A letter of intent to build the ship. Risks to shipyards and shipowners

A letter of intent in the process of concluding a shipbuilding contract is a commonly used instrument at the preliminary stage of negotiations between a shipowner and a shipyard. Although such a document is, in principle, non-binding, under certain circumstances its provisions may give rise to tangible legal effects. In the practice of the shipbuilding industry, the boundary between a declaration of intent and a contractual obligation is often blurred.

Letter of intent in the process of negotiating a ship construction agreement

Among other reasons, this explains why it has become almost standard practice for a shipyard and an interested shipowner to sign a so-called letter of intent (“letter of intent”). As a rule, by the date of signing the letter, the parties have already reached preliminary arrangements concerning the key elements of the future project. These typically include the type of vessel (with an initial, broadly defined technical and operational specification), the number of planned units, an indicative price level, and the time frame within which construction is expected to be carried out by the shipyard.letter of intent"). Usually at the date of signature of the letter – the parties are already following preliminary findings on key elements of the future project. This concerns the type of ship (with a pre-established general technical and operational characteristics), the quantities of planned units, the initial price estimate and the time during which the construction (construction) should be carried out by the yard.

At this stage, however, the project’s “input data” remain highly general in nature. In many cases—particularly on the shipowner’s side—financing for the contemplated project has not yet been secured. As a result, this very condition (for example, the shipowner obtaining appropriate bank financing) is often expressly included as a condition precedent in the letter of intent.

Generally speaking, we should agree with Lord Willberforce's statement on "Generally speaking, one should agree with the statement of Lord Wilberforce in the case Reardon Smith Line Ltd v Yngvar Hansen Tangen (“The Diana Prosperity”) [1976] 2 Lloyd’s Rep. 621, that letters of intent are, in the absence of special circumstances, widely regarded within the industry as comprising no more than their name suggests, i.e. a statement of the parties’ intention, imposing moral rather than legal obligations.” („The Diana Prosperity") [1976] 2 Lloyd’s Rep. 621 that ‘Letters of Intent are, in the absence of special circuits, highly regarded within the industry as comprising no more than their name suggestions i.e. statement of the parties’ intention, imposing moral than legal obligations." [muffled] Letter .”].

In other words, when a shipowner and a shipyard sign a document of this kind, it should be understood primarily as an expression of their intention to continue negotiations in good faith with a view to concluding a final, legally binding shipbuilding contract, rather than as an attempt to formalise the negotiations conducted to date in a manner that could give rise to contractual liability.

This general rule (of a non-binding nature of the ‘list of intent’) must be limited and subject to any individual interpretation of the individual provisions which in a given ‘letter of intent"we found them. Judge Leggath on "Wilson Smithett v Cape (Sugar) Ltd. v Bangladesh Sugar and Food Industries Corporation" [1986] 1 Lloyd’s Rep. 378 – analyzing and interpreting the "letter of intent" in the case under consideration, stated, among other things, that in such analysis it is necessary to ‘(...) look at the document itself, at the surrounding circuits, and what happened when (the letter of intent) was brought into existence. The fact that it has the partial label that it has done not brand it at the outset as contractual document or as non-contractual documentThis general rule concerning the non-binding nature of a letter of intent must, however, be limited and assessed on the basis of an individual interpretation of the specific provisions contained in a given letter of intent. In this context, Judge Leggatt, in the case Wilson Smithett v Cape (Sugar) Ltd v Bangladesh Sugar and Food Industries Corporation [1986] 1 Lloyd’s Rep. 378, emphasised that when analysing and interpreting a letter of intent it is necessary to examine the document itself, the surrounding circumstances, and the events that occurred when the letter of intent came into existence. The mere fact that a document bears a particular label does not, at the outset, determine whether it is contractual or non-contractual in nature.. "(...) look at the document as such, under the circumstances in which it was drawn up, and what effect (the letter of intent) may have when it is signed. The fact that a particular document has a specific title does not prejudge from the outset that it is a legally binding contract document or that it is not such a document”].

This is an extremely important remark from Lord Wilberforce. The mere fact that the document is entitled ‘Letter of Intent", does not yet determine that, ex definition, it must be a non-legal document. This will be judged by the content of such a document and the specific conditions contained therein (and the way in which they are formulated).

Therefore, if, on the one hand, there are clear statements in the document confirming the non-legal nature of the document and the statements contained therein, this will make it decisively easier to interpret the highly informal and non-binding nature of such a "list". Often, the formula which ultimately prejudges such a letter is the statement that the provisions, statements or declarations contained in the document are always "subject to agreement upon terms of the Shipbuilding Contract"or similar wording.

On the other hand, the presence of all the relevant conditions of the ship construction contract (the subject matter of construction, time and price) with other categorical and unambiguous declarations of will of the parties signing the said "Letter of IntentOn the other hand, the inclusion of all essential elements of a shipbuilding contract—such as the subject matter of construction, the time of performance and the price—combined with other categorical and unambiguous declarations of intent made by the parties signing the “Letter of Intent”, may lead to the interpretation that the parties have in fact created a written, legally binding contractual nexus, with all the legal consequences arising therefrom.

Liability of the parties and exclusivity arrangements in letters of intent

The burden of proof as to whether a particular letter of intent is non-binding or, conversely, legally binding rests with the party that seeks to derive legal effects therefrom, that is, the party having an interest in establishing the legal nature of the letter of intent in question. This approach is reflected, inter alia, in the case law, including Edwards v Skyways [1964] 1 W.L.R. 349 and Hong Kong and Shanghai Banking Corporation Ltd v Jurong Engineering Ltd [2000] 2 S.L.R. 54.Letter of Intent”) „Edwards v Skyways" [1964] 1 W.L.R. 349; «Hong Kong and Shanghai Banking Corporation Ltd. v Jurong Engineering Ltd." [2000] 2 S.L.R. 54.

The parties to the letter of intent include a statement of type that they undertake to negotiate in good faith (‘It's not possible in good faithLetters of intent often contain provisions under which the parties declare their intention to conduct negotiations in good faith (“to negotiate in good faith”). The question therefore arises whether, in a situation where one of the parties, in the manner in which the negotiations are conducted, manifestly demonstrates bad faith by deliberately obstructing or undermining the negotiations, such a provision entitles the other party to pursue a claim based on the concept of so-called culpa in contrahendo.culpa in contrahendo”?

The position of English law is clearly negative. As Lord Ackner pictured in the ruling "Walford v Miles" [1992] 2 W.L.R. – «The concept of a Duty to carry on negotiations in good faith is inherently repugnant to the advanced position of parties when involved in negotiations. Each party to thenegotiations is entered to shine this (...) own interest, so long as he avoids making misrepresentations (...)" [translation. " the concept of a duty to negotiate in good faith remains in internal contradiction with the adversarial position of the parties involved in the negotiations. Each party to the negotiations aims to achieve and secure (...) its own interests, to which it is fully empowered, as long as it does not advance to false declarations of willThe position of English law on this issue is unequivocally negative. As Lord Ackner expressed it in the judgment in Walford v Miles [1992] 2 W.L.R., “the concept of a duty to carry on negotiations in good faith is inherently repugnant to the adversarial position of parties when involved in negotiations. Each party to the negotiations is entitled to pursue its own interests, provided that it avoids making misrepresentations.” This approach is also reflected in Courtney & Fairbairn Ltd v Tolaini (Hotels) Ltd [1975] 1 All E.R.Courtney & Fairbairn Ltd. v Tolaini (Hotels) Ltd."[1975] 1 All E.R.).

A similar position of interpretation of the jurisdictional English courts has been met by other, very often used in letters of intent, such that "the parties undertake any or rationally justified action to reach agreement and to conclude a contract" ("promise to use best or rational endeavours to reach agreement"). Court of Appeal in the case ‘Little v Courage Ltd." [1995] 70 P&CR 469 – stated among others – ‘(...) an undertaking to use one’s best endeavours to agree is no different from an undertaking to agree, to try to agree or to negotiate with a view to reading agreement, all are equally uncertain and incapable of giving rise to effective legal liability" (to Lord Millett (J.). [mul] commitment to make any effort to reach agreement (the given agreement), is nothing more than an obligation to agree, attempt to agree or to negotiate in order to conclude a specific agreement. All such commitments are equally uncertain and do not result in a legally binding commitment."

Delict liability and exclusive agreements in letters of intent

Lord Ackner (of the case "Walford v Miles" [1992]), he mentioned very significantly that however the provisions and declarations of will contained in the letter of intent cannot, in principle, lead to any compensation claims. This may not apply to situations where one of the parties ‘Letter of Intent"has made a statement in it which were, or may have been, the fault of misleading the other party to the letter."misrepresentation”, „statement made fraudulently or negligently"). Thus, if, for example, the yard in the letter of intent confirms its technical and operational capacity (including docked availability) to carry out a project negotiated under a given letter of intent, in the event that the yard in fact does not have such operating capacity at all, that statement may constitute, under English law, a title to make a full claim for damages from a so-called ‘delict claim’, ‘in cake”). 

Under the letter of intent (or sometimes in a separate document), the parties currently negotiating, in order to increase the efficiency of the negotiations in question, conclude an exclusive agreement (so-called "lockout agreement"also called "exclusive agreement" etc.). In accordance with such agreement, the parties undertake that, while conducting talks and arrangements, neither party will negotiate, to the same extent, with other parties. Precedent ‘Walfard v Miles" [1992] 2 WLR 174, confirmed that under English law such agreements would be legally binding, under one essential condition "Lockout agreement” – is effective, but only, if the restriction on freedom to deal with third parties is explicitly established to apply for a specific period of time" [translation. "The exclusive agreement is legally binding, but only if such a restriction of contractual freedom with third parties is expressly provided for for for a limited period of time"] (see also "Pitt v P.H.H. Asset Management Ltd.” [1994] 1 WLR 327).  

Therefore, each exclusive agreement must, for its legal efficiency, specify a strict, calendarly specific period for which the exclusive agreement is concluded. Determination of that term in an "open" way, for example, by the term "Reasonable period" etc. makes it non-binding legally.

Where the parties have concluded a legally binding exclusivity agreement and one of the parties to the agreement has breached it (by opening parallel negotiations with a third party), then the injured party may take two types of legal action. On the one hand, she may claim compensation for damages she has suffered because of the actions of the other (often, such compensation is already strictly defined in the contract itself). Alternatively, he may apply to the court for a order prohibiting the infringing party ‘lockout agreement", the continuation of negotiations with the third party (so-called "injection"). In both cases, this may prove very severe legally and financially for the infringing party contract.  

Marek Czernis – a lawyer specialising in maritime law and shipbuilding contracts, for years dealing with issues related to the construction of ships, shipping and contract liability in the shipbuilding industry. It advises shipowners and maritime industry, combining legal practice with an in-depth knowledge of the reality of the shipbuilding market.