Negotiating & Drafting Shipbuilding Contracts
NEGOTIATING AND DRAFTING SHIPBUILDING CONTRACTS
Although the prospect of buying a new vessel may seem tempting for some, the thought of negotiating a shipbuilding contract may seem equally daunting. This is where lawyers play an important role – that of advising and protecting their client to the best of their abilities. This article contains a brief account of some of the issues that a buyer should consider when negotiating a shipbuilding contract. In particular we shall discuss three main provisions:
- Payment of the contract price
- Delivery of the vessel
- Rejection and rescission by the buyers.
Payment of the contract price
The payment of the contract price needs to be carefully considered and negotiated. Care should be taken when negotiating what instalments should be paid and at what time. Buyers must aim to defer payment for as much of the price as possible, until delivery of the vessel (and after the vessel has successfully completed its trials etc.) to safeguard against any default by the builder and also to defer the cost of capital.
However, in cases where a buyer has available funds with which to complete the transaction, it may be a worthwhile option to accept payment of greater amounts up front and in return agree for stricter penalties against the builders in the event of default such as delays in delivery or deficiencies in quality.
Another option open to the buyers is to agree with the builder that in the event of undue delay in delivery of the vessel or if the builder fails to comply with certain aspects of the vessel’s specifications, the builder should pay the buyers a fixed amount of money as compensation, referred to as “liquidated damages”. The advantage of such provision to the buyers is that they will not be required to prove their loss (in the event of default by the builder) in order to be able to claim for liquidated damages. However, due to the fixed nature of liquidated damages, it is crucial that the buyers estimate as best possible the loss that they are likely to sustain as a result of such a delay or failure to meet specifications. This may be achieved by consulting their team of technical and legal advisers and by considering the market trend.
In any event, it is important to ensure that the builders have incentives to meet both the vessel specifications and the specified delivery date.
Examples of liquidated damages clauses include the following:
- The buyers may agree for a permitted period of delay in delivery during which no damages will accrue and thereafter a liquidated sum of damages will be due;
- Liquidated damages for delay which relate to the cost of chartering another vessel;
- Liquidated damages for failure to meet certain specifications such as warranted speed, fuel consumption, deadweight and cargo capacity.
A special category of liquidated damages applies to cases where the delay is due to factors beyond the control of the builder or their subcontractors, which were not existing and/or known to the builder or could not reasonably have been foreseen by the builder at the date of signing the shipbuilding contract. These are referred to as “permissible delays” (or “force majeure”) and include things such as acts of God, war, acts of terrorism, revolutions, requirements of civil or military authorities, earthquakes, tidal waves, typhoons, hurricanes and even force majeure caused to a preceding vessel in the builder’s building programme that subsequently caused delay to the buyer’s vessel. For these purposes, the buyer should aim to restrict the events which can come under the force majeure definition to prevent the builder from being able to claim unjustified delays or delays due to its own default.
A common problem that may be experienced by buyers is that the shipyard may cause delays in the completion of vessels when there is an increase in the price of steel, in the hope that this will enable the builder to renegotiate a higher price for the vessel. In order to avoid the possibility of such unreasonable behaviour, the buyers should try and negotiate a term in the shipbuilding contract, to the effect that a rise in the price of steel shall neither affect the agreed price nor the agreed time of delivery of the vessel. Thus upward price fluctuations of steel should not be considered part of the “force majeure” provision.
Delivery
The shipbuilding contract should specify the procedure for delivery of the vessel and the documentation that must be provided by the builder upon delivery (in exchange for the final instalment of the purchase price). The buyers should ensure that they have received a copy of all the necessary documents prior to the delivery date and review and accept them. Such documents include a Builder’s Certificate or Bill of Sale (confirming that title to the vessel has passed from the builder to the buyers), an inventory of all equipment supplied with the ship (including spare parts), all trading and class certificates, an inventory of bunkers and lubricating oils remaining on board the vessel at delivery (payable by the buyers) as well as commercial invoices in respect of the purchase price and the cost of any additional bunkers and stores.
The buyers should ensure that:
- The builder tenders regular notices of the anticipated delivery date so that they can arrange their payment instalments on time. The builder would be eager to deliver the vessel as soon as possible after the completion of sea trials and as such, the buyers will only have a limited time (for example five working days) to pay the delivery instalment due.
- There are not any provisions in the shipbuilding contract to the effect that the purchase price is to be increased as a result of an early delivery (unless the buyers want to specifically agree to pay a bonus to the builder for early delivery).
Rejection and rescission by the buyers
As discussed above, the buyers should ensure that in the event of default by the builder in relation to unreasonable delay or substantial non-compliance with the specifications, they will have the right to cancel the contract.
In the event of cancellation, the buyers would have to ensure that they receive a refund from the builder consisting of all the pre-delivery instalments (together with interest thereon since the date of payment) and should also make an immediate claim under the refund guarantee provided for under the contract.
Another alternative open to the buyers would be to take possession of the unfinished vessel and to move it to another shipyard for completion. In such cases, the builder will have an obligation to cooperate with the removal and any assignments of sub-contracts required by the buyers. The buyers will continue to have a claim against the builder for any additional costs incurred or losses suffered as a result of any delay and increased costs caused by the requirement to finish the ship elsewhere. The refund guarantee should also cover such claim.
As a final note it is important that every shipbuilding contract incorporates the agreed forum for the resolution of possible disputes, be it mediation, arbitration, or court proceedings and also the appropriate choice of law and jurisdiction.
These are just a few aspects that a prospective buyer should bear in mind when negotiating a shipbuilding contract. However, in line with other contracts, the terms of these agreements should be carefully considered and professional legal and other advice should be sought when required. Negotiation skills are vital, but a well-drafted contract can minimise the number of problems that may arise in the event of a dispute.
Maria C. Stavropoulou