A Brief Guide to Liquidated Damages

We often receive queries from readers at the Shipping Law Blog, and today we received one from a non-lawyer, who had been asked to confirm whether one of their contracts contained a 'liquidated damages clause'.

(Image Credit: Western Area Power)

To non-lawyers this language is typical of the legalese used by lawyers, to refer to what is really a very simple concept; in short it means, does the contract contain specific compensation amounts payable.

When two parties enter into a contract they agree to both do something for each other (consideration). Normally, in the maritime industry, one party pays and the other performs a service. If either party does not maintain their side of the deal they are considered to have breached the contract. 

Only very serious (fundamental / repudiatory) breaches will actually bring the contract to an end. So, in general, the legal position is that the party who has breached a part of the contract must pay the other compensation (damages) for that breach and the contract continues. Normally, when such a breach happens, the parties have to agree on how much compensation should be paid, or the case goes to arbitration or court to decide. 

Litigation costs an awful lot of money and in cases like a long-term hire agreement for a vessel (charterparty), where there will probably be many small breaches, it is better for the parties to agree beforehand how much compensation is due for different types of breach. These amounts are then inserted in the contract and becasue they are damaged which have been refined to specific (normally USD) amounts, they are known as liquidated damages. 

Example

A common example would be demurrage. When you hire your ship, you might say that the ship will spend 1 day at the load port and 1 day at the discharge port. The charterer therefore agrees that they will load the cargo and discharge the cargo at their chosen ports within this timeframe. If the vessel stays in port longer (say because the Charterers are slow to get the cargo trucked to of from the ship), the vessel owner will incur additional charges, fees and delays. Therefore a clause in the charterparty may say that demurrage (i.e. delay by the charterer) will be charged at USD 500 per day, or pro rata per hour. When there is a delay of 3 hours, this becomes payable, without an argument as to whether it is reasonable.

Penalty Clause

The amount cannot be any amount, but must broadly reflect the additional costs of the breach on the party who has suffered. Otherwise the English Courts would likely consider the clause a penalty clause, which would be unenforceable under English Law. The main case law on this area dates back to 1915 (Dunlop Pneumatic Tyre Co Ltd vs New Garage & Motor Co Ltd), and outlines when a liquidated damages clause will be considered a penalty clause.

GUIDE: Salvage Claims

'Salvage' is the term used in maritime law to refer to the process whereby a third party rescues a vessel from a danger which would have likely destroyed it by sinking, breaking it up or otherwise. 

The third party is generally entitled to a financial reward for such an action as their assistance can often lead to a saving of several thousands or millions of dollars for the vessel's owner (the vessel may be worth a considerable amount, its cargo may be worth a considerable amount and the consequences of its loss being avoided - i.e. no fine for oil pollution - may also be worth a considerable amount to the owner.

A salvage operation is generally distinguished from 'wreck removal' as its purpose is usually to save a vessel as a going concern, whereas a wreck removal generally concerns a vessel which is already agreed to be a total loss. Consequently salvage operations usually try to cause minimal damage to the concerned vessel whereas wreck removal operations often involve intentionally breaking the vessel involved into pieces.

There are myriad laws around the world concerning salvage and each situation will turn on the particular laws and contracts that apply, as well as the court which has jurisdiction, but there are some general principles which are useful to know as a base knowledge.


GENERAL PRINCIPLES

1. Normal contractual assistance will not generally constitute a salvage operation. For example, if your vessel is in distress and you decide you need the services of a tug to tow you to a safe port. If you radio a local port and agree basic contractual terms for a towage operation with a set fee then the tug owner could not take your vessel back to port and claim salvage.

2. It is generally accepted that the salvor has a right to a reward for saving the vessel because as we have seen above his service in this regard can be priceless but clearly he cannot merely decide the ship is his own property. Therefore the courts' view is that an amount of reward should be given to the salvor by the distressed vessel, which is appropriate to the value of the vessel saved, the level of distress it was in and the level of risk which the salvor(s) had to take to salve the vessel.

3. As time is of the essence when a vessel is in distress it is understood that neither the salvor nor the captain / owner of the distressed vessel will generally have time to take lengthy legal advice and negotiate contractual terms for the salvage operation. For this reason procedures such as LOF (Lloyds Open Form), have evolved,  which allow the parties to essentially agree that the operation will go ahead and if they are unable to agree on the appropriate amount of salvage reward afterwards then a specialist arbitrator appointed by Lloyds of London shall make the decision. This option is popular with salvors and distressed vessels as in the heat of the moment it allows decisions to be made quickly without the risk of any gross injustice resulting to either side.

4. In some countries certain vessels in distress may be able to benefit from the assistance of a charitable organisation, such as the RNLI in Britain and Ireland. They respond rapidly to emergencies at sea and whilst the crewmembers waive their right to claim maritime salvage, it is widely accepted that a suitable donation should be made to the service in lieu of them claiming any salvage.

OTHER TYPE OF MARINE SALVAGE

A. FLOTSAM / JETSAM
These terms refer to parts of a ship or its equipment or cargo which wash up ashore. Flotsam refers to things which are accidentally lost at sea (say cargo which is washed overboard in a storm) and Jetsam refers to things which are intentionally put overboard (usually to lighten the ship in heavy weather or in the event of engine problems). When either washes up on the shore they are sometimes referred to as salvage, mainly because in principle those finding them are rescuing them on the shipowners behalf (they should be reported to the receiver of wrecks but sadly this does not frequently happen).

B. DAMAGED / UNWANTED CARGO
Often cargo which is not paid for or accepted by the consignee (say rolls of paper which have got wet during transit and the buyer rejects them or shop fittings for a shop which has gone bankrupt) will be sold as, or for, salvage. Often such goods only achieve a fraction of their original value, which is referred to as their salvage value.