The importance of the safety net of a Letter of Indemnity

In most business transactions there is always the potential for unexpected  irregularities to arise.  A Letter of Indemnity (LOI) in shipping is a legal document that exonerates carriers of any liability and claims that might result from changes to the contract, potential damage to the goods, additional costs, or other unfavourable effects.

Generally, a shipper (or charterer) out of expediency, issues a LOI when it wants a carrier (or shipowner) to operate outside its standard practices, thereby undertaking additional risks. In these situations, where a party is asked to go beyond the extent of its contractual obligations, a LOI serves as an unofficial form of insurance.

The parties usually involved in a LOI are: first, the party requesting or being offered the indemnity (generally the carrier) then the granter of the indemnity (generally the shipper or the person/business receiving the goods, namely the consignee) and finally a bank or other financial institutions. In fact, as the LOI is only as good as the parties signing it, a bank countersignature is strongly advisable.

A LOI provides valuable protection in a variety of shipping situations. The following are some of the most common scenarios:

1. The consignee asks the carrier to release the cargo without presenting the original bill of lading as it is not available at the discharge port.

Under normal circumstances, upon presentation of the Original Bill of Lading, carriers release the cargo to the owner.  Carriers will typically provide shippers with a bill of lading (BL) when transporting cargo by sea (a BL is proof of the contract of carriage and document of title, in which the carrier assumes liability at the time the goods are handed over). However, because shipping has become fast, cargo ships frequently reach their port of discharge before the documentation is delivered by courier. In these situations, through issuing a letter of indemnity the goods are released to the consignee indicated by the shipper at the destination without sight of the BL. In this way even if the shipment is later shown to be significantly different from what was stated on the initial BL or the consignee might not have title to the goods, the LOI will absolve the carrier from any liability or financial penalties (in fact, in the case of such mis-delivery the party who has legal title to the goods can file a claim against the carrier for the full amount of the mis-delivered cargo, even going as far as having the ship arrested).

Moreover, issuing a LOI is convenient, as the consignee will secure the goods without any delay arising from waiting for the late BL to arrive, saving costs.

2. Lost BL

It may happen that the BL get lost. In this scenario, the consignee will be unable to collect the goods at the destination port. Therefore, the shipper, to avoid delays, has the option to provide a LOI, which indemnifies the carrier from any liability should the cargo be released without the original Bill of Lading. In addition, the shipper would have to explain why the original BL was lost and consent to paying any costs that could arise. In this case the crucial function of the LOI is to relieve the carrier from any liability if the missing Bill of Lading is found and surrendered for release.

3. Cargo sold during transit as part of a high sea sale.

In some circumstances happens that, during transit, cargo is traded multiple times (this is especially true of the oil trade). This case frequently results in complex situations where a LOI is issued by the shipper to cover all parties involved in the chain of selling until cargo is released at the port of destination. In fact, without a LOI, the carrier can be held accountable for the transactions that lack documentary evidence as well as establishing who owns the cargo when it reaches the port of discharge.

4. Cargo is delivered to a discharge port other than the one specified on the original BL (i.e. a geographical deviation)

• the goods have been shipped on board, the port of origin, port of discharge and the final destination have already been decided upon. However, a change of destination may happen. It is possible the cargo to be delivered to a port other than the one listed on the BL due to unforeseen circumstances such as political turmoil or a human error. In such cases, the carrier may ask the shipper or the consignee to provide a LOI clearly stating the request and committing to pay for additional freight charges.

Moreover, the shipper must surrender the original BL that was issued. Once the LOI has been acknowledged by the carrier, it can convey the cargo to the new destination without incurring any more liabilities.

5.Shipments with split BL

A LOI may be issued in the case that the cargo owner requests a split BL. Some carriers might just issue a split BL and charge a fee for it, but other carriers might insist on a LOI, particularly after the cargo has been loaded and the vessel has already sailed.

6.Having extra crew on vessel 

Generally, a designated crew is assigned to operate and maintain ocean vessels. However, in case additional crew members are on board, carriers might request a LOI to protect themselves from any potential incidents involving the extra crew members.

7.When a clean bill of lading is issued.

In this case, the shipper consents to protect the carrier from any potential repercussions that may arise when issuing a clean bill of lading.

An LOI should address these three key aspects:

• the type of indemnity.

The LOI should specify the scope of the carrier's indemnity. Carriers typically seek complete liability exemption.

• Arbitration. A LOI should specify the country in which an arbitration would be heard if legal action is taken. Typically, this is the country where the port of loading is located and where the LOI is issued and signed.
• The signature of the parties involved. The signatories are often the carrier, the shipper who is indemnifying liability, and in some cases, a consignee. Moreover, the signatories should use their business titles to clearly indicate that they are signing on behalf of their company, not themselves, as the LOI refers to business affairs. A notary public should ideally witness the signatures, but this is not a mandatory requirement.

Khizar Arif, a partner commented “as carriers bear most of the risk during transportation, it is critical that they make sure that the wording of the letter is as specific as possible, and all these above-mentioned aspects are covered. On the other hand, the shipper or sometimes the consignee must make sure they are at ease with waiving the right to sue the carrier for any damages.!” Khizar also commented “furthermore, the terms of the LOI should clearly detail the date when the indemnity expires. In many LOIs the indemnity typically expires after 13 months because based on the terms of the Hague Visby Rules' a cargo claims must be submitted within 12 months of the loss or damage being reported. However, mis-delivery claims might arise also many years after the goods were delivered and therefore the mentioned one-year time limit may not apply.”

The potential risks of a LOI in shipping

Although a LOI is operationally valuable, there may also be some risks associated it. The first risk refers to the coverage a LOI actually offers and the second risk is its legal enforceability. 

• Coverage – Every time a carrier accepts a LOI, it is required to make sure that the subject granting the indemnity (i.e. the shipper) explicitly establishes the request and releases the carrier from all the obligations. Additionally, the carrier must make every effort to ensure that the shipper will be reliable and therefore able to pay in the event of any additional charges or claims. In fact, given the long-term nature of claims, it can happen that the LOI issuer lacks the financial means to ’make good’ on the LOI or has since fallen insolvent.
• Enforceability – Normally, a LOI is legally enforceable as long as the actions it offers indemnity against are legal. Yet, if the carrier acts in bad faith or if the LOI predates the bill of lading, it will not be enforceable. In the well-known case of Brown Jenkinson v Percy Dalton the court affirmed this principle holding that a LOI issued in respect of an illegal act is unenforceable at law.

A LOI would not be enforced, for instance, if the carrier willfully misrepresented the description, weight, quantity of goods. A shipper might ask for a LOI to issue clean bills of lading for damaged cargo. In this case the carrier may commit misrepresentation or even fraud if it accepts the LOI knowing that the items were damaged.

THE USE OF LOIs AND THEIR POTENTIALLY PREJUDICIAL IMPACT ON MEMBERS’ P&I COVER

Regardless of whether the member has obtained a LOI or bank guarantee, P&I insurance club cover is likely to be invalidated and no longer automatically accessible when cargo is delivered without presentation of a negotiable document of title, such as the BL. The truth behind the widespread use of LOIs is that they are essentially employed as a plug to close the gap in P&I coverage that is created when an owner or operator chooses (or feels commercially obligated to do so) to deliver cargo without presenting original BLs

The LOI agreements’ clauses should provide the maximum amount of security and indemnity. Carriers should be cautious when accepting LOIs that give a level of indemnity that is just equal to the cargo's value. This is due to the fact that any claim filed against the carrier may involve much more than just the value of the items themselves. Examples of claims include the price of obtaining new items quickly or damages incurred by the company as a result of the original shipment's non-delivery.

In conclusion, international shipping is a fast-moving process in constant evolution. Therefore, it is crucial for carriers in particular to be able to respond swiftly and accept adjustments that might otherwise cause the shipping process to stall, without having to assume extra risk. This is made possible by the LOI.  The language used is crucial since, in the end, a LOI is a contract. For this reason, it is always advised that the letter be drafted and countersigned by a bank, insurance, or other expert with knowledge in these areas. Additionally, as carriers will frequently be convinced to accept a LOI because of commercial pressures (i.e. the consignee requires the items immediately, or the transportation firm needs the cargo unloaded as soon as possible) to make sure their risk is sufficiently covered, it is crucial that any company thinking about accepting the terms of a LOI should make sure the agreement's and indemnity's scope are sufficiently broad, the grantor of the indemnity is sufficiently reliable and will be able to indemnify as per the terms of the indemnity and the indemnity extends long enough to eventually cover any claim that may arise at a distance of time.

Khizar Arif  is a partner He advises on all aspects of dispute resolution and litigation, from pre-action stage to final settlement.

He has a distinguished reputation for resolving complex cross-border commercial matters.  Khizar always attempts to conclude a dispute by alternative dispute resolution, without resorting to litigation, where possible.  However, he is a robust tenacious litigator when required.  

He leads the shipping and maritime department and has extensive knowledge of this sector. Khizar advises on a wide range of maritime disputes as well as commercial contracts, bills of lading, waybills and charterparties

If you would like to know more about letters of indemnity and the issues that surround them please contact Khizar's clerk Sam Groom on SG@giambronelaw.com or please click here