Retrofits – the approach to innovative technology and new equipment
With a general trend towards a more technologically advanced and “greener” shipping fleet, many ship owners are looking to retrofit new equipment on their vessels.
A lot of the new equipment is based on new and innovative technologies, or at least technologies that have not previously been put to use for maritime applications. Examples include exhaust gas cleaning systems, commonly referred to as “scrubbers”, battery packs for hybrid vessels and ballast water treatment systems. The parties involved are therefore to a certain extent entering unchartered territories when the relevant contracts are being negotiated, although many of the same principles that apply to the retrofitting of more conventional types of equipment are still relevant.
Fitting a scrubber unit on an existing vessel in response to the upcoming IMO 0.50% global sulphur cap is something many ship owners have opted for, and gives a good illustration of some of the contractual and financial issues that arise in connection with the retrofitting of equipment.
Financing new equipment
Retrofitting scrubber systems is expensive – both in respect of the capital cost for the scrubber unit/installation of same and loss of income during the period the vessel is out of service – which in total can amount to between USD 2-5 million. For larger ship owning companies this may not be a problem, but many ship owners will not be able to meet the costs themselves and will need help with finance. Banks may however not be willing to provide further capital under existing loan arrangements, in which case ship owners will have to seek financing from alternative sources.
In circumstances where the ship owner seeks new separate debt funding for the scrubber system and a mortgage is already granted over the relevant ship the question arises of what security can be given for the new funding.
New equipment installed on a ship will normally be deemed to form part of the ship and thus be covered by an existing ship mortgage (either by local laws or by express agreement between the parties to the ship mortgage). In certain jurisdictions an existing ship mortgage may even cover equipment owned by a third party that is installed on the ship. A new equipment lender may therefore be unable to take security over the equipment being financed and will require alternative security.
An alternative to get around these issues may be for the equipment financier to be granted a second lien mortgage for its claim in the vessel as such, but such arrangement will require consent and negotiation of inter-creditor principles with the existing mortgagee.
The three key phases of retrofitting a scrubber on-board a vessel are as follows: (1) the manufacture of the unit; (2) the marine engineering and design required for installation; and (3) installation, commissioning and testing. The parties commonly involved are the ship owner, the scrubber manufacturer and the yard which will be conducting the installation of the unit. Some scrubber manufacturers may agree to phase (2) being included in their scope of work, whereas others cannot take on that responsibility either because they do not have the capacity to do so, or because they do not possess the relevant marine design and engineering experience. The responsibility for phase (2) is then likely to fall on the ship owners whom in many cases will sub-contract the work to a third party marine design and engineering company. The number of parties involved and the potentially severe consequences of delays in the retrofitting or underperformance of the scrubber makes it important to determine the responsibilities of each party with respect to each of the phases in the relevant contracts.
Carefully setting out the liabilities of each party for under-performance of the scrubbers is therefore very important. The scrubber manufacturer is likely to be responsible for defects in the scrubber unit and under performance of the unit resulting solely from such defects. It may also be liable for delays during phase (3) if the relevant delays are caused by or attributable to the manufacturer.
Provided that the scrubber manufacturer has not taken on the responsibility for phase (2), its liability for under-performance resulting from a flawed overall system design, incorrect installation drawings and procedures, or mistakes made during installation is however likely to be limited and the ship owner would need seek damages from the party having provided the design and engineering. Although the installation yard typically will have a responsibility to rectify a flawed installation, it is not unlikely that the yard argues that the error is not caused by the installation but from an error in the design and engineering or even the unit itself.
The inclusion of a liquidated damages regime for delay in delivery of the relevant work product under the contract for each of the phases of the retrofitting project, taking into account the knock-on effect that a delay might cause for the other phases of the project and the extension of the off-hire period for the vessel, is also recommended.
The issue at heart with the new environmental regulations and technology is not only compliance as such, but how to get greener and achieve long term compliance in the most cost effective way in an increasingly stringent regulatory environment. As for scrubbers, having one installed will likely lower fuel costs or at least avoid having to purchase more expensive fuel that complies with the 2020 IMO regulations, but in addition to these commercial considerations there are also aspects related to the retrofitting contract and the possible financing of the unit and its installation that will need to be taken into account.