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Constructive Loss of a Ship Due to the Non-constructive Position of Cargo Owners: Features of Disputes Due to Blocking of Ships in Ports

Date of publication: 19 June 2023

Sergey Nedelko, Attorney at Law, Counsel, Head of Odesa Office

Source: Yurydychna Gazeta

According to the Skytek monitoring group, as of 21 February 2023, 58 vessels with a total market value of USD 440 million remained blocked in Ukrainian seaports. According to the report of the Interfax-Ukraine news agency with reference to the press service of the Ukrainian Sea Ports Authority of (USPA), as of 14 March 2023, 51 ships were still unable to leave Ukrainian ports. Since then, the situation has not changed dramatically.

Blocked ships can be conditionally divided into 3 groups according to the location in ports:

1. Closed ports of Berdiansk, Mariupol, Skadovsk, and Kherson (Order of the Ministry of Infrastructure of Ukraine No. 256 dated 28 April 2022) – all vessels;

2. Ports of the Mykolaiv region, located in the area of active hostilities, where navigation is impossible for security reasons – all vessels;

3. Ports of Great Odesa, involved in the Grain Initiative – vessels that do not formally meet the criteria for participation in the Grain Initiative, which include: (a) vessels that are not directly designed by their type for the transportation of grain cargo (for example, Joseph Schulte container ship in Odesa Port), or (b) vessels that are unable to leave through the Grain Corridor due to the nature of the cargo on board, which for one reason or another cannot be replaced.

From 25 February 2023, one year after the actual suspension of navigation in Ukrainian ports, shipowners received the right to claim compensation for total constructive loss if the ships were insured in accordance with the provisions of the Institute War & Strikes Clauses (IWSC). This article will deal specifically with the vessels of the last category, in respect of which the insured (shipowners) made notices of abandonment, justified by the total constructive loss of the vessel due to the impossibility of free possession and disposal of them. This category of ships causes the most disputes between shipowners and insurance clubs in terms of the validity of recognizing the ship as having suffered a total constructive death.

Constructive loss of a ship: concept and regulation

Total loss of the vessel can be actual or constructive. Insurance coverage of total loss also includes constructive coverage, unless otherwise provided by the terms of the insurance policy. Typically, ship insurance policies are subject to the law of England and Wales and contain arbitration clauses, so it is advisable to consider the conditions for establishing and the consequences of constructive loss taking into account the provisions of the Marine Insurance Act 1906 and English case law.

Therefore, under the Marine Insurance Act 1906 (Section 60), subject to any express provision in the policy, constructive total loss occurs where the insured object is reasonably abandoned because: (i) its actual total loss is inevitable or, or (ii) the impossibility of saving the object from the actual total loss without costs that may exceed its value at the time of their incurrence. In Ukrainian legislation, structural damage/destruction of a vessel is defined as resulting in the loss of the ship’s seaworthiness, after which it is not advisable to carry out refurbishment (disaster) (Order of the Ministry of Agrarian Policy and Food of Ukraine dated 8 September 2017 No. 500, Order of the Ministry of Infrastructure of Ukraine dated 29 May 2006 No. 516).

According to the Marine Insurance Act 1906 (Section 60), constructive loss occurs when the insured has lost free possession of the vessel or goods as a result of the insured risk and: (a) it is unlikely that he will be able to regain possession of the vessel or goods, depending on the specific or (b) the cost of regaining possession of the vessel or goods, as the case may be, would exceed their value upon restoration. At the same time, it is not important whether the deprivation of the opportunity to own the vessel was lawful (arrest, detention, forcible seizure, etc.) or occurred as a result of illegal actions of other persons (for example, capture by pirates).

Conditions for determining constructive loss

The Marine Insurance Act 1906 does not disclose the meaning of the concepts of dispossession and reasonable time in the context of such dispossession, although they are key to establishing constructive death.

At the same time, it is advisable to be guided by the conclusions of arbitral awards, which have a precedential value in English law. The Bamburi case (1982) is indicative, during which a dispute was resolved between the insured and the owner of the ship of the same name, detained by the Iraqi authorities on the Shatt al-Arab waterway during the Iran-Iraq war of the 1980s. There were no claims from the Iraqi authorities regarding the ownership of the ship, but the shipowners lost the right of free use and disposal. In the Bamburi case, the issue of the interpretation of the concept of loss of possession was decided. The arbitrator upheld the finding previously made in the case of Panamanian Oriental v. Wright Footnote, that loss of possession means deprivation of rights of free use and disposal. The arbitrator also referred to the case of Peele v. The Merchants’ Insurance Company, in which a district court judge noted that damages, in terms of law, do not necessarily involve the actual destruction of the insured object – it can technically exist when the thing is safe but temporarily lost to the owner or withdrawn from his free use and possession.

Also, the Marine Insurance Act 1906 does not define what constitutes a reasonable time for loss of possession, so it is necessary to refer again to the findings of the arbitrator in the Bamburi case, who decided that the time should be 12 months. After the Bamburi case, modern insurance contracts and war risk insurance policies introduced a retention clause and specified a continuous period of loss of possession.

For example, under the IWSC standard clause, for the purpose of establishing total constructive loss, the insured is deemed to have been deprived of possession of the vessel without any reasonable possibility of its recovery if: (i) the vessel is captured, arrested, confiscated, expropriated or detained; (ii) as a result, the insured lost the right to free use and dispose of the vessel continuously for 12 months. However, in some insurance policies there is also a reduced period of 6 months, after which the shipowner can declare the total constructive loss of the vessel.

Consequences of the constructive loss of a vessel

According to the Marine Insurance Act 1906 (Section 61), in the event of a constructive loss, the shipowner may consider the damage as a partial loss or abandon the insured vessel in favor of the insured and consider the damage as a total actual loss. If the insured decides to abandon the insured vessel, he must inform the insurer about this by making a notice of abandonment, which means a total and unconditional renunciation of his rights to the vessel in favor of the insurer and a requirement to receive the full insured amount.

The Marine Insurance Act of 1906 does not specify the form of a notice of abandonment, and it may be written, oral, or partly written and partly oral. A mandatory requirement is that the notice of abandonment can clearly establish the intention of the insured to unconditionally renounce his interest in the insured property in favor of the insurer.

After the shipowner has made a notice of abandonment, he must not take any action that would contradict the intention to unconditionally leave the property to the insurer. Therefore, for example, the continued work of the crew on the vessel, partial operation of the vessel, its sale, arbitration proceedings on the collection of freight or demurrage from the charterer can be used by the insured to refute the position of the shipowner about the loss of free ownership and abandonment of the vessel.

Total constructive loss of vessels blocked in Ukraine

Regarding ships blocked in closed ports and ports in the area of active hostilities, the situation, in general, is clear and does not cause fundamental disputes. However, such disputes arise regarding the statements about the total constructive loss of the vessels of the third group indicated above, which before the start of the full-scale Russian aggression entered the ports of Great Odesa, were loaded with non-grain cargo (cast iron, ore, metal, etc.) and currently cannot unload, take on board agricultural products and eventually leave the port through the Grain Corridor. The reason is that cargo interests (charterers/ consignors/ cargo owners/ consignees) do not agree on such unloading for their own reasons.

In such cases, insurers mostly reject shipowners’ notices of abandonment, justifying their decision as follows:

1. The nature of the cargo on board is the main reason for the declared loss of the vessel, which prevents it from leaving the port. Shipowners have not lost the opportunity to freely use and dispose of the vessel, as the vessel can freely leave through the Grain Corridor provided that the cargo on board is replaced.

2. The shipowner makes insufficient efforts and does not apply all possible measures to unload non-grain cargo and release the ship. In this case, the insurer reserves the right to suspend the insurance coverage.

3. Application of the Doctrine of Frustration in English Law. As a matter of law of England and Wales, the charter contract in this case has all signs of frustration under the Law Reform (Frustrated Contracts) Act 1943 since: (a) the circumstances (war and restriction of navigation) arose after the conclusion of the charter contract, (b) the circumstances are beyond the control of the parties and beyond their control, (c) the fulfillment of obligations under the contract is objectively impossible under the current circumstances. In this case, the obligations of the parties terminate.

Under English law, the doctrine of frustration does not require the shipowner to apply to arbitration to establish such a fact and terminate the charter contract. To terminate contractual obligations, it is sufficient to notify the other party (charterers/ cargo owners), and their consent to terminate the contract is not required at all. After that, the shipowners have the right to demand from the cargo owners to pick up their ships at their location. If cargo owners do not comply with the requirement, the shipowner has the right to unload the ship on his own without the consent of the owner/ charterer or other parties concerned (cargo interests) with subsequent collection of costs from the other party. In Ukrainian legislation, an analogue of frustration is the termination of an obligation due to the impossibility of its fulfilling due to a circumstance for which neither party is responsible (Article 607 of the Civil Code of Ukraine).

Therefore, the ability to restore the free use and disposal of the vessel and, accordingly, the validity of the notice of abandonment in connection with the total constructive loss of the vessel depends on the possibility of unloading non-grain cargo from the vessel and loading it with agricultural products. However, it is extremely difficult to carry out forced unloading without the consent of cargo interests and the assistance of the terminal.

Disputes between shipowners and cargo interests regarding the unloading of the ship

Undoubtedly, the best option for the shipowner would be to agree with cargo interest on the unloading of the cargo. However, the latter will often refuse to give consent, in particular, due to the possible loss of war risk insurance coverage for the cargo after it has been unloaded at the terminal and possible destruction or damage as a result of hostilities.

If the charter contains a Voywar 1993 military risk clause, it will be easier for the shipowner to find legal grounds and carry out the unloading. The clause provides that the shipowner has the right to unload the cargo at any safe port of his choice (including the port of loading), thereby fulfilling the contract of carriage, subject to the following conditions:

1. In the reasonable opinion of the master and/or owners, the vessel, cargo/part of it, crew or other persons on board the vessel may be or are likely to be exposed to war risks.

2. Owners sent a message to the charterers asking them to designate a safe port for unloading the cargo/part of it.

3. Within 48 hours of receiving the notice, the charterers have not designated such a port.

Guided by the Voywar 1993 clause, the shipowner of the SEA LUCK bulk carrier under the flag of Panama managed to unload and release the ship, which had been blocked in the Odesa port since the beginning of the full-scale Russian invasion.

Search for alternatives under Ukrainian law

An alternative way to solve the problem could be the application of measures to secure a claim in a possible dispute with the participation of the shipowner. Since mostly all charters are subject to English law and have an arbitration clause of the London Maritime Arbitrators Association, such securing is possible in support of a claim submitted to international commercial arbitration/arbitration court in accordance with the Code of Civil Procedure of Ukraine, that is, after initiation of arbitration proceedings. The corresponding claim together with copies of the statement of claim, evidence of its submission and the arbitration agreement is submitted to the general court of appeals at the location of the arbitration, the defendant or his property at the choice of the applicant (Articles 151-152 of the Civil Procedure Code of Ukraine).

However, in practice, Ukrainian courts adhere to a rather formalistic approach to the consideration of such claims, demand a high standard of evidence from the applicants and carefully evaluate them. Unfortunately, appellate courts of general jurisdiction do not always fully understand the specifics of legal relations in ship chartering and maritime transportation, because cases of this category do not belong to their specialization and are extremely rare in general courts.

This conclusion can be reached after reading the court decisions in the case regarding POLARSTAR vessel, which remains blocked in the Odesa port with a cargo of steel products on board. The shipowner filed a claim with the Ukrainian court to secure an arbitration claim for the recovery of freight debt, additional insurance premiums, bunkering costs and compensation for future potential losses. Collections were rarely carried out by recognizing the shipowner’s lien on the cargo with its subsequent realization. In order to secure his claims, the shipowner asked to seize the cargo, prohibit its alienation and hand it over to a third party at the shipowner’s choice for safekeeping.

Unfortunately, the Ukrainian procedural legislation does not contain effective mechanisms that could guarantee the forced unloading of the vessel in order to secure a claim. Currently, the problematic issues in this aspect are:

1. Absence in the procedural codes of such a method of security as the obligation of the defendant to perform certain actions and the transfer of the subject of the dispute to persons not otherwise involved for safekeeping – this method of securing was excluded in 2020;

2. Inability to secure a claim prior to the commencement of arbitration proceedings by analogy with securing a maritime claim;

3. High probability of non-fulfillment of the court ruling on securing a claim – even if the shipowner receives a ruling on securing a claim involving unloading, the port operator can simply block the actual unloading on quite legal grounds, so the assistance of the terminal is almost decisive in the process of forced unloading. At the same time, very often terminals have a conflict of interests, so they simply refuse to conclude a transshipment contract with the shipowner and fulfill any of his requirements regarding the cargo.

To date, we are aware of at least six sea vessels with a total value of tens of millions of US dollars, that remain blocked in the ports of Great Odesa with non-grain cargo on board and in respect of which there are disputes between ship owners and insurers regarding the validity of the claimed total constructive loss. Such vessels have actually become victims to the non-constructive and unscrupulous position of cargo owners, who do not allow the unloading of non-grain cargo, as well as certain imperfection of the legal regulation, which does not provide for a clear mechanism of forced unloading.