Shipbuilding contracts – legal issues from technological innovation

Decarbonisation is radically changing shipbuilding. In addition to shipowners taking steps to reduce their carbon emissions and future-proof their fleet, international legislation targeted at increasing the efficiency of vessels has led to significant changes in the specifications of ships on order and under construction at shipyards.

There have been rapid technological developments as a result of decarbonisation initiatives. Significant numbers of ships under construction at the world’s leading shipyards have dual-fuel engines, and some shipowners are looking to acquire vessels with rotor sails, which can significantly reduce fuel consumption and emissions. Shipyards and buyers are increasingly looking at constructing ships capable of consuming alternative fuels including ammonia, hydrogen, and methanol, once these become commercially available.

However, the implementation of innovative technology in ships also brings significant risk, particularly when the technology is still evolving and international standards for that technology are in the process of being fully developed.

Shipyards and buyers would, therefore, be well advised to consider the legal issues and the allocation of risk when entering into shipbuilding contracts which are based on emerging technology. These include considering the allocation of design risk, the scope of warranty provisions, and the process for modifications during construction.

Design risk

The incorporation of nascent technology such as alternative fuel engines into vessels carries with it risks specific to that technology. By its nature, such technology is less well tested and, consequently, poses a risk that a vessel may not be able to perform as intended if the technology or its design is defective.

The most straightforward manner for addressing risks relating to vessel design or technological design is for the shipyard and buyer to allocate the risk of design defects under the shipbuilding contract. In principle, it is possible for design risks to be allocated to either the shipyard or the buyer, under principles of freedom of contract.

However, if design risk is not expressly allocated in a shipbuilding contract, the buyer is likely to be in a strong position to argue that the design risk is the responsibility of the shipyard, although this will depend on the wording of the contract in question.

Buyers may seek to rely, in particular, on Aktiebolaget Gotaverken v Westminster Corporation of Monrovia & Or [1971], where the Court held that obligations to remedy defects in “materials used and work performed” in respect of waterproof hatch covers extended to design errors, on the basis that design errors were capable of being characterised as “bad workmanship”.

Furthermore, buyers may also seek to rely on MT Højgaard A/S v E.ON Climate & Renewables UK Robin Rigg East Ltd & Or [2017]. In this case, a contractor agreed to design, fabricate and install the foundations of wind turbines, with technical requirements providing that “the design of the foundations shall ensure a lifetime of 20 years”. The technical requirements required the contractor to submit a detailed design for the foundations of the wind turbines in accordance with an international standard, J101, published by DNV.

Although the contractor designed and fabricated the foundations in accordance with the J101 standard, shortly after completion of the project, the foundations started to fail. It later transpired there was an error in the J101 standard, which meant that the foundations did not have a “lifetime of 20 years”.

The Supreme Court held that compliance with the J101 standard was only a minimum requirement under the contract, and the contractor had a duty “to identify any areas where the works need[ed] to be designed to any additional or more rigorous requirements” in order to comply with contractual performance criteria.

If a shipyard does not wish to be liable for the risks of design defects affecting components in their vessels, it is important that this is expressly stated in the shipbuilding contract. Shipyards should also be mindful of whether other contractual provisions could have the effect of expanding a straight-forward obligation to construct according to an agreed specification into an obligation to build a vessel which complies with that agreed specification and also to wider standards.

Alternatively, if a shipyard is prepared to accept liability for the risks of design defects potentially present in the technology used to build the vessel, the shipyard should consider whether it would be in a position to claim against their subcontractors for any losses caused by defective components the latter supplied, and whether their insurance coverage is sufficient.

By contrast, where innovative technology is used in vessel construction, buyers should consider whether the shipbuilding contract gives them the option to reject delivery if the vessel’s technology does not comply with minimum performance standards. Buyers may also wish to ensure that they have a right to receive liquidated damages if there is a shortfall in performance of the vessel’s technology during sea trials.

Warranty provisions

The use of innovative technology also raises questions regarding the scope of warranty provisions in shipbuilding contracts.

Shipbuilding contracts typically contain warranty provisions which operate as a complete code and strictly limit post-delivery claims to the repair of defects which are notified within a fixed period of time, and also expressly exclude claims for consequential loss.

Under the standard provisions of the SAJ[1] form, the warranty period under a shipbuilding contract is limited to 12 months. However, if innovative technology is used, or there is a plan to incorporate technology which is not intended to be used initially (for example to allow future compatibility), buyers may wish to press for longer warranty periods in respect of those components.

By contrast, shipyards may wish to consider placing restrictions on the ability of the buyer to claim under warranty provisions for any defects in innovative technology, given that issues with and repairs of defects in technology sourced from third parties may not be easily remediable and could fall outside of the shipyard’s control.

Modifications during construction

Where innovative technology is being used in the construction of a vessel, it is advisable for both shipyards and buyers to consider how any modifications from the agreed specification are dealt with.

Disputes regarding modifications are frequent in shipbuilding contracts, and significant numbers of arbitrations centre on disputes over the cost of modifications and the extent to which the shipyard may be entitled to an extension in the delivery date.

For example, it may be that modifications are requested to address changes in standards or in regulatory rules, or as a result of further developments in the technology that is to be incorporated into the vessel. Alternatively, if a series of vessels is under construction at a shipyard, the buyer may wish to request modifications of the specification of subsequent vessels based on how construction of the first vessel proceeds.

The risk to be wary of here is that of vessels becoming obsolete before construction is completed. Given this, it is likely to be in the interest of both buyers and shipyards to agree a clear contractual regime with respect to modifications.

Generally, in shipbuilding contracts, the shipyard will want to ensure that they are not obliged to proceed with non-compulsory modifications, unless they first receive the buyer’s agreement to adjustments in both the purchase price and the delivery date. However, when vessels are being constructed which use nascent technology, shipyards may wish to go a step further and consider whether they require reduced post-delivery warranty obligations, or, alternatively, amendments to performance warranties which may be affected by the modifications.

Comment

The rapid development of technology used in shipbuilding is likely to be a significant positive for the maritime industry and, in particular, for efforts to decarbonise the sector.

However, nascent and emerging technology also brings with it risks. For this reason, shipyards and buyers are actively encouraged to consider the precise allocation of risk in shipbuilding contracts, as well as the manner in which the contract should deal with any modifications during the construction process.


[1] Shipbuilders’ Association of Japan

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Written by Paul Collier, Legal Director, and Jonathan Cockerill, Senior Associate, Clyde & Co

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