Enforceability of LOIs – a practical guide

Aislinn Fawcett, Skuld Claims Executive and Lawyer, has written on the topic of Letters of Indemnity and their enforceability.

Fawcett noted that, in the normal course of trade, situations might arise whereby shipowners were subjected to commercial pressure to take certain actions – involving additional risks – in return for receiving a Letter of Indemnity (LOI) from their charterers, shippers or other third parties. Such letters in effect promise the shipowner that if they do what the issuer asks – specifically something that they are not obliged to do – then the issuer will ensure that they do not suffer any loss as a consequence.

Shipowners might be asked to accept an LOI at the time of shipment, for example if the shippers ask them to issue bills of lading incorporating an incorrect description of the goods or an alternative date of shipment, in exchange for an LOI. Alternatively, such request may arise at the time of discharge, for example where shipowners are asked to discharge the cargo against an LOI as the original bills of lading are not available. Sometimes shipowners might be asked to continue cargo loading or discharging during rain against presentation of an LOI. In other cases, cargo interests may request that shipowners allow commingling of cargo, or that they issue split bills of lading, against receipt of an LOI.

Fawcett said that, in the context of a valued commercial relationship, shipowners were often inclined to accept such an LOI, but any party doing so should be aware of the risks involved in order to make a fully informed decision on whether to proceed.

What are the risks involved in accepting an LOI?

Greater claims exposure

Acceptance of an LOI can increase the shipowner’s exposure to cargo related claims. For example, where there is damage to a cargo upon loading, but the shipowner accepts an LOI in return for issuing clean bills of lading, the shipowner may subsequently face a claim for cargo damage, to which their defences would likely be limited. Equally, in the case of delivery of cargo without original bills of lading in exchange for an LOI, the shipowner risks a claim for mis-delivery.

Mitigation may be available to reduce this risk.

For example, if the shipowner is asked to issue new bills of lading, it would be highly recommended to collect all of the original bills before this is carried out. Furthermore, if such new bills are to reflect a change in discharge port, ideally confirmation of such change would be obtained from the cargo receiver – as the party who will be affected by that amendment – to ensure that any opposition they might have is identified before the change is made.

Inapplicability due to restrictive wording

Fawcett said that it was vital that the scope of the prospective LOI was wide enough to comfortably apply in the envisaged scenario and that it was not too restrictively time limited to be of use to shipowners. If not, a dispute might arise with the issuer as to the applicability or validity of the LOI, undermining the reassurance shipowners may have placed on the LOI. One way to reduce this risk, at least as between shipowners and charterers, was to include a standard LOI wording for an envisaged scenario in the charterparty.

Operation outside of P&I rules

In various situations, the action which the issuer asks the shipowner to take will mean that the shipowner is operating outside of P&I cover. This would be the case, for example, where a description of the cargo which the Member or an officer of the vessel knows to be incorrect is included in a bill of lading in exchange for an LOI. In such cases, a commercial decision will be taken by the shipowner as to whether they are prepared to accept an LOI to effectively operate as an alternative to P&I cover. This of course places utmost importance on the reliability of the LOI issuer.

Although standard LOI wordings have been drafted by the International Group of P&I Clubs to cover the most common scenarios where acceptance of an LOI might be sought: for delivering cargo without production of the original bill of lading, for delivering cargo at a port other than that stated in the bill of lading and for delivering cargo at a port other than that stated in the bill of lading and without production of the original bill of lading, and although for each scenario two versions are available, the second incorporating a bank’s agreement to join the letter of indemnity, Fawcett warned that “nonetheless, use of these wordings does not change the fact that shipowners accepting such LOIs will be operating outside of standard P&I cover”.

Will the LOI be enforceable?

Fawcett observed that no party wanted to reach the stage of commencing enforcement proceedings under an LOI. Court action tended to involve significant financial outlay and risks of delay and disruption to the parties’ commercial activities. Parties would wish to avoid this in any event, but all the more where the vessel might be under arrest by cargo interests. As such, the reliability of the LOI issuer and the strength of the shipowners’ commercial relationship with that party would be crucial considerations in assessing the risk that enforcement proceedings might become necessary.

Nonetheless, said Fawcett, “in view of the additional risks that the shipowner would be taking on, a key factor in deciding whether to accept an LOI will also be its potential enforceability”. If the LOI was not enforceable, then its issuer might be able to walk away from the indemnity that they agreed to provide.

Legal enforceability:

Authority of the signatory: Fawcett said that it was vital that the individual who signed the LOI was properly authorised to do so.

Illegality: Depending on the LOI’s substance and the applicable law and jurisdiction, there was a risk that it might be unenforceable for illegality, said Fawcett.

Financial standing of the issuing party: Essentially, an LOI is only as reliable as the party which issued it. Fawcett said that, before agreement, it was vital to consider whether the would-be-issuer was credit-worthy and in which jurisdiction their assets were located, in case shipowners were later forced to make a claim under the LOI.

Counter signature: A further consideration would be whether the issuer would agree that the LOI be counter-signed by a first-class bank or a parent company. Fawcett said that a counter signature could provide a safety net for shipowners in the event of a claim arising under the LOI, where the issuer had gone insolvent or ultimately had no traceable assets.

The writer concluded that the shipowners’ decision whether or not to accept an LOI would be taken in the context of the facts arising in each individual case, but the careful weighing up of risks, and considerations of enforceability would always be vital to informing that choice.