If it is apparent to a master that cargo is damaged or in a condition that does not truly reflect its description on the bill of lading, the master may insert qualifying words noting that the cargo is in some way damaged or defective or deficient. In these circumstances, the bill of lading is described as a “claused”, “foul” or “dirty” bill of lading.

Legally, a master is justified in refusing to sign the bill of lading in circumstances where the shipper/charterer has presented the master with a bill of lading that does not accurately describe the cargo, even where the charter party requires the master to sign bills of lading “as presented”.

Sometimes, however, charterers or shippers attempt to negotiate the wording that the master wishes to insert on the bill of lading, so as to cast less doubt on the integrity of the cargo, or even to remove the qualifying words altogether. As long as the final wording accurately describes the cargo, this is an acceptable practice.

  Professor Tetley describes a letter of indemnity as a written undertaking by a shipper to indemnify a carrier for any responsibility that the carrier may incur for having issued a clean bill of lading when, in actual fact, there is a dispute as to the condition of the cargo received on board the carrying vessel.

This practice is designed to set up an “indemnity regime’’ in favour of the carrier should an innocent third party holder of the bill of lading (e.g. a consignee, endorsee or a financial institution institute a claim against the carrier as a result of the cargo being received in a damaged condition, despite a clean bill of lading.

The injured third party, having relied upon the alleged good order and condition of the cargo at the time of loading, as evidenced by the clean bill of lading, has often already paid for the cargo only to receive damaged goods.

As explained below, the practice of issuing letters of indemnity in these circumstances can be fraught with risk. In many cases, Canadian courts will refuse to enforce such letters of indemnity, leaving the master and ship-owners with little to secure their claim against such shippers.

Courts have often held that such letters of indemnity are tantamount to an agreement to defraud a third party. For example, as early as 1928 in United Baltic Corporation Ltd v. Dundee, Perth & London Shipping Company Ltd, Mr. Justice Wright stated that:

“The practice of issuing clean bills of lading when goods are damaged is very reprehensible. It leads to trouble, and the people who do it ought to suffer trouble”.

Over time, however, the practice of carriers accepting letters of indemnity from shippers has developed as a commercial way of resolving a dispute at the port of loading as to whether the cargo received for shipment is in fact damaged. This, of course, is often a subjective opinion that necessitates an understanding of the nature of the cargo and its intended use by the receiver.

According to Professor Tetley, the letter of indemnity given by the shipper to the carrier in exchange for the clean bill of lading has been held to be unlawful, and therefore been treated as unenforceable by some courts.

As Morris L.J. stated in in Brown Jenkinson & Co. Ltd v. Percy Dalton (London) Ltd.:

“On the facts as found, and, indeed, on the facts which are not in dispute, the position was, therefore, that at the request of the defendants the plaintiffs made a representation which they knew to be false and which they intended should be relied on by persons who received the bill of lading, including any banker who might be concerned. In these circumstances, all the elements of the tort of deceit were present. Someone who could prove that he suffered damage by relying on the representation could sue for damages. I feel impelled to the conclusion that a promise to indemnify the plaintiffs against any loss resulting to them from making the representation is unenforceable. The claim cannot be put forward without basing it on an unlawful transaction. The promise on which the plaintiffs rely is, in effect, this: “if you will make a false representation which you will deceive endorsees or bankers, we will indemnify you against any loss that may result to you”. I cannot think that a court should lend its aid to enforce such a bargain”.

As the practice of the issuance of letters of indemnity develops, Canadian courts will have to decide whether, as a matter of public policy, they must refuse to enforce letters of indemnity given in exchange for the issuance of clean bills of lading.

Policy considerations abound. On one hand, it is a well-established rule that the condition of the goods must correspond to the description contained in the bill of lading when issued. The opposite may subject vulnerable and innocent third parties to what some call the illegal and deceitful agreement entered into between the shipper and the carrier. Moreover, the practice of signing clean bills of lading for defective cargo may also void insurance coverage provided by Protection and Indemnity clubs “P & I clubs”.

On the other hand, given the often subjective nature of the debate that sometimes arises over whether particular cargo is damaged, it is arguable that letters of indemnity are the most efficient way to deal with such disagreements, rather than clausing of bills of lading and denying the shipper the opportunity, in most cases, to draw down payment from letters of credit. Given these considerations it remains to be seen whether and to what extent Canadian courts will enforce letters of indemnity provided in exchange for clean bills of lading in cases involving allegedly damaged cargo, in the future.