Letters of Indemnity (LOI)

Letters of Indemnity (LOI)

Conflicts often arise between what Charterers/Shippers/Receivers desire and what the Carrier/Shipowner is obliged to do under the Bill of Lading (B/L).

For these conflicts, Letters of Indemnity (LOI) were developed. Essentially, a Letter of Indemnity (LOI) promises that if the requested actions are taken, the party will compensate (indemnify) for any resulting losses.

Letters of Indemnity (LOI) are widely utilized, with several standard formats available.

 

PRINCIPLES OF LETTERS OF INDEMNITY (LOI)

Typically, a Letter of Indemnity is provided to a Shipowner/Carrier under a Bill of Lading (B/L) to perform actions beyond their obligatory duties, thereby:

  • The Letter of Indemnity (LOI) serves as a distinct agreement between the signer and the addressed parties, often including Shipowners, Ship Masters, Charterers, and their agents/servants, who are the beneficiaries.
  • It is generally not feasible to compel a Bill of Lading (B/L) Carrier/Shipowner to accept a Letter of Indemnity (LOI).
  • Accepting a Letter of Indemnity (LOI) introduces additional risks for the Bill of Lading (B/L) Carrier/Shipowner beyond those associated with the B/L holder. Since he could have declined the action, he cannot claim against the Charterer under the Charter Party for accepting increased risks. This necessitates the explicit indemnity provided by the Letter of Indemnity.
  • Claims on a Letter of Indemnity (LOI) arise only if the beneficiary incurs a loss, ensuring payment from the Letter of Indemnity (LOI) is crucial before acceptance.

 

LETTERS OF INDEMNITY (LOI) AS ILLEGAL CONTRACTS

Under English law, the enforceability of many common Letters of Indemnity is questionable due to potential illegality or association with fraud. The beneficiary might not be able to secure payment from the Issuer of the Letters of Indemnity.

Frequently, the actions requested of the Bill of Lading (B/L) Carrier serve to validate the Bill of Lading for a Letter of Credit (L/C), facilitating smoother payment transactions. For example:

  • Issuing a Clean Bill of Lading (B/L) for goods not in apparent good order can be problematic as Letters of Credit generally require a clean Bill of Lading. If the B/L is marked with clauses indicating damage, the payment becomes disputable and requires renegotiation.
  • Back-dating Bill of Lading (B/L) to meet sale contract deadlines can jeopardize payment under a Letter of Credit, compelling renegotiation.
  • Issuing Under-Deck Bill of Lading (B/L) loaded on deck, which is often cheaper for Charterers but contradicts many sale contracts that demand under-deck carriage to minimize transit damage.
  • Misrepresenting the loaded quantity can lead to discrepancies in the payment under a sale contract and Letter of Credit (B/L), as the Bill of Lading (B/L) Documents the shipped quantity. Overpayment occurs if less is shipped than stated.

In these scenarios, the party requesting a defective Bill of Lading (B/L) has a compelling commercial motive, aiming to secure payment under the Letter of Credit (L/C). Although the Bill of Lading (B/L) Carrier may be aware of these motives, the buyer pays based on incorrect beliefs about the goods’ condition or quantity, rendering the Bill of Lading (B/L) Fraudulent..

Under English law, any agreement between two parties to create a fraudulent document is considered an illegal contract and is therefore unenforceable. Consequently, if a Letters of Indemnity (LOI) Beneficiary agrees to issue a defective Bill of Lading (B/L) and incurs a loss (because the buyer/Bill of Lading (B/L) holder sues him), he cannot rely on the Letters of Indemnity (LOI) to seek compensation from the party who requested the issuance of the defective Bill of Lading (B/L). This leaves the requester free of responsibility, and the Letters of Indemnity (LOI) Beneficiary financially disadvantaged but more informed.

A Carrier/Shipowner might also lose his Protection and Indemnity (P&I) Insurance Cover if he enters into an illegal contract and suffers losses as a result. In this case, the Carrier/Shipowner must cover the losses himself and cannot recover through the Letters of Indemnity (LOI).

 

ENFORCEABLE LETTERS OF INDEMNITY (LOI)

Not all Letters of Indemnity (LOI) are considered illegal or unenforceable due to Fraud. Many Letters of Indemnity (LOI) are issued for the convenience of the Charterer without adversely affecting the receiver. Some examples include:

  • Letters of Indemnity (LOI) for issuing split delivery orders—typically, there is one delivery order at the discharge port for each Bill of Lading (B/L). If the goods are sold to multiple buyers, split delivery orders facilitate separate deliveries.
  • Letters of Indemnity (LOI) for changing discharge ports—sometimes Charterers/sellers have not finalized their sale when the bills of lading are issued. The bills might specify a discharge port that needs to be changed once the sale contract terms are finalized.

Letters of Indemnity (LOI) are commonly offered to allow for the discharging/delivering of goods from a ship without the production of Original Bills of Lading (B/L).

A Bill of Lading (B/L) Carrier is entitled to refuse to give delivery of goods except against the production of the Original Bills of Lading (B/L). Carrier can wait until the Original Bills of Lading (B/L) is produced. The Charterer cannot compel the Carrier/Shipowner to discharge the goods and deliver them.

However, if a Bill of Lading (B/L) Carrier/Shipowner agrees to discharge or deliver the goods in return for a Letter of Indemnity (LOI) from the Charterer/Receiver, then the Bill of Lading (B/L) Carrier/Shipowner is exposing himself to additional risk. That risk involves delivering goods to someone who may not become a Bill of Lading (B/L) Holder entitled to the goods. If another party later becomes the Bill of Lading (B/L) Holder and demands the goods, the Carrier/Shipowner will be liable to compensate them for the full value of the goods misdelivered.

The Carrier/Shipowner (Letters of Indemnity Beneficiary) should be able to depend on his Letters of Indemnity (LOI) to recover his losses from the Charterer/Receiver.

It is possible for a Letter of Indemnity (LOI) given in exchange for a Clean Bill of Lading (B/L) to be a legal contract if there is a genuine dispute regarding the condition of the goods. If the Ship Master believes the goods are damaged and wants to clause the Bill of Lading (B/L), but the Shipper/Charterer insists on a clean Bill of Lading (B/L), and credible evidence (such as from an Expert Surveyor) shows that the goods are not damaged or that their condition does not diminish their value, then there is a legitimate dispute. This indicates no intent to defraud the receivers by issuing a Clean Bill of Lading (B/L). Therefore, the Letters of Indemnity (LOI) would not be an illegal contract. Consequently, if a claim arises against the Carrier/Shipowners who suffer loss from issuing a Clean Bill of Lading (B/L), they would be able to seek compensation under the Letter of Indemnity (LOI).

 

ADDITIONAL RISKS OF LETTERS OF INDEMNITY (LOI)

Besides the risk of being an illegal contract and therefore unenforceable, a beneficiary of Letters of Indemnity (LOI) faces several other risks:

  • Creditworthiness of the Letters of Indemnity (LOI) Provider – There might be instances where the Letters of Indemnity (LOI) Beneficiary cannot assess the financial stability of the Letters of Indemnity (LOI) Provider. Even with an assessment, there’s no assurance that the Letters of Indemnity (LOI) Provider will have the necessary funds to fulfill their obligations. In scenarios where goods are discharged without the production of bills of lading, and these goods are valued in the millions, it may come to light that the Letters of Indemnity (LOI) Provider lacked the funds to pay for the goods and consequently, cannot compensate the beneficiary, despite being liable under the Letters of Indemnity (LOI).
  • Dispute Over Cause of Loss – Letters of Indemnity (LOI) Providers might argue that the beneficiary’s losses would have occurred regardless of their actions and were not a direct result of following the Letters of Indemnity (LOI) Provider’s instructions.
  • Insurance Coverage Issues – Some Protection and Indemnity Clubs (P&I Clubs) view the acceptance of any Letters of Indemnity (LOI), even those that are enforceable, as a violation of their rules, which may lead to the cancellation of their P&I cover. Consequently, a Shipowner could lose P&I coverage for claims unrelated to the circumstances addressed by the Letters of Indemnity (LOI), such as crew claims or cargo damage.

 

TERMS OF LETTERS OF INDEMNITY (LOI)

The Letters of Indemnity (LOI) typically contain the following terms:

  • Beneficiary – While it might seem obvious that the person executing the requested action should be the beneficiary, the correct answer includes anyone who might face liability. Thus, Letters of Indemnity (LOI) are often addressed broadly, for instance, to Shipowners, Charterers, their agents and/or servants, and the Ship Master. In the case of Laemthong Glory (2005), the Letters of Indemnity (LOI) were addressed to Charterers, indemnifying Charterers’ servants. Although Shipowners sought to claim under the Letters of Indemnity (LOI), the Letters of Indemnity (LOI) Providers contested their beneficiary status. The court decided that the Shipowners were indeed Charterers’ agents or servants, thus beneficiaries under the Letters of Indemnity (LOI).
  • Details of the Voyage/Goods – It’s crucial that these details are sufficiently specified so the requests made under the Letters of Indemnity (LOI) are clear and actionable.
  • Preamble/Description of Events and Requests – This section typically describes the ongoing situation and specifies the request, such as discharging goods without the production of bills of lading.
  • Indemnity – Clearly articulated indemnity clauses outline the liabilities of the Letters of Indemnity (LOI) Provider, often including provisions for security in case, for example, the beneficiary’s ship is detained for a claim by the Bill of Lading (B/L) holder.
  • Duration – Some Letters of Indemnity (LOI) specify a duration, often expiring once the original bills of lading are presented to the Letters of Indemnity (LOI) Beneficiary.
  • Jurisdiction – Including a jurisdiction clause in Letters of Indemnity (LOI) is prudent, as enforcement can vary globally.
  • Issuer/Signatory – It is vital that the Letters of Indemnity (LOI) are properly signed and endorsed by an authorized representative of the Letters of Indemnity (LOI) provider.
  • Counter-signatories – They agree to undertake the same obligations as the Letters of Indemnity (LOI) provider, which reduces the credit risk for the beneficiary. Although banks are sometimes requested to act as counter-signatories, they seldom agree to this role.

 

 

CHARTER PARTY REQUIREMENT TO ISSUE Letters of Indemnity (LOI)

It is fairly common for charterparties to include clauses that mandate Shipowners to accept a Letters of Indemnity (LOI) from a Charterer under specific conditions. What are the reasons a Shipowner might consent to such terms?

  • Risk Assessment – Based on his experience, a Shipowner may determine that the risks associated with needing to enforce a Letters of Indemnity (LOI) or facing a scenario where a Letters of Indemnity (LOI) is not honored are minimal.
  • Commercial Need – The necessity to secure certain business opportunities might compel a Shipowner to agree to such clauses, especially if he is eager to engage in the transaction.
  • Ignorance – A Shipowner might not fully understand the risks involved in accepting such a clause.
  • Insurance Coverage – Shipowners often believe that their liability can be insured, thus alleviating the need to depend on the Letters of Indemnity (LOI) for loss coverage. For instance, it is typical for a Shipowner to secure Shipowners’ Liability (SOL) insurance if he loads goods on deck and issues an under-deck Bill of Lading (B/L), knowing that his Protection and Indemnity (P&I) insurance may not cover losses or damages to on-deck cargoes. With insurance in place, the reliance on the Letters of Indemnity (LOI) for compensation is reduced.
  • Limiting Risk – If the Charter Party clause stipulates issuing a clean Bill of Lading (B/L) only in cases where there is a legitimate dispute regarding the goods’ apparent good order and condition, then the Bill of Lading (B/L) Carrier/Shipowner can be confident that any Letters of Indemnity (LOI) provided under these circumstances will be enforceable.
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