LOIs - worth more than the paper they’re printed on?


Published: 23 September 2021

Credit to: Borsuk Renat / Shutterstock.com

We reconsider the risks and benefits of exchanging Letters of Indemnity (LOI) under standard and extraordinary vessel operations.

Skuld recognizes a noticeable rise in the use of Letters of Indemnity in day-to-day operations in the industry, and, consequently, a great rise in the number of queries from our mutual members and assureds seeking Skuld advice or assurances on the drafted language. Skuld is always prepared to address these queries on a case-by-case basis, but in the meantime wishes to provide some reminders hopefully far in advance of parties needing to resolve a commercial dispute at a final hour.

An LOI provides the very practical function of allowing one party on an ad hoc basis to take on specified risk(s) in performing a particular operation or set of operations involving risks that he or she may not otherwise be legally obligated to bear. The parties in the most ideal circumstances can continue to enjoy a cooperative commercial relationship with this promise of indemnity memorialized in a legally enforceable writing.

Please note that this information is not meant to replace Skuld’s important October 2019 Enforceability of LOIs – a practical guide, provided by our colleague Aislinn Fawcett. Instead, we follow up and highlight concerns already addressed within this guide, with respect to inherent risks with enforceability and the potential conflict with traditional club cover.

Members as prospective recipients of an LOI

The risks undertaken pursuant to an LOI are traditionally those that lie outside of club cover, either as extraordinary risks explicitly excluded under conditions of cover or in some circumstances only available for cover subject to prior risk assessment and express confirmation by club management in writing.

Skuld understands the commercial pressure that members and assureds face when negotiating LOI terms, because the reassurance they stand to gain in accepting an LOI from their counterparty is effectively a substitute for prejudiced or missing cover. By the same token, a breach of this promise can represent a great liability not only for the underlying risk, but also legal defence, no matter whether this breach is committed deliberately and wrongfully or as consequence of unfortunate circumstances.

Skuld is regularly notified of disputes where a promisor of indemnification is not willing or able to honour his or her promise. Despite how advantageous its terms, an LOI’s promise that cannot or will not be honoured in short course quickly becomes the focus of a costly, drawn-out legal dispute between not only the parties to this LOI, but also several other sets of counterparties in the contractual chain trying to enforce their own rights on back-to-back LOI terms.

For reasons above, the enforceability of an LOI as a contractual agreement is paramount to this commercial decision. As discussed in Skuld’s October 2019 practical guide, common challenges to the validity of an LOI is the LOI’s signatory valid authority and claims that the LOI cannot be enforced on the grounds that it promotes illegality—for example, that one or both of the parties knowingly or negligently engaged in facilitating fraudulent activity against the interests of an innocent third party. These are only common examples, but of course claims and defences will vary depending on the governing jurisdiction.

Skuld always reminds members and assureds of their obligation to make commercial decisions as a “prudent uninsured,” especially for risks that may not be covered. Despite the ongoing obligation that members and assureds recognise and responsibly act against risk of extra liability exposure, due diligence is always required to assess the strength of the commercial relationship between the parties and the enforceability of promises exchanged between them.

Aside from the legal enforceability of its terms, an LOI must also be practically enforceable. The promising party must be creditworthy, or have enough assets to willingly—if not under force of law—honour this promised indemnity. As discussed in Skuld’s October 2019 practical guide, a first-class bank’s co-signature guaranteeing the credit of the indemnifying party is the “gold standard” for evaluating the promisor’s creditworthiness. However, obtaining same will often not be feasible under the circumstances.

With respect to the specific terms of agreement, it goes without saying that the recipient of a promise of indemnification must negotiate for inclusion of the broadest indemnifying language possible.

Members as prospective offerors of an LOI

Much advice on LOIs has already been given on the risks and pitfalls of club members and assureds as parties receiving the promise of indemnification. However, it is just as important for Skuld to point out potential pitfalls for those making a promise of indemnification to take on certain risks. Promising indemnification to another party for some extraordinary risk-taking operation outside of already approved terms nearly always corresponds to increased exposure to liability, often in contravention of the terms of club cover.

This is especially common with respect to the carriage of cargo, for example where special risks to be undertaken will expose members or assureds to loss of special rights or defences under the Hague or Hague–Visby Rules, or similar rules of carriage. Skuld’s terms of cover exclude risks for actions taken negligently or deliberately in breach of these rules. Among these rules are the omnipresent seaworthiness obligations and strict conformity to rules concerning the issuance of bills of lading. Invalidly issuing clean bills of lading or issuing claused bills that otherwise do not accurately conform to the facts of the shipment are chief among the root of carriage-related disputes where club cover might be prejudiced.

In highlighting these concerns above, Skuld wishes to make clear that a member or assured promising indemnification for risks undertaken in contravention of Skuld rules or terms and conditions will not automatically be protected under Skuld cover by reason that it has received an LOI on back-to-back terms. Put in another way, the LOI that a member or assured receives for a non-covered risk is effectively a substitute for prejudiced cover, and an LOI on back-to-back terms does not revive this cover.

When members or assureds are considering promising to indemnify a counterparty and take risks outside of the terms of Skuld cover, it is essential to timely contact Skuld to seek special guidance, approval based on current cover terms, or a quotation for additional cover (where available). If this is not followed, it is possible that the club may be limited in providing assistance or support.

Please note that this Skuld advice is meant for general guidance purposes only and should not be relied upon as legal advice or a formal position with respect to club cover. In the case of any doubt related to Skuld’s support for Letters of Indemnity in your specific matter, we invite you to contact your dedicated claims handler or underwriting representative.