Re: Metal Trade Finance

I have one principal concern in respect of one of the three structures called
the "Commodity Transit Trade" structure. The concern relates to the passing
of title to the metal forming the subject-matter of the contract. Under this
structure, MCC sells metal to the counterparty ("Counterparty") on a spot
basis with payment deferred (Contract 1). Counterparty simultaneously sells
back the metal to MCC, also on a spot basis, but not on deferred payment
terms (the spot payment received Counterparty therefore constitutes the
finance) - Contract 2.

The concern is that, as the transaction has been explained to us, there may
be a delay of two or three days between (i) legal title to the metal passing
to Counterparty under Contract 1 and (ii) legal title passing back again to
MCC under Contact 2. There is therefore a risk that an event could occur in
the interim which prevents title passing back to MCC. The most likely event
would be the insolvency of the counterparty, but other events (eg supervening
illegality due to the imposition of sanctions) are conceivable. More
specifically, a liquidator of Counterparty could seek to disclaim (or set
aside) Contract 2 if the market price of metal has increased during the
interim.

Consequences

The consequences stem from the fact that the metal forming the subject matter
of these financings will typically be on the high seas bound for a third
party (ie not counterparty). MCC will have a contractual obligation to
transfer good title to the metal to that third party. If title to the metal
remains vested in Counterparty then Enron cannot fulfil this obligation to
the third party. Conversely, if MCC completes the sale to the third party,
MCC cannot be said to have passed good title to Counterparty under Contract 1
above. In other words, MCC could be sued for breach of contract for failure
to transfer good title to Counterparty or the third party, on the basis that
it has sold the same goods twice.

The likely downside is that Enron could be forced to perform both to
counterparty and to the third party at a loss (or to perform to one and pay
market damages to the other). However, there is a remote possibility that
punitive damages could also be awarded against MCC on the basis that it has
sold the same goods twice, or possibly on the basis that the transactions are
not "genuine" sales of goods, but a sham (this danger should not be
exagerated and is mitigated by the choice of English law as the governing law
of the contract).

A further consequence would of course be that the financing itself would not
be capable of being completed, with the attendant loss of fees/commissions
etc, but this is probably a minor consideration.

Mitigants?

There are possible mitigants of the risk highlighted above, as follows:

Cross default - Contracts 1 and 2 will include cross default language to the
effect that if Counterparty does not execute Contract 2, Contract 1 is
cancelled. Care should be taken to ensure that this language is wide enough
to cover all circumstances (eg if Counterparty has "executed" but not
performed Contract 2, would the cross default apply?). More significantly,
even if the cross default language works contractually, it may be overriden
by the bankruptcy laws of the Counterparty, as invoked by Counterparty's
liquidator. In other words, the liquidator may be able to "cherry pick"
Contract 1 while renouncing Contract 2. This could be checked on a
jurisdictional basis, if considered appropriate.

As mentioned, English law, as the governing law of the contracts, may
mitigate the risk described above to some degree, but local insolvency law in
the country of Counterparty could override the parties' choice of English law.

Probability - As a matter of crude probability, it may be regarded as fairly
unlikely that, within a narrow window of a few days or so (i) a Counterparty
goes bankrupt (ii) in a rising market and (iii) its liquidator takes the
point and insists on performance of Contract 1 while renouncing Contract,
particularly in light of the fact that Counterparty does not have posssession
of the metal and possession would be difficult to obtain. This may be why
the issue appears not to have arisen under past transactions. It is however
no assurance that these circumstances will not arise in the future.

Conclusion

There is a real risk of loss to MCC should the Counterparty go bankrupt after
Contact 1 above, but before performance of Contract 2. This risk is most
accute in a rising market and is relatively unlikely to materialise in a
given case. If it does materialise, it is hard to assess definitively the
possible loss involved, but this would be likely to be, at a minimum, the
difference between the then prevailing market price and the price of the
metal under Contract 1.

Please (anyone) let me know if you would like to discuss this before we move
to a formal DASH.

Thanks

Paul

Olivier Herbelot
01/09/2000 15:00
To: Paul Simons/LON/ECT@ECT
cc:

Subject: Re: Metal Trade Finance

Paul: Did you have any big concerns from your point of view after this
morning's meeting ? Olivier