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Aug 12, 2024
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Lockton P.L. Ferrari

“Pay to be paid” clause: consequences of the High Court’s marine ruling

The European Union’s Emissions Trading System (EU ETS) was extended to cover emissions from shipping as of 1st January 2024.

The EU ETS is limited by a 'cap' on the number of emission allowances. Within the cap, companies receive or buy emission allowances, which they can trade as needed. The cap decreases every year, ensuring that total emissions fall.

Each allowance gives the holder the right to emit:

  • One tonne of carbon dioxide (CO2), or;
  • The equivalent amount of other powerful greenhouse gases, nitrous oxide (N2O) and perfluorocarbons (PFCs).
  • The price of one ton of CO2 allowance under the EU ETS has fluctuated between EUR 60 and almost EUR 100 in the past two years. The total cost of emissions will vary based on the cost of the allowance at the time of purchase, the vessel’s emissions profile and the total volume of voyages performed within the EU ETS area. The below is for illustration purposes:
  • ~A 30.000 GT passenger ship has total emissions of 20.000 tonnes in a reporting year, of which 9.000 are within the EU, 7.000 at berth within the EU and 4.000 are between the EU and an outside port. The average price of the allowance is EUR 75 per tonne. The total cost would be as follows:
  • ~~9.000 * EUR 75 = EUR 675.000
  • ~~7.000 * EUR 75 = EUR 525.000
  • ~~4.000 * EUR 75 * 50% = EUR 150.000
  • ~~Total = EUR 1.350.000 (of which 40% is payable in 2024)
  • For 2024, a 60% rebate is admitted to the vessels involved. However, this is reduced to 30% in 2025, before payment is due for 100% with effect from 2026.
  • Emissions reporting is done for each individual ship, where the ship submits their data to a verifier (such as a class society) which in turns allows the shipowner to issue a verified company emissions report. This report is then submitted to the administering authority, and it is this data that informs what emission allowances need to be surrendered to the authority.
  • The sanctions for non- compliance are severe, and in the case of a ship that has failed to comply with the monitoring and reporting obligations for two or more consecutive reporting periods, and where other enforcement measures have failed to ensure compliance, the competent authority of an EEA port of entry may issue an expulsion order. Where such a ship flies the flag of an EEA country and enters or is found in one of its ports, the country concerned will, after giving the opportunity to the company concerned to submit its observations, detain the ship until the company fulfils its monitoring and reporting obligations.
  • Per the EU’s Implementing Regulation, it is the Shipowner who remains ultimately responsible for complying with the EU ETS system.

There are a number of great resources on the regulatory and practical aspects of the system – none better than the EU’s own:

https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A02003L0087-20230605

https://climate.ec.europa.eu/eu-action/transport/reducing-emissions-shipping-sector_en

https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/what-eu-ets_en

In a significant ruling for the marine insurance industry, the High Court of England & Wales has confirmed the enforceability of “pay to be paid” clauses in marine insurance policies.

What is a “pay to be paid” clause?

The “pay to be paid” concept stipulates that an insurer’s obligation to indemnify an insured only arises after the insured has paid the third-party claim in question and has consequently discharged the relevant liability.  

Such a rule applies to all marine insurance policies, including P&I.

The background

MS Amlin Marine NV on behalf of MS Amlin Syndicate AML/2001 -v- King Trader Ltd & others (Solomon Trader) EWHC 1813 (Comm)

Owners: King Trader Ltd (owners of the Solomon Trader)

Charterers: BMC

Charterers’ insurer: MS Amlin

The owners fixed the vessel to the charterers under a time charterparty dated 29 May 2017. BMC held a charterers’ liability insurance policy with MS Amlin, effective from 1 April 2018 for 12 months.  

On 4 February 2019, the vessel grounded in the Solomon Islands.

In March 2023, arbitrators from the London Maritime Arbitrators Association (LMAA) found BMC liable to the owners and their P&I Club in respect of the grounding for a total award amount of US$47 million.  

BMC’s liability insurance included a “pay to be paid” clause, and MS Amlin argued that it meant that no indemnity was payable unless BMC had first discharged liability towards the owners. The Court had to consider whether this clause was enforceable considering BMC’s insolvency.  

The High Court decision

The Court ruled that the “pay to be paid” clause was enforceable. It held that such clauses are common in marine insurance and are intended to ensure that insurers are only liable to indemnify once an insured has discharged its liability.  

The Court further found that there was no inconsistency between the “pay to be paid” clause and the main purpose of the charterers’ liability policy, which was to provide liability cover.  

The Court has also addressed the applicability of the Third Parties Act 2010. This Act transfers the rights of the insured to third parties in the event of insolvency.  

The Court held that while the Act allows third parties to claim directly against insurers, it does not override “pay to be paid” clauses in marine insurance contracts, except in cases involving death or personal injury, which was not the case in the circumstances.

The consequences

The “pay to be paid” concept is now a protected right of the insurers and cannot be challenged as per this recent High Court decision. This means that even if there are contractual contradictions between the marine insurance policies and other documents, the “pay to be paid” clause will prevail.  

We should therefore expect marine insurers to rely on this rule and resist any direct third-party actions.  

Also, this court decision emphasises the need for every insured to manage their financial responsibilities and be ready to discharge any claim and liability before claiming any reimbursement from their insurers.

At the same time, we recommend any insured to carry out due diligence when dealing with a new counterparty to ensure their credible financial standing. This is to to avoid situations of insolvency which may deprive the insured of their right to claim against the insurer on the basis of the “pay to be paid” rule.  

For further information, please contact:

“Pay to be paid” clause: consequences of the High Court’s marine ruling
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