What is a Demise Charter Agreement?
A demise charter agreement is a type of bareboat charter agreement that gives the charterer full control of the vessel and hence, all the risks and benefits associated with ownership. This type of charter is less common as it passes more liability to the charterer. The charterer under a demise charter is not simply a user of the vessel like a bareboat charterer, rather by taking the entire responsibility of the vessel in its custody and by paying hire, with no supervision or control by the lessor, the charterer is considered a legal owner.
The demise charterer will be the one that is responsible for the safety and seaworthiness of the vessel , and will have the option to sub-charter as long as they do so in good faith.
Demise charters are very close to a sale and purchase transaction, so much so that they are often referred to as a Sale and Leaseback (SLB) transaction. A purchase and lease-back transaction enables the owner of the vessel to sell it to the lessor upon or prior to delivery, and then lease purchase back the vessel over a period of time. This is common where a security deposit for the vessel is required by a financier who is providing financing for the vessel.
Legal Considerations and Liability
When it comes to a demise charter agreement, the obligations and legal responsibilities of the shipowner and the charterer can be considerable. Under this type of agreement, the charterer will be in complete control over the vessel. This means that the demise charterer will be responsible for the vessel in its entirety, meaning they will be the party in the best position to make decisions regarding the use of the vessel.
The demise charterer will be obliged to pay hire as stipulated in the agreement. They will also inherit the obligations of the shipowner regarding ownership of the vessel. This means the demise charterer is responsible for the vessel and all the ship’s equipment, as well as all crew that may be involved in operating it. Technically, whatever misdeeds are committed on-board or in regard to the vessel, could be laid at the feet of the demise charterer, but that does not mean they cannot take recourse against the shipowner. In the event that a passenger were to suffer an injury while on board, the demise charterer might be the liable party, but their shipping line would still be able to take action against the shipowner in order to cover any damages they may face.
There are other legal aspects of a demise charter agreement that must be taken into account. It is very likely that the charter agreement will state what kind of damage will be covered, who is liable, and how to conduct the required surveys. Other specifics often included in such agreements includes:
In addition, the agreement usually includes some sort of hold harmless provision to protect the charterer from any legal consequences that may arise from their use of your vessel, as well as being exempt from liability if there are defects in the vessel that could not have been discovered through a survey.
Advantages of a Demise Charter Agreement
Demise charter agreements are popular between shipowners and charterers in the offshore sector because they can benefit the parties in a number of ways.
From the owner’s perspective, entering into a demise charter agreement provides an additional income stream via the time charter hire paid by the charterer. There is also reduced operational complexity as the vessel is being bareboat or demise chartered as opposed to hired-out on a time charter where the owner has more responsibilities regarding the operation, safety, crewing, and classification of the vessel. This lower level of responsibility includes the ability to retain financial confidentiality (compared with a time charter, where the bank will often require the owner to disclose charter profits so that the bank can confirm that debt service on a loan facility can be met by such profits). The vessel is likely to attract a higher secondhand value in the market than if the vessel was on a time charter, as the charterer’s goodwill rights in the vessel will be apparent in a period where supply/demand for offshore supply vessels is potentially going to lessen.
As for the charterer, the benefits of entering into a demise charter agreement include the following:
• greater operational autonomy, with the charterer able to remove third-party components from the vessel, or install new non third party components (e.g. satisfy a contract requirement for a helideck); and
• greater flexibility with regard to the vessel’s trading area (where the vessel is trading on a time charter, the owner will have limitations on where the charterer can trade and therefore where the vessel can make money).
Both owners and charterers of offshore supply vessels will benefit from the fact that the vessel will be commercially managed by the charterer, free from ownership constraints such as drydocking or crewing costs (the owner’s costs will not be protected against these costs under the risk of loss allocation in a time charter). As a consequence, a demise chartered vessel should be able to be operated more competitively on a day rate basis than a time chartered vessel.
A demise charter agreement may also be seen as an insurance policy for shipowners that are concerned that the commercial issues relating to the oil price fall may affect the future value of the vessel. A demise charter agreement, by allowing the owner to retain its economic interest in the vessel, provides a lifeline for an otherwise illiquid asset. The demise charterer will also be taking on a substantial part of the owner’s commercial risk, as a charterer would be required to continue trading the vessel if the market worsens, and the owner will be relieved from the ongoing difficulties of managing a poor performing asset.
Negotiating a Demise Charter Agreement
The main consideration for owners when concluding demise charterparties will be to incentivise demise charterers to care for vessels and for charters to look after their own interests. Owners therefore need to ensure that the terms of the demise charter place a duty upon demise charterers to exercise due diligence in order to mark sure that the vessel is in the good condition when it is delivered and redelivered. Once a vessel is demise chartered, all issues concerning the vessel will ordinarily be dealt with solely by the demise charterer as if they had direct ownership of the vessel and not just repossession. This will include commercial management, technical management and the employment of the crew. Accordingly, one of the most important elements to a demise charter is the precise allocation of risk between owners and demise charterers. It is vital that parties clearly define their respective duties to avoid liability for breaches of due diligence requirements and loss or damage to the vessel, its wreck and/or cargo.
Demise charterers are often granted the right to assign the mine charter to their affiliates or to place the vessel under the management or beneficial ownership of any third party. Since demise charterers cannot give valid discharges and would not be able to change the ownership, management or control of the vessel without owners’ consent, a demise charterer should be permitted to confer any or all of their rights and obligations under the demise charter (including the right to give valid discharges) on any third party. This is also supported by the fact that demise charters may remain in place under the protection of any third party mortgagee (in such situation the defaulting demise charter’s rights to possession are subordinated to that mortgagee). Permission to assign to third party managers would also be recommended to avoid putting a restriction on the ability of demise charterers to ensure that the vessel remains competently managed and remains port classed.
Even though under demise charters the demise charterers are responsible for the operation of the vessel, they do nevertheless have an obligation to Owners to ensure that the vessel is maintained in class and the owner is entitled to set off amounts due under the charter against charter payments. In practice, demise charters for ships normally require that the vessel be kept in class and demise charterers are obligated to keep the vessel in a seaworthy condition at the time of redelivery. Therefore, in effect, the ownership of the vessel is transferred subject to Owner’s rights to take back the vessel and provide damage to the vessel while it is demise chartered. In practice, demise charterers are responsible for damages to the vessel which occur during the period of the demise charter. In addition, it should be noted that the demise charter should provide that any exclusions from risk or limitations of liability by demise charterer’s care, custody and control insurance policies should not apply so that owners will always have full recourse to the demise charter.
Demise charters are often impliedly set for a period of time which is terminable by notice: once it is agreed that the demise charter has terminated (in accordance with the notice provisions in the agreement), the vessel is immediately redelivered and possession and control reverts to owners (see for example, the decision in Freuhaufwerke AG v Panindo [2013] EWHC 3001 (Comm)). If the demise charter does not mention voyages, the courts will imply that the agreement is meant to cover a number of voyages and will allow the owner to terminate the demise charter after each voyage by giving timely notice to desist and/or to engage the sub-demise (see for example, the decision in Progressive Era Shipping Co Ltd v Teekay Shipping (USA) Inc and Fleet Management Ltd [2011] HKCFI 652). In any case, the demise charter should contain an express warranty for owners to recover charter hire and expenses from demise charterers in the event of termination. This can be done by expressly incorporating terms of the sale and leaseback finance, which would require the demise charter to make all payments necessary to maintain the condition of the vessel so as to enable the ship to be redelivered in the same conditions as at delivery.
Even though the demise charterer will usually be held responsible for any repairs necessary to meet the drydocking standards required under the particular trade rules, maintenance of the hull in good order is usually the demise charterers responsibility, although the responsibility for maintenance of the equipment on board may be retained by the owner. Another issue which could arise is whether owners should be responsible for the replacement of any deficiency in the ship’s stores on redelivery – some demise charters contain a clause of this nature, while others exempt owners from having to replace any stores removed by the demise charterer. Owners and demise charterers should on the other hand be mindful of exposing themselves to potentially significant loss or damage in the event of a dispute arising concerning the precise condition of the vessel or its equipment.
In the event that the demise charter ceases to trade and the demise charterer lapses into insolvency, demise charterers will frequently delegate power to demise charterers so that owners can exercise their own rights over the vessel (such as registration of a caveat and re-registration in the owners name). Where the demise charterer is prohibited by law from dealing with its assets in a particular way, the demise charter should contain an undertaking by the demise charterer to remove any legal impediments and assist owners in exercising their rights of repossession.
Typical Provisions Found in a Demise Charter Agreement
Demise charter agreements are not standard contracts. The parties are free to define the terms and scope of their agreement. However, in practice, there are certain common clauses that are often included in these agreements. Below is a description of some of these clauses.
Duration
As with bareboat charter parties, the duration of a demise charter party can be either for a defined period or on a bareboat basis. Generally, the standard period for a demise charter agreement will be between 18 months to five years with options of increasing or reducing the hire term.
Maintenance of Vessel
As the demise charterer (operator) is not the owner of the vessel, the agreement should set out the appropriate standard for maintenance, repair and dry-docking of the vessel. It is principally the demise charterer’s responsibility to maintain the vessel, however , it is commonplace for the owner to re-imburse the operator after the owner has inspected the vessel.
Insurance
Although there is no implied duty on the part of a demise charterer to provide insurance coverage, in practice both parties commonly agree that the demise charterer is to procure protection and indemnity coverage of the vessel. This is mainly because the demise charterer is responsible for care of the hull of the vessel.
Employment
The demise charterer is entitled to put the vessel to any lawful employment of their choice (including trading the vessel) unless otherwise agreed.
Termination
It is normal for the demise charterer to be allowed to terminate the agreement on giving a notice period of two to four weeks. In addition, a demise charterer may compensate the owner by paying up to six months’ hire if they terminate the agreement prior to the agreement’s expiry.
Potential Risks and Litigation
A potentially contentious area that arises under a demise charter agreement is the position in relation to fixtures, that is, what is a fixture and when does it become a trade fixture. Under a demise charter agreement the demise charterer has almost complete control of the vessel. As such the demise charterer is responsible for maintaining and repairing the vessel and for any damage that occurs. This therefore includes mandatory repairs under the ISM rules and obligations imposed by port state control. However, where a fixture which has been installed by the demise charterer is damaged in the process of complying with one of these obligations is the demise charterer liable for its repair? This was the question considered in the recent circuit court decision of Teekay Offshore Production Norway A/S v. Patrick.
The court considered the definition of indentures as giving the demise charterer the exclusive control over the vessel (and therefore the ability to install fixtures) however the obligation to repair under that clause does not extend to replacements or repairs. The court also helpfully considered what constitutes a fixture and what does not. Fixtures are attached to the vessel in such a way that they add value to the vessel. They usually form part of the structure of the vessel or cannot be removed without damaging it. By contrast removable fittings, such as carpets, can be removed without damaging the vessel or affecting its value. In contrast, trade fixtures, such as scaffolding and cranes, are attached to the vessel for the purpose of carrying on trade and can be detached without damage. The court confirmed that in order for a fixture to be a trade fixture there needs to be a connection between the installation of the item and the carrying on of trade. The requirement for the fixture to be trade fixture is important: the demise charterer is entitled to remove any trade fixtures from the vessel even if it causes damage to the vessel itself in doing so. It is suggested that the terms of the demise charter agreement should include an obligation on the demise charterer to maintain and repair all fixtures or removable fittings, with the exception of trade fixtures, and to indemnify the owner against any loss or damage to the vessel that arises from the replacement or repairing of any fixture. It is also suggested that the definition of fixture should be more specifically drafted to include the types of item that will fall within this definition.
Demise Charter Agreement Case Studies
In the case of Chanel v. Baryon Ltd, the demise charter agreement was used with the intention to bypass an asset lease agreement. Chanel was seeking a remedy because Baryon failed to hand over possession in full and refused to remove structures from the yacht as per previous orders.
12 Rounds Productions also shows the demise charter party agreement being misused. 12 Rounds was chartering a yacht for a film when the yacht was seized by the US Coast Guard and declared unfit for navigation. The demise charterer attempted to claim charter hire payments, damages , and loss of profits but was denied due to the demise charter agreement being a "sham" to allow the owner to swoop in and own the yacht. The case was ruled against 12 Rounds and the initial agreement for the demise charter party was considered as a lease and not an agreement to do business.
These examples serve as a warning that the demise charter within the yacht industry is frequently used in wrong ways that attract the attention of lawsuits. Both lawsuits in these cases are based on the term ‘sham’ which means that an agreement does not actually show the true intent of the parties involved.
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