The Mutual Insurance Club`s letter of undertaking: prospects for use in Ukraine

Evgeniy Sukachev

senior partner

Irina Dolya

associate

Black Sea Law Company

International merchant shipping is undeniably a link for the global economy. At the moment, it is impossible to imagine the vigorous activity of the global market without the ability to ensure uninterrupted transportation of significant volumes of cargo over long distances along international sea routes.

Relations in the merchant shipping sphere are regulated not only by national systems of laws and codes, but also by international law, including the use of documents of a recommendatory nature and customs.

In the process of transporting goods by sea, incidents are not uncommon, which may subsequently lead to claims and a dispute between the parties to the carriage. Since the ship is a permanent participant in such legal relations, the ship can become the first “hostage” of your dispute.

To date, Ukraine has ratified the International Convention Relating to the Arrest of Sea-Going Ships of 1952 (Brussels Convention), which establishes the procedure for the arrest of a ship as security for a maritime claim. The Brussels Convention provides for 17 types of maritime claims. The main criteria for determining a claim as maritime one, is the emergence of a claim from legal relations related to the use of the ship.

To implement international provisions, each of the countries participating in the Brussels Convention additionally has its own legal instruments for the arrest of a ship in order to secure maritime claims, which are determined by national legislation. In Ukraine, such rules are contained in the Merchant Shipping Code of Ukraine, the Commercial Procedural Code of Ukraine and the Civil Procedure Code of Ukraine.

It should be noted that the Brussels Convention clearly indicates that the arrest of a ship should only be imposed by a court or a judicial authority, which, in our deep conviction, excludes the possibility for any state authorities to exercise their authority to arrest a ship and impose restrictions on ship`s commercial activity.

In addition, we must accept the indisputable fact that the maritime business, in all its aspects, needs to make quick, competent and professional decisions to exclude even the slightest possibility of delay in meeting obligations, and causing financial losses. Merchant shipping is always tied with exceptionally great financial risks, and it is not surprising that the legal insurance institution first appeared in this area.

Commercial insurance is the most common in the maritime business, in which a specialized insurance company directly insures the risks of its customers (policyholders) and for this receives an insurance premium, as well as mutual insurance of special associations (Protecting & Indemnity Club, P&I Club, Mutual Insurance Club), the essence of which is based on a voluntary association of interested shipowners with the aim of creating a common insurance fund to cover accidental losses of association`s members; the insurance fund is formed by contributions and each member of the club is essentially both an insured and an insurer.

The Mutual Insurance Club`s LOU is an incredibly powerful tool that clubs can provide to the owner when they are threatened with the arrest of their ship by the plaintiff trying to secure a claim. LOU is not only a form of security recognized in the vast majority of maritime jurisdictions around the world, but also a form that can usually be issued much more easily than other forms of security, allowing the threatened ship to resume trading much faster.

It is important to note that according to established international practice, the concepts of Letter of undertaking (LOU) and Letter of indemnity (LOI) are separately distinguished. GARD SA, the International Mutual Insurance Club in Loss Prevention Circular No. 01-10, points out the distinction between the concepts of Letter of undertaking, Letter of indemnity and bank guarantee.

The main ground of sending a Letter of indemnity is the need to deviate from the established agreement, which is expressed in the active actions of one of the parties, for example, making a ship call at a port that was not previously determined by a charter party. Thus, the LOI gives the party that performs the risky action a guarantee of compensation for damage that may be caused by such an action.

On the other hand, Letter of undertaking is issued in case of an incident that has caused or may lead to losses in the future. This form of security provides a guarantee if there is already a claim to the vessel that is subject to security.

Despite the presence of several types of documents described above, it is the concept of the Letter of undertaking of the Mutual Insurance Club (Letter of undertaking, LOU) that is to be considered in this article as a form of security, which must be fixed at the legislative level and introduced into widespread use for the territory of Ukraine in disputes over maritime claims.

It would seem that Ukraine, as a maritime state, should not be an exception, but the use of a P&I Club`s LOU is not a common practice in our country, if not to say otherwise. The concept of LOU began to develop back in 1855. Since then, clubs have constantly adapted to new trends in the maritime industry, and after World War II, clubs introduced new financial instruments to free ships from arrest. Given that issuing bank guarantees is a rather long, often highly bureaucratic, and painstaking process, which, in addition, entails additional financial costs for paying for bank services, P&I Clubs have introduced their own guarantee form.

In fact, the Letter of undertaking of the Mutual Insurance Club is a form of guarantee issued by the Club – an obligation to pay the applicant the amount due to him by court order, or the amount agreed upon under the terms of settlement. This is a private security agreement between the parties, and the court does not participate in the process of establishing the terms of the obligation, which are agreed between the Club, on the one hand, and the other party (whether it is a party to the contract, a third party), a participant or another club or insurer on the other. This is an important point, since only the Club, and not authorized agents, representatives, or local correspondents of the Club, are entitled to issue such letter of undertaking.

Although the exact wording of the Letter of undertaking will differ depending on the Club, they all display the following features: name of the vessel; name of the claimant; a description of the incident that served as the basis for the claim; maximum guaranteed amount (which includes interest and expenses); law and jurisdiction applicable to claim; catalyst for payment; and reservation of all rights. After the acceptance of such a letter of undertaking, the recipient must release the ship from arrest and not detain it again, at the same request (in most cases, such security is issued upon arrest of the ship, or even upon probable arrest).

For the recipient of such a letter, it becomes possible to collect the claim directly from the Club, and not from the Shipowner or the manager / operator of the vessel. The basis for the payment of the amount of the guaranteed obligation should be a final court decision, an arbitral award, or an amicable agreement. It is important that the Letter of undertaking has a purely discretionary nature, that is, the Club does not have an obligation to issue a letter for each individual case, but does so only by its own decision, guided by the situation.

For the Club, the Shipowner and the Recipient of such a letter of undertaking there are a number of certain advantages: firstly, the letter of undertaking has a light and flexible form of content, and secondly, the LOU, although it is made in writing, however, thanks to modern technologies, it can be delivered to any country in minutes. Due to the simple and capacious form of issuing a letter of undertaking from the P&I Club, the Shipowner minimizes, and in some cases avoids the additional costs that could be incurred in connection with the arrest of the vessel and the restriction of its commercial activities.

Most clubs further emphasize that the vessel for which Letter of Undertaking is provided should be included in member P&I insurance. The confirmation is a Certificate of entry from the Club. In other words, the vessel must be insured at the Club. In cases where the vessel was insured after the event, but before the arrest, the Club will not approve the issuance of LOU.

There is no single international act that would govern the adoption of a letter of undertaking from the Mutual Insurance Club. But despite this, the UK, Hong Kong, Australia, Italy, France, and Singapore accept this type of document as security. Most P&I Clubs note the effectiveness of using LOU, which is increasingly written in their publications.

Is it possible in Ukraine to use such a modern financial instrument as the Letter of Undertaking of P&I Club?

Based on the practice of representing the interests of both the mutual insurance clubs and the Shipowners in general, we believe that the letter of undertaking of the mutual insurance club in its interpretation and in essence is associated with the concept of the guarantee defined by the Civil Code of Ukraine.

Chapter 49 of the Civil Code of Ukraine describes the basic terms, conditions, and requirements of the forms of security. According to article 560 of the Civil Code of Ukraine, under a guarantee, a bank, other financial institution, insurance organization guarantees that the debtor will fulfill his debt to the creditor. The guarantee is valid for the period for which it is issued. The guarantee is valid from the date of its issue, unless otherwise specified in it. The guarantee cannot be revoked by the guarantor, unless otherwise provided in it, in accordance with article 561 of the Civil Code of Ukraine.

In case of the debtor`s violation of the obligation secured by the guarantee, the guarantor is obliged to pay the sum in accordance with the terms of the guarantee. The creditor's claim to the guarantor for the payment of a sum of money in accordance with the guarantee is presented in writing. The requirement is accompanied by the documents specified in the guarantee. The creditor may present a claim to the guarantor within the period specified in the guarantee for which it was issued.

The guarantor has the right to refuse to satisfy the creditor’s claim if the claim or documents attached to it do not meet the conditions of the guarantee or if they are presented to the guarantor at the end of the guaranteed period. The guarantor must immediately notify the creditor of the refusal to satisfy his claim. The guarantor's obligation to the creditor is limited to the payment of the amount for which the guarantee is issued. The guarantor's obligation to the creditor shall be terminated in the event of: payment of the amount for which the guarantee was issued; guarantee expiration date; the creditor renounces his rights under the guarantee by returning it to the guarantor or by submitting to the guarantor a written application for relieving him of the obligations of the guarantee. The guarantor who becomes aware of the termination of the guarantee must immediately notify the debtor.

It should be noted that LOU in its essence can be used in Ukraine and be recognized by state authorities of Ukraine without any restrictions. The validity and enforceability of LOU is indicated by its compliance with the requirements of applicable law. Also, LOU should be understandable and executable. The validity period of the document, as well as the procedure for its execution should be directly displayed in the content.

In case of Ukrainian legislation application, the guarantor under such document may be an insurance organization or other financial institution. Thus, the person issuing the Letter of Undertaking, for recognition by the Ukrainian authority, may additionally provide confirmation of his registration as an insurance or financial institution in accordance with the legislation of registration place.

Analyzing the Ukrainian legislation, it can be confidently stated that a number of certain changes should be introduced, or rather, additions to the existing legal acts in order to clearly determine the procedure for its application in the commercial practice of Ukraine. However, it is important to note that the current regulations do not prohibit the use of such a security tool and recognize the existence of an extensive guarantee institution.

The Commercial Code of Ukraine provides that, by agreement of the parties, the types of security for fulfilling obligations stipulated by law or those that do not contradict it may be applied. The provisions of the Commercial Code clarify such type of security as a “bank guarantee”, while pointing to the concept of a “letter of guarantee”, but only with respect to a document issued by a bank. The Civil Code clarifies the concept of “guarantee”, and also specifies the requirements and procedure for using this type of security.

The proceeding legislation (commercial and civil) also needs to be supplemented with norms regarding the ways of securing a claim, counterclaims, cancellation and replacement of security measures. Article 137 of the Commercial Proceeding Code provides for the possibility of securing a claim by other means in cases provided for by laws, as well as international treaties of Ukraine, the applicability of which is agreed by the Verkhovna Rada of Ukraine. Thus, it is possible to secure the claim with other means of security, for example, those provided for by the Civil Code of Ukraine. However, for the purpose of legal certainty, this article may be supplemented with a separate security measure, namely, the provision of a letter of undertaking to secure payment of claims by a solvent financial institution.

This decision of the commercial court is inherently revolutionary and progressive. This is actually the first case when the court describes and recognizes an international financial instrument – the Letter of Undertaking of the Mutual Insurance Club in the process of securing a maritime claim and declares the possibility of its use taking into account all regulatory requirements.

Once again, the commercial specialization courts showed professionalism and took into account the specifics of considering such a category of cases as an application for arrest of a ship; preparation of Shipowner`s representatives; groundless demands of the authorities; the absolute indifference of the representatives of the Environmental Inspectorate of Ukraine and the Administration of the Ukrainian Seaports to the judicial process, as well as the amount of losses that may be incurred by a foreign shipping company.

It remains for us to continue the diligent work in the most difficult disputes, seek justice, guided by law, common sense and optimism, as well as work on draft laws of Ukraine to improve and develop modern legislative and judicial systems and practices.

17 June, 2020
Ukrainian maritime bar association