The Risks Associated with Letters of Indemnity (LOI).

Problems Secro Solves - This is the first in a series of explainers on the “Problems Secro Solves.”

What is a Letter of Indemnity (LOI)?

In a shipping context, it is where a cargo interest in the commodity sale chain or a charterer agrees to indemnify the shipowner for any losses/liabilities that may arise following a non-contractual request.

LOIs are used for various non-contractual requests made by cargo interests/charterers. Here we are focused on LOIs for delivery without the presentation of the paper original bill of lading (OBL).  That is where the OBL is not available to be presented to the ship at the discharging port and cargo interests want the cargo off the ship.

An OBL is a ‘document of title’.  That’s one of its main three functions.  The proper holder of the OBL is considered the owner of the goods.  So, in an ideal world, the holder can turn up when the ship arrives at the destination, physically hand over the paper OBL to the Master, and collect their goods.  Unfortunately, that ideal world does not always exist.

This title function of the OBL protects the shipowner from misdelivery.  The shipowner knows that whoever turns up with the OBL is the owner of the goods.  So, when the OBL is not there, the cargo owners/charterers often make a non-contractual request in asking shipowners to deliver without the OBL and offer an LOI to do so.  This seems to keep the shipment moving.

But,… this IS risky.  Why?

In practice, LOIs are typically not secured (ie. not counter-signed by banks or insurers). A corporate LOI is only as good as the financial strength of the party issuing it. Of course, that’s often hard to assess. And the full value of commodity shipments can run into many millions of dollars. The LOI needs to cover the full value in the event of misdelivery.  So, if an LOI is not honored when called upon, then what?

This can be a problem for shipowners.  The shipowner must then chase the cargo interest/charterer under the LOI.  Test its financial strength.  Chase assets after the fact.  That risk is uninsured.  Not covered by P&I.  There is full, unmitigated exposure here to the value of the shipment if the shipowner does not recover under the LOI.

This can be a problem for banks.  We will circulate a summary of a recent legal case, where the prevalence of LOIs in the oil trade was a major problem for a bank trying to assert security rights as an OBL holder, where they had routinely allowed cargo to be delivered against LOIs.  The title function of the OBL had effectively been eroded by practice and policy.

This can be a problem for cargo interests.  The use of LOIs can sometimes mean other cargo parties in the sale chain that have not paid the purchase price get their hands on the cargo.  Sure, the proper holder of the cargo can pursue the shipowner for misdelivery, but that is not always a straightforward proposition in the world of one-ship spvs.

When these LOIs go wrong, they tend to go wrong in a big way.

There is a better way:  Secro’s electronic bill of lading.

The Secro e-bill does away with these LOIs.  Backed by recent changes to law and with many security features, the Secro e-bill is a document of title.  It has functional equivalence with a paper bill of lading.  In other words, the Secro e-bill works in the same way as the paper bill providing security as a document of title.

The big difference is that Secro e-bills can be transferred in a matter of minutes, whereas the old paper bill needs to be couriered across the world.  An LOI is not needed because the e-bill will be ready at the discharge port.

Eliminating the need for LOIs promotes the function of the original bill of lading.  The bill can once again do what it was always intended to do.  Be the ‘keys to the warehouse’.

*Disclaimer: This, and all Secro explainers, are general comments and intended as marketing material only.  This is not legal advice or representation – it cannot be relied upon as such.