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Watertight contracting

Market Insight
22 March 2011

This article first appeared in the March 2011 issue of Containerisation International. It was written with the assistance of Containerisation International and is reproduced with their kind permission.

The ease with which many ocean freight agreements were torn up by shippers in 2009, and then by ocean carriers in 2010, suggests that the old adage of ‘my word is my bond’ no longer holds as much water as before.

Matthew Gore examines how contracting can be made more secure.

A large number of headlines over recent months have focused on uncertain contractual relationships between shippers and ocean carriers. It has been particularly intense following the case of Argos and Maersk Line, which was settled out of court.

This highlights the need for ‘gentlemen’s agreements’ and contracts between shippers and carriers to be tightened up so that both sides understand and honour their commitments.

The loose nature of many contractual arrangements between shippers and ocean carriers has often resulted in agreements being too open to interpretation and difficult to enforce. The wording of many contracts is ambiguous and often based around rate sheets, standard terms or limited bespoke contractual wording. Nevertheless, in most cases shippers and carriers tend to work out any differences between them on an amicable basis. However, this is not always the case.

Shippers and ocean carriers, therefore, need to communicate more to better understand their respective positions, as improved contracting alone will not solve existing problems.

In many cases it is not easy to even identify whether a contract exists. There will be instances where parties have agreed rates and may simply be contracting on either standard terms, a limited bespoke agreement or one which is not wholly fit for purpose.

Attempting to identify the precise terms of a contract may not simply be an exercise of opening the drawer and dusting off one single document. There may have been a number of exchanges between the parties with one party believing that it has contracted on certain terms and the other party genuinely believing that the agreed terms are completely different.

The loose contractual arrangements entered into between many shippers and ocean carriers have led to calls for greater clarity and certainty in the form of tighter contracts.

The position in the domestic contract logistics market, for instance, is usually significantly different.

Here, the parties often have comprehensive and clear written agreements containing all of the agreed provisions, including change control mechanisms to deal with changes in circumstances, thereby providing the agreements with the necessary degree of flexibility.

There may be lessons to be learnt here for the liner shipping sector. The industry would also truly benefit from a widely recognised industry-standard document, which had the backing of shippers and carriers alike and could be tailored to parties’ needs in much the same way as BIMCO documents are throughout the shipping industry.

Contracts should be prepared as the basis of a framework between the parties with provisions outlining how the parties will work together on a day-to-day basis including communication and sharing of information.

Any individual bookings made between the parties would each be construed as a separate contract, albeit one entered into upon the terms and conditions of the overarching framework agreement. Framework agreements often provide a very convenient means for parties to effectively outline their contractual relations where it is near impossible to effectively legislate for every particular eventuality or specific transaction.

The framework agreement should contain the main commercial terms, such as duration, termination, payment terms, service levels, liability, exclusivity and other commitments on rates and volumes along with other legal ‘boilerplate’ provisions. The parties should enter into transactions within the scope of the framework agreement following standard booking procedures and upon agreed rates.

The terms of an agreement may be varied by a subsequent agreement, whether oral or written. Written contracts should incorporate clauses which expressly deal with amendment and variation to the agreement.

The main characteristics of any such wording is that for the variation to be effective and binding it should be one which has been mutually agreed by both parties, contained in writing and signed by, or on behalf of, both parties by a duly authorised representative of each party. While this may appear to be formal, it is likely to be the most effective means of avoiding future disputes over the varied terms of the agreement.

A mere unilateral notification by one party to the other, in the absence of any agreement, cannot constitute a variation of contract. However, there may be circumstances where parties may unilaterally vary obligations under contract although such power will not be unlimited. The UK courts may imply into the contract a term, the effect of which is to curtail that power.

It is inevitably very difficult for shippers to provide detailed and accurate long-term predictions of when containers will be shipped and in what quantity. Therefore, inevitably there is a resistance for shippers to commit themselves strictly in terms of volumes and a timetable for their shipment.

Shippers face inherent difficulties forecasting quantities and timings of shipments because of fluctuating markets conditions.

Communication between shippers and carriers is key in order to ensure that commitments given by either party, particularly in relation to volumes to be shipped, work effectively. Many shippers are unable to give forecasts months in advance with the level of detail desired by carriers.

Understandably, carriers cannot be expected to guarantee space commitments to shippers where shippers fail to make any reciprocal commitment in terms of the volumes to be shipped or offer any compensation to carriers for the failure to provide the volumes which have been projected.

Inevitably, for ocean carriers to effectively plan their capacity for the short or medium term, it is necessary for them to have reliable and preferably detailed forecasts from shippers.

Therefore it is in shippers’ interests to provide the most detailed and accurate forecasts they are able to provide in order to ensure that carriers can attempt to balance the supply and demand of capacity in order to meet their requirements.

Some carriers have been trialling ‘no-show’ fees. These are aimed at shippers making bookings in order to guarantee space availability and then failing to deliver containers to the terminal.

The ideal solution from a carrier’s perspective is that parties would agree a minimum space commitment on the basis that the shipper would pay for the space on a used/unused basis to mitigate any losses otherwise incurred by the carrier. The ocean carrier would then be relieved of the risk of shippers failing to provide sufficient cargo to fulfil the minimum space commitment given by the carrier.

Where carriers either over-book sailings based on the anticipation that there will be ‘no-shows’ or where operational issues cause difficulties with the stowage or intake of a vessel, carriers will often have to ‘rollover’ containers or bookings.

The pre-advice of roll-overs by carriers to shippers can help alleviate any issues with the interruption caused to the supply chain by allows supply chain managers to look at contingency measures. It also potentially allows them to make bookings with other carriers and where necessary effects equipment interchange arrangements between the first carrier and the actual carrier used.

If shippers are to be expected to compensate carriers for breaches of contract in failing to deliver volumes which they have committed to ship, they should reasonably expect compensation when carriers fail to meet agreed service levels. These could include availability of equipment when required, shipping containers on vessels as booked and meeting pre-agreed transit times.

Inevitably, careful consideration and attention needs to be paid in drafting such provisions. Discussions will arise to carefully defi ne the circumstances, tolerances and thresholds of such provisions as low hurdles with multiple caveats will have little value for shippers as recourse for service failures.

In order to give parties the greatest degree of certainty over freight rates for the duration of the agreement, the most straightforward method is to agree fixed rates for the entire duration of the agreement.

However, fixed rates rarely offer either party the best value throughout the duration of the agreement. There are other adjustment mechanisms which could be applied though, either during the term of the agreement and/or at the end of the agreement.

Agreements may often be renewed on substantially the same terms and conditions, albeit with a revision in the applicable rates for the subsequent renewal period of the agreement. There are mechanisms which can be used to provide for predetermined adjustments in rates, with many of these are based around index related fl uctuations such as the Shanghai Containerised Freight Index (SCFI), or certain elements of the SCFI for the corresponding tradelanes or which look at other forms of published and independent indices for effecting rate adjustments.

However, any such adjustment will always be in arrears of actual market movements and is either applied in full or by means of a multiplier or fraction, which is applied to the index before the rates are adjusted accordingly.

Nevertheless, this introduces an element of transparency and fairness along with certainty as to the adjustment of rates on a regular basis. The use of such indices is arguably much fairer than either party attempting to assert a particular level of ‘market rates’ which inevitably leads to debate over like-for-like comparisons.

Carriers impose ad-hoc surcharges as a means to recover increases in costs incurred as a result of the provision of the services. Surcharges may be either fixed for the duration of the agreement or may fluctuate depending on the type of surcharge and the rationale for their application.

It is often prudent to provide for predefined trigger points in agreements so that surcharges will only apply in pre-agreed circumstances and to outline both the nature of these circumstances and also the magnitude of the consequential surcharge to be applied.

Carriers now tend to provide greater transparency to shippers to justify surcharge increases and whilst indexing may also be a way forwards, this could potentially over-complicate matters with a multitude of indices to be applied to different surcharges and freight rates at different points in time.

An alternative solution which shippers many adopt is to negotiate all-in rates with carriers and as such the surcharge elements would be subject to any adjustment mechanism adopted for the freight rates as outlined above.

In summary, shippers and carriers should ensure they have clear, comprehensive written agreements in place covering all of the key essential commercial and legal terms in a single document. It is key to follow the provisions of the written agreement in relation to variation, including the process and form of variation.

Include provisions covering communication in relation to space commitments, particularly forecasts, bookings and rollings and seek win-win solutions or accept the risks of failing to make mutual commitments and look at contingency measures.

Ensure that written agreements fully cover contractual agreements relating to freight rates and consider index-based adjustment mechanisms for longer duration agreements which are fair and balanced for both parties. Ensure parties’ agreed positions on surcharges are reflected, the circumstances in which they will apply and any limits on their magnitude and duration.

Finally, consider the longer term savings of engaging a law firm with relevant industry experience to assist with the process of preparing robust legal agreements against the commercial and legal costs of lengthy disputes arising from poorly constructed contracts and the benefit of protecting both parties’ bottom lines against unanticipated increases or decreases in rates.

John Court
Global Director of Information Technology