Shipbuilding Chronicles: Invisible Risks in Procurement

Actual stories of oversights that could adversely impact the marine equipment contract and eventually the related shipbuilding project.

The Binding Letter of Intent

A purchasing executive was supposed to issue a non-binding letter of intent to a vendor upon condition that the purchase of the equipment was subject to the finalization of a shipbuilding contract under negotiation. However, the letter of intent which he had issued was a binding letter of intent. When negotiations for the shipbuilding contract was aborted, he told vendor that the shipyard was not going to purchase the equipment. The vendor was very upset and threatened to sue. Luckily a new shipbuilding project was imminent. The vendor agreed to overlook the whole incident when they were invited to quote for the new shipbuilding project.

Purchasing agreements were negotiated by personnel with basic knowledge of contract law. Shipyard ended up with an onerous agreement and had to pay huge sums for commissioning and other extras.

Lesson Learned: Those managing? equipment purchase contracts should inter alia (a) possess in-depth knowledge of? contract law, sale of goods and international trade, essential terms in an equipment purchase contract, customs requirements, import and export duties and shipping terms (Incoterms), (b) working knowledge pertaining to request for proposal, letter of intent, letter of credit, shipping documents, classification requirements, pre-qualification of vendors, shipbuilding construction process as it relates equipment and systems to be installed on a vessel and relevant shipbuilding technical terms.

No RFQ is Created Equal

A few vendors were invited to provide quotations for a specific equipment. The order was awarded to a vendor with the lowest price. It was later discovered that technical and quality requirements in the request for quotation sent to this particular vendor was less stringent than the rest of the vendors.

Lesson Learned: Effective control must be in place and there must be an audit clause in all purchase contracts. Under such a clause, random audit could be performed to prevent abuse of the procurement process.

A Big-Ticket Early Delivery

A shipyard purchasing manager enjoyed rushing out equipment purchase orders swiftly without consulting the planning department. Subsequent inquiry revealed that he was not on the same page with the planning department. He must have believed that his duty was akin to that of the marketing manager; closing sales to meet targets. As it turns out, a shipbuilding project was delayed for more than a year and warranty for the equipment, which was 12 months from delivery of the equipment expired. Also, some of the equipment were problematic as they have not been stored properly. In additional to charging star rates for their work the vendor’s personnel took their time on the rectification work. This contributed to delay the shipbuilding project further.

Lesson Learned: Relevant shipyard’s department must work in synergy to ensure that equipment is ordered with reference to the shipbuilding planned programme. Warranty provisions in purchase contracts must be negotiated properly to provide contingency for related shipbuilding project delays. Storage instructions for equipment must be strictly observed.

Putting the Inspectors to the Test ?

During scheduled inspection the classification society and owner’s representative discovered that some equipment was substandard or improperly installed. This resulted in unnecessary rectification with costs and time impact.

Lesson learned: A robust quality system must be in place. Shipbuilder must send its QA/QC engineers to the vendor’s factory to examine the manufacturing procedure, design, materials, and complete assemblies to ensure conformity with the standard and other technical requirement, as well as to participate in the factory acceptance test. The quality of materials to be used must be checked on the basis of quality certificate issued by manufacturers of such materials. All equipment testing should be carried out in the vendor’s factory according to the agreed program in the presence of shipbuilder’s QA/QC engineers. As for installation, this must be carried out in accordance with related installation manual and under vendor’s supervision.

Nominated Vendors Gaming the Yard

Owner contracted with equipment vendors and novated the supply agreement to shipbuilder. The terms of the vendors’ agreement were onerous. Shipping terms were ex-works and. Warranty for the equipment and validity of vendors’ price rates starts 12 months from delivery. When the shipbuilding project was delayed for more than 12 months, the vendors charged an exorbitant sum (or star rate) for commissioning and related support services. They also brought in more engineers than required. Some of these engineers were basically rookies as they took their time to complete the work due to lack of experience. It was fair to assume that the vendors’ agenda was not to accelerate the work but to clock in extra day rates. The engineers also left a hefty hotel bill for the account of the shipyard as they were not restricted to consuming soft drinks at the hotel.

Lesson Learned:? All potential vendors must be comprehensively vetted. (See pre-qualification questionnaire in the front portion of the book.) ?Agreement with nominated vendors should be based on a properly drafted contract prepared by professionals on behalf of the shipbuilder. The agreement should inter alia, comprise the following: (a) shipping terms - CIF, Incoterms as a minimum, (b) longer duration for equipment warranty, and (c) an option for shipyard to purchase extended warranty at a pre-agreed sum, exercisable within a stipulated period after contract signing.

Additionally, the commissioning procedure must clearly indicate the duration for each of the activity, the required numbers of engineers and the test equipment. The vendor’s schedule of price and rates must be valid for at least 3 years with an agreed progressive increment for subsequent years.

Commissioning Woes

Commissioning for an equipment has gone on for weeks. The vendor’s commissioning engineer could not resolve problems affecting the equipment. The free man-days for commissioning have been depleted. The vendor is now charging daily star rate for their services. As this was equipment for a proto-type vessel it seems that the engineers were working on trial-and-error basis instead of doing what they were expected to do as professionals. Further, the test equipment that they brought were faulty and replacement ones had to be flown in. Eventually, after shipyard demanded solutions from the vendor’s top management, the vendor sent an experienced engineer. After a few days commissioning was completed.

Lesson Learned: The qualifications and experience of all engineers to be deployed are vetted in advance and duly approved by shipyard before contract signing. Delays due to faulty test equipment should be for the account of the vendor. To ensure that vendor completes the commissioning diligently with the required number of manpower, the contract must specify (a) the numbers of days and specified manpower required for the commissioning, (b) that any delays beyond the specified days will be for the account of vendor.

Pulling the Wool Over the Eyes

A major international vendor contracted to supply new engines for installation on board a vessel under construction. Instead of supplying newly fabricated engines they supplied second hand or refurnished engines. The shipyard sued the vendor successfully. However, shipyard was potentially liable to its client. Under the related shipbuilding contract, delays to the shipbuilding project caused by shipyard’s vendor’s default were at shipyard’s risk.

Lesson Learned: Even when dealing with international major vendors, shipyard must not slack on its quality control and inspection practice. Shipbuilder’s engineers must travel to vendor’s factory and examine the manufacturing procedure, design, materials, and complete assemblies to ensure conformity with the standard and other technical requirement, as well as to participate in the factory acceptance test. Upon arrival of the equipment, a detailed inspection must be conducted to ensure that the equipment complies with contract requirements.

Monkey Business

Following the inception of a shipbuilding project, a shipyard’s estimating department depends on budgetary quotation from vendor to prepare indicative pricing for their clients. However, some vendors simply refused to provide them. A few vendors subsequently revealed that someone from the purchasing department had been extracting favours from them. Tell-tale signs that something is not right at your purchase department: (a) when vendor respond to your request for urgent technical support is lukewarm, (b) an increase in order for missing parts, and (c) vendor’s quotation is extremely high or simply refused to quote.

Lesson Learned: When personnel managing the procurement process is mistreating the vendors, do not expect too much service or co-operation from them. When one encounters problems during the installation or commissioning or warranty stage, they will understand why treating vendors fairly is a prudent exercise. Ensure strict oversight practice to minimize unethical business behavior.

Complexities of Performance Guarantees

The refund guarantee provided by vendor may be invalid due to legal technicalities. Some salient examples - It is not a demand bond; drawdown is subject to court decision or the bank’s signatory is not duly authorized to sign the guarantee.

Lesson Learned: As the rules surrounding such guarantee is a highly complex, it must be vetted by professionals specializing in such bank instrument. The refund guarantee should be governed by English law, where the courts are will not restrain calls on refund guarantee in the absence of fraud.