|Koval Dmytro, senior associate at AGA Partners||Pavlo Lebediev, associate at AGA Partners|
The Greek Coast Guard has suddenly received a distress call: in the Sea of Crete, a huge vessel has collided with another ship and is steadily going under the water. The Chief of the Coast Guard immediately instructs two patrol boats and a military helicopter to rescue 16 crew members who have already sent numerous calls for help. Due to the prompt and desperate reaction of the coast guard, they have been rescued from the vessel and taken to the nearest city in Greece. But the vessel together with 7,000 tons of Ukrainian wheat was not that lucky – it has eventually gone to the bottom of the Cretan Sea.
Do you think this is a teaser for a new Hollywood movie? Not at all! Recently this event has actually shaken up the mass media becoming a subject matter of lively discussion. It has also raised several questions interesting from a legal point of view for those involved in international trade.
Will the seller receive the payment for the shipped and subsequently lost goods? Who is responsible for the loss of the cargo: the buyer or the seller of the goods? Or can the insurance company compensate for the incurred losses?
These questions are frequently posed to all those trading commodities – so, let's figure out who ultimately bears losses in this rather difficult situation!
At a first glance, a shipwreck may seem like an extraordinary event that rarely appears on the front pages of the newspapers. However, in fact, cargoes are lost during the sea voyages almost every day. According to Bloomberg, only in 2020, more than 3,000 containers of sea lines went under the water! As a result, lawyers specializing in international trade quite often encounter cases about the loss of the cargo during their carriage by sea.
Since the vast majority of international trade transactions is carried out under English law, its precedents set global trends in these matters. Ironically, the trends continue to be largely based on those rules devised by English courts over a hundred years ago.
Inglis v Stock is a landmark dispute on the loss of cargo due to a shipwreck, which was examined by the House of Lords in far 1885.
In this case, parties concluded a contract for the sale of 200 tons of sugar, which were to be shipped at the port of Hamburg on FOB terms (a buyer charters a vessel ship and a seller loads the cargo into it). Upon loading of the goods in Hamburg, the vessel set off in the direction of Bristol. But during the voyage on the Elbe, she unexpectedly went underwater. Despite that, the seller tendered shipping documents for the goods and the buyer made payment against them.
Since the buyer did not receive the purchased goods, it applied to the insurance company with a demand to reimburse its losses caused by the loss of the cargo. The insurance company refused to pay compensation, which led to legal proceedings between them. As a result, the English courts had to figure out who was ultimately responsible for the loss of the goods.
After several rounds of legal battles, the House of Lords established the basic principles of transfer of risks under the FOB contracts:
(1) once the seller has loaded the goods on board the vessel, all risks pass to the buyer,
(2) accordingly, upon receipt of the shipping documents, the buyer must pay for the goods, even if they were lost during the sea voyage,
(3) the buyer is entitled to recover its losses under the insurance policy if it covers the risks in question.
As a result, the English court upheld the buyer’s claim in this dispute and ordered the insurance company to pay the buyer compensation for the lost cargo.
This precedent shows that in the case of loss of goods during their carriage by the sea – either by vessel or by containers – the following questions are crucial to establishing which party is liable for the losses.
The answer to this question can be found in your contract – in most cases, the delivery will be executed on the terms of 'Cost, Insurance, Freight' (CIF) or 'Free on Board' (FOB).
For CIF deliveries (and their modifications – CFR, CIFFO), the seller charters the vessel and loads the cargo. FOB terms have a significant difference – the buyer organizes transportation by sea and the seller must load the goods into the vessel.
Despite this fundamental difference, the FOB and CIF terms are equivalent in terms of the risk transfer – the risk shifts when the goods are loaded onto the vessel . In other words, as soon as the goods have crossed the ship's rail, the seller can relax since the buyer undertakes all the risks connected with the sea voyage.
In international trade, a buyer naturally expects that it is purchasing certain goods when concluding a CIF or FOB contract. But surprisingly, from a legal point of view, it is not the goods that are purchased but the documents for them .
This rule is explained by the legal peculiarities: the buyer normally must pay for the goods after receiving the shipping documents specified in the contract. And it does not matter for the buyer’s payment obligations whether the ship eventually arrived with the cargo at the port of destination or not.
This legal feature leads to a very interesting consequence: once the goods are loaded and the documents are tendered, the buyer must pay for the cargo, although it may never receive the goods if they are lost during the sea voyage.
For CIF deliveries under the terms of the International Grain and Feed Trade Association (GAFTA), it is also important whether the seller has fulfilled his obligation to appropriate the goods.
Usually, buyers purchase not a specific product but goods of certain description (for example, Ukrainian wheat). Accordingly, after loading the cargo onboard the vessel, the seller needs to determine the specific goods that are supplied to the buyer under the contract. To this end, the seller must send the buyer a special notification (“appropriation”) with the name of the vessel, the loading port, at least the approximate amount of the loaded goods and the date of loading (which must fall within the period specified in the contract).
In any event, the appropriation notice must be submitted within the contractual period – even if the cargo is lost during the sea voyage. As a consequence, if the seller tenders shipping documents but fails to appropriate the lost goods within the specified time, the buyer will be entitled to refuse to pay.
When determining who is responsible for the loss of the goods during the sea voyage, it does not matter who is the actual owner of the goods.
This is explained by the fact that the risk of loss/damage and title to the goods can transfer at different times. Quite often, the risks are transferred to the buyer at the loading of the goods but it becomes their owner only after the full payment.
Thus, the ownership and the transfer of risks exist independently of each other. For this reason, the identity of the owner is not critical in establishing who is responsible for the loss of cargo.
Notably, it was this argument that played a key role in Inglis v Stock mentioned above and led to the liability of the insurance company for the loss of the goods.
For such a complex situation, still, there is an efficient means of protection – to obtain the insurance of the risks of loss of and damage to the cargo during the sea voyage.
If the buyer is forced to pay for the lost goods, it will get a chance to receive compensation for its losses from the insurance company. The terms of the insurance policy are of fundamental importance here as they will decide the fate of the compensation in such a dispute.
In case of any accident during the sea voyage, every hour is worth its weight in gold. It is critical to take the right and timely measures so that your company does not become the one responsible for the unfortunate loss of the cargo or its deterioration. In this situation, these are experts in international trade law who can save your company from an unexpected storm in your business.