World trade in both finished products and raw materials, including the movement of oil, coal and increasingly gas depends almost exclusively on shipping. The complex contractual arrangements that facilitate international trade all stem from shipping contracts originating from the early part of the last century.
An understanding of the effect, purpose and to an extent the history of shipping contracts will help to demystify the often complex contractual arrangements that stem from the movement and trade of goods. This article aims to provide an overview of the various shipping contracts and how they interact with standard forms of international trade contracts.
All students of English law will, whilst many do not know it, be familiar with many shipping cases and principles. Many of the leading cases used to demonstrate and support the tenets of English common law principles are shipping cases; so in tort the test of foreseeability in the context of negligence is usually traced back to the cases of "the Wagon Mound (1961)" and "re Polemis (1921)." This history is not altogether surprising; in the late 19th and early 20th century Great Britain was a trading nation and fiercely supportive of the laissez faire approach to economic policy.
The result of this approach to world trade was the development of a strong merchant fleet and contractual arrangements to support the trade that ensued. Not surprisingly contracts were subject to English law and jurisdiction and the English courts developed a strong degree of commercial experience and body of precedent law. This remains the case today with the divisions of the High Court including both the Admiralty & Commercial Court and Mercantile Court.
What then are the commercial contracts that arise? In shipping the contracts commonly referred to are bill of lading contracts and charterparty contracts. In relation to sales of goods, the Incoterm contracts are often used, and terms such as FOB (Free on Board), CIF (Cost Insurance & Freight), C&F (Cost & Freight), DExS (Delivered Ex Ship) and DExW (Delivered Ex Works) are seen commonly. These standard contract terms are then supplemented by provisions to ensure and secure payment of purchase monies; references to Letters of Credit, Bank Guarantees and Bills of Exchange are commonly seen.
A word of warning; the use of these expressions when used in the context and with reference to Incoterms are defined and clear; however, if no reference to Incoterms is made, local interpretations of the terms may differ. For example FOB as a term in the UK is commonly called Ex Works in the U.S.
This article cannot hope to cover these many complex contracts in detail, however, the intention is to provide an overview and basic understanding, and if nothing else to ensure that "alarm bells" ring when you are confronted by such a term and appropriate specialist help is obtained.
Shipping-Related Contracts
A shipowner makes his money in two ways: trading on the value of his vessel and by carrying cargo on his vessel, either for his own account or for the account of someone else (a charterer). When cargo is loaded onto a vessel, a receipt is given for that cargo; the receipt, in simple terms, is the bill of lading. The bill of lading takes an important role. In the hands of the shipper it is a receipt for the goods and a document of title for the goods. When it is endorsed by the shipper to a third party who has purchased the goods, it becomes - in addition to a receipt and document of title - a contract of carriage between the cargo owner and the shipowner.
In the late 19th century shipowners sought to exclude virtually all liability arising from the carriage of goods on their vessels by the inclusion of onerous exclusion clauses in their contracts of carriage as evidenced by bills of lading that they issued. This created a significant risk of reducing world trade and as a result, to balance matters following a conference in the Hague, the Hague Rules (subsequently revised to become the Hague Visby Rules) came in to existence. These Rules impose on the owners of ships obligations to ensure the seaworthiness and cargoworthiness of their vessels in return for defined exceptions from liability for cargo damage and a right to cap liability to defined limits.
The Rules are effected, as is much Maritime legislation, through consent and the accession of various signatory states to international conventions. In the UK the Hague Visby Rules are given statutory effect through the Carriage of Goods by Sea Act 1971 (COGSA). In addition, and to ensure adequate protection, the Rules are applied commonly to Bill of Lading contracts (and often charterparties) through an express contractual provision (the Clause Paramount).
A shipowner will alternatively earn income from his vessel by releasing its space to a third party, a charterer. This is done in one of two ways: either on a voyage basis (a voyage charterparty) or for a set period of time (a time charterparty). Charterparties are so named simply because in years gone by and prior to the invention of photocopy, fax and email, documents would be handwritten. To simplify matters the charter would be written once and then torn in half, each party to the contract retaining one part, the charter then through custom became known as a "charterparty."
A voyage charter is in essence a contract of carriage where the shipowner releases the whole of his vessel for the carriage of the charterers cargo from a defined loading port to a defined discharging port. In return the shipowner is paid freight. The variables in the equation that affect the owners calculation of his overall return will be: likely delays on the voyage through weather (a risk that the owner generally carries) and the length of time that will be taken to load and discharge the vessel. To address this voyage charterparties provide a defined period of time for the loading and discharge of cargo (laytime) and a liquidated damage provision for any time taken that exceeds the laytime period (demurrage).
A time charter is a contract for the hire of the vessel for a defined period of time. It transfers the commercial operation of the vessel to the charterer who can dictate, in broad terms, where the vessel goes and what cargo she loads. In return the owners are paid hire for the vessel on a daily basis.
One final concept in shipping law is also important, and that is General Average. The carriage of goods on board a ship by sea is still an adventure, considerable risks are faced, and on occasion in order to preserve the cargo and vessel it is necessary to incur expense and or effect sacrifices (for example the jettison of deck cargo to keep the vessel afloat and save the underdeck cargo). In these circumstances through the application of the principles of General Average the costs or losses incurred are shared proportionately between all of the parties involved in the adventure depending upon their financial share in the adventure. This concept is known as "averaging."
Cargo-Related Contracts
The cargo sales contracts on the whole define who is responsible for the provision of the ship and placing of insurance, etc. So sales contracts will be defined as CIF or FOB. The responsibilities that arise are then further defined in the contract of sale itself.
Under a CIF contract the seller is obliged to procure a vessel and arrange for the cargo to be laden on board; he places insurance and pays freight. The buyer, in effect, obtains a "turnkey solution" where all steps have been taken for him and he need only take delivery of the goods at the discharge port. However, things are never quite that simple. A CIF sale is commonly referred to as a sale of documents. The seller is entitled to payment against the documents regardless of whether or not the cargo continues to exist, so that in a worst case where the vessel sinks and cargo is lost, the seller may still demand payment against the documents. The buyer is protected by the insurance that the seller has placed, but care does need to be taken to ensure that the sale contract makes adequate provision for the extent of insurance cover to be obtained.
An FOB contract places the shipping risk with the buyer who must arrange and provide a vessel at the designated load port within the loading window contained in the sales contract. Such contracts are common in the oil industry. What risks arise? Quite simply the risk of delay in shipment or in discharge of the vessel. Such issues need to be considered and incorporated into the purchase and sales contracts for goods so as to minimise risk. Basically, through careful drafting, contractual risks should, ideally, flow through the various chains of contracts that are devised to move liabilities arising down to the ultimate cargo owner.
Trade in oil is a good example of international trade in action. Oil will be purchased from suppliers, commonly on FOB terms. Vessels are chartered on either voyage or time charter basis to load the cargo. Bills of lading are issued and the cargo is then financed and traded on the basis of the bills of lading which may often pass between various parties hands many times before the cargo arrives at its destination. To facilitate such trades complex arrangements are incorporated into the various contracts to pass risk along the sales contract chain in parallel with the risks passing under the charterparty arrangements.
Provision is made for discharge of cargo and variation in the discharge port nomination. Flexibility to meet market objectives is the name of the game.
Finance of the transaction is achieved through bank letters of credit, so the transacting parties remain secure in the knowledge that the cargo exists and they will be paid for their transactions.
Contrast such a trading regime with that of, for example, LNG - another liquid cargo but one which has for a long time been traded on long-term contracts with "take or pay" provisions and delivery based on ex-ship quantities. Increasingly there is a move to bring LNG in line with oil and an impetus to develop spot trading of LNG as a commodity. The key to this will be, like in the oil industry, flexibility in contracts and a careful consideration and understanding of the risks that arise and how they should be managed and transferred.
International trade, particularly the international trade of energy, is an exciting and constantly evolving area. It is one where the risks are high, but equally, the returns for carefully managed transactions are good. Considered use of your specialist legal advisers at an early stage and throughout the process will inevitably assist in minimising risk and ensuring a smooth and successful outcome.
Published October 1, 2008.
