In the Tom Stoppard scripted film “Shakespeare in Love”, the money lender, Hugh Fennyman, responds to the pleadings of his debtor, the theatre-owner Philip Henslowe, with the immortal line “Why do you howl, when it is I who am bitten?” (Mind you, Henslowe’s feet were on fire –Ed). In the last 18 months, we have heard much howling from both yacht builders and buyers; often the largest howls have come from those who have done the biting, not those who have been bitten!
In common with my colleagues within the legal community, we have seen more litigious activity in the last 12-18 months relating to yacht building contracts than many of us did in the previous ten years put together. This lamentable tragedy has caused us to re-examine the way that we approach yacht-building contracts, and as the market begins to acquire a degree of vitality we should all be prepared for the new realities.
Whether what has gone wrong has been a matter of outright fraud, mischance or inexperience, the consequence has been the same: suffering, and from that suffering there has been a lot of pain which has caused people to exit our industry, perhaps never to return. This article will focus on those repeated problems that have led to litigation or near litigation.
“They are never going to deliver it on time!”
Every build contract has a delivery date; it often will have a mechanism allowing for Force Majeure which will extend the delivery date; it will also have a mechanism for permissible delays where changes are made to the yacht and, as a consequence, the original delivery date is postponed.
There is often also a “drop dead date” (subject to contractually agreed extensions) whereby there is a date beyond which the owner and the builder have the individual rights to draw a line under a project and agree that the yacht is never going to be delivered within a reasonable timeframe and people walk away.
All these clauses are drafted on the basis that there is a reasonable expectation that the builder will build the yacht with due haste and diligence and further that the owners’ team delivers to the builder, in a timely manner, all the decisions the builder needs to progress the build. I have been made aware of situations where a builder, often due to cash-flow problems, has reduced the number of workers working on any particular yacht to one or two people. By doing this, the builder can legitimately say to an owner that it is continuing to work on the yacht and that the builder has not abandoned the project and created an event of default pursuant to which the owner could clearly terminate the contract.
This, is as you can imagine, is incredibly frustrating for owners who clearly can see that the yacht is at a virtual standstill, but a virtual standstill is not a standstill. There is a cause of action under English law called “anticipatory breach” whereby the actions of the builder can be argued to be repudiating the contract by displaying that he no longer wants to be bound by the terms of the contract by behaving in such a way as to effectively undermine the contract.
In effect it’s a clear indication that the builder will not build the yacht and deliver the yacht on time. This is extremely hard to prove and by the time the legal process is exhausted, the yacht may be delivered anyway, thus putting the buyer in an impossible situation. However, the yacht builder is not always at fault. In a recent arbitration (unreported), the arbitrator decided that although the yacht was delayed, a high degree of responsibility lay with the buyer who was less than diligent on delivering drawings and taking other key decisions. Result? The arbitrator deleted the drop date and gave the builder more than one year of permissible delays, even though the buyer was arguing that ultimately it was the builder’s responsibility to deliver the yacht on time.
As a result I would now recommend inserting a clause into all build contracts obligating the builders and buyers to exercise their obligations with due dispatch having regard to the delivery date and making time of the essence. At present I am aware of one builder who has gone from 85 workers to two workers and they are attempting to maintain the fiction of ‘ongoing’ work.
Latent Defects – “I’m sorry, it’s out of warranty”
Let me briefly explain what I mean by latent defect. A latent defect is a hidden weakness or failing in the yacht which either the builder knows about or ought to have known about, but one the buyer cannot discover by a reasonable inspection of a yacht. One can go further and say that the latent defect would extend to cover a construction where the builder has acted negligently and ought to have known that his negligent actions would lead to a failure in the yacht. It is all too easy for builders to hide behind their warranty and wash their hands of any ongoing liability. The builder of a hotel cannot escape; why should a yacht builder? I would therefore counsel buyers negotiating the construction of new yachts not to agree to the exclusion of latent defects from warranty claims – whatever the builder’s lawyers say, just say “no!”
Interestingly enough, it is possible under a number of jurisdictions, including England and as far as we know Italy, that a subsequent owner of a yacht who is surprised by a latent defect may have a cause of action against the original builder notwithstanding that they have no contractual relationship with that builder.
Quickly Advancing Stage Payments – “Why is it time to pay again so soon?”
It is not unknown for builders to artificially advance particular areas of construction in order to trigger stage payments. Often, stage payments when negotiated tend to reflect the necessary cash flow required to keep a build going. It is assumed that, for example, when engines are installed there is sufficient work completed on the hull, the superstructure and the engine room to make the installation of the engines appropriate.
Similarly, a stage payment trigger which refers to the commencement of interior fit-out will expect such a trigger to occur when the yacht is fairly advanced in her construction. We have seen, for example, builders who have simply dumped engines on board at a time that was not appropriate or have started the interior fit-out of a single small cabin completely outside the time line for construction in order to trigger the stage payment for the commencement of interior fit-out. I have a case where a builder has claimed stage payments for hull completion and engine installation where the hull is 85% complete and the engines have been strategically moved on board. I would strongly recommend that, in negotiating stage payment clauses, there are extensive checks and balances to avoid shipyards abusing these stage payments and to stop them acting in bad faith. Date triggers are often useful when combined with clear construction events. It has been very tempting, especially with certain cash strapped builders, to push forward particular events just to technically achieve a stage. This practice has to be stamped out.
Penalties for Default – “It’s not a cash machine!”
Until the recent crisis, if a buyer pulled out of a build it was likely that the builder could flip the contract fairly quickly, often for a higher price than the original contract price and, as a consequence, the enforcement of penalties on buyers was an all too rare occurrence. Due to a number of high profile contract cancellations and having had to examine a number of these across a number of builders, it is clear that there are some fundamental flaws in these termination clauses; the weakest of all are those which have a blanket penalty payable on buyer’s breach, whatever that breach might be, let us say for the sake of argument, 20% of the contract price.
It is important to understand that under English law, penalties are not enforceable – the Courts will not countenance a non-defaulting party being put into a better position than he would have been had the contract continued. The reason for this is that the English Courts have logically argued that a non-defaulting party could manipulate a default and enrich himself from the default if the penalty was sufficiently large. Therefore, the Courts have said that the liquidated damages that are enforceable, and this applies both to liquidated damages for late delivery, noise, vibration etc., will only be those which are a genuine pre-estimate of loss.
Therefore, if a buyer signs a contract on day one and on day five he decides he cannot proceed with the contract, is the builder entitled to recover 15%, 20% or 30% of the contract price? I would argue not, because unless the builder has signed all the sub-contracts in advance and has purchased materials and equipment for that particular yacht under construction, the builder’s loss is not going to be 15%, 20% or 30%.
The builder also has a duty to lessen his loss. He cannot sit back and watch his losses rack up and then claim the liquidated damages. Therefore, my recommendation is that owners negotiate graduated termination sums which reflect the true nature of the builder’s loss. Further, if the builder suffers no loss they should not be allowed to double-dip.
Who is Buying this Yacht Anyway?
Buyers have got into the habit of putting their yachts into special purpose vehicles (SPVs), one-ship companies if you will. There are many logical reasons for doing this, and the truth is I would never advise any other way of owning a yacht. Shipyards should know who the beneficial owner is, but them knowing is not the same as being able to hold a beneficial owner to account. Some individuals who are known as being behind projects have legitimately, if not ethically, abdicated their responsibility by hiding behind the SPVs which contracted with the builder. Builders, designers and other sub-contractors have been faced with the prospect that debts owed to them will never be recoverable because the ultimate beneficial owners have hidden behind the shimmering gauze of the corporate veil.
It therefore becomes more important for shipyards when entering into contracts with people who are wealthy to guarantee themselves by either securing bank guarantees for the payment of the instalments under the build contract or seeking the personal guarantees of the private individual behind the company. Even seeking the personal guarantee of the individual behind the company is problematic as one has to be certain the form of guarantee that one secures is binding and secondly that the individual in reality has assets in their name which can discharge any debts owed. Often the very wealthy on paper are really very poor. A more insidious development is builders themselves putting projects into SPVs which share common names with the builder but which can be jettisoned if the ‘builder’ got into trouble. That needs to be watched.
The Relationship to the Classification Society – It’s a class thing
Traditionally, yacht builders have had the responsibility for establishing that a yacht is built to the class rules of the agreed Classification Society. The Classification Society agrees to do this by signing a contract with the builder. We have one case in front of us at the moment where there is a dispute as to whether the yacht complied with class or not. In this case, our client has been legitimately denied access to the class records which may or may not provide information about the construction of the yacht, because the builder has blocked access to those records and the Classification Society has to respect that block because the buyer did not have the original contractual relationship with the Classification Society.
To that end, I would now insist on an express clause in the build contract that a buyer, at the commencement of the construction, is given an irrevocable licence by the builder to allow the buyer to have access to all the class records, surveys and correspondence between the builder and the Classification Society in connection with the construction of the yacht.
What has been particularly disturbing has been the breakdown in trust between buyer and builder. Over the years, brokerage luminaries such as Mark Hilpern, Jeremy Comport, Chris Cecil-Wright, Nick Edmiston and Jonathan Beckett have individually said to me that yachting should be about fun and the moment it stops being fun owners lose interest and move on. It is our job as lawyers and advisers to owners and builders to remove from the equation those loopholes which allow the unscrupulous to abuse a situation, and make the yacht building experience less than fun. Karl Marx, who I don’t believe was a yacht owner, said: “When history repeats itself for a second time, it is a farce; the first time it occurs it is a tragedy.” In our recent yachting history, we have had many tragedies, let us not repeat the mistakes and become farcical.
In my opinion unless we openly deal with the abuses that have arisen in the recent period, it will cause erstwhile owners to remain former owners and never to return to yachting. Many of those owners, rightly or wrongly, have looked at the way that the industry has treated them and they have seen that parts of the industry have treated them as a potential bottomless pit of money. Remember, no owners means no industry. Equally, if building yachts does not yield a reasonable profit, more builders will go to the wall or decide that yacht building is not rewarding enough. The casualties have begun. The industry has to mature and recognise the symbiotic relationship between builder and buyer. A good place to start is to root out the abuse.
I started this article with Tom Stoppard writing about Shakespeare. Let me end it with Shakespeare himself:
“BRUTUS: There is a tide in the affairs of men. Which, taken at the flood, leads on to fortune. Omitted, all the voyage of their life is bound in shallows and in miseries. On such a full sea are we now afloat, and we must take the current when it serves or lose our ventures. ”
Julius Caesar Act 4, scene 3 218-224.