- IMO’s mandatory short term goal-based technical and operation measures for the reduction of greenhouse gas (GHG) emissions.
- Regionally, the EU’s ‘Fit for 55’ package also seeks to regulate the shipping sector’s carbon footprint.
- Trading System (EU ETS) and the FuelEU Maritime initiative, in line with the bloc’s aim to reduce net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels.
In this article, we will discuss how these regulations may impact contractual relationships in the shipping sector, and the steps parties should consider taking now, says an article published on standard club website.
Decarbonisation in shipping
In terms of global intervention, there are the IMO’s mandatory short term goal-based technical and operation measures for the reduction of greenhouse gas (GHG) emissions – namely, the Energy Efficiency Existing Ship Index (EEXI) and Carbon Intensity Indicator (CII) regimes under MARPOL Annex VI, which will enter into force on 1 November 2022 and will apply to applicable ships from 1 January 2023, says an article published on their standard club website.
Regionally, the EU’s ‘Fit for 55’ package also seeks to regulate the shipping sector’s carbon footprint, for example by including shipping in the EU Emissions Trading System (EU ETS) and the FuelEU Maritime initiative, in line with the bloc’s aim to reduce net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels.
The IMO’s Energy Efficiency Existing Ship Index (EEXI) and Carbon Intensity Indicator (CII) regimes (the operation of which is set out in the Club’s previous article ‘Overview of the regulatory framework’, are likely to impact the performance of both existing and future contracts and the traditional rights and obligations of the parties involved.
The possible commercial / legal challenges that could materialise from these regulations and create disputes are varied and complex, but may include:
- allocation of responsibility / risk / cost of compliance with EEXI (technical) and CII (operational) regulations;
- how a ship’s attained operational CII will be maintained (or improved) on an annual basis and what possible steps can be taken to do so;
- risk and likely impact of failing to maintain a ship’s CII rating – enforcement, sanctions and/or commercial consequences; and
- risk and exposure to third party claims and impact on insurance coverage.
Standard time charter framework
The following fundamental rights and obligations feature in most standard time charters:
- Charterers are entitled to direct the use and employment of the ship within limits set out in the charter (e.g. trading, cargo and safety), in return for payment of hire.
- The Master is obliged to follow charterers’ legitimate / lawful orders within the charter limits, and execute them properly and promptly. This includes entering into third party contracts for the carriage of cargo (e.g. shipowners’ bills of lading) on terms.
- Typically, shipowners warrant that the ship will be seaworthy and fit for the service (or that they have exercised due diligence to maintain seaworthiness) throughout the charter.
- An express or implied indemnity in favour of shipowners may arise against liabilities or harmful consequences incurred as a result of complying with charterers’ employment orders.
On a practical level, compliance with the IMO regulations (in particular, CII) require adjustments to the way in which a ship is operated.
These are not aligned with current commercial shipping practices, and they directly impact charterers’ traditional rights enjoyed under time charters.
Shipowners are primarily responsible for compliance with international regulations. This will include the EEXI regulations provided the flag of the ship is a MARPOL contracting state.
The EEXI does not require technical modifications to ships – this will depend on the type and design of the relevant ship, her trade, the attained EEXI, and the particular required EEXI the ship has to meet.
However, for many ships, technical modifications may be the only realistic way to attain the required EEXI. This may give rise to disputes over what type of modifications are required and acceptable to the parties and what impact this may have on the commercial operation of the vessel.
If technical modifications are to be made, bespoke contractual solutions may be required to allocate the risk, time and cost of such modifications.
For example, in the absence of an applicable compulsory modification clause, dealing with the cost of purchasing, installing and trialling new equipment, responsibility for time out of service, and when / where any drydocking is to take place are likely to be important issues in both mid to long-term time chartersThe shorter the duration of time charter, however, the less likely there is to be community of interest and traditional off-hire, time out of service and drydocking provisions will be more relevant.
Dependent on the nature of the technical modifications, consideration will need to be given as to whether the technical description, questionnaires and speed and consumption warranties in the charter require amendment.
This will impact both existing and future charters (regardless of duration) running into 2023 and will lead to significant complications, especially for shipowners, if not adequately addressed in the contract.
Due to favourable installation time and cost implications, engine power limitation (EPL) and shaft power limitation (ShaPoLi) appear to be the preferred choice for compliance.
However, as the EEXI regulations do not mandate the type and nature of technical modifications, disputes may arise over what is required and/or necessary in the particular circumstances – for example, over more expensive and innovative solutions for compliance.
It is again possible that compulsory modification clauses may resolve this issue, but this will be dependent entirely on the particular wording used, and again tailor made provisions may be required.
With technical modifications may come additional training and awareness for a ship’s crew and this may also have an impact on the existing maintenance regime under time charters.
At the outset, it is very important to understand that whilst compliance with the EEXI (a technical requirement) and CII (ongoing operational requirement measuring carbon dioxide (CO2) emissions per unit of ‘transport work’) are inter-connected, they are nevertheless separate requirements.
The annual carbon intensity reductions achieved by a ship will be highly dependent on how it is operated, not just its technical efficiency. Operational efficiency, however, has no influence on the EEXI.
Complying with the CII regulations on an ongoing basis is likely to be complicated.
- A ship will be required to calculate its required operational CII for a three-year period in advance and in accordance with a CII reduction factor, using an equation set out in Regulation 28 of MARPOL Annex VI.
- On a practical level, a ship’s attained operational CII (and, in turn, its CII rating) in any given year will be heavily dependent on the way in which the ship is traded and also external factors (e.g. the weather), which impact on the way in which the ship can perform.
- It will be prudent for shipowners to monitor and assess the ship’s actual operational CII in real time in order for them to establish how close they are to that ship’s required operational CII, and they may need to take appropriate steps / actions to avoid being in breach of their CII obligations.
- Calculating actual carbon emissions of a ship upon the date of delivery or redelivery under a time charter is also likely to be an important (yet complicated) exercise to carry out for shipowners and (both redelivering and incoming) charterers alike, especially when this takes place in Q2/Q3 of a calendar year.
Such corrective steps, could, depending on the specific circumstances, conceivably involve one or more of the following:
Option 1: reducing speed / slow steaming.
Option 2: deviating from the shortest / quickest route.
Option 3: increasing distance sailed (including ballast voyages).
Option 4: reducing cargo intake.
In the absence of tailor-made clauses, if shipowners were to unilaterally pursue any of these options to maintain and / or improve the ship’s attained operational CII (and therefore CII rating), disputes could arise. Option 1 may place shipowners in breach of speed and performance warranties.
Options 2 and 3 could lead to shipowners being in breach of their due / utmost despatch obligations, employment orders / instructions or sailing directions, and could amount to a deviation, again leading to a breach.
If pursuing option 4, shipowners would likely find themselves in breach of express cargo capacity warranties, the obligation to make sure the whole reach is available, and employment orders. Option 4 could also breach shipowners’ due diligence obligations.
In most standard charters, breach of these obligations will result in claims for damages, rather than creating rights of termination, although the consequences under tanker charters could be more significant.
In relation options 1 – 3, off-hire clauses or other hire deductions could be triggered, subject to the facts. Claims for delay or damage to cargo may also be brought against shipowners or the ship by third party cargo interests under bills of lading.
Whilst it may be more commercially straightforward to negotiate terms in spot voyage charterparties for compliance with the CII regulations (e.g. more narrow speed and performance warranties), similar issues to those seen in time charters might arise if specific clauses are not agreed.
Standard industry clauses, such as the BIMCO Slow Steaming Clause 2012, might assist with compliance (by allowing shipowners to reduce speed in certain circumstances).
However, these clauses often give this right in return for a minimum speed and performance warranty, which in particular circumstances could itself lead to non-compliance with the CII regulations.
Contracts of Affreightment (COAs)
Slow steaming or otherwise extending voyage lengths might reduce total annual voyages in pre-existing long term COAs, potentially reducing shipowners’ earnings under the relevant COA, or placing shipowners in breach of any term stipulating a minimum number of annual voyages.
However, reducing cargo intake (as a way of complying with the CII regulations) would probably not be an option.
In those circumstances, if protective clauses had not been agreed, shipowners would have to argue that there is an implied duty of cooperation on the parties, requiring them to cooperate to obtain compliance with the regulations.
Alternatively, that an implied term operates in the circumstances. However, such arguments will be prone to difficulty.
In most standard pro-forma bareboat charters (e.g. BARECON), the risk and responsibility for complying with the EEXI regulations is likely rest with charterers, including making any technical modifications sufficient to meet the required EEXI, due to (i) charterers’ obligation to keep Class up to date and all necessary certificates in force; and/or (ii) their maintenance obligations.
However, it may be possible to apportion costs of any technical modifications, depending on the nature and value of these modifications.
Shipowners’ prior approval will often be required before charterers can make any structural or “substantial” changes to the ship or its machinery, unless (for example) Class have directed that the changes are necessary.
This could be problematic if, for example, shipowners did not approve of the type of technical modifications required, particularly if they also had to contribute to costs, given the value.
The fact that MARPOL Annex VI does not mandate the type and nature of technical modifications required to comply with the EEXI regulations may also lead to disagreement.
As charterers are obliged to return the ship in the same condition as on delivery, it is arguable that they must also maintain the ship’s CII rating.
However, there may not be any identifiable breach when redelivery takes place, because the assessment of the ship’s attained operational CII (and CII rating) might take place months after the event.
In these circumstances shipowners might be able to rely on indemnity provisions (e.g. in the BARECON standard forms) depending on the specific facts.
EU Measures: The EU ETS/ FUELEU Maritime
It should be noted that the measures put forward by the European Commission (EC) on 14 July 2021 as part of its ‘Fit for 55’ package are still subject to the EU legislative approval process, which involves consideration by the European Parliament (EP) and the European Council.
As such, they do not yet form part of EU law and there is still much to be worked out (for example, delegated acts of the EC still need to be formulated and published). It is therefore conceivable that the measures eventually adopted may differ from the text currently proposed.
Subject to this caveat, there are a number of important considerations which are likely to impact both existing and new contracts running into 2023 and these are discussed below.
This section focusses on the EU ETS and FuelEU Maritime. Whilst not exhaustive, there are likely to be common issues (Section I) and issues which are specific to each of those measures (Sections II and III).
However, there are two important points to note at the outset. First, these measures apply to ships irrespective of which flag they fly.
Secondly, the scope of application is wider than intra-EU voyages. Therefore these regional measures will have a significant impact on global shipping.
Whilst outside of the scope of this article, it must be noted that there are additional measures which are likely to impact the maritime sector within the European Economic Area (EEA).
These include the Energy Taxation Directive (which seeks to introduce taxes on bunkers sold in the EEA for EEA voyages and electricity used to directly charge ships at berth) and the Alternative Fuels Infrastructure Regulation (which seeks to regulate the infrastructure required to enable ships to have access to alternative fuels at EU ports).
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Source: standard club