Article: Letters of Indemnity (LOIs) and recent English court decisions

Introduction

This article:

• outlines the use of letters of indemnity (LOIs) and the impact on members’ P&I cover
• discusses some recent English law court decisions concerning the enforcement of LOIs
• offers recommendations to members when negotiating, issuing, and using LOIs.

What is an LOI and why are they used?

An LOI is an agreement whereby the issuer requests the recipient to do (or refrain from doing) something in exchange for an indemnity for any losses that result from complying with the request.

In shipping, in the interest of expedience, a shipper or charterer might request a shipowner to undertake additional risks in exchange for an LOI issued by the charterer or the shipper.

The most common situations in which an LOI might be used include:

• the delivery of cargo without presentation of original bills of lading (OBLs), because the bills are not available at the discharge port
• a ship being required to deliver cargo at a different port to the one identified as the discharge port in a bill of lading (ie a geographical deviation)
• a shipper requiring a ship’s master to issue clean bills of lading for damaged cargo.

While the issues discussed in this article are likely to be relevant to all types of LOI, our examples focus on LOIs for delivery of cargo without presentation of OBLs.

Potential issues with LOI usage

While LOIs are operationally useful, their use often exposes the recipient to additional risks as follows:

Increased risk of claims
When delivering cargo without the presentation of OBLs, the shipowner exposes itself to an increased risk of delivering the cargo to a party who may well not have title to the goods (ie the actual holder of the original bills). If such a misdelivery occurs, the party with rightful title to the goods may assert a claim against the owner for the whole value of the misdelivered cargo including by arrest of the ship.

Potential prejudicial effect on P&I cover
Where cargo is delivered without presentation of a negotiable document of title such as the OBL, club cover is likely to be compromised and no longer automatically available [1], regardless of whether the member has obtained an LOI or bank guarantee.

The reality underlying much use of LOIs is that they are effectively used as a plug to fill the hole in P&I cover that is created when an owner or operator wishes (or feels commercially compelled) to deliver cargo without presentation of OBLs.

Enforcement
There are at least four reasons why a shipowner might face difficulties when seeking to enforce an LOI:

• The LOI issuer does not have the financial means to ’make good’ on the LOI or has since become insolvent.
• The shipowner has not effected delivery of the cargo in a manner strictly compliant with the wording set out in the LOI.
• The claims under the LOI have become time-barred.
• A court refuses to enforce the LOI on grounds of illegality/public policy considerations.

Delivery of cargo without presentation of original bills of lading

The International Group of P&I Clubs (IG) has created a series of standard form LOIs, including the ‘Group A’ LOI form, which concerns delivery absent OBLs. It provides as follows:

‘The above cargo was shipped on the above ship by [insert name of shipper] and consigned to [insert name of consignee or party to whose order the bill of lading is made out, as appropriate] for delivery at the port of [insert name of discharge port stated in the bill of lading] but the bill of lading has not arrived and we, [insert name of party requesting delivery], hereby request you to deliver the said cargo to "X [name of the specific party] or to such party as you believe to be or to represent X or to be acting on behalf of X"  at [insert place where delivery is to be made] without production of the original bill of lading.’

Pursuant to this wording the indemnity is triggered when the LOI recipient:

• delivers the cargo to Party X or a party representing or acting on behalf of Party X
• delivers the cargo to such party he believes to be Party X
• delivers the cargo to such party as he believes to represent or be acting on behalf of Party X.

Recent English court decisions

Several recent English court decisions have construed various parts of the operative wording of the Group A LOI in different practical and legal situations.

In each case, the LOI issuer(s) alleged that delivery had not been made in accordance with the LOI request, hence the LOI could not be enforced by the LOI recipient. 

The Bremen Max [2009] [2]

Facts: Pursuant to an LOI on Group A wording, X issued an LOI to the owner requesting delivery of the cargo to A absent presentation of the OBLs. 

The owner subsequently released the cargo to A.

B, who claimed to be the holder of the OBLs, and to whom delivery had not been made, arrested the vessel and sued for misdelivery of the cargo.

X contended that whilst the cargo may have been discharged, no delivery of it had been made to A, and thus the LOI was not engaged.

X refused to put up security pursuant to the LOI to enable the release of the vessel.

Decision: The LOI was engaged by the owner’s act of delivery, which the court held had been made to A. The LOI issuers were ordered to put up security.

Take home points: The purpose of an LOI is to avoid the owner having to suffer the arrest of its vessel after having complied with the LOI issuer’s request for delivery. The court will grant specific performance of the obligation to indemnify under an LOI (which on the facts of this case was the provision of security to release the vessel). A standard form LOI will be engaged if the owner does in fact deliver the cargo to the named party A, or to a party that does in fact represent party A. It is important to remember that discharge and delivery of cargo are different concepts – they may (and very often will) occur simultaneously, but they may not. The standard form LOI responds only to delivery [3].

The Zagora [2017] [4]

Facts: LOIs were issued up a charter chain. Each LOI requested delivery without presentation of the OBLs to:

i) a party named Xiamen
ii) such party as the LOI recipient believed to be Xiamen; or to be acting on behalf of Xiamen.

An entity named Sea-Road was identified up the chain as the shipping agent at Lanshan, the discharge port. At Lanshan, a representative of Sea-Road boarded the vessel, and told the master that he was there to handle discharge on behalf of Xiamen. The cargo was discharged.

Eight months later, the vessel was arrested by the Bank of China, who claimed to be the (unpaid) holders of the OBLs to whom delivery ought to have been made. The LOI recipients argued that Sea-Road did in fact represent or act on behalf of Xiamen, and in any event since the master had believed this to be the case, the LOIs were engaged. 

Decision: On the evidence, Sea-Road did in fact represent or act on behalf of Xiamen. Delivery to them thus engaged the LOIs. If that had not been the case, the master (and hence head owner, on whose belief the parties up the LOI chain could rely) had believed that Sea Road were representing, or acting on behalf of, Xiamen. Additionally, therefore, had it been necessary, the LOIs would have been engaged on that basis.

Take home points: If actual delivery to party A is not satisfied, the LOI will be engaged if the owner believed the party to whom delivery was made was or was representing party A (even if, in the end, the owner was wrong). In a chain situation, a disponent owner or charterer is entitled to rely on the belief of the head owner’s servants (eg the master). That is important as it is only the head owner who will actually be effecting discharge, and whose servants or agents will actually form a belief about who they are delivering cargo to.

Whether an owner must prove that the belief relied upon was not unreasonable (or capricious, arbitrary or irrational) remains an open question. Prudent owners should therefore take all steps necessary to ensure the beliefs they (or their servants) operate under are well-founded and the basis for such a belief is clearly and contemporaneously documented (eg by clear written instructions / confirmations by email to and from their counterparties).

The Songa Winds [2018] (Commercial Court) [5]

Facts: LOIs were issued up a charter chain requesting delivery absent the OBLs to
i) Aavanti
ii) such party as the recipient believed to be or to be representing or acting on behalf of Aavanti.

Delivery was effected to an entity known as Ruchi, who the LOI recipients argued were acting on behalf of or representing Aavanti.

The LOI issuers denied this and argued delivery had not been made to the correct party.
As such, the issuers of the LOI refused to put up security or indemnify the LOI recipients after the head owner’s vessel was arrested, and a misdelivery claim had been asserted by Société Générale, who claimed to be the rightful holder of the OBLs. 

Decision: The court was persuaded on the evidence that Ruchi was acting on behalf of Aavanti. The LOIs were therefore engaged. The court therefore did not have to decide the question of the belief (or otherwise) of the master, as was the case in The Zagora. However, whilst the judge indicated that question was not amenable to determination by way of summary judgment, it seems unlikely from the terms of his discussion of the issue that he would have departed from The Zagora approach of imputing the knowledge of the belief owner to LOI recipients up the LOI chain.

Take home point: Whilst the belief of the master was not determined in the course of the judgment, there were strong indications that the judge would have followed the approach taken by Teare J in The Zagora on the issue.

However, the case again shows that such arguments will not generally be amenable to resolution by way of summary judgment application, meaning that, as per the comments in relation to The Zagora above, owners must take all necessary steps to ensure that they have a sound basis for delivering cargo to a particular party, backed up by relevant contemporaneous correspondence. 

The Songa Winds [2018] [6]

Facts: In addition to the main dispute concerning the construction of the wording of the LOIs (see above), at first instance, Glencore (one of the LOI issuers) had unsuccessfully argued that disponent owner’s (the LOI recipient vis a vis Glencore) claim against Glencore under the relevant LOIs was time-barred. 

Glencore alleged that a provision (clause 38) in the voyage charter that existed between it and disponent owner amounted to a time bar, and that this time bar was automatically transposed into and applied to the LOIs.

The disponent owner contended that clause 38 did not amount to a time bar. In the alternative, they argued that even if it did, its application as such a provision was confined to the voyage charter and was not apt to be transposed to the LOI in the absence of express wording in the LOI. The LOIs were separate contracts and had to be construed on their terms alone.

Decision: The Court of Appeal agreed with disponent owner. Applying established principles of contractual construction under English law, the court made clear that if the parties to an LOI intend it to contain rights and obligations that had earlier been agreed in a charterparty between the same parties, that needed to be evident as a matter of construction of the LOI. One could not just rely on the charterparty’s existence. Separate contracts had to be interpreted independently of one another.

Take home point: An LOI is an independent contract, to be construed on its own terms and not (without express agreement to this effect) by reference to a preceding charterparty between the same parties. If a party wants to be sure that a right or obligation set out in a preceding charterparty is enforceable under a later issued LOI, that party must include express wording to that effect in the LOI, or otherwise make that intention clear as a matter of construction of the LOI.

By the same token, LOI recipients should always take care to enforce their rights under a specific LOI in compliance with any potentially applicable time bar that may apply

Conclusion

The use of LOIs is, and will likely remain, an important feature in the conduct of international trade. Used properly, they protect a shipowner being asked to perform operations which will potentially prejudice its P&I cover.

However, members would do well to remember that the use of LOIs potentially exposes the recipient to substantial additional risks and can raise complex issues of law. Due consideration and diligence must be given to the precise wording and scope of the LOI that is being negotiated.  An owner who fails to do this runs the risk that the LOI may fail to be legally or practically enforceable when most needed. 

Additionally, as each situation is different, care should be taken to comply with the precise wording of the request made by the LOI issuer in an individual LOI.

If our members have specific queries relating to LOIs, they should not hesitate to get in touch with their usual club contact.

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This article was written with contribution from Oliver Caplin at 20 Essex Street. 

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[1] Proviso (5) Exclusion to rule 3.13 Club Rules
[2] [2009] 1 Lloyd’s Rep 81
[3] To deliver cargo one must 'transfer possession of it': §32 of The Bremen Max.  There are unresolved questions as to how the wording 'release' fits in here, so owners should be cautious about the language they use in LOIs and charters in this regard.
[4] [2017] 1 Lloyd’s Rep 194
[5] [2018] 2 Lloyd’s Rep 47 (Commercial Court)
[6] [2018] 2 Lloyd’s Rep 374 (Court of Appeal)