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Covid-19: force majeure and termination rights under shipbuilding contracts

Covid-19 force majeure and termination rights | BDM Blog | BDM Law

Since the outbreak of the Covid-19 pandemic, many shipyards have faced significant restrictions in workforce or have even been forced to suspend operations. While many yards in China and Korea are now starting to reopen, this has undoubtedly caused delay and disruption to ongoing projects and we have seen a sharp rise in the number of enquiries and potential disputes resulting from this.

These problems are compounded by the recent crash in the oil price and negative global economic outlook, which affect not only the asset value of the newbuild vessels, but also the future demand for them.

In this article, we consider some key legal issues relating to force majeure and termination rights under a shipbuilding contract arising from the Covid-19 pandemic.

Force majeure

The most commonly used standard form shipbuilding contracts, such as the SAJ Form and BIMCO’s Newbuildcon, provide that force majeure is treated as a “permissible delay”, which entitles the shipyard to an extension of time to the delivery date. Following the spread of Covid-19, many shipyards have given force majeure notices in respect of delays caused by the pandemic (see our earlier blog article on key questions and issues relating to force majeure and Covid-19).

Since a party to a contract can only rely on force majeure to the extent that it is specified under the contract, it is critically important for both shipyards and buyers to consider carefully the wording of their force majeure clauses, as well as any provisions dealing with cancellation/rescission of the shipbuilding contract. We deal with some common questions and issues below.

Has a force majeure occurred?

The first step is to prove that a force majeure event has occurred. In the SAJ and Newbuildcon forms (amongst others), the force majeure provisions expressly include “epidemics”, in addition to quarantines, government action and other similar causes beyond the builder’s control. There is little doubt that these express provisions will come into play in projects affected by Covid-19.

Was the delay caused by the force majeure event?

Proving that a force majeure event has been triggered under the contract is only the first step. Most force majeure clauses will also require a party to show that the particular event has had a tangible impact on the critical path of the construction schedule. This is a common area of dispute (and one that usually involves detailed expert evidence), not least in situations where the shipyard was already failing to keep to the construction schedule, which presents competing reasons for the delay.

Mitigation

Shipbuilding contracts commonly require a party relying on the force majeure provisions to use reasonable efforts to mitigate or avoid the effects of the force majeure event (see Article 34(a)(iii)(4) Newbuildcon). This is a provision that shipyards should be particularly mindful of, since they do have a certain degree of control over how they can respond to Covid-19 in terms of the allocation of workforce and supply of materials.

Notices

Shipbuilding contracts typically contain strict notice requirements relating to force majeure events (e.g. Article VIII.2 SAJ or 34(a) Newbuildcon). These notice provisions are enforced by the courts (see Adyard Abu Dhabi v SD Marine Services), so long as they can be read as being a pre-requisite to the delay being treated as a permissible delay. Notice provisions are usually short, such as 10 days in the SAJ and Newbuildcon forms, which is likely to present some challenges to yards and buyers facing severe disruption due to Covid-19.

Buyer’s right to terminate

While legitimate force majeure events entitle the shipyard to extend the delivery date, this only goes so far. It is common in shipbuilding contracts for there be a “drop dead” date (such as 180 or 270 days beyond the contractual delivery date) beyond which a buyer may terminate the contract and demand return of the sums it has paid. With the fall in the markets and poor economic forecast, it is to be expected that many buyers will look to take advantage of these types of provisions to exit their contracts.

Termination of a shipbuilding contract can be fraught with difficulties. If a buyer is found to have wrongfully terminated, the consequences could be disastrous including losing the right to claim pre-delivery instalments and the protection of any refund guarantees. Before taking any steps to terminate a shipbuilding contract, it is essential that a buyer seeks legal advice and calculates delays carefully, taking into account any extensions granted by modifications to the contract, buyer’s default (such as late payment), in addition to permissible delays.

We set out some practical tips below:

  • Check the force majeure wording in the shipbuilding contract – do not assume that it adequately covers circumstances arising from Covid-19
  • Be aware of any notice provisions in force majeure clauses and preserve supporting evidence
  • Consider what steps you can reasonably take to minimise or avoid the delays caused by the force majeure event
  • Buyers should carefully consider and calculate all delays and seek specialist legal advice before taking steps to terminate a shipbuilding contract
  • Buyers should be aware of the expiration date of any refund guarantees and the requirements that need to be met before calling under those guarantees

BDM is currently handling a number of matters relating to shipbuilding contracts, including disputes relating to delays and termination. If you have any questions relating to shipbuilding contracts please do not hesitate to contact us.

 

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