Seller’s Interest Insurance

This is the first guest article written by L M Mohamed Ismail¹ and we hope to see more such posts².

1. INCOTERMS:
   1. International Commercial Terms or INCOTERMS, for short, has been the bedrock of international trade for the past eight decades or so. First published in 1936 by the International Chamber of Commerce, its purpose was to bring about a certain amount of clarity on the roles and responsi-bilities of the trading community. The INCOTERMS have been revised eight times, with the latest being in 2010.
   2. In this article we will highlight the challenges that traders face when contracting on Ex Works, FAS, FCA, FOB or CFR terms. The responsibility of the seller ceases as follows:
      1. Ex Works: When goods are placed at the disposal of buyer at the seller’s ware-house
      2. FAS: When goods are alongside the nominated vessel
      3. FCA: When cargo is handed over to the carrier’s representative
      4. FOB & CFR: When cargo is on board the overseas vessel or the Trader procures goods which are already on board overseas vessel.
   3. While INCOTERMS state when the delivery and documentation responsibilities of the seller cease, it makes no mention on the ownership or transfer of title to the goods or deal with payment terms. In an Ex Works, FCA, FAS, FOB or CFR sale, the seller may take, even though it is not required under the sale contract, insurance to cover his risks. Once the cargo has been handed over it becomes the responsibility of the buyer to ensure that his financial interests are adequately protected.
   4. International trade is invariably conducted through documentary credit or letters of credit issued by banks, which serve as security for payment for the goods supplied. The letter of credit (“LC”) guarantees payment provided the seller meets the conditions stipulated in the document. In the context of a Ex Works, FCA, FAS FOB or CFR, the seller is assured of obtaining payment so long as the conditions of the LC are fully complied with. Accordingly, the seller is assured of payment even if the carrying vessel suffers a marine casualty.
   5. As the costs of establishing LC is high, some sales are done without them. Additionally, the seller may face some challenges in fulfilling the requirements stipulated in the LCs and which may lead to losing their (Seller’s) right to be paid. Hence, traders are also making their purchases by way of Documents against Acceptance or Documents against Payment. In fact, there are some Traders who also supply goods on open credit when dealing directly with the end Buyers.
2. SELLERS INTEREST INSURANCE:
   1. We now explore the financial challenges faced by Sellers in an EX Works/ FOB / FAS/ FCA / CFR transaction. These Incoterms provide for risk to be transferred to the buyer once the goods are placed on board the ship or at the point where the buyer takes over the cargo (e.g. Ex Works in which the risk transfers on delivery at Seller’s warehouse). Accordingly, the Buyer is responsible for arranging insurance for the goods once the risk is transferred to him.
   2. In sales without LC’s, payment to the Seller is generally made when the documents are accepted by the Buyer. If the vessel carrying the goods sinks or catches fire, there is a strong possibility that the Buyer refuses to pay for the goods (Why should the Buyer pay when he has not received the goods?). It may  be wishful thinking to expect the Buyer to honour the contract and pay the Seller for the goods first and subsequently claim from his insurance, a process that may take months or even years. If unfortunately, the Buyer does not make payment for  the goods,  the Seller is only left with a contractual right to sue the Buyer for the payment.
   3. The Marine Insurance Act 1906 S5(2) states that “any person who stands to benefit from the safe persecution of the voyage has an insurable interest in the cargo”. This therefore permits the Seller to arrange for insurance cover (known as Contingency Cover/ Seller’s Interests Insurance) for the goods and for which the risks may have already been transferred to the Buyer. Insurance companies have been providing this cover to protect the financial interests of Sellers for many decades. The challenge with these clauses is that there are more than thirty different versions leading to severe lack of uniformity. Unlike the Institute Cargo Clauses which are widely accepted and used by marine underwriters world wide, Sellers Interest Clause is usually drafted by brokers in the London market.
   4. We now consider three such versions and also identify some of the shortcomings seen in them.
      1. Version One:
         1. Wordings of the Clause:
            “It is hereby agreed that subject to the terms and conditions of the policy, this insurance is to cover the interest of the Insured as Seller in respect of ex-store, FOB, FAS, CFR shipments and/or other similar terms which according to the Contract of Sales should be insured by the Buyer. Insurance shall attach hereto retrospective to the commencement of the transit if one or more of the following contingencies for any reason occurs:
            (a)        the Buyer fails or refuses to accept the shipping documents,
            (b)        the Buyer fails or refuses to accept the goods
            (c)       the Insured exercises a lien on the goods or interrupts their transit, or suspends the sales while the goods are in transit, when this is reasonable to safeguard his interest,
            (d)      the title of the goods concerned is not transferred to the Buyer and remains with or reverts to the Insured
            and
            (e)       the buyer’s insurer fails to pay for such loss or damaged goods. All rights and benefits which the Insured may possess against the Buyer and/or the Buyer’s Insurers and/or carriers and/or other persons are to be preserved and subrogated to the Insurers herein. This insurance is for the benefit of the Insured only as Seller and no rights under this insurance may be assigned, except to the Insured’s bank(s).It is WARRANTED that the existence of this insurance is not disclosed to the Buyer and/or his agents.Claims to be payable hereunder only to the extent that the Buyers fail to pay for the lost or damaged goods.”
         2. Analysis:
            • The first paragraph clearly identifies the purpose and intention of the seller’s interest clause which is to cover the interest of the seller in respect of Ex Works, FOB, FCA, FCA and CFR sale. There is also a caveat that the engagement of this clause is subject to the terms expressed in the contract of sales. This is because if there is a conflict, it will be the terms expressed in the sales contract that will override.
            • The policy triggers can be found in paragraph two and which consists of the following:
              a. the buyer fails or refuses the shipping documents,
              b. the buyer fails or refuses to accept the goods
              c. the Insured exercises a lien on the goods or interrupts their transit or suspends the sales while the goods are in transit and when this is reasonable to safeguard their interests
              d. the title of the goods is not transferred to the Buyer and remains with or reverts to the Insured and
              e. the Buyers insurer fails to pay for such loss or damage.
            • The second paragraph explains the exact scenario during which the sellers interest cover will come into force. Taking them individually below:
              • The Buyer fails or refuses to accept the shipping documents: Common in DA (Documents against Acceptance or DP (Documents against Payment) sale scenario, a Buyer may be unwilling to accept or pay for the documents after knowing the vessel carrying the goods has suffered loss by say fire or sunk. In such a case, it is deemed that the risk has reverted to the seller.
              • The Buyer fails or refuses to accept the goods: Here the Buyer refuses to accept the goods after knowing that the goods has either been damaged or lost during the voyage.
              • The Insured exercises a lien on the goods or interrupts their transit, or suspends the sales while the goods are in transit, when this is reasonable to safeguard his interest: This comes about in cases where the Seller may have canceled the sale while the goods are in transit.
              • The title of the goods concerned is not transferred to the Buyer and remains with or reverts to the Insured: This adds clarity to the points expressed in points a) b) and c).
              • The Buyer’s insurer fails to pay for such loss or damaged goods: The Sellers Interest Insurer will only pay if the Buyers Insurers have rejected the claim or there is conformation that there was no other policy(s) covering the same interest. This is to prevent a situation where the Shipper and Buyer both collect the proceeds of the claim for the same loss.
            • Paragraph three states as follows:
              • All rights and benefits which the Insured may possess against the Buyer and/or the Buyer’s Insurers and/or carriers and/or other persons are to be preserved and subrogated to the Insurers herein: This requires the Seller to preserve the rights of his insurance provider so that they can seek recovery from the Buyer or their insurance company once the Sellers claim has been paid.
              • It is WARRANTED that the existence of this insurance is not disclosed to the Buyer and/or his agents: This is to prevent the Buyer from refusing to accept responsibility for the damage or loss of goods because the Seller has insurance protection.
              • Claims to be payable hereunder only to the extent that the Buyers fail to pay for the lost or damaged goods:The Sellers interest policy will only pay for the actual financial loss suffered by the Seller – an example of this could be where the Buyer has made a partial payment of the goods or the damaged goods could be sold for a lower price to someone else.
      2. Version Two:
         1. Wordings of the Clause : It is hereby agreed that subject to the terms and conditions of the policy, this insurance is to cover the interest of the Assured as Seller in respect of ex-warehouse, FOB and CFR shipments and/or other similar terms according to the contract of sales should be insured by the consignee. Insurance shall attach hereto retrospective to the commencement of the transit if one or more of the following contingencies occur:
            (a)        the Buyer fails or refuses to accept the shipping documents,
            (b)        the Buyer fails or refuses to accept the goods,
            (c)       the Assured exercises a lien on the goods or interrupts their transit, or suspends the sales while the goods are in transit when this is reasonable to safeguard his interest
            (d)       the Buyer fails to pay the seller following a total loss or non-delivery of the goods
            and
            (e)       the Buyer’s insurer fails to pay for such loss or damaged goods. The Assured must advise the insurers immediately of the occurrence of any of the above contingencies.  All rights and benefits which the Assured may possess against the Buyer and/or the Buyer’s insurers and/or carriers and/or other persons are to be preserved and subrogated to the insurers herein. This insurance is for the benefit of the Assured only as Seller and any assignment of this policy or of any interest hereunder shall discharge underwriters from all liability whatsoever. Warranted that the existence of this Insurance will not be divulged to the Buyer or to any other party interested in the program. Claims to be payable hereunder only to the extent that the Buyers fail to pay for the lost or damaged goods.
         2. Analysis: We see that the trigger points are very similar to the first version. The weakness in this set of wordings lies in clause (d) which says:
            the Buyer fails to pay the seller following a total loss or non-delivery of the goods.: The catch word here is following a total loss. Not all losses are total losses and therefore there may be no recovery under the policy.
      3. Version Three:
         1. Wordings of the clause: The goods described in this policy are insured to the conditions of this policy against the risk specified in the Institute Cargo Clauses ‘A’ 1.1.09 but this insurance covers the contingent interest of the assured as Seller only for consignments of goods sold on ‘F.O.B’ and ‘C. & F.’ terms. Claims in respect of loss or damage to the goods caused by perils insured against shall be payable hereunder only if and to the extent that:
            1. The Buyer fails to pay for such loss or damaged goods or
            2. The Buyer refuses or rejects to accept such loss or damaged goods or
            3. The Buyer treats such loss or damaged goods as the Seller’s risks
            And
            4. The Buyer’s insurer fails to pay for such loss or damaged goods The claims under this policy shall only be paid 6 months after the survey of the lost or damaged goods. Underwriters will be subrogated to the assureds’ rights against the Buyers as well as other parties. This policy shall be for the benefit of the insured only, and shall not be treated as double insurance. Any assignment of this policy or of any certificate of Insurance issued in pursuance hereof or of any interest or claim hereunder shall discharge the insurers from all liability whatsoever. The cover terminates upon receipt by the assured of payment of the goods in accordance with the terms of the contract of sales, which for the purpose of this insurance is deemed to form part of this agreement.Warranted the existence of this insurance is not disclosed to the buyer or to any other party interested in the consignment. It is the condition of this clause that the Assured must give immediate notice to the underwriters of any occurrence whereby the risk and or property in the goods remains with, or reverts to the Assured. It is the condition of this clause that evidence of the terms and conditions of the contract of sales shall be submitted in substantiation of any claim made hereunder.
         2. Analysis: The four trigger points in this clause are clear. However, there is a caveat just below the trigger and which states “ The claims under this policy shall only be paid 6 months after the survey of the lost or damaged goods”. Accordingly,  the underwriter will only settle the claim six months after the survey. Although it is common for Seller’s claims to be settled, an arbitrary time frame of six months is extremely long and unwarranted.
3.  Conclusion:
   1. Traders may wish to consider Sellers contingency cover, particularly, when they are contracting directly or on terms which do not provide for the use of Letters of Credit.
   2. Traders should also consider the cover available under the Seller’s interest wordings as some wordings can be more onerous than others.
   3. Assigning such Sellers interest policy to a third party such as a bank will render the cover void.

¹This guest article has been written by L M Mohamed Ismail,a marine insurance broker employed with Acclaim Insurance Brokers Pte Ltd, involved in various classes of marine insurance and with a strong following in the cargo business. He can be reached at ismail@acclaim.com.sg

²We welcome all such articles on Marine Insurance, International Shipping, Transportation & Trade and Dispute Resolution and which may be of interest and hope to see more such posts.