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The English High Court has recently decided that in certain circumstances a letter of indemnity issued by a charterer to a shipowner can be legally enforced and that in some cases even a letter of indemnity issued by a third party in favour of a charterer can be enforced by a shipowner.

Letters of indemnity (LOIs) have been used in the shipping industry for many years and in relatively recent times, they have become widespread. Many would say they greatly facilitate the smooth flow of commercial business and that, without them, there would be significantly more commercial disputes than there are. The courts of many countries have consistently regarded LOIs with great caution and where they have been issued pursuant to a fraud (as they frequently are) the courts have held that they are generally unenforceable. By way of example, as a matter of English law, when an LOI is given to shipowners in exchange for clean bills of lading being issued by them, even though it was known to the shipowners that the cargo was damaged, a court is likely to consider the LOI to be unenforceable.

Nevertheless, shipowners who accept LOIs in other, less controversial circumstances – where there is no question of fraud, but the shipowners are asked to accept an LOI in exchange for doing something they are not obliged to do – are taking a gamble. On the one hand, they wish to preserve their commercial relationship with the party (usually the charterer) asking them to accept an LOI. On the other hand, by accepting an LOI and agreeing to comply with the charterer’s request – often to deliver cargo without presentation of an original bill of lading – the owner is almost certainly breaching his P&I cover, as well as exposing himself to a possible claim for misdelivery for which he is unlikely to have any defence if in fact the goods have been misdelivered. The owner is also dependent upon the provider of the LOI honouring his obligations (and having the money to honour such obligations) thereunder.

However, a recent case before the English High Court1 indicates that:
a) in certain circumstances obligations resting upon a charterer according to an LOI issued by the charterer to the shipowner can be legally enforced as a matter of English law, and;
b) to the extent that the obligations resting upon the charterer under its LOI to the shipowner are replicated in an LOI issued by a third party in favour of the charterer, obligations thereunder in favour of the shipowner can be legally enforced by the shipowner even if the shipowner is not a direct party to or beneficiary under that LOI.

The facts
The vessel was chartered to carry a cargo of bagged sugar from Brazil to Aden, Yemen. The charterparty indicated that bills of lading evidencing a contract with the shipowners would be issued. Specifically, the charter said that, if the original bills of lading were not available for presentation when the vessel arrived at the port of discharge, the owners would, if so requested by the charterers, discharge the cargo to receivers against provision of an LOI by the charterers.

The charterers were also the sellers of the cargo, which they sold on C&F terms. Shortly before the vessel was due at Aden, the receivers asked the charterers to request the shipowners to deliver the cargo without presentation of the original bills of lading. The receivers also asked the charterers to give an LOI to the shipowners for so doing. In turn, they (receivers) provided an LOI to the charterers.

The wording of the LOIs
It is understood that both LOIs were, essentially, in the same wording. The wording was very similar to that recommended by the International Group clubs in such circumstances.2 However, three clauses of the receivers’ LOI are worth quoting:
“(…) In consideration of your complying with our above request we hereby agree as follows:
1. To indemnify you, your servants and agents (…) in respect of any liability (…) which you may sustain by reason of delivering the cargo in accordance with our request.
2. In the event of any proceedings being commenced against you, or any of your servants or agents, in connection with delivery of the cargo as aforesaid to provide you or them on demand with sufficient funds to defend.”
3. If in connection with delivery of the cargo as aforesaid the ship (…) should be arrested or detained (…) to provide on demand such bail or other security as may be required to prevent such arrest or detention or to secure the release of the ship (...) and to indemnify you in respect of any liability (…) caused by such arrest or detention (…)”.

1  Laemthong International Lines Co. Ltd. v. ARTIS and Ors; QBD (Com Ct) (Cooke J), 8th November 2004; LMLN 0655, 22nd December 2004.
2  See Assuranceforeningen Gard’s Circular to Members No. 2/01 of February 2001, reproduced in Appendix III of Gard Guidance on Bills of Lading, available at www.gard.no under “Publications/Guidances”.

When the vessel arrived at Aden, and in accordance with the receivers’ request, the cargo was discharged to them without production by them of the original bills of lading. However, a bank in Sanaa, Yemen arrested the vessel on the grounds that the bills of lading were endorsed to it and that it was therefore entitled to the goods. The shipowners required the charterers to honour the terms of their LOI, in particular the part saying that charterers would provide “bail or other security” to “secure the release of the ship”. When the charterers declined to do so, the shipowners applied to the English High Court for specific performance by the charterers and the receivers of their obligation under their LOIs to provide such “bail or other security”.

The issues before the court
The court had two questions to decide. Firstly, whether the shipowners could enforce any obligations contained in the LOI given by the receivers to the charterers (bearing in mind that that LOI was not addressed to the shipowners and therefore was not a direct contract with them) and secondly, whether the shipowners could legally force either or both parties to perform the specific obligation contained in both LOIs to provide “bail or other security”.

In relation to the first question, the shipowners had a problem, because the LOI was not addressed to them. However, they tried to overcome this by referring to the Contracts (Rights of Third Parties) Act 1999 which, in certain circumstances, allows a party who is not party to a contract (i.e., a third party) to enforce part or all of that contract.

The decision
The court appears to have taken a practical approach to the issues. The court said that, prior to discharge, the cargo was clearly in the shipowners’ possession and that, in practice, only they could deliver it. If and when the shipowners did so, the court decided that they would be complying with their obligations to the charterers (who had provided the LOI required by the charterparty in return) and with the charterers’ obligations to the receivers under the contract of sale. The receivers’ LOI related to the obligation of the charterers to deliver the cargo under the sale contract, but, the court said, in practice, it was the shipowners and only the shipowners who could deliver the cargo (it being on their vessel). Further, the shipowners had issued the bills of lading. To comply with their obligation to deliver under the sale contract, the charterers had to work through the shipowners.

Shipowners that accept LOIs are taking a gamble.

The court decided that, for these and other reasons, the shipowners were in fact the “agents” of the charterers within the meaning of the word used in the LOI given by receivers.

The court held that the shipowners were entitled to enforce the charterers’ LOI (given to owners), as well as to enforce the receivers’ LOI against them (receivers). On the specific performance issue, the court decided that one of the major purposes of the LOIs was to ensure that “(…) bail or other security (…)” was provided to ensure the release from arrest of the vessel. Were owners to provide security to release the vessel and later pursue an indemnity claim against the receivers in Yemen, this was likely to be difficult and problematic and would defeat the object of clause 3 of the LOIs. Thus the court decided to order specific performance of this obligation and thereby found in favour of the shipowners on this issue as well.

Other developments
The vessel was under arrest in Aden for some eight and a half months. During that time, several applications were made by owners to the English courts, of which this was the last. After eight and a half months the vessel was released from arrest without the “(…) bail or other security (…).” having been put up. The shipowners have presumably suffered substantial losses as a result of the vessel’s long detention and regardless of the merits of their claims against charterers and/or receivers, enforcement of any court judgment against either or both parties may be a problem.

The decision of Cooke J is being appealed shortly and Gard News will keep readers informed.

As mentioned, the courts of most countries generally regard letters of indemnity with great disfavour and often decline to uphold them. The decision of the English court in this case is something of a landmark and should go some way to reassure shipowners who accept LOIs in exchange for delivering cargo without presentation of the original bills of lading. That said, the decision is specific to the facts of this particular case and also relates to the question of whether a third party (in this case, the shipowners) can establish rights against another party with whom they have no contractual relationship. It should not be taken to indicate that the English courts are likely to change their general approach of regarding LOIs with disfavour.

In any future case, much may depend on the wording of the LOIs and the law applicable thereto. It is quite possible that the courts of another country, or indeed another English court, might not adopt the practical approach taken by the English court in this case. Furthermore, regardless of the (favourable) decision in this case, the owners are still facing significant losses as a result of their willingness to agree a clause in the charterparty requiring them, if so requested, to discharge the cargo without production of the original bill of lading.

One wonders whether, if there had been no clause in the charterparty requiring owners to comply with a request from the charterers to deliver the cargo without presentation of the original bills of lading, owners would have been under any obligation to so deliver. This must be doubted. If no such obligation on owners existed, would the court have regarded their decision to deliver without production of the original bills as purely voluntary and “commercial”? Further, in other circumstances, such as the deliberate co-mingling of liquid cargoes, or the issue by the owners of a clean bill of lading in exchange for an LOI even though they (owners) knew or should have known that the cargo was not in apparent good order and condition at the time of shipment, it is unlikely that a court anywhere would have much sympathy with owners.

Other circumstances may produce a completely different outcome and an owner could be exposed to significant liability, with no comeback against the charterer and potentially with no P&I cover for such liability. Thus Gard’s advice to owners is that they should continue to be extremely careful about accepting LOIs and should remember that they are usually asked to do so in circumstances where another party has failed to do something which it should have done. In many cases, the LOI depends on the willingness of the party giving it to honour their obligations thereunder and on their financial ability to so do. It may not be worth the paper on which it is written.

Any comments to this article can be e-mailed to the Gard News Editor.

Gard News is published quarterly by Gard AS, Arendal, Norway.