The downturn in economic activity and the resulting decline in international trade following the 2008 financial crisis along with record newbuilding deliveries have resulted in an oversupply of ships in the market. The supply/demand imbalance in the first two months of 2009 has been especially severe in the containership and bulk carrier sectors. Lloyds List recently reported that at the beginning of March 2009, 453 containerships with a combined total capacity of 1.4M TEU or 11 per cent of the world boxship fleet are currently inactive, if not in lay-up. This figure has already surpassed the previous peak of 5 per cent experienced in the shipping depression two decades ago. The number of bulk carriers in, or proceeding to, lay-up paints a similar depressing picture for shipowners.
Commentators predict that the number of ships proceeding to lay-up will increase in the coming months as the global economic recession deepens. Det Norske Veritas estimate that by 2013, 6,000 ships could be in lay-up, slow steaming or idling. As freight and charter hire rates fall below a shipowner’s cash operating cost level, it makes commercial sense to lay-up the ship until market conditions improve. Expectation of a lay-up boom is also evident in the decision of classification societies and protection and indemnity clubs (e.g. Det Norske Veritas and the UK P&I Club) to issue guidelines for shipowners preparing their ships for a period of lay-up. In such circumstances, it is worth reconsidering the concept of lay-up and how it affects the various stakeholders in a shipping venture.
This article will initially examine the meaning of the concept of lay-up and then go on to consider how it impacts on shipowners, charterers and ship financiers.
What is lay-up?
In shipping, the term lay-up or laid-up, refers to the practice of taking a ship “out of service” in times of economic downturn when the supply of ships exceeds demand. It is distinct from taking a ship temporarily out of service for dry-docking or for repairs or simply idling a ship for short periods waiting for a cargo or waiting for orders from a charterer. The objectives of lay-up are, first, to reduce daily operating costs during the period of lay-up and, secondly, to maintain the safety, security and protection of the ship and the marine environment. The shipowner must implement a lay-up plan which will include procedures to protect the ship, its structure, machinery, cargo and ballast tanks, holds, pipelines and cargo systems from deterioration, seizure and corrosion.
The concept of lay-up of a ship falls into three different categories:
- Long term or cold lay-up. Cold lay-up involves taking a ship to a dedicated, secure location where the ship will be deactivated. The aim is to manage the ship during the lay-up period with minimum personnel and little ongoing maintenance. Dehumidifiers will be employed to reduce moisture in enclosed spaces to prevent or reduce corrosion. All machinery and onboard systems are deactivated and secured. Tanks, cooling systems and pipelines are drained of saltwater and additional sacrificial anodes are deployed on the hull and in ballast tanks for increased cathodic protection of the hull and ship’s structure. A specialist shore-side lay-up team will be employed in place of the existing crew to maintain the ship or group of ships.
- Medium term or warm lay-up. Operating costs are reduced by retaining only a skeleton crew in order to maintain the ship and keep the machinery operative so that the shipowner can quickly mobilise a full crew to prepare the ship for normal trading. A limited number of systems will be deactivated during a warm lay-up period. The reduced number of crew on board will continue with planned maintenance during the lay-up period and will regularly operate deck and engine room machinery to keep the machinery in good working order.
- Short term or hot lay-up. During a period of short term or hot lay-up, the shipowner will retain a reduced but sufficient crew to save costs so that the ship can be quickly reactivated at short notice with a minimum of cost. The lay-up crew will continue with normal planned maintenance routines to ensure that the ship, its machinery, electrical and electronic systems are kept operative and in good working order ready to trade at short notice.
Risk assessment and lay-up plan
In preparing for a period of lay-up, the shipowner should carry out a full risk assessment on the lay-up location, the prevailing weather and sea conditions, mooring or anchoring facilities, safety of personnel, security of the ship, its equipment and personnel, piracy risks and protection of the marine environment. In conducting the risk assessment, the shipowner should consult widely with its shipmanager, the classification society, protection and indemnity association, hull insurers, flag state, local agents and other shipowners in order to take advice on all aspects relating to the proposed lay-up location. The shipowner should consider security of the ship and personnel, access to transport facilities and the availability of specialised lay-up service providers. Following the risk assessment, the shipowner should prepare a detailed written lay-up plan and procedures covering all aspects of the deactivation and reactivation of the ship, its crew and systems.
A shipowner must carefully balance the need to reduce daily operating costs against the need to protect its asset against corrosion, deterioration, piracy, pilferage and reduce the risk of any claims resulting from death or injury to personnel or damage to shore-side facilities or damage to the environment. As importantly, the shipowner will need to address the requirements of its ship financier to ensure that the ship financier’s security position is protected as much as possible. The shipowner should also consult with its ship financier to ensure that the ship financier is comfortable with the jurisdiction of lay-up and that any consents which are required under any of the relevant ship security and finance documents have been obtained. All of these factors will add to the costs incurred by the shipowner during the lay-up period, but are necessary in reducing the risk of any long term damage to the ship and the possible reduction in the security value of the asset for the ship financier.
What does lay-up mean for a shipowner?
The attraction of lay-up for a shipowner is a reduction in daily operating costs that may be achieved by effectively putting the ship out of service for a set period of time. Cold lay-up, in particular, could see a shipowner save up to 60 per cent of its daily operating costs in reduced crew wages and other savings after an allowance is made for the costs of deactivation and reactivation. Shipowners may also make significant savings in lube oil consumption, consumption of stores and repair costs during the lay-up period. Insurance costs will also be significantly reduced as the ship may, subject to advice from specialised insurance advisers, only need to be insured for port risks and protection and indemnity risks whilst in lay-up.
What does lay-up mean for a charterer?
Where a ship is under a long term time charter, it will be the charterer, as opposed to the shipowner, who shall make the decision to lay-up a ship and direct a ship to lay-up. As discussed above, lay-up is currently topical in the container ship sector, where containerised trade has slumped by as much as 25 per cent in the past few months and the major container shipping lines are reducing costs by ordering owned and chartered ships to lay-up. A number of industry standard form time charterparties contain a clause which allows a charterer to order a ship to lay-up. For example, clause 13(n) of the BIMCO BOXTIME charter for containerships and clause 13 of the SHELLTIME 4 tanker time charter are clauses which specifically address lay-up of a ship during the charter period. Such clauses usually provide that the shipowner will have an obligation to pass on to the charterer by way of a reduction in charter hire any net savings in daily operating costs achieved by the shipowner during the period of lay-up.
In negotiating a lay-up agreement, there are a number of important issues that a shipowner and a charterer need to address in order to ensure that their respective positions under the time charter are protected as much as possible. On the one hand, the charterer will want to maximise any savings in daily operating costs and lower charter hire by reducing lay-up costs by as big a margin as possible. On the other hand, the shipowner will want to implement a conservative and expensive lay-up strategy to minimise any deterioration of the ship during the lay-up period and reduce the risk of injury to personnel or damage to the environment. The shipowner and charterer should ensure that, amongst other issues, the following matters in particular are addressed in the lay-up agreement with as much certainty as possible:
- the place where the ship is to be laid-up is a place which meets the fundamental criteria set out in the shipowner’s lay-up risk assessment;
- the period of lay-up or at least an initial estimate of the lay-up period;
- the notice period that the charterer is required to give to the shipowner for the ship to be re-activated;
- the application of the speed and fuel consumption performance warranties under the time charter once the ship is reactivated and resumes normal service under the time charter;
- the shipowner to have the right during the lay-up period to place the ship in drydock in circumstances of emergency or if required by the classification society;
- the allocation of liability between the parties for the costs and expenses of the initial lay-up, the deactivation of the ship, including expenses related to classification and flag state surveys and compliance costs during the lay-up period, and expenses related to inspections of the ship;
- the allocation of liability between the parties for the costs of reactivating the ship at the end of the lay-up period, including the costs of drydocking to clean the bottom of the ship under the waterline, cleaning the propeller and rudder and mobilising the crew and conducting any necessary repairs for any damage to machinery or equipment as a result of the lay-up;
- a requirement that the charterer shall not place the ship off-hire at anytime during the period of the lay-up; and
- the charterer’s obligation to pay the cost of all HFO and MDO bunkers consumed during the period of lay-up.
What does lay-up mean for a ship financier?
A decision by a shipowner or a charterer to lay-up a ship will raise a number of issues for a ship financier. In addition to the common interest of shipowner and ship financier to ensure that the lay-up location, lay-up plan and procedures are sufficient to ensure the ship’s security, safety of crew and other personnel and protection of the environment, the ship financier will need to be satisfied that a shipowner has sufficient financial reserves to continue to meet its repayment obligations under the loan agreement during the period of lay-up (taking into account, if applicable, the reduced rate of hire payable under any time charter). The jurisdiction of the lay-up site will also be a major concern for a ship financier. Does the jurisdiction of lay-up have an acceptable legal system which will allow the ship financier to enforce its mortgage over the ship if there is a default during the lay-up period?
Disadvantages of lay-up
The most obvious disadvantage of a ship being laid-up is the potential deterioration of the condition and value of the ship, its structure, machinery and equipment during the lay-up period. Another disadvantage is that lay-up may result in the loss of experienced officers and crew during the lay-up period and, in the case of a cold lay-up, the risk that the shipowner may miss the start of any recovery in the market due to the time lag in reactivating a ship, mobilising the crew and getting the ship in a condition to return to service. Finally, and arguably the most important issue - the ship will not be working and earning revenue for the period of the lay-up.
Best available option in a downturn?
In times of economic downturn, where the supply of ships exceeds demand and operating revenue declines to the point where the daily operating costs of running a ship exceed the daily cash generated, lay-up may be the best available option for a shipowner. During turbulent market conditions, instead of selling or scrapping a ship, a shipowner may have no other alternative but to lay-up a ship until the freight and charter markets improve. All of the stakeholders in a shipping venture, including the shipowner, shipmanager, crew and other service providers, charterer and ship financier should all be consulted by the shipowner as part of the lay-up plan to ensure that the procedures will be conducted in a cost-effective, safe and environmentally friendly way and that all parties’ interests are considered.