THE SECOND INTERNATIONAL CONFERENCE ON INSURANCE & MARINE TRANSPORTATION - "CLAIMS & RISK MANAGEMENT" GENERAL AVERAGE Paper of Jonathan S.

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1 General Average is an ancient institution of maritime commerce, which traces its roots to the Phoenician era in the Eastern Mediterranean. Average in this context means marine damage and general indicates that the average involves everyone in the voyage as opposed to particular average, which involves the private interests of only one party. In recent times, starting in the 19 th century, the General Average regime has been embodied in the York-Antwerp Rules, an international code administered by the Comité Maritime International, or International Maritime Law Association. The York-Antwerp Rules are almost invariably incorporated into contracts of carriage, and reference to them will be found in the General Average clause of bills of lading and charterparties. The York-Antwerp Rule A defines General Average as follows: There is a General Average act when, and only when, any extraordinary sacrifice or expenditure is intentionally and reasonably made or incurred for the common safety for the purpose of preserving from peril the property involved in a common maritime adventure. It is readily apparent that General Average involves sacrifice or expenditure which must be extraordinary, intentional, and reasonable and have the effect of preserving from peril the property involved in the voyage. Typical examples include damage to the vessel or cargo by water used to extinguish a fire, holes cut in the plating of a ship in order to gain access to the seat of a fire in order to extinguish it, the jettison of cargo in order to lighten a stranded vessel and refloat it, and expenditure by way of towage to refloat a stranded vessel or to bring a disabled vessel to a place of safety. General Average sacrifice and expenditure is borne by all the parties to the adventure in proportion to the value of the property that is saved. If the ship and the cargo are of equal value then the shipowners and cargo owners, and their respective insurers, will both pay half of the General Average. If the cargo is worth twice as much as the ship, then the ship will pay one third of the General Average and the cargo will pay two thirds. The York Antwerp Rules have been subject to periodic change since their inception, every twenty to twenty-five years 1890, 1924, 1950, 1974, 1994 and, most recently, Change was largely evolutionary, and each successive version of the Rules replaced the previous one, a pattern that changed in The 2004 Rules were written as an alternative to the 1994 Rules so that both versions are now encountered and practitioners need to be familiar with both. In 1994 various changes were made to the Rules all with the intention of promoting uniformity of practice. The most striking change was the introduction of a Rule Paramount to ensure that all allowances made in General Average became subject to a test of reasonableness. This change arose from the structure of the Rules, which are organized into a group of lettered Rules that establish general principles of adjustment followed by numbered Rules that address the treatment

2 of specific items of sacrifice and expenditure. These are subject to a Rule of Interpretation that provides that the numbered Rules prevail over the lettered Rules. A dispute arose in the case of a ship called the Alpha (Corfu Navigation v Mobil Shipping [1991] 2 Lloyd s Rep. 515), a small tanker that went aground while loaded with cargo, and the ship s Master strained its engines over a period of days, beyond any reasonable measure, attempting to refloat it, even though members of the ship s staff assured him that the effort would not succeed and would result in damage to the engines. The claim fell to be considered under Rule VII of the York-Antwerp Rules, which establishes that damage caused to a ship s machinery in endeavoring to refloat while the ship is ashore and in a position of peril shall be allowed in general average when shown to have arisen from an actual intention to float the ship for the common safety at the risk of such damage. It had always seemed axiomatic to most practitioners that, to be properly allowable as General Average, such damage should be reasonably incurred, but the Court in the Alpha held that because the numbered Rules prevail over the lettered Rules and because the word reasonable does not appear in Rule VII, the damage consequential on the Master s misguided effort to refloat the vessel, since the numbered Rule VII prevailed over the lettered Rule A. That decision gave rise to the Rule Paramount, which now provides: In no case shall there be any allowance for sacrifice or expenditure unless reasonably made or incurred. The next change was an entirely new provision, now found at Rule B: There is a common maritime adventure when one or more vessels are towing or pushing another vessel or vessels, provided that they are all involved in commercial activities and not in a salvage operation. When measures are taken to preserve the vessels and their cargoes, if any, from a common peril, these Rules shall apply. A vessel is not in common peril with another vessel or vessels if by simply disconnecting from the other vessel or vessels she is in safety; but if the disconnection is itself a general average act the common maritime adventure continues. Jurisprudence was conflicting in various countries on the matter of tug and tow General Averages, and the purpose of the new Rule, again, was to bring about uniformity of practice. A 1994 change that affected various Rules was the so-called Pollution Compromise. Prior to 1994 it was technically possible that, if pollution occurred as the consequence of a General Average act, the clean-up could become a charge on the contributing interests. As the international response to instances of pollution became more and more energetic, and the costs of 2

3 clean-up increased, it was clear that if such a claim were to arise it would place a heavy burden on the parties to the adventure and possibly obliterate any benefit that they might otherwise have derived from their property being saved. Furthermore, insurers of ships and their cargoes were not happy to bear a potential exposure to pollution liabilities by virtue of insuring General Average contributions. On the other hand, the P&I Clubs were unwilling to see an obligation transferred to them by the property insurers. However, the Clubs were already insuring most pollution risks and were well-prepared to confront them. Accordingly, the compromise was struck that any liability for pollution itself would become the subject of a claim against pollution insurers but, where a General Average act involved measures to avert pollution, the cost of these measures would be General Average. The compromise entailed changes to various Rules. First, a new paragraph was added to Rule C: In no case shall there be any allowance in general average for losses, damages or expenses incurred in respect of damage to the environment or in consequence of the escape or release of pollutant substances from the property involved in the common maritime adventure. Next, Rule V, dealing with Voluntary Stranding, had to be harmonized with the addition of the words shown in bold: When a ship is intentionally run on shore for the common safety, whether or not she might have been driven on shore, the consequent loss or damage to the property involved in the common maritime adventure shall be allowed in general average. Rule VII, dealing with Expenses Lightening a Ship When Ashore, and Consequent Damage, similarly needed to be qualified: When a ship is ashore and cargo and ship's fuel and stores or any of them are discharged as a general average act, the extra cost of lightening, lighter hire and reshipping (if incurred), and any loss or damage to the property involved in the common maritime adventure in consequence thereof, shall be admitted as general average. (The final part of the previous Rule VII had read and the loss or damage sustained thereby, shall be admitted as general average. In order to clarify the intention and operation of the compromise, the following provisions were added at section (d) of Rule IX, dealing with expenses at a port of refuge: 3

4 The cost of measures undertaken to prevent or minimise damage to the environment shall be allowed in general average when incurred in any or all of the following circumstances: (i) as part of an operation performed for the common safety which, had it been undertaken by a party outside the common maritime adventure, would have entitled such party to a salvage reward; (ii) as a condition of entry into or departure from any port or place in the circumstances prescribed in Rule X(a); (iii) as a condition of remaining at any port or place in the circumstances prescribed in Rule X(a), provided that when there is an actual escape or release of pollutant substances the cost of any additional measures required on that account to prevent or minimise pollution or environmental damage shall not be allowed as general average; (iv) necessarily in connection with the discharging, storing or reloading of cargo whenever the cost of those operations is admissible as general average. A change, basically administrative in nature, was brought about by the addition to Rule G of a non-separation wording, as follows: When a ship is at any port or place in circumstances which would give rise to an allowance in general average under the provisions of Rules X and XI, and the cargo or part thereof is forwarded to destination by other means, rights and liabilities in general average shall, subject to cargo interests being notified if practicable, remain as nearly as possible the same as they would have been in the absence of such forwarding, as if the adventure had continued in the original ship for so long as justifiable under the contract of affreightment and the applicable law. The proportion attaching to cargo of the allowances made in general average by reason of applying the third paragraph of this Rule shall not exceed the cost which would have been borne by the owners of cargo if the cargo had been forwarded at their expense. Prior to this rule change, it was always necessary to contact cargo interests after the General Average event to seek their consent to forwarding cargo under a non-separation agreement. This meant that, occasionally, an opportunity to forward cargo was lost if a vessel was available to transship into but there was not time to contact the cargo interests and seek their agreement to such transshipment. Now, if time is so tight that it is not practicable to notify cargo interests, with the benefit of the new provision the cargo can still be sent forward. 4

5 Complementary to the non-separation wording, the following addition was made to Rule XVII, dealing with Contributory Values: In the circumstances envisaged in the third paragraph of Rule G, the cargo and other property shall contribute on the basis of its value upon delivery at original destination unless sold or otherwise disposed of short of that destination, and the ship shall contribute upon its actual net value at the time of completion of discharge of cargo. Next, Rule III, dealing with Extinguishing Fire on Shipboard, was the subject of an important clarification. This Rule had previously provided that Damage done to a ship and cargo, or either of them, by water or otherwise, including damage by beaching or scuttling a burning ship, in extinguishing a fire on board the ship, shall be made good as general average, except that no compensation shall be made for damage by smoke or heat however caused. This seemed clear enough but controversy had arisen over General Average claims arising from fires aboard a certain type of vessel designed to carry refrigerated cargo, by means of a system that circulates cold air to keep the cargo chilled. When fire breaks out in a hold of such a vessel, the first step in combating it is to turn off the circulation of cold air, which otherwise would feed oxygen to the fire. It is plain that this is an intentional and reasonable act, undertaken for the common safety, and it was the practice of most average adjusters to allow as General Average sacrifice damage done to refrigerated cargoes in such a circumstance. However, certain insurers took the position that where a refrigerated cargo suffered damage by reason of the refrigeration system being turned off, this was damage by heat and fell within the above exclusion. This clearly was not the intention of the Rule and also defied basic principles of General Average and, for clarity, the exclusion of damage by smoke or heat however caused has now been replaced with an exclusion of damage by smoke however caused or heat of the fire. Finally, Rule XXI, dealing with the allowance of interest at 7% per annum on General Average expenditure and sacrifice, was amended to provide that such interest would now be allowed until three months after the date of issue of the General Average adjustment, whereas previously interest had run until the date of the adjustment. The Rules were adopted on October 7 th 1994 in the Plenary Session of the CMI Sydney conference and most delegates felt that a satisfactory result had been achieved. However, during the preparation for the 1994 conference, some cargo Underwriters had been voicing increasingly strident opposition to the institution of General Average arguing that it had become a vehicle for subsidizing substandard shipowners. Their stance eventually was espoused by the International Union of Marine Insurance (IUMI), which took the position that the 1994 Rules had been adopted without sufficient debate, whereas in fact the debate had been conducted over a period 5

6 of years at the level of national maritime law associations and an international subcommittee formed by the CMI in late Nevertheless it was felt that IUMI was a sufficiently important body that its voice had to be heard and a new international subcommittee was formed around 2000 to commence the work that would lead up to the York Antwerp Rules The principal theme of the IUMI initiative was that allowances in General Average should cease with the attainment of safety whereas previous versions of the Rules permitted various allowances for the common benefit, the most generous of these being the allowance of wages and maintenance of the ship s crew while the vessel was detained at a port of refuge making repairs necessary for the safe prosecution of the voyage. The most cynical of the commentators suggested that some shipowners would defer maintenance until the ship broke down while there was cargo on board so that they could collect in General Average the crew s wages that otherwise would have fallen to the Owners account if maintenance had been planned and performed in the proper way, taking the ship out of service. By the time the conference opened, IUMI had indicated a willingness to compromise from their most radical position, that General Average should be restricted to common safety and that common benefit should be eliminated entirely; indeed, there was, by general agreement in committee no debate or vote on the radical position and the conference largely addressed itself to various incremental restrictions of what can be allowed under the York Antwerp Rules. The IUMI delegation also expressed the intention, in its opening remarks at Vancouver, that the new rules should stand as an alternative available to those who opt to use them, rather than replacing the 1994 Rules. All of the changes that had been adopted in 1994 were preserved, with further changes occurring in First, Rule VI was amended to eliminate the redistribution in General Average of salvage settlements. Salvage will now be dealt with in the General Average adjustment only where it is paid by one party to the adventure on behalf of other parties to the adventure, for example, where the shipowner settles the salvage on behalf of all interests. The new Rule reads as follows: RULE VI. SALVAGE REMUNERATION Salvage payments, including interest thereon and legal fees associated with such payments, shall lie where they fall and shall not be allowed in General Average, save only that if one party to the salvage shall have paid all or any of the proportion of salvage (including interest and legal fees) due from another party (calculated on the basis of salved values and not General Average contributory values), the unpaid contribution to salvage due from that other party shall be credited in the adjustment to the party that has paid it, and debited to the party on whose behalf the payment was made. 6

7 Salvage payments referred to in paragraph (a) above shall include any salvage remuneration in which the skill and efforts of the salvors in preventing or minimising damage to the environment such as is referred to in Art. 13 paragraph 1(b) of the International Convention on Salvage 1989 have been taken into account. Special compensation payable to a salvor by the ship owner under Art. 14 of the said Convention to the extent specified in paragraph 4 of that Article or under any other provision similar in substance (such as Scopic) shall not be allowed in General Average and shall not be considered a salvage payment as referred to in paragraph (a) of this Rule. It must be noted that the salvage is dealt with on a separate basis from General Average, calculated on the basis of salved values and not General Average contributory values, requiring the adjuster now to make two apportionments. It appeared to be the intention of the drafters that salvage settlements paid by one party on behalf of other parties shall not attract an allowance for interest under Rule XXI but subsequent enquiry indicated that this was not so. This omission was taken up by the Association of Average Adjusters of the United States, which adopted the following Rule of Practice: XXII. SALVAGE SETTLEMENTS UNDER YORK ANTWERP RULES 2004 ALLOWANCE FOR INTEREST When the adjustment is subject to the York Antwerp Rules 2004 and includes, applying the provisions of Rule VI (a) of those Rules, contributions to salvage paid by one party to the adventure on behalf of another party to the adventure as well as on its own behalf, the provisions of Rule XXI of the Rules will apply to the paying party s salvage payments, including interest thereon and legal fees associated with such payments, as if they were General Average expenditure. The UK-based Association of Average Adjusters also identified a potential problem in the new Rule VI and adopted a probationary Rule of Practice, providing as follows: C5. York-Antwerp Rules Rule VI: For the purpose of applying Rule VI of the York-Antwerp Rules, 2004, the term "salvage payments" shall be interpreted to mean payments made in respect of salvage services for which there is contractual and / or legal provision for apportionment and payment between the salved interest upon termination of the salvage services, independent of the York-Antwerp Rules

8 The object of this Rule apparently is to forestall the possibility of arguing that simple towage arranged for the common safety and paid for by one party to the adventure is salvage and therefore cannot be recovered in General Average. Rule XI was changed to eliminate allowances for wages and maintenance during General Average detentions. This entailed a certain rearrangement of the Rule best illustrated by a sideby-side comparison of the 1994 and 2004 versions, as appended, with substantive changes in new paragraphs (c)(i), (c)(ii) and (c)(iii) (paragraph numbers were introduced as part of the 2004 changes). Rule XI(d) remained unchanged from the new wording adopted in 1994, which has already been set out above. A further curtailment of General Average was made in Rule XIV, dealing with the cost of temporary repairs. The International Sub-committee in the course of its preparatory work for Sydney had recommended that an effort be made to limit allowances for temporary repairs so as to avoid any undue advantage to the shipowner, particularly in cases where a temporary repair makes it possible for the ship to make final repairs at a place where repairs can be made more cheaply than at a port of refuge. Such a limitation, at least for the cost of repairs to accidental damage, was achieved in 2004 by adding a second sentence to the second paragraph of Rule XIV: Where temporary repairs of accidental damage are effected in order to enable the adventure to be completed, the cost of such repairs shall be allowed as general average without regard to the saving, if any, to other interests, but only up to the saving in expense which would have been incurred and allowed in general average if such repairs had not been effected there. Provided that for the purposes of this paragraph only, the cost of temporary repairs falling for consideration shall be limited to the extent that the cost of temporary repairs effected at the port of loading, call or refuge, together with either the cost of permanent repairs eventually effected or, if unrepaired at the time of the adjustment, the reasonable depreciation of the value of the vessel at the completion of the adventure, exceeds the cost of permanent repairs had they been effected at the port of loading, call or refuge. The IUMI delegates were fiercely opposed to the allowance of commission on funds advanced to pay for General Average expenditure. By the deletion of the first paragraph of the old Rule XX, the 2% commission for advancing funds was removed from the York Antwerp Rules Nevertheless, where the York Antwerp Rules 2004 are supplemented by United States adjusting practice, a 2½% advancing commission will now be allowable. The potential allowance for interest on sacrifices and expenditure was also addressed. Whereas the old Rule XXI had provided for interest at the fixed rate of 7% per annum, these words were deleted. The following second paragraph was added to the Rule: 8

9 (b) Each year the Assembly of the Comité Maritime International shall decide the rate of interest which shall apply. The rate shall be used for calculating interest accruing during the following year The International Working Group provided the following guidelines to the Assembly: The Assembly is empowered to decide the rate of interest based upon any information or consideration, which in the discretion of the Assembly are considered relevant, but may take the following matters into account: The rate shall be based upon a reasonable estimate of what is the rate of interest charged by a first class commercial bank to a ship owner of good credit rating. Due regard shall be had to the following: That the majority of all GA adjustments are drawn up in USD. That therefore the level of interest for one-year USD loans shall be given particular consideration. That most adjustments, which are not drawn up in USD, are drawn up in GBP, EUR or JPY. That, if the level of interest for one year loans in GBP, EUR or JPY differs substantially from the level of interest for one year loans in USD, this shall be taken into account. That readily available information about the level of interest such as USDprime rate and LIBOR shall be collected and used. Any amendment of these guidelines shall be made by a decision of a conference of the CMI. To date the CMI has set the following rates of interest: 1st January 2005 to 31st December 2006: 4.5% 1st January to 31st December 2007: 5.5% 1st January to 31st December 2008: 5.75% 1st January to 31st December 2009: 6% For comparison, the Association of Average Adjusters of the United States applies the following Rule of Practice, in situations where the York Antwerp Rules do not apply: 9

10 II. Interest on Allowances in General Average (Adopted April 21, Amended October 2, 2002) When allowance, sacrifices or expenditures are charged or made good in general average, interest shall be allowed thereon at the prime rate prevailing on the last day of discharge, plus 2 %, and continue until three months after the issue date of the general average statement. Finally, a new Rule was adopted applying a time bar to claim General Average contribution of one year from the date of issue of the adjustment, but in no case to exceed more than six years after the completion of the common maritime adventure. In addition to the foregoing specific provisions, a series of amendments were implemented to introduce more consistency in the terminology employed in the Rules. Which version of the Rules, then, is to be preferred? The York-Antwerp Rules are a commercial regimen to be agreed between carriers and shippers of cargo. Average adjusters should provide counsel, if asked. We do not advocate any particular position. To those who say we have a vested interest in the status quo, we say that someone ultimately will insure these exposures once the hull, cargo and freight policies have been rewritten and the claims will still have to be adjusted. In current times, no discussion of General Average is complete without some reference to the topic of piracy, hijacking and ransom. The phenomenon of piracy has persisted in some form or another throughout modern times. Attacks against merchant vessels off Indonesia and Singapore in the 1980s, for example, prompted the formation in 1992 of the International Maritime Bureau s Piracy Reporting Centre (IMBPRC) in Kuala Lumpur. However, piracy in that region took the form of occasional thefts of entire vessels and their cargoes or, more frequently, a brief attack on a vessel with the objective of stealing valuables from the ship s safe. The pattern of piracy that has developed more recently off the Horn of Africa has taken a different form, involving the seizing and detention of vessels and their cargoes to procure the payment of ransom. The cost is huge. Some secrecy surrounds the quantum of the ransom payments but they are widely believed to be in the range of $1,000,000 to $2,000,000, or more, per event. The cost of assembling, transporting and delivering the ransom, with payment typically being demanded in used bank notes of small denominations, can easily approach half a million dollars. And for the shipowner, it is the tip of the iceberg, with the negotiation of ransom commonly taking days, during which time the vessel is not earning freight. The crew is usually confined to the accommodation block and is able to perform only minimal, if any, maintenance so that, on release, the major machinery and a lot of ancillary equipment requires immediate repair, resulting in further delay to the vessel and her cargo before the voyage can be resumed. 10

11 The International Maritime Bureau's Piracy Reporting Centre recorded in its 2008 annual report that 111 of the 293 incidents of piracy and armed robbery against ships which took place last year occurred off the Somali coast. Nigeria ranked second in the world for hijackings though some of these were politically-motivated whereas the Somali activity is purely for financial gain. The main difference between the East and West African pirate activities is that almost all the incidents in Nigeria are conducted within its territorial waters, therefore come within the jurisdiction of national authorities, whereas the incidents along the East coast of Africa and in the Gulf of Aden occur on the high seas. Multinational naval forces have been assembled to respond to the threat in the Gulf of Aden, Somali Basin and Horn of Africa. These seemed initially to be effective in January and February 2009 there were, respectively, zero and two attempted attacks off the east coast of Somalia. However, March 2009 then saw a spike, with fifteen reported attacks off Somalia, resulting in eight hijackings, a spike which has continued at the time of this writing in early April. The pirates have been operating further and further afield, now avoiding the northern coast of Somalia and operating 400 or 500 miles off the eastern coast, and further south into the Indian Ocean an attack on a bulk carrier was reported 900 nautical miles off the coat of Kenya. The area involved is therefore vast. The U.S. Fifth Fleet issued an alert to mariners on April 7 th 2009 describing it in the following terms: The scope and magnitude of problem cannot be understated. The area involved off the coast of Somalia and Kenya as well as the Gulf of Aden equals more than 1.1 million square miles (2.5 million square kilometers), roughly four times the size of Texas or the size of the Mediterranean and Red Seas combined. The length of the Somali coastline is roughly the same length as the entire Eastern Seaboard of the United States. This means that when an attack occurs far offshore, any prospect of intervention can often be several days away. In 2008, according to IMBPRC statistics, 42 vessels were hijacked off Somalia, with 815 crew taken hostage. As at December 31 st 2008, Somali pirates were holding 13 vessels for ransom and 242 crew hostage. It can readily be appreciated that the direct and indirect costs run into hundreds of millions of dollars. What are the implications for marine insurers? In the first place, some have seized it as an opportunity. For example, kidnap and ransom insurance, a line of business that has existed for decades, is now being extended to vessels and their crews, although rates of premium have increased substantially in the early months of Nevertheless, the April 9 th 2009 issue of TradeWinds reported an Aon spokesperson as saying that the increase in pirate attacks means that shipowners could be paying $30,000 for $3m of K&R cover for seven days, a premium of about 1%; this might seem low in relation to the apparent exposure but the entire phenomenon must be viewed in the context of some 20,000 transits of the Gulf of Aden each year, the vast majority of them being completed without material incident. 11

12 It was also Aon who in December 2008 launched a new insurance policy for charterers, shipowners and cargo owners to cover loss of earnings from a ship being detained by pirates. In the absence of special insurances and even if there are special insurances, because claims on K&R policies can be complicated by an other insurances exclusion where does the payment of ransom and its attendant costs fall? In the first place we must establish where coverage for piracy lies. Here, different insurance regimes have evolved in different markets. In London, for example, piracy has been treated as a marine risk in the standard hull & machinery forms since 1983 and in the all risks cargo policy. In standard AIMU forms, it is treated as a war risk. The London market has also announced moves to move piracy from the marine policies to the war risks cover. The distinction is quite important in hull insurance, because hull war risks traditionally has not carried a deductible, although that appears likely to change. On the other hand, war risks Underwriters charge an additional premium for each transit through what is considered a war zone at any given time. This enables the market to adjust its prices to more accurately reflect the current risk though makes budgeting difficult for vessel Owners, because whereas rates of premium can be adjusted from day to day the freight to be earned for the voyage in question might have been fixed weeks before. Some commentators have suggested that ransom be treated as Sue and Labor. However, Sue & Labor expenditure by definition is an expenditure incurred solely in respect of a single insured interest thus where a ship and cargo is seized it would technically be necessary for each interest which might include not only the concerned in the vessel and its cargo but also owners of such other interests as shipping containers and time charterers bunkers to negotiate a separate ransom, for this to be recoverable under the respective interests insurances as Sue and Labor. There have also been suggestions that the P&I Clubs somehow have a dog in this fight, although for public consumption at least they have resolutely maintained the position that hijacking is an issue for the property Underwriters. There have been a handful of cases where Clubs have contributed a small portion of a ransom, on the basis that they insured the lives of the crew and had benefit from their safe release, but it seems wholly insidious to ascribe a monetary value to the lives of seafarers for this purpose. The principle established in The Bosworth (No. 3) (1962) I.L.R. 483, that where salvors had their award enhanced by virtue if saving the lives of the crew, this cost nevertheless fell on the property insurers, seems equally appropriate here. By the same token the crews lives, and their personal effects, have never been called on to contribute in General Average. Surprisingly, given the general level of opposition to the institution, there has been a high degree of consensus that ransom properly forms the subject of General Average. For example, Chris Potts of Crump & Co. s Hong Kong office in a paper dated March 11 th 2009 called When the Worst Happens: Recovering Piracy Losses states that In most piracy 12

13 situations affecting cargo, the shipowners or their protection and indemnity insurers or hull underwriters will be obliged to negotiate and pay a ransom and related expenses. The shipowners will then endeavour to recover a contribution in general average from cargo interests after obtaining a general average bond or guarantee. Speaking at the Connecticut Maritime Association in March this year, James Gosling of Holman Fenwick was reported in the March 30 th issue of Business Insurance to have said I think it s generally accepted by adjusters that ransom is a (general average) expense. But Mr. Gosling also said in piracy cases he has handled, his firm asks for a voluntary contribution from the cargo insurer to avoid the need to declare general averages, and that many cargo underwriters have done so. The idea of an informal settlement seems an appropriate response, thus avoiding the extra trappings of General Average. Under the 1994 York-Antwerp Rules, assuming payment of $1,500,000 in ransom, the General Average commission alone would be $30,000 and interest would accrue at a rate slightly in excess of $2,000/week from the date of payment until 90 days after the issue of the adjustment. Nevertheless insurers often are constrained from such an arrangement by the terms of their reinsurance contracts, which generally preclude extracontractual settlements. WK Webster put out a position paper on General Average and Piracy in January 2009 which is worth quoting in full, because it summarizes the major issues: W K Webster have been involved on behalf of cargo Insurers in a number of recent piracy cases where the ship owners have declared General Average (GA) and indicated that they would seek recovery of a share of any ransom payments made through GA proceedings. As yet, no such payments have been demanded or made and there is no legal precedent. However, the following aspects are common to all enquiries so far: [ ] under the York-Antwerp rules, common law GA requires four key elements: Peril Extraordinary Loss / Expenditure Voluntary incurring of such Loss / Expenditure Common Benefit / Common Maritime Adventure Armed pirates on board the vessel without doubt constitute a peril. Ransom payments do not constitute expenditure reasonably contemplated in the fulfilment of the intended voyage - they are extraordinary. There is no legal duty or pre-existing (contractual) obligation to pay a ransom - it is voluntarily incurred. 13

14 It allows release of ship & cargo so that the common maritime adventure may be fulfilled - it is for the common benefit. Also, albeit in passing, the standard textbook on GA (Lowndes & Rudolf) allows piracy as a GA casualty. Under Rule D of the York Antwerp rules, contesting a GA tends to be almost exclusively limited to demonstrating pre-existing unseaworthiness before and at commencement of the voyage. It is difficult to imagine a circumstance where that defence would be appropriate in cases of piracy. Concurrently, there have been questions regarding the legality of paying ransoms under FSA-type regulations, Proceeds of Crime legislation, etc. These do not hold water. Not least, the Insurance Market offers K & R policies. Consequently we believe that seeking to dispute GA in principle will fail. What is left open, however, is the difficulty shipowners will have in proving their losses the total amount (it's in cash these days), whether they actually paid it out (or all of it), what were the ancillary expenses, etc. There remains scope for negotiation on quantum. Case law is quite sparse. The most-cited English case is Hicks v Palington (1590) Moore s (Q.B.) R 297, where cargo given to pirates by way of ransom was treated as a General Average sacrifice, an example of voluntary sacrifice cited with approval by the United States Supreme Court in Ralli v Troop (1894) 157 US 386. An interesting case was reported in the New York Times of March 20 th 1875 involving the decision on March 18 th of that year by the Court of Commissioners of the Alabama Claims in the case of Moses Hyneman v. the United States, involving an action arising from a ransom bond exacted by the rebel cruiser Alabama from the master of the steamship Ariel, bound with cargo from New York to San Francisco. On the arrival of the goods at San Francisco, the owners of the steamship line, regarding the case as one of the [sic] general average, placed it in the charge of professional adjusters. [ ] They apportioned the respective amounts which the vessel, the freight, and the cargo were liable to contribute if payment of the bond were fully exacted, and they also apportioned the expense of the adjustment among these different interests. With the cessation of hostilities, the bond was not enforced, but the Commissioners, who had been asked to adjudicate over a sum of gold paid as security by the hapless Hyneman, determined that the ransom, if paid, would have been General Average. It may be freely admitted that where a ship is seized and detained by superior force a sum of money paid to ransom her constitutes a case of General Average. (Emerigion on Insurance, 485; Parsons on Maritime Law, 299; Clarkson vs. Phoenix Insurance Company, 9 of Johnson.) 14

15 A thorough review under the title Piracy, Ransom, and General Average Risk was published by Ik Wei Chong and Derek Hodgson of Clyde & Co. in that firm s December 2008 Shipping Update, and is worthy of reproduction here: The General Average Contribution scheme is a system long entrenched within the Maritime industry. There is a general average act when, and only when, any extraordinary sacrifice or expenditure is intentionally and reasonably made or incurred for the common safety for the purpose of preserving from peril the property involved in the common maritime adventure. (York-Antwerp Rules, Rule A.1) Traditionally, it has been accepted that any loss suffered as a result of a ransom paid due to piracy, will be covered under a General Average contribution. Barnard v. Adams (51 U.S 270 [1850]) saw the Court enunciate that the ransom from pirates is to be contributed for; the loss is inevitable, and indeed actual. Similarly, in Hicks v. Palington (1590 Moore s QB R 297) the Court held that cargo given to Pirates by way of ransom was a sacrifice which could properly be the subject for General Average contribution. The rationale under English law for such practice is premised on the idea that any reasonable payment made to hijackers to secure the release of the ship and cargo, represents a general average sacrifice; a sacrifice which the ship-owners are entitled to recover contributions from cargo and other interests (Royal Boskalis Westminster NV v. Mountain [1999] QB 674). Germany also provides useful guidance in that the German Commercial Code provides: when in a case of arrest of the ship by enemies of pirates, ship and cargo are ransomed, whatever is paid as ransom forms part of general average together with the expenses incurred by maintenance and the ransom of hostages. (S 706.6) And as further evidence of this practice to compensate for ransom monies, the United States Supreme Court in Peters. v. The Warren Insurance Company (39 U.S. 99 [1840]) deemed the ransom a necessary means of deliverance from a peril insured against, and acting directly upon the property. The issue becomes less lucid when the definition of piracy is questioned. Some consider piracy to be a war risk. For example, the Norwegian Marine Insurance Plan 1996 (2007) does not make any distinction between piracy and war and therefore losses related to piracy are covered as a war risk. Other parties however, traditionally term piracy as a marine risk. Complications thus arise as terrorism would be considered a war risk so potentially the pirate could be classed as a terrorist. Therefore the characterization of the piracy attack is seemingly important, yet clearly difficult in practice. (For further see: Terrorism goes to Sea (available at Payment of ransom has not been illegal per se under English law since the repeal of the 1782 Ransom Act and early cases support the view that payment of a ransom in cash or kind to obtain the release of ship and cargo is a General Average matter. A distinction may also exist between the initial payment of a ransom and the subsequent payment or contribution to the resulting General Average. The question of legality may be more difficult if the captors are an overtly political or terrorist organization, given the extensive modern legislation relating to providing financial support for such entities. Where the payment of a ransom is illegal in the jurisdiction(s) 15

16 of the parties the adventure it is difficult to see how any right of contribution could be enforced. (Lowndes and Rudolf (General Average and York Antwerp Rules 13th Edition 2008) at A.68) To conclude in short, it seems accepted that the payment for a ransom in a piracy case will be included in a General Average Contribution. Given the sharp increase in piracy attacks in the recent decade, and the suggested links with terrorism post-september 11th, it is likely that the definition and characteristics of piracy are going to be subjected to further scrutiny in future years. The preponderance of commentary thus supports the precept that ransom is claimable as General Average. The principle is borne out by a study of the ancient texts, specifics of which are outwith the scope of this paper but, in summary, the Digest of Justinian, Rhodian Law and Consolado del Mare, together spanning the 6 th through 15 th centuries AD, all appear to endorse the payment of ransom as General Average, provided it was done voluntarily and with the agreement of those merchants available to be consulted. What we are left to grapple with is, which policy pays? It is a well-founded principle that, to be recoverable on the policy, Sue and Labor charges or General Average expenditure must be incurred in the avoidance of a peril insured against. Under the current, albeit obsolescent, English scheme of hull and cargo insurance, where piracy is a marine peril, the distinction is not too fine. However, under the American scheme of things, where marine perils are on the hull policy and piracy is on the war policy, what peril insured against is being avoided? The argument can go both ways; damage done to the ship by pirates is, under the American scheme of things, claimable on the war policy. If, therefore, the pirates say that they will blow up the ship if the Owner does not pay ransom, and ransom is then paid, the proportion attaching to the ship clearly is claimable on the hull war risks policy, having demonstrably been incurred to avert a peril insured under that policy. The reality, however, is that the demand for ransom and the ensuing negotiation is not, typically, accompanied by such an overt threat. It is more of a waiting game. The pirates know that payday eventually will arrive and the timing is determined at the intersection of the pirates avarice and the Owners patience. Meanwhile, the ship is not being maintained, a proper watch is not being kept, the anchors and chains are not being tended so what is the real peril? Arguably, it is that a storm could blow up and drive the ship ashore before she could start her neglected engines (Somali pirates customarily directing their captives to anchorages reasonably convenient to shore and home) or that the ship is unable to avoid being struck by, or even timely spot, another vessel bearing down on her. These are marine perils and are not they, truly, the perils that are being averted by the payment of ransom? Finally, no discussion of the payment of ransom would be complete without some analysis of the legality of it. Bruce Paulsen of Seward & Kissel, who advised the Owners of the only UScontrolled vessel thus far seized for ransom, has provided the following commentary relevant to cases falling under US jurisdiction: 16

17 The basic provision of the FCPA [Foreign Corrupt Practices Act] defining outlawed conduct is found at 15 U.S.C. 78dd. This statutory provision expressly makes it illegal for any domestic concern, or for any officer, director, employee, or agent of such domestic concern, to make payments intended to undermine the rule of law in a foreign country. It is clear from the text of the statute that Congress intended to prevent US firms from engaging in acts intended to influence the acts or decisions of foreign officials, political parties, etc. Nowhere in the FCPA does it refer to gifts or payments to private persons except in the context of those to be shared with foreign government officials, foreign parties or officials thereof and only if such individuals are expected to affect or influence any act or decision of such government or instrumentality in order to assist such issuer in obtaining or retaining business for or with, or directing business to, any person. Given that the pirate gangs that seize vessels appear to be freelancers operating wholly outside the law of Somalia, the ransom funds do not appear to be intended to influence or undermine the Somali government s actions or policies and the FCPA should not apply to ransom payments to such pirates. In addition, OFAC [US Treasury Office of Foreign Assets Control] administers a series of regulations (the OFAC Regulations ) that impose economic sanctions to further U.S. foreign policy and national security objectives against hostile targets. A close reading of the OFAC Regulations makes it evident that the sanctions are targeted at certain foreign governments, political parties, terrorist groups and numerous individuals. The critical step for any US entity is to ensure that any ransom proceeds that are paid do not go to any person, organization or foreign government on OFAC s list of Specially Designated Nationals and Blocked Persons (the SDN List ). To date, there has been no information that would confirm that pirates who have been paid ransom are on the SDN List. With respect to anti-money laundering laws, the principal federal statute detailing the rights and obligations of individuals, banks and financial institutions with respect to money laundering is the Bank Secrecy Act ( BSA ) of The implementing regulations of the BSA are found at 12 CFR and 31 CFR Most pertinent is 31 CFR , which applies to all individuals who physically transport monetary instruments of more than $10,000 at one time from a place in the United States to or through a place outside the United States. A person is deemed to have caused such transportation if s/he aids, abets, counsels, commands, procures or requests it to be done by a financial institution or any other person. If funds originating outside the US are used to pay ransom, federal anti-money laundering laws are not implicated. We suspect that substantially the same conclusions would be reached in other major jurisdictions. It might be argued that the topic of piracy has given General Average a new relevance as a mechanism for distributing losses voluntarily and intentionally incurred for the common benefit. Nevertheless it is not a universally popular institution. In competitive trades shipowners and charterers will go to great lengths to avoid inconveniencing their shippers and customers, both by avoiding the delay often inherent to a General Average 17

18 security collection and avoiding the collection of cargo s proportion of General Average itself. The fact that there has been a General Average does not automatically imply that the shipowners will proceed with the preparation of a full-scale security collection and average adjustment. It is often possible to avoid this process because shipowners increasingly include provisions in their hull policies permitting them to recover General Average, up to a specified sum, from hull insurers, even when it is General Average properly attaching to cargo. In this way, a great deal has been done to simplify the administration of General Average, particularly by the widespread introduction into hull insurance policies of General Average absorption clauses, which pay General Average expenditure up to a fixed amount, obviating the need to demand contribution form cargo. BIMCO produced a model wording, which has been adopted as one of the available, optional clauses in the International Hull Clauses, as follows: 40 GENERAL AVERAGE ABSORPTION 40.1 If the Underwriters have expressly agreed in writing and subject to the provisions of Clause 8, the following shall apply in the event of an accident or occurrence giving rise to a general average act under the York-Antwerp Rules 1994 or under the provisions of the general average clause in the contract of affreightment The Assured shall have the option of claiming the total general average, salvage and special charges up to the amount expressly agreed by the Underwriters, without claiming general average, salvage or special charges from cargo, freight, bunkers, containers or any property not owned by the Assured on board the vessel (hereinafter the "Property Interests") The Underwriters shall also pay the reasonable fees and expenses of the average adjuster for calculating claims under this Clause 40, in addition to any payment made under Clause If the Assured claims under this Clause 40, the Assured shall not claim general average, salvage or special charges against the Property Interests Claims under this Clause 40 shall be adjusted in accordance with the York-Antwerp Rules 1994, excluding the first paragraph of Rule XX and Rule XXI, relating to commission and interest Claims under this Clause 40 shall be payable without the application of the deductible(s) in Clause Without prejudice to any other defences that the Underwriters may have under this insurance or at law, the Underwrites waive any defences to payment under this Clause 40 which would have been available to the Property Interests, if the Assured had claimed general average, salvage or special charges from the Property Interests In respect of payments made under this Clause 40, the Underwriters waive their rights of subrogation against the Property Interests, save where the accident or occurrence giving rise to such payment is attributable to fault on the part of the Property Interests or any of them Claims under this Clause 40 shall be payable without reduction in respect of any underinsurance For the purposes of this Clause 40, special charges shall mean charges incurred by the Assured on behalf of or for the benefit of a particular interest to the adventure, for which 18