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Building blocks

With growing demand for new vessels in the Middle East, how can builders and buyers unite to ensure shipbuilding contracts are covering their interests?
ANALYSIS, Ports & Free Zones

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With growing demand for new vessels in the Middle East, how can builders and buyers unite to ensure shipbuilding contracts are covering their interests?

With contracts for new ships ranging from millions to billions of dollars, the shipbuilding trade is a very serious business indeed. This lucrative industry is further capitalising on the demand for ships driven by the growth of the sea freight sector in the Middle East region.

It is not surprising, therefore, that in order to protect such valuable assets, both shipbuilders and buyers rely heavily on having a comprehensive and detailed shipbuilding contract in place.

 

It has to be kept in mind that the need for a well drafted contract mainly arises when something does not proceed as presumed. - Alessandro Tricoli

Without this, both parties run the risk of jeopardising their investments when the building process does not go according to their best laid plans.

"A shipbuilding contract defines the basic terms and conditions involved in the construction of the vessel - from the contract signing to the delivery of the vessel and any other services thereafter," summarises Sharafuddin Sharaf, president of the UAE Ship Owners Association (UAESOA) and vice chairman of the Sharaf Group.

If a properly drafted contract is not in place, it can lead to confusion or ambiguity." UAESOA itself was established in 2006 to promote the interests of the growing community of ship owners in the region, providing a range of services, such as advice on local and international marine laws.

As Sharaf advises, for ship owners the contract defines the date, place and time of delivery for the vessel and various other stages of construction, such as keel laying, launching, testing of machinery, sea-trial and so on.

Furthermore, the contract specifies the terms of payments and can also include any additional special requirements as needed.

"The contract is required to define the conditions of acceptance for the vessel at various stages of construction, together with the method of review, approval of drawings and other important factors," he adds.

Sharaf positively believes that there is a very good awareness among the region's shipping fraternity regarding the need for a well-drafted and defined shipbuilding contract, and points to the many law firms in the region that are currently available to help.

One such law firm specialising in marine law in the region, Fichte & Co, has been active in advising on this very subject. The firm has dealt with the market for tankers, bulk carriers and container vessels, having helped many buyers in securing orders for new builds in these sectors.

During the last few years, we have drafted and negotiated different kinds of shipbuilding contracts, from relatively small, but still detailed, offshore vessels to more technical product carriers," expands Alessandro Tricoli, legal consultant at the firm.

Unsurprisingly, Fichte & Co has gained plenty of experience in the intricacies of creating such contracts.

"In a nutshell, the main concerns regard the description and thus the characteristics of the vessel, her price, and its adjustments and payment, default, and hence security, delays and of course warranty," explains Tricoli.

As he points out, the construction of a ship not only involves legal aspects, but also very technical details. In addition, payments are made at a very early stage and well in advance, thus calling for guarantees on both sides to be in place in order to secure the deal.

"Its mainly because of this mix of contents, both from a legal and from a technical point of view, that the shipbuilding contract needs to be carefully drafted using the skills of different parties," Tricoli highlights.

Indeed, as shipbuilding contracts often involve these numerous interests, their execution does not involve the buyer and the builder alone.

To build a ship is a time consuming exercise and it's usual practice to have charterparties signed even before the construction of the ship commences," says Tricoli. "Hence its vital that no delays occur in the long period required to build a ship to avoid dangerous repercussions on other contracts."

The obvious way to avoid such consequences is having a clear contract from the outset, which can foresee and resolve every possible scenario that may arise through its duration.
 

It has to be kept in mind that, apart from saving from sleepless nights, the need for a well drafted contract mainly arises when something does not proceed as presumed," Tricoli emphasises.

If everything is going well, nobody will look at the contract after signing it. On the other hand, lawyers will rush to the drawers where its kept as soon as something unpredicted happens, to look for the specific situation and check whether, and how, it should be regulated.

Willie Stewart, vice president of marketing at worldclass shipbuilder Abu Dhabi Ship Building (ADSB), agrees.

 

If a properly drafted shipbuilding contract is not in place, it can lead to confusion or ambiguity. - Sharafuddin Sharaf

Not having a contract in place could jeopardise the delivery date of the vessel, he adds, and it puts the shipbuilder at risk for claiming payments for work already completed and leaving the door open for the customer to reject claims for additional work, acceptable delays, etc.

It also leaves everything up to individuals own interpretations of rules and regulations, shipbuilding practice and terms and conditions to be applied," he says. "A contract assists in keeping the project on time, on price and to the correct quality."

ADSB has been specialising in the construction, repair and refit of naval, military and commercial vessels at its Abu Dhabi located shipyard since its inception in 1996.

The company has delivered tug boats, dredgers, coastal tankers and crew boats for the commercial boat market, in addition to landing craft, assault boats and fast supply vessels for the naval markets.

Just recently, ADSB also constructed and delivered a 40 metre aluminium crew boat for Abu Dhabi oil operating company ESNAAD under a shipbuilding contract.

When drawing up a ship building contract, the shipbuilder should ensure that he limits his risks as much as possible," shares Stewart. "Apart from contract terms and conditions, the shipbuilder should include a technical specification and general drawing for the vessel.

In order to avoid, and reconcile any difficulties between the buyer and the shipbuilder, Stewart believes its imperative from the outset for the builder to work closely with the customer from the tendering and bidding process to identify any areas of difference and solve these before contract signing.

It is also very important to involve the project manager designated for the particular project from day one, so that he gets to know the customer and the contract, technical specifications and other commercial documents," he advises.

In fact, having a transparent contract in place from the outset is important for shipbuilders and buyers alike in
order to avoid future disagreements.

"From the buyer's perspective, it's essential to ensure that their investment is well protected," says Leslie Reis, vice president, Transworld Group of Companies.

To achieve this, Reis maintains that the first step to the shipbuilding process needs to involve both parties (buyer and builder) in the deliberation and negotiation of the terms of the shipbuilding contract.

Transworld Group of Companies (TGC) itself has recently awarded a US$80 million shipbuilding contract to Guangzhou Wenchong Shipyard (GWS) in China for new builds - namely two container vessels.

As part of that process, Reis reiterates that a contract is mandatory to clearly define the roles and responsibilities of the builder and buyer, and the extent of liability of both parties involved.
 

Where conflicts between the two parties do arise, mechanisms for resolution also need to be included in the contract.

"The modalities for resolving disputes between buyer and builder is also detailed in the contract, and is usually through arbitration, by bodies such as the LMAA (London Maritime Arbitrators Association)," he adds.

Predictably, one of the most common causes for conflict between ship buyer and builder is timing for payments or delivery.

 

When drawing up a shipbuilding contract the ship builder should ensure that he limits his risks as much as possible. - Willie Stewart

Whilst, as Tricoli points out, there is no magic formula to ensure payment schedule and delivery times are adhered to, penalties can be put in place through the contract to ensure that these conditions are respected.

From a preventative view, he further advises buyers to deal only with the ‘serious' existing yards whilst yards themselves need to ensure their prospective buyers are providing guarantees for payment.

The bottom line is, to ensure a well-drafted and fair shipbuilding contract, attention has to be paid to all the conditions right from the beginning of the process.

When drafting a contract from scratch, one should always bear in mind that the protection of the clients' interests needs to be balanced with the end result of a fair contract," asserts Tricoli.

The final interest of both buyer and builder though is eventually the same. The former wants to buy a vessel and the latter wants to sell the vessel, so its a more or less usual ‘give and take' approach for most of its content.

However, as he points out, whilst this sounds fair in principle, in practice due to current market trends leaving many shipyards so busy that they can pick and choose their customers, some can adopt a ‘take it or leave it' mentality when it comes to shipbuilding contracts.

As Tricoli concludes, "ensuring that all interests are accounted for and well protected while negotiating with a yard, especially in today's builders market, is a challenge indeed.

 

Inside the shipbuilding contract

Vessel Description

The description of the vessel is very important and buyers must have a clear understanding about the kind of vessel they need. Although the description is technical, it's a vital clause that will heavily reflect on the rest of the contract, increasing its importance during the drafting stage. It requires different knowledge, both legal and technical.

Price and Terms

Yards are very keen to have a detailed clause with regard to the price and its terms. The clause, that in essence provides finance for the builder, is instead often wrongly perceived as a diminution in the risk of the buyer discarding the contract should the market conditions change or the buyer's own requirements vary.

Pre-delivery instalments amount and timing fluctuate depending on different factors like the contract price, the bargaining position of the parties, the buyer's financial strength etc.

Adjustments to Contract Price

In a typical shipbuilding contract many different mechanisms are in place to ensure that every difference between the contracted vessel and final result, notwithstanding how minimal, will be reflected in the final purchase price.

Such adjustments can be agreed between the parties at a later stage when extra work is asked for by the buyer or needed because of changes in rules and legislation, or can be pre-agreed in the contract.

Warranty Issues

Both buyers and shipyards are very concerned with the warranty. Because of the high cost of repairs, warranty problems can lead to litigation as well, and it is important to double check that the details on when the warranty is valid has been defined in the contract.

Alessandro Tricoli, legal consultant at Fichte & Co summarises some of the main conditions making up a shipbuilding contract.
 

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