Web Alert: Lloyd's Open Form: a contract on the rocks?

This web alert is based on comments made by Sam Kendall-Marsden, Head of Division, UK & Americas, during a panel discussion on the Lloyd’s Open Form salvage contract (LOF) at the 19th Annual Salvage & Wreck Conference in London on 7 December 2016. Sam represents the club on the International Group’s salvage subcommittee and large casualty working group, and has been responsible for the club’s management of a number of major casualties.

Lloyd’s Open Form: a contract on the rocks?

In recent years, there has been a marked decline in the use of LOF in favour of commercial contracts, often the 2010 versions of the BIMCO Wreckhire, Wreckstage and Wreckfixed forms. In this web alert we explore possible drivers behind this trend, question whether LOF is likely to have a future in the modern world of salvage and wreck removal and propose some solutions to arrest its decline.

The decline of LOF

Earlier this year, the International Salvage Union (ISU) published its 2015 annual review. It showed that 2014 saw the fewest LOF cases on record (37), and that revenue from LOF cases in 2015 ($83m) was the lowest it has been for a decade. This is despite the total number of services performed (212) being the second-highest since 1999.

In contrast to the decline in the use of LOF, the ISU reported that ‘revenue from operations conducted under contracts other than LOF was the second highest at $98 million and shows a gently rising trend.’

The ISU noted that ‘safer ships and better operating practice have generally reduced the amount of emergency response work for salvors’. This is significant in the context of a decline in the use of LOF – a contract specifically designed for emergency situations.

The importance of LOF

In his foreword to the ISU’s review, its President, John Witte, stated that:

‘better understanding of the value and place of the Lloyd’s Open Form … continues to be important for us – most commentators agree that, in many emergency response situations, it is the best contract. ISU and Lloyd’s are committed to continuing to promote better understanding of the contract.’

However, he later added the caveat that:

‘For all parties, it is important to use the right contract in the right circumstances.’

It is also important to remember - as the ISU’s Legal Advisor, Rob Wallis, points out:

‘(LOF) was created by Lloyd’s more than a century ago for the benefit of the marine insurance market, not salvors.’ And that, ‘At its heart is the intent to encourage investment in salvage services to help prevent loss’.

LOF was, therefore, in its genesis a contract for the benefit of the market as a whole, not just salvors.

LOF vs commercial contracts

Like the ISU and Lloyd’s, the International Group P&I clubs are, in principle, supporters of the LOF regime. The contract is well-known, it is simple and straightforward (which obviates the need to negotiate terms in an emergency situation), the principles of recovery set out in The International Convention on Salvage, 1989 (the Salvage Convention) are well-established and a reliable dispute resolution process is in place with Lloyd’s Arbitrators.

However, despite the positive aspects of the LOF regime, the decline in its use suggests there are reasons for this which we explore below.

Speed

It could be argued the speed of modern communications undermines the need for an emergency-type contract. A master is not always required to make a unilateral decision in the heat of the moment as he once was. Now, he can obtain advice from shore-based colleagues, which opens up the possibility of alternative forms of contract. Against this though, it may be argued only the master is in a position to appreciate all of the relevant circumstances he faces that will dictate the speed and nature of response required, and LOF may be the best contract for the situation.

Ease of use

The essence of LOF is that it does not require amendment. However, there have been recent instances where this has occurred. An example is where the parties have agreed to cap the exposure under article 13 of the Salvage Convention in a case where SCOPIC has been invoked. This may have the effect of increasing the SCOPIC exposure on the P&I club concerned. However, agreeing a cap of this nature would prejudice a shipowner’s P&I cover, leaving them with an uninsured exposure to SCOPIC costs.

Principles of recovery

Whilst the principles of recovery (under the Salvage Convention) are well-established, they are inherently uncertain as they depend on consideration of listed factors (for example, the nature and degree of the danger faced by the salvors) which introduces at least some degree of subjectivity not seen in a commercial contract for services with prescribed rates, or for a lump sum. If agreement cannot be reached on the level of salvage remuneration then the only way to resolve the issue is to proceed to arbitration, which inevitably involves time and cost.

Arbitration

Whilst a fixed cost arbitration procedure (FCAP) exists ‘where the amount of the salved fund is small or where no point of law arises and the facts are uncomplicated’, it is thought to have been used fewer than 10 times since 2005. To put this in context though, according to the Lloyd’s Open Form Report 2015, approximately 78% of LOF cases from 2004 to 2013 reported to the Lloyd’s Salvage Arbitration Branch were settled amicably between the parties without recourse to arbitration.

Salvage rewards

Could the size of rewards be a factor in the decline in use of LOF? Article 13.1 of the Salvage Convention relevantly provides the reward to a salvor ‘shall be fixed with a view to encouraging salvage operations’ (our emphasis). That said, the reward must not be out of proportion to the services performed and their cost. Returning to the Lloyd’s Open Form Report 2015, over the period in question, the average award was 23% of the value of property salved. In its 2015 review, the ISU notes average LOF revenue as a percentage of average LOF salved value was 13%, having fallen for the second consecutive year. However the ISU also notes SCOPIC revenue ‘increased significantly’ in 2015 (to $139m) which may be having a deterrent effect.

Contractual freedom

There is concern in some quarters that LOF may restrict commercial and contractual freedom. LOF can only be terminated ‘when there is no longer any reasonable prospect of a useful result leading to a salvage reward’. The problem is exacerbated in cases where LOF incorporates SCOPIC and it is invoked by a salvor where there is concern about whether the operation will be a success and/or the likely residual value of the property salved. If the relevant authorities prevent the salvor from demobilising then clause 9(iii) of SCOPIC operates to prevent termination, which may frustrate a shipowner and their insurers’ wish to move to a commercial contract. There have been recent cases where this has significantly added to the cost of wreck removal. Also, a shipowner terminating SCOPIC does not automatically terminate the underlying LOF.

To echo the words of the ISU’s President quoted above, whilst LOF is ideally suited to emergency situations, it may not be the most appropriate form of contract in all situations. It is also worth noting it is not just shipowners who have a say but also their underwriters - both hull and machinery and P&I. If there is sufficient time, negotiating a bespoke commercial contract allows complete flexibility in terms of the scope of work, standard of performance, allocation of risk and remuneration.

Salvaging LOF

It is concerning that there have been cases where parties have sought to amend LOF in a way that could leave a shipowner partially uninsured. To the extent it is felt the regime requires amendment, it is submitted changes should follow dialogue and agreement within the Lloyd’s Salvage Group, comprised of relevant stakeholders including representatives from the ISU, the P&I clubs and property interests.

Concerns about the cost of proceeding to arbitration for a salvage award might be addressed by revising the FCAP. Two reasons why the FCAP is little-used are perhaps because the indicative threshold for a dispute qualifying for the procedure (where security of less than $1.5m has been requested by salvors), and the level of costs that may ultimately be recovered are both too low. The forthcoming review of the FCAP is welcomed.

The potential for clause 9(iii) of SCOPIC to frustrate termination and the transition to a commercial contract remains a concern. A review of the SCOPIC termination provisions is to be conducted as a result and is a positive step. Sharing the financial consequences of the relevant authorities preventing a salvor from demobilising is one option which would serve to align the parties’ interests. In the meantime, clubs would expect salvors to work with them and their shipowner-members in transitioning from LOF to a commercial contract in appropriate cases.

In his General Manager’s report, the ISU’s Mark Hoddinott stated

‘In 2015 … (the ISU) commenced a joint project with Lloyd’s of London to try and improve the use of the Lloyd’s Open Form contract through education and information. This is a long term project as, in many cases, attitudes and positions have been established for decades. It may be some time before we see an increase in the use of LOF but ISU remains resolute in its determination to see it used more than at present.’

This initiative is also welcomed.

Conclusion

The fact the LOF regime is supported by the relevant stakeholders but its use is declining suggests there is a need for reform if the contract is to remain viable. Reforms ought to reflect the original aims of LOF: to encourage investment in salvage services and the rendering of assistance to ships in need in a way that fairly benefits the marine industry as a whole.

This article was published in the February issue of Maritime Risk International, available at www.maritime-risk-intl.com/salvage