Nordisk Skibsrederforening

FSRUs and LNG Regasification contrats

Main risks from an owner’s perspective

Introduction
As demand for energy and electricity has increased worldwide, since 2005 we have seen some LNG vessel owners developing fleets of LNG regasification vessels (commonly known as Floating Storage Regasification Units, FSRUs). The special feature of an FSRU is its ability to receive and store LNG, which it subsequently regasifies and discharges as natural gas.

The contracts used for fixing FSRUs are quite different from the charterparties used for ordinary LNG transports. The owner under an FSRU contract, as well as fulfilling the usual “owner’s obligations”, will be providing additional services of a sophisticated technical nature. Furthermore, the interface between the charterer’s property, such as the topside facilities and the pipeline securing the off-take capacity, and the FSRU is of crucial importance for the successful operation of the regasification services. The contractual provisions in this respect are similar to those found in some offshore service contracts.

FSRU projects may be fixed on time-charter terms. It is not unusual, however, for the “time charter” to be split into two contracts: a bareboat charter and a service agreement. In this case the vessel is provided under the bareboat charter while the more specialised FSRU services are rendered under the service agreement.

Below we address some issues that we find need particularly careful consideration in order to mitigate the risks involved in FSRU projects, namely: commencement of hire, staying on hire, liabilities and indemnities, warranties/performance, and taxes.

Commencement of hire
Commencement of hire will normally require the charterer’s acceptance of the vessel, evidenced by the signing of an acceptance protocol. In order to mitigate the risk of the charterer rejecting delivery of the vessel, it is important to draft the delivery mechanism carefully and to ensure that the owner has full control over the delivery criteria. For instance, if the vessel is a newbuilding, the owner should ensure that the vessel’s specification in the FSRU contract, which the vessel shall “(fully) comply with” at the time of delivery, is aligned with the specification in the building contract, including all margins given to the yard.

A concern for the owner in relation to delivery is potential exposure in the event of delay. Such exposure could be onerous if the owner were to face unlimited liability for the charterer’s losses due to delay in delivery. Accordingly, such liability should be capped, e.g., by providing for liquidated damages for each day of delay, always subject to a maximum number of days for which liquidated damages may be applicable. Ideally a charterer who terminates in the event of delay in delivery, which option should only be available to the charterer after the maximum amount of liquidated damages has been incurred, should not be entitled to any damages in addition to the liquidated damages.

FSRU contracts usually require commissioning to be carried out in relation to delivery. As some time will necessarily elapse between the time the owner presents the vessel for delivery and the time the commissioning process is completed and the acceptance protocol signed, it is important to specify clearly who will pay for this time. It is not unusual for this liability to be split, with the charterer paying for a defined period and all time used in excess of this period being for the owner’s account. It is important to note here that the FSRU will provide some services during the commissioning process, e.g., the regasification and discharging of gas. The charterer should pay for any services rendered during the commissioning process, even if the time spent on commissioning is for the owner’s account.

A final point in relation to delivery is that the owner should be wary of a request by the charterer for the right to use the vessel for a predelivery voyage. An owner who agrees to such a request must ensure that all risks relating to such a voyage, including the risk of delivery being delayed under the FSRU contract, are for the charterer’s account. Otherwise the owner could be at risk of losing a long-term project by complying with the charterer’s order to perform one short pre-delivery voyage.

Staying on hire
Once the vessel has been successfully delivered to the charterer, clearly it is important for the owner that the vessel stays on hire throughout the charter period. Hence the wording of the off-hire clause, and of any other clauses in the FSRU contract that may reduce the time or rate of hire, will be of importance.

From an owner’s perspective, the events that may place the vessel off hire should obviously be reduced to a minimum. Equally importantly, the owner needs to ensure that the vessel will only be off hire for the time actually lost due to the off-hire event, and not for the whole period from the commencement of the off-hire event until the vessel is ready to resume service. If the owner has to agree to the latter approach, his position will be improved if the clause states that the owner shall be compensated for services rendered and distance made good while off hire. It is important to note, however, that even though the owner will be compensated for services rendered, off hire days will still accrue and may potentially result in termination due to prolonged off hire. Generally owners should only accept net-loss-of-time off-hire clauses. This ensures that hire is suspended only for time actually lost. Another benefit of such clauses is that the charterer has to prove that time has been lost, instead of the owner having to prove what services have been rendered and the amount of compensation due.

Owners should try to limit the application of off-hire clauses to situations where the vessel is totally unavailable. In cases where the vessel is actually performing some services, the situation should be regulated by a service failure compensation scheme (see below). Such a scheme will compensate the charterer for any reduction in services and potential loss of time, while at the same time allowing the vessel to remain on hire while the vessel is providing some services under the contract.

In order to ensure that the vessel stays on (full) hire, the owner should make sure that the charterer bears the whole risk for charterer’s performance of his obligations to provide certain items and services under the contract. Such items and services include the quality of the LNG provided by charterer, the functioning of the charterer’s topside facility, and the provision of sufficient off-take capacity. This can be achieved by making the owner’s obligation to perform throughout the contract subject to the charterer’s continued performance of his obligations under the charter. The charterer’s obligations should be specified clearly. Examples of the charterer’s obligations include importing the vessel, ensuring that the site and the facility are ready and suitable for the vessel, providing mooring for the vessel, and providing the LNG, pipeline and gas off-take capacity. The owner will only be able to perform the FSRU services (e.g., loading of LNG, regasification of the LNG, and gas discharge) if the charterer fulfils his obligations. Consequently, if the charterer is in breach of any of his obligations, the owner should be excused from performing his services while continuing to earn full hire. For example, if the charterer does not provide off-take capacity for gas discharged from the FSRU, this will affect the owner’s possibility to perform the services in accordance with the contract. Quite simply, the owner will be unable to discharge gas, which in turn means that the FRSU will have to stop regasification and at some point will be unable to receive LNG. As the owner’s non-performance in this situation will be a direct result of the charterer’s failure to comply with his obligation to provide sufficient off-take-capacity, the owner should not be penalised for failing to discharge gas.

Likewise, the charterer should accept full risk of force majeure. It is not unusual for FSRU contracts to reserve force majeure as an excuse for non-performance for the owner’s benefit. The effect of this is that the owner is entitled to full hire if his performance is prevented by a force majeure event. The rationale for this has usually been that the charterer’s main obligation under these contracts is to pay hire, which will not be excused by force majeure, while the owner’s obligations are of a nature that easily may be affected by force majeure. A compromise may be to give the charterer a right to terminate the contract if the force majeure event prevents the owner from performing for a prolonged period, e.g., 12 months, but coupled with an obligation to pay compensation to the owner if the charterer choses to terminate the contract in such circumstances.

FSRU contracts contain specific performance criteria that the owner must comply with throughout the charter period, such as a specific loading and discharging rates and regas and storage capacities. If the owner is in breach of any of these performance criteria, FSRU contracts contain regimes, the so-called service failure compensation schemes mentioned above, for compensating the charterer for the reduction in performance. Some regimes operate on the basis of reducing hire in proportion to the reduction in performance, while others apply a system of damages/penalties. These regimes are completely separate from off hire and should not be applicable for the same events. Ideally, as mentioned above, off hire should only apply where the vessel is completely unavailable, while the service failure compensation scheme should regulate situations where the vessel continues to provide some services. Unfortunately, some FSRU contracts we have seen fail to distinguish clearly between the circumstances in which service failure compensation and off hire would apply. Such a contract may expose the owner to two types of liability – off hire and service failure compensation – in relation to the same event.

Finally, the charterer’s right to terminate the contract obviously has an impact on whether the vessel can stay on hire. Several charterers insist on a right of early termination. From an owner’s perspective, however, the charterer’s right to terminate should be limited. Termination of the contract may have onerous consequences for the owner unless he receives proper compensation. The termination fee the charterer should have to pay on exercising the right to early termination should, as a minimum, cover the owner’s capital expenditure for the remaining period of the contract. Any smaller termination fee may jeopardise the owner’s financial stability and be devastating if new employment is not secured immediately after termination.

Liability and indemnity
The liability and indemnity provisions in FSRU contracts have much in common with those found in offshore service contracts. Liability for damage to either personnel or property is usually regulated on a knock-for-knock basis, with each party bearing the cost of damage to its own personnel and property. Such a regime should generally be acceptable to owners. It is not unusual, however, for FSRU contracts to contain more extensive knock-for-knock regimes than the traditional approach. For instance, the knock-for-knock regime may apply to other types of damage than damage to personnel and property, the definition of “Contractor/Owner Indemnified Personnel” may be unusually wide, or the “Charterer’s Group” may not include some important third parties with whom the charterer has a contractual relationship, such as the owner of the infrastructure to be used for loading and discharging or the owner of the pipeline that the gas is going to be sent through after discharge. Such clauses may increase the owner’s exposure compared to the position under a traditional knock-for-knock regime.

Liability for pollution is an important aspect of the liability regimes in FSRU contracts, and is usually covered by the knock-for-knock regime. The owner should only accept liability for pollution that emanates from the FSRU itself. The charterer should carry the risk of all other pollution.

FSRU contracts, like most other shipping and offshore-related contracts, should exclude liability for consequential losses. This exclusion should be general and not limited to the liability and indemnity provision. Furthermore, it is important to define carefully the meaning of consequential losses in order to ensure the exclusion of potentially significant losses such as loss of profit. We should emphasise that under English law it is not necessarily sufficient to state that “neither party shall be liable for consequential loss” in order to exclude loss of profit. The contract should specify that some important categories of losses (loss of profit, loss of business opportunity, loss of use, loss of revenue etc.) are excluded whether or not they are considered to be consequential or indirect.

In addition to liability for damage covered by the liability and indemnity provision, both the owner and the charterer will also be exposed to liability for breach of contract. FSRU contracts usually contain detailed provisions regarding damages for breach of contract, in particular in relation to termination for breach of contract. These provisions are of importance when carrying out a contract risk assessment. If the contract is terminated due to the owner’s breach, the owner may be liable for damages. These damages may be specified in the contract (“liquidated damages”), with such damages usually operating on a sliding scale according to when the contract is terminated or alternatively a fixed amount applicable irrespective of when the contract is terminated. These liquidated damages should be the only damages available to the charterer. As an alternative to liquidated damages the owner may be liable for losses caused to the charterer by the breach/termination. If this approach is used, it is of the utmost importance that consequential losses are excluded (as discussed above). From an owner’s perspective, termination should be the sole remedy available to the charterer for the owner’s breach.

Conversely, where the owner is entitled to terminate due to the charterer’s breach, the contract should clearly regulate the owner’s right to damages. The same liquidated-damages approach as described above should be available, but ideally with different levels of damages. From an owner’s perspective, it will be important to ensure the availability of damages in an amount that will reflect his (and his investors’) interest in the contract.

Finally, to cater for the owner’s need to assess his potential exposure under an FSRU contract (and his need to insure against such exposure), it is not uncommon for such contracts to place a global cap on liability. We do however see examples of carve-outs from such caps, which is unfortunate as it undermines the purpose of a global cap. Generally the liabilities and indemnities included in the knock-for-knock regime are not included in the global cap. This should not however be problematic provided that the liability/indemnity exposure is fully absorbed by the party who has suffered the damage and his insurers.

Warranties/performance
FSRU contracts typically impose a set of more general performance obligations on the owner, concerning matters such as the vessel’s specifications, crew requirements and maintenance. When negotiating such contracts we frequently encounter problems in relation to the maintenance obligation. While charterers would prefer an absolute maintenance obligation for the entire charter period, owners should only agree to maintain the FSRU on a due diligence basis. Some charterers argue that the maintenance obligation should be absolute and should apply “throughout the charter period”, with any failure to comply with the vessel’s specifications and other (vessel) related requirements entitling the charterer to a reduction of hire to the extent necessary to indemnify the charterer for such failure. Some charterers have argued that this is in line with industry standards and referred to clause 3 of ShellLNGTime as the “LNG standard” on this issue. ShellLNGTime clause 3 is almost identical to clause 3 of Shelltime 4 (as well as to the equivalent clause in the previous version of Shelltime). In The Fina Samco [1995] 2 Lloyd’s Rep. 344, however, this argument was rejected by the Court of Appeal. The Court of Appeal decided that despite the unfortunate wording of clause 3 of the first version of the Shelltime charter, the maintenance obligation was a due-diligence obligation as set out in clause 3 (i) and not an absolute obligation. The court stated that on delivery the vessel had to comply with the specifications listed in the charterparty. If the vessel did not comply with these specifications on the delivery date, the charterer would be entitled to a reduction of hire. If the vessel post-delivery failed to comply with the listed specifications, the charterer would be entitled to place the vessel off-hire pursuant to clause 3 (iii), provided that the failure to comply with the specifications was caused by the owner’s failure to use due diligence in maintaining the vessel. This result is not obvious from the wording of the particular clause and owners should generally be cautious about accepting similar wording. Accordingly the contract should state clearly that the maintenance obligation is a due diligence obligation only. This will ensure that the owner is not bound by an absolute maintenance obligation.

Contracts where the charterer is given a right to trade the vessel set forth a number of provisions in this regard that we will not discuss in this article. However, one particular warranty given by the owner should be mentioned: the contract will contain a warranty by the owner that the vessel will be compatible with terminals. For an owner it may prove onerous for the charterer to have an unrestricted right to nominate terminals that the vessel shall comply with. Generally such warranties are therefore restricted to compatibility with a list of named terminals at a specific date, e.g., the delivery date. This is because an owner can only be certain that his vessel is compatible with a particular terminal at the date the contract is entered into. If he warrants compatibility at a later date, he will assume the risk of changes to the terminal requirements in the future. Accordingly this risk should be clearly addressed in the contract.

Taxes
Finally we should emphasize that FRSU contracts may have complex tax implications. An FSRU is likely to remain in one country for a substantial period, which may require the vessel to be imported into and exported from the country in question, triggering applicable import and export duties. Accordingly an FSRU contract should establish clearly who is to be responsible for importing and exporting the vessel, the identity of the importer of record, and the tax implications of the import and export. If the owner has to undertake such obligations, the contract should ensure that the charterer is required to participate in the import and export process to the extent requested by owners. In addition, the fact that the vessel will remain in one country for a substantial period of time while rendering FSRU services may create a risk that the owner will have a “permanent establishment” in that country for tax purposes, with the result that the owner will be subject to income tax as a resident company. This may have substantial financial implications for the owner, and the position should obviously be clarified before the contract is entered into.