Problems in newly constructed vessels are usually attributable to design issues, poor construction, or defective materials. Some problems are readily apparent during construction or sea trials. Others may not manifest themselves for years after delivery–frequently at the worst possible times.

The buyer of a newly delivered vessel that experiences a problem is usually not so concerned with the niceties of whether the problem is design or construction related. His immediate concern is that unexpected repairs are now required and his ability to use the vessel as an income-generating asset has been lost or diminished for a period of time. The buyer’s level of frustration becomes even greater if the problem is chronic, with multiple attempts by the Yard to remedy the problem yielding unsatisfactory results. This may prompt a buyer to investigate his recourse against the Yard—an exercise that can be as frustrating as the vessel’s problem itself.

Ship construction contracts are rife with clauses that: (1) limit the types of claims that can be brought against the shipyard; and (2) restrict the damages that may be recoverable by stipulating agreed remedies and excluding some categories of damages altogether. Most shipyard contracts contain clauses that address a vessel’s non-compliance with the contract’s specifications, such as specifications relating to speed, fuel consumption, and cargo capacity to name a few. Contracts usually limit the buyer’s remedy for each of these problems to the option of: (1) an agreed percentage reduction in the contract price; or (2) cancellation of the contract and refund of the deposit and contract payments. Further, the contracts invariably provide that if the buyer elects to cancel the contract, cancellation and refund is the buyer’s sole remedy; the buyer is not entitled to any further monetary relief.

The above problems and deficiencies, and other problems that are discoverable during the construction process or sea trials, most times can be remedied with minimal loss and inconvenience to the buyer. Accordingly, the contractual remedies indicated above may adequately compensate the buyer for the consequences of such deficiencies.

The more nettlesome problems are those that result from latent defects that are not readily apparent and do not manifest themselves until after the vessel is delivered to the buyer and placed in service. These can include a myriad of problems, such as fatigue or stress related failures of the hull or internals, vibration problems, faults or failures with specialized gear, flaws in moving parts such as shafts, and problems with improper installation of the vessel’s systems.

Shipyards have gone far to fully protect themselves from liability for defects and problems discovered after delivery. To be sure, all shipyard contracts guarantee the design, material, and workmanship. But this guarantee provides little comfort given its limitations and qualifications. First, the guarantee is good only for a limited time, generally twelve months. The Yard is not liable for problems that manifest themselves after the guarantee period expires. Although a Yard may agree to remedy the problem, it is not legally obligated to do so.

Second, the buyer’s remedy under the guarantee usually is expressly limited to “repair or replacement.” The guarantee does not provide for monetary compensation even for recurring problems.

Third, the repair or replacement must be made at the Yard. Only if the buyer can demonstrate that it is impractical for the buyer to bring the vessel to the Yard may the repairs be made in another agreed yard. In either case, contracts usually provide that the buyer is responsible for all costs for the vessel to travel to and remain at the Yard or agreed alternate repair site, including towage, dockage, port charges, line handling, and all other costs. If the vessel is repaired at another yard, the contracts generally provide that the builder will compensate the buyer only in an amount equal to some benchmark defined in the construction contract.

Finally, shipyard contracts invariably exclude any claim for consequential damages, which generally include lost profits, lost earnings, and the like. Some provisions are even broader, excluding from recovery any pecuniary loss or expense, any liability to any third party, and any fine, penalty, or other payment incurred by, or imposed upon, the buyer in connection with the vessel. This can have harsh results. The lost earnings and business disruption losses caused when unexpected major repairs are required can be extremely damaging to a shipowner. Yet this clause can preclude recovery of such losses from the Yard–even when the problem was clearly caused by the Yard and it occurred within the guarantee period.

Now for the really bad news for buyers. The above exclusions and limitations generally are enforceable absent evidence of overreaching or unconscionability, which would be very difficult, if not impossible, to demonstrate in a commercial shipbuilding context.

Now for the good news. Judicial decisions and the laws of most states have provided some limited relief from the exclusions and limitations.* The following are some examples:

• Clauses drafted by the Yard that exclude or limit a buyer’s rights will be construed strictly against the Yard. Thus, if a clause is fairly subject to two interpretations—one that favors the Yard and one that favors the buyer—courts will interpret the clause favorable to the buyer.
• The guarantee period may be extended where the Yard was notified of the problem within the guarantee period and the Yard either did not fix it or the repair was inadequate. This at least addresses the issue of chronic or recurring problems and obligates the Yard to continue efforts to remedy such problems even after the guarantee period has expired. Courts also may extend the guarantee period by the amount of days the vessel spends in the Yard during that period.
• Damages considered as “incidental” (i.e. out-of-pocket expenses reasonably incurred as a result of the problem) will not be excluded by clauses excluding “consequential” damages unless the contract contains specific language excluding such types of damages.
• The “repair or replacement” limitation will not be enforced where a court finds that remedy has failed in its essential purpose. Thus, if the Yard is unable to satisfactorily remedy the problem, the buyer may have the right to avoid the contractual limitation and obtain monetary compensation.

The law thus can provide some assistance in avoiding or mitigating the effects of limitations and exclusions in shipyard contracts, particularly with respect to chronic problems. But the old saying “an ounce in prevention is worth a pound of cure” is particularly relevant here. Focusing on modifying the exclusions and limitations when negotiating the contract is a more certain way of obtaining what may be some much needed relief later on.

“Liability of Shipyards–Buyers Beware,” by Richard V. Singleton III, first appeared in the July 2008 issue of Maritime Reporter.

Notice: The purpose of this newsletter is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. The Advisory should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.