ARTICLE
27 November 2020

Letters Of Indemnity

RS
Reed Smith (Worldwide)
Contributor
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Reed Smith is a dynamic international law firm helping clients move their businesses forward. By delivering smart, creative legal services, we enrich clients' experiences with us and support achievement of their business goals. Our longstanding relationships and collaborative structure enable the speedy resolution of complex disputes, transactions, and regulatory matters.
Welcome back to our new series of ‘back to basics' blogs in which we will provide blogs focused on common legal issues. This blog post looks at letters of indemnity, a sometimes...
UK Transport
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Welcome back to our new series of 'back to basics' blogs in which we will provide blogs focused on common legal issues. This blog post looks at letters of indemnity, a sometimes unreliable but commonplace feature of the shipping industry.

When might an LOI be required:

Letters of indemnity act as an unofficial form of insurance in instances where a party is requested to step out of the bounds of its contracted obligations.

The most common example of such an instance is where the carrier is asked to deliver the cargo without production of the original bills of lading as the cargo has reached its destination before the bills of lading. Often this is simply due to couriering delays or, where the cargo has been traded during the course of the voyage, due to delays in transfer between the parties. It is a problem which is out of step with the speed of modern day trading and communications and yet, curiously, is still a very common one.

Other instances when an LOI may be offered are:

  1. Where the cargo is required to be delivered to a place other than the port named on the bill of lading/charterparty;
  2. For carrying riding crews/other personnel on board;
  3. Where "split" bills of lading are used; and
  4. Unwisely, where a "clean" bill of lading is requested in place of a rightfully claused one.

Potential concerns and liabilities

The main concern with making delivery without the original bills of lading is a claim for mis-delivery, i.e. when, after the cargo has been discharged, a party claiming to be the rightful holder of the bill of lading appears with the original bills of lading, demanding their cargo.

In such an instance, the carrier could face a claim for breach of the contract of carriage as he has failed to deliver to the person specified as the rightful recipient thereunder. If there is no contract between the carrier and the claimant, the carrier could face a claim for the tort of conversion. In that case, the carrier could find himself liable not just for damages to the value of the cargo but also all foreseeable losses suffered by the owner of the goods. In addition, the carrier would not be able to rely on the limitations of liability or defences incorporated in the contract, such as the Hague/Hague-Visby Rules.

Mis-delivery would also prejudice a carrier's insurance cover, which would mean that the consequences are not covered by his P&I insurance.

The situation is the same with delivery at a different port to that named in the Bill of Lading, where again the carrier could face a claim for breach of contract and prejudice his P&I cover.

In terms of carrying supernumeries on-board, a carrier may face claims in the event such persons sustain an injury whilst on board. With split bills of lading, the carrier is again at risk of mis-delivery claims. Some insurance providers also exclude liability for claims arising from having issued split bills.

In all the above instances, the carrier may have other options, such as to discharge into storage or to retain the cargo on board until the original bills of lading arrive or to simply refuse orders not in line with the charterparty. However, in practical terms, these options may not be commercially viable.

It is also common to see a clause in a charterparty obliging a carrier to discharge against an LOI in the event the vessel arrives before the bills of lading, e.g. "should a bill of lading not arrive at the discharge port in time, owners should release the entire cargo without presentation of the original bills of lading. Charterers hereby indemnify Owners against all consequences of discharging cargo, without presentation of the original bills of lading."

In such circumstances, a carrier's only hope for protection against potential losses may be an LOI.

The risks of accepting an LOI

  • An LOI is only as valuable as the person who grants it.

It is important to consider whether the grantor actually has the necessary funds available should the LOI be called upon, and whether there are any longer term risks to the availability of these funds. For example, will the grantor still be in business when the LOI is relied upon, or are they in any danger of  becoming insolvent?

Is the grantor reliable and trustworthy; what is their reputation in the market? In "The Zagora" [2016] EWHC 3212 (Comm), the charterers were held liable to indemnify the owners and since the LOIs down the line were in the same form it followed that there was liability under each of them. Unfortunately for the charterers, the sub-charterers' lawyers came off the record mid-way through the proceedings, leaving the charterers uncertain about the prospects of enforcing the LOI against them.

  • The wording of the LOI may not be watertight.

The wording of the LOI, even where using the IG Group standard wording, should always be considered carefully against the circumstances. In "The Bremen Max" [2008] EWHC 2755 (Comm), the carrier was obliged to discharge against an LOI by the terms of the Charterparty. The wording of the LOI was held to contain a clear instruction as to who the cargo should be discharged to and a failure to do so meant that the charterer's undertakings in the LOI were not engaged.

Following this case, the International Group revised their standard wording for LOI to provide that discharge is to be made 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". This wording was tested in Court in the "Songa Winds" [2018] EWCA Civ 1901, which considered the particular facts and arrived at a conclusion that the carrier did believe the party to whom the cargo was discharged represented or acted for the party named in the LOI and accordingly, the undertakings of the LOI were engaged.

  • The LOI may not be enforceable

An LOI in support of an illegal act would not be enforceable. For example, if a carrier knowingly provides clean bills of lading where they should be claused, this is considered an act of deliberate misrepresentation and fraud. In such an event, the carrier prejudices his P&I cover and any LOI obtained in consideration of this act would be unenforceable at law. As such, it is preferable simply  to refuse such requests.

Managing the risks

Those accepting an LOI should give thought to the following risk management checklist:

  1. Conduct as much financial due diligence as possible on the party granting the LOI, their assets and where such assets are based.
  2. If at all possible, have the LOI counter-secured by a reliable bank.
  3. Use the International Group wording for LOIs (as most recently revised)
  4. Make sure the LOI is of wide enough scope to cover all liabilities, costs and losses that you may face.
  5. If there is a chain of LOIs, ensure the wording is back to back.
  6. Avoid having a time limit for the LOI or if unavoidable, ensure the expiry date is sufficiently long after any potentially applicable time bar.
  7. Ensure the LOI is signed by a person authorised to sign on behalf of the grantor.
  8. Ensure the LOI is addressed to the correct party.
  9. If possible, incorporate the terms of the Contracts (Rights of Third Parties) Act 1999 or have the LOI addressed to 'The Owners/Disponent Owners/Charterers of the [vessel]'. By doing so, it may afford the grantee an option to enforce the LOI against a more financially sound party down the chain.
  10. At delivery, make sure the recipient is the party named in the LOI or their agent. Seek evidence of their identity and authorisation and retain a copy of this evidence.

Those granting an LOI should consider the following:

  1. Limit the lifespan of the LOI as much as possible.
  2. Limit your liability under the LOI.
  3. Make sure the LOI is addressed specifically to your contractual counterpart and exclude the Contracts (Rights of Third Parties) Act 1999 to ensure that no other parties up the chain try to claim thereon;
  4. Issue your own demand for security down the chain first before paying out under the LOI you provided.

In conclusion, LOIs are a necessary part of the smooth running of international shipping and trade. However, it would be unwise to adopt a casual approach when providing or accepting an LOI. As with all legal contracts, care must be taken to ascertain your risks and clearly identify who you are contracting with. Where possible, legal advice should be sought to minimise your risks from the outset.

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.

ARTICLE
27 November 2020

Letters Of Indemnity

UK Transport
Contributor
Reed Smith (Worldwide) logo
Reed Smith is a dynamic international law firm helping clients move their businesses forward. By delivering smart, creative legal services, we enrich clients' experiences with us and support achievement of their business goals. Our longstanding relationships and collaborative structure enable the speedy resolution of complex disputes, transactions, and regulatory matters.
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