Letters 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. It is for this area of conflict that Letters of Indemnity (LOI) were created. An LOI in essence promises that if you do what I ask, I will indemnify you (pay you) for any loss you suffer as a result. Letters of Indemnity are so commonly used that there are various standard forms available. PRINCIPLES OF LOIs: Generally, a Letter of Indemnity 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 is a separate contract between the signatory, and the parties to whom it is addressed. It is usual that the 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. • If the bill of lading carrier/owner (beneficiary) accepts a Letter of Indemnity, 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 LOI. • A claim will only be made on a Letter of Indemnity if the beneficiary has suffered a loss. Therefore, before accepting the Letter of Indemnity, the beneficiary must be sure that he will be paid under the Letter of Indemnity if he claims. This is his key concern. LOIs AS ILLEGAL CONTRACTS: Under English law there is a real risk that many common LOIs will not be enforceable. The beneficiary will not be able to enforce payment against the 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: • A ‘clean’ bill of lading where goods are not in apparent good order and condition – Letter of Credit under sale contract usually requires a clean bill of lading. If the bill of lading is claused, showing damage to the goods, payment will not be made automatically, but will have to be renegotiated between the buyer and seller. • Back-dated bills of lading – sale contracts often have shipment deadlines, requiring the loading of goods by certain dates. Bills of lading record the date of completion of loading. If the bill of lading date is later than the shipment date required under the sale contract, payment under a Letter of Credit 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 date is changed, the price payable may well change. • Under-deck bill 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 owner uses extra space aboard the vessel. • Misstating the loaded quantity – the price payable under a sale contract and Letter of Credit is usually dependent upon the quantity shipped. The bill of lading 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 carrier to issue a defective bill of lading has a strong commercial reason for doing so – it will ensure payment under the Letter of Credit. The bill of lading carrier will probably know that. However, the buyer is only paying because he wrongly believes the seller is offering what he has promised in the bill of lading. In fact, he is not. Therefore, the defective bill of lading 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 LOI beneficiary agrees to issue a defective bill of lading, and suffers loss (because the buyer/bill of lading holder sues him), he cannot rely on the LOI to claim against the party who asked him to issue the defective bill of lading. That person then escapes responsibility, leaving the LOI beneficiary poorer but wiser. A carrier/owner may also lose his P&I Insurance cover if he 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 LOI.