"The owners of the cargo lately laden on board the mv [name of ship] and/or their subrogated underwriters c/o [name of solicitors]".

Ship Agents may demand security for a cargo claim, this is usually a demand for counter-security or indemnity in respect of their own potential exposure to cargo claimants or local authorities in accordance with the local law. Again, security may be given if necessary, provided, the wording makes it clear that the Member's and Club's liability to the agent, mirrors that which the Member would have had to the original claimant.

Is the wording (terms) of the Guarantee acceptable?

The contractual conditions of any security receive careful consideration, particularly when security is being given through a correspondent or a bank, in order to ensure that they are satisfactory. As a general rule, the precise wording must be established before the Guarantee is finally authorized.

In particular, the following points receive attention:

Legal liability

The security should always be limited to the Member's legal liability established by agreement or, in case of disagreement, in accordance with the relevant law. Club LOU wordings should limit payment to "final and unappealable" determinations of courts.

Jurisdiction and Applicable law

The issues of jurisdiction and applicable law are critical. It does not necessarily follow that the place of arrest or threatened arrest should determine these points.

At the outset, a club would find posting security attractive where legal rights are properly tested and a liability established. There are jurisdictions where the amount of a guarantee or other security always equates to the final judgement. A guarantee, it must be remembered, is provided to test legal rights and as often seen from the shipowner's perspective, to defeat a claim entirely.

Similarly both owners and clubs may decline to provide security; on the basis it is better to immediately settle an alleged claim, or to immediately test an issue in court.

Fixed amount

Wherever possible security should be given for a fixed amount that includes interest and costs. An identified amount offers certainty for the club issuing the security.

Limit of Liability

In some circumstances the claimed amount may exceed the ship's limit of liability. In that case, security restricting the Club's liability to the limitation fund is given.

If, however, this proves unacceptable to the claimants, security in excess of the ship's limit of liability may be given, provided that specific reference to the right of the Member to plead limitation, is reserved. A typical form of words which is acceptable is:

"... our liability under this Guarantee shall be limited to $ [amount] or to such sum as the owners may be found to be entitled to limit their liability under [insert the applicable law e.g. English] law whichever is the lesser".

Enforcement in Bermuda, or site of Club

Many clubs are legally based in Bermuda, and will have enforcement clauses there. Other clubs will have the site of their base, and in limited circumstances other jurisdictions may be agreed.

Undertakings or Warranties

Some Guarantees include undertakings or warranties on such points as instructing solicitors to enter an appearance, or confirmation that the ship was not demise chartered at any material time.

For example, some draft letters of undertaking include wording to the effect that: "... we warrant that the ship was not demise chartered at any material time...". As clubs don't own the ships, they can at best state: "...we warrant that WE ARE INFORMED BY THE OWNERS THAT the ship was not demise chartered at any material time..."

Clubs will not agree to include undertakings or warranties that are not within their direct knowledge or control.

Guarantee forms and wordings

There are many different variations in wording dependent upon the nature of the claim, the jurisdiction in which the arrest is threatened and the identity of the claimant.

Obtaining counter-security

When issuing a Guarantee there may well be a necessity to obtain counter security from the member or other third parties. This will be in respect of the uninsured element of the claim e.g. deductible, three fourths of the collision risk or non-Club bail.

The Advantages of Club Security

In most circumstances, a club letter of undertaking (Club LOU) is the fastest means for claimants to receive security, and the fastest means for an owner to have a ship released. Amongst professional cargo recovery agencies, a club's word that it will post security still is enough. Thus, a club LOU often facilitates a same-day release of a ship, but more often permits both parties to avoid an actual arrest, and thus save costs.

Claimants accepting a club LOU can avoid the legal costs of an arrest, and avoid delays waiting for banks and courts to process matters. From the P&I clubs' point of view, a bank guarantee often bears a commission rate of 0.25% - 1.0 % annually on the assured amount. Additionally many banks have a minimum commission charge and various fees such as amendment fees, set-up fees, administrative charges and so on.

Such fees can be relatively significant in all claims, particularly large claims lasting many years to resolve.

Non-Club Bail: liabilities outside the scope of Club cover

P&I clubs cannot use their funds to pay claims outside the scope of cover, so as noted above, they do not post security for un-insured claims. For example, if an insured excluded crew claims from the P&I policy, the club could not pay a crew claim. Likewise, the club cannot pay lost hire if a ship is unable to operate.

However, each Club may define circumstances when it can issue letters of undertaking for liabilities outside the scope of P&I insurance cover against adequate counter-security. When it will do so, and what constitutes adequate counter-security are often the key questions. However, the effect of a club receiving adequate counter-security is that club funds are not exposed.

For example, a shipowner may have 1/4 of his collision liability covered by the P&I club, and the remaining 3/4 covered by a commercial hull and machinery underwriter (often several). Because Club LOU's can be rapidly issued and are widely accepted, a P&I club with only ¼ of the risk will frequently post security for 4/4 collision liability, against ¾ counter-security from the hull underwriter(s). Assuming the counter-security is adequate, the club is still only at risk for its ¼ of the liability.

As another example, a ship may be arrested for a disputed commercial debt, such as disputed hire or demurrage payments. An owner may seek P&I Club assistance, if the arrest occurs before a banking weekend or holiday. The club could post a Club LOU, against counter-security from the owner, such as a bank guarantee or often a cash deposit. However, owners almost always have some advance warning of arrest during commercial disputes. Hence, owners are most frequently and are advised to arrange security directly with claimants.

"Wrongful Arrest" and Defence Cover

Sometimes ships are arrested by claimants who ultimately fail to prove a claim. Owners suffer delay and may face consequential commercial losses, such as missing a cancellation date for a future charterparty. Owners generally have no insurance covering commercial losses, and often wish to pursue the party making the wrongful arrest.

Whether an arrest is 'wrongful' depends on local law. An arrest can be proper even where no claim is later proven. In most circumstances, a arrest is proper where it is authorised by a judge and based on factually correct information provided to a local court. Where the issue of wrongful arrest arises, the critical issue is whether the judge permitting the arrest was misled factually. If so, in some jurisdictions there may be recourse.

Defence cover - or legal costs insurance - may assist an owner by covering some of the legal costs in pursing such a claim.

Conclusion

One should not be misled by what may seem like the dry mechanics of posting a Club LOU. There is often true drama when a ship is arrested. Suddenly owners face loss of future fixtures, additional expenses in port, berth occupancy fees, extra pilot expenses, tides are missed, and so on. However, during the commotion, clubs run through the type of checklist stated above, and owners and claimants must be aware of this.

Christopher Brown

November 2001