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A smart approach to intercepting sub-freights

Richard Hickey, Senior Associate, Campbell Johnston Clark

The recent MV Smart judgment is an excellent example of the English High Court taking a pragmatic approach to an issue that has real-life implications for many shipowners; i.e., what limitations, if any, should be placed on their rights to intercept freight due under sub-charters and bills of lading in circumstances where it would ordinarily be paid to charterers.  CJC Senior Associate, Richard Hickey, provides the details.

Summary

In deciding that shipowners have a wide discretion to revoke charterers’ authority to collect the freight, and instead order that it be paid directly to owners, the Court rejected an approach suggested by the charterers that would potentially have led to uncertainty in the market about the circumstances in which an owner is entitled to intervene.

The judgment adopts a clear and easy to follow approach to the issue that will be welcomed by many in the market as reducing uncertainty in relation to this area of the law.

Facts

Briefly, the background to the dispute was the grounding of the MV Smart (“Vessel“) during her departure from the port of Richards Bay in South Africa in 2013. The grounding gave rise to numerous disputes. However, this judgment was concerned only with the question of whether Alpha Marine Corp (“Owners“) were entitled to revoke the authority of Minmetals Logistics Zhejiang Co. Ltd. (“Charterers“) to receive freight due from General Nice Resources (Hong Kong) Ltd (“Subcharterers“) under the relevant voyage charter, and demand payment directly from cargo interests under the bill of lading.

In the weeks after the incident, Owners sought to secure their claims relating to the grounding by revoking Charterers’ authority to receive the freight, and issued invoices directly to cargo interests. Subcharterers were faced with competing demands from Owners and Charterers respectively, and ultimately a tripartite agreement was put in place whereby Subcharterers agreed to pay the freight into escrow. However, in 2016, Subcharterers were wound up in Hong Kong as a result of financial difficulties, by which stage they had only paid USD 550,000 into escrow, in circumstances where the total amount of freight outstanding was approximately USD 1.86 million.

In the arbitration between Owners and Charterers under the head charter (“Charter”), Owners argued that the port was unsafe, claiming more than USD 100 million in damages. Charterers, on the other hand, alleged that the grounding was caused by negligent navigation on the part of the Master. They put forward a number of counterclaims, including a claim valued at approximately USD 1.86 million in relation to freight. In this respect, they argued that Owners had acted wrongfully when they revoked Charterers’ authority to receive the freight and demanded payment directly from Subcharterers and cargo interests. They argued that, had Owners not intervened, the freight would have been collected in full, whereas on the facts only a small proportion had been paid into escrow by the time that Subcharterers went insolvent.

Charterers were largely successful in the arbitration, the Tribunal finding that it was the Master’s negligence that had caused the grounding, although there were some shortcomings in the running of the port. This decision was not appealed.

The Tribunal also found in favour of charterers in relation to the issue of freight, finding that it was wrong of Owners to intervene in the way that they had, and that charterers were therefore entitled to damages in the amount of approximately USD 1.86 million, minus the amount held in escrow. It was this decision that was the subject of the appeal to the High Court by Owners.

Charterers’ arguments

The Tribunal had decided that Owners were not entitled to intervene in relation to the freight because the charterparty clause in question, Clause 18 of the NYPE form, only gave owners a lien on sub-freights in relation to any amounts due under the Charter. The Tribunal’s decision was based on their findings that the Charter contained an implied obligation that Owners would not revoke Charterers’ right to collect the freight unless hire or other sums were due under the Charter, and that no such amounts were due.

Charterers submitted on appeal that the Tribunal’s decision was correct, and put forward three different possible ways in which the implied term could be formulated, which are discussed further below.

Owners’ arguments

Owners put forward a number of arguments as to why the Tribunal had erred, but focused in particular on their argument that, not only was the implication of a term unnecessary, but it was also very difficult to formulate that term, both of which are factors recognised under English law as going against the implication of a term.

Law

The judge started by recapping the general rule that a shipowner has the right to demand bill of lading freight from the holder of a bill of lading, and to revoke charterers’ authority in this respect. However, if a shipowner intervenes in this way, he will generally have to account to charterers for any excess over and above that which is due under the Charter.

Moving onto the suggested implied term, the judge noted that the issue in dispute resulted from obiter (non-binding) comments made in a previous High Court case, The Bulk Chile [2013]. In that case, it was suggested that there might be a restriction on owners’ rights to redirect freight if no hire or other amounts were due under the Charter in question. Although the point did not have to be decided in that case, the judge’s comments were adopted in one of the leading practitioner texts, Time Charters, and formed the basis of the Tribunal’s award in The MV Smart.

Turning to the test under English law for the implication of a turning to a contract, the judge recapped the main requirements, which are as follows:

  1. The term must be obvious and/or commercially necessary in order to make the contract work properly; and
  2. The term must be clear and capable of being easily expressed.

Judicial analysis

From the outset, the major problem Charterers faced was that it was difficult for them to succinctly express the alleged implied term. They put forward no less than three alternative formulations, which were dismissed in turn by the Court for the following reasons:

  1. The “All Freight Implied Term”: this proposed implied term would have meant that Owners were not entitled to intervene to collect freight unless a sum was outstanding under the Charter. The term was dismissed by the judge partly because of the difficulties in assessing and quantifying what sums would qualify, and partly because it would reduce the value of an owner’s lien on freight, in that it would stop them intervening if they knew that the next instalment of hire would be missed, but no sum was yet outstanding under the Charter.
  2. The “All Freight (Sum Identified) Implied Term”: this proposed alternative suggested restricting Owners’ rights to redirect freight unless a sum was due under the Charter at the time, and that sum was identified at the time of any revocation of Charterers’ authority. This alternative was dismissed for similar reasons to those set out above, alongside the fact that it would have introduced further complications, in particular in identifying when, how, and to whom notice would have to be given in order to trigger the right of intervention.
  3. The “Dollar for Dollar Implied Term”: this alternative version of the implied term would have held that Owners were only entitled to collect sub-freight in respect of an amount up to, but no more than the amount due under the Charter. However, the judge found that this was irreconcilable with the long established rule that a shipowner was under a duty to account to a charter for any excess amounts received following the exercise of a lien on freight.

Having expressed the above criticisms of the scope of the alleged implied term, the judge also determined that it was not obvious that it was necessary to imply a term in order to make the contract work. Most charterparties on the NYPE form function perfectly well without such a term.

Judgment

Given the above, the judge allowed Owners’ appeal, and held that the Charter did not contain an implied obligation that Owners would not revoke Charterers’ authority to collect the freight from Subcharterers unless hire and/or other sums were due under the Charter. The arbitration award was remitted to the Tribunal for reconsideration.

Comment

It is unusual to see a successful appeal on a point of law such as this, especially given the eminence of the arbitration tribunal, which consisted of Simon Gault, Sir David Steel, and Lionel Persey QC. It remains to be seen whether the judgment will be appealed.

Charterers’ approach ran the risk of leaving other shipowners uncertain as to the circumstances in which they might be held liable in damages for exercising their legitimate right to lien sub-freights.

Owners’ successful argument, on the other hand, results in a rule that is easy for the market to follow i.e. shipowners contracting on the NYPE form generally remain entitled to call upon cargo interests under bills of lading to pay the freight to them directly and/or exercise their rights of lien on sub-hires and sub-freights, so long as they account for any excess amounts collected in.

Given the above, assuming that it is not appealed, the judgment is to be welcomed as providing clarification of an issue that had given rise to some uncertainty amongst practitioners.

Source: Campbell Johnston Clark