How to make build contracts watertight

Most yards have their own ‘just sign here’ standard build terms, which vary in length and complexity and are reasonably fair, but given the amount of money at stake, such contracts should be viewed only as an opening to contractual negotiations as they often miss out crucial aspects.
Where the buyer is providing the plans to a yard for their superyacht, the following golden rules should be adhered to. These ensure a smooth build, and to protect the buyer’s intellectual property.

The build contract must set out who is going to be responsible for which elements of the design, in order to minimise the risk of a dispute over responsibility for any defects caused by defective design.
The buyer must make sure that the naval architect, plus any separate stylist(s), provides their final plans in good time.
The yard should be obliged to review the plans and check thoroughly for any likely deficiencies in the design, giving notice of any to the buyer, and be held contractually liable in the build contract where this has not been undertaken.
It should be clear from the build contract how the yard is to be compensated for putting right any design defects.
There should be a clear mechanism for agreeing to put back the delivery date where it becomes clear that a particular design is flawed.
The build contract should leave no room for doubt as to whether and how the buyer is to be compensated if a problem arises during the warranty period as a result of a defective design.
Most importantly, the buyer should put in place a system of active contract management to ensure that the various parties adhere to the contracts made with them, and cooperate between themselves as required.
Privacy

One immediate concern not often covered is privacy. Shy buyers will need agreement on this even before full negotiations begin, and once incorporated these provisions will need to cover third-party suppliers. However, publicity about the yacht itself and any technical innovations will enhance its reputation and may boost its resale value.

Design and specifications

If a designer is appointed steps must be taken to ensure that the yard does not interpret the designs in its own (possibly cost-cutting) way. Specifications must be highly detailed.

Further, a separate naval architect might have to be instructed to assess and modify the plans and agree the detailed specifications with the yard. A separate interior designer is normal.

Modifying a yacht after it has been built can be particularly expensive, so the detailed specifications – which will dictate whether, for example, the vessel can be chartered – must be set out in exquisite detail.

To maintain exclusivity, the buyer must ensure that the yard agrees to respect the designer’s intellectual property, and since a vast amount of equipment and spares will be purchased, what is to be supplied by the builder must be made absolutely clear.

As large projects can take several years to complete, buyers sometimes change their minds on various details. The contract must allow this to take place without the potential for misunderstanding. Flexibility to take account of cost fluctuations in materials and exchange rates is also wise, as putting the yard under financial strain is to no-one’s advantage.

Payment

The yard will almost certainly need instalments to be paid to cover the cost of materials. It is better though to pay following the completion of specific stages, to encourage the yard to stick to the schedule, with stage completions confirmed by the classification society. A down payment before construction starts is normal.

To avoid confusion, the yard should be expressly liable for any of its suppliers’ or sub-contractors’ mistakes, and must be obliged to pay suppliers promptly. The materials provided must not be allowed to be subject to any form of title retention, to prevent anything being reclaimed later.

Insolvency

If the yard enters administration due to insolvency during the build – it happens – it will theoretically be obliged to repay any instalments to the buyer, but as the buyer will be at the end of a long queue of creditors, the chances of making any sort of recovery are slim. It is far better to have this obligation backed by a bank guarantee.

Alternatively, buyers can have legal title to the unfinished yacht, but the yard may then ask for a guarantee against non-payment of the remaining instalments. This option may or may not provide adequate security, since any transfer of title once construction begins may be governed by the law of the yard’s location as well as the agreed contractual law.

Formalities such as registration in the buyer’s name may be required, which might not be possible until completion. Further, the buyer must still complete the yacht in a yard where work will otherwise have ceased or have the project moved.

Insurance and damage

It is important for the liability of anything untoward happening to the project to remain expressly with the yard – even if title is to be transferred to the buyer stage by stage – as the risk may otherwise be transferred to the buyer. Clearly, it would be impractical for the buyer to maintain the physical security of the project before completion.

While the yard should be obliged to insure the part-built project, the quality and wording of that insurance must be clearly specified. The Institute Clauses for Builders’ Risks policy wording is adequate, and security obtained on the Lloyd’s of London insurance market (or equivalent) should be insisted on. The yard and buyer should be named as joint assured, with any claims payable to the yard and buyer as a reflection of their interests at the time of the claim.

Other matters have to be considered in the event of the project being damaged.

The buyer should have the option of either cancelling the contract and being refunded payments made up to that point, or requiring the yard to use its insurance pay-out to carry on with the build in spite of the enormous delays.

Where the damage causes the project to be scrapped rather than just delayed, a yard will normally be reluctant to compensate the buyer for the loss of the slot or for any premium a speculative buyer hoped to make on the build. It is still open to the buyer to seek separate insurance for this loss.

The yard must juggle risks stemming from often unproven designs and materials, failures by third parties and other events beyond its control, the yacht being lost or damaged during construction, and the buyer not sticking to the payment schedule.

Getting a grip on subcontracting

Some subcontracting of parts of the build will be necessary, even desirable – even where the yard is taking complete responsibility. However, buyers should consider the following – and make provision in their build contract accordingly:

There must be transparency on the part of the yard to ascertain exactly which elements are going to be subcontracted. If, for example, a yard is going to have the bare hull built at a reduced cost in another cheaper and less prestigious yard, how might this affect the yacht’s future resale value?
It is important to know exactly to whom parts of the build are going to be subcontracted, and to formally approve their use.
The buyer may need to review the terms of the subcontracts to make sure that these do not conflict with the build contract.
It will also be essential to make sure that subcontractors are not given a contractual lien over their supplies, or the yacht, if the yard does not pay them promptly.
The yard should negotiate – where possible – guarantees from subcontractors which can be passed on to the buyer following launch.
It might be necessary to make the benefit of a subcontract assignable to the buyer – in case the failure of the yard necessitates the buyer moving the build to another yard.
The build contract must make it clear that subcontractors are going to be contracted with directly, and the yard is not going to hold itself out as an agent contracting on behalf of its client.
It may be tempting for the buyer’s advisers to save costs by using a standard shipbuilding contract, but these are only suitable for use in the speculative and unstable commercial shipping markets. Negotiations will need give and take on both sides, and proper guidance.

Benjamin Maltby is an English barrister with consultants MatrixLloyd providing impartial guidance on all aspects of large yacht purchase, building, ownership and operation.

Any errors or omissions are the author’s alone. This article does not provide, or replace, legal, financial or tax advice.

Originally published: March 2008. Updated September 2012.