Ship in distress? Get out your wallet

When a ship sinks or suffers damage on the high seas, cargo owners must share the cost of setting things right—even if they weren't at fault.

By Toby Gooley

Suppose you're importing containers of machine parts from, say, Japan. Every week, the containers are loaded on a ship operated by the same carrier you've used for years. The ship casts off and your cargo heads out on what looks to be another routine voyage across the Pacific. What could go wrong?

An earthquake and tsunami, followed by a nuclear disaster, for one thing. Or the steering could fail and cause the ship to run aground, the engine could catch fire, or a collision could leave the ship with a hole punched through its hull—to name just a few of the more common possibilities.

When disaster strikes, many people assume the ocean carrier will absorb the cost of recovery and repairs. But that's generally not the case. Under a doctrine of maritime law known as "general average," cargo owners are required to pay a share of those costs.

General average allows carriers to charge beneficial cargo owners for costs that meet criteria established by international maritime law. Examples include the costs of towing the ship to safety, repairs, unloading and reloading cargo, rescuing the crew, and compensating customers for jettisoned cargo.

This legal principle, enshrined in international maritime treaties, contracts, and insurance policies, dates back to ancient times. Yet many importers and exporters are taken by surprise when a carrier declares that general average is in effect and the bills start rolling in. It's a complex matter best addressed by transportation lawyers and cargo insurance professionals, but the following overview will explain how general average works and what you can do to make sure you're prepared for the worst.

ANCIENT PRACTICE IN A MODERN AGE
The concept of general average dates back nearly 3,000 years. In centuries-old maritime parlance, "average" refers to loss, and "general" means that something is spread among all parties, according to Richard W. Bridges, a vice president with Roanoke Trade Insurance Inc., which specializes in international insurance solutions. Thus, general average is a pooling of a financial loss by all parties involved in an ocean voyage. (A variation is "particular average," or partial loss, which applies only to directly affected parties.)

More specifically, general average acts as a mechanism for reimbursing the carrier for the extraordinary expenditures or sacrifices it makes for the common good and safety of a voyage, says Laura Otenti, a lawyer with the firm Posternak Blankstein & Lund LLP. "In other words, losses incurred for the common benefit of the participants in a maritime voyage are paid proportionately by all who participate in the voyage," she says.

When would an ocean carrier declare general average? Historically, it typically happened when a ship was in imminent danger and the crew had to jettison cargo to lighten the vessel, Otenti says. That still applies, but today a ship's owner or master (captain) may also declare general average for other reasons, such as when a ship is not in imminent danger but cannot complete the voyage, she explains. Some examples include damage to the vessel caused by bad weather, running aground due to navigational errors, or a mechanical breakdown such as the loss of steering.

These scenarios are uncommon. But they are not rare. According to a report issued by the insurance company Allianz Global Corporate & Specialty, 25 cargo ships were lost in 2014, and hundreds more suffered damage of some type. Most incidents involve bulk vessels, but containerships are also at risk; from 2005 through 2014, a total of 36 sank or suffered serious damage. The largest loss in 2013 was the MOL Comfort, a containership that broke in half and sank off the coast of Yemen, the report said.

PAY YOUR PERCENTAGE
When general average has been declared, the carrier, the vessel owner, or more likely a third party called an "average adjuster" will notify cargo owners and shippers of record. In Otenti's experience, that initial communication usually explains the circumstances that caused the carrier to declare general average and may also include instructions for providing a bond, guaranty, or cash payment. The vessel owner must also prepare a general average statement that allocates the expenses to be paid by each cargo owner, Otenti explains.

How much you'll pay is based on the value of your cargo as a percentage of the total value of the voyage: the value of the ship itself plus the value of the cargo on board, says Bridges. If the value of your cargo is equal to 5 percent of the total value of the voyage, then you'll be required to pay 5 percent of the costs that meet the general average criteria.

The cargo owner's actual outlay over the course of a general average event can be significant. "When I started in the business 20 years ago, a typical general average payment was equivalent to 3 to 5 percent of the value of the cargo, but now we are seeing 7 to 10 percent as the norm," mostly because today's larger ships cost more to tow, unload, and repair, says Bridges. (See the sidebar for a hypothetical example of how a cargo owner's share is calculated and some very costly real-life examples.)

To ensure that cargo owners pony up, the carrier places a lien on all shipments aboard the stricken vessel. The cargo cannot be picked up until whoever owns the risk at that point—the exporter or the importer, depending on the terms of sale—or that party's insurer pays an estimated share of the expenses that are already known. Early on, that's usually the cost of towing the ship, and possibly crew rescue and cargo handling expenses.

But there's more to come, Bridges cautions. Cargo owners or their insurers must also post a bond to guarantee payment of additional charges that may be calculated after the cargo has been released. Examples might include ongoing costs like debris removal and environmental remediation. It can take a long time for the carrier to complete those activities and determine its final expenses, according to Bridges. Then it has to correctly apportion those costs among potentially hundreds of cargo owners—a monumental task he compares with handling a class-action lawsuit. "Some general average claims take up to seven years to complete, and three years is the norm," he observes.

BE PREPARED
Although many aspects of general average are out of the cargo owner's control, there are steps you can take to manage your costs and make sure your rights are protected.

One that may seem obvious but is often overlooked is to become thoroughly familiar with the terms of the carrier's bill of lading, says Suzanne Richer, director, trade advisory practice at Amber Road, a provider of global trade management software and advisory services. "People forget that the bill of lading is a contract of carriage. The back of the bill of lading is loaded with restrictions favoring the carrier, yet few people read it," she says. As a result, some shippers and consignees are not fully aware of their contractual obligations and may be unprepared for what's coming.

Surprisingly, another often-overlooked protective measure is to educate yourself about what your insurance policy does and does not cover, Richer says. That's because people frequently "set it and forget it" when it comes to cargo insurance.

Most policies, including "all risk" and less-inclusive ones, provide coverage for expenses incurred as a result of a general average declaration. But even with coverage, shippers can still get into trouble. For instance, if you purchase insurance through a broker who knows little about cargo, your general average claim may not be handled with urgency. And an importer that buys on sales terms where the seller bears the risk of loss may find that the exporter is in no hurry to pay a general average claim. "In some cases, the exporter may even decide to abandon the freight, leaving the importer stuck," Bridges says.

Be aware that there's more at stake than just covering the cost of general average assessments. There's also the physical loss or damage to the goods, and business costs associated with the delayed delivery and loss of the use of the cargo. Such unpredictable matters are excluded by most policies, but it's possible to purchase additional coverage, Richer says.

Richer recommends carefully considering the legal liabilities and contractual obligations that may apply and quantifying the financial impact in light of the value of the cargo and business impacts. "With that information, you can make a decision about the best option: to pay this or reject the freight, and if I do that, what will be the repercussions?" She also suggests working with your insurance carrier to find out how often such incidents occur in the trade lanes your shipments frequently traverse, and whether it's more economically advantageous to absorb a certain amount of loss.

Regardless of how well informed and prepared you might be, if you export or import a large volume of cargo on a regular basis, sooner or later a notice of general average is likely to arrive in the mail (or your inbox). Don't let the notice sit around, advises Otenti. Alert your insurance carrier and transportation lawyer that you've received the notice and consult them right away about what to expect and the best way to proceed, she says.

I have to pay how much?

When a carrier declares general average, the amount of money you'll be required to pay will be based on the value of your cargo as a percentage of the total value of the voyage—in other words, the value of the ship itself plus the value of the cargo on board.

To illustrate how the losses might be apportioned, Richard W. Bridges, a vice president with Roanoke Trade Insurance, offers a hypothetical example of a ship valued at $50 million that carried cargo valued at $50 million, which combined would yield a $100 million voyage value. If you were a cargo owner with $1 million worth of goods on board, you would be a 1-percent participant. Now suppose that the ship ran aground, and that subsequently, $5 million worth of cargo (not yours) was jettisoned to float the vessel off a sandbar and a salvage tug charged the ship owner another $5 million to tow the vessel to safety. You would be responsible for paying 1 percent of $10 million, or $100,000, though additional payment might be required once the final costs have been determined.

The actual amount to be paid, though, depends on the carrier's total cost and how much cargo is on board the ship. Although typical costs run around 7 to 10 percent of the value of the freight, that figure can go much higher, Bridges says. He cites the example of a 2006 fire on board the Hyundai Fortune, which was caused by undeclared flammable liquids loaded near the engine room and which destroyed over 500 containers. About $160 million in cargo was ruined and the vessel, worth $70 million, was a total loss. The demand on cargo owners was about 40 percent of the value of their freight.

Another large general average loss arose from the 2012 fire on board the MSC Flaminia, which resulted in an initial general average contribution (demand) of all the cargo owners for 110 percent of the value of their cargo. No definitive cause has been found, but most experts agree the ignition source was misdeclared hazardous cargo.