Shipbuilding contracts: Tips and traps 1

Briefing note November 2016

Shipbuilding contracts: Key issues

 Shipbuilding contracts are
contracts for the sale of

Tips and traps 

goods.
Unless excluded, a
shipbuilding contract can be
Despite the recent sharp decline in oil prices and the subject to implied terms under
the relevant Sale of Goods
reduction in offshore equipment spend, the offshore legislation.
oil and gas sector remains a key market for the  Liquidated damages can be
payable in respect of defects
shipbuilding industry. Market analysts have identified
in the vessel, provided that
Australasia as a 'regional market bright spot'; the sum stipulated is a
'genuine pre-estimate' of loss.
predicting growth of 3% per annum in offshore
 Liquidated damages can also
equipment spend between 2016 and 2020. be payable in respect of delay
in delivery, provided the delay
Australia's LNG projects are said to be a key driver is not caused by the buyer; in
for Australasia's positive market outlook. which case the Prevention
Principle will apply.
Further, the Australian government has recently  The right to terminate a
contract may be subject to
announced that it proposes investing 25% of its express provisions of the
defence capital expenditure to 2025/2026 on contract, or common law.
The parties may exclude the
maritime capabilities, with a focus on local common law right to
terminate the contract.
manufacturing.

Given these emerging market opportunities, it is

timely to highlight some key aspects of shipbuilding contracts.
1. Shipbuilding contracts be had to the rules underlying is generally secured by a Refund
contracts for the sale of goods when Guarantee. Continuous title
and Sale of Goods determining disputes arising out of provisions where title to the partly
legislation shipbuilding contracts. constructed hull passes to the buyer
Shipbuilding contracts are are rare. See also ss 17 to 20 SOGA
Title passes when the parties intend it
categorised by both Australian and for rules on transfer of title.
to pass; for example see s 17 Sale of
English law as contracts for the 'sale Goods Act 1895 (Western Australia) 2. Does the vessel
of goods': The Ship 'Hako Endeavour' (SOGA) . Generally, most
v Programmed Total Marine Services international shipbuilding contracts
conform to the contract?
Pty Ltd [2013] FCAFC 21; McDougall provide that title to the partly This is often one of the most vexed
v Aeromarine of Emsworth Ltd [1958] constructed hull rests with the questions in the context of
1 WLR 1126. The ultimate purpose of shipbuilder until delivery and shipbuilding contracts, and requires
these contracts is to transfer legal title acceptance of the vessel. In such a consideration of the express and
in the ship (the good) in return for scenario, the buyer's pre-delivery implied terms of the contract.
payment of a price. Thus regard must credit risk in respect of the shipbuilder
2 Shipbuilding contracts: Tips and traps

Express terms SOGA or its equivalent legislation. exclude statutory implied terms. The
Where they do not, regard must be question for determination by the
A shipbuilding contract will expressly
had to the SOGA, or equivalent court was whether fitness for purpose
provide detailed specifications that
legislation. These rules only apply to obligations under s14(3) of the UK
the vessel must comply with. These
contracts for sale of goods made in SOGA could be implied into the
typically include a number of
WA: Ginza Pty Ltd v Vista Corp Pty shipbuilding contract in circumstances
'guaranteed' standards of
Ltd [2003] WASC 11 at [187]. Unless where the vessel was built for use in a
performance, such as speed,
otherwise excluded, the SOGA 'standardised trade' known to both
deadweight and fuel consumption and
implies the following terms into the buyer and shipbuilder ie "bulk carrier
the like. Parties will agree that breach
contract: for normal worldwide service". The
of the guaranteed standards entitles
buyer argued that the contract
the buyer to liquidated damages and,  where goods are sold by
contained an implied term under
in extreme cases, to reject the vessel description, there is an implied
s14(3) as to fitness for the particular
and treat the contract as having been term that the goods correspond
standardised purpose. The
repudiated. with that description: s13;
shipbuilder argued that the implied
Shipbuilders warrant the vessel, her  where the buyer has made term of fitness for purpose did not
machinery and equipment usually for known that the goods are apply as while the vessel was built for
a period of 12 months from the date purchased for a particular use in a standardised trade, the
of delivery and acceptance. In the purpose, the goods will be specific purpose was not expressly
event that a defect occurs during that reasonably fit for that purpose: identified.
period due to faulty workmanship or s14(2); and
 where goods are bought by The court held that the fitness for
materials, the shipbuilder is obliged to
description from a seller who purpose term was implied into the
rectify the defect at its own cost, but
deals in goods of that description, contract, provided that term was
provides no guarantee of quality and
those goods shall be of consistent with, and put into effect,
accepts no liability for the buyer's
merchantable quality: s14(3). the contractual specifications. There
losses arising from the deficiency. All
was no need (for purposes of s14(3))
losses or expenses resulting from The SOGA provides that the following
that a particular purpose be identified
defects discovered after the warranty remedies are available to the buyer:
– "normal use" (in accordance with
period fall to the buyer's account.
 damages for non-delivery (s50); contractual specifications) was
Defects in compliance with sufficient.
 specific performance (s51);
contractual specifications,
However, the contract contained a
international conventions, class and  damages for breach of warranty
guarantee period of 12 months and
regulatory requirements constitute a (s52); and
specified that notice of claims were to
breach of contract that "goes to the
 interest and special damages be given within 30 days after the end
root of the contract", and may entitle
(s53). of the guarantee period. The buyer
the buyer to reject delivery of the
failed to give notice of defect within
vessel: Photo Production Ltd v Section 54 permits parties to contract
the contractual notice period. The
Securicor Transport Ltd [1980] 1 out of, or exclude, these statutory
court therefore held that the
Lloyd's Rep. 545 at 553. Where the implied terms by express agreement.
contractual time bar applied and
defect(s) represents a lesser breach, It is important to note that an express
excluded all claims not notified within
the buyer may not have a right to warranty or condition does not
the 30 day period.
reject the vessel - its remedies are necessarily negative a warranty or
usually limited to either liquidated condition implied by the SOGA unless 3. Liquidated damages v.
damages or damages assessed in the two are inconsistent: s14(5).
accordance with general principles.
penalties
In Neon Shipping Inc v. Foreign
A liquidated damages clause will be
Implied terms Economic 7 Technical Corporation Co.
enforceable against a party to a
of China & Ors [2016] EWHC 399
Shipbuilders often seek to exclude shipbuilding contract where the sum
(Comm), the parties did not expressly
statutory implied terms under s54 of stipulated is a 'genuine pre-estimate'
 Shipbuilding contracts: Tips and traps 3

of the loss that will probably arise increases by reference to the principle provides that the contractual
from the breach of contract: Paciocco gravity of the breach, it is more time for completion will be extended if
v Australian and New Zealand likely that the court will find the the buyer's act or omission "renders it
Banking Group Ltd [2016] HCA 28 at sum stipulated is a "genuine pre- impossible or impracticable for the
[16]. If the damages prescribed are estimate of the loss likely to be [builder] to do his work within the
'exorbitantly disproportionate' to the suffered", rather than a penalty. stipulated time": Trollope & Colls v
actual loss likely to be suffered, then Clauses structured in this way North West Metropolitan Regional
the clause will be unenforceable as a are widely used in shipbuilding Hospital Board [1973] 1 WLR 601. In
penalty. In Castaneda v Clydebank contracts. such circumstances, the buyer is
Engineering and Shipbuilding (1903) precluded from claiming liquidated
It is worth noting that a liquidated
10 SLT 622, 624, the court said that damages (and is unable to require the
damages provision will not be
liquidated damages must be shipbuilder to deliver the vessel by
construed as a penalty merely
"reasonable and moderate" and not the specified date, or any other date
because the damages payable may
exorbitant and unconscionable or "in ascertained by reference to the
exceed the actual loss suffered in
terrorem". contract): Multiplex Constructions v
certain situations: Philips Hong Kong
Honeywell Control Systems [2007]
Factors that may influence whether a Ltd v The Attorney-General of Hong
EWHC 447.
liquidated damages clause in a Kong (1993) 61 B.L.R 41.
shipbuilding contract is enforceable If the shipbuilder is able to satisfy
If a liquidated damages clause is
include: these requirements, time is set 'at
found to be unenforceable as a
large', and the shipbuilder's obligation
 Commercial justifiability - penalty, the claimant is relegated to
to deliver the vessel by a specified
liquidated damages must be seeking and proving damages,
date is replaced with an implied
commercially justifiable, and assessed in accordance with general
obligation to deliver the vessel 'within
should not be an unreasonable compensatory principles: United
a reasonable time'. What is a
remedy for the breach of contract Dominions Trust (Commercial) Ltd v
'reasonable time', is a question of fact
to which it relates. In Azimutt- Ennis [1968] 1 Q.B. 54 at 68. The
determined in light of all relevant
Banetti SpA v Darrell Marcus monetary compensation is to place
circumstances: Shawton Engineering
Healey [2010] EWHC 2234, the the party in the position it would have
v DGP International [2005] EWCA Civ
liquidated damages clause been in had the contract been
1359.
withstood attack on the basis it properly performed: Wavemaster
was a penalty, despite requiring International Pty Ltd (in liq) v JR The buyer need not breach the
repayment of all but 20% of the Marine Systems Pte Ltd [2009] contract for this principle to apply.
purchase price if the shipbuilder WASC 203. The shipbuilder must however
lawfully terminated the contract in demonstrate a causal link between
In addition to applying to defects in
the event of the buyer's breach. the buyer's act or omission and the
the vessel, liquidated damages can
The court said such a clause can delay: Jerram Falkus Constructions v
also be awarded for delays in delivery
be "commercially justifiable", Fenice Investments [2011] EWHC
of the vessel. Such liquidated
"provided that its dominant 1935.
damages are usually calculated on a
purpose is not to deter the other
per diem basis, and are usually In practice, the Prevention Principle is
party from breach." The court
payable by way of a reduction in the often excluded - shipbuilding
characterised the clause as an
contract price or in cash upon delivery. contracts typically expressly provide
attempt to strike a balance
an EOT in certain circumstances:
between the parties in the event Prevention Principle
Adyard Abu Dhabi v SD Marine
that the shipbuilder lawfully
Liquidated damages and the right to Services [2011] EWHC 848 (Comm)
terminated the contract in the
cancel a shipbuilding contract for at [255]. EOT clauses must be clear
event of the buyer's breach.
delay are subject to rules which and unambiguous terms - any
 Graduated levels of damages protect the shipbuilder from the ambiguity will be construed contra
payable – where the sum consequences of delay caused by the proferentum – i.e. against the
payable as liquidated damages buyer: the Prevention Principle. This
4 Shipbuilding contracts: Tips and traps

shipbuilder as the party whose affect the buyer's ability to cancel the shipbuilder fails to perform the
interests the clause seeks to protect. contract for non-performance: see for contract as per its terms, a clause to
example Zhoushan Jinhaiwan that effect can be incorporated into
The Prevention Principle can create
Shipyard Co Ltd v Golden Exquisite the contract. The third-party
traps for unsuspecting buyers. In
Inc [2014] EWHC 4050 (Comm). guarantee can be called on in the
some circumstances, the buyer may
event of the shipbuilder's default.
agree to grant the shipbuilder extra Non-conforming vessel
What is often negotiated in the
time to deliver the vessel, and will do
A separate, but related, consideration context of shipbuilding contracts is a
so by way of formal contractual
is whether the buyer is permitted to parent guarantee, by which the parent
amendment. In such circumstances,
cancel the contract for delivery of a company accepts joint obligations
it is important not to derogate from the
"non-conforming vessel", or whether with the shipbuilder to build and
contractual EOT clause by an
the buyer must await until expiry of deliver the vessel, rather than a
amendment, as this may give rise to
the 'drop-dead' date. In McDougall v traditional performance guarantee.
the application for the Prevention
Aeromarine of Emsworth Ltd [1958] 1
Principle. Refund guarantees
WLR 1126, the court held that a buyer
4. Delays and EOT is entitled to refuse delivery if it is not Shipbuilders are commonly called
reasonably satisfied with performance upon to provide the buyer, at the
Shipbuilding contracts will contain an of the craft. 'Performance' is outset of the contract, a refund
express provision setting out the construed widely and includes guarantee, which is an undertaking by
contractual delivery date, and when standard of workmanship and a bank (or other surety) that if the
the buyer is able to cancel the materials, compliance with shipbuilder fails to refund the pre-
contract in the event the vessel specifications, and performance of the delivery instalments of the contract
delivery is delayed i.e. by a 'drop- craft. If the defect in question is price upon the buyer's lawful
dead' date. However, the capable of being remedied and the cancellation of the contract, it will
shipbuilder's performance of the shipbuilder is able to deliver the repay those instalments to the buyer
contract may be delayed by the vessel within the period permitted by in full.
buyer's conduct, or a range of events the contract, the buyer is not entitled
that are out of either party's control. From the buyer's perspective, it is
to treat the contract as being
To allow for these possibilities, it is preferable that the refund guarantee
repudiated by reason of such defect
common for shipbuilding contracts to is unconditional, irrevocable and
when the vessel was first tendered for
set out a contractual mechanism that payable 'on demand'. This is in
delivery. The court found that
shares the risk of delay between the contrast to circumstances where the
'deliverability' is not the converse of
parties by: guarantee is payable only on a
'rejectability'. See also s11(2) of
secondary basis after the
 providing that the date for SOGA, which provides that whether a
shipbuilder's liability has been
delivery of the vessel be term is a condition (breach of which
independently determined by a court
extended in circumstances where gives rise to a right to treat the
or arbitral tribunal and the shipbuilder
the buyer has impeded the contract as repudiated), or a warranty
has failed to make payment: see
shipbuilder's performance, or (breach of which gives rise to a claim
Nanjing Tianshun Shipbuilding Co Ltd
where the shipbuilder is impeded for damages, but not to reject the
v Jiangsu Skyrun International Group
by events beyond its control goods and treat the contract as
Co Ltd [2011] EWHC 164.
(commonly referred to as force repudiated), depends in each case on
majeure events); and the construction of the contract. Recovery under the refund guarantee
does not necessarily preclude the
 entitling the buyer to cancel the 5. Performance and refund buyer from claiming damages at
contract if the delay exceeds an guarantees common law: Stocznia v Gdynia SA v
agreed number of days. Gearbulk Holdings Ltd [2009] EWCA
Performance guarantees 75.
Thus the contractual construction of
EOT clauses and the events of delay If the buyer wants to recover its It should be noted that the ability to
are important questions, which can expectation losses where the call on the Refund Guarantee is often
 Shipbuilding contracts: Tips and traps 5

limited to certain events, depending exercise its discretion whether to used in its construction may still
on its terms. Buyer need to be aware grant an injunction “by changing the belong to a third party and not to the
of any such limitations. Buyers complexion of the status quo and shipbuilder. Note, under the contract,
should also ensure that the Refund raising the prospect of substantial the shipbuilder only warrants that it
Guarantee does not expire before injustice if the purpose of the owns the completed vessel; it is
resolution of any dispute. provision is defeated. That is, the unusual for the shipbuilder to give any
status quo becomes what the parties assurance that prior to delivery it
Injunctions
had agreed to as to which of them owns the materials used in
Generally, common law courts are should bare the financial risk pending construction. It is common that the
reluctant to grant an injunction final determination ...” As such, the shipbuilder's suppliers contract with it
restraining a party calling on a court held an injunction should not be on the basis that they retain title in the
performance bond (e.g. refund granted unless the applicant materials and equipment supplied to
guarantee). The common exceptions establishes a “strong case, and not the shipbuilder until they receive
to this general rule are fraud, merely an arguable case" that the payment, pursuant to Romalpa
unconscionable conduct by the party other party did not consider, acting clauses.
in whose favour the bond had been bona fide, that it is or will be entitled
given, and where the party in whose to recover from the applicant, 7. Termination of contract
favour the bond has been given has otherwise commercial purpose (e.g. A right to terminate a shipbuilding
made a contractual promise not to call risk allocation) would be defeated. contract can arise expressly, and at
on the bond (normal principles common law.
relating to enforcement of negative 6. Title to the vessel &
contractual stipulations by prohibitory Romalpa clauses The interplay between common law
injunctions apply): Lang O’Rourke and contractual rights of termination
Australia Construction Pty Ltd v Most shipbuilding contracts provide are not always straightforward, but
Samsun C&T Corporation [2016] that during construction, title vests in are important to remember. In
WASC 49. the shipbuilder, and passes only on Newland Shipping v Toba Trading
the buyer accepting delivery of the [2014] EWHC 661 (Comm) at [49]-
In Duro Felguera Australia Pty Ltd v vessel and paying the full purchase [54], Leggatt J said:
Samsung C&T Corporation [2016] price. The buyer risks the shipbuilder
WASC 119 (appeal pending), the running into financial difficulty before  A contractual right to terminate
court said that there are generally two delivery of the vessel, (with the buyer arises under the contract, subject
purposes for performance bonds, having to join the line of unsecured to notice requirements.
namely, (a) providing security for valid creditors to recover its pre-delivery  A common law right to terminate:
claims against a contractor and, (b) payments). Securing a refund arises if a party commits a
allocating risk between the parties, i.e. guarantee mitigates against this risk. ‘repudiatory breach’, e.g. where
who shall be out of pocket pending (a) the party's breach ‘goes to the
resolution of dispute between them. An alternative method of guarding root of the contract’ or deprives
Which purpose prevails is a matter of against the shipbuilder's insolvency is other party of substantially whole
contractual construction. In that case, to transfer title to the vessel as it is benefit of performance; (b) a
the Judge held that the purpose of the constructed. This is effected by what party breaches a condition; or (c)
performance bond was to allocate risk. is often referred to a continuous a party renounces the contract by
That commercial purpose would be transfer of title provision. If the making it clear that it is going to
defeated if an injunction were granted contract is structured in this way, it is commit a breach listed above.
– the interlocutory injunction had the important that the interest be
registered under the Personal  On valid termination at common
capacity to equate to final relief, i.e.
Property Securities Act 2009 (Cth). law, the parties’ primary
completely defeating the commercial
obligations of performance are
purpose of risk allocation before the On a practical level, the problem in released and substituted with a
final determination of the matter. seeking to confer title to the vessel secondary obligation to pay
The purpose of the clause alters the upon the buyer prior to its completion compensation: Photo Production
context in which the court must is that the materials and equipment
6 Shipbuilding contracts: Tips and traps

Ltd v Securicor Transport Ltd  is not tendered for delivery before 2. When drafting liquidated
[1980] AC 827 at 849 an express right to cancel the damages clauses, be mindful that
 Note that the inclusion of an contract accrues – i.e. 'drop the sum stipulated must be a
express cancellation clause will dead' date; or genuine pre-estimate of loss. In
not exclude the right to terminate this respect, in addition to
 is tendered for delivery before the
under common law for a ensuring the sum is commercially
'drop-dead' date, but not in a
repudiatory breach, unless the justifiable, it is also useful to
condition that contract requires.
parties' ability to elect is stagger levels of damages
expressly excluded in the Absent express contractual wording, payable by reference to
contract: Stocznia Gdynia SA v parties also have the right under the seriousness of defect. Court will
Gearbulk Holdings Ltd [2010] QB common law to terminate the contract look beyond the form, to the
27 at [22]–[23]. if the other party is in repudiatory or substance of the clause.
'renunciatory' breach of contract, or
 Where the right to terminate 3. Future pain can be avoided by
has breached a condition. It is
exists under both common law clear drafting of the extension of
presumed that the parties do not give
and contract, a party can elect to time clause. The 'drop-dead'
up these valuable rights, unless the
exercise both rights at the same date may be difficult to determine.
parties expressly and clearly rebut
time, provided that doing so is that presumption: Modern 4. If the parties intend to exclude
not inconsistent with exercising Engineering v Gilbert Ash [1974] A.C. statutory implied terms, and to
the other: Dalkia v Celtech [2006] 689 at 717G. have the shipbuilder's
1 Lloyds Rep 599 at [143]-[144]. performance assessed solely
What right that is sought to be 8. Tips & traps against the contract's express
evoked should be expressly terms, such an intention should
stipulated 1. Generally, the shipbuilder retains
title to vessel until final payment be clearly expressed. The
Generally, the buyer will have three by buyer; in these circumstances incorporation of express
express contractual rights to it is important to ensure that the conditions will not per se
terminate the contract, where the shipbuilder provide the buyer with necessarily exclude the
vessel: a unconditional, irrevocable incorporation of statutory implied
refund guarantee in the amount terms.
 fails to meet specified
performance criteria which are of its pre-delivery instalments and
the subject of an express right of interest thereon
termination;
 Shipbuilding contracts: Tips and traps 7

Contacts

Pat Saraceni Gervais Green

Director of Litigation and Dispute Resolution Partner
T: +61 8 9262 5524 T: +65 6410 2252
E: [email protected] E: [email protected]

Kate Sherrard Alastair MacAulay

Partner Consultant
T: +65 6661 2023 T: +852 2825 8988
E: [email protected] E: [email protected]

Nicholas Summers
Associate
T: +61 8 9262 5538
E: [email protected]

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