Letter of Indemnity (LOI)
Situations where conflicts can arise between what charterers/shippers/receivers want and what the carrier/shipowner can be required to do under the Bill of Lading (B/L). It is for this area of conflict that Letters of Indemnity (LOI) were created.
Letter of Indemnity (LOI) in essence promises that if you do what I ask, I will indemnify you, I will pay you for any loss you suffer as a result. Letters of Indemnity are so commonly used that there are various standard forms available.
Principals of Letter of Indemnity (LOI)
Generally, a Letter of Indemnity (LOI) is offered to a shipowner/carrier under a bill of lading for agreeing to do something which he otherwise has no obligation to do. Therefore:
• The Letter of Indemnity (LOI) is a separate contract between the signatory, and the parties to whom it is addressed. It is usual that the Letter of Indemnity (LOI) is addressed to several parties, for example, the owners, the master, charterer, their servants/agents etc. They are the beneficiaries.
• It is not generally possible to require a Bill of Lading Carrier/Shipowner (Beneficiary) to take a Letter of Indemnity (LOI).
• If the Bill of Lading Carrier/Shipowner (Beneficiary) accepts a Letter of Indemnity (LOI), then he will be undertaking risk in addition to that of the bill of lading holder. However, because he was entitled to refuse that action, he would not be able to claim against the charterer under the Charterparty for taking the action which increased his risk. That is why he needs the express indemnity given by the Letter of Indemnity (LOI).
• A claim will only be made on a Letter of Indemnity (LOI) if the beneficiary has suffered a loss. Therefore, before accepting the Letter of Indemnity (LOI), the beneficiary must be sure that he will be paid under the Letter of Indemnity (LOI) if he claims. This is his key concern.
Letters of Indemnity (LOI) as Illegal Contracts
Under English law there is a real risk that many common Letters of Indemnity (LOI) will not be enforceable. The beneficiary will not be able to enforce payment against the Letter of Indemnity (LOI) Issuer. This is because the contract may be illegal or for fraud. Many of the things which the Bill of Lading Carrier may be asked to do will be done to ensure the Bill of Lading is acceptable under a Letter of Credit, and to ensure easy payment. For example:
1- Back-dated Bill of Lading (B/L)
Back-dated Bill of Lading (B/L): sale contracts often have shipment deadlines, requiring the loading of goods by certain dates. Bill of Lading (B/L) record the date of completion of loading. If the Bill of Lading (B/L) date is later than the shipment date required under the sale contract, payment under a Letter of Credit (LC) will not automatically be made. The parties will have to negotiate again. This puts the seller in a weak position. In oil trades, the price for the goods is often fixed based on the market price around the shipment date. Thus, if the Bill of Lading (B/L) date is changed, the price payable may well change.
2- Under-deck Bill of Lading (B/L) for Goods Loaded on Deck:
Under-deck Bill of Lading (B/L) for Goods Loaded on Deck: many sale contracts specify carriage under deck to reduce the risks of damage in transit to goods. On-deck carriage is often cheaper for a charterer, as the shipowner uses extra space aboard the ship.
3- Clean Bill of Lading (B/L):
Clean Bill of Lading (B/L): where goods are not in apparent good order and condition – Letter of Credit (LC) under sale contract usually requires a Clean Bill of Lading (B/L). If the Bill of Lading (B/L) is claused, showing damage to the goods, payment will not be made automatically, but will have to be renegotiated between the buyer and seller.
4- Misstating the Loaded Quantity:
Misstating the Loaded Quantity: the price payable under a sale contract and Letter of Credit (LC) is usually dependent upon the quantity shipped. The Bill of Lading (B/L) will be the evidence of the quantity shipped. If less quantity is shipped, then the buyer/receiver will be overpaying.
In all of these situations the person asking the Bill of Lading (B/L) Carrier to issue a defective Bill of Lading (B/L) has a strong commercial reason for doing so, it will ensure payment under the Letter of Credit. The Bill of Lading (B/L) Carrier will probably know that. However, the buyer is only paying because the buyer wrongly believes the seller is offering what he has promised in the Bill of Lading (B/L). In fact, he is not. Therefore, the defective Bill of Lading (B/L) is a Fraudulent Document.
Under English Law, any agreement between two parties to create a Fraudulent Document is an illegal contract. It is unenforceable. Therefore, if a Letter of Indemnity (LOI) Beneficiary agrees to issue a Defective Bill of Lading (B/L), and suffers loss, because the buyer/Bill of Lading (B/L) Holder sues him, he cannot rely on the Letter of Indemnity (LOI) to claim against the party who asked him to issue the Defective Bill of Lading (B/L).
That person then escapes responsibility, leaving the Bill of Lading (B/L) Beneficiary poorer but wiser. A carrier (shipowner) may also lose his Protection and Indemnity (P&I) Insurance Cover, if a carrier (shipowner) enters into an illegal contract and suffers loss as a consequence. In that case, the carrier/owner will have to pay the loss himself and will be unable to recover under the Letter of Indemnity (LOI).
—
Charterparty Requirement to issue Letter of Indemnity (LOI)
It is quite common for Charterparties to contain clauses requiring the owners to accept an Letter of Indemnity (LOI) for a charterer in certain circumstances.
Why would a shipowner agree to issue Letter of Indemnity (LOI)?
1- Commercial Need: Shipowner may have to agree to this in order to do this business, which he may be very keen to do.
2- Risk assessment: From experience he knows there is little risk either of having to enforce an Letter of Indemnity (LOI), or that an Letter of Indemnity (LOI) will not be honored.
3- Ignorance: Shipowner may not appreciate the risks in agreeing this clause.
4- Limiting Risk: If the Charterparty clause requires a Clean Bill of Lading (B/L), but only where there is a genuine dispute over the apparent good order and condition of the goods, then the Bill of Lading (B/L) carrier or Shipowner will know that any Letter of Indemnity (LOI) he receives will be enforceable.
5- Insurance Cover: Shipowner believes that he can insure his liability, so he will not have to rely on the Letter of Indemnity (LOI). For example, it is common for a shipowner to obtain SOL (Shipowners’ Liability) insurance cover if he loads goods on deck and issues an under-deck bill of lading. This is because he knows his Protection and Indemnity (P&I) Insurance is unlikely to cover him if the goods on deck are lost or damaged by risk associated with on-deck cargoes. In this case, by taking insurance, Shipowner would not be relying solely on the Letter of Indemnity (LOI) for repayment of any loss.
—
Enforceable Letter of Indemnity (LOI)
Not all Letters of Indemnity (LOIs) are illegal contracts unenforceable for fraud. Many are issued for the convenience of the charterer without affecting the receiver. Some examples are:
• Letter of Indemnity (LOI) for issuing split delivery orders: usually there is one delivery order at the discharge port for each Bill of Lading (B/L). if the goods are sold on to several buyers, split delivery orders will allow separate deliveries.
• Letter of Indemnity (LOI) for changing discharge port: sometimes charterers or sellers have not finalized their sale when the Bill of Lading (B/L) are issued. The bills will show a discharge port which may need to change when the sale contract terms are finalized.
Usually, a Letter of Indemnity (LOI) is offered for discharging/delivering goods from a ship without production of Original Bill of Lading (B/L). A Bill of Lading (B/L) Carrier is entitled to refuse to give delivery of goods except against production of the Original Bill of Lading (B/L). The Shipowner or Ship Operator can sit and wait until the Original Bill of Lading (B/L) is produced to him. The charterer cannot force the Shipowner or Ship Operator to discharge the goods and deliver. However, If a Bill of Lading (B/L) Carrier or Shipowner agrees to discharge or deliver the goods, in return for a Letter of Indemnity (LOI) from the charterer or receiver, then the Bill of Lading (B/L) Carrier or Shipowner is creating an additional risk for himself. That risk is that the person to whom the Bill of Lading (B/L) Carrier or Shipowner delivers the goods will not become a bill of lading holder entitled to the goods. In that case, someone else will become the Bill of Lading (B/L) Holder and demand delivery of the goods which the carrier/shipowner has already delivered. The carrier/shipowner will then be liable to compensate that Bill of Lading (B/L) Holder for full value of the goods which the carrier/shipowner had misdelivered.
The carrier/shipowner (Letter of Indemnity Beneficiary) should be able to rely upon his Letter of Indemnity (LOI) and recover his losses from the charterer/receiver. It is possible for an Letter of Indemnity (LOI) given in return for a Clean Bill of Lading (B/L) to be a legal contract. There must be a genuine dispute as to the condition of goods. The Ship Master may believe the goods are damaged and wish to Clause the Bill of Lading (B/L). The shipper/ charterer will probably want the Ship Master to issue a Clean Bill of Lading (B/L). If the shipper is able to produce good evidence, for example from an expert surveyor that, in fact, the goods are not damaged and/or that the condition of the goods will not reduce the value of the goods, then because there is a genuine dispute as to the condition of the goods there is no attempt to defraud the receivers by issuing a Clean Bill of Lading (B/L). The Letter of Indemnity (LOI) would not be an illegal contract. Thus if a claim is made against the carrier/shipowners, who suffer loss as a result of issuing a Clean Bill of Lading (B/L), the carrier/shipowner/Letter of Indemnity Beneficiary would be able to claim under the Letter of Indemnity (LOI).
—
Terms of Letter of Indemnity (LOI)
The Letter of Indemnity (LOI) will contain the following terms:
Beneficiary: who should be the beneficiary under the law? The obvious answer is the person who is doing what is asked, but the proper answer is anyone who might incur liability. Consequently, Letter of Indemnities (LOI) are widely addressed, for example, to owners, charterers, agents and/or servants, and the ship master etc. In a recent case, Laemthong Glory (2005), the Letter of Indemnity (LOI) was addressed to charterers and promised to indemnify charterers’ servants. The owners wanted to claim under the Letter of Indemnity (LOI) but the Letter of Indemnity (LOI) providers said the owners were not a beneficiary. The court held that the owners were charterers’ agents or servants, so they were a beneficiary to the Letter of Indemnity (LOI).
Details of the Voyage and Goods: these need to be sufficiently identified so that the request can make sense and any action under the Letter of Indemnity (LOI) can be made clearly.
Preamble – Description of Events and Request: this will usually say what is happening and why and will set out what the specific request is, for example, to discharge goods without production of bills of lading etc.
Indemnity: clear indemnity clauses will set out what the Letter of Indemnity (LOI) provider is liable for. It is common to include a provision that they provide security if, for example, the beneficiary’s vessel is arrested for security for a claim by the Bill of Lading (B/L) holder.
Duration: In some forms of Letter of Indemnity (LOI) a duration is stated. Typically, where there is delivery of goods without production of Original Bill of Lading (B/L), the LOI expires when the original bills of lading are produced to the Letter of Indemnity (LOI) beneficiary.
Jurisdiction: It is always sensible to have a jurisdiction clause in an Letter of Indemnity (LOI), as Letters of Indemnity (LOI) are enforced differently around the world.
Issuer/Signatory: Letters of Indemnity (LOI) must be properly signed and endorsed by the Letters of Indemnity (LOI) provider. It is very important to ensure that the person who signs has proper authority.
Counter Signatories: They agree to take on the same obligations as the Letters of Indemnity (LOI) provider. This is good for the beneficiary. It reduces his credit risk. Although banks are often asked to be counter-signatories, they will very rarely agree to this.
—
Risks of Letter of Indemnity (LOI)
As well as the risk that an Letter of Indemnity (LOI) will be an illegal contract and thus unenforceable, the beneficiary of an Letter of Indemnity (LOI) runs other risks:
• The creditworthiness of the Letter of Indemnity (LOI) provider: it is possible that the Letter of Indemnity (LOI) beneficiary will not have an opportunity to examine the creditworthiness of the Letter of Indemnity (LOI) provider. Even if beneficiary examine the creditworthiness, that is no guarantee that the Letter of Indemnity (LOI) provider will be able to pay. In a case of discharge without production of Bills of Lading (B/L), the goods may be worth millions of dollars. The beneficiary may then find out that the reason the Bills of Lading (B/L) were not collected by the Letter of Indemnity (LOI) provider was that he did not have funds to pay for the goods. Letter of Indemnity (LOI) provider will not then be able to pay the beneficiary, even if he is liable to under the Letter of Indemnity (LOI).
• The Letter of Indemnity (LOI) providers may argue that the Beneficiaries’ Losses would have occurred anyway and did not occur as a result of doing what the Letter of Indemnity (LOI) provider asked.
• Some Protection and Indemnity Clubs (P&I Clubs) consider the acceptance of any Letter of Indemnity (LOI), even an enforceable Letter of Indemnity (LOI), to be a breach of their rules and they may cancel their Protection and Indemnity Cover (P&I Cover). Thus, an owner may lose Protection and Indemnity Cover (P&I Cover) for crew claims, cargo damage etc. unconnected with the circumstances of the Letter of Indemnity (LOI).