The collapse in the freight market is causing severe difficulties for many. We are increasingly seeing shipowners facing the risk of wrongful repudiation of charterparties, non-payment of freight and hire, and a potential liability for charterers bad debt. The shortage of liquidity in the banking market has meant that it has become increasingly difficult to raise finance for new projects, which is causing real problems in the shipbuilding sector. Shipyards, particularly those in China, who have been used to seeing their order books filled years in advance are suddenly finding that due to a lack of finance buyers are seeking to pull out of contracts wherever possible. It is expected that many of the newbuilds presently under order will not be completed, either due to default on the part of the shipyards, or buyers not having committed finance in place. The difficulty of obtaining refund guarantees in the current conditions will also put an added pressure on the newbuild sector. This article will seek to address a few of the credit crunch related issues currently affecting the shipping world.
Cancellation and Frustration of Charterparties
To a much greater extent in recent months parties have been considering whether their charterparties, sale contracts and contracts of affreightment are profitable, and if they are not, whether there is a way that they can be cancelled. As a result, we are increasingly seeing parties exercising their contractual option to cancel (via an express right to terminate). In order for a party to be able to cancel a charterparty there does not necessarily need to have been a breach of charter, although one finds in practice that a breach will normally have occurred. Examples of when a right to cancel may accrue under an express clause,would be: a charterers' failure to pay hire, prolonged periods of off-hire, or a lack of readiness for delivery within the lay days. Express rights to cancel hardly ever provide for cancellation purely on economic grounds. When considering whether a charterparty entitles you to cancel it is vital that you are clear as to the meaning of the clause. A wrongful cancellation may well amount to a repudiatory breach for which the other party may be able to terminate the contract - thus providing an easy escape for a party caught in an unprofitable charter. It is therefore important to consider any alternative options that might also be available to you - for example a lien on sub-freight for a late payment of hire claim.
In addition to parties seeking to exercise their right to cancel, we are also beginning to see parties considering whether or not they can argue that their charterparties are frustrated. The sheer extent of the financial crisis has raised the question of whether it could frustrate commercial contracts.
In order to understand this within the context of the doctrine of frustration it is useful to have in mind Bingham LJ's classic statement in The Super Servant Two  1 Lloyd's Rep 1. In this case he set out several fundamental propositions that summarise the essence of the doctrine of frustration. He said that frustration has evolved in order to "mitigate the rigour of the common law's insistence on literal performance of absolute promises" and its object is to "achieve a just and reasonable result". Frustration operates to kill the contract and discharge the parties from further liability under it, and as a result must be kept within "very narrow limits and ought not to be extended". "The essence of frustration is that it should not be due to the act or election of the party seeking to rely on it", but rather that it must be a result of some "outside event or extraneous change of situation".
The test for frustration is whether, if the literal words of the contractual promise were to be enforced in the changed circumstances, would performance involve a fundamental or radical change from the obligation originally undertaken? Essentially are the events alleged to frustrate the contract "fundamental enough to transmute the job the contractor had undertaken into a job of a different kind, which the contract did not contemplate, and to which it could not apply" (Asquith LJ in Sir Lindsay Parkinson & Co Ltd v Commissioners of Works  2 KB 632). A good illustration of this principle is the Suez Canal cases. In The Eugenia  2 QB 226, the Eugenia was time chartered for a trip from Genoa to India via the Black Sea. She loaded metal goods at Odessa and reached Port Said at the beginning of hostilities in the Suez War. Despite this the charterers ordered her to proceed via the canal, resulting in her becoming blocked in the canal from the end of October until early January. The charterers contended that the contract was frustrated, arguing that even if they had not ordered her into the canal, the contract would have been frustrated in mid-November when it became apparent that the Eugenia would not be able to proceed through the canal until March or April of the next year; the voyage via the Cape of Good Hope rendering performance fundamentally different from that which the parties contemplated. The Court held that there was no frustration - although longer and more expensive, performance of the voyage via the Cape of Good Hope was not something radically different from that which the parties contemplated when they entered into the charter. From delivery at Genoa, a voyage via the canal to the re-delivery range would take about 108 days, as compared with 138 days via the Cape. The cargo was not perishable nor required urgently, and the necessity to proceed via the Cape made no difference to the charterers other than in higher expenses. In contrast, events that have been considered frustration include: various war-time events - such as requisitioning, trade restrictions or trading with the enemy; cancellations of an expected event (eg, the ‘coronation cases'); and special cases such as the trapping of vessels in the Shatt-al-Arab waterway at the start of the Iran-Iraq war.
Therefore, while it is possible that the sudden downturn in the markets may be sufficient to constitute a frustrating event, it is unlikely that these economic issues alone will frustrate a contract. Case law tells us that an agreement will not be frustrated simply because performance of the contract would be commercially onerous or unprofitable. Rather "it must be more than merely more onerous or more expensive. It must be positively unjust to hold the parties bound" (Lord Denning in The Eugenia  2 QB 226). It is therefore unlikely that economic conditions alone will be enough to allow a contracting party to escape from burdensome obligations under a shipping contract.
When a party becomes insolvent there are several issues that need to be considered. The relevant ones in the current market are whether or not it is possible to place a vessel off-hire, and whether the entry into administration might be classified as a repudiatory event that means that the disponent owner is unable to perform its obligations under the charterparty, thus entitling the charterer to terminate.
The fact that a disponent owner has entered into administration does not in itself give a charterer the right to put the vessel off-hire. Under a standard off-hire clause the full working of the vessel and the ability of the disponent owners to comply with orders is unlikely to have been affected by the administration. The key factor is rather whether the administrators (on behalf of the disponent owners) can continue to effect performance of their contractual obligations without an off-hire event occurring. As a result normal principles as to off-hire would apply and would be considered in the usual way.
It might however be possible to argue that the fact that the disponent owner has gone into administration is a repudiatory event, meaning that they are unable to perform their obligations under the charterparty, thereby entitling the charterer to terminate. For an event to be repudiatory there needs to be clear evidence of an intention on the part of the disponent owner not to perform his obligation. It is likely therefore that the simple fact that the disponent owner has gone into administration will not be sufficient to entitle the charterer to terminate. Notably, even where the charterer is entitled to terminate, this will only give them a right to claim in the liquidation, along with all the other potential creditors. In this situation charterers need to consider whether economically it would be more favourable to try and maintain the charter, or whether they would rather terminate and attempt to recover in the liquidation.
Another significant issue is how the current market conditions - and in particular the reduction of available debt capital and a freeze on credit, will affect the ability of buyers to fund the purchase of newbuildings and shipyards to complete projects.
The global credit crunch has had investors and banks in this sector teetering on the edge of their seats. It has been estimated that the maritime sector will need in the region of US$350 billion over the next three or four years in order to be able to fund the construction of vessels that are already on order. The slowdown in trading is compounded by the inability or reluctance of banks to extend financing for orders. It is likely that we will increasingly see the construction of new vessels being postponed as buyers struggle to obtain finance. As credit tightens, we are going to see more and more cancellations by buyers, even at the risk of losing their deposits.
Clearly, the primary difficulty that the shipbuilding sector faces at the moment is a lack of finance. Many shipyards, even those with full order books, are struggling to obtain finance to support construction and provide the refund guarantee required by owners. The effect of a failure to provide a refund guarantee will depend on the wording of the contract - however, whether it is a condition precedent to the shipbuilding contract or not, the failure by the shipyard to provide a refund guarantee presents a serious risk for the buyer. Whether a buyer has a remedy for the shipyard's failure to provide a refund guarantee will largely depend on the wording of the shipbuilding contract - in some cases the contract will not be effective, while in others a right to terminate or a right to damages, or both, will accrue. A delay in providing a refund guarantee is also often an early indicator that a shipyard is experiencing financial difficulties.
Dramatic increases in prices of raw materials, and in particular steel, over recent years has often led to shipyards making demands for non-contractual payments prior to delivery to cover their rising costs. Despite the fact that buyers are not legally obliged to make extra financial contributions, if the shipbuilding contract has been concluded on a fixed-price basis and with no escalation clause, buyers are often still left with no choice but to agree to extra payments. In the previously rising market, given a choice between insisting on their contractual rights or making further payments to facilitate completion of the vessel, buyers would have been likely to elect for the latter. It was often more advantageous for buyers to agree to the additional demands, so that they could take delivery of the vessel and start trading as soon as possible. However, in the current market buyers will not be prepared to make such contributions - the current collapse in freight rates has made buyers reassess whether they wish to continue with projects. This means they are much more likely to be looking for a way out of the shipbuilding contract and, if possible, make a claim under the refund guarantee. Although even here there are traps for the unwary. In a recent Ince & Co case, Gearbulk Holdings Limited v Stocznia Gdynia SA  EWCA Civ 75, it was held at first instance that the buyers, by claiming under the refund guarantee, were precluded from claiming damages for breach of contract. Fortunately, the Court of Appeal restored common sense and held that there was no reason in principle why the buyers could not claim both, under the refund guarantee and for general damages, pursuant to common law.
As explained at the outset of this article, frustration has a restricted sphere of operation and it won't enable a party to escape his contractual obligations even where the market crash makes it considerably more expensive for him to perform.
The position in England may be contrasted with that in certain Continental countries - Italy being a good example. In Italy, there appears to be a doctrine that, where the cost of performing a contract moves up by more than a certain percentage then the party affected can request the other party to renegotiate the price and, if the other party refuses, the party affected may treat the contract as terminated, without further liability on his part.
It may be thought that the Italian doctrine has much to commend it and that it's quite simply ‘unfair' to hold parties to their contractual bargain where the markets are crashing all around them. English law, however, appears to operate on the opposite premise: namely, that the cardinal requirement is certainty and if the law provides this underlying certainty, then the parties will be able to regulate their affairs and predict their respective rights and obligations. ‘Certainty' or ‘fairness'? - which of these is preferable involves philosophical considerations beyond the scope of this article.