Letters of Indemnity - The Pitfalls

February 2009

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The recent English High Court decision in Farenco Shipping Co. Ltd v Daebo Shipping Co Ltd (The “Bremen Max”) considered issues of construction concerning a Letter of Indemnity (“LOI”) for discharge of cargo without production of the original bills of lading and has again highlighted some of the potential pitfalls of what is no doubt a relatively widespread practice, albeit one for which there is no “as of right” P&I cover. 

The claim was brought by disponent owners of the “Bremen Max”, against their charterers and was in relation to a cargo from Tubarao, Brazil to Bougas, Bulgaria under a NYPE 1946.  There was a series of back to back sub charters all of which imposed an obligation on the owner to “allow discharge and release the cargo on board [without production of the bills of lading] against Charterers’ single Letter of Indemnity…with wording as per Owners’ Protection and Indemnity Club recommendation”. 

The bills of lading were not available at the port of discharge and the owners were requested to deliver the cargo against the charterers’ LOI. The wording provided, inter alia, that the cargo was to be delivered to a specific entity without production of the original bill of lading and, should the vessel be arrested or threatened with arrest, the charterers would provide bail or other security “ … as may be required to prevent such arrest or detention or secure the release of the ship ….”. 

Subsequent to discharge of the cargo the vessel was threatened with and, in the event, arrested by the lawful holder of the bills of lading (“Stemcor”) for security for US$11m. The vessel owner had called on their charterer to provide security to avoid the threatened arrest and each charterer down the chain made the same demand on the charter below them. However, no security was forthcoming and thus, in order to mitigate their loss and release the vessel from arrest, owners provided security. Owners then sought and obtained security from their charterer by way of a Rule B attachment. A dispute then followed between charterers down the chain on a number of points in relation to the construction of the LOI. 

 In particular Teare J had to consider whether: 

1)      The LOI obliged the party giving the indemnity to provide it directly to Stemcor 

2)      The obligation in the LOI to provide bail or other security was no longer required as the owners had already issued security to release the vessel

 3)      The undertakings provided are conditional upon delivery to the nominated party in the LOI 

It was accepted that the answer to the first issue was that the party giving the LOI was obliged to give it to the lawful bill of lading holder. This decision is based upon the clear and unambiguous wording of the LOI that prescribed that the party issuing the indemnity is “to provide on demand such bail or other security as may be required to prevent such arrest or detention or to secure the release of such ship..”. Charterers under the LOI are obliged to secure the party that arrested the vessel; namely Stemcor. 

As for the second issue, it was argued that the obligation under the LOI to provide security to prevent or secure the release of the vessel had lapsed because owners had already provided security to release the vessel (and the head charterer had not provided security to release the vessel but, pursuant to a Rule B attachment, to release their own assets). Teare J dismissed this argument in favour of owners.   

Despite the owners providing security to lift the arrest, that did not discharge the charterer’s obligation to provide bail or other security. The obligation had accrued and did not cease simply because owners had mitigated their loss by providing security to Stemcor. The commercial purpose and intention of the LOI was that the owners should not have to incur the cost of providing security.  

The third issue considered whether the undertakings set out in the LOI were conditional upon delivery to the party named in the LOI. Teare J held in favour of charterers on the basis that the LOI contained a clear agreement as to whom to deliver the cargo, so it follows that if the shipowners delivered to anybody else the undertakings set out in the LOI “were not engaged” (Teare J) .   

In order to reach this decision consideration was given to the obligations under the Clause 68 to “discharge and release the cargo”, and the distinction between ‘discharge’ and ‘delivery’. The wording of Clause 68 was clear to the extent that it allowed the charterers to ‘discharge’ the cargo in return for an LOI, but it did not identify the party to whom ‘delivery’ was to be made.  It was the owner’s P&I Club standard form LOI wording which provided a clear request to deliver to a specific person and, equally, it was clear that owners had to comply with the charterer’s request and deliver the cargo to that named person. It follows that if owners deliver to anybody else then the charterer’s undertakings are not engaged. It was however intimated by Teare J that owners can protect themselves if in doubt about the party requesting delivery. Owners must ask charterers to identify the intended receivers. If owners then comply and issues arise due to the delivery to the wrong party then charterers will be estopped from denying that the owners delivered the cargo to the person whom the charterer requested. 

The importance of this case is that is underlines the risk of reliance on LOIs not simply from the perspective of enforcement but just as significantly the construction of the LOI. Owners cannot merely rely upon a charterer’s LOI based upon the P&I Clubs’ standard wording as a safety net to cover all consequences arising out of the request to deliver cargo without production of bills of lading. As P&I Clubs in the International Group exclude this practice from standard P&I cover, it is crucial for owners to assess and check that they are delivering the cargo to the person nominated by the charterers as stated in the LOI.  It is not the first time and will not be the last time that courts are called upon to interpret the true intention and obligations of the parties to the LOI using standard P&I Club wording. As with the case of Laemthong International Lines Co. Ltd v ARTIS & Ors each LOI will be construed according to its own terms.