Originally published in Lloyd's List, 2 September 2009.
A question often asked by shipowners is to what extent they can legitimately walk away from orders of newbuildings or, as an alternative course of action, can they delay the construction of the vessel?
Shipowners are often raise these legal inquiries prompted by the hope that the market will pick up in the future and for buyers who have been unable to organise financing due to the decline in ship values.
Answers will depend on the terms of each contract. However, if the buyer is locked into a contract price, he will almost certainly be unable to terminate, even if he decides to abandon the pre-delivery instalments already paid and just walk away. The shipbuilder in such cases may be entitled to reject the buyer's breach and keep building the ship, invoicing the buyer for the stage payments and the delivery instalment, as each falls due.
Practically, the builder is likely to terminate the contract on the grounds of the buyer's breach and fall back on its remedies for breach of contract. This includes not only the right to retain the instalments already paid, but also the right to recover the balance of the builder's losses from the buyer after selling the vessel in a partly-completed, or completed, state, together with interest.
In some cases, the builder may indicate to the buyer that it would like an extension to the delivery date. This can be a buyer's get-out-of-jail-free card in some contracts. It may not be so if the buyer has specific contractual remedies for late or non-delivery of the ship, such as liquidated damages for late delivery and, separately, a right to terminate the contract and have all instalments refunded, if the vessel is not delivered by the contractual long-stop date.
Usually, a shipbuilding contract will not permit a buyer to terminate the contract if the ship's construction falls behind schedule during the pre-delivery period. Accordingly, in the absence of such a termination right, the buyer would face the unattractive prospect of continuing to perform the contract by paying the remaining instalments as they fall due and wait for the contractual back-stop date before being able to terminate and claim a refund of its instalments.
Another common question is whether a buyer may terminate a contract if it is apparent that a default is coming. In the context of shipbuilding contracts, this is problematic for three main reasons.
It is difficult to succeed with a claim for repudiatory breach for conduct to which the contract provides a detailed set of remedies. Secondly, if the buyer wrongly claims a repudiatory breach it could end up being found to be in repudiatory breach itself, instantly turning itself from the innocent party to the guilty party. This would entitle the builder to terminate the contract.
Lastly, the buyer's remedy for a repudiatory breach would be damages for breach of contract and this is rarely secured by the refund guarantee, which usually covers only specific refunds due under the contract itself.
A particular issue for shipyards in China has been the difficulty that new greenfield shipyards have faced in the current economic climate. With contracts cancelled and funds drying up, many have found it difficult to complete these yards and we have seen cases where the drydock was being constructed as the first newbuilding vessel entered it.
In these cases, the buyer may have a stronger hand in re-negotiating the terms of the deal. Of course, the absence of the funds has a knock on effect in terms of the quality of work and materials used in the construction of the vessel.
Delay may have far-reaching and unexpected consequences, for example, if regulations applicable to a vessel have changed during construction delay. Shipbuilding contracts will usually specify that the regulations applicable at the date of the contract was signed will apply but there will usually be a provision for the shipyard to undertake (at the cost of the buyer) work to the vessel to bring it into line with mandatory requirements of the flag state.
A buyer's discomfort will usually be shared by its bank, whose interests run together with the buyer's and who will have taken security over the shipbuilding contract and refund guarantee. Just as the buyer may have to keep paying instalments as they fall due, the bank will usually be obliged to keep advancing the pre-delivery loan instalments as long as the buyer continues to satisfy the terms of the financing agreement.
The position will be different if the buyer is in default. If the bank has already funded a previous instalment, it may face a dilemma. If it refuses to fund the relevant instalment (as it is entitled to do under the loan documents), this may put the buyer in breach and entitle the builder to terminate the shipbuilding contract. This in turn would mean that the instalment(s), already funded by the bank, could be retained by the builder and the bank would have no prospect of recovering the sums already advanced.
So, if there is no other means of recourse for the bank, it may find itself having to decide whether to abandon the instalments already funded or to keep the contract alive by continuing to fund the remaining instalments and possibly striking a deal with another of its customers, interested in an acquisition.
Commercial and legal skill will be required to navigate these conflicting pressures and steer the circumstances to a client's best interest. Some contracts, if imprecisely worded, can allow a buyer to build up a picture of the shipyard's overall default that will mean the buyer can terminate and claim under its refund guarantee. The wording of each clause needs to be checked carefully.
It is often recommended that the buyer agree a compromise with a builder, particularly where there is contractual ambiguity and both parties are looking for certainty. For example, by delaying delivery, cancelling a certain number of vessels from a series of orders and varying the purchase price, usually by a deduction from the final instalment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.