Letter of undertaking

In this issue of The Field, Lewis McDonald of Skuld Offshore shares some thoughts in relation to Letters of Undertaking.

"Sensible and experienced solicitors do not, as a matter of course, go out and issue in rem writs when they are already protected by a Club undertaking " – High Court Judge Timothy Walker.

The Club Letter of Undertaking (LOU) is an incredibly powerful tool which clubs can provide to an owner, when facing the threat of the arrest of their vessel by a claimant seeking to secure a claim. The LOU is not only a form of security that is recognised in the vast majority of maritime jurisdictions around the globe, but also one which can typically be issued much more readily than other forms of security, allowing the threatened vessel to resume trading much more swiftly. As Walker J. makes clear in the quote above, LOUs enjoy something of an exalted status, but how did that come to pass and how do LOUs operate?

Background

Most courts have the power to grant orders requiring the defendants to an action to provide security to the claimant, provided certain thresholds are met. For the majority of claimants, it can be extremely difficult to pinpoint bank accounts or assets owed by the defendant, or to demonstrate a pressing need for security. However, when it comes to disputes arising from shipping, there is a very visible asset for the claimant to seek to attach, and the transient nature of shipping providing a basis to demonstrate a necessity for security to be provided.

When a vessel is arrested, that prevents it from leaving port until the arrest is released. If the vessel cannot leave port, it cannot trade and this has a potential double consequence for the owners – not only are they not making any money from their asset, they also potentially face claims from other parties for their failure to fulfil contractual obligations. It is therefore extremely important for them to be able to have the arrest swiftly released.

There are many ways in which an arrest can be either avoided or released but, in shipping, the one most commonly sought and utilised by owners is the provision of an LOU. The LOU can either be provided before the ship is arrested, so as to stave off the possibility of arrest, or after the ship has been arrested, as a substitute form of security. Once the LOU has been accepted by the claimant, their claim is secured on a without prejudice basis, and the vessel will be released.

What is an LOU?

LOUs are, in effect, a form of guarantee issued by the Club – an undertaking to pay to the claimant the sum adjudged by a court to be due to them, or the sum agreed under settlement terms. This is a private security contract between the parties and the court is not involved in the process of setting the terms of the undertaking, which are negotiated between the Club on the one hand and the other party (whether that be a contractual party, a third party or another club or insurer) on the other. This is an important point, as only the Club, and not the assured, agents, representatives or the Club's local correspondents, have the authority to issue an LOU.

While the exact wording of the LOU will vary from club to club, they will all display the following features: the name of the assured vessel; the name of the claimant; a description of the incident giving rise to the claim; the maximum sum guaranteed (which is inclusive of interest and costs); the law and jurisdiction for dealing with the claim; the catalyst for payment; and, a reservation of all rights and defences.

When can an LOU be issued?

In order for the Club to be able to issue security, a number of factors must first be met: The ship must be entered at the time of the event giving rise to the security request; all premiums have to have been paid; there should be no other sums outstanding; the required wording must be acceptable; the security sum sought must be reasonable in all the circumstances; and, the event for which security is sought must be a covered event.

It is however important to note that even if all these factors are met, the Club is not obliged or under a duty to issue an LOU. The provision of security is wholly discretionary and if it is issued, it may also be subject to additional considerations and will always be considered on a case by case basis. One such consideration that is of particular importance is that clubs have to be very careful to avoid issuing security which may end up with them facing a demand from a sanctioned entity. It should also be noted that it is not possible to provide "anticipatory security" – or security in case a claim arises in the future.

What are the advantages?

For the owner, there are a number of advantages in providing an LOU to a claimant rather than issuing an alternative security. Most obviously, the alacrity with which an LOU can be issued as compared with, for example, a bank guarantee, is significant. In cases where an LOU can be issued, it is not at all unusual for it to be issued in a matter of hours. The fact that LOUs are so widely recognised also adds to the general speed of the process.

In the current climate, the fact that there is no fee payable by the assured to the Club for issuing security, while if a bank guarantee was issued it would be subject to various charges, which is a significant benefit to the assured.

Other, potentially less obvious benefits are the fact that issuing security also allows parties to negotiate the law and dispute resolution forum, which can be extremely important when facing a claim in a tricky jurisdiction and, as noted above, the fact that the LOU is a continuing security that is risk free for the claimant also enhances its appeal.

How we can help

Although issuing an LOU is an entirely discretionary matter, we recognise its importance to the industry. In circumstances where security may be required, it is very important that Skuld are advised as soon as possible. This will allow us to properly consider all avenues available and to take the steps necessary to protect the owners' interests. In addition to our regular contact details, we can be contacted on our 24-hour emergency response number: +47 952 92 200.