Q&A: default, liability and remedies for shipbuilding contracts in China

Bizar Male

Default, liability and remedies

Liability for defective design (after delivery)

Do courts consider defective design to fall within the scope of poor workmanship for which the shipbuilder is liable under the warranty clause of the contract?

The courts will comprehensively consider the facts and investigate the causation in order to determine whether the builder is liable under the warranty clause of the contract for defective design.

Remedies for defectiveness (after delivery)

Are there any remedies available to third parties against the shipbuilder for defectiveness?

Third parties can claim against the builder for defectiveness based on the principle of tort. The third party will be entitled to compensation and to request the manufacturer or builder to undertake the tort liability by ceasing infringement, removing the obstruction or eliminating the danger.

When the ship under construction or the delivered off-spec ship has caused environmental pollution or ecological damage resulting in serious consequences, the builder will need to undertake the tort liability and compensate the third party.

Liquidated damages clauses

If the contract contains a liquidated damages clause or a penalty provision for late delivery or not meeting guaranteed performance criteria, must the agreed level of compensation represent a genuine link with the damage suffered? Can courts mitigate liquidated damages or penalties agreed in the contract, and for what reasons?

No genuine link with the damage suffered is compulsorily required when deciding the level of compensation. However, the courts or arbitration institutions may, at the request of a party, adjust the amount of liquidated damages agreed upon based on the damages suffered. PRC law does not expressly prohibit the stipulation of a ‘penalty’ in the contract. Nevertheless, there are certain limits – for instance, the liquidated damages cannot be ‘significantly higher’ than the damage suffered. Pursuant to the Interpretation II of the Supreme People’s Court on Several Issues concerning the Application of the Contract Law of PRC (expired now due to the Civil Code absorbing the PRC Contract Law, but this practice will generally be supported by the courts or arbitration institutions), if the liquidated damages sum agreed on by the parties exceeds the damage suffered by 30 per cent, generally it shall be deemed as ‘significantly higher’ and the courts or arbitration institutions may mitigate the agreed liquidated damages, at the request of a party. However, the party may still need to take the burden of proof for the damage suffered, for the courts to satisfy the 30 per cent threshold.

Preclusion from claiming higher actual damages

If the building contract contains a liquidated damages provision, for example, for late delivery, is the buyer then precluded from claiming proven higher damages?

The buyer will not be precluded from claiming proven higher damages and will be entitled to recover the same if ascertained by the courts or arbitration institutions. Where the amount of liquidated damages agreed upon is lower than the damages suffered, the courts or arbitration institutions may, at the request of the buyer, increase the amount of liquidated damages. Pursuant to Interpretation II of the Supreme People’s Court of Several Issues concerning the Application of the Contract Law of PRC, the amount of the liquidated damages after the increase shall not exceed the amount of the actual damages.

Force majeure

Are the parties free to design the force majeure clause of the contract?

Yes, the force majeure clause can include various force majeure events in detail. In order to rely on force majeure events and obtain an extension to the delivery date, the shipyard may consider establishing at least the following three points:

  • the event – there has been a force majeure event under the force majeure clause of the shipbuilding contract;
  • the causation – the delay to the construction process or delivery of the vessel is caused by the force majeure event; and
  • the notice requirements – the notice requirements set out in the force majeure clause are satisfied.

Umbrella insurance

Is certain ‘umbrella’ insurance available in the market covering the builder and all subcontractors of a particular project for the builder’s risks?

Yes. Subject to the terms and scope of the insurance policy, ‘umbrella’ insurance may cover the builder, all named subcontractors, the general contractor, the supervising engineer employed by the builder, and the individuals or enterprises having a close relationship with the project (eg, the loan banks or investors).

Disagreement on modifications

Will courts or arbitration tribunals in your jurisdiction be prepared to set terms if the parties are unable to reach agreement on alteration to key terms of the contract or a modification to the specification?

In general, the courts or arbitration tribunals will not make a decision to set terms, but award other remedies based on the legal facts and parties’ claims.

Acceptance of the vessel

Does the buyer’s signature of a protocol of delivery and acceptance, stating that the buyer’s acceptance of the vessel shall be final and binding so far as conformity of the vessel to the contract and specifications is concerned, preclude a subsequent claim for breach of performance warranties or for defects latent at the time of delivery?

No. In circumstances where the builder furnishes standard terms unreasonably excluding or limiting its liability, aggravating the liability of the buyer or restricting the main rights of the buyer, the standard terms shall be invalid.

Repair location and associated costs

When repairs or replacements covered under the warranty must be carried out, may the buyer insist they be carried out at a shipyard or facility not operated by the builder? Must the buyer bear all costs associated with moving the vessel to the location selected for the repair and replacement work and any sea trials? If the remedial work requires the vessel to be docked, will the costs be covered under the warranty, or will the buyer have to pay?

For the location of repairs or replacements and associated costs, the parties can reach further agreement and negotiate regarding the remedial measures. There are no statutory requirements as to how and to what extent to perform the remedial measures. However, the builder may rely on the protective standard terms in the contract and require to repair at its shipyard. If this is the case, the buyer may leave the issue to be determined by the courts.

Liens and encumbrances

Can suppliers or subcontractors of the shipbuilder exercise a lien over the vessel or work or equipment ready to be incorporated in the vessel for any unpaid invoices? Is there an implied term or statutory provision that at the time of delivery the vessel shall be free from all liens, charges and encumbrances?

Yes, it is legitimate for suppliers or subcontractors of the builder to exercise a lien. Unless otherwise provided by the law, the builder as the seller shall have the obligation to warrant that no third party has any right to the delivered ship. Hence, the builder shall warrant no liens, charges and encumbrances on the ship pursuant to the statutory provision.

Reservation of title in materials and equipment

Does a reservation of title by a subcontractor or supplier of materials and equipment survive affixing to or incorporation in the vessel under construction?

The different machinery, equipment, spare parts and structures will be mixed, processed and attached together to constitute the ship, and the ship can be the property arising from processing, attachment or mixing under Article 322 of the Civil Code; usually the ownership shall be determined under the principles of maximum use of the property and protection of innocent parties. Hence, the reservation of title in materials and equipment can only bind the builder, because the builder has the direct contractual relationship with the subcontractor or supplier, and the buyer’s ownership shall not be infringed by the reservation of title.

Third-party creditors’ security

Assuming title to the vessel under construction vests with the builder, can third-party creditors of the builder obtain a security attachment or enforcement lien over the vessel or equipment to be incorporated in the vessel to secure their claim against the builder?

In this case, the third-party creditors of the builder can apply to the courts to obtain or register a security attachment or enforcement lien over the vessel or equipment to secure their claim against the builder, and further have priority in receiving payment of compensation, namely, the third-party creditors will be awarded priority to receive compensation from the debtor as compared with other common creditors.

Subcontractor’s and manufacturer’s warranties

Can a subcontractor’s or manufacturer’s warranty be assigned to the buyer? Does legislation entitle the buyer to make a direct claim under the subcontractor’s or manufacturer’s warranty?

Unless otherwise modified by the parties, the subcontractor’s and manufacturer’s warranty can normally be assigned to the buyer. On condition of obtaining consent from the buyer, the builder may delegate part of the contracted work to a subcontractor. The subcontractor shall be jointly and severally liable to the buyer in respect of the work completed by the contractor. Thus, the buyer can make a direct claim under the warranty against the subcontractor or the manufacturer.

Meanwhile, based on the alternative remedy of tort, the buyer has the option to claim against the subcontractor or manufacturer for compensation of actual losses sustained as a result of the defectiveness of the product.

Default of the builder

Where a builder defaults in the performance of the contract, is there a legal requirement to put the builder in default by sending an official notice before the buyer’s remedies begin to accrue? What remedies will be open to the buyer?

Unless otherwise agreed in the shipbuilding contract, there is no compulsory requirement to put the builder in default by sending notice before the buyer’s remedies begin to accrue. The remedies can be specific performance or claim for damages or both, if applicable.

Remedies for protracted non-performance

Are there any remedies available to the shipowner in the event of protracted failure to construct or continue construction by the shipbuilder apart from the contractual provisions?

Where the builder fails to perform its obligations under the shipbuilding contract, or its performance fails to satisfy the terms of the contract, the builder shall take remedial measures, pay damages, or be otherwise held liable for breach of contract. Where the parties agree upon liquidated damages in respect of the delay in performance, the builder in breach shall still perform the obligations after paying the liquidated damages.

Builder’s insolvency

Would a buyer’s contractual right to terminate for the builder’s insolvency be enforceable in your jurisdiction?

Unless otherwise agreed in the shipbuilding contract that the buyer is entitled to terminate the contract for the builder’s insolvency, the insolvency administrator of the builder (if instructed) will normally be in charge of the builder’s business when the insolvency is declared and the administrator will decide whether to terminate the contract.

Judicial proceedings or arbitration

What institution will most commonly be agreed on by the parties to decide disputes?

The parties are free to agree qualified arbitration institutions – the most commonly agreed arbitration institutions under the general shipbuilding contract are the China Maritime Arbitration Commission and the China International Economic and Trade Commission.

In general, if no arbitration agreement can be reached by the parties or the shipbuilding contract does not include any ADR clauses, the relevant maritime court where the shipyard is located would have jurisdiction to deal with shipbuilding disputes.

Buyer’s right to complete construction

Would a buyer’s contractual right to take possession of the vessel under construction and continue construction survive the bankruptcy or moratorium of creditors of the builder?

In the event of the bankruptcy or moratorium of creditors of the builder, the bankruptcy administrator will be instructed to manage the business of the builder. The administrator will evaluate and decide whether to continue construction or terminate the contract. Hence, the buyer’s contractual right to take possession of the vessel under construction and continue construction will be influenced by the administrator’s decision.

ADR/mediation

In your jurisdiction, do parties tend to incorporate an ADR clause in shipbuilding contracts?

The trend is for the parties to incorporate an arbitration clause in the shipbuilding contract.

Default of the buyer

Where the buyer defaults in the performance of the contract, what remedies will be available to the builder? What are the consequences of the builder’s cancellation of the contract?

The parties can incorporate terms regarding the consequences and remedies in case of the buyer’s default and breach. For instance, the builder can retain the advance payment and instalments, resell the vessel to a third party and claim for costs, charges, expenses and a reasonable sum for loss of profit of construction incurred in consequence of such default.

Law Stated Date

Correct On

Give the date on which the information above is accurate.

8 March 2021.

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