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Demise charters for better for worse: Ocean Victory

The Supreme Court judgment on May 10 2017 in Gard Marine and Energy Ltd v China National Chartering Co Ltd [2017] UKSC 35 provided one expected answer, one surprise and one brainteaser

OCEAN Victory was lost at the port of Kashima in Japan on October 24, 2006.

The circumstances at the port at the time were unusual: there was a long swell, combined with a northerly gale.

Ocean Victory was, at the time of loss, subject to a demise charterparty and two time charterparties, each containing a safe port warranty. The demise charter placed on demise charterers the responsibility for making insurance arrangements, including a hull policy covering the loss of the vessel.

Once the insurers had paid for the loss under the insurance, they looked to recover the indemnity from the time charterers, on the basis that they had been in breach of the safe port warranty.

The judge at first instance ([2014] 1 Lloyd’s Rep 59) permitted recovery, but the Court of Appeal ([2015] 1 Lloyd’s Rep 381) did not.

Before the Supreme Court, the safe warranty issue was considered along with the question of the insurers’ rights to recover and the rights of charterers to limit their liability.

 

Safe port warranty

Two factors, each in itself not unusual for the port, combined to cause the loss of Ocean Victory: a long swell and a strong wind. While each of the features was not uncommon, the combination was a hitherto unrecorded occurrence in the port. The judge, at first instance, noted: “There is no meteorological reason why they should not occur at the same time,” (at para 127) and held that the warranty was one of safety, not reasonable safety. This absolute standard was a harsh concept of the charterer’s duties — the judgment has been labelled “very pro-owner” (Paul Todd, “Safe port issues”, [2014] LMCLQ 1).

When the Court of Appeal came to consider the issue, the appeal was allowed.

The Supreme Court adopted the same, less pro-owner approach as the Court of Appeal. Lord Clarke, giving the leading speech, emphasised that the safe port warranty did not mean that charterers guarantee that the ship would never find itself in an unsafe port, but only that they would nominate prospectively safe ports. The date for judging breach of a safe port warranty is the date of nomination of the port.

The law here is not controversial. If the obligation were absolute from that moment on, the effect would be to make charterers the owners’ insurers of the vessel. However, past authorities have suggested that the rule applies in the absence of some “abnormal occurrence”. In Leeds Shipping Co Ltd v Societe Francaise Bunge (The Eastern City) ([1958] 2 Lloyd’s Rep 127), Seller LJ said: “A port will not be safe unless, in the relevant period of time, the particular ship can reach it, use it and return from it without, in the absence of some abnormal occurrence, being exposed to danger which cannot be avoided by good navigation and seamanship …”.

Subsequent cases have considered what would amount to an “abnormal occurrence”. The question was whether the freak combination of the two port characteristics was reasonably foreseeable, or whether it amounted to such an abnormal occurrence.

While Gard had argued that “abnormal occurrence” was not a term of art, and the Supreme Court agreed, it can perhaps, following Ocean Victory, be said that it has become one. At para 25 Lord Clarke asked the question: “Was the danger alleged an abnormal occurrence, that is something rare and unexpected, or was it something which was normal for the particular port for the particular ship’s visit at the particular time of year?” He went on to add that the meaning of abnormal is “something well removed from the normal” which “the notional charterer or owner would not have in mind” (at para 27).

Lord Clarke has judicially favoured solutions that play into shipping’s commercial balance (see e.g. NYK Bulkship (Atlantic) NV v Cargill International SA (The Global Santosh) [2016] 1 Lloyd’s Rep 629) and, on this occasion, again emphasised the allocation of liabilities between the parties. Abnormal occurrences should fall on shipowners and, ultimately, on their hull insurers.

So, what is an abnormal occurrence, and was this an abnormal occurrence? More striking than the case law analysis is the passage where Lord Clarke considers the relationship between what is foreseeable and what is abnormal. He highlights the observations of the Court of Appeal on earthquakes in San Francisco or volcanic eruptions in Syracuse, beneath Mount Etna — while those are foreseeable, in the sense that it is known that earthquakes and volcanic eruptions will happen at some point, they are, nevertheless, abnormal occurrences. While not quite as dramatic as such events, the conditions at the port of Kashima in this case qualified as an abnormal occurrence, so that the port was not prospectively unsafe at the time of nomination.

The other four judges agreed with Lord Clarke on the safe port warranty point. As a result, there was no liability for the charterers, so that everything that followed was obiter. The Supreme Court’s conclusions on the following two issues are, nevertheless, of great importance to shipping and insurance practice.

 

Insurers’ rights to recover

The conclusion on this point will be quite a puzzle to many, due to the complexity of the issue. It is worth noting that the outcome was not unanimous — Lord Clarke and Lord Sumption both disagreed with the majority reasoning, each giving reasons of their own. There also appear to be some elegant ways to escape the trap in which the insurers landed here, by contract design or by formulation of pleas in litigation.

A first salient point is that the Supreme Court did not have sight of the actual insurance policy. The outcome depended entirely on the provisions of the bareboat charterparty. Nevertheless, the situation might be termed a battle of the contracts. Which contract — the insurance policy or the demise charter — governed the insurers’ rights to recover?

It is uncontroversial that where parties are co-insureds under a policy taken out by one of them for the benefit of both, the insurers who have paid the innocent party cannot recover the indemnity from the other party. If they could, one of the parties would not have any benefit from the insurance, although it was taken out for its benefit. In this case, the terms of the demise charter (clause 12) obliged bareboat charterers to take out insurance for the benefit of themselves, as well as the shipowners. The shipowner and bareboat charterer were, therefore, co-insureds.

The bareboat charterparty was on a standard form widely used in the business, Barecon 89. The widespread use of this form was, in fact, the reason for giving permission to appeal to the Supreme Court. The demise charter also contained a safe port warranty (clause 29), as did the time charterparties. This safe port warranty replaced clause 5 (“Trading limits”) of the Barecon 89 standard form. Within the contractual paradigm of the chain of charterparties only, without taking into account any presence or obligation of insurance, this clause was, presumably, intended to be back-to-back with the safe port warranties in the time charterparties. In the, entirely hypothetical, situation of insurance being no part of the equation, the owner would wish to look to the demise charterer which, in turn, would wish to look to its time charterer for compensation for the loss of the vessel.

The case of the insurers was based on liability under this warranty: if the bareboat charterer was liable to the owner under the safe port warranty, and entitled to pursue, in turn, that same liability against the time charterers, then so was the insurer who had taken assignment of the rights of the owner and demise charterer, including its rights of recourse against the time charterer. As it turned out, choosing this as the only basis for their argument was a crucial mistake.

As would be expected, both the majority decision and the minority speeches are internally logical and consistent — where they differ is on priorities. Put at its simplest, the insurance rule trumped the carriage contract. The insurers’ rights to recover had to give way, where insurance provided a complete answer to the insured parties’ mutual liabilities under the charterparty.

 

The parties’ liabilities under the charterparty

In the minority, Lords Clarke and Sumption emphasised, as had the judge at first instance, that the shipowner and demise charterer had nowhere, expressly, given up their rights under the safe port warranty. Lord Sumption also considered the character of the rule that joint insurance gives the insurer no right of recovery against a fellow insured: if that rule meant that the insured’s liability had been fulfilled (as opposed to excluded) by providing insurance, it did not mean that the liability never existed. It could still be passed on to insurers by subrogation.

The majority saw things differently. Lord Mance observed that it was not necessary for the parties to the charterparty to state expressly that the shipowner’s rights of recourse against the charterer were being given up. The bareboat charterparty contained an alternative insurance clause (clause 13 — designed for short-term charters), where such language was present. That, he said, was by way of belt and braces. Clause 12 served as a complete answer to all the demise charterer’s liabilities, including under the safe port warranty. The shipowner and demise charterer had, by clause 12, designed a system whereby they both agreed not to look to each other for compensation for liability, but to the insurer. An important purpose of the clause was to create a fund available to answer any claims between the parties, so that disputes could be avoided.

If there was no liability between the parties, and they had agreed to look to insurers rather than to each other in the event of loss, there was no liability for the demise charterer to the shipowner under the safe port warranty and, as a result, it had suffered no loss. There were, as a result, no rights to recover against the time charterers that could be assigned on to the insurer.

 

Shipping v insurance

The outcome will divide shipping lawyers and insurance lawyers — insurance lawyers will welcome the recognition that co-insurance is for the benefit of both (or all) insureds. Shipping lawyers will agree with the minority that the demise charterparty did not, expressly, exclude liability for breach of the safe port warranty, and will consider unsatisfactory the answer that an obligation to procure insurance and pay the premiums takes care of any, and all, liabilities.

To the extent that future judges tasked with answering similar questions disagree with the responses given, it ought to be relatively simple to distinguish the case. For example, the bareboat charter was made by parties operating within the same sphere and having common business interests. Would the observations of the majority chime differently in a contract entirely at arm’s length, with less commonality of interest between the parties? It is not a given in all business relationships that insurance is for the purpose of precluding disputes: sometimes, an insurance is just an insurance.

It was, ultimately, the demise charterparty itself, and what the parties said, therein, about insurance, that defeated the insurers’ right to recover from third parties. The judgment on this point is not a game-changer for the shipping industry — the outcome depended on the precise terms of the contracts. For insurers to escape the position where they cannot recover from third parties, they can insist that the joint insureds under the contract preserve the liability between them. In the context of Barecon 89, if there were a separate remedy for the safe port warranty, making it clear that it did not fall within the purview of the insurance provisions in clause 12, the demise charterer’s liability to pay, as well as its assignee’s right to recover from third parties, would be preserved. Drafters of standard forms, as well as individual charterparties, can clarify that the insurance clause does not exclude liabilities between the parties. The price for not doing so will be a high one: a reluctance of insurers to insure, for fear that they will not be able to recover from the third party.

Where the contract has already been made on similar terms, it is worth noting that no less than three of their Lordships, both in the majority and the minority, noted that the insurer could, alternatively, have relied upon the demise charterer’s position as bailee of the vessel —irrespective of the parties’ rights under the insurance contract, that could well be a viable basis for a claim against a third party, capable of being assigned to insurers. The insurers chose not to adopt this basis for their argument and, as the point had not been pleaded, it was not decided.

 

Limitation of liability

The third issue before the Supreme Court was the question of limitation of liability for the charterers. The issue was not mooted in the lower courts because they were bound by the decision of the Court of Appeal in CMA CGM SA v Classica Shipping Co Ltd (The CMA Djakarta) ([2004] 1 Lloyd’s Rep 460). On this point, the insurers notched up a rather hollow victory. Given the outcome on the other two points, this part of the judgment, too, was obiter. The unanimous decision of the court was to approve the Court of Appeal’s judgment in The CMA Djakarta.

The question was whether the Convention on Limitation of Liability for Maritime Claims 1976 permitted charterers to limit liability. The Supreme Court noted the definition of “shipowner” in the Convention, which includes charterers. In general, charterers were, therefore, just as entitled to limit liability as the shipowners themselves. However, limitation with reference to the tonnage of the ship was not appropriate where, as here, it was the ship herself that had suffered the damage or been lost. According to Lord Clarke (at para 86), the Convention’s words “loss of or damage to property … in direct connection with the operation of the ship” did not include loss of or damage to the vessel herself. “Property” meant property external to the ship, such as a bridge or jetty, not the ship herself. Where charterers’ actions in operating the ship caused her to be lost, so “operation of the ship” did not give them a right to limit liability for claims in respect of those actions.

Charterers had proposed an alternative interpretation of the operative words in article 9 of the Convention, to the effect that a charterer could only limit liability in respect of operations performed in place of the shipowner. This was rejected by the Supreme Court, unanimously approving the judgment of the Court of Appeal in The CMA Djakarta.

While most of the judgment was obiter, in view of their Lordships’ conclusion on the safe port warranty, and good contract drafting and considered pleas in litigation will create ways around the conclusion on the insurance point, this should, in the final account, prove to have been the most important shipping case of the year, thanks to the range of issues addressed and the comprehensive responses provided.

 

 

Dr Johanna Hjalmarsson, Informa Associate Professor in Maritime and Commercial Law, Institute of Maritime Law, Southampton Law School, University of Southampton

 

This article was first published on our sister site at i-law.com. i-law is a premium online research tool for legal professionals, offering case reporting, commentary and analysis on all areas of maritime and commercial law.

 

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