Introduction
Accounting for around 90% of traded goods, shipping is the lifeblood of world trade. To match global demand, the shipbuilding industry has grown to an estimated USD132.52 billion in 2021 and is anticipated to grow to USD175.98 billion by 2027.
[1] In the geographical context, Malaysia is at the heart of the shipbuilding industry, neighbouring the sector heavyweights, China and South Korea. However, Malaysia lags behind its competitors. In response, the Government has extended the Malaysian Shipping Masterplan initiative to 2025 in a push to drive the domestic shipbuilding sector forward. Cognisant of possible tailwinds in the near future, this article sets out a succinct guide on the key terms and best practice in shipbuilding contracts.
The Basics
Modern shipbuilding contracts are almost always drafted based on certain pre-existing standard forms. There is no standard form of shipbuilding contract in Malaysia. The choice of form is almost entirely dependent on the identity and domicile of the Builder. In the Asia Pacific region, the most prolific standard form used is the Shipbuilders’ Association of Japan 1974 Standard Contract ("SAJ Form"). However, alternate forms such as the "NEWBUILDCON" Standard Newbuilding Contract introduced by the Baltic and International Maritime Council ("BIMCO"), the Association of European Shipbuilders and Shiprepairers’ Form ("AWES Form") and the Norwegian Standard Form of Shipbuilding Contract ("Norwegian Form") are also used. These forms provide a standard foundation for parties to negotiate their respective terms and amendments to the standard forms.
Completed ships need to be registered. Article 91 of the United Nations Convention on the Law of the Sea states permits each State to determine their conditions of registration and for flagging. Malaysia signed the Convention in 1982 and ratified the same in 1996. Ship registration in Peninsular Malaysia is governed by the Merchant Shipping Ordinance 1952. Section 17 of the Ordinance provides that before registration every ship is to be surveyed by a surveyor working under the surveyor-general. For both Malaysian ship registries (Malaysia Ship Registry and Malaysia International Ship Registry), Marine Department Malaysia has authorised numerous Classification Societies to act on behalf of the Government for surveys and classification, including the American Bureau of Shipping ("ABS"), Lloyd's Register of Shipping ("LRS"), Nippon Kaiji Kyokai ("NKK") and Malaysia’s own Ship Classification Malaysia ("SCM").
A newbuild’s country of registration determines its flag-state. This means the Vessel operates under the law of its flag-state in international waters and can claim privileges from their flag-state. Selecting a flag-state is almost always a purely commercial decision influenced by financial considerations and the intended use of the Vessel. For example, registration in Malaysia entitles a Malaysian shipowner to a statutory 70% income tax exemption.
[2] By virtue of the Income Tax (Exemption) (No 7) Order 2022, where a Malaysian shipowner conducts a business of transporting passengers or cargo by sea on a Malaysian ship or letting out on charter their own Malaysian ship, they may be exempt from income tax in respect of income derived from their Malaysian ship(s) for the year of assessment 2021-2023. As such, it is commercially attractive for a newbuilt Vessel intended for use in Malaysian waters to be registered in Malaysia.
In both the SAJ and NEWBUILDCON forms, the default position is for the Purchaser to bear all costs of registration under the chosen flag, which will be stipulated in the shipbuilding contract. Registration is an administrative process. The Purchaser will need to be informed on the requisite documents and procedures required for successful registration in the chosen flag-state. The Builder’s obligation is often limited to the duly notarised and legalised delivery of the bill of sale of the Vessel upon which the Purchaser would rely on for registration.
Shipbuilding Contracts: Navigating the Sale of Goods Act 1957
Common law recognises two broad categories of contracts: contracts relating to a supply of a service and contracts relating to the sale and purchase of goods. English courts have long categorised shipbuilding contracts as contracts for the sale of goods.
[3] More specifically, shipbuilding contracts are contracts for the sale of
future goods by description.
[4] However, shipbuilding involves both the supply of workmanship to build a Vessel (akin to a construction contract) as well as the sale and purchase of the completed Vessel (akin to a sale of future goods contract). The unique character of shipbuilding contracts was appreciated on two occasions in
Hyundai Heavy Industries Co Ltd v Papadopoulous and others[5] and
Stocznia v Latvian Shipping Co[6], where on both occasions the House of Lords highlighted the similarity of shipbuilding contracts to regular construction contracts.
This hybrid approach has not gained traction in Malaysian courts. In the Malaysian Court of Appeal case of
NGV Tech Sdn Bhd (appointed receiver and manager) (in liquidation) & Anor v Kerajaan Malaysia[7], arguments in favour of the “hybrid” approach were rejected. The Court of Appeal, speaking through Nallini Pathmanathan JCA (now FCJ), confirmed the applicability of the Malaysian Sale of Goods Act 1957 (SOGA) to shipbuilding contracts in Peninsular Malaysia, thereby recognising them as contracts for the sale of goods. As the law stands today, whilst there is judicial appreciation of the hybrid characteristics of shipbuilding contracts, they remain fundamentally contracts for the sale of future goods.
Thus, parties must be aware that unless expressly excluded, shipbuilding contracts are subject to the relevant default provisions in SOGA.
Passing of Title
Section 23(1) SOGA:
Where there is a contract for the sale of unascertained or future goods by description and goods of that description and in a deliverable state are unconditionally appropriated to the contract, either by the seller with the assent of the Purchaser or by the Purchaser with the assent of the seller, the property in the goods thereupon passes to the Purchaser.
In the absence of an express provision,
NGV Tech Sdn Bhd confirms that the statutory presumption in section 23(1) SOGA is also generally applicable to shipbuilding contracts. The Court rejected the applicability of Section 19 SOGA, which only applies to ascertained goods. Section 23(1) SOGA provides that title passes to the Purchaser where a Vessel is in a deliverable state and is unconditionally appropriated to the shipbuilding contract either by the seller with the Purchaser’s consent or vice versa. In
NGV Tech, the Court agreed that “unconditional appropriation of future goods normally involves their physical delivery to the purchaser.”
[8] Thus, in practical terms, passes under section 23(1) where the Vessel is completed to the Purchaser’s satisfaction and after physical delivery to the Purchaser.
NGV Tech Sdn Bhd was a case of the Builder entering receivership. Whilst the decision of the Court of the Appeal was against the Purchaser, Section 23 SOGA reflects common commercial practice. The SAJ form’s default provision states title shall pass “only upon delivery and acceptance having been completed as stated above…”. The risk of the Builder’s liquidation prior to delivery of the Vessel is usually secured by a refund guarantee in favour of the Purchaser in the amount of its pre-delivery instalments and interest thereon.
Passing of Risk
Section 26 SOGA:
“Unless otherwise agreed, the goods remain at the seller's risk until the property therein is transferred to the Purchaser, but when the property therein is transferred to the Purchaser, the goods are at the Purchaser's risk whether delivery has been made or not:
Provided that where delivery has been delayed through the fault of either Purchaser or seller, the goods are at the risk of the party in fault as regards any loss which might not have occurred but for such fault…”
Where a shipbuilding contract is silent on when risk passes, Section 26 SOGA applies - risk passes with property in the Vessel, irrespective of whether delivery has been completed. This is, commercially, highly undesirable. In almost all shipbuilding contracts and indeed all the standard form contracts, parties will agree for risk to pass only after delivery and acceptance by the Purchaser. The practical reasons for this are twofold: the Vessel will remain at the Builder’s premises until valid delivery to the Purchaser and the Builder’s insurance will likely mitigate or negate such risk. As such, it is equally common that shipbuilding contracts obligate the Builder to insure the Vessel and all machinery delivered to the shipyard or incorporated into the Vessel.
Sale by description
Section 15 SOGA:
Where there is a contract for the sale of goods by description there is an implied condition that the goods shall correspond with the description…
The contractual description of the Vessel is the key focus of a shipbuilding contract. The key characteristics of a Vessel typically included in its contractual description include its length (overall and between perpendiculars), breadth, propelling machinery, deadweight, trial speed, fuel consumption and so on. Purchasers who undertake a shipbuilding contract will need a Vessel that corresponds to their unique commercial needs. Courts tend to enforce contractual descriptions of materials or methods used in a commercial contract where it is reasonable to do so. For example, in
Rolls-Royce Power Engineering plc v Ricardo Consulting Engineers Ltd[9], the English High Court held that the words “of first-class quality” meant the services provided would be “to a standard which would not be exceeded by anyone who might actually have been engaged to provide them.” As such, it is advised that parties exercise their best judgment and caution when agreeing to the terms of description to avoid any potential dispute.
In shipbuilding contracts, it is common to measure quality performance by performance during trials. Trials typically comprise two parts: dockside trials and sea trials. Dockside trials would include inspections and dockside tests such as establishing the Vessel’s lightweight and deadweight, stability tests while sea trials would include assessments of the Vessel’s speed, manoeuvrability and general sea-keeping characteristics. Further consideration for the “trials clause” would be the staffing of the Vessel during the trial, the weather conditions permissible for the trial and which party bears the risk of running the trial. The nature of such trials is critical and should always be expressly detailed in the contract.
This is the end of Part I of the article on key terms in a ship building contract. Part II, which discusses common issues, contractual remedies and dispute resolution clauses, will be published in February 2023.