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Letters of indemnity

In today's trading market, owners are frequently requested to accept a letter of indemnity (LOI) in exchange for complying with charterers' or shipper's request to take on risks which can fall outside the contractual demands normally placed on a carrier.

Letters of indemnity
07 March 2014 - 20:39
In today's trading market, owners are frequently requested to accept a letter of indemnity (LOI) in exchange for complying with charterers' or shipper's request to take on risks which can fall outside the contractual demands normally placed on a carrier. These can also fall outside the scope of standard insurance coverage, and hence deserve careful attention.

Key points of advice

    Taking a LOI against a request may create obligations outside of the basic contractual agreement;
    These may impact on standard insurance coverage;
    Careful consideration needs to be had of the nature and terms of the request;

    -nature and terms of the request
    -terms of the LOI
    -party making the request
    -authority of the signor of the LOI
    -enforceability of the LOI

    It is best to address these issues, if foreseeable, at the outset of the fixture, with suitable charter terms and LOI templates included as addenda to the charterparty

 Owner's obligations

Owners' basic obligations are very closely connected with the three functions of a negotiable Bill of Lading (B/L), in particular as a:

    Receipt of the goods, which operates as prima facie evidence of the goods' quality and condition
    Evidence of / being the contract of carriage, which gives to the parties of the sales transaction rights against the carrier in regard to the safe carriage of the goods and their delivery at destination
    Document of title which is subject to transfer and endorsement and gives a right to demand delivery

Market practice

The owner's obligations are set down in law, and are also the basis for the insurance coverage for cargo claims, yet in practice parties may seek to adopt alternative practices that aim to address commercial considerations that arise from time to time.

The most common way of dealing with traders' requests outside the contractual obligations are closely related to the use of letters of indemnity (LOIs). These should contain, effectively, a straight forward promise: if you do what I ask, I will make sure that you do not suffer any loss.

Main types of LOI situations

Broadly speaking, LOIs can be distinguished between those related to shipment and those related to discharge.

Shipment LOIs

In general terms, LOIs requested upon shipment are closely connected with a request to the Master to issue a B/L that contains a representation, which was made knowingly or without belief in its accuracy, about matters such as the nature, condition or quantity of the cargo – BUT which are not correct.
For example, B/Ls with an incorrect description of goods (quality and / or quantity), a failure to mention defective packaging or incorrect dates of shipment (Antedated or Postdated B/Ls).

Discharge LOIs

On the other hand, LOIs at discharge are usually related with a request to the Master to deliver the goods in good faith without the production of the original Bs/L and/or at a port other than the one stated on the B/L.

Other LOI situations

There are, however, various other occasions where an LOI may be the only commercial way to deal with charterer's requests, which go beyond contractual and insurance limits.

For example there may be a request for co-mingling of liquid bulk cargoes or mixing of dry cargoes which obviously raise various problems in relation to the description of the "new" cargo and issuance of new set of B/Ls. There can also be incidents where an Owner needs to serve a request for issuing split B/Ls or substituting a B/L with an amended one and it may not always be possible to have the original returned before the new set is issued. Again on those occasions the pragmatic solution can be found in a provision of an LOI.

Considering a LOI request

When an LOI is to be accepted, special consideration should be given to the terms and the extent of liability in order to provide sufficient protection to the carrier. The reality is that many anticipated pitfalls can be forestalled through careful drafting of the LOI wording; thus reducing the risks involved.

The key features of the IG recommended wordings are the provisions for "indemnity for any liability, loss, damage to expense of whatever nature arising out of complying with the request" as well as the issuer's obligation to provide sufficient funds to defend any claim and arrange the placement of adequate security to any third party.

It is always best to consider such matters at the outset of a fixture, and to pre-arrange suitable contract terms and LOI templates rather than seek to agree these ad hoc, often under urgent time pressure.

Risks

It is indeed quite evident that acceptance of an LOI is not a risk free exercise. What it is important to keep in mind is that the security is only as good as the person granting it and hence it is important to carefully assess the financial standing of the issuer.

Moreover, the clubs will recommend that the guarantee should be countersigned by a first class bank in order to provide the carrier with a safety net when trying to enforce the LOI. The reality though is that the majority of the traders tend to resist such a request, and LOIs are often issued without such countersignature.

Furthermore, the scope of the indemnity needs to be kept as wide as possible and preferably not to include any time limit.

In a nutshell, what needs to be considered and carefully assessed when seeking to minimize the risks related to LOIs is the creditworthiness of the issuer, the authority of the person signing the LOI and at last but not least the prospects of enforceability.

A particular point to note is that for instance there is no reciprocal recognition between P.R. China and the United Kingdom of Court Judgments, but both nations apply the New York Convention on Arbitration Awards. Therefore care needs to be taken when considering the applicable law and jurisdiction of the LOI.

Authority to issue the letter of indemnity

In addition to carrying out a risk assessment exercise to ascertain the creditworthiness of the issuer before accepting an LOI, it is equally important to carefully scrutinize the original document and check the authority of the person signing it.

The LOI should be in a form of an original signed document on the issuer's headed notepaper (fax or e-mail may be sufficient) and should be signed by a clearly identified signatory accompanied by an express statement that he/she is authorized to sign on behalf of the issuer. Needless to say, the original LOI should be sent out to the owners as soon as possible.

In case of doubt or concern, a senior officer of the company, such as a director of the board, should be asked to either sign the LOI or delegate the authority to a designated person, backed by a clear board resolution given the authority.

Straight indemnity clauses

Most issues that arise when an actual LOI is to be provided can be sorted out at the outset by incorporating a "straight indemnity clause" in the charterparty.

Such a clause provides for charterers to indemnify owners where the cargo is discharged without production of the B/L or at a place other than the one stated in the B/L.

In practice such a clause can help to ensure fast resolution of requests, as no separate LOI wording needs to be negotiated or considered. Furthermore the basic law and jurisdiction provisions of the charterparty will apply, which again speeds up the process.

It is important, however, to ensure such clause retains discretion for the owners to refuse a request to deliver without the original bill and the indemnity included needs to be worded sufficiently widely. The former is important so that the owner can protect himself in case there are suspect circumstances at the delivery port.

Enforceability

The rule of thumb that one needs to bear in mind is that an LOI which is accepted in return of issuing a B/L which is not accurate, may be unenforceable as it has the effect of potentially prejudicing an innocent party. Indeed, under English law, it may actually be held to be a fraud on the 3rd party.

Nevertheless, enforceability will always depend on the jurisdiction which either is designated for the dispute resolution, or which is seized of the matter.

The ethical dilemma is that both the carrier and the charterer are parties to the same situation and LOI device, and if the carrier is not permitted to eventually invoke the LOI against the charterer because of the perceived "fraud", the charterers is thus indirectly permitted to benefit from the situation. The concern for a court, however, would typically be the innocent 3rd party that may have been disadvantaged, and both owner and charterer will be taken to have taken a calculated commercial risk and will have to take on board the consequences.

A LOI may be enforceable, however, if there is a genuine doubt about the underlying situation such as whether or not the cargo is damaged when loaded onto the vessel, or the precise quantity laden. Also, a LOI for delivery without production of original B/L and/or change of destination should be to be enforceable, if the owner can show he had no reason to suspect that there was any underlying foul play involved, and it was just – ostensibly – a genuine matter undertaken for commercial convenience.

Duration of the LOI

As far as the duration of an LOI is concerned, it is obvious that there are indeed conflicting interests between owners and the LOI issuer.

The usual time limit under English law for a contractual claim is six years while the time bar limit for claims against the carrier under the Hague-Visby Rules is one year from the date of delivery or the date when the cargo should have been delivered.

The owner is obviously better protected if the LOI is either without a time limit or it is clearly stipulated therein that the LOI will expire after seven years.

The relevant provisions included in the IG LOI wordings provide that liability is to be terminated only when the original B/L is delivered to the carrier, if not, liability continues.

P&I considerations

As within the frame of todays' demanding market there is a wide recognition of the commercial pressure faced by carriers. Nevertheless, it is common ground between all P&I clubs that the principle of mutuality needs to be maintained and hence all members must comply with the Rules.

A LOI is an alternative to P&I cover as it applies to situations where the carrier needs to operate outside the scope of the rules. However, the clubs are always willing to offer assistance with the drafting of LOIs for non-production of B/L or change of destination as well as to discuss any other issue related to a situation where a request for an LOI is to be considered.

The association invites all members to consult the individual claims handlers whenever an LOI related issue comes up for discussion within the scope of their vessel's trading operation.
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