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25 February 2015
In a volatile market, many owners face the difficult challenge of having a vessel redelivered early under a profitable charter. Early redelivery may arise where a charterer is no longer willing or able to perform the charter or where, faced with non-payment of hire, the owner decides that it has no choice but to withdraw the vessel and terminate the charter.
Where a charterer's failure to perform its obligations amounts to repudiation of the charter, the owner has – at least initially – a choice: it can decide either to maintain the charter and insist on the charterer's performance, or to terminate immediately. Both options may seem equally unpalatable to an owner faced with the prospect of having a vessel redelivered early; however, the consequences of either decision should be carefully considered.
Where the owner decides to maintain the charter, it can continue to invoice the charterer for the hire but must also continue to keep the vessel available to perform any service required by the charterer.
The recent English High Court decision in The Aquafaith confirmed that in certain circumstances it is legitimate for an owner to maintain the charter, and to continue to invoice the charterer for hire due up to the earliest redelivery date under the charter.(1) The rationale behind this decision is that the courts consider time charters to be different from other service contracts in which a greater degree of cooperation is required from the defaulting party in order for the contract to be maintained. In the case of a time charter, an owner does not require the assistance of the charterer in order to continue to give orders to the vessel to maintain its position and perform any service required, despite a lack of orders or payment from the charterer.
Such a course might be attractive for owners to follow, at least in the short term, since there is no obligation on an owner to mitigate losses. However, in the case of longer-term charters, the owner may need to balance the financial ramifications of having to fund the escalating costs of running the vessel against the prospects of actually recovering its losses from the charterer (whose solvency may be become an issue).
There are two situations in which an owner has no option to maintain the charter. The first is where the owner has no legitimate interest in continuing performance of the charter, such that to insist on further performance would be unreasonable. This may arise, for example, where the charterer is clearly insolvent or where it is clear that the charterers will not engage in any further performance of the charter. The second is where performance of the charter is reliant on the charterer's own performance. In such case an owner has no choice but to accept that the charter has ended and to act accordingly.
In order to protect its claim for damages when a charter is terminated, the owner should be aware of the mitigation steps it must take. Where a vessel is redelivered early, the owner is entitled to be placed in the position in which it would have found itself had the charter been performed.
The standard approach by the courts for measuring damages for early redelivery is the difference between the charter rate and the market rate for the vessel (determined as at the date of termination of the charter) for the unexpired term of the charter.
Where there is an available market rate for the vessel, the damages calculation is based on that market level and hence is theoretical. The fact that the owner may charter the vessel at a higher or lower rate than the market rate is ignored, unless the owner can show either that the replacement fixture rate is representative of the market or that there is no available market rate for the vessel and the terms achieved were the best available. In difficult market conditions it may be challenging to establish the correct market rate. Thus, it will always be in an owner's interests to enter into a replacement charter at market rates for the balance of the term of the original charter.
Where there is no available market at the time the charter is terminated, but such a market subsequently emerges, damages will be assessed by reference to the actual loss of the owner. In The Wren the charterer prematurely redelivered the vessel at the height of the economic crisis.(2) The court held that there was no available market at the time of termination and the owner therefore chartered the vessel on the spot market at a loss. When the market subsequently revived, the owner continued to trade the vessel on the spot market, which had become more profitable than to enter into a 'like for like' charter. The owner based its claim for damages on the initial losses suffered on the spot market and thereafter by reference to the market rate. The court held that this approach was not correct and that the owner was under a duty to take all reasonable steps to mitigate its losses. As a result, the damages payable by the charterer were assessed by reference to the actual losses that the owner had suffered.
The decision in The Golden Victory further established that any assessment of damages must take account of the charter terms; and where a supervening event arises after termination, its effect must be reflected in the assessment of damages.(3) In this case the charter was prematurely terminated in 2001 and the owner sought to recover damages for its losses during the remaining unexpired period of the charter, totalling four years. However, in 2003 war broke out in Iraq and the charter's war clause would have entitled the charterer subsequently to cancel the charter. The court held that the owner could recover damages only for the period up to when the charterer would have been entitled to terminate.
The decision in The Golden Victory is perhaps a dramatic example of where subsequent events can influence the damages that an owner is entitled to recover. Although accepting early redelivery allows an owner to enter into replacement fixtures and earn revenue from its vessel, there are often disagreements with the charterer as to how damages should be assessed. Disputes may arise over whether there is a market and what the applicable hire rate should be, or what deductions should be made to reflect the likely off-hire periods and what credit should be given for accelerated payment of damages, as compared with hire payments made over a period of time.
Given the frequency with which early delivery cases appear before the courts, there is now a wealth of case law to guide owners faced with early delivery. While this does not always make the commercial decisions any easier (particularly during difficult market conditions), owners can perhaps derive benefit from the experiences of others who have faced similar problems.
For further information on this topic please contact Clare Calnan or Lesley Tan at Wikborg Rein by telephone (+47 22 82 75 00), fax (+47 22 82 75 01) or email (firstname.lastname@example.org or email@example.com). The Wikborg Rein website can be accessed at www.wr.no.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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