What is a letter of indemnity (“LOI”)?
A person issuing a letter of indemnity promises: To repay (or pay on behalf of) the recipient of the LOI; liabilities incurred by the recipient through doing something of the issue and requests.Most LOI contain a number of other promises, i.e. To provide security, defend cases etc.
When and why are LOIs used?
Three common examples:
- Original bills of lading have not yet reached the hands of the receiver and/or the receiver wishes the cargo discharged at a port other than that named in the bill of lading.
- Disagreement about what is to be written in the bill of lading.
- A common theme in each of these examples is that the formal procedures governing the transaction are all becoming impractical and the issuers of the LOI want to do something different.
3. What is LOI’s practical/legal effect?
- Transactions can be executed at much greater speed than otherwise possible.
- It makes “strings” easier to handle (hence: “market practice” and oil and other trades).
- The market becomes more flexible and benefits from greater liquidity.
- Saves time and money – for example demurrage.
- Provides a practical solution that will reduce the scale of the problems.
- Issuer becomes liable for all/any liability incurred by the beneficiary in performing actions requested/ specified in the LOI.
- Increased exposure to the risk of fraud, insolvency and, of course, litigation!
- LOI may be ineffective in law, where its effect is to defraud a third party.
4. What are the potential problems?
The issuer assumes liability under the LOI to the ship owner if the cargo can be shown not to be as described under the bill of lading, i.e. The bill of lading is clean when in fact the mates receipts were claused.
However, ship owners may not be able to rely on the LOI if it can be shown that they were aware that the goods did not correspond to the bill of lading description.English law is very restrictive and will not hesitate to strike down such an LOI. Therefore, owners will rarely accept them in those circumstances. Interestingly the law in continental Europe is less harsh.Issuing or receiving such an LOI is very risky and should not be done without consulting your club or your lawyers.
5. What are the solutions?
Clean bills LOI
LOI will be legally effective if there is a bona fide dispute as to quality/quantity. This goes back to the earlier point that the master is only obliged to act reasonably. If the master is an assured, and reasonably believes, the shippers and/or charterers that in fact the cargo was in good order and condition, then he/she can accept an LOI.
The ship owner should only embark on such a course when there is a bona fide dispute and be prepared for consequences if there is a dispute at the destination.
If the LOI is not designed to simplify a bona fide dispute over clausing, then it is likely to be ineffective as it will be deemed to be fraudulent. The fraud is the owner knowing that the LOI was given in order to negotiate a bill of lading, which is inaccurate, to an innocent third party.
Expiry/cancellations of LOI
If there is no provision included in the LOI, then it will remain valid and the provider of the LOI will be liable without any time limit. This of course is subject to a statutory time bar. All LOIs should provide for expiry or cancellation of the LOI in specified circumstances. However, as a ship owner, you want an LOI that is valid for the longest possible period. You do not know when you might get sued in relation to a bill of lading, so you want an open ended LOI.
There is no obligation on the master to accept an LOI. If the master honestly believes that the cargo is damaged and he wishes to issue a claused mates’ receipt or a claused bill of lading, then that is his right. He is not obliged to accept an LOI in relation to goods that he believes to be damaged.
Having said this, one must recognise that in many trades it is a contractual obligation in the charter party to accept an LOI for delivery without bills of lading or for a change of destination. It is also worth pointing out that in the event that you accept an LOI, either for a disputed relation to the condition of the cargo, or for a discharge without production of bills of lading or for a change of destination, there is a likelihood you will lose your P&I insurance cover. All P&I clubs’ rules provide that if you discharge cargo without the production of the bills of lading or to a port other than that set out in the bill of lading or issue a bill of lading knowingly mis-describing the cargo, you will lose your P&I cover. It is important, if the owner is to be contractually bound to accept an LOI that the issuer of the LOI is solvent!
Beware of the signature on the LOI
It is vital to check the validity of the signature of the LOI. This applies whether there is a contractual obligation to accept an LOI or not.
In the “nelson”  HCA 35 in the Australian courts, a carrier accepted LOI from a well-known international bank. The cargo was discharged without production of the bills of lading, the bills of lading never arrived, and the cargo was stolen. The carriers applied under the LOI to bank for payment of us $4,500,000. Bank refused to pay on the basis that the LOI was not signed by the proper parties within the bank. The carrier succeeded on appeal in Australia, but it is a very important point.
The owners do not have to accept an LOI. If the owners do, make very certain that it is from someone who has the money to pay and that it is properly signed. Further, please consider the impact on your P&I insurance. Business is about taking calculated risks.
Bills of lading – delivery of cargo
Standard forms of letters of indemnity to be given in return for:
(a) Delivery of cargo without production of the original bill of lading
(b) Delivery of cargo at a port other than that stated in the bill of lading
(c) Delivery of cargo at a port other than that stated in the bill of lading and without production of the original bill of lading
Standard form letter of indemnity to be given in return for delivering cargo without production of the original bill of lading incorporating a bank’s agreement to join in the letter of indemnity
To: [insert name of owners] [insert date]
The owners of the [insert name of ship]
Ship: [insert name of ship]
Voyage: [insert load and discharge ports as stated in the bill of lading]
Cargo: [insert description of cargo]
Bill of lading: [insert identification numbers, date and place of issue]
Ten golden rules for the delivery of cargo
- Bills of lading: Always obtain the original bill of lading and not a “non-negotiable copy”
- Bills of lading: Always obtain the correct bill of lading. A container or a parcel may contain cargoes, for which more than one bill of lading have been issued for part cargoes. Release only that amount of cargo which is on the bill of lading.
- Delivery of cargo against an indemnity: One of the agent’s option, when original bill of lading is not available, is to give delivery against a letter of indemnity (bank guarantee).The indemnity does not relieve the carrier of liability to the cargo owner; it only provides for compensation for amounts which the carrier may have to pay to the original bill of lading holder.
- Has your principal given written authority to release & agreed to the wording of security? It is important that the ship’s agent obtain his principal’s written authority to release cargo without bills of lading; he should also follow the wording and security recommended by the ship owner.
- Has the cargo owner authorised release in writing? The ship owner’s agent should check both with his principal and shipper to ensure that the ship owner had agreed to the release without the original B/L and the shipper had given permission to the receiver to take delivery of cargo without original B/L and his authorization.
- Is it counter signed by a first-class bank? Before releasing the cargo against indemnity counter signed by a bank, it should be checked whether the bank is first class or not. Additionally, the agent should contact the bank to confirm that the bank had issued the indemnity/ counter signed it.
- Is it addressed to the carrier & his principals? Agents must always ensure that the letters of indemnity cover all parties who may seek to rely on them.
- Does it contain adequate financial & time limit? Agents should always be careful to ensure that the letter of indemnity covers all claims and costs which could be incurred. The general rule under English law is to obtain a letter of indemnity valid for 7 years, the 6-year statutory period, plus 1 year allowed for the serving of a writ.
- Do the goods itemised correspond exactly to those in the delivery order? The quantity to be delivered should only be that mentioned in the letter of indemnity and not more.
- Is it an original document? The agent should check whether the letter of indemnity is original or any faxed or photocopy of same. He should not release cargo against copy of letter of indemnity.