Charterparty Chains - where the 'buck stops'

This briefing considers the passing of liability in a contractual chain and instances where it may not be possible.  It is relevant to those that negotiate charters, handle charterparty claims and also to hull and machinery insurers in light of the discussion in two of the five scenarios considered. 

Introduction

A sign above President Truman’s desk in the White House famously declared “the buck stops here”. This was a reminder that he had ultimately to accept responsibility for his decisions. In the case of Charterparty chains, the parties will look to pass on responsibility for claims from up the chain to down and vice versa. Often, it is the party either at the top (i.e. head owners) or the bottom of the contractual chain (i.e. sub-charterers or sub-sub-charterers etc.) that bears the loss through the operation of back-to-back Charterparty terms. However, that is not always the case and there are instances in which the flow of liability from one party to another is prevented. That is where the 'buck stops'. This article considers five such scenarios. 

Scenario 1: the loss lies where it falls. This occurs when the party experiencing the loss is ultimately at fault or responsible under the contract terms and unable to look to its counterparty to make good the loss suffered. 

An owner suffering losses following damage to its ship after a grounding will be unable to hold its charterers to account if the incident results from a causative failure to exercise due diligence to make the vessel seaworthy, such as a failure to have onboard up to date navigational charts. That too, is likely to prevent an owner's General Average claim against cargo interests under bills of lading (see for example The CMA CGM LIBRA[1]). An owner will have little right of recourse in such instances and will need to try and rely upon its insurers to indemnify its loss, although this too may be problematic.

In other cases, although the party experiencing the loss may not be at fault or responsible, the contract may offer no obvious recourse against its counterparty to make good the loss. For example, an owner may be unable to pass onto its charterers losses due to delays caused by an overly zealous Port State Control official. In those cases, without recourse to specific Charterparty wording, an owner may need to look to implied contractaul terms, such as for compliance with charterers' orders, which is rarely straightforward.

Absent fault by either party, there may be cases in which the loss is shared. This will depend upon the Charterparty wording and must be provided for specifically. See for example, the Inter-Club Agreement 1996 (as amended in September 2011) providing that claims for shortage or over carriage are shared 50:50, absent neglect by either party or pilferage by their servants. In turn, that apportionment would be shared down the contractual chain so that sub-charterers account for 25% of the loss etc.  

As always, clear wording in the contract is required for the allocation of responsibility and in order to try and avoid disputes.

Scenario 2: counterparty solvency – when the weakest link determines the strength of the chain. A key issue in any contractual situation is how well do you know your counterparty and can you rely upon their financial integrity to make good a loss arising from a breach? 

On rare occasions it may be possible to ‘leap frog’ or bypass an insolvent party in the chain in order to pass on a liability or effectively pursue a claim. As food for thought, four examples are below.

Circumventing an insolvent party in the chain

1. An assignment of rights. Normally, in order to establish the right to make a recovery the innocent party must establish that it has suffered a loss. What then if an insolvent party in the chain is unable to settle its liability, therefore suffering no loss, does that mean that the party at fault further down the chain is off the hook? A similar issue arose in the case of Total Liban SAL v Vitol Energy SA[1].

• Facts: a seriously off-specification shipment of gasoline to Lebanon caused nausea to motorists exposed to the noxious fumes of the gasoline supplied to their cars.
•  The sale of the fuel involved a chain of three parties, namely:

• The claim: As a result of the off-spec fuel, (T) claimed USD5m from (M) under the relevant sale contract. However, (M) had no funds to satisfy the claim and assigned all of its contractual rights of claim against (V) to (T).
• The issue: whether (V) could be held liable where (M) was not in a position to discharge liability to (T) on grounds of impecuniosity, so that the loss potentially stopped with (T). 
• The outcome: The court did not accept the argument that prior payment or discharge of liability was fatal or necessary so that (T)’s claim against (V) in the shoes of (M) as its assignee, was not prevented.

2. Non-contractual claims. An owner with an insolvent charterer unable to pay hire but with cargo onboard may look to ‘common law’ / ‘equitable’ remedies in which to seek compensation against the third party receiving the benefit of the carriage services provided, such as on grounds of unjust enrichment, quantum meruit or bailment. The case of The Kos[1] is an example of a successful claim based on the latter.

3. A contractual right to ‘leap frog’. The express wording of a contract may allow party (A) to exercise rights to bypass insolvent party (B) and look to payment from party (C) directly. This is reliant on back-to-back contractual arrangements of the material terms. An example is a right of lien over sub-hire or sub-freight, exercised by a head owner against sub-charterers based on back-to-back rights in charterparties. However, difficulties can arise and a common result is payment of hire / freight by the sub-charterer into escrow in light of the competing claims from both the head and disponent owners.

LOIs. A further example would be back-to-back letters of indemnity where shipowner (A) with the benefit of a LOI from an insolvent charterer (B) may seek to enforce a separate back-to-back LOI from party (C) made out for the benefit of “The owners of the ship M/V (X)” or party (B)’s “servants and agents". This potentially allows the enforcement of the indemnity by shipowner (A) under the Contracts (Rights of Third Parties) Act 1999 (see The Jag Ravi[2]) against party (C).

4. Rights under more than one contract.  A party may find itself subject to and benefiting from rights under more than one contract allowing another right of recourse if the avenue under one contract is unattractive. This would be quite unusual. An example would be an owner exercising its right under a bill of lading to intercept freight in circumstances that an impecunious charterer has failed to make hire payments under a charterparty. By exercising the right to intercept freight from the shipper, an owner essentially withdraws the right of the charterer as its agent to collect freight under the bill of lading on its behalf (see The Bulk Chile[3]).

Scenario 3: the charters are not ‘back-to-back’ so that the chain of liability may be severed. 

There are often instances where material clauses are not back-to-back, creating difficulties to pass on claims. This can be the case where different Charterparty forms are used, as is common where a time charter is above a voyage charter in the chain, or due to a simple oversight. Potentially fatal examples might include mismatching time periods under time bar clauses (an issue arising in the 2018 US Gulf off-spec bunker claims - some fuel contracts provide for very short time bar periods that may be upheld).  

Fixing the chain - rectification?

If there is a failure by the broker to record in writing that the charters are back-to-back, despite the parties’ intention to do so, then this may be resolved by consent, or failing that, rectification may be possible. Rectification is an ‘equitable remedy’ often seen as an option of last resort and is rarely seen in practice. The burden of proof is on the party seeking rectification to produce convincing proof that the written agreement does not reflect the intentions of the parties, so that that rectification is required in order to restore the intended position. 

Scenario 4: jointly held insurance policies – one pool for claims to satisfy all – The Ocean Victory. 

A controversial instance in which the ability to pass on liability to another party may be prevented is in the context of jointly held insurance policies, where both a charterer and an owner are named in the relevant insurance policy. 

In The Ocean Victory[1], an unsafe port case, the Supreme Court found that one jointly insured party owed no liability to the other for a loss covered by the joint insurance policy, with the effect that the jointly insured parties could not claim against third parties (i.e. sub-charterers) for potential breach of an unsafe port warranty. The logic underpinning the decision is expressed by Lord Toulson’s finding that “[t]he commercial purpose of maintaining joint insurance in such circumstances is not only to provide a fund to make good the loss but to avoid litigation”.

Circumventing The Ocean Victory decision?

There may be avenues to explore, so that notwithstanding co-insurance, claims may be pursued down the contractual chain. For example, where applicable in cases of a bareboat charter, it has been suggested that charterers may instead pursue a non-contractual claim, such as in negligence or seek to rely upon their position as bailee of the vessel to found the basis of a claim.

BIMCO produced a revised Barecon 2017 to keep alive the ‘links’ in the chain and allow the opportunity to claim against sub-charterers. It does this by expressly providing that any payment under a joint insurance policy towards an owner’s loss “shall be treated as satisfaction (but not exclusion or discharge) of the Charterers’ liability towards the Owners”. 

Scenario 5: expressly waiving a right of claim

 Joint insurance - related to the ideas underpinning The Ocean Victory decision is the decision by jointly insured parties to expressly contract out of the ability to claim against each other or procure a waiver of subrogated rights of claim. This arguably means that there can be no such liability to pass on or claim against their sub-charterers. For example, Clause 34 of Shelltime 4, the war risk expenses clause, includes an obligation upon owners to obtain a waiver of subrogated rights against charterers in cases that charterers are to reimburse owners for any additional war risks insurance premia paid.

Knock-for-knock clauses (KFK) - some standard contracts such as BIMCO’s Supplytime 2005 (clause 14(b)), Towcon 2008 (clause 25) and Towhire 2008 (clause 23), included KFK clauses which are commonplace in offshore oil & gas industry contracts. The intention is that each party bears responsibility for and damage or loss to its own property, without claiming against the other party even if the other party is at fault. The purpose is to avoid litigation and simplify insurance arrangements. 

However, the position is not always straightforward. For example, the Supplytime 2005 contains numerous exceptions to KFK, the majority of which are removed in the subsequent 2017 version.

Conclusion

Above we look at five scenarios in which claims may not be passed down the contractual chain and in some cases, provide potential solutions. Each party in the chain will be looking to protect its own interests and to ensure it is not where the ‘buck stops’. Due diligence and risk assessment with your legal advisors as well as clear drafting at the time of entering into the relevant contract will undoubtedly improve your position.

January 2020

Rory Grout, lawyer at Stephenson Harwood LLP [email protected]

None of the above is intended to be or should be treated as legal advice.   

[1] [2017] UKSC 35

[1] [2012] UKSC 17

[2] [2011] EWHC 1372 (Comm)

[3] [2013] EWCA Civ 184

[1] [1999] Vol 2 QB (Com. Ct)

[1] [2019] EWHC 481 (Admlty).