At the outset of any luxury yacht construction project, it is important to spend time understanding and negotiating the build contract. This will almost always be based on the standard form draft prepared by the shipyard. These are complex legal agreements that set out the rights and responsibilities of buyer and builder, and a well-negotiated build contract will allow the buyer to manage the risk and understand the construction process. Ideally, a buyer will have a technical adviser or team in place to follow the construction on the buyer's behalf during the life of the project, and to ensure that the construction is proceeding as provided for under the build contract.
If something goes wrong, a well-drafted build contract provides a framework for resolving disputes, but the primary focus is to try to prevent issues from arising in the first instance by putting in place sufficiently detailed specifications and well-defined obligations. The build contract should also clearly set out the builder's post-delivery obligations, including the buyer's rights if a problem arises during the warranty period as a result of a defect in the yacht.
Here, Alex Sayegh, a partner at international law firm HFW, which represents prominent owners and leading shipyards, and who provides legal advice on some of the largest and most complex construction projects in the yacht industry, answers key questions yacht owners may have.
What are the legal implications if an owner wants to bring in their own subcontractors or suppliers?
As an owner, the position is most straightforward where the builder assumes responsibility for every aspect of the design and construction of the yacht and, for this reason, it is usual for the builder to contract directly with the owner's preferred subcontractors and suppliers, the identity of which will be recorded in the specifications, often in a dedicated 'makers list'.
The fundamental difficulty for an owner looking to introduce its own suppliers and sub-contractors, outside the scope of the pre-agreed specification, is that it is unlikely to be able to do so at all. Even if this can be subsequently agreed, there is the risk that doing so will dilute the builder's assumption of overall responsibility for the project and disturb other elements of the contract which were previously settled.
Additionally, it will seldom be the case that an individual owner is better positioned than an established yacht builder to obtain favourable commercial terms from a third-party supplier.
Can buyers include pre-agreed penalties (liquidated damages) for delays to delivery of the yacht in the build contract, and how are these enforced in practice?
It has traditionally been the case that build contracts will make provision for liquidated damages to be payable at a daily rate which is agreed between the parties during the contract negotiation. These damages are payable in the event that the shipyard is, through its own fault or, at least, due to matters which are within its responsibility, delayed in delivering the yacht.
From an owner’s point of view, liquidated damages can often be a bit of a distraction. In reality, most buyers are focused on ensuring that the delivery of the yacht is not significantly delayed and any reduction to the contract price occasioned by liquidated damages will not be uppermost in their thinking. What they want is the yacht delivered to them on time – particularly if the Mediterranean season is approaching. Liquidated damages will certainly be a factor in a shipyard's thinking on the timing of delivery but, plainly, they should not be seen by an owner as a guarantee that a project won't run into delays.
So, are liquidated damages all that worthwhile?
Yes, they are a necessary part of the overall matrix, but you have to bear in mind that they don't exist solely for the benefit of the owner – liquidated damages also function to limit the shipyard’s liability for a delayed delivery. There is also the issue that, in circumstances where a shipyard's margins may be quite thin, the burden of liquidated damages can bring to the fore an unhelpful conflict between the owner and the builder regarding when the yacht is sufficiently complete for delivery to take place.
In my experience, the best steps that a buyer can take to guard against delays are often practical ones. Are you dealing with a shipyard that has a reputation for completing yachts to schedule? If not, it would be naive to assume that yours is going to be the project that bucks that trend. Again, the importance of having a well thought-out technical specification cannot be overstated. An inadequate specification or design phase will inevitably lead to variations later on down the line and these will have a knock-on effect on the delivery schedule.
Are refund guarantees still effective protection for a buyer to ensure that, in a worst-case scenario, the money they have paid on account of construction is protected? What would you advise as an owner if a shipyard cannot obtain them?
If a buyer terminates the construction contract before delivery of the yacht, it will typically be entitled to a refund of the instalments paid up to the time of termination. Refund guarantees, issued by a reputable bank or insurance company, secure the buyer's right to the return of those payments in the event that the shipyard fails to pay the sums due. Where the buyer is using pre-delivery financing to fund the construction, refund guarantees are often a crucial part of the lender's security package.
It is worth bearing in mind that refund guarantees won't protect the buyer against inflationary pressures. For example, if a problem arises deep into a project and a buyer wants to use the amounts received under refund guarantees to start the project again then, in a rising market, it will inevitably find that its purchasing power is reduced. Likewise, refund guarantees do not usually cover a buyer's ancillary expenses such as its site team or financing costs. Refund guarantees will not therefore make a buyer whole on a project which has gone seriously wrong and, crucially, they will not deliver to the buyer the very thing that he wanted at the outset, which was a completed yacht. However, if available, a refund secured by refund guarantees is likely to be the cleanest method for a buyer to exit the project.
One alternative means of security is for the buyer to take title to the yacht whilst it is under construction, meaning the buyer actually owns the yacht during the build period. This type of security is far more common than you might think, as the majority of shipyards simply don't have the credit lines available to them to be able to arrange refund guarantees right the way through construction for all of their projects.
Is taking ownership of a yacht during construction risk free?
No large scale construction project is risk free. It is always about understanding and mitigating the risk, where that is possible. Yacht building is no different. Where a buyer takes ownership of a yacht during construction and is subsequently forced to terminate the build contract, there is no doubt that the project will become far more complicated, and that there will be cost overruns and delays. The practical and logistical challenges involved in relocating a large yacht part way through construction can be considerable. Any new shipyard selected to complete the yacht will need time and resources to familiarise itself with the original builder's design and engineering. Even then, the successor yard may be unwilling to give a warranty over work completed by the original builder.
It all sounds quite daunting, but the reality is that we have seen several projects where buyers have had to enter into possession and complete their yachts with an alternative shipyard and, in fact, the outcomes have generally been pretty favourable. The owners have all got what they want in the end, which is a completed yacht. It is however important that the owner understands and has some appetite for this sort of risk – you've got to be willing to roll with the punches and, to a certain extent, even enjoy the process. If that prospect terrifies you, you may be better off buying a pre-owned yacht!
There is often the fear that a yard could inflate costs or delay delivery when handling change orders which arise during the course of construction. How do you mitigate this?
Large projects can take several years to complete so buyers sometimes change their minds on various details. The contract should define a clear process for formalising these changes including transparent benchmarks for how costs and additional time resulting from them will be calculated.
Although we have seen concerns expressed that a shipyard might use owner-requested modifications as a pretext to build-in a cushion to the schedule or to offset budget overruns which it has already incurred, in practice, I haven't seen much evidence to support those fears.
Variations can however invariably have consequential effects which need to be managed. The best way of avoiding these consequential effects is to limit the need for variations in the first instance. Again, this means ensuring that the scope of work and specifications are as fully defined as possible from the outset. A rigorous design phase will also help to ensure that every aspect of the yacht’s design and build is carefully considered and, to the extent possible, resolved in advance.
Of course, yachts being what they are, owners will sometimes change their minds and we always recommend including contractual provisions which require that any adjustments to the contract price or delivery schedule resulting from a change order are proportionate to the modification and are based on evidence.
Does this advice extend to refits too?
The principles involved (i.e. the need for a clear mechanism for calculating changes to the contract price or delivery schedule resulting from change orders) are broadly the same but, with refits, you have the prospect of emergent work. When you start with a new build, you're building something up from scratch and the builder knows exactly what it is working with. Refits can be different in that regard. The shipyard can open up one area of a yacht with the aim of addressing a particular item, only to discover that there are other, unanticipated issues which will also require intervention.
It is therefore key to have a clear basis for costing emergent work, preferably with prior agreement on labour rates, which are locked in at the time that you enter into the refit contract. For a longer term refit project, this could include some flexibility for those rates to be adjusted or increased by reference to an index which takes into account inflationary movements.
How are payments to the shipyards best managed?
The yard will require instalments to be paid during the construction period to cover the cost of labour and materials. It is preferable for the buyer for these to be payable only after verification of the completion of specific milestones in construction. The construction milestones themselves should be meaningful events (ideally marking the completion rather than the commencement of a particular element) and the amounts payable at each instalment should be in proportion to the progress in construction. This is desirable in any build contract but it assumes an absolutely critical importance if the buyer's security for its pre-delivery instalments is the ownership of the yacht itself.
How important is it for a build supervisor advising the buyer to inspect the build milestones?
Preferably, the buyer's obligation to make payment of each pre-delivery instalment will be dependent on the yard evidencing that it has achieved a particular milestone in construction, so it’s important that the buyer’s technical representative is on hand to approve those milestones and to confirm that this is the case.
Each milestone should be clearly defined and objectively verifiable. The shipyard will usually sign off on the achievement of the milestone and then present its certification to the buyer’s technical representative for counter-signature.
If there does happen to be a dispute as regards whether or not a milestone has been properly completed, such that a payment instalment is triggered, we'd always expect there to be a mechanism in the build contract providing for the Classification Society or an independent expert to come in and make an assessment. In practice, we don't tend to see disputes in this area, as the agreed construction milestones will usually be so clear-cut that the scope for disagreement is virtually non-existent. Unfortunately, the same does not apply when it comes to the delivery instalment. This will fall due once a yacht is 'ready for delivery', the threshold for which can be far more challenging to assess, however well-developed the acceptance criteria set out in the contract may be.
How are disputes solved most effectively?
The overwhelming majority of disputes we see in yacht construction projects are more technical than legal in nature. If those disputes can't be settled by ordinary discourse and negotiation, it can be to both parties' advantage to have these settled by appointing an independent technical expert rather than by arbitration or court proceedings. This is because an expert's determination can be obtained in a fraction of the time and at a much lower cost than it would take to resolve the dispute through legal channels. We try to encourage both owners and shipyards to view the appointment of an independent technical expert as a practical step which will help them to obtain resolution at short order and allow the working relationship to survive even if, by the nature of these things, only one party can ever be completely happy with the outcome.
From an owner's perspective, if you have to resort to the alternative of legal proceedings to resolve what may be a relatively minor technical dispute, then that is quite a significant barrier to you enforcing your rights and there is every chance that the need to initiate a legal process will deter you from doing so.
From a shipyard's perspective, a common 'pinch-point' in yacht construction projects occurs during the very final stages, where the parties cannot reach agreement on whether whatever work is remaining is in the nature of 'snagging', which can be carried out after delivery or whether that work should be completed before delivery takes place. Again, recourse to an independent technical expert allows for the swift resolution of the dispute, in circumstances where the delay caused by legal proceedings may prove far more damaging than the underlying disagreement. Most shipyards are happy to adopt this method of dispute resolution and the process is intended to be more conciliatory and less bruising than legal proceedings.
If a disputed matter does escalate, shipyards and owners alike generally prefer arbitration over court proceedings for the key reason that arbitration remains confidential, something that is key to participants in the yacht industry.
In terms of law, we favour English law as the governing law of the build contract because it brings with it a rich body of pre-existing case law which is relevant to the narrow area of shipbuilding. This system of precedents means that we are often able to give clear advice on many of the issues that arise during the build process. The selection of English law is normally paired with London arbitration as a forum for dispute resolution. That's not out of blind patriotism – most jurisdictions where yachts are built also have sophisticated legal systems. It's more the case that, typically, the most obvious alternative venue will be the jurisdiction where the shipyard is located and, for obvious reasons, it's far more comfortable for a party to bring or defend a claim from the comfort of its home jurisdiction than it is to have to make those arrangements from elsewhere. With that consideration in mind, the combination of English law and London arbitration is usually neutral as between the parties and has become standard in international yacht building.
Any errors or omissions are the author's alone. This article does not provide, or replace, legal, financial or tax advice.