What is a letter of indemnity?

Indemnification means compensation of loss. Put it into a letter and you have two contracting parties, where one party A outlines a general term and condition and promises to fulfill them to the other party B.

Should party A failed to meet the arrayed terms, party B has the legal position to request for compensation.

Using a letter of indemnity is common in any industry. It is even more common in the maritime industry.

By nature, the letter of indemnity eases the mind of the party that stands to have a loss in damages. Consequentially, it acts as lubricating oil to doing business among contracting parties.

Often enough to a state of a common pattern is that David is usually the Indemnifier and Goliath is the indemnified.

The industry’s Goliath is the ones that are in a stronger negotiating position to dictate the terms of doing business. In juxtaposition, the David of the maritime industry is the importers and exporters that have to adhere to terms arrayed by Goliath.

Source: Pixabay

A simple example to emphasize this disparity, whenever a Letter of Indemnity is issued by an importer or an exporter in favor of a carrier, the compensation is not limited to a nominal value. Whereas the Hague/Hague Visby rule that carriers are held responsible by has a limited Special Drawing Rights amount only

The topic of the applicability of Letters of Indemnity is a treacherous path to maneuver about, we do not advocate that we are legal experts to be able to provide an in-depth analysis of the implications and applications of Letters of Indemnity (LOI). Nevertheless, what we can do is tell you how a letter of indemnity has been used in the maritime industry.

Delivery Against Letters of Indemnity Instead of Bill of Lading

A Bill of Lading has insurmountable importance in 3 aspects, as we routinely touch on: –

  1. Document of Title
  2. Evidence of a Contract of Carriage
  3. Receipt of Goods loaded

The first aspect, a document of title, is the most important aspect. By which the document of title acts as a right to the possession of goods.

Therefore, if an original bill of lading is issued, the only document of proof of the right to possession is that bill of lading.

Should the importer fail to produce the Original Bill of Lading, the carrier may opt to accept a Letter of Indemnity in exchange for the delivery of cargo.

That being said, using the Letter of Indemnity this way has been shunned upon by various authoritative bodies and insurers.

The P&I Clubs, for instance, generally refuse cover to their members for claims arising from the use of letters of indemnity issued against a clean bill of lading. The Gard’s Guidelines also exclude cover for claims arising from the Letters of Indemnity issued against the clean Bill of Lading.

Letters of Indemnity for a Clean Bill of Lading

One particular circumstance where a Letter of Indemnity is mostly unenforceable is when there is a deliberate attempt of fraud.

Referring back to the Bill of Lading having a function of a receipt of goods, carriers and charterers drawing the bill of lading has the obligation to portray accurately the cargo carriage.

A small note, the term “Said to Contain” that shows in your Bill of Lading is carrier’s effort to exempt itself from proper inspection of cargos shipped on board.

Anything less or more than what is advertised by the shipper/chartererwhile the carrier inspects the cargo load, compels the carrier to issue a “Dirty Bill of Lading” instead of a clean one, whereby the Bill of Lading is added with remarks and clauses to reflect the actual cargo loaded.

Shipper/Charterer may insist on a clean bill of lading, it could be the case that the cargo is financed by a bank’s letter of credit (LC) and the LC requires a clean bill of lading.

Issuing a Letter of Indemnity to indemnify Carriers of issuing a clean bill of lading instead is an outright misrepresentation of information and therefore the LOI may not enforceable, to the detriment of the carrier.

Letter of Indemnity for a Change in Delivery Location

The general rule of thumb is, whenever there is a change operating circumstance, and the carrier undertakes a significant risk in order to perform its duties unconventionally, the letter of indemnity can be used to mitigate the risk from the carriers.

Another such change in operating circumstance is a change in delivery location, after the original bill of lading is issued.

A Bill of Lading is akin to a birth certificate, what has been recorded cannot be amended to suit any circumstances, including the change of delivery port.

The risk involved is that if the Original Bill of Lading is not surrendered back to the carrier to issue a new Bill of Lading to reflect the new change of address. The carrier is exposed to a risk of misdelivery, ergo a breach of contract.

Once again, a letter of indemnity can remedy the situation where the carrier accepts the change in destination. 

Letter of Indemnity Against Container Delivery

It is a common practice especially in developing countries for shipping carriers to request the consignee to issue a blanket Letter of Indemnity for the release of import containers.

In addition, shipping carriers also imposes a container deposit held in lien until the container released is returned to the depot.

The blanket Letter of Indemnity in question envelopes the importer to fully pay for detention, demurrage, damages and losses from the temporary possession of the carrier owned containers.

The container deposits collected from the importer serves as a guarantee that money will be reimbursed to the carriers.

This is not practiced in other developed nations, because of the perceived efficiency of container handling of those developed nations.

From the perspective of the importer, this letter of indemnity is forced upon. A regrettable condition that carriers impose upon them to receive the cargo.

By our own experience, this letter of indemnity fundamentally allows the carriers to be the judge, jury, and executioner. Any container damages caused are immediately judged to be the fault of importers.

Failure of the importer to reimburse the claimed damaged charges, which is inflated in some cases, will result in two possible outcomes. 

  1. Deduction of container deposit without prejudice
  2. Holding the next shipping container hostage for payment

Is it a legal use of a blanket Letter of Indemnity?

We must understand that a letter of indemnity is distinctively a contract. A legally binding contract.

Hence to understand the enforceability of the contract we have to ask ourselves: –

  1. Are the involved parties in the agreement with the terms?
  2. Is the agreement fair?
  3. Do both parties have the capacity to enter a contract?
  4. Is there a misrepresentation?
  5. Is there an undue influence that forces a person to sign the contract?

Whether or not the letter of indemnity is legally binding and enforceable depends on the circumstance. The circumstance which carriers imposes the requirement to sign the aforementioned Letter of Credit. It is very much open to interpretation.

The legitimacy of a Letter of Indemnity

A letter of carries enforceable weight with the countersignature of a renowned Bank. There are many parties that can be involved in a Letter of Indemnity, but mostly it is a bilateral agreement.

The letter of indemnity is only as strong as the indemnifier’s creditworthiness.

For example, a seller shipping a container to a buyer with a CIF Incoterm may not have received full payment upon the cargo’s arrival at the destination port. However, the shipping document may not have arrived at a destination yet.

Photo by Matthias Zomer from Pexels

Either the seller or the buyer can issue a letter of indemnity that is countersigned by a bank, either the seller or the buyer will then need to deposit funds into the bank as collateral for the added security. Only in that case bank agrees to countersign a letter of indemnity and the carrier’s woe is addressed with an added security of the bank.

Conclusion

Lest forget that a letter of indemnity’s purpose is to mitigate the risk of a party to perform its obligation that may result in a breach of the underlying contract (Bill of Lading). Moreover, that risk is undertaken under the instruction and request of the indemnifier.

Any other motives of utilizing the letter of indemnity, for example, in the case of requesting a letter of indemnity against the release of import containers, is no less than an exploitation of legal rights in our opinion.

Resources

Maritime Letters of Indemnity, (Arizon, Semark), 2014

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