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Owners’ risk of charterers’ default in uncertain times: withdrawal/termination and insolvency

Posted: 20/07/2020


A wealth of guidance - including from Penningtons Manches Cooper - has been published about the effect and business interruption aspects of Covid-19.

But what happens in circumstances where an existing contract is no longer desirable or financially viable and one of the contractual counterparties does not want to be bound by it because of the state of the market or because the other party is not performing its end of the deal, whether as a result of Covid-19 or otherwise?

This article reviews the various pitfalls associated with the performance and cancellation of charterparties.

Suspension of service

Suspension of service is only a right expressly afforded by the contract. That is, it requires an express provision in the charter such as clause 11(a) of NYPE 1993, clause 11(c) of NYPE 2015, clause 8.4 of BPTIME 3, clause 8(b) of GenTime, and clause 10(e) of SupplyTime 1989 in order to exist. As such, a mere failure by the charterer to pay hire does not entitle the owner to suspend the services of the vessel temporarily.

Unless the charterparty provides otherwise, there is no need for the owner to give notice of his intention to suspend performance before doing so and hire continues to accrue during temporary suspension of service.

Withdrawal

The right of an owner to withdraw his vessel from the charter service is a separate and different remedy to suspension and termination. It is not a temporary but a permanent remedy that results in the cancellation of the charterparty. Like suspension, withdrawal is a contractual right (eg clause 5 of NYPE 1946 and clause 9 of SHELLTIME 4).

An owner who wishes to withdraw is not required to prove deliberate non-performance or negligence on the part of the charterer. However, hire must be due. 

A notice of withdrawal is normally required in order to withdraw. The notice:

  • need not have a particular form of words
  • cannot be conditional
  • must contain an unequivocal statement by the owner that he is exercising his right to withdraw
  • must comply with any anti-technicality clause in the charterparty (eg giving the charterer 48 or 72 hours to make full payment)
  • must be given within a reasonable time after the default

If the charterer has made deductions, the owner will have a reasonable time to consider whether such deductions were lawful or wrongful. A mere late payment of hire does not remedy a charterer’s default and the owner can still withdraw.

However, acceptance by the owner of a late payment without protest and without reservation will normally amount to a waiver of the owner’s right to withdraw. The owner has the choice either to accept the late payment or to give it back.

Finally, the owner may not both withdraw the vessel and accept an advance payment of hire, although it may be possible for an owner to retain hire as security for cross-claims.

Remedies for withdrawal

The owner will only be entitled to hire up to the date of withdrawal, rather than damages for any losses he may have for the rest of the charterparty period.

The owner may seek damages for the remainder of the charter period only if the charterer’s conduct also amounted to a repudiatory breach of the charter.

Following withdrawal, the owner will be a non-contractual bailee of the cargo and will be entitled to remuneration for the use of his vessel in any event.

Opportunities and risks of withdrawal

If the market is rising, an owner may wish to find reasons to withdraw. However, if the charterer is later found to have properly exercised a contractual or equitable right to make deductions from hire, the owner may be found to have withdrawn unlawfully.

Termination

A party will be in repudiatory breach of a charter if it shows an intention to no longer be bound by the charter or an inability to perform such that the threatened non-performance would deprive the innocent party of substantially the whole benefit of the charter.

Examples include a charterer’s failure to pay hire and a vessel being redelivered early or late. Both of these have created a wealth of case law dealing with the intricate and complex issues that arise in these scenarios.

Damages for repudiatory breach

According to the “minimum performance rule”, where the contract allows for alternative methods of performance by the guilty party, damages are calculated by reference to the minimum level of performance consistent with the terms of the contract. That is the performance which is “least burdensome” to the guilty party.

In assessing damages, the court can take into account facts that became known following the breach.

The existence of an available market is important in measuring an innocent party’s loss. An available market is defined as a market on which the vessel could be re-chartered for the balance of the charter period on terms (other than the hire rate) generally similar or equivalent to those of the repudiated charter.

In particular, where an available market exists:

  • the measure of the innocent party’s loss will be the difference between the market rate and the charterparty rate of hire for the remainder of the charter
  • this measure of loss applies irrespective of what the innocent party did in fact do following the termination
  • the actual earnings of the vessel post-termination are not taken into account

Where there is no available market:

  • calculating the measure of loss becomes a difficult exercise
  • the exercise involves an assessment of the actual losses suffered by the owner (on the basis that the charterparty had been performed) to the date of the relevant assessment and a projection of future losses
  • a charterer can challenge whether the owner properly mitigated his losses every time he chartered the vessel
  • deductions will be applicable for:
    • commissions that would have been payable in any event
    • off-hire days (based on, among other things, the vessel’s previous off-hire record)
    • a discount for accelerated receipt
    • a discount for catastrophic contingencies such as total loss, bankruptcy etc.

Opportunities/risks of charter termination

In the interest of certainty, it is advisable for any party to include wording in the charterparty that deals expressly with repudiatory breach. For example, making time of the essence or making a term expressly a condition.

However, there are risks involved. In particular, it is generally a precarious situation to be without receipt of hire from the charterer and there may not be certainty as to whether a charterer’s failure to pay hire gives rise to a successful claim for damages for repudiatory breach of contract.

In addition, there is always the risk of getting it wrong which will, in itself, constitute a repudiatory breach which the other party may seek to accept and itself bring the charter to an end.

Best practice for a party would be to:

  • allow sufficient time before terminating
  • send messages asking the other party to confirm if or when it is going to perform (eg make payment of outstanding hire)
  • continue to reserve its position
  • involve lawyers to assist

Withdrawal or termination?

In a falling market, the owner will most likely want to keep the charterer tied in to the charterparty for as long as possible.  The decision to withdraw the vessel from the charterer’s service will also depend on whether there is any chance of recovery from the charterer.

In a rising market, the owner should withdraw at the first available opportunity, particularly if there is evidence that the charterer’s conduct has effected a repudiatory breach as this would entitle the owner to damages referable to the remainder of the charter period.

There may also be issues in relation to the cargo on board. Depending on the owner’s/carrier’s contractual and/or physical obligations, there may be no advantage to the owner in withdrawing the vessel before the cargo is delivered.

Summary of commercial considerations

When a charterer fails to comply with its obligations under the charterparty regarding re-delivery of the vessel or payment of hire, the owner generally has the simple and quick option of withdrawal. This will usually result in either no damages being claimable or the lengthier and less certain option of waiting until the charterer is in repudiatory breach before terminating the charter and claiming damages.

The state of the hire market should be taken into account together with the general financial well-being of the charterer. The option of suspension of service, where available, often leads to a quick resolution of disputes that could otherwise lead to the charter being cancelled.

Many of the above considerations will bring back vivid memories to those in the shipping community who experienced the post-September 2008 era. Indeed, the impact that the Covid-19 outbreak may have on shipping in 2020 may not be dissimilar to the post-Lehman Brothers era where the market collapsed creating havoc.

But remember that careful business planning and appropriate legal advice can still help to secure the best possible outcome in the current circumstances.


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