This year, many of our clients have faced claims arising out of the delivery of cargo without production of the original bills of lading and against letters of indemnity (“LOIs”).

This scenario has become increasingly common in the PRC, particularly in the iron ore trade where banks are looking to enforce their rights in view of the deteriorating financial health of local steel mills and traders. In many cases, the original bills of lading have not passed through the banking chain to the ultimate receivers and cargo is discharged against an LOI and released to a party who has not paid for the goods. This results in a claim against the carrier by the bank for misdelivery and, ultimately, a claim under the LOI by the carrier.

The delivery of cargo without production of the original bills of lading and against an LOI has become widespread and accepted. However, parties often issue LOIs without a full appreciation of the risks involved.

If a party is considering providing an LOI, careful scrutiny of the security for payment under the sale contract and of the risk of the bills of lading being stuck in the chain should be conducted first.

If a party issues an LOI then it should always obtain an LOI from its charterer/buyer down the chain. The indemnity should be on materially identical terms to the LOI provided. Parties should remember that security is only as sound as the solvency of the party providing it and so, ideally, the indemnity should be backed by a guarantee from a first class international bank or, at the very least, a parent company of substance.

In the PRC, the importance of the delivery order and the lack of physical control of the cargo are leading to significant exposures. Parties should try to insert provisions into their contracts which ensure that delivery orders are only exchanged in return for original bills of lading and find ways of asserting greater control over local agents.

Another option which should be explored is increasing the usage of independently owned or leased warehouses or bonded warehouses into which cargo can be discharged. Whether this is viable would largely depend on the facilities at the relevant port and the point at which import duty will become payable.