March 01, 2015

What the General Litigator Needs to Know about Handling a Maritime Case

Maritime practitioners should be aware that other jurisdictions’ laws may be applicable to their cases and the rules for sorting through them.

Bruce G. Paulsen

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From the time early man placed goods on log rafts to carry them downriver, waterborne commerce has been at the center of trade. Today, 90 percent of all goods are shipped by sea. Shipping is by far the cheapest form of transport and is not likely to be replaced by any other form in our lifetimes.

Since the days of the Phoenicians and perhaps before, shipping laws developed to reflect the realities of transport by sea. Maritime transport has always been dangerous, and despite the technological leaps in the course of the past century, the oceans remain a hazardous place for ships, cargoes, and seafarers. Ships also move from jurisdiction to jurisdiction and are exposed to a variety of legal regimes. Ships burn, sink, or run aground. Cargoes become damaged or lost. Crew members can be injured or killed at sea or during cargo operations. Also, in shipping, the assets move. Parties who extend credit to ships routinely watch their security sail away. Banks that lend into the shipping market have their collateral travel around the world and exposed to dangerous situations. These and many more realities of shipping have driven and shaped maritime law for centuries. General practitioners who take the time to understand this will position themselves to do well in cases that present maritime issues.

In a single voyage, one ship might touch upon many nations. Accordingly, shipping is an international business, which presents issues of international law, both private and public. It is typical of a shipping company to be headquartered in Athens, listed on the NASDAQ, domiciled in a jurisdiction favorable to the registration of vessels (such as the Republic of the Marshall Islands, Liberia, or Panama), and do business worldwide. The jurisdictions where vessels are registered are known as flag states. The places where ships call are known as port states. All flag states and port states have different legal regimes. Shipping contracts, whereby ships are leased by their owners to others (called charters), contain arbitration clauses that choose the law of particular nations. As a result, over time, U.S. courts, including the Supreme Court, have created choice-of-law rules specific to maritime cases to try to untangle the very complicated question of what law applies in any given case. Maritime practitioners thus need to know that other jurisdictions’ laws may be applicable to their cases and appreciate the rules for sorting through which law applies when.

Civilized maritime nations, including the United States, have long sought uniformity in legal matters related to shipping. The wellspring for shipping law is English law, and American decisions often will follow English ones where there is no U.S. maritime precedent on point. With vessels going from place to place and crossing from one legal regime to another, the more uniformity and predictability in the law, the easier it is for commercial operators to know what they are getting into when they send their ships to specific ports. But although uniformity is a laudable goal, it is not often achieved. Accordingly, to be an adequate maritime practitioner, it is important to know something of both the law and the lawyers in the places where your clients’ vessels call and are registered.

Creditors’ Rights

Maritime law has long recognized that issues arise due to the transitory nature of ships and shipping. This has given rise to certain creditors’ rights in the shipping space that are broader than creditors’ rights in other areas of law. Take the case of the supplier of fuel to ships. Shipping fuel is traditionally referred to as “bunkers,” a term that goes back to the days of coal, which was kept in bunkers. Bunker fuel today is a petroleum product that is burned in ships’ engines. Bunker suppliers are in almost every port and often sell fuel on credit. In the United States, bunker suppliers and suppliers of other “necessaries” are entitled, and presumed, to rely on the credit of the vessel that they supply. The lien arises only as to the single vessel to which the necessaries are furnished; there is no lien on a fleet of ships under U.S. law.

A lien for necessaries does not have to be recorded anywhere; it is a secret lien. It arises by operation of law when the goods are supplied, and it follows the ship wherever it goes, worldwide. In the United States, the bunker supplier who is not paid by the ship owner has rights in rem against the vessel. Under U.S. law and in most maritime nations, the vessel is a fictional entity that can be sued. When that vessel returns to the bunker supplier’s home port, or when the bunker supplier reaches out to some other port where the vessel might be calling, the supplier may seize the vessel and sell it in satisfaction of its debt. This process is available in most maritime nations, with some jurisdictions more favorable than others for taking such a step. It is important to know where best to arrest a ship before doing so.

Many of you may have seen, but probably few of you have read, the Supplemental Rules for Admiralty or Maritime Claims and Asset Forfeiture Actions, which appear at the back of your booklet of the Federal Rules of Civil Procedure. The Supplemental Rules set forth both creditors’ rights and the procedures for seizing a vessel in rem in satisfaction of a maritime debt. Maritime practitioners need to be fully familiar with the Supplemental Rules and the policies underpinning them.

Should our bunker supplier choose to proceed against a ship in rem in the United States, he will do so under Rule C. Rule C controls in the case of a ship arrest and permits a federal judge to issue a warrant for arrest of a vessel for maritime lien claims. (The “arrest” here is more akin to the French “arrêter”—to stop.) Once the warrant is issued, the U.S. Marshal serves the vessel with the warrant and the papers on which it is based, and the Coast Guard backs up the court’s power, in case the master has any ideas about leaving port after the vessel is arrested.

The action must be brought in federal court, which has exclusive jurisdiction over such matters under the Constitution. Before commencing the arrest action, the creditor must notify the U.S. Marshal and deposit funds to cover insurance and maintenance costs while the vessel is under arrest. Usually, a substitute custodian is appointed, relieving the U.S. Marshal of the duty of keeping the vessel while the case is pending. If the conditions set forth in the complaint satisfy the judge that an arrest is warranted, he or she will issue the arrest warrant. The shipowner can post security in the form of a bond, insurance company letter of undertaking, or something else that will allow the vessel to sail. In distressed situations, however, the owner may not be able to put up security. Once the original claimant has seized the ship, creditors from around the world may also pile on, making the posting of security more difficult. If the ship cannot be freed on bail, it frequently will be sold quite early in the action by way of an interlocutory sale, which is permitted under U.S. law. Usually, the largest creditor, which is often but not always the mortgagee bank, will move the court for an interlocutory sale. Notice of action and arrest is given to the world pursuant to the Supplemental Rules, as is notice of a U.S. Marshal’s auction. The time from commencement of the motion to the sale of a vessel is often around two months in U.S. courts. The U.S. Marshal sells the vessel and is awarded poundage, the court confirms the sale, and the sale cleanses the vessel of liens. This is the archetypal “admiralty sale.”

Courts around the civilized world will recognize an admiralty sale by a U.S. federal court as one that cleanses the vessel of liens. American courts will also recognize foreign admiralty sales as such—again, uniformity. The parties to the arrest proceeding will then go ahead and fight over who gets the proceeds of the sale, with an established ranking and priority of liens under U.S. law. Under that ranking, costs of keeping the vessel while in custodia legis are paid first, followed by such things as crew wages, tort claims, maritime lien claims, foreign flag ship mortgage claims, and so on.

In addition to ship arrest, maritime creditors can bring prejudgment maritime attachment actions, even if they don’t have a lien claim, against any property of a defendant who is not found within the federal district where the action is brought for either service of process or jurisdictional purposes. Maritime attachments are effected under Rule B of the Supplemental Rules. Rule B attachment allows a maritime claimant to seize bank accounts, bunkers, entire ships, or any other assets that belong to the defendant. Rules B and C provide powerful tools to maritime creditors seeking payment for many kinds of maritime claims. They have developed over centuries to give maritime creditors the power they need to be paid in a situation where their security travels from port to port. Rule B attachments are often used in aid of foreign proceedings, mostly maritime arbitrations.

In addition, maritime lien claimants are secured creditors in maritime bankruptcies in the United States. This is true even though the liens are secret and have never been recorded. Bankruptcy judges also have the power to sell ships free and clear of liens pursuant to section 363 of the Bankruptcy Code. It is still an open question whether foreign courts would recognize a section 363 sale as an admiralty sale that cleanses the vessel of liens. Finally, mortgagee banks, which historically did not have a lien under common law, acquired one when the federal Ship Mortgage Act was passed in 1920 to encourage banks to lend into the shipping markets. When vessels are seized under Rule C, whether by the bunker supplier or the mortgagee bank, and even if a bankruptcy follows, the same rank and priority of liens used in admiralty, noted above, will be applied by the bankruptcy court to determine who takes what. Maritime lawyers representing claimants in an arrest proceeding or a bankruptcy need to understand this ranking—if your client’s claim comes after the mortgage, for example, your client is unlikely to make any recovery.

Salvage and Piracy

Because of the hazardous nature of shipping, laws have arisen over the centuries to deal with the legal implications. For instance, if a ship is in distress, the law has developed such that those who voluntarily respond and save the ship will be rewarded for doing so. For centuries, salvage operations have existed around the world to save ships in peril and to make money in the process. Salvors today have sophisticated vessels for towing and righting vessels, such as the equipment used to right and refloat the Costa Concordia last year in Italy. In addition, recreational boating salvors ply the waters where pleasure craft operate and charge high rates for towing vessels that have had mechanical problems, run out of gas, or run aground. The same salvage laws apply to them as to commercial vessels. Salvors also have a possessory lien on a vessel they have salvaged. In the recreational boating context, when a salvor retains a vessel as security for payment, the reaction of the owner is usually complete amazement that the law permits such a thing. Salvors are rewarded based on the degree or “order” of the salvage, considering the degree of peril that the vessel is in and the risks the salvor took to save it. Salvage operators may be given a salvage award reflecting a percentage interest in the value of the vessel. A high order of salvage will give rise to a high award. This law developed to reward those who go to the aid of vessels in distress, and the cases show that the policy behind the law is to encourage them to do so.

Another interesting concept that reflects the realities of ships and sea is that of general average. To understand this concept, you must reject the notion of what the word “average” means. In ancient usage, “average” means damage. This concept recognizes that every time cargo is placed aboard a vessel, it becomes something akin to a joint venture between the shipper and the carrier to bring the cargo, ship, and crew safely to a port of discharge. There are times when, for instance, a storm at sea may require the master of the ship to jettison cargo in order to save the entire venture. When there is a general average event—damage suffered by the overall venture—the cost is shared by the parties to that venture. Accordingly, if a portion of a cargo is jettisoned to save the entire venture, it is a general average expense to be shared by the vessel and cargo based on the relative value of the two. An average adjuster will do the calculations and an award will be granted, one way or another, depending on who has to pay whom.

Among the expenditures that would qualify as general average is ransom paid to pirates to free a vessel and its crew. Piracy is an age-old scourge for shipping companies and has never fully gone away, but for many years, it was a risk associated only with certain places in the world, such as the Straits of Malacca, and not viewed as a substantial risk worldwide. The Somali model of piracy changed all that and brought piracy to a high level of attention in the shipping world and the world in general. In 2011–2012, shipping companies began to regularly employ armed guards aboard their vessels. No ship with armed guards has ever been taken by Somali pirates.

Piracy is now on the rise on the west coast of Africa, and it is certain that the last of pirates has not yet been seen, though the Somali risk has faded with the advent of armed guards. Accordingly, shipping companies now prepare for this risk, not only by having armed guards or other physical protections for the ship, but also by having the correct insurances. For ships passing through pirate-infested waters, this includes kidnap and ransom coverage, which historically was not obtained by shipowners. Traditional marine insurances and the general average process also provide coverage for such things as the payment of ransom. Compared with traditional marine insurance protections, however, kidnap and ransom coverage extends to such things as public relations, communications with the families of crew members who have been kidnapped, ransom funds lost or stolen in transit, and mental health care and counseling for crew members following their detention. That said, it is expensive coverage in a capital-intensive and currently low-profit industry. In addition, while no law prohibits U.S. companies from paying ransom to pirates, there is a 2010 executive order that prohibits payment of any funds to certain persons in Somalia—including two known pirates. If a shipowner has a ship detained by pirates off Somalia, the owner should take steps to advise the Treasury Department’s Office of Foreign Assets Control before paying ransom. Happily, in 2015, piracy is not the risk it was in 2013. Lawyers who advise shipowners need to understand what methods exist for recovering a ransom paid, including available insurance and how to construe applicable policies. It is hoped that, with the right insurance and physical protections in place, shipowners can avoid the crime of piracy or at least be made whole if it occurs.

Charter Parties

While some shipowners operate vessels for their own account—some oil companies, for example, own vessels and only ship their own products in them—most ships are chartered to third parties as part of the day-to-day shipping business. These leases are called charter parties. This term is yet another ancient one that defies modern meaning. In Latin, the charter party was a carta partita, a “document divided.” To ensure the authenticity of an ancient charter, it was customary to execute the contract two times on the same piece of paper and then tear it half, each party taking one of the fragments. The authenticity of the document could then be proven when the two halves were reattached.

Charter parties take numerous forms, many of which have been in use for many years. There are time charters, in which the owner maintains operational control of the vessel but charters it out to a third party; there are bareboat or demise charters, in which the owner relinquishes control and the charterer operates the vessel as if he or she were the owner (owner pro hac vice); and there also are voyage charters for specific journeys from point A to point B for a particular cargo. All charter party forms contain clauses that relate to the reality of business on the high seas. They include provisions about where the vessel can trade. Non-ice class vessels, for instance, will not be permitted to go to ports where ice may be present, and there will often be prohibitions on trade with sanctioned nations. Charter party forms may also contain provisions that allocate risk between ship and cargo for cargo loss or damage, clauses that relate to collisions at sea, general average, and so forth. In addition, for almost 200 years, nearly every charter has contained an arbitration clause.

Maritime arbitration centers are located in New York, London, Singapore, Shanghai, and other venues around the world. Maritime arbitrations are often ad hoc, but they may, in some circumstances, be administered by arbitral bodies or governed by particular rules. By far the most popular venues for maritime arbitration are London and New York, where the marketplace perceives that there is an abundance of arbitrators familiar with the commercial realities that make shipping and shipping law different. Some charters may require that the arbitrators be commercial people—that is, non-lawyers—so the decisions are rendered by people steeped in commerce rather than law. Maritime arbitral decisions may involve basic contract construction questions as well as more esoteric issues unique to the maritime industry, such as disputes over cargo contamination, general average, demurrage (the liquidated damages awarded to an owner for a charterer retaining a vessel longer than provided in the charter party), and other subjects. Lawyers presenting claims before maritime arbitral tribunals have to understand the commercial realities of shipping as well as the personalities of the local arbitrators—these factors are often more important than the niceties of the law.

Maritime law reflects literally thousands of years of commercial experience. This often makes maritime law different from other types of commercial rules. If you are a creditor, you have special rights that have developed in recognition of the fact that the assets in the maritime world are transitory. In addition, the law recognizes that ships and their crews are subject to the hazards of weather, navigation, fire, and collision, and both the law and the contracts between maritime parties will take these into account. Finally, to the extent it can be accomplished, maritime nations seek some degree of uniformity in the law as ships and their cargo travel from jurisdiction to jurisdiction and in and out of different legal regimes.

Maritime practitioners, even those located in small ports in the United States, truly practice international law. It is important to understand the historic underpinnings and policies at work so that clients obtain the best results possible.

Bruce G. Paulsen

The author is a partner with Seward & Kissel, LLP, New York City.