Contractual considerations for shipbuilding in USA

Key contractual considerations

Are there any statutory formalities in your jurisdiction that must be complied with in entering into a shipbuilding contract?

There are no statutory formalities or requirements (beyond standard contractual requirements) that must be complied with by parties when entering into shipbuilding contracts for commercial vessels.

May the parties to a shipbuilding contract select the law to apply to the contract, and is this choice of law upheld by the courts?

Parties to a shipbuilding contract may select the law to govern their shipbuilding contract as long as the choice of law has some reasonable relation to the contract and the work to be performed thereunder. The law can be that of the place where the shipyard is located or where the contract is negotiated or where one or both of the parties reside - and such choice of law will be upheld by the courts. Even foreign choice-of-law clauses will be enforced if there are sufficient contacts present. For instance, in Hartford Fire Insurance Co v Orient Overseas Containers Lines (UK) Ltd, 230 F3d 549, 556 (2d Cir. 2000) it was held that ‘[a]bsent fraud or violation of public policy, a court is to apply the law selected in the contract as long as the state selected has sufficient contacts with the transaction’. Additionally, New York law permits parties to select New York law to govern their contractual relationships where the transaction amount is at least US$250,000 and to avail themselves of New York courts where the transaction amount is at least US$1 million despite lacking other contacts with the state. See IRB-Brasil Resseguros SA, v Inepar Investments SA, 20 NY3d 310, 958 NYS 2d 689 (2012) and McKinney’s General Obligations Law sections 5-1401, 5-1402.

Is a shipbuilding contract regarded as a contract for the sale of goods, as a contract for the supply of workmanship and materials, or as a contract sui generis?

Under US law, a contract for construction of a vessel is a contract for the sale of tangible personal property and is not a maritime contract. Thus, such contracts are subject to articles 2 and 9 of the Uniform Commercial Code (UCC) in the relevant state as well as other applicable state laws. See Primera Maritime (Hellas) Ltd v Jiangsu Eastern Heavy Industry, 2009 WL 249249 (SDNY 2009) (citing CTI-Container Leasing Corp v Oceanic Operations Corp, 682 F2d 377, 380 n.4 (2d Cir 1982)). It is ‘well established that a contract to build a ship is not maritime’.

Is the hull number stated in the contract essential to the vessel’s description or is it a mere label?

The hull number of a vessel is always stated in the contract; it is unique to the vessel’s description and for the identification of components and equipment in the shipbuilders’ and subcontractors’ yards or premises including any equipment and materials furnished by the owner. The hull number also serves other functions, including shipyard accounting for materials and equipment (especially where the shipyard is building a series of vessels and the contract provides that title to work and material passes to the buyer as payments are made - see question 13) and critical path tracking for the shipyard and the classification society. A hull identification number (HIN) (which is not the vessel’s hull number) is required by the US Coast Guard to be located on the transom of all vessels constructed in the United States. An HIN is a serial number for vessels. The Code of Federal Regulations (at 33 CFR section 181.23) provides that the last two digits of the HIN denote the year in which a vessel was constructed (33 CFR section 181.25) and that the manufacturer or builder is required to affix the HIN to the vessel in two locations (33 CFR section 181.23). Vessel identification by HIN or other clearly descriptive data is also a prerequisite to official documentation under 46 CFR section 67.205.

Do ‘approximate’ dimensions and description of the vessel allow the builder to deviate from the figure stated? If so, what latitude does the builder have?

The vessel’s dimensions are generally specified or described in the shipbuilding contract or may be specified in the vessel’s specifications, which are typically incorporated by reference in the shipbuilding contract. Generally, the vessel’s length and depth are described as ‘abt’ (about), which affords the shipyard extremely limited deviation within the tolerances of the construction standards of the shipyard and the classification society. However, the vessel’s breadth, length between perpendiculars and draft should always be stated precisely so as to allow no deviation from these critical measurements, which are also critical to the vessel’s ability to load and trade to certain ports and for some vessels’ ability to transit the Panama Canal. The dimensions, if not strictly complied with, may also affect the vessel’s deadweight capacity and the liquidated damages clause of the contract.

May parties incorporate guaranteed standards of performance whose breach entitles the buyer to liquidated damages or rescission? Are there any trade standards in your jurisdiction for coating, noise, vibration, etc?

Shipbuilding contracts generally contain provisions for the payment of liquidated damages for the failure to meet certain technical requirements of the contract, namely, delays in delivery that are not excused by events of force majeure or buyer’s fault, insufficient speed, deadweight capacity shortage and excess fuel consumption. The shipyard is provided limited leeway for each of these elements before liquidated damages are payable (as a deduction from the payment of the contract price due on delivery). The buyer is also generally afforded the right to rescind the contract if any of these elements exceed negotiated amounts. Liquidated damage clauses must be reasonable and geared to an estimate of the losses likely to be sustained from the relevant breach. If the liquidated damages specified are deemed to be penal in nature or unconscionable, they are not likely to be enforceable. See In re Trans World Airlines, 145 F3d 124 (3d Cir 1998) (liquidated damages provision unenforceable as against public policy, in that damages provided for had no bearing on lessor’s probable loss in event of breach); also Resources Funding Corp v Congrecare, 1994 WL 24825 (SDNY 1994) (citing Truck Rent-A-Center v Puritan Farms 2d, 41 N.Y.2d 420, 424-25 1977): ‘It is plain that a provision which requires, in the event of a contractual breach, the payment of a sum of money grossly disproportionate to the amount of actual damages provides for a penalty is unenforceable.’). At this time, with the exception of specifically negotiated terms, there are no disclosed trade standards for coatings, noise and vibrations.

Do statutory provisions or previous cases in your jurisdiction give greater definition to contractual quality standards?

Quality standards are achieved in great part by contractual requirements to comply with classification and other regulatory requirements and by the buyer confirming that the shipbuilder and its subcontractors have satisfied the relevant requirements of the International Organization for Standardization. Most shipbuilding contracts reference quality standards, albeit in various formats. Some refer to ‘good quality and standards of workmanship and scope of subcontractors to be no less than those which have been incorporated by the builder in vessels of the same class as the vessel’ or ‘the builder will utilise and incorporate in the vessel the best quality and standards prevailing in the shipyard as of the date of the contract’ or ‘such standards will be no less than those which have been reviewed and agreed to for the construction of an earlier vessel for the same buyer’. Shipyards are generally loath to refer to quality standards as the ‘highest’ because such a description is likely to lead to disputes.

Where the builder contracts with the classification society to ensure that construction of the vessel leads to the buyer’s desired class notation, does the society owe a duty of care to the buyer, or can the buyer successfully sue the classification society, if certain defects in the vessel escape the attention of the class surveyors?

Classification societies provide a comprehensive framework of rules (the Rules) detailing the structure and mechanical details of the vessel, the methods to be utilised in the construction of the vessel and assessing the compliance of the vessel with both the Rules and relevant statutory regulations. In addition, working together with the builder and the buyer’s on-site supervision team, the classification society surveyors supervise the construction of the vessel and witness tests of materials for the hull and certain items of machinery as required by the Rules. Throughout construction, the classification society’s surveyors will maintain an ongoing dialogue with the buyer and the builder to ensure the Rules are understood and adhered to and to assist in resolving differences that may arise. When a vessel is constructed under the supervision of the classification society the classification notation will be preceded by a Maltese cross. In the US, most vessels are classed by the American Bureau of Shipping (ABS), which also performs many supervisory regulatory functions on behalf of the US Coast Guard to ensure compliance with applicable US regulations.

Classification societies are employed by the builder, who also pays their fees. Accordingly, contractual obligations of the classification society are the builder’s responsibility rather than the buyer’s and, except in limited circumstances under which courts have opened the door to classification society liability (In re Eternity Shipping Ltd, 444 F Supp 2d 347 (DMd 2006)), US courts have not imposed tort liability on classification societies in favour of the buyer in conjunction with losses attributable to defects on vessels they have classified. See generally Sundance Cruises Corp v American Bureau of Shipping, 799 F Supp 363, 383 (SDNY 1992) aff’d, 7 F 3d 1077 (2d Cir. 1993) (‘[I]n Shipping Corp of India v ABS (SDNY 1990) 744 F Supp. 447, Judge Motley applied East River to relieve the defendant now before us from tort liability for its professional services in issuing classification certificates.’); and Reino de Espana v American Bureau of Shipping, 729 F Supp 2d 635, 643-44 (SDNY 2010) (‘[T]he court stated, citing a long line of federal maritime cases, that the ultimate responsibility for the vessel’s seaworthiness rests on the shoulders of the shipowner, and the shipowner cannot delegate this duty to a classification society or to any other entity.’).

Have the flag-state authorities of your jurisdiction outsourced compliance with flag-state legislation to the classification societies? If so, to what extent?

As stated in question 10, the US Coast Guard has outsourced a good part of monitoring compliance with applicable US regulations to the ABS.

Does your jurisdiction allow for registration of the vessel under construction in the local ships register in the name of the builder or the buyer? If this possibility exists, what are the legal consequences of this registration?

US federal law does not currently allow for registration of vessels under construction. In 2009, the Maritime Law Association proposed legislation that would permit a vessel under construction to be documented in the name of the party that actually has title to the vessel construction project under the terms of the construction contract, but this proposed legislation has not yet been enacted. If this proposed legislation becomes law, it would permit the party that has documented the vessel under construction to subject the vessel to a preferred mortgage that would enjoy the same priority benefits and the benefit of admiralty foreclosure procedure that are now enjoyed by the mortgagee of a completed vessel.

May the parties contract that title will pass from the builder to the buyer during construction? Will title pass gradually, upon the progress of the vessel’s construction, or at a certain stage? What is the earliest stage a buyer can obtain title to the vessel?

The parties to a shipbuilding contract may agree as to when title passes from the builder to the buyer. Generally, property in and title to the vessel and all risk and loss remain with the builder until the contract price has been paid in full and the vessel is actually delivered to and accepted by the buyer as evidenced by a protocol of delivery and acceptance signed by both parties. However, some contracts provide that title to all completed work, materials and equipment pass to the buyer as instalments of the contract price are paid to the builder.

Will risk pass to the buyer with title, or will the risk remain with the builder until delivery and acceptance?

See question 13.

May a shipbuilder subcontract part or all of the contract and, if so, will this have a bearing on the builder’s liability towards the buyer? Is there a custom to include a maker’s list of major suppliers and subcontractors in the contract?

Shipbuilding contracts generally permit the shipyard, subject to negotiated limits such as dollar amounts, distance from the shipyard, the magnitude of work and whether the builder will have to obtain the buyer’s consent to each subcontractor, to subcontract certain portions of the work without derogating from the builder’s obligations or the buyer’s rights under the contract. These clauses are generally the subject of intense negotiations, as the more geographically widespread the subcontractors are, the more difficult it is for the buyer’s site supervision team to monitor the quality of any work performed by such subcontractors.

Must the builder inform the buyer of any intention to have certain main items constructed in another country than that where the builder is located, or is it immaterial where and by whom certain performance of the contract is made?

For a US-flagged vessel to be qualified to engage in US coastwise trade (46 USC 55102(b), originally section 27 of the Merchant Marine Act, 1920, as amended (Jones Act trade)) and qualify for a coastwise endorsement on its certificate of documentation it must be, inter alia: built in the United States and owned by entities whose chief executive officer, president and chairman of the board of directors (and anyone that can act in their absence or disability) must be US citizens, and whose equity is at least 75 per cent held (of record and beneficially) by US citizens. A vessel is deemed to be built in the US only if all major components of the hull and superstructure are fabricated in the US and the vessel is entirely assembled in the US (46 CFR 67.97). The US Coast Guard has consistently held that items not integral to the hull or superstructure, such as propulsion machinery, consoles, wiring harnesses and other outfitting that has no bearing on a US build determination, may be foreign-built without compromising the vessel’s coastwise eligibility. The US Coast Guard has also held that foreign components amounting to less than 1.5 per cent of a vessel’s steel weight are not considered ‘major’. Within these confines the shipbuilding contract and the vessel’s specifications should permit foreign-sourced materials and equipment to be incorporated in the vessel without adversely affecting the vessel’s qualification for a coastwise endorsement on its certificate of documentation. Virtually all shipbuilding contracts will provide for an agreed maker’s list of major supplies of listed components. A list of approved subcontractors for specific components of the vessel may also be attached to the shipbuilding contract.