* Louis Dreyfus will take legal action on defaults
* Merchants demand deposits, end centuries-old practices
* ICA's default list up over a third since 2011
* Mills 'victim of circumstance' - Bangladesh association
By Josephine Mason
NEW YORK, Jan 24 The global cotton trade, which
still operates on handshakes and trust to the astonishment of
hard-bitten operators in other commodities markets, might lose
much of that clubbiness because of a wave of defaults by textile
Merchants are reviewing centuries-old practices that relied
on promises of payment rather than cash deposits - with any
disputes sorted out calmly through arbitration. They are now
either taking or considering legal action to stem the tide of
contract defaults caused by the wild price volatility that has
engulfed the industry since 2011.
The National Cotton Council (NCC) estimates that contracts
worth a whopping $1 billion, or 7 percent, of the $14 billion a
year global cotton market could be in default.
Many of the deals being ripped up were signed when prices
were soaring to record highs of $2.20 per lb in March 2011. In
many cases, the scramble to secure supplies meant mills agreed
to pay record prices, while delivery of the fiber was not for
When prices collapsed to below $1, spinning mills struggling
with squeezed margins and weak demand walked away from those
higher-priced deals at an unprecedented rate.
Joe Nicosia, the global head of cotton at trading house
Louis Dreyfus, the world's biggest cotton merchant, is
threatening legal action against customers who renege on
contracts and is now forcing some buyers to post deposits.
"Arbitration's not the last resort. It's a middle phase.
There are legal enforcements," he said in an interview earlier
this month on the sidelines of the Cotton Beltwide conference,
the biggest meeting of farmers in the country. "We'll be taking
people to court."
Nicosia would not name who he had in his crosshairs, but his
message was clear.
"We're not going to forget, we're not going to stop
pursuing. We will pursue it politically and legally," said
Nicosia, who is regarded as the unofficial spokesman of the
cotton merchant community.
Resorting to costly and time-consuming lawsuits with the
hope of seizing goods as compensation is a dramatic step for the
industry. The strategy has not been used widely for decades and
navigating foreign courts is rare, market participants say. As
agents between growers and mills, merchants have been hit the
hardest by the reneging.
Taking deposits or asking for guarantees from banks or the
parent companies of some customers would help to revive trust.
That is considered more secure than getting letters of credit,
which have been the traditional method of guarantee.
Some merchants have managed to demand and get 5 percent to
10 percent deposits from mills in Asia, said Jordan Lea,
chairman and co-owner of cotton merchant Eastern Trading in
Merchants are also doing much more due diligence on new
customers, trade sources said.
Still, a seismic shift in practices would be hard to
introduce in the United States, where prompt-paying mills would
baulk at requests for deposits.
It is also likely to increase the financial burden on many
mills that are already cash-strapped because the wild swings in
prices have hurt demand for natural fibers.
Mills in Bangladesh, which have had the highest number of
defaults since 2011, were left high and dry when credit lines
were pulled as prices more than halved from the March 2011
peaks, said Muhammad Ayub, president of the Bangladesh Cotton
Clothes manufacturers have also canceled orders in the wake
of the price swings, sources at the mills said.
"Defaulters are the victim of the circumstances," Ayub said.
FARMERS ALSO RENEGED
To be sure, it's not the first time the industry has
struggled with excess capacity, low margins and contract
wash-outs. And many mills also honored their contracts,
incurring enormous losses, or negotiated new terms with their
Mills are not the only ones to blame, either. Many farmers
who contracted to sell their cotton crops at much lower prices
in 2010 reneged on those deals as prices soared a year later,
forcing merchants to pay much more to meet export commitments.
Those "wash-outs" were dealt with more quickly than the
longer-term deals the mills were lured into.
About 185 companies from almost 50 countries, including the
United States, tore up contracts and disregarded arbitration
rulings against them over the past two years, according to
records kept by the International Cotton Association (ICA),
which polices the industry. Its 500-strong membership includes
farmers, merchants and mills.
With the market undergoing one of the most tumultuous
periods in its history, lawsuits have been starting to flow in a
number of directions.
Nicosia, Dreyfus and its U.S. subsidiary, Allenberg Cotton,
are themselves the target of a lawsuit. They are facing
allegations from former Glencore International Plc
trader Mark Allen of artificially inflating prices during the
2011 run-up in one of the highest profile commodity manipulation
lawsuits in more than a decade.
Allen has accused the company and its boss of violating
antitrust laws by cornering the futures market, driving the May
and July 2011 prices higher, even while prices in the physical
market were lower.
He left his job at Glencore in November 2011 after the
trading firm lost more than $300 million in the market during
the upheaval. Louis Dreyfus has denied the charges and filed a
motion in November to dismiss the case.
The high stakes have also pushed some growers to the brink,
often to the benefit of merchants such as Dreyfus. Last week,
one of Australia's biggest grower groups, Namoi Cotton
Co-operative Ltd, accepted a bail-out from the trading
house after losing almost A$70 million, partly due to defaults
in 2011 and 2012.
By playing hardball, Nicosia, who grew up in Chicago, far
away from the clubby cotton market in Memphis, Tennessee, wants
to recoup some of the company's money. Dreyfus has not disclosed
the size of the outstanding bills.
In turn, merchants hope that one of the industry's most
influential and high profile figures will help turn the tide.
"He is trying to find a remedy to the situation itself. It's
good for the industry. We should all be doing it," said Eastern
Trading's Lea, who is also an ICA-registered arbitrator.
"It's also trying to counter that mindset and belief that
it's OK (to default)."
While the ICA was inundated by a record number of
arbitration requests in 2011 and 2012, it has struggled to
Its blacklist of companies that have not complied with its
arbitration proceedings has risen by more than a third since
2011 to over 500.
Bangladesh, the world's second-biggest cotton importer
behind China, has by far the highest number, with 47 companies,
equating to a quarter of additions since 2011. Vietnam, the
world's No. 6 importer, has 24 listed in the past two years,
while Pakistan has 15 companies, followed by Tanzania with 14.
Until 2011, the threat of being added to the blacklist,
which dates back to around 1976, was often enough to deter
But with companies ignoring rulings, enforcing awards has
become one of the ICA's biggest challenges. In a radical step,
the association has set up a surveillance committee to monitor
companies it suspects of using "dishonorable" methods, such as
setting up shell firms to buy on behalf of defaulters.
Nicosia, who joined Dreyfus' grains trading desk over 30
years ago, also urged Washington to pressure foreign governments
to enforce contracts and arbitration awards.
His request comes as a trade delegation, including
representatives from major merchant Cargill Cotton and U.S.
trade associations, prepares to march on the capitol next week
to plead for help.
They hope to hear of diplomatic progress from Department of
Agriculture Secretary Thomas Vilsack, who has contacted his
counterparts abroad, NCC president and chief executive Mark
The trip follows a similar effort in September, although
this time the group will also meet a trade representative from
the Vietnamese embassy.
But with counterparty trust in shreds, it might take more
"The industry has a long history of integrity," Nicosia
said. "That's been challenged and if it's not fixed, it will
result in changes in prices and contracts."