Introduction
Terminal operations involving the storage, transportation and blending of crude oil or other product can be a balancing act. The operator must keep the terminal compliant with state and federal safety regulations, air emissions permits and other regulatory requirements. It must also address customer issues, whether product nominations, blending requests, or disputes concerning operations that could challenge the terminal’s capabilities and regulatory compliance. Through all of it, the operator is, of course, always watching its “bottom line” to ensure the enterprise stays profitable, while still acting in a commercially reasonable manner and as a prudent operator under its customer agreements.
This article addresses an operator’s storage relationships and agreements, specifically, how an operator can better protect itself and limit risk with product-storing customers.
Terminal Storage Agreements
The storage agreement is the foundational document in a crude oil (or other petroleum product) storage relationship with a terminal. Often called a ‘Terminal Services Agreement,’ a ‘Crude Oil Storage Agreement,’ a ‘Storage Tank Lease,’ or some variation, it is the base document governing a customer’s storage of product at the operator’s facility. It generally covers storage fees (usually “take or pay” – i.e., the customer pays an agreed rate multiplied by the maximum available barrel storage within the tanks being leased despite the amount of product stored), other fees charged, invoice and payment protocols, contract term and renewals, nomination and delivery protocols, agreed terminal services provided to the customer, product title requirements, force majeure, insurance and taxes, indemnification, and product shrinkage or loss, among other things.
Obviously, each party negotiates for its own interests in arriving at the ultimate agreement. The product storer (usually a ‘customer,’ ‘lessee’ or ‘tenant’) is most interested in facilitating its ability to move crude into and out of the terminal, depending on whether the market is in contango (a reason to store) or backwardation (a reason to sell). The operator is, of course, interested in being paid for its services, whether that be storage, blending, testing, transportation or otherwise — that’s the terminal’s business and what drives profitability. But other considerations are equally important to the operator, especially protecting it from a customer’s delinquency and commercially unreasonable requests and protecting the valuable services the terminal extends to the customer.
A separate set of terminal rules sometimes overlays this base agreement, providing further detail on the rights and duties of the parties at the terminal. If they exist separate from the agreement, they can be incorporated into it as additional terms and conditions, binding the customer to them. They tend to be one-sided (in the operator’s favor), usually outlining its ability to operate the terminal in its discretion and to ensure its own commercial reasonableness in responding to customer nominations or other requests.
Protections Against Delinquency
Whether or not the storage agreement or terminal rules say so, terminal operators have strong legal protection against customer delinquency and non-payment: lien rights arising in the operator’s favor and covering stored product. These rights come from the ‘warehouse lien’ provisions of the Uniform Commercial Code (UCC) – a standard set of laws adopted by all states (usually in uniform fashion) applicable to the storage of goods, including petroleum products. If effective as to stored goods, these lien rights plausibly give the warehouse a superior interest in the product stored by the customer at the terminal in the event of delinquency or non-payment, including when a dispute leads to the customer’s withholding of payment.[1]
The warehouse lien arises automatically in favor of a ‘warehouse’ (i.e., the operator) when ‘goods’ (such as petroleum products) are stored with it by the customer (referred to as the ‘bailee’) under a storage agreement or ‘warehouse receipts’ (documents identifying the details of the storage relationship and the product stored). Because the relationship of the operator and storer can be viewed somewhat as an extension of credit (i.e., the operator extending substantial services in return for future payments for such services),[2] the lien operates to secure payment to the warehouse for the stored goods covered by the storage agreement or warehouse receipts, including storage fees, transportation costs, insurance, labor and other charges relating to the stored product. It attaches to product stored at the terminal under the agreement, usually within the tanks the operator has dedicated to customer use, although the storage agreement can extend it to the customer’s product more generally.
The lien is possessory only. It extends only to the customer product the operator still possesses. If possession is relinquished, the lien falls off the released product as a matter of law. The lien also attaches only to the product identified in the storage agreement, so if the customer’s product departs from its designated tanks and is held elsewhere in the facility (perhaps in other customer tanks that have been emptied), the lien likely ceases to attach to it. However, where a storage agreement provides for the lien to attach with respect to charges “in relation to other goods,” the lien broadens in scope to those other goods.
A lien against stored product is an important feather in the operator’s cap. But it does not automatically get the operator paid for the extent of a customer’s default (over and above any letter of credit that may be posted). To convert product collateral to cash and satisfy unpaid debt owed under the storage agreement, the UCC requires the operator to foreclose its warehouse lien against that collateral by public or private sale. A customer that regularly deals in petroleum product is likely to be held out as a ‘merchant’ in such product, meaning the operator can use the substantially easier private sale mechanism under the UCC to foreclose its lien. It can also opt to sell the product publicly, a much more cumbersome undertaking.
For a private sale of stored product, the operator must notify its customer (and any other person with an interest in the product)[3] of the sale, including the amount owed and the sale terms. Although the customer may not appreciate the sale of its product to satisfy unpaid sums owing to the terminal, it has the right to ‘redeem’ the product by paying the warehouse lien value and any expenses the operator has incurred in the proposed sale. If redemption does not occur and a sales notice is given, the operator may apply the proceeds to its lien, paying any resulting surplus over to the customer.
An operator whose customer is a product ‘merchant’ may sell publicly if it chooses; it must do so if the customer is not a ‘merchant.’[4] The public sales process is more cumbersome, requiring the operator to set a time and place for the sale and a date by which the customer may redeem its product, along with notice of that timeline to the customer and any interested parties. It also obligates the operator to comply with a host of additional requirements, including a sale by auction with pre-published advertisements that again state the customer’s redemption deadline. As with a private sale, the operator may then apply sales proceeds to its lien, paying any surplus over to the customer.
Storage Agreement Suggestions
For a terminal operator, five areas deserve attention in negotiating a storage agreement with customers: [i] strong damages limitations language, [ii] broadened lien language, [iii] reasonable governing law and convenient forum requirements, [iv] broad operator discretion, and [v] product quality exceptions.[5]
First, damages limitations. While the agreement should not (and likely cannot) negate all damages, a damages limitations clause should be used in the storage agreement or terminal rules. Such a clause limits the amount and types of damages a customer can seek (applied reciprocally to the operator), stripping out consequential and incidental damages, lost profits, prejudgment interest, expectation damages, punitive or exemplary damages, loss in value of the product stored, and the like. The operator can also attempt to impose caps on actual damages — for example, at the aggregate storage charges the customer has paid over a certain period (inception-to-date, year-to-date, etc.). A jury trial waiver is likewise a significant benefit, goes hand in hand with damages limitations, and should be spelled out in the storage agreement. These limitations help the operator better foresee and control the overall risk of its relationship with the storage customer.
Second, broad lien rights. A storage agreement need not specify the operator’s UCC lien rights for them to arise — they arise ‘by operation of law’ — but it remains prudent to include them in the storage agreement or the terminal’s rules to place the customer on direct notice. The lien rights should apply to the product stored in assigned tanks and also ‘in relation to all other goods or product’ of the customer, wherever located within the terminal. This gives the operator both the specific and the general lien the UCC affords, and lets it reach customer product held within the terminal but outside the assigned tanks to satisfy unpaid charges and fees. The notice of warehouse lien rights should be conspicuous within the agreement or rules; where possible, the agreement should also define the customer as a ‘merchant’ — one familiar with and regularly dealing in the types of goods (i.e., product) stored at the terminal. Finally, such clauses should recite that the customer exclusively owns the stored product and that, to the extent others have interests in it (such as lenders or other secured parties), they authorized the product to be in the customer’s possession before storage for purposes of storing it with the terminal, or of transporting or selling it, and for the customer to pledge it to the operator for payment due under the agreement in order to procure a warehouse receipt. Terms like these advance the operator’s lien claims if issues arise with a delinquent or non-compliant customer.
Third, governing law and forum. Parties often negotiate governing law and forum-selection clauses with an eye toward their own states of incorporation or headquarters, or land on a situs that bears no real relation to their relationship. If the relationship later becomes the subject of litigation, the parties may be forced to litigate in unfamiliar territory under unfamiliar law — though as to lien rights, the UCC’s uniform nature is a straightforward benefit to lien rights and foreclosure, generally. Serious consideration should be given to choosing the law and forum of the state where the terminal operates and the product is stored, though other business factors certainly call for a different jurisdiction to apply.
Fourth, broad discretion. A storage agreement cannot be so one-sided as to relieve an operator of its ‘commercial reasonableness’ – the obligation to act as a prudent operator with respect to a customer’s stored product. The agreement or the terminal’s rules can, however, define the extent of the operator’s obligations and better delineate what acts are specifically permitted and, thus, commercially reasonable if the operator undertakes them. For instance, the storage agreement should directly address the operator’s discretion to accept or reject nominations, or partial nominations, delivered by its customers. That relieves the operator of having to perform every nomination exactly as the customer outlined it. The agreement should also address the operator’s discretion to acknowledge or accept title transfers – transfers of product ownership while the product sits in situ at the terminal – which, left unchecked, can work to the operator’s disadvantage with respect to its lien rights. Requiring a formal title transfer process and, ultimately, the operator’s approval enables the operator to better retain its lien and secured interest in the product sought to be conveyed. Other duties under the storage agreement or terminal rules may be described as discretionary as well, provided the discretion is not so one-sided as to render the customer’s rights illusory.
Finally, product quality. An operator’s duties certainly include an obligation to preserve the product the customer delivers. However, as any operator knows, contamination — whether by water, sulfur or differing grades of product passing through common piping at the facility — can diminish the overall quality of a customer’s crude delivered to and stored in its leased tanks. A storage agreement should, therefore, address the operator’s exculpation from liability for product quality variation or degradation, reciting the customer’s acknowledgment (and acceptance) of conditions that could diminish the quality of its delivered and stored product. Such a clause may effectively reduce the customer’s available remedies from the world of tort to a simpler (and more ascertainable claim for breach of contract, which the operator would then be better able to defend and for which damages claims are somewhat more limited.
Conclusion
Terminal operations can impose significant burdens on an operator. Carefully crafted clauses — ones that protect the operator, more precisely define its obligations and its commercial reasonableness, and strip the customer of potential claims, remedies, and damages — give the operator more certainty in the operator/customer relationship and limit its risk.
[Our attorneys at McGinnis Lochridge regularly assist clients in negotiating and counseling on product storage relationships. Please contact the author if you need assistance, whether as an operator or a potential storage customer.]
[1]It is also common for operators to impose letter of credit posting requirements of its customers that serve to ‘secure’ the operator’s extension of valuable services at the terminal. Other than this notation, this article does not address those requirements, which operators are encouraged to include within their storage agreements.
[2]This is relevant in terms of viewing the lien rights provided to a terminal operator under the law. The operator is in essence extending credit in the form of valuable services to the customer (i.e., hundreds of thousands of dollars per month per tank plus other fees charged to the customer as may be applicable) in return for payment through installment billings delivered after product is moved into the facility. Technically speaking, the creditor’s extension of credit here is unsecured (unless the operator files a financing statement for charges over and above the value of the storage charges, such as money advanced and interest or obtains a letter of credit) except that the operator’s possession of the stored goods under the storage agreement or warehouse receipt gives rise to its lien rights, thus securing it in the stored product as collateral for its extended credit.
[3]This, of course, could include a customer’s lenders who are also secured by the customer’s product being stored, as well as any other person who claims an interest in the product, including the customer’s product seller, if there is one.
[4]For instance, say the customer is a business who does not regularly deal in petroleum products but, for whatever reason, owns or is in possession of such product stored with the terminal. The storer likely does not qualify as a ‘merchant,’ meaning the operator may only foreclose its lien by the public sales process.
[5]Obviously, terms other than the five mentioned below are important in negotiation of a storage agreement with the customer depending on the relationship of the parties to the agreement and the product being stored.