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Dealing in the exclusive

Market Insight
28 March 2011

This article first appeared in the March 2011 issue of Port Strategy and is reproduced with their kind permission.

Terminal users generally wish to retain as much flexibility to source their terminal requirements elsewhere as is consistent with achieving acceptable rates from terminal operators; terminal users will therefore generally be unwilling to offer exclusivity.

Terminal operators, on the other hand, need to protect their investments in terminal facilities and, if they do not require exclusivity, may often require terminal users to make a minimum volume commitment. This is often a major subject for negotiation.

In terms of the level of commitment given by terminal users, this may vary from true exclusivity – committing all volumes at a particular port or within a particular region – to offering either a fixed volume commitment or one which is proportionate to the user’s total throughput at a particular port or within a particular region. In any event, the terminal user will be keen to learn what financial or other benefits they will gain in return for agreeing to either requirement.

In order to assist a terminal user to meet a minimum throughput commitment, certain cargo or throughput on its ships may be counted as part of the minimum throughput commitment, particularly cargo of other shipping lines carried under vessel sharing agreements, consortia, alliances and slot swap or charter which may be included under the terms and conditions of the terminal service agreement.

Where a shipping line has contracted on liner terms with the other shipping lines, the costs of loading and discharging would be included in the charges paid to the vessel operator by the other shipping lines and thereby the vessel operating shipping line would pay the terminal operator in respect of such cargo.

However, if a shipping line had contracted on free-in free-out terms with the other shipping lines, the costs of loading and discharging would be invoiced separately by the terminal operator to the non-vessel operating shipping line and paid directly under an individual terminal service agreement between such parties whereby the non-vessel operating shipping line would not enjoy the rates applicable to the vessel operating shipping line.

The circumstances where a terminal operator would be likely to offer its facilities exclusively to a terminal user may be limited. Unless a terminal user is able to guarantee a certain level of throughput and/or revenue to provide assurances in terms of utilisation and profitability then any such exclusivity arrangement is unlikely to arise.

Where, however, a terminal operator serves only one user at a particular terminal then such an arrangement may go beyond a simple terminal service agreement and result in some form of formal co-operation between the parties. This co-operation may either be at an operational level or even at a corporate level.

The terminal operator may consider allowing the user some involvement in the management or operation of the terminal. Depending on the degree of co-operation the user may consider investing in terminal handling equipment or even in the terminal operating company itself. All of these options carry their own risks and rewards and should be properly documented between the parties to ensure a clear understanding of their respective rights and obligations.

It is notable that some shipping line affiliated terminal operating companies have now gone almost complete circle in taking steps to distance themselves from their terminal user counterparts to demonstrate complete independence and develop third party traffic.

The terminal operator may require the user to agree exclusivity or guarantee a minimum level of throughput throughout the term of the terminal service agreement in order to benefit from certain preferential rates, terms and conditions or agreed levels of productivity and other key performance indicators.

In some circumstances, rates offered by terminal operators may be tiered to encourage additional throughput with either marginal or all units handled above a certain threshold charged at lower rates.

Where parties do agree to an exclusive relationship, this will often be based on a desire to build a longer term partnership which will lead to a deeper and clearer understanding of each others’ businesses. The parties will have greater opportunities to work together to identify efficiency improvements and cost savings arising from their heightened understanding of each others’ operations.

Inevitably it is much simpler and easier dealing with a single terminal operator in any given port than managing multiple service providers, avoiding issues with inter-terminal transfers and the benefit of a single terminal for collections and deliveries by hauliers, rail freight and barge/feeder operators. This is always an issue for terminal users to consider when entering into vessel sharing, consortia, slot swapping or chartering and feedering arrangements.

One of the main disadvantages of any exclusivity arrangement for the user is the hindrance on its commercial freedom and ability to call at other terminals. In those circumstances where a terminal user has agreed to exclusivity it may find that there will be instances where this precludes its involvement with certain business where shippers and/or consignees insist on the use of another terminal.

There will also be the risk that the terminal used by the user’s customers is currently either the sole or preferred terminal but that it may subsequently lose that status where end users and/or freight forwarders change their preference or a new terminal facility is developed nearby.

The longer the duration of any commitment given with respect to exclusivity, the greater the potential risks for users as unforeseen events may turn into reality and exclusivity becomes a thorn in the side. Inevitably the duration of any exclusivity commitment will correlate to the term of the agreement, although not necessarily coincide exactly with it.

A single terminal operator may also represent a greater risk for users when operations do not go according to plan. A user may be particularly exposed when it has agreed an exclusivity or volume commitment with a terminal operator and either congestion, berthing delays and/or poor performance levels occur at the terminal. This reinforces the need for the inclusion of a well drafted service level agreement with a service credit/debit mechanism and also the consideration of various other exclusions from the exclusivity commitment as outlined below.

The parties may agree that in the event of a failure to meet the agreed minimum level of throughput that the user pays liquidated damages to the terminal operator whereby the throughput guarantee effectively becomes a revenue guarantee.

The terminal operator may also seek to be relieved of its obligations under any performance or productivity undertakings in the event that the user fails to meet its minimum throughput, citing such a failure on the part of the user as the cause or a contributory factor in its failure to meet such performance or productivity undertakings.

The terminal user will wish to make it clear that in the case of an event of force majeure, that any exclusivity or volume commitment given would be suspended or at least calculated pro-rata in accordance with the number of days which the terminal was fully operational during the relevant period.

The terminal user should also seek to be relieved of its obligations for additional volumes where it grants the terminal operator a right of first refusal to accommodate the user’s requirements for additional berthing windows and the terminal operator has been unable to accommodate these. The terminal operator should resist these exclusions where berthing window clashes arise with other services operated by the same user.

Check the competition smallprint

Many agreements between terminal operators and users may contain exclusivity provisions but these do not, themselves have as their object the restriction of competition; they must be examined in their legal, factual and economic context in order to determine whether they have such an effect.

On balance, a wide range of factors must be taken into account in deciding whether an exclusivity arrangement falls within Article 101(1) of the Treaty on the Functioning of the European Union (“TFEU”). These include the novelty or technical complexity of the service to which the agreement relates, the level of investment and commitment the operator is expected to undertake (in a user exclusivity context), and the strength of the undertakings on the market for the service involved.

The EU vertical agreements block exemption will apply to agreement containing these kinds of clauses provided the terminal operator’s and the terminal user’s respective market shares do not exceed 30% and that they are not combined with any “hardcore” restrictions prescribed by Article 4 of the block exemption.

It is therefore only where the agreement as a whole does not benefit from the block exemption that the question of the application of Article 101(1) of the TFEU to such clauses is an important issue; there is no presumption of illegality in such cases.

This is a complex area of the law and specialist legal advice is recommended.

John Court
Global Director of Information Technology