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[Tank]ing contracts: Doctrine of ‘Good faith’ versus ‘WOG’ and other exclusionary terms

2021 has been a very important year for the Shipping industry with the issue of carbon emissions, radical changes in the supply chain logistics, and with countries and corporations coming together to address larger issues at hand. What is fascinating to a novice to the industry are carriers particularly designed for the carriage of oil cargoes… e.g. Motor Tankers, Oil carriers, crude carriers, FPSO/FSO’s, etc., (will be referred to as Tankers collectively). If you have gasped at the size of the recent Ever Given vessel that halted world traffic at the Suez Canal, or the oil rigs in the movie Deepwater Horizon, try googling ULCC’s and VLCC’s. The Oil & Gas industry obscures as much as it reveals whether it is with respect to allegations of oil spills, carriage of cargo from sanctioned countries, or the general manipulation of market forces determining prices of the commodity.

It is no secret that the ship-recycling industry has always been under scrutiny, with ‘end of life’ Tankers being sold for safe-recycling to the Indian sub-continent to the West’s distress. This article aims to address nuanced issues arising at the time of sale of Tankers for demolition and representations and warranties (express/implied) made at the time by sellers and various commercial considerations.

Method/mode of sale: Tankers, often due to their inability to be worthy of carriage for another journey, or (increasingly of late) to battle the uncertainties and protect oneself against the uncertainties of the freight market, are circulated for sale by owners through brokers/broking houses for sale. Negotiations ensue between direct buyers/intermediary buyers and sellers: a crucial stage where contracts are concluded in course of the day, two at most due to volatile markets, competitive bidders, etc. If the terms and conditions for sale asserted by the Sellers cannot be agreed upon at the earliest, the negotiations die down and the deal withers away elusively, making prompt cost–benefit analysis of the deal a determining factor in the prices put in for the bids. This is a time sensitive and extremely competitive process in a niche and concentrated market.

Particularly, sellers are always on an inexorable march to be unrelenting in the incorporation of exclusion terms that only favor one side, and have repercussions on fair dealing in trade. One of the key themes of this article converges on the declaration of the quantity of ‘Sludges/Slops’ present onboard the Tankers. Specific and technical definitions can be found in The International Convention for the Prevention of Pollution from Ships (MARPOL), but below is a paraphrased version:

A Tanker (specifically designed to carry cargoes of Oil & Gas of complex compositions) over years (also depending on the number of years it has been chartered/commissioned as a carrier for crude/oil) accumulates residues/sludge/slops in the Tanks used for storage of cargo.

  • Slop - This mostly includes oily water that can be pumped out and cleaning is relatively quick and convenient.
  • Sludge – Depending on the density of cargoes the carrier has carried onboard, the semi-solid residues requiring precise cleaning and Hot wash;
  • Residue – Residues are mostly solid in form and require manual labor for removal, which is a time- and resource-consuming process (mostly found in older tankers that have been out of commission for a long time).

Tankers, even when markets showcase a conservative trend, fetch a decent recycling price. Sellers usually give an estimate of sludge and slops present onboard the vessel in MT/Cbm that determines the bids to be received from intermediary/end buyers who shall further sell the vessel for recycling or purchase the vessel themselves. These bids are not only placed keeping profit margins in mind, but also delivering clean and safe Tankers following best recycling practices

The Tanker needs to be thoroughly cleaned and freed of sludges and residues, gas free certificates must be provided to the ultimate recycler as a pre-condition of sale, and an inspection by safety officers and a state environment agency is required before any demolition permits are granted.

However, the position of parties in negotiations is often adversarial and parties are entitled to pursue their own best interests, as long as they avoid misrepresentations. This duty to negotiate ‘in good faith’ is often cited as being unworkable in practice as it is believed to be inherently inconsistent with the position of negotiating parties. The declaration of the quantity of sludge and slops onboard the vessel is directly proportional to the price the intermediary/end buyer will offer for the purchase of the vessel--cleaning costs of the residual sludge and slops being factored into the offered price to ensure that vessel is free of any potential hazard when finally delivered to compliant yards employing safe recycling practices.

 

Without Guarantee: Legal Implications

At the time of these contract negotiations, the estimate of sludge and slops stipulated in the MOA is preceded with the qualified condition that the same is ‘… given in good faith but without guarantee.’ The requirement of negotiating in good faith seeks to promote fair and open dealing to prevent unfair surprises and absence of real choice [1].T[2]? Yet, the inclusion of the word ‘without guarantee’ in itself should be enough to raise serious questions about the good faith aspect of negotiations, especially when bargaining positions of parties differ by and large.

Now, this is not to suggest that it is always so only in case of unscrupulous sellers who want to limit their liability knowingly, but also in cases of unsuspecting sellers who may want to cash in and hedge their position when freight markets are underperforming without making a  good faith AND reasonable attempt to determine the sludge quantities, or, make inadequate attempts that do not qualify as reasonable to determine the quantities, therefore jeopardizing accuracies.

Under English Law, the position of the meaning of ‘good faith’ is evolving jurisprudence, the effect of caveating any representation with the term ‘without guarantee’ is seemingly resolute; Dickensian descriptions would be [Pickwick Papers]- “…what can’t be cured, must be endured.”

For example, the leading Judgment on the effect that this disclaimer would have in a maritime contract (Lenodoudis Evangelos II) The Lipa[3], held that a standard deviation of 5%-10% shall be tolerated in case of short loading/cargo disputes, etc. as long as there are no major deviations from the material terms of the contract. Interestingly, it was also observed that when parties are involved in similar trade/businesses, the question of either party’s ‘reliance’ on representations hardly arises till the time a dispute surfaces.

In an alternate observation by an Arbitral Tribunal, the treatment of qualifying reservations on representations made in correspondence between parties is rather stringent, i.e. absent bad faith any such qualified notice preceded with Without Guarantee/ Without Prejudice is accepted by the party at their own peril and an unqualified declaration/Notice should be sought.[4]

What is abundantly clear is that on the basis of the above, when estimates are preceded with WOG, the Burden of proof to be discharged is the proof of bad faith on part of the party making representations. A buyer having an equal bargaining power may be able to factor in the cleaning costs for sludge and slops already in 10%-15% excess of declared quantities as a result of the qualified reservation of WOG, but serious issues arise when quantities are found to exceed any budgeted calculations and significant additional costs have to be incurred for the cleaning.
This begets an important question on which there seem to be none to limited answers in legal textbooks:

Can exclusion clauses like Without Guarantee extend to deviations in excess of tolerable/acceptable industry standards, and yet not qualify as misrepresentations on the seller’s part? Recent examples of Tanker sales to intermediary/end buyers are proving detrimental to trade practices where on ‘as is where is’ sale of vessels, the quantities observed onboard are found to be 100 % - 300% in excess of declared quantities.

The Tankers are sometimes in the Seller’s ownership for more than 10 years with a specialized crew, Masters, and team of engineers employed onboard to ensure smooth functioning and are specifically trained in management and cleaning of these vessels. In all probability, the seller’s crew may even be attempting to obtain this estimate in good faith but with the quantum that is at the time observed and inspected on sale, it comes across as manifest misdeclaration, given the resources that were at the sellers disposal to arrive at an accurate quantity. The parties find themselves in a closed loop, and sellers in these cases are often quick to resort to asserting their ‘Without Guarantee’ exclusion that they have insisted upon at the time of contract negotiation, raising the question of whether the estimates were accurate, to begin with.

In most cases, buyers may be forced to salvage their losses elsewhere with no hope of recovery. Most of the brokers/broking houses will sit on the fence and not provide either parties with any inputs in such a situation. The reason for this sometimes can range from Brokers failure to communicate the parties requirement and insistence clearly, their own lack of understanding of the repercussions aforesaid misdeclarations have on the parties commercial position, to the mere nonchalance that their role is confined to the ultimate delivery of goods from seller to the buyer and nothing beyond.

 

‘Contra Proferentem’: Solving the ambiguity of exclusion clauses

 

While Courts have insisted on parties’ freedom to contract and not interfere to solve and assist with minor inconveniences caused to parties by virtue of their own conduct [agreeing to exclusion terms in a contract], the liberties provided as a result of freedom to contract cannot leave one party with losses that they cannot breakeven on a deal while affording the other unqualified freedom to retreat into patterns where they continue to indulge in practices deterrent to fair trade. Legally, the principle of Contra Proferentem means:

if there is any doubt about the meaning or scope of an exclusion clause, the ambiguity should be resolved against the party seeking to rely on the exclusion clause on the basis that parties are not lightly to be taken to have intended to cut down the remedies the law provides for breach of contract, unless the contract contains clear words to that effect. In the case of exclusion clauses this means the narrower interpretation should be applied.”

One might argue that even with the best team of experts and reasonable efforts, only an estimate of sludge and slops onboard can be provided due to the inherent lack of scientific formula to determine the same, but with experts specifically dealing with the cleaning of Oil carriers to ensure safety, a clear and definite estimate (+/- 10%) is one phone call away. An alternate argument may be to suggest that rule of contra proferentem applies when there is an ambiguity/doubt about the meaning or scope of a term. We have already examined the flexibility offered by the term ‘Without Guarantee’ and implications thereof, but the reliance on the same cannot be sought upon by the Sellers in case the quantities so under-declared that had it not been for the misrepresentation, the Tanker would have been sold for a much lower price.

In light thereof, the interpretation of the meaning of Without Guarantee remains ambiguous and unclear vis-à-vis its scope w.r.t misrepresentations. Even with legal fiction created by yardsticks per the above case-laws, it is pertinent that contra proferentem apply and be construed against the sellers so narrow interpretation is given, especially in cases where sellers attempt to wriggle out of their obligation to provide an estimate in good faith by incorporating exclusion terms.

 

Author


Ms. Prachi Shah

In-House Counsel,
GMS Dubai
Email: legal@gmsinc.net

 


[1] BEATSON J., BURROWS A., CARTWRIGHT J., ANSON’S LAW of CONTRACT 65, OXFORD UNIVERSITY PRESS 2010

[2] [2001] UKHL 52, [2002] 1 AC 481, at 17

[3] [1997] 1 Lloyd’s Rep. 404

[4] IMT Shipping and Chartering GmbH v. Changsung Shipping Company Limited: THE ZENOVIA [2009] EWHC 739 (Comm)

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