Stakeholders in a shipbuilding contract

The construction and sale of a ship is both a time-consuming and a capital intensive business.

Aside from the builder and buyer, there will be multiple other stakeholders in an intricate web of relationships, each having a vested interest in the construction and completion of the ship.

Banks, finance companies and government credit export agencies will be asked to provide loans and subsidies, and to furnish guarantees in connection with the construction of the ship. Classification societies will be engaged to verify that each stage of the ship’s construction complies with technical rules and safety standards. Insurance companies will be asked to provide cover for builder’s risks. Potential charterers will be persuaded to commit to a future charter of the completed ship, as a hedge against rising hire or freight rates.

At the start of and during the construction stage, with no ship yet in existence, each of these stakeholders are likely to be investing a significant amount of time and resources into the construction of the ship. Each takes the risk that the ship may not in fact be completed or delivered. But they will be careful to limit their exposure to appropriate risk levels. The builder would ask for performance guarantees to be issued by the buyer’s bank. The buyer would negotiate for a progressive transfer of title to the vessel, as well as for refund guarantees to be furnished by the builder’s bank. The lenders will demand for a range of securities, including an assignment(s) of the shipbuilding contract, refund guarantees, insurance proceeds, and future earnings of the vessel. Insurance companies covering builder’s risk will be careful to ensure that the object or subject matter of their policy is defined specifically, and to exclude liability cover for certain types of losses (e.g. fraud).

With those safeguards built in, the risks undertaken by each of these stakeholders in the shipbuilding process is mitigated or minimized, but not entirely negated. The ordinary expectation is that each of these stakeholders would have agreed to undertake a limited amount of risk, commensurate with the price or the fee that each has been paid.

Central to each of these securities or safeguards, in respect of a ship that has yet to come into being, is the subject matter of their contracts being identified or defined by reference to ‘construction at the yard of a vessel bearing Hull No. XXXX’). Once assigned, this hull number is then incorporated into the loan agreements, performance guarantees, refund guarantees, builder’s risk policy, classification society agreements, and charter-parties etc., as a means of identification.

The problem defined: Reardon Smith Line Ltd -v- Yngvar Hansen-Tangen (“DIANA PROSPERITY”) [1976] 1 WLR 989

Common lawyers will know the strict (and often times) harsh rule in s. 13, Sale of Goods Act 1979 (SOGA) (UK) that goods sold must correspond exactly with the description in the sale contract, failing which the buyer will be entitled to terminate. This is so, even if non-compliance by a seller is so minor as to be immaterial.

The “DIANA PROSPERITY” blurred that otherwise strict and unjust rule under s. 13 SOGA by drawing a distinction between a description that goes to the identity (i.e. the essential characteristics) of the goods sold, and a description that is merely used for identification. Lord Wilberforce said in the “DIANA PROSPERITY”:

‘Even if a strict and technical view must be taken as regards the description of unascertained future goods (e.g. commodities) as to which each detail of the description must be assumed to be vital, it may be, and in my opinion is, right to treat other contracts of sale of goods in a similar manner to other contracts generally so as to ask whether a particular item in a description constitutes a substantial ingredient of the “identity” of the thing sold, and only if it does to treat it as a condition (see Couchman -v- Hill [1947] KB 554, 559 per Scott LJ)…’

Thus, in the “DIANA PROSPERITY”, the House of Lords unanimously held on the facts that the hull number of the ship in the context of a charterparty is a mere label, and not an essential ingredient of her description (cf. Simon Curtis, The Law of Shipbuilding Contracts, Fourth Edition (2012, Routledge), p. 24). The charterers were therefore not entitled to refuse delivery of the ship from her owners, on grounds that the ship was built at a different yard with a different hull number. Understandably so, since the ship built and delivered to the charterers was the very same ship that was contemplated by the terms of the charterparty ([1976] 1 WLR 989, p. 999).

Although hull numbers do not go to the identity of the goods being sold, they are nevertheless an important means of identifying the subject matter of a shipbuilding contract, and its related securities. A relatively recent Singapore High Court, Simgood Pte Ltd -v- MLC Shipbuilding Sdn Bhd & Ors, [2015] SGHC 303 will illustrate the importance of hull numbers and the dangers involved in renumbering of hull numbers.

Simgood -v- MLC Shipbuilding Sdn Bhd & Ors

At a time of booming oil prices, the Simgood Group had ordered the construction of several anchor handling tugs (AHTs), which were to be built at a Chinese yard (Nantong MLC) in accordance with the specifications of oil companies that had agreed to charter them on completion. Separate shipbuilding contracts were entered into between the Simgood Group and MLC Shipbuilding Sdn Bhd for each AHT, but with the specifications for each AHT being similar.

Two of the AHTs to be built at Nantong MLC for separate entities within the Simgood Group, were described as ‘MLC 5282’ and ‘MLC 5284’ respectively, but with their keels laid at different times, ‘MLC 5282’ in April 2007 (‘vessel A’) and ‘MLC 5284’ in September 2008 (‘vessel B’).

To finance the construction of MLC 5282, the builder had taken on a loan from DBS Bank in the sum of US$5.95 million. Significantly, the loan repayment from the builder to DBS Bank was to commence only upon completion of the vessel bearing hull number MLC 5282 (see paragraphs 112-118, Simgood -v- MLC Shipbuilding. The usual securities were then granted to DBS Bank, including but not limited to the assignment of the shipbuilding contract and the performance guarantees, which unsurprisingly were also defined by reference to a vessel bearing hull number MLC 5282.

Unknown to DBS Bank and the Simgood Group, however, the builder (together with the Chinese yard, Nantong MLC) had sometime in August or September 2008 deceitfully renumbered vessel A (originally MLC 5282) as ‘MLC 5284’, and vessel B (originally MLC 5284) as ‘MLC 5282’, claiming there was a ‘paper mess-up’. The reason or motives behind the builder’s acts was to postpone or defer their loan repayment obligations on vessel A to DBS Bank. By ‘swapping’ the two hulls and redesignating vessel B as the new ‘MLC 5282’, which keel was laid later in time, the builders were able to effectively say to DBS Bank that the vessel bearing hull number MLC 5282 was not yet complete.

Among various issues, the Singapore Court had to consider whether the builder’s act of changing or renumbering the hull of vessel A to ‘MLC 5284’ and appropriating it to a separate and different contract (albeit a contract for a vessel with the same specifications, and for delivery to an entity within the Simgood Group) constitutes an unlawful act (i.e. actionable civil wrong).

The Singapore Court held on the facts that the builder’s act of renumbering vessel A as ‘MLC 5284’ was not an unlawful act (see paragraph 179 of Simgood). In coming to its decision, the court referred to the House of Lords’ decision in Stocznia Gdanska SA -v- Latvian Shipping Co, [1998] UKHL 9 and stated that Stocznia ‘did not turn on the fact that the keels were renumbered, much less does it suggest that it was a breach of contract or some other civil wrong to renumber a keel, or indeed a hull’. This appears to be a fairly broad and sweeping statement, which if not read in context, can be construed wrongly. Before I discuss the reasons for this, we should examine the decision in Stocznia.

In Stocznia, the yard had contracted to build six reefer ships for Latvian Shipping, each identified by a keel number. Keel numbers 1 and 2 were laid, but following a downturn in the reefer market, the buyers then sought to re-negotiate the price on their shipbuilding contracts, and refused to pay the keel-laying instalments for hull numbers 1 and 2. In what was a controversial act, the builders then redesignated keels 1 and 2 for hull numbers 3 and 4, and again demanded payment of the keel-laying instalments for those contracts. When the buyers again failed to pay, the builders repeated the same process for hull numbers 5 and 6. When the dispute came before the House of Lords, one of the issues to be determined was whether the yard was entitled to payment of the keel-laying instalments for hull numbers 3 to 6. The HL held that the yard was not so entitled. Construing the provisions of the shipbuilding contract, the HL held primarily (among other things) that the keel-laying notices issued by the yard for hull numbers 3 to 6 were defective, because the sections of the hulls were not being joined by the builders at the berth in which she was intended to be constructed.

But more than that, the HL also explained why the redesignation of hulls would not be permitted, in the absence of permission from buyers. Lord Goff in Stocznia explained as follows:

‘In truth, what the yard was doing was to appropriate to contracts 3 and 4 (and subsequently to contracts 5 and 6) sections which had been joined as part of the construction of a vessel being built under a different contract. There was nothing to stop them doing that, if the buyers agreed. In normal circumstances, it might well be possible to obtain such an agreement; but in a case such as the present, there was no chance of it being obtained. Moreover, if the yard’s argument is right, they were entitled to do this as of right in a case where the contracts in question were with different buyers. In such a case it would be most surprising if the yard could so proceed without first obtaining the consent of the second buyer. On the buyer’s construction of the clause, such a step would not be open to the yard. Furthermore, their construction fully recognises the right of the buyers to supervise the construction of the vessel under their contract with the yard.’

Lord Lloyd reiterated Lord Goff’s earlier point in his own written judgment, by saying:

‘Waller J. held that it was arguable that the wording does not enable the plaintiffs to say that the first and second sections of hulls 3 to 6 were joined at a time or place where those vessels were being constructed…. In my opinion, Waller J. was right. Indeed I would go further, and decide the point now in favour of the buyers…. One can test the position by assuming that vessels 3 to 6 had been sold to a different purchaser. Would the purchaser of vessel 3 have been obliged to accept sections which had already been constructed in the workshop and joined on the berth in respect of another vessel? Clearly not. …. the purchaser of vessel 3 would have been entitled to appoint a supervisor to supervise every aspect of the construction of the vessel. Thus the purchaser of vessel 3 could in theory have objected to the keel sections of hull 1 being appropriated to his contract, since his supervisor would not have had any opportunity to inspect, for example, the integrity of the welding. No doubt the purchaser would in practice have accepted the keel sections of hull 1 by agreement. But on the facts, as they are, the buyers never agreed to the keel sections for hulls 1 and 2 being renumbered 3 to 6. If the plaintiffs rely on a technicality to recover the keel laying instalments on hulls 3 to 6, they should not be surprised to receive a technical answer.

The rationale behind the Stocznia decision is easy enough to understand (and can be easily reconciled with the identity/identification principles of the “DIANA PROSPERITY”), given that the identity of the goods being delivered under contracts 3 to 6 were not as described in the contract.

Once seen in that light, it is surprising the Singapore Court in Simgood should seek to limit the effect of the decision in Stocznia, by saying that it did not lay down any general principle of law that a renumbering or a switching of hulls (which goes to the identity, and not merely identification, of the subject matter of the contract) is unlawful.

See also the discussion at pages 24 to 25, Simon Curtis, The Law of Shipbuilding Contracts, (Fourth Edition, 2012), where the learned author recites the often held understanding of Stocznia: ‘it is equally clear that the builder cannot, without the buyer’s consent, simply redesignate hulls (or parts thereof) built under one contract with a new number for the purposes of ensuring performance of an entirely different contract’. That would have been a breach of the shipbuilding contract (in particular s. 13 SOGA), as it changes the identity of the goods which are being delivered to the buyer.

The judge’s finding in Simgood that the renumbering of the hull was not unlawful, also appears to be inconsistent with his own earlier observations in the judgment (when considering the effect of the switch on DBS Bank’s security), where he says: ‘A hull number is fundamental to the identity of a vessel under construction. More importantly, the change prejudiced their security’. If a hull number is fundamental to the identity of a vessel under construction, surely any renumbering or a swapping of hulls going to identity must be a breach of the shipbuilding contract, and therefore unlawful.

The intricate link between the identity of a ship and her hull number

There are good reasons why the hull number of a ship under construction is a fundamental ingredient of her identity, and why a renumbering of the hulls should not be permitted, save in exceptional circumstances.

The construction of each ship is fundamentally unique. The reliability and performance of a ship depends heavily on the quality of its individual construction. For example, the weldings and the evenness of the vessel’s external surface plating can all have an effect on the eventual speed and fuel consumption of that vessel. No two vessels, even if built to the same specifications, will have the same exact performance. It is for that reason that buyer’s station superintendents in the yard inspect and supervise the construction of each ship, by reference to her specific hull number.

Multiple stakeholders will also have a vested interest in the construction of that particular ship, the identity of which is tied to her specific hull number. Banks who finance the construction of a ship should not be allowed to unknowingly lose their security in a valuable newbuild, only because the yard had (as was the case in Simgood) covertly and deceitfully appropriated and renumbered the hull for the purposes of satisfying a different contract. If as the Singapore Court in Simgood says that the act of renumbering vessel A to ‘MLC 5284’ (and in so doing, changing the identity of the goods being delivered) was not unlawful, does the security of DBS Bank then lie in vessel A (now named as ‘MLC 5284’, or in vessel B (the new ‘MLC 5282’, but which was never the subject matter originally in contemplation)? Insurance companies insuring for specific builder’s risk will also have to have some form of certainty in the subject matter they are insuring, which they would not otherwise have had if a redesignation of hulls by the yard were permitted.

The redesignation of hulls, if not regarded as unlawful (as Simgood appears to suggest), would permit a change in the fundamental identity of the goods that are to be delivered under the contract, which can in turn affect and defeat various stakeholders’ interest in and security over the construction of the newbuild, in particular those of the banks and the insurers. Without a general rule that hulls under construction may not, save for all the stakeholders’ (and not just the buyer’s) consent, be renumbered for the purposes of satisfying a different contract, it will always be open to a yard to commit a fraud, and to leave stakeholders high and dry.

This paper was originally presented at the ICMA Conference in September 2017