further obligation on either side. This is commonly referred to as a "Target Redemption Forward" ("TRF"). Conversely, if the customer (here CPC) wants to increase the value of the upside, the balance of the transaction can be maintained by increasing its exposure on the downside, for example, by raising the level of the floor or increasing ("leveraging") the number of barrels on which it is at risk of making payments under the put option.
8. T8 and T9 were both structured as, or based on, ZCCs, but with additional features designed to modify the parties' exposure to market movements. Both transactions incorporated a seagull and a TRF and in the case of T8 the downside was leveraged: the notional quantity subject to the put option was twice that subject to the call option. In the case of T9 there was no difference between the strike prices of the call and put options; in other words there was no collar. However, it was the essence of these transactions that their initial cost to CPC was to be neutral, with the cost of the call option being balanced by the sale of the put option.

The Citibank arbitration

9. It is convenient at this point to refer briefly to the proceedings between Citibank and CPC which culminated in an arbitration award published on 31 July 2011, Citibank NA v Ceylon Petroleum Corporation. We have been informed that the parties to the arbitration have consented to the use and thus publication of the award. The arbitrators were Lord Millett, Mr Michael Hwang SC and Mr V. V. Veeder QC (President). In those proceedings Citibank sought to recover from CPC sums alleged to be due under two derivative transactions of a very similar kind to T8 and T9. As in the present case, CPC contended that the two contracts under which Citibank made its claim were beyond its capacity and therefore entirely void. That argument was accepted by the tribunal which therefore held that Citibank's claim failed.
10. Many of the arguments advanced by CPC in the arbitration in relation to that part of the case were very similar to those that were advanced in this case, but with one important difference. The tribunal recorded in Part V of its award that it was common ground between the parties that speculating on the price of oil was beyond CPC's capacity (paragraph 5.14) and that it followed that the question of capacity turned on whether the transactions were to be regarded objectively as exercises in risk management or mere speculations (paragraph 5.15). That appears to have been accepted, even though the parties did not agree on what exactly constituted hedging and what constituted speculation or how the two were to be distinguished. As a result, the tribunal was presented with the task of deciding, with the assistance of expert evidence from those who were familiar with international oil trading, whether the two transactions in question were to be regarded as hedges or speculations. That inevitably meant that it was invited to approach the question by reference to the practices and standards of international oil traders, rather than from the perspective of CPC's objects, asking whether the transactions in question were incidental or conducive to the particular business that CPC was established to undertake. It was simply taken for granted that whereas managing the risk of adverse movements in the price of oil would be conducive to CPC's business, "speculating in the price of oil" would be outside its contractual capacity. The expert witnesses in the arbitration differed in their views of the character of the two transactions with which they were concerned, as did the experts in this case, which only tends to reinforce the conclusion that there is no hard and fast line between what traders regard as hedging and what they regard as speculation. That it is possible to take different views about the essential difference between hedging and speculation is also apparent from the judgments of the Court of Appeal and House of Lords in Hazell v Hammersmith and Fulham London Borough Council [1992] 2 A.C. 1, to which it will be necessary to refer in more detail at a later stage.
11. The tribunal in the Citibank arbitration held that the essential distinction between hedging and speculation lies in the existence of an underlying obligation to which the transaction is linked. It held that hedging involves reducing existing exposure to a particular risk, whereas speculation involves the assumption of a new risk for the purpose of financial gain independently of any other risk. However, even that definition of speculation can characterise some aspects of quite ordinary commercial transactions: for example, buying commodities or currencies forward at a fixed price in order to achieve certainty of price in anticipation of future needs involves incurring a risk that the market may have fallen when the time for performance comes and in that sense could be said to involve an element of speculation. One important element in the tribunal's reasoning was that hedging provides protection against future price increases, not against price increases which have already occurred and that therefore the use of derivative instruments to raise money in order to reduce the effect of already high prices is necessarily speculation, not risk management (paragraph 5.47). In terms of the definition adopted by the tribunal that may be true, but we are not sure that it necessarily follows that a transaction of that kind entered into for other reasons directly relating to the functioning of the business is beyond CPC's capacity. However, the position adopted by the parties obliged the tribunal to accept that it was.
12. The tribunal's analysis of the similar transactions in the Citibank arbitration demonstrated that the effect of them was to give CPC a $5 per barrel discount on the price of oil (i.e. a profit of $5 per barrel before the transaction knocked out) provided that the market remained high, at the price of undertaking the risk of loss if the market collapsed below the floor. The tribunal concluded (at paragraph 5.98):

"It is impossible to categorise as examples of risk management transactions which do not protect the company against either adverse movements or volatility in the market price, but yield a fixed return unless the market price should collapse. While the analogy with insurance is not exact, it is impossible to regard these Transactions as insuring CPC against an unwanted risk. They provide for it to receive a relatively small fixed sum akin to a premium in return for assuming a large and unquantifiable though remote risk. They were premised on a view taken by CPC's senior officers that a sudden collapse in the oil price was unlikely (though it was probably bound to happen sometime and did). Far from obtaining insurance against an increase in the oil price, CPC was in effect insuring the unknown market counterparty against the risk of prices falling. It was acting as insurer, not as insured. The only difference between its position and that of an ordinary insurer is that the physical event against which it was insuring its counterparty is one which it would welcome".

Hedging and speculation

13. Since the case being made by CPC on the question of capacity was essentially the same as that which it subsequently presented in the Citibank arbitration, it is not surprising that before the judge a great deal of attention was directed to the question whether T8 and T9 were properly to be regarded as hedging transactions or simply as speculations. CPC accepted that it had capacity to enter into derivative contracts insofar as they constituted hedging, but maintained that it did not have capacity to do so insofar as they constituted speculation. The judge was not satisfied that the transactions were speculations rather than hedges; indeed, in paragraph 401 of his judgment he held that they were within the capacity of CPC precisely because they were hedges of its exposure to the market in relation to future purchases of petroleum.
14. The judge had the benefit of hearing evidence from two witnesses, Ms Elizabeth Bossley and Mr. Johannes Benigni, each of whom had considerable experience in trading in oil products and derivatives based on oil products. Although they both recognised a difference between hedging and speculation, neither of them found it easy to identify with any precision the essential difference between them. It is not surprising, therefore, that in paragraph 369 of his judgment the judge referred explicitly to the difficulty of distinguishing between hedging and speculation and to the difficulty of identifying by reference to the terms of any particular transaction on which side of the line it falls. In the context of commodity trading, we would agree that the term "hedging" is generally used to describe in broad terms steps taken to reduce existing exposure to risks, usually the risk of market fluctuations, and increase certainty of outcome, usually of price, whereas "speculation" is used to describe the act of entering into a new obligation in the hope of making a profit as a result of favourable movements in the market and thereby at the same time incurring the risk of adverse market movements. That reflects the distinction drawn by the Citibank tribunal.
15. In the present proceedings, however, SCB did not accept either the sharp dichotomy between hedging and speculation for which CPC contended, or that CPC did not have capacity to enter into transactions of a speculative nature. It argued that, whatever the nature of transactions T8 and T9, CPC had capacity to enter into them, but undoubtedly the distinction between hedging and speculation assumed considerable importance at the trial. The two concepts and the differences between them have been most fully elaborated in the context of international currency and commodity trading, a specialised form of commercial activity in which the general nature of the risks involved are well recognised. However, the financial and commercial risks facing an enterprise such as CPC may take many different forms and the means by which they can be reduced will vary. Moreover, the dichotomy which CPC sought to draw between hedging and speculation is to some extent illusory, in the sense that the two shade into each other. There are undoubtedly aspects of these two transactions that have a speculative element to them (in particular, the fact that they provided no protection against rising prices at the risk of incurring a substantial liability if there were a significant fall in the market), but they were underpinned by CPC's existing commercial and legal obligations relating to the purchase of crude oil and products.
16. We are not surprised that the experts in this case (as in the Citibank arbitration) were divided in their opinion. We consider on the whole that hedging may come in more or less speculative forms, and that speculation may come in more or less hedged or risk averse forms. Either may be more or less prudent, something which in any event is likely to look very different, depending on whether the matter is considered ex ante or ex post. We understand why, especially in the context of a question of capacity, it is unrealistic to seek to look into the minds of those who entered into the transactions, but we are troubled by the idea that the distinction between speculation and hedging can be found solely objectively, as the Citibank tribunal sought to do, and the judge in these proceedings was asked to do. Of course, if a definition of hedging, or speculation, could be devised, and that definition excluded subjective considerations, the definition would have to be applied accordingly. (We believe that, in the regulatory environment, there may be definitions which have to be applied according to their terms, but such definitions tend to be formally, rather than functionally, based.) Without a formal definition, however, we think that it would be difficult to exclude all subjective elements from a consideration of whether a transaction was speculation or hedging, and we observe that the use of the word "objective" in the submissions before us has wavered (as did the evidence before the judge as to the place of subjective considerations - see for instance paragraphs 342, 362(3) and (7), 369(3), 370 or 386). Moreover, intentions and aims can be objectively ascertained, even if that may be a difficult exercise.
17. We derive support for these considerations from the expert evidence in this case. Thus the judge set out the following passages in the evidence before him:

340. As SCB's derivatives expert, Ms Bossley pointed out in the Joint Expert's Report:

"… at the extreme ends of the spectrum it is clear what is hedging and what is speculating. In the middle of the spectrum there is a grey area where the same action can be hedging or speculation depending on the context, including the party's intention. The existence of a physical position makes it more likely that any particular action involves hedging".

341. As further pointed out in a paper of Professor Hieronymous of the University of Illinois in a paper exhibited to the expert report of Mr Begnini CPC's derivatives expert:

"This (a suggested definition of hedging) assumes that "hedging" and "speculation" are at least different, if not opposite. They are not. All hedges are more or less speculative, and all speculative positions are more or less hedged".

18. The judge set out the considerations which the two parties, their experts, and he regarded as relevant in an extended passage of his careful judgment at paragraphs 345 – 389. We do not intend to paraphrase what he there wrote. However, we take from this passage the following hedging and speculative elements of the transactions.
19. In favour of regarding T8 and T9 as hedging transactions are the following:

(i) there was a Cabinet decision to make use of derivatives to carry out hedging. Hedging was "to be implemented without delay";

(ii) CPC, with SCB's help, devised a strategy designed to avoid up-front payments to the bank (the "zero cost" device) and the risk of losses (by ensuring a low floor price);

(iii) until shortly after T9, CPC's strategy had been generally successful and profitable;

(iv) CPC was a physical importer of oil, month by month, at spot prices, so that any losses in the transactions would be more than matched by CPC'S larger gains achieved by purchasing physical oil at lower prices;

(v) although the upside gain was limited, the transactions still gave some protection against high prices, and alleviated CPC's most pressing need, which was the shortage of hard currency.

20. In favour of regarding T8 and T9 as speculative transactions are the following:

(i) as time went by, CPC's strategy became increasingly short-term, whereby transactions would be knocked out or unwound and gains realised. It could be said that the objective of the strategy was to make short-term profits, rather than to hedge risk;

(ii) the strategy led to the situation outlined in the Citibank arbitration, whereby a fixed and limited profit was bought at the expense of undertaking an uncertain and potentially large downside risk. This became akin to taking an (uncertain) premium to insure the counterparty against falling prices;

(iii) although CPC's strategy had been successful in the past, many commentators might have said that in a more volatile economic world, and in the presence of a higher and higher oil price, a correction was on the cards. As time went by, the strategy was becoming riskier;

(iv) although there was a physical exposure in the background, CPC was unwilling to accept financial losses as a concomitant to a falling market. If the hedger sleeps soundly, while the speculator bites his nails, CPC was in the latter camp. Moreover, CPC would come under pressure to reduce its domestic prices, were the international oil price to collapse;

(v) ultimately, the risk to CPC's foreign currency obligations was even greater by reason of the absence of the money which would have been received by sale of a naked put option.

21. In these circumstances, it becomes difficult and almost self-defeating to choose one set of considerations above the other. Some factors push one way, and some the other. The judge (see at paragraph 369) resolved the conundrum by asking himself whether CPC had "shown that the transactions were speculations rather than hedges" and deciding that it had not. In resolving the matter thus, i.e. on the burden of proof or persuasion, he expressly relied inter alia on "the difficulty of distinguishing between hedging and speculation" and the exclusion, by common consent, of subjective intentions.
22. In our judgment, the question of hedging or speculation is, at any rate, in the context of an issue of capacity, a false question (see below). If, however, it were necessary to describe the transactions (although for reasons which will become apparent we do not think it is), we would describe them as either highly speculative hedges or speculations with elements of hedging about them. And if it were necessary to categorise them into one camp or the other, which again we do not think it is, we could ultimately agree with the Citibank tribunal, emphasising the fixed and limited nature of the upside, or we could just as well, by emphasising the background of physical exposure, categorise in favour of hedging. On balance, we would incline to the former, but if, as has remained common ground, the theory is that subjective facts are irrelevant (which we do not think they can be on such a question), the issue perhaps becomes less than coherent.
23. As we have said, in the present case SCB did not accept that CPC lacked capacity to enter into any transaction that contained some speculative elements and in those circumstances, and in the absence of clear criteria by reference to which it is possible to determine whether a particular transaction amounts to impermissible speculation in the context of CPC's corporate capacity, we think it is unhelpful to begin by asking whether T8 and T9 involved hedging or speculation, treating that as determinative. Instead it is better simply to ask whether they were within CPC's capacity.

Capacity

24. It was common ground before the judge and before us that the scope of CPC's capacity is to be determined by reference to the law of Sri Lanka, but it was also accepted that there is no material difference for these purposes between the law of Sri Lanka and English common law. As a statutory corporation CPC's capacity is determined by the legislation under which it is established, in this case section 5 of the Act, which provides as follows:

"5. The general objects of the Corporation shall be–

(a) to carry on the business as an importer, exporter, seller, supplier or distributor of petroleum;

(b) to carry on the business of exploring for, and exploiting, producing, and refining of petroleum; and

(c) to carry on such other business as may be incidental or conducive to the attainment of the objects referred to in paragraphs (a) and (b)."

25. The purpose of section 5 is to define the commercial field in which CPC is to operate. As such it fulfils the function of the objects clause in the memorandum of association of a company incorporated under the Companies Acts. CPC's principal objects as described in section 5(a) are to carry on business as an importer, seller, supplier and distributor of petroleum. (One can ignore exporting for present purposes.) In commercial terms its principal function was to act as the national importer and refiner of crude oil and supplier of refined products to the internal market. In order to meet its responsibilities it purchased crude oil under long term contracts priced broadly by reference to the market price at or around the date of shipment. It also purchased refined products at current market prices. Moreover, since refined products are sold within Sri Lanka in local currency, whereas the world market for crude oil and products is priced in US Dollars, CPC is exposed to the risk of rising market prices combined with increased foreign exchange requirements.
26. Mr. Ali Malek Q.C. submitted, almost as if it were axiomatic, that if T8 and T9 were speculative transactions CPC did not have capacity to enter into them. That argument reflects the decision of the House of Lords in Hazell v Hammersmith and Fulham London Borough Council, in which it was held that local authorities had no power to enter into interest rate swap agreements because, whatever the circumstances under which they were entered into, they were designed to produce a profit which would increase the funds available to the council and were therefore essentially speculative in nature. That remained so, even when the swap was underpinned by an existing loan carrying an obligation to pay interest, the burden of which might be reduced by the transaction. In the view of Lord Templeman, with whom the other members of their Lordships' House agreed, the question had to be decided by reference to the particular statutory provisions relating to borrowing by local authorities. He said at page 31D-E:

"The authorities deal with widely different statutory functions but establish the general proposition that when a power is claimed to be incidental, the provisions of the statute which confer and limit functions must be considered and construed. The question is not whether swap transactions are incidental to borrowing but whether swap transactions are incidental to a local authority's borrowing function having regard to the provisions and limitations of the Act of 1972 regulating that function." (Emphasis added.)

27. Lord Templeman held that the provisions of Schedule 13 to the Local Government Act 1972 effectively limited the scope of local authorities' powers in a way that precluded transactions of that kind, but he recognised that different considerations might apply in other cases. At page 31 E-F he said:

"The authorities also show that a power is not incidental merely because it is convenient or desirable or profitable. A swap transaction undertaken by a local authority involves speculation in future interest trends with the object of making a profit in order to increase the available resources of the local authorities. There are many trading and currency and commercial swap transactions which eliminate or reduce speculation. Individual trading corporations and others may speculate as much as they please or consider prudent. But a local authority is not a trading or currency or commercial operator with no limit on the method or extent of its borrowing or with powers to speculate. The local authority is a public authority dealing with public moneys, exercising powers limited by Schedule 13." (Emphasis added.)

28. Parallels can be drawn between interest rate swaps of the kind considered in that case and oil derivatives of the kind represented by T8 and T9, but we do not think that a clear parallel can necessarily be drawn between English local authorities, whose functions and powers are carefully defined by statute, and a body such as CPC, which was incorporated for a different purpose to carry out a different function in a different context. Whether CPC had the capacity to enter into oil-based derivative transactions of any kind, and if so, under what circumstances, is a matter that has to be determined by reference to the terms of the legislation under which it was incorporated. We have not been shown any authority in which the approach of Hazell has been applied to a commercial company.
29. In Ashbury Railway Carriage Co. Ltd v Riche (1875) LR 7 HL 653 the principle was established that a company incorporated under the Companies Acts does not have capacity to enter into any transaction which falls outside the scope of its objects. However, the risks posed to persons who entered into contracts with such companies without being aware of the precise scope of their objects soon led the courts to adopt a broad construction of memoranda of association. In Attorney-General v Great Eastern Railway Co (1880) L.R. 5 App. Cas. 473 the House of Lords held that whatever is fairly incidental to the carrying out of the company's objects should be regarded as falling within them. Lord Selborne L.C. said at page 478:

"I assume that your Lordships will not now recede from anything that was determined in The Ashbury Railway Company v. Riche. It appears to me to be important that the doctrine of ultrà vires, as it was explained in that case, should be maintained. But I agree with Lord Justice James that this doctrine ought to be reasonably, and not unreasonably, understood and applied, and that whatever may fairly be regarded as incidental to, or consequential upon, those things which the Legislature has authorised, ought not (unless expressly prohibited) to be held, by judicial construction, to be ultrà vires. "

30. Lord Blackburn said at page 481:

" . . . those things which are incident to, and may reasonably and properly be done under the main purpose, though they may not be literally within it, would not be prohibited."

31. In our view it is clear from the terms of the Act that, although CPC was formed to act in the public interest, the legislature intended it to act as a commercial entity for the purposes of engaging in international and domestic trade. It was expected to purchase crude oil and refined products on the international market, refine crude oil within Sri Lanka and sell products to the public through filling stations and other commercial outlets. In the absence of any indication to the contrary, therefore, we think the legislature must have intended that CPC should have the capacity to enter into the whole range of transactions that a commercial organisation acting in that field of business would ordinarily undertake and that the Act should be interpreted as giving it capacity to enter into any transaction that could fairly be said to be incidental or conducive to its statutory objects. Although CPC was not established to make profits for the state, it was not intended to be a loss-making organisation. It therefore had a responsibility to manage its finances, including its requirement for the foreign exchange needed to purchase oil on the international market, in a commercial manner. It also had a similar responsibility, and certainly a capacity, to use the increasingly sophisticated tools available to and ordinarily used by a commercial oil trading company, such as it was despite its public status, to provide for attempts to mitigate the risks to which it was otherwise exposed as an importer of oil subject to the vagaries of the oil market.
32. That view of the matter is reinforced by section 6 of the Act which sets out specific powers given to CPC for the purpose of carrying out its functions. They include many powers that enable CPC to act as an ordinary commercial body engaged on the business of exploring for, producing, importing, refining and selling crude oil and products, such as power to acquire and dispose of movable and immovable property, power to build, purchase or charter and operate vessels and power to enter into agreements with banks and other bodies to obtain rights that seem to the board to be conducive to its purposes. Ultimately, however, the Minister of Petroleum can control the corporation's activities by giving it directions to which it is bound to give effect (section 7).
33. In view of that it is perhaps not surprising that CPC has always accepted that it has capacity to enter into oil-based derivative contracts, because they are transactions of a kind that may properly be regarded as incidental or conducive to its objects. In our view that is clearly correct. Moreover, since the question in issue is whether CPC had capacity to enter into certain specific transactions, that question must be answered by reference to the nature of those transactions, not with whether they were prudent or imprudent. It follows that in our view the critical question for present purposes is not whether T8 and T9 are properly to be classed as hedges or speculations, but whether by their nature they fall within the scope of the business that CPC was formed to undertake.
34. At this point it is necessary to consider the context in which CPC entered into T8 and T9. From the latter part of 2006 the rise in the market price of crude oil and products presented CPC with considerable problems, both in terms of cash-flow and in terms of obtaining the foreign exchange needed to pay for oil under existing purchase contracts. As market prices continued to rise the pressure became increasingly severe and the need to investigate means of alleviating it was recognised both in government and within CPC. There was an obvious attraction in entering into transactions of a kind that could reduce, even to a modest degree, the price CPC had to pay suppliers, and therefore the amount of foreign exchange it would require for that purpose, even though it would necessarily have to accept the risk of incurring a significant liability to the bank if the market were to fall to an unexpected extent.
35. Mr. Malek submitted that the potential benefits to CPC from the two transactions were at best very modest by comparison with the risks of incurring very substantial liabilities to SCB, as eventually turned out to be the case. He characterised them as speculative, both because they increased the level of risk to which CPC was exposed and because at best the benefit to be derived from them was no more than to provide CPC with a profit representing a small discount from the market price while that price remained high. The potential upside benefits were indeed small - a maximum of $5 a barrel on 100,000 barrels per month in the case of T8 and $10 a barrel on 100,000 barrels per month under T9, subject to the knock-out of $1.5 million and $2.5 million in the case of T8 and T9 respectively. Moreover, the benefits would be obtained only if the market remained high throughout the 12-month period of the transaction, or at any rate until the knock-out figure was reached. On the other hand, the downside exposure, if there were to be a substantial fall in the market, was considerable, particularly under T8 because of the leveraging. In those circumstances both transactions, viewed in isolation, might be described as imprudent, particularly given the very high level of the market, but that of itself does not mean that CPC lacked the capacity to enter into them. In fact the judge found that CPC was not speculating in derivatives in the classic sense of taking a risk on market movements unrelated to any existing exposure in the hope of making a profit. He found (paragraph 389) that the transactions:

" . . . were all related to underlying physicals and provided protection against both high and rising prices. Although the extent of that protection became limited, and although CPC became increasingly keen to use hedging more for cash flow and foreign exchange generation than price protection purposes, price protection remained an element of its strategy and that strategy never became one that was solely or predominantly driven by speculative profit making".

36. Mr. Malek accepted that CPC had capacity to enter into derivative contracts for the purpose of risk management, but not for the purpose of speculation. However, we find that an unsatisfactory distinction. In the absence of a clear line between hedging and speculation it is likely to give rise to immense difficulties in practical operation, since in many cases the other party to the contract will be unable to tell with any confidence on which side of the line the particular transaction falls. Apart from the need to analyse and assess the effect of a complex set of terms, a transaction that appears on its face to be a speculation may be justified by its relevance to other considerations facing the corporation, of which the counterparty may know little or nothing. Moreover, it is also inconsistent with the principle that CPC has capacity to enter into any transaction which is incidental or conducive to the pursuit of its express objects. It is difficult to see on what basis it can be said that CPC has capacity to enter into some kinds of derivative contracts and not others, other than the established test of "incidental or conducive". If a transaction is conducive to the pursuit of the corporation's objects, it should not matter whether it is also speculative in nature, a fortiori if in truth the degree to which it is more or less speculative may vary. Mr. Malek's proposition also fails to explain why CPC should have capacity to enter into derivative contracts to manage the risk of market price volatility, but not for other purposes that might be of benefit to its business and thus assist in achieving its objects.
37. In the present case T8 and T9 were incidental and conducive to the pursuit of CPC's objects because, as the judge found in paragraph 401 of his judgment, while market prices remained high they could be expected to produce payments from SCB and thereby a modest degree of protection in relation to its requirement for foreign exchange, as well as a positive flow of cash which the business urgently needed. They were intended to help CPC manage the twin risks of running out of cash in general and foreign exchange in particular. If that is correct, the fact that they could be characterised as hedges or speculative transactions (about which even the experts disagreed) is immaterial. It is unnecessary for the purposes of this appeal to decide whether CPC has capacity to indulge in purely speculative transactions unrelated to any immediate commercial pressures.
38. By section 5(c) of the Act CPC's objects include carrying on such other businesses as may be incidental or conducive to the attainment of its primary objects. Little emphasis was placed on that provision and I doubt whether it adds very much in this case. The findings do not suggest that CPC was carrying on a business of trading in oil or derivatives separate from its primary business as a purchaser, refiner and distributor of oil. In general, speculation is not regarded by commodity traders as a prudent way to do business, but speculative trades are sometimes made even by established commodity traders and if CPC had been carrying on business as a trader in derivatives, it would be difficult for it to argue that an individual transaction was ultra vires simply on the grounds that it was speculative.
39. It may be that in retrospect, with the catastrophic credit crunch which overtook western economies in the autumn of 2008 following the collapse of Lehman Brothers, the downside risk undertaken by CPC in its transactions, and in particular T8 and T9, looks imprudent, especially compared to the limited opportunity for gain on the upside. That, however, is the wisdom of hindsight. If we were all as wise as hindsight teaches us to be, we would always prosper, but history relates a different lesson. At the time, there were those who said that the price of oil was marching towards $200 per barrel. In such circumstances, CPC may well have thought, and presumably did think, that even a modest contribution to its foreign exchange difficulties was sound business, and even necessary to its business, and that the risk of a break to the downside was protected by the significant extent to which the strike price at which the put options were entered into was below the market level. Furthermore, even if the distant floor might be breached, there were two mitigating consequences: one was that CPC's imports of physical oil would become cheaper – and those imports always far exceeded the quantity of oil involved in the derivative contracts; the other was that CPC could always maintain the option of selling out before the price declined too far. CPC retained the first benefit. Unfortunately, and partly because the matter became overladen with political and then litigious disputes, CPC gave up the second opportunity for mitigation.
40. In our judgment, however, all these considerations only go to illustrate that the disputed transactions must be regarded as within CPC's capacity. The question is whether in anticipation, and not in retrospect, these transactions were ordinarily part of, ancillary or conducive to, the business of a commercial, if public, corporation. It seems to us to be impossible to say that they were not. Therefore, whether categorised as speculative or not, or as hedging or not, or, as we ultimately consider, more or less one or the other, these transactions were in our judgment within the capacity of CPC and are binding on it. We would therefore dismiss the appeal.

Powers

41. Mr. Robin Dicker Q.C. also submitted that CPC had capacity to enter into the two transactions by virtue of the powers contained in 6(l) and 6(q) of the Act. Section 6 provides as follows:

"6. The Corporation may exercise all or any of the following powers:–

. . .

(l) to give any guarantee, security or indemnity to, and to enter into any agreements with, any bank, Government department, local authority, or any other person in order to obtain any rights, concessions, or privileges that may seem to the Board to be conducive for the purposes of the Corporation;

. . .

(q) to do all other things which, in the opinion of the Corporation, are necessary to facilitate the proper carrying on of its business."

42. Mr. Dicker submitted that the effect of those subsections was to give CPC capacity to enter into any transactions which the board or CPC itself honestly believed were in its interests because they were conducive to or facilitated the achievement of its objects. Alternatively, he submitted on the authority of Re David Payne & Co. Ltd [1904] 2 Ch 608, In re Introductions Ltd [1970] 1 Ch. 199, Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] 1 Ch. 246 ("Rolled Steel") and Halifax Building Society v Meridian Housing Association [1994] 2 BCLC 540 that the effect of subsection 6(l) was to give CPC capacity to enter into T8 and T9 because they were transactions of a kind that were capable of being conducive to its achieving its objects, even if they were entered into for another purpose, in this case speculative trading.
43. Mr Malek, on the other hand, submitted that the powers of the company could not be exercised in aid of something which was beyond CPC's objects: so that, if SCB's claim failed under section 5 of the Act, it could not save itself under section 6.
44. In the circumstances, it is unnecessary for us to determine this further issue. If it had been fully argued, we might have been tempted to give our views on it. As it is, time constraints meant that it was not fully argued, and the jurisprudence concerned is not without difficulty. We would prefer, therefore, to say nothing further about it.