TT Talk - Letters of indemnity in the global supply chain
Letters of Indemnity (LOI) are quite frequently used in the international shipping and trade practice. Despite discussions and advices around the topic, there are always concerns around the value and enforceability of such undertakings.
What is a Letter of Indemnity (LOI)?
LOIs are contracts between two parties whereby the issuing party (indemnifier) asks the recipient to do (or not to do) something in return for the issuer’s indemnity in the event that the recipient suffers any loss as a result of his compliance with such request.
When would an LOI be required?
Whilst there is no exhaustive list of all the situations under which LOIs may be requested, the most common circumstances would include the following:
- a carrier is asked to deliver cargo without presentation of the original bill of lading
- a carrier is asked to deliver cargo at a port other than the one originally specified in the bill of lading [these first two, separately or in combination, arise frequently since ships may have arrived at the port of discharge before the necessary documents or even before the bill of lading has been produced]
- a bill of lading has been lost
- ‘split’ or ‘switch’ bills of lading need to be used
- a dispute arises regarding the condition or quantity of the goods
- a ‘clean on board’ bill of lading is requested instead of a ‘claused’ bill [note, however, that if the condition of the goods has been deliberately misrepresented and the carrier is aware of it, this indemnity will be unenforceable]
It is, however, not uncommon for LOIs to be pursued more extensively to cover other perceived trade or incident risks. Where exposure may already be addressed by contract or established law, it may be more appropriate to seek evidence of valid insurance protection, which may be less of an irritant to customer relations, as well as more efficient and effective.
Which are the parties to a LOI?
In principle, there will be three parties involved:
- the recipient (mostly the carrier or other third party beneficiaries), requesting the indemnity;
- the issuer or indemnifier (in most circumstances cargo interests, such as shipper or consignee), granting it; and
- a bank to back up the indemnifier.
The recipient needs to be confident that the issuer is reliable and creditworthy, able to meet its contractual undertakings. Consequently, it is preferable to ensure that the security is counter-signed by a parent company or by a first-class bank. Inevitably, for commercial reasons, an issuer may resist this additional level of guarantee and recipients may not insist. Note, however, that the LOI is only as good as the reliability and the creditworthiness of the party issuing it.
Note that the LOI is only as good as the reliability and the creditworthiness of the party issuing it
What should the LOI always include?
LOIs need to be carefully worded and, while not an exhaustive checklist, should always include:
- detailed description of the reasons why such indemnity is being requested
- parties to the LOI (issuer and addressee/recipient) – ensure the issuer has signed the document and it is addressed to the correct party
- clear request to the recipient to do or refrain from doing something
- financial limit to the indemnity (noting that the recipient may prefer an unlimited indemnity)
- risks against which the recipient would be indemnified
- undertaking to provide the funds or the security to defend a possible claim
- governing law and jurisdiction
What are the risks?
As mentioned above, LOIs are only as good as the reliability and creditworthiness of the party issuing it. The recipient must carry out due diligence and ascertain that the issuer is trustworthy and sufficiently solvent to satisfy his undertakings in case the indemnity is called upon. Where there is likelihood of insolvency, the LOI request should be declined.
LOIs carry risk and the recipient may ultimately receive liability claims for breach of contract, for mis-delivery or conversion. Furthermore, the LOI might be unenforceable for various reasons, such as the issuer’s financial difficulty to comply with his undertakings, potential time bars or the LOI being found illegal.
It is advisable to check with your liability insurer to ensure the LOI does not prejudice cover, for example with excluded liabilities.
Mitigating the risks
Taking into consideration that the recipient is accepting risk, ensure that the indemnity is granted against any losses, damages, costs and consequences that may arise out of the risks associated with the issuer’s request. Inevitably, the broader the scope of the indemnity, the better security may be afforded to the recipient.
In relation to the security provided, the recipient could seek for the indemnity to be issued jointly by the shipper and consignee, and counter-signed by a first class bank.
Moreover, the recipient should ensure that the validity of the indemnity is sufficiently extended to cover for the risk being accepted, even beyond a potential time bar under the contract of carriage, and, if possible, avoid having time limits in the LOI.
For all such reasons, it is prudent to take legal advice.
Considering the position carefully, and obtaining proper guidance and advice, can prove critical for mitigating the risks – as well as ensuring that LOIs are an appropriate and effective trade tool. Each circumstance will turn on its own facts and, therefore, TT would urge liaising with your liability insurer (such as the Club) and consulting with your lawyers in order to provide specific advice and practical recommendations.
Considering the position carefully… can prove critical for mitigating the risks – as well as ensuring that LOIs are an appropriate and effective trade tool
If you would like further information, or have any comments, please email us, or take this opportunity to forward to any others who you may feel would be interested.