Claims etc. - Rule 88: Payments and undertakings to third parties

1. The Association shall be under no obligation to provide any guarantee, certificate, bail or other security or undertaking ("security") for or on behalf of a Member, or to pay the costs of such provision.

2. The Association may at its discretion provide security or pay the cost of such provision in relation to liabilities within the scope of a Member's cover, and may recover any costs incurred thereby from the Member.

3. The Member shall indemnify the Association for any liability the Association may incur to a third party under or in connection with any security issued by the Association for or on behalf of the Member and for any payment made by the Association to a third party for or on behalf of the Member (irrespective of whether that liability was incurred, or that payment was made during or after the period of the Member's insurance by the Association), save to the extent that, had that third party pursued its claims in respect of the relevant liability against the Member rather than against the Association, or had that payment been made by the Member rather than by the Association, the Member would have been entitled to reimbursement pursuant to these Rules.

4. 1. Where the Association has issued any guarantee, undertaking or certificate as referred to in Rule 58.2 or Rule 73.2 or other bail or security by which it undertakes to directly meet or guarantee any relevant liabilities (together the “Direct Liabilities”) and claims in respect of Direct Liabilities alone or in combination with other claims may in the sole opinion of the Association exceed any limit(s) on the cover provided by the Association as set out in the Rules or in the Certificate of Entry, the Association may in its absolute discretion defer payment of any such other claims or any part thereof until the Direct Liabilities, or such parts of the Direct Liabilities as the Association may in its absolute discretion decide, have been discharged.

   2. To the extent that any claims or liabilities (including any Direct Liabilities) discharged by the Association exceed the said limit(s) any payment by the Association in respect thereof shall be by way of loan and the Member shall indemnify the Association promptly upon demand in respect of such payment and shall assign to the Association to the extent and on the terms that the Association determines in its discretion to be practicable, all the rights of the Member under any other insurance and against any third party.”

A very attractive feature of P&I insurance is the ability of P&I clubs to provide security to third party claimants on behalf of a member and, thereby, enable an entered ship to minimise the threat of arrest and to trade freely. However, the terms upon which such security is provided by the Association may differ depending on the particular situation.

In the majority of cases, the provision of such security is not an automatic right that is given to the Member. Pursuant to the “pay to be paid” principle the Association may, but is not obliged, on the occurrence of a claim that may be brought by a third party against a Member, to offer security on behalf of the Member to pay any claim that may be successfully made against the Member and may impose conditions on its willingness to do so.

However, in other situations, the Association, like the other P&I clubs that are members of the International Group of P&I Clubs, may have agreed to provide security in advance of the receipt of claims that may be made by third parties. In the majority of cases, such security is provided pursuant to the requirements of various international conventions¹ and by providing such security, the Association makes itself directly liable to the third party claimant for the satisfaction of such claims (referred to hereafter as Direct Liabilities).

Rule 88 regulates the terms upon which the Association may be prepared to offer security. Rules 88.1 – 88.3 regulate the terms on which the Association may be prepared to offer security for claims that have traditionally been subject to the “pay to be paid” principle whereas Rule 88.4 a regulates the Association’s right to defer payment of other claims than Direct Liabilities if the Direct Liabilities alone or together with other claims may exceed the applicable limits of cover. Rule 88.4 b regulates the situation when payment is made by the Association for claims whether or not of a Direct Liability nature which exceed the limit of cover that is available under the Rules or the relevant Certificate of Entry.

(A) The Association shall be under no obligation to provide…security…or to pay the costs of such provision… (Rule 88.1) The Association and all other P&I clubs that are members of the International Group of P&I Clubs provide indemnity insurance to their Members in accordance with the ’pay to be paid‘ principle.² Consequently, if the Association were to be legally obliged to provide a guarantee, certificate, bail or other security to a third party, that would undermine the ‘pay to be paid’ principle since the Association would, thereby, become committed to pay compensation directly to the third-party beneficiary of the security. Rule 88.1 recognises the importance of this principle and emphasises that the Association does not have a legal obligation to provide security to third parties on behalf of the Member except in special and very limited circumstances. Similarly, all the other P&I clubs that are members of the International Group have adopted the same principle. 

Furthermore, if the Member pays a fee to some other security provider to provide security to a third party claimant in the form of a bank guarantee or bail bond or some other form of guarantee, Rule 88.1 makes it clear that the Association is not obliged to compensate the Member for the costs that are incurred by him in this respect. 

(B) The Association may at its discretion provide security or pay the cost of such provision in relation to liabilities within the scope of a Member’s cover… (Rule 88.2) Notwithstanding the above, the Association recognises the importance to a Member of the ability to trade his Ship without any undue risk of arrest by claimants that are seeking security. Therefore, the Association may, as a service to the Member and on a discretionary basis,³ agree to provide security on behalf of the Member, or to reimburse the Member for the cost that he has incurred in order to provide security by other means, e.g. a commission paid for a bank guarantee. 

Should the Association exercise its discretion to provide security, it will usually do so only for claims that are, or are expected to be, within the scope of the Member’s cover. The Association is less likely to provide security on behalf of the Member if there is doubt whether the claims fall within the scope of cover, or if the claims exceed any applicable limit of cover, or if they fall within the Member’s agreed deductible, particularly if a high deductible has been agreed pursuant to special terms of entry. Similarly, it is unlikely that the Association will provide security if the event or claim is likely to cause the Member to incur a liability that is specifically excluded under the Rules, e.g. liability for delivery of cargo without production of the original Bills of Lading.⁴ 

The Association will usually agree to provide security only in respect of claims that have already arisen, in the sense that an event has occurred that is likely to result in a claim or claims for which cover is available. In other words, the Association in common with all the other P&I clubs that are members of the International Group of P&I Clubs, will not, except in special and very limited circumstances,⁵ agree to provide security before a claim has arisen, i.e. they will not provide what is known as ’anticipatory security’. 

The Member will normally request the Association to provide security for a claim that has already arisen when the claimant tries to enforce a claim by the arrest or threatened arrest of the Member’s Ship, or by an injunction or other legal measures that prevent the Member from drawing upon funds in bank accounts, collecting freight or hire, or obtaining payment from hull insurers. Such action may cause damage to the Member’s business interests since it may delay the sailing of the Ship, or affect the Member’s cash flow, or his ability to repay his financiers. Since the Association is not obliged to provide security in such circumstances, but has the discretion to do so, the Association will, when deciding whether to exercise such discretion, consider all the relevant circumstances including factors such as whether the Member has paid all premiums and other sums that are due to the Association. The Association will also take account of whether the Member has complied with his other obligations under the Rules. If the Member is in breach of such obligations, the Association is unlikely to exercise its discretion in favour of the Member at least until the Member has rectified such breaches, However, should the Member have failed to comply with those obligations that are considered to be fundamental Conditions of Cover for both P&I and Defence cover, such as those that are specified in Chapter 3 of Part 1 of the Rules (e.g. the obligation to classify or certify the Ship properly pursuant to Rule 8), it is almost certain that the Association will not exercise its discretion to offer security for claims that have arisen during a period when the Member is not fulfilling, or has not fulfilled, such obligations. 

If the Association agrees to provide security, it will, in most circumstances, offer its own letter of undertaking (the so-called ’Club letter of undertaking‘ or LOU), which is a form of security that is normally acceptable to claimants in most, but not all, countries. The provision of security in the form of a Club letter of undertaking has many advantages. It can be issued quickly once the amount and the terms and conditions of the security have been agreed. Furthermore, since the Association does not normally make any charge for providing a Club letter of undertaking, the Member does not incur the commission or other charges that a bank or surety bond provider would normally require, and his funds are not ’tied up‘ as collateral for the provision of such security. 

If the claimant insists on receiving security in the form of a bank guarantee, surety bond or other financial guarantee rather than a Club letter of undertaking, the Association does have the ability to assist the Member by doing so. However, it is unusual for the Association to provide security in the form of a cash deposit, except where it is necessary to make a payment of cash into court in order to assist the Member to establish a limitation fund under the applicable law. Since such a limitation fund serves as security for all claims in respect of which the Member is entitled to limit his liability, the Association may exercise its discretion to make such a payment only if it is mutually beneficial to the Member and the Association to establish a limitation fund promptly. 

(C) The Member shall indemnify the Association for any liability the Association may incur to a third party under or in connection with any security…save to the extent that…the Member would have been entitled to reimbursement pursuant to these Rules. (Rule 88.3) The fact that the Association provides security at the Member’s request is not to be treated as an admission by the Association that cover is available for the claim. Security may be, and often is, demanded shortly after the event that gives rise to the claim, e.g. upon discharge of the damaged cargo, or when the Ship reaches its next port of call after a collision. A detailed investigation of the circumstances of the event or casualty may not be feasible at such an early stage since it may delay the trading of the Ship. Consequently, security may be provided for a claim for which, at that stage, cover appears to be available. 

However, further information may come to light during the course of subsequent investigation or litigation that casts doubt upon the Member’s entitlement to cover. For example, it may transpire that the claim arises as a result of a deviation that would deprive the Member of defences or rights of limitation that would otherwise be available to him.⁶ Consequently, Rule 88.3 requires the Member to indemnify the Association in respect of any liability that may arise under, or in relation to, any payment that has been made by the Association pursuant to any security that has been provided by the Association on behalf of the Member in circumstances where the Member would not be entitled to receive compensation from the Association for the particular claim if such claim had been enforced against the Member rather than against the security that has been provided by the Association. 

It is important to the membership as a whole to ensure that membership funds are not used to pay claims that are not insured by the Association. Accordingly, in order to secure a Member’s potential liability to indemnify the Association in such circumstances, the Association may require the Member to provide counter-security as a condition of providing security to a third party on behalf of the Member. It will also require such counter-security if it is clear that only a part of the claim will be for the Association’s account, e.g. if the Member’s entry is subject to a large deductible or, in the case of collision claims, if the Association covers less than four-fourths of the liability.⁷ 

The Association has the right to determine the form of counter-security that is to be provided by the Member in such circumstances. For example, the Association may require a guarantee from a first class bank, or a surety bond from some other financial institution provided that it has an acceptable credit rating. The Association will also normally require such guarantee or surety bond to be issued in, and be subject to, the law and jurisdiction of, a country where the guarantee or surety bond can be easily enforced, e.g. guarantees or surety bonds that are issued in the United Kingdom or the USA and which are subject to English or US law and jurisdiction. 

If, in the case of a collision or damage to fixed and floating objects, counter-security is to be provided by the hull underwriters, the Association will not normally accept separate security from each individual underwriter for their individual share of the overall risk that is covered under the Hull Policies. The Association will normally insist on the receipt of one, single, counter-security from one underwriter that secures the liabilities of all individual underwriters, e.g. from the ’lead underwriter‘ if that underwriter has an acceptable credit rating.

(D) Where the Association has issued any guarantee, undertaking or certificate as referred to in Rule 58.2 or Rule 73.2 or other bail or security by which it undertakes to directly meet or guarantee any relevant liabilities (together the “Direct Liabilities”) (Rule 88.4)

Many international conventions⁸ require shipowners to provide, as a condition of being allowed to trade, guarantees that security is available from a financially viable organisation for claims that may be made by third parties against the member. To enable their members to continue to trade in these circumstances, the Association, together with all other P&I clubs that are member of the International Group of P&I Clubs, has agreed to provide such security in the form of guarantees, certificates or undertakings (often called Blue Cards) which oblige the Association to make payment directly to such third party claimants if called upon to do so.

(E) ….and claims in respect of Direct Liabilities alone or in combination with other claims may in the sole opinion of the Association exceed any limit(s) on the cover provided by the Association as set out in the Rules or in the Certificate of Entry, (Rule 88.4 a)

The provision of such “Blue Cards” has created a difficulty for the Association and the other P&I clubs that are members of the International Group since the limit that may apply for claims that are categorised as Direct Liabilities may be very high. Furthermore, additional claims could be made against the Member as a result of the same incident which may not be covered by the particular Blue Card. As a result, there is a risk that the total liability that each Club including the Association might have for claims arising as a result of the incident might exceed the limit of cover that is available under the Rules or the particular Certificate of Entry. This could put severe stresses on the financial ability of the Association or particular P&I club to respond to all such claims and might require the Association or particular P&I Club to impose the applicable limit of cover for that particular incident with the result that the Member may not be able to be indemnified for its total losses.

(F) ….the Association may in its absolute discretion defer payment of any such other claims or any part thereof until the Direct Liabilities, or such parts of the Direct Liabilities as the Association may in its absolute discretion decide, have been discharged (Rule 88.4 a)

It is considered that such a situation is not beneficial either to the interests of the mutual membership of the individual P&I club including the Association or to the reputation of the International Group as a whole since the ability to provide and honour payment under Blue Cards has become a fundamental necessity for the performance of modern shipping operations. Consequently, the P&I clubs that are members of the International Group of P&I Clubs have unanimously agreed that each club should have the discretion to prioritise the payment of Direct Liability claims should it consider this to be necessary.

It is emphasised that Rule 88.4 does not oblige the Association to give preference to Direct Liability claims over other claims – it merely gives it the right to do so if it believes that this is necessary in the particular circumstances. However, the Association has the absolute discretion to decide whether this should be done.⁹

Furthermore, Rule 88.4 does not entitle the Association to reject claims that are not Direct Liability claims but merely to defer payment of them until it is clear whether, and to which extent, cover may be available having regard for the applicable limit. The provision could, for example, allow the Association to reserve an amount which in its opinion is sufficient to discharge all possible Direct Liability claims, and to restrict payment of other claims (such as a fine) to what is available after the reserved amount is subtracted from the relevant limit of cover. The final amount of Direct Liability claims may not be finalised until several years after an incident but as the handling of claims progresses, it may be possible to release further funds to meet other claims. Once Direct Liability claims have crystalised because of settlements or final judgments, the final balance available to owners under the P&I policy can then be ascertained.

(G) To the extent that any claims or liabilities (including any Direct Liabilities) discharged by the Association exceed the said limit(s) any payment by the Association in respect thereof shall be by way of loan and the Member shall indemnify the Association promptly upon demand in respect of such payment and shall assign to the Association to the extent and on the terms that the Association determines in its discretion to be practicable, all the rights of the Member under any other insurance and against any third party. (Rule 88.4 b)

This provision is a further example of the general right that the Association has to be indemnified by the Member in relation to any payment that the Association has made or is obliged to make on behalf of the Member that exceeds the maximum amount that the Member is legally obliged to claim from the Association under the Rules in respect of the particular claim. (Insert footnote: see also the Guidance to Rules 87.3 (c) and 88,3 (b)). Rule 88.4 provides that any payment (including payment of Direct Liabilities) that may be made by the Association on behalf of the Member in excess of that maximum amount is made by way of loan and that the Member is obliged to indemnify the Association in respect of such loan promptly on receipt of a demand from the Association to do so.

To ensure that the Association has the means, if necessary, to recover the relevant sums even if recovery is not possible from the Member, Rule 88.4 b requires the Member to assign to the Association on terms that the Association considers in its discretion to be practicable all rights that the Member has under any other insurance or against any third party. The Rule does not merely require the assignment of rights relating to the particular payment that has been made by the Association on behalf of the Member but the assignment of “all the rights” that the Member has under the relevant insurance or against a third party. Consequently, the Association might be able to secure the necessary reimbursement by enforcing a claim of a completely different nature. The Rule allows the Association to enforce “all the rights of the Member under any other insurance and against any third party.” This wording gives the Association the wide powers that it needs in order to ensure for the benefit of all mutual Members that the assets of the Association are adequately protected. However, the Rule recognises that it may not be possible in all circumstances to realistically enforce a wide-sweeping assignment and provides that the Association will only demand an assignment on terms that it considers to be practicable. Furthermore, it will normally be possible to enforce against other insurers only rights which relate to a similar risk to that for which cover is afforded under the Rules..