Letters of Indemnity – A Health Warning

Provision of security

The International Group (IG) approved standard form for a letter of indemnity (LOI) to be given in return for delivering cargo without production of an original bill of lading contains a term that the issuer will provide security, as may be required, to prevent an arrest or detention in connection with a mis-delivery claim.

In The Miracle Hope, LOIs in that form were issued up through a charter chain to allow more than a million barrels of oil to be discharged in China without production of an original bill.  The trade had been financed by a bank, which paid the seller US$ 65m under a letter of credit, but the bank was not reimbursed by its customer, the receiver.  The bank, as holder of the bills, then pursued a mis-delivery claim worth US$ 76m against the carrier and arrested the vessel in Singapore to obtain security.

Head time charterers obtained an interim mandatory injunction to compel sub-charterers to provide security to release the vessel.  A similar order was issued in proceedings between the sub-charterers and sub-sub-charterers.

The parties could not agree the form of the security and due to COVID-19 it seemed the Singapore Court would be unable to break the deadlock for some time. The matter then came back before the English courts.

Instead of deciding what form of bank guarantee should be provided, the Court simply ordered the defendants to put cash of US$ 78m into the Singapore Court within 8 days and pay defence funds of US$ 83,333 to the head owners within four working days.

In that case, the judge was not persuaded that the sub-charterers could not pay the US$ 78m into Court for practical reasons since it had not produced evidence that it was unable to find the money, supported by appropriate financial documents.

In Tenacity Marine Inc v. NOC Swiss LLC and Gulf Petrochem (06 November 2020), by contrast, the English court discharged a similar injunction requiring NOC to provide security for a mis-delivery claim under the terms of an LOI because NOC had shown it was insolvent and so it was impossible for it to meet its obligations under the LOI.

LOI invocation clauses

A clause requiring an owner to comply with a request by a charterer to discharge cargo without production of an original bill of lading in return for an LOI is now a common feature of charterparties.  Under some charter clauses, the LOI is deemed to be given as soon as a proper request is made.  These are known as LOI invocation clauses.

In The Miracle Hope, it was argued that the charterparty required a free-standing LOI to be provided in a separate document and that the charter itself did not confer any indemnity.

The Judge determined that some wording within the relevant clause of the charter – such as “following indemnity deemed to be given by Charterers” – showed that the indemnity arose under the charter without the need for a separate letter.  The Judge said this interpretation was also consistent with how the parties had conducted themselves.  Finally, he said it would be commercially unreasonable and absurd to suggest the charterer should not indemnify the disponent owner against the consequences of an order to discharge without production of the original bills of lading.

Validity periods

Mis-delivery claims can arise many years after the cargo was discharged and are not always subject to the usual one-year time limit applicable to cargo claims.  Therefore, the IG approved standard wordings do not contain any explicit time limit on the validity of the indemnity, and the inclusion of a validity period should be resisted.

In The Songa Winds (2018) the governing voyage charter stated that any letter of indemnity would only be valid for three months from delivery.  Fortunately for the shipowner, this validity period was not included in the LOI when it was issued and so the LOI did not expire after three months.  The Court of Appeal did note, however, that the charterer could have insisted on including the validity period specified in the voyage charter in any LOI.

Bypassing the charter chain

In a charter chain, there is no direct contractual relationship between the head owner and a sub-charterer.  This means that, ordinarily, a head owner cannot seek to enforce a right of indemnity granted by a sub-charterer to an intermediate charter.  This can put a head owner in a difficult position if its charterer is insolvent when a mis-delivery claim arises.

Under English law, the Contracts (Rights of Third Parties) Act 1999 allows a third party to enforce a term of contract which purports to confer a benefit on them.  The IG approved LOI form provides that the issuer will indemnify “you, your servants and agents” for losses sustained by delivering cargo without production of an original bill of lading.

In The Laemthong Glory in 2005 the Court held a shipowner could enforce an LOI issued on those terms by the receiver to an insolvent charterer because the word “agent” indicated an intention to benefit the shipowner.  The same result occurred in The Jag Ravi in 2012 where the LOI was issued by the receiver to “the owners/ disponent owners/ charterers”.

The International Group is currently reviewing its approved form LOI wordings and revised forms are likely to be issued in the near future.

Find out more

North Members can read more on LOIs in our dedicated loss prevention guide.