Managing compliance risks in shipbuilding projects

Shipbuilding projects are by nature particularly vulnerable to changes in the geopolitical landscape and emerging regulatory measures. While compliance traditionally has encompassed risks such as anti-corruption, bribery, human rights, and working conditions, the landscape has become much more complex with the adoption of ever-increasing sanction laws. Non-compliance comes with a high price, involving the risk of severe financial consequences and even criminal charges. Managing these risks thus becomes key in modern shipbuilding projects.

Examples of how compliance risks may affect shipbuilding projects

Sanctions and export controls are particularly sensitive to changes in the geopolitical environment, as authorities may implement them quickly to restrict trade with specific countries, entities and individuals, as well as the export and import of certain goods. If a shipyard or sub-suppliers are targeted by sanctions, or the project involves restricted materials or technology, this may potentially affect material sourcing and vessel transfers, and the consequences may include severe delays and increased costs. 

Several countries known for shipbuilding, such as China and Turkey, have not implemented similar sanctions as Norway, EU, UK, and the US. These countries may be associated with an increased risk of circumvention of sanctions, which can constitute a separate breach of sanctions regulations. A transaction that may be legally permissible for a company operating in the jurisdiction of the shipyard, might constitute an indirect breach of the sanction laws applicable to a Norwegian company involved in the transaction. 

Additionally, a shipyard building or even repairing vessels for e.g. Russian owners, may be designated by sanctions authorities or face secondary sanctions, which could result in significant operational challenges for the shipyard and its clients. Challenges may include disruptions in production timelines and financial repercussions, or, in a worst-case scenario, severe difficulties in completing and delivering the vessel. Continued cooperation with the shipyard would also expose all its business partners to a risk of violating sanctions or being made subject to sanctions. 

Given that steel is a critical material in shipbuilding projects, a notable example of the impact of sanctions is the ban on the import of certain iron and steel products located in, originating from, or exported by Russia. The prohibition even extends to certain products, including important components for shipbuilding, that have been processed in third countries incorporating Russian-origin steel. Further, if the shipyard uses steel that is subject to an import ban in Norway and the EU, it could raise questions as to whether purchasing the ship would be considered an indirect purchase of this steel. Alternatively, such situations could be assessed under the ban on sanctions circumvention. This shows that the use of Russian origin steel in shipbuilding projects is associated with a high sanctions risk. 

We note that while the EU, UK, and US have up until now been relatively aligned in their sanctions efforts against Russia, there are signs that these sanctions regimes may begin to diverge, which could complicate compliance strategies and necessitate more tailored approaches. Geopolitical divergence could also affect export controls. Shipbuilding projects involve advanced technology of strategic significance from an export control perspective. Sub-supplies to the yard might be or become subject to export controls, and such controls might apply both the physical goods and immaterial technology transfers, and US export controls could, in certain scenarios, apply to goods that have never been on US soil. Such export controls could affect the ability of sub-suppliers, who are often chosen by the buyer, to supply equipment to the shipyard. Furthermore, export from the shipyard may be challenging for the same reasons and, in geopolitically tense situations, export controls could also be used as countermeasures. 

National security concerns may extend beyond applicable sanctions and export controls. In sensitive projects, involving for example advanced technologies or strategic assets, buyers or end users of the vessels may drive increased requirements for due diligence of shipyards, sub-suppliers and technology providers to avoid security vulnerabilities relating to the vessel in operation. The growing number of cyber, intelligence, and sabotage threats, together with increasing dependency on digital systems, underscore the need to elevate such risks on the agenda in shipbuilding projects. 

Reputational risks could attach not only to shipyards that become sanctioned or breach export control regulations, but also to shipyards that engage with owners or customers from sanctioned jurisdictions or military end users, for example by contributing to the maintenance of the shadow fleet. This reputational risk also extends to anyone continuing their engagement with the shipyard, including Norwegian customers, beyond the potential legal risks.

Risk mitigating measures

To mitigate the exposure to compliance risks in a modern shipbuilding project, owners are advised to adopt proactive measures including:

• Carry out due diligence on shipyards and suppliers to ensure they comply with applicable rules on corruption, human rights, sanctions, and export control. This includes examining ownership and past behaviour
• Consider compliance issues from the outset when negotiating contracts
• Include contract clauses that mandate compliance with regulations, termination rights, and rights to access and inspections, including notification requirements for changes in ownership of the shipyard or suppliers, as well as termination and substitution options
• Conduct regular inspections of the shipyards to ensure they meet contractual obligations, regulatory standards, and ethical practices
• Obtain documentation regarding the origin of steel
• Monitor requirements and track changes in sanctions regulations and new sanctions

Taking a proactive approach to ­identify and mitigate risks is key, but it is ­impossible to eliminate all risk. It is ­therefore also important to consider ­various scenarios to ensure that the ­shipbuilding contract protects your interests in the event of the introduction of sanctions against involved parties, ­integrity breaches in the supply chain, or similar events. Our team of dedicated experts is always available to assist you in navigating these issues.