TRANSACTIONAL: Transaction: Allocation of Ship-Shore Liability: Use of Port Liability Agreements to Provide Protection and Mitigate Uncertainty for U.S. LNG Project Participants

by King & Spalding

[author: Monica Hwang]

The use of port liability agreements to allocate ship-shore liability in a marine casualty event has been widely adopted by U.S. LNG import terminals. As many of these terminals transition to bi-directional operations, they will likely extend the same regime to their liquefaction operations. Indeed, the LNG sales agreements for the Sabine Pass export project provide explicitly for port liability agreements.

Buyers seeking to procure LNG or tolling services from a U.S. LNG export project, as well as parties considering developing an LNG project in the U.S., will benefit from understanding the purpose and effect of port liability agreements. This article provides an overview of (a) the need for and purpose of port liability agreements, (b) main content of port liability agreements, and (c) key considerations in negotiating and implementing port liability agreements.

Limitation of Vessel Owner’s Liability Act

Port liability agreements are advisable because of a federal law enacted over 150 years ago. The Limitation of Vessel Owner’s Liability Act, 46 U.S.C. §§ 181 et seq. (the “Act”), limits a vessel owner’s liability in a marine casualty event to the value of his vessel and cargo determined upon termination of the voyage on which the casualty occurred. Thus, the extent of the vessel owner’s liability depends on the extent of the damage suffered. In a truly disastrous situation, the Act can give rise to perverse outcomes. For instance, if a vessel and its cargo are totally destroyed in a situation that causes large damages to third parties, the vessel owner may be able to limit his liability to zero. On the other hand, if the vessel suffered minimal damage (i.e., the vessel and/or cargo still has significant value), the vessel owner’s liability would be significantly higher.

Role of a Port Liability Agreement

To counteract these potentially perverse consequences under the Act, a project owner and a vessel owner may enter into a port liability agreement that allocates liability in a marine casualty event by contract and specifically waives the limitation of the Act. Key features of a port liability agreement typically include:

  • in contrast to the Act, a clear cap on the vessel owner’s liability to a specified amount per incident;
  • liability regime - typically fault-based;
  • requirement that the liability cap be covered by a vessel’s P&I insurance; and
  • waiver by a vessel owner of the right to limit his liability pursuant to the Act - to facilitate higher P&I coverage.

The form of a port liability agreement is typically agreed to and attached to a commercial agreement, whether a tolling agreement or LNG sales and purchase agreement (for simplification, both types of commercial agreements will be referred to as offtake agreements and the tolling counterparty and LNG buyer as offtakers).

Drafting Considerations

More specifically, a port liability agreement names the shore-side and ship-side entities and allocates liability between them. In addition to the terminal owner, shore-side parties typically include shore personnel involved in the loading/unloading of the vessel. While not yet the case in the U.S., a foreign LNG terminal may consist of multiple liquefaction trains and the shared common facilities owned by different parties. In such a case, the port liability agreement should be properly drafted and executed to capture all shore-side facility owners. Ship-side parties typically include the vessel owner, ship personnel, pilots, tugs, and other persons assisting such vessel.

Implementation Considerations

To ensure enforceability of a port liability agreement regime, a project developer can consider one of two common approaches in the drafting and negotiation of its offtake agreements. First, the offtake agreement may entitle the LNG terminal to refuse to berth a vessel that has not executed a port liability agreement. Alternatively, a developer can cause the offtake agreement to contain a provision providing, should the vessel fail to execute a port liability agreement, that the offtaker must fully indemnify the LNG terminal for any ship-shore liability.

A project developer should also take into consideration the term of its offtake agreements. Given that LNG projects are typically supported by long-term agreements (often times 20 years), a project developer may consider negotiating for the right to amend the agreed form of its port liability agreement from time to time. Such right assures that the port liability agreement can be updated in response to any future change in industry norms, such as the amount of the liability cap.

If appropriately structured, a port liability agreement provides protection against uncovered damages for U.S. LNG project developers. At the same time, it mitigates uncertainty of risk exposure for both project developers and vessel owners.

  Monica Hwang
  +1 713 276 7346

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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