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Keep close tabs on your newbuildings if you want shipyards to remedy defects

Contractual issues arising from building merchant ships are inevitably “tricky” and give rise to problems requiring solutions. At a seminar organised by the London Shipping Law Centre on February 27th, speakers focused on a wide range of legal, technical and insurance issues. The event was held at the London headquarters of Watson Farley & Williams under the chairmanship of Mr. Justice Andrew Baker.

Sean O’Sullivan QC covered shipyard delays——“ordinary,” (and likely to be settled reasonably); “permissible,” e.g. force majeure events involving delayed delivery; and “excluded,” where buyers’ variations might well mean disputes with shipyards. Contracts are not always sufficiently clear on excluded aspects. Some yards tended to fall back on the prevention principle, claiming to have been “prevented” from completing the construction job on time. English courts have held that the prevention principle does not prevent liquidated damages but prevents the cancellation right.

However, buyers are always likely to challenge this principle being used to justify cancellation. It is not uncommon for shipyards to make trifling allegations against a buyer’s site team in order to argue that they had lost their right to terminate.  Mr O’Sullivan stressed that contracts needed to contain well crafted provisions for extensions of time. Buyers might be justified in terminating a contract if the yard stopped work, depending on the immediate and ensuing circumstances.

Buyers could seek to terminate at common law in extreme cases of stoppage of work and claim damages for “loss of bargain,” rather than just seek a refund of paid instalments. On the other hand, if they had failed to pay instalments or refused to take delivery, there could well be grounds for the shipyard terminating the contract at common law—-a high risk for the buyer. Disputes about ‘deliverability’ are common when the market falls or there are finance difficulties.

As a rule, the shipyard should undertake to remedy defects due to defective materials or bad workmanship, provided the defects were notified within 12 months of delivery. A buyer’s claim would usually be limited to the cost of remedying. “That amounts to protection for the shipyard, not the buyer.”

Recent court decisions held that the effect was to exclude any claims except those under warranty.  Buyers might well find this unsatisfactory where a defect is discovered after a12-month guarantee has expired—-especially if major. So it was vital to be clear about the terms of the builder’s guarantee for defects. A buyer needed to establish defects before the ship left the yard.
If a hitherto concealed defect only becomes manifest after the guarantee expiry, there would be prima facie grounds for a claim by the buyer. “Nevertheless, the message for buyers is that if you do not discover the defect within 12 months, it will be very difficult to get compensation or restitution.”

Charles Buss, of Watson Farley &Williams provided a ship finance lawyer’s perspective in a “new economic climate.”

Since 2008, there had been a tightening of bank credit, given losses realised on pre-2008 financings. There is a widely held view that pre-delivery financing is inherently much riskier for the buyer’s lender than traditional post-delivery secured lending.

Financiers have become reluctant to issue foreign builders with guarantees re pre-delivery instalments while fewer long-term time charters are available for buyers to offer lenders as further assigned security.  Far Eastern builders have turned increasingly to their own lenders to fund pre-delivery milestones. It is common for only 20/30 per cent of the contract price to be paid pre-delivery which the buyer usually funds.

From the lender’s perspective, assuming the ship is delivered, the ship mortgage will secure repayment of the loan over many years if that loan is restructured.

From the buyer’s perspective, if a ship’s market price falls, his cancelling for delay might replace an overpriced or unemployable ship with a full refund plus interest.

Refund guarantees (RGs) have to be capable of assignment and within a relatively generous period while avoiding jeopardising the guarantee itself.  They could well be invalidated if fraud or fraudulent misrepresentation were proved.

Recent cases show that RGs can present problems if there is no sufficient cushion beyond the ultimate ‘drop dead’ date of the building contract cancellation period. Care must be taken to ensure the builder procures an extension of the RG with an anti-discharge clause in case of material variations in the contract. A skilfully drafted ‘demand RG’ should provide that arbitration commencement would defer the RG’s expiration date.

With shipyard insolvency, recent case law has indicated that the buyer might not have an automatic right of cancellation in the absence of express wording. It might be smart to claim under the RG if its wording provides for builder insolvency, rather than waiting for the ‘drop dead’ date.

However, new financial restructuring might enable the yard to resume business and, therefore, construction of the buyer’s vessel. There appeared to be growing global recognition about the enforceability of foreign bankruptcy arrangements/stays, under UNCITRAL Model Law (Cross Border Insolvency Regulations 2006); EU Insolvency Regulation 2000; or through common law/ doctrine of comity.
Dr Ken Kirby of Brookes Bell surveyed “the many latent defects” which variously subsisted in new buildings. For example, materials defects at the atomic level, which occurred when metal solidified.

Prominent defects in newbuildings often relate to welds, forgings and castings, mechanical damage and corrosion. As there are typically around 15,000 metres of welds in a large vessel, it would take far too long to inspect them all. Consequently, inspection is focussed on critical areas where tensions are likely to be greatest during actual sailing.

His Brookes Bell colleague Brendan Cuffe highlighted the approach buyers’ representatives should take in monitoring delays. Top of the agenda was a clearly expressed and understood construction schedule from acquisition and contracts through steel cutting and keel laying to launching, delivery and sea trials.

Site team construction progress reports should be linked to key dates, such as chart block assembling, hull outfitting, machinery and painting, set in contexts such as availability of labour, tests and trials. He stressed that outfitting needs to be especially carefully scheduled as most disputes related thereto. “Take lots of photographs.”

All causes of delay have to be carefully noted and documented. These include modifications; late delivery of equipment to the shipyard; builder’s failure to provide contractual notices and to remedy defects; labour availability and behaviour; and even the weather.

Buyers should be selective in identifying defects most in need of remedy. In a list of 1,500, for example, only 100 or so might be worth following through.

Nicola Cox of the West of England P&I Club summarised the purpose and scope of FD & D cover. This encompassed legal, investigative and expert costs, in-house advice and liability to pay a successful opponent’s costs. Support is available for all formal procedures: courts, tribunals and alternative dispute resolution, including mediation.

All clubs lay down cover limits——US$10 million at the West of England with an option to purchase an additional US$5 million. Some clubs have particular requirements for newbuildings. Deductibles ranged from US$5,000 to US$100,000 at West of England. Inevitably, there is a discretionary dimension. The key question is: did the member acted reasonably and prudently in the circumstances? Where a member recovered costs in a settlement or award, the club might well ask for a contribution.

In considering prospective entries, an FD &D Club would look for prior claims on a yard for poor building; any relevant ongoing disputes; and the jurisdictions in which particular claims were being pursued. Underwriters might sometimes backdate cover but not to encompass faults which emerged subsequently but emanated from an earlier period.

It is essential for members to notify their clubs promptly of any incident which might give rise to claims and certainly of any intention to cancel contracts!

“Generally, it is best to keep risk with the same club throughout a new building project. Changing clubs often produces administrative turmoil with much to be agreed. Close relations are much to be
encouraged, as between members, club managers and solicitors.”

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