Shipbuilding contracts and the threat of war

We are now, unfortunately, living in a time of heightened geopolitical tension in several regions around the world. A number of shipowners with ships under construction are concerned about what the outbreak of war, or even low level skirmishes might mean for shipyards in close proximity to conflict.

A buyer will usually be unable to terminate the shipbuilding contract unless hostilities cause a long period of delay in the construction of the vessel. The buyers are therefore likely to have their capital tied up for a substantial period before it can be recovered. In these uncertain times it is worth trying to negotiate a carve out to the force majeure clause for hostilities in the region or attempting to cover this risk in other ways.

Under a number of standard forms of shipbuilding contracts, such as the Shipbuilders’ Association of Japan (SAJ) form, the NEWBUILDCON form published by BIMCO and the China Maritime Arbitration Commission (CMAC) form, war is considered to be a force majeure event which allows the builder to extend the delivery date. The definition of force majeure is usually wide and covers ‘acts of princes or rulers, requirements of government authorities: war, war like operation or other hostilities, or preparations therefor, blockade, revolution, insurrection, mobilization, civil war, civil commotion …'

If a delay is caused by any of the events within the definition the shipyard will be entitled to extend the delivery date for a substantial period of time, commonly for at least 180 days. During that period the buyer will not be able to cancel the contract or to recover instalments already paid from the shipyard or the refund guarantor bank.

Furthermore even if hostilities have commenced the buyer will, under the contract have to keep paying instalments when required to by the triggering events under the contract which may simply be dates on which payments are due or events such as steel cutting which could take place even if the shipyard is not operating normally.

What if hostilities actually commence and it becomes clear that the shipyard will be unable to finish the vessel, because for example, the shipyard has been requisitioned or destroyed?

It is difficult to succeed in an argument that the contract has been frustrated when the very event that is the cause of the frustration is covered in the force majeure clause as discussed by Lord Simon of Glaisdale in National Carriers Ltd v. Panalpina (Northern) Ltd (1981).

However given that the whole point of a force majeure clause is to deal with events that cause delay rather than events that make it impossible to carry out the objective of the contract, it is arguable that if it is clear that it is impossible to construct the ship (for example because the shipyard has been destroyed) the contract would be frustrated despite the provisions of the force majeure clause.

From the point of view of the buyer, frustration, although it brings the contract to an end, is not necessarily an attractive solution. If the contract is frustrated the buyer need not continue to pay instalments but on the other hand the question of how much of the funds already paid are recoverable will be up in the air. If the contract is frustrated the tribunal can order the return of all or part of the buyer’s pre-paid instalments of the contract price to the extent that the same is necessary to “do justice” between the parties s. 1(2) of the Law Reform (Frustrated Contracts) Act 1943. As a matter of discretion, provision may, however, also be made for a deduction from such sums to reflect expenses incurred by the builder in the period until termination of the contract. The buyer may therefore find that it can recover none of the pre-delivery instalments because the builder will be able to show that those funds cover only the costs that it has incurred.

The other problem for the buyer in the case of frustration of the contract is that any pre-delivery instalments that are recoverable will not be payable by the refund guarantor bank but by the builder in circumstances where it is likely to be impecunious.

One possible solution is to include a provision in the force majeure clause excluding hostilities in the region from the definition of force majeure and specifically providing that in those circumstances the contract can be terminated early and the pre delivery instalments returned. This provision would have to be referred to in the refund guarantee if it were to be covered by it. Such a term would of course be novel but given the current dearth of new building orders the shipyards may be willing to consider it.

Another factor to take into account is of course that the refund guarantor banks are usually based in the same state as the shipyard. This means that their financial position may be affected and they could be prevented from paying out, whatever their contractual obligations, by capital controls, so, practically speaking the buyer may still not be able to recover their funds. However it would be likely that much would depend on timing, the level of hostilities and how quickly the buyer was able to terminate the contract.

Another possible solution as far as the buyers are concerned could be to arrange insurance that would pay out an amount equal to the prepaid instalments in the event of war. Such insurance would be unlikely to cover the position if further instalments fell due but on the other hand from a practical point of view in a war situation the buyer may take a commercial decision to stop making payments and wait for a reaction from the builder. Insurance of this type would have to be individually tailored and would of course be very expensive and is unlikely to provide a complete solution.

Parties may wish to consider more carefully force majeure provisions dealing with war when considering business in areas where geopolitical tension is not only present but also a possibility.