*This article originally appeared in the online edition of HFW's Commodities Bulletin / July 2022 and is published with the kind permission of HFW.

essDOCS Preamble:

Discharging goods against a letter of indemnity (LOI) – as opposed to an original bill of lading (B/L) – can be a risky business. The below article by HFW’s Philip Kelleher provides an excellent overview of the legal risks of using LOIs as opposed to B/Ls, plus steps traders can take to minimise risk if using an LOI is absolutely necessary.

(Note: Since original electronic bills of lading (eB/Ls) are the functional and legal equivalent to their paper counterparts, the fact that they are transferred much faster than the goods themselves leads to a substantial reduction, or even outright elimination, of the need for discharge or trading LOIs and the risks they entail.)

What’s the problem?

When goods are discharged from a ship, only the lawful holder of the relevant bill of lading (BL) is legally entitled to delivery of them. However, original BLs can be slow to progress through the banking chain and may not be available before the cargo is ready to be discharged, particularly for short voyages. When this happens, in order to avoid delay, traders will often ask the vessel owner/carrier to discharge the cargo without original BLs. This gives rise to a problem. If delivery is not made in accordance with the BL, a vessel owner may face substantial claims from the lawful holder, including for the value of the goods. As a result, no sensible owner will agree to discharge cargo without production of the original BL unless they are indemnified, by agreement, for the consequences of doing so. This is done by provision of a letter of indemnity (LOI).

The LOI: the usual requirements

Under an LOI, the issuer will usually agree to:

• indemnify the recipient, their servants or agents, for any liability, loss, damage or expense incurred as a consequence of delivering the cargo without original BLs.
• provide the recipient with sufficient funds to defend any proceedings brought in connection with such delivery.
• provide on demand such security as may be required to prevent arrest/detention or secure release of the vessel.
• The LOI will typically be governed by English law and subject to the exclusive jurisdiction of the English courts.

What are the risks? A case example 

While the use of LOIs may avoid delays and reduce demurrage liabilities for the trader, it can still give rise to risk.

The Navig8 Amertrine [2021] EWHC 3132 (Comm) illustrates some of the risks involved when instructing a carrier to discharge without original BLs. In that case, the claimant (time charterer), C, sub-chartered the vessel to the defendant, A, for a single voyage from Thailand to Singapore. A was also the seller of the cargo.

The original BLs were unavailable at the discharge port and so A instructed C to discharge the cargo without production of the BLs to one of its buyers, B. In return, A issued an LOI to C. C complied with A’s instructions and delivered the cargo to B.

B’s bank then alleged that they were the lawful holders of the BLs and requested delivery of the cargo. As security for their claim, the bank arrested the vessel in Singapore. C called upon A under the LOI to provide security to release the vessel, which A failed to do. Accordingly, C applied to the English Court for a mandatory injunction to enforce the terms of the LOI.

In deciding the claim for final relief, the English Court ordered A to: (1) provide C and/or the owners with sufficient funds to defend the Singapore proceedings; (2) provide security to secure the release of the vessel in Singapore; and (3) indemnify C for any loss, damage or expense caused by the arrest. Where, as it happened, the vessel had already been released upon provision of security by owners, A remained under an obligation to put up substitute security^[1]. The English Court further ordered A to pay damages to the claimant arising from the detention of the vessel in Singapore.

Minimising the risks

Plainly, issuing an LOI has its risks for trader/charterers. In the case example above, A found itself involved in expensive litigation with a costly outcome. However, LOIs are an essential document in international trade and it would be uncommercial to advise that they should be avoided at all costs. There are some steps traders can take to minimise the risks they face:

• Where possible traders should seek to:
  • narrow the delivery instruction to a named receiver only, i.e. not use ‘or to such party as you believe to be or to represent [the receiver] or to be acting on behalf of [the receiver]’.
  • address the LOI to the immediate contractual counterparty and exclude the Contracts (Rights of Third Parties) Act 1999.
  • limit the level of liability under the LOI.
  • limit the validity period of the LOI.
• In circumstances where a buyer asks its seller to issue an LOI, a seller should seek to preserve a right of recourse against its buyer in the event of a call on the LOI. This can be done by inserting an appropriately worded indemnity provision in the sale contract or alternatively, by seeking a back-to-back LOI from the buyer at the time of the request. Where possible, the LOI should be counter-signed by a bank.

Philip Kelleher
Senior Associate, Hong Kong
T: +852 3983 7739
E: philip.kelleher@hfw.com
 

Footnotes:
¹The Bremen Max [2009]) 1 Lloyd’s Rep 81