Legal

Stepping in and out of shipping contracts

30 August 2018

Summary

In a volatile market where parties are susceptible to cash flow problems, a stronger party entering into a long charterparty can for instance minimise the risk of their counter party defaulting and bringing the contract to an end for non-performance by finding a third party Nominee, willing to step in, since there is no legal obligation, to the ongoing contract and novate it thereby preserving the contract.

Historically and in financially challenging periods, a large number of parties in the middle of the charterparty chains were defaulting on their obligations due to insolvency or bankruptcy. One way to circumvent the contract's life span being cut short and the innocent party having to claim damages against a financially insecure defaulting party was to have a Nominee on standby willing to perform the contract by novation on receiving notice to do so.

An incentive for a third party becoming a Nominee would be for a sub-charterer to benefit from favourable hire rates under a long term charterparty. Usually a parent or affiliate company would act as a third party Nominee but it is not unusual for a Sub Charterer who has a vested interest in the charter remaining in force to agree to becoming a Nominee.

What are Step-In Rights?

Step-In Rights otherwise known as Step-In Agreements permit a third party to step in to the shoes of a defaulting contractual party and replace them in order to continue the performance pursuant to novation taking place, and the new contract replacing the old one.

When a contractual party breaches the contract/cp by failing to pay hire or becomes insolvent during the life of the contract the Nominee will step in, fulfil and continue with the defaulting contractual party's obligations.

A Step-In Agreement is a novation agreement between two parties and their Nominee who is subject to conditions precedent, being default by one of the parties and the service of a Step-In Notice. They are used to enable continuity with one party being replaced by a Nominee.

What ensues is the Nominee steps in and under a novation and performs the contract in the normal way. This prevents the contract from coming to an end for want of frustration or repudiatory breach.

This type of novation is particularly widespread in financing and construction agreements but also has an important role in shipping contracts.

How can they be used in shipping contracts?

In related shipping matters, they provide a contracting party with a degree of certainty that if their contractual counter party defaults in performing its obligations.

Novation takes effect where two contracting parties agree that a Nominee, who also agrees, shall stand in the relation of either of them to the other.

How are Step-In Rights formed?

It can be entered into at the outset of the contract by way of a standard clause or as an addendum which lists events which give rise to triggering the Step-In Agreement.

But the assignment of the contract as a whole is impossible see Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1993] UKHL 4.

Under English law there can be no assignment of a contractual burden through transfer of all obligations. Rather it is a novation agreement by consenting parties who effectively create a completely new yet identical contract. It is therefore imperative that the consent of all three parties is obtained for novation to take effect. (see Chitty on Contracts (32nd ed) Vol.1, para 19-087).

Step-In Rights only seek to regulate what it concerns. If the parties have novated a 'head charter' it will only relate to that relationship.

As soon as the contractual party defaults thereby satisfying the condition precedent, the Step-In Agreement novates the original charterparty and introduces the third party as the new contractual party.

A further advantage of entering into a Step-In Agreement, rather than a performance guarantee, is the relative ease of enforcing it against the Nominee to perform or pay damages.

Triggering the Step-In Clause

The contractual party defaulting in their obligations under a charterparty would trigger the other contractual party to serve and send a written Step-in Notice to the third-party Nominee requiring them to step into the charterparty causing the defaulting contractual party to step out.

Usually a suitable Nominee would be a financial subsidiaries or sister companies of the contractual party defaulting under the contract.

The form of the Step-In Notice does not require any particular form; it need only be in writing and served on the third-party Nominee stating that the contractual party has defaulted and that the other contractual party requires them to assume the defaulting party's obligations under the charterparty.