UK: Potential Closure Of The Strait Of Hormuz: Implications For Shipping And International Trade

The background

Both the EU and the US have recently tightened their existing sanctions against Iran. In particular, the EU has recently prohibited Member States from dealing with Iranian crude oil and petroleum products. A grace period applies in relation to existing contracts but new contracts cannot be entered into. Similar prohibitions which will apply to EU companies and individuals are expected to follow shortly. In the US, a new Bill is likely to be introduced making it mandatory for US-listed public companies to disclose Iran-related transactions in their public filings and making US companies responsible for such transactions entered into by their foreign subsidiaries.

In response to ever-more stringent sanctions, Iran's oil ministry has announced that it has halted oil exports to UK and French companies in advance of the EU's embargo taking full effect and Iranian officials have threatened to close the strategically important Strait of Hormuz (the "Strait"). The Strait's importance in terms of the world's oil supplies is significant; around 20% of the world's oil (more than a third of the world's sea-borne oil) passes through it. As well as providing access to Iran's major ports, the Strait is the only point of access by sea to Iraq, Kuwait, Abu Dhabi and Qatar. Qatar, which is responsible for a third of the world's LNG trade, is reportedly planning to cease LNG production in the event of the Strait's closure. If the Strait is closed, therefore, it would likely have a major impact on both world oil and LNG prices.

As the only passage from the Gulf to the open ocean, the Strait is classified as an international strait under the 1982 UN Convention on the Law of the Sea (UNCLOS). UNCLOS, which has not however been ratified by Iran, stipulates that ships have a right of transit passage through international straits. Pre-UNCLOS, there was a right of "innocent passage" for foreign vessels through the territorial seas of a coastal state. Therefore, notwithstanding that it is not a party to UNCLOS, Iran is arguably obliged to permit innocent passage through the Strait despite its disputed claim that the Strait is in Iranian territorial waters. Whether Iran will continue to respect this obligation as further international sanctions bite remains to be seen.

The current tensions in the Persian Gulf have evoked memories of the trapping of vessels in the Shatt al-Arab and attacks on tankers in the Persian Gulf during the Iran-Iraq war of 1980-1988. Yet throughout that war, the Strait was never actually closed. Although most experts are sceptical about Iran's ability to close the Strait for long, the potential disruption for the oil industry and the resulting rise in oil prices has caused considerable concern. Even a relatively unsuccessful attempt to close the Strait is likely to lead to a military response and an escalation of tensions. This would have repercussions for ship-owners, charterers, crews and insurers alike.

We consider below some of the issues with which  the shipping industry might be faced if Iran were to close the Strait.

Charterparties

Frustration

Charterparties may become frustrated if vessels are unable to navigate through the Strait for a long enough period of time. Frustration is difficult to argue successfully under English law and would require the party claiming frustration to show that the event relied on had fundamentally changed the performance obligations originally contemplated by the parties and had made further performance under the charterparty impossible, illegal or radically different from that which was originally contemplated by the parties.

The fact that contractual obligations become more onerous or expensive to perform is unlikely to frustrate the contract. So if, for example, the Suez Canal were blocked and a charterparty required delivery of goods from India to Europe or vice versa, the charterparty may not be frustrated because another route would be available, being via the Cape of Good Hope. However, since no other route by sea would be available if the Strait were closed, frustration might be more arguable in those circumstances.

Whether there is frustration will depend on the nature of the charterparty and the length of the delay caused. Those entering into charterparties which might be affected by a future closure of the Strait should consider incorporating terms which allocate the risks associated with a closure of the Strait e.g. for delays, extra expenses etc.

Port safety

Charterparties may contain either express or implied safe port warranties. A port will be safe where, at the relevant time, the vessel can reach it, use it and leave it without, in the absence of some abnormal occurrence, being exposed to danger which cannot be avoided by good navigation and seamanship. At the time the charterer nominates a port, it must be prospectively safe. Safety means both physical safety and political safety. The port may, therefore, be unsafe if there is a risk of seizure or attack or the vessel may be detained, impounded, blacklisted or confiscated.

The question of whether a blockade at the entry to the Persian Gulf would amount to an "abnormal occurrence" for the purposes of a safe port warranty is complicated. Following the House of Lords decision in The "Evia" (No.2)[1983] 1 AC 736, the test for an "abnormal occurrence" in these circumstances would be one of foreseeability. An event can be abnormal but foreseeable. The deemed foreseeability or otherwise of a blockade would be key to the question of whether or not damages might be available to ship-owners for breaches of charterers' safe port warranties. Given that Iran has publically declared its intention to blockade the Strait, it is possible that were such a blockade to go ahead it would be deemed foreseeable. On the other hand, an argument could be made that such a blockade would harm Iran's interests more than any other country's and therefore it was not foreseeable that Iran would carry out a threat which many regard as "sabre-rattling".

Where charterers nominate an unsafe port, owners are entitled to reject that nomination on the basis that it is invalid. In the event that a valid nomination is made, but prior to the arrival of the vessel the port becomes unsafe, a time charterer will be obliged to nominate a new port. Under a voyage charter, the position is less clear and, unless the charterparty specifically provides for it, the charterer may not be able to change its nomination without the express consent of the owner. That is why voyage charters will often provide for a vessel to proceed to the nominated port "...or so near thereto as she may safely get...". In the event of the closure of the Strait, that may not be very close to the nominated port at all and the parties will have to consider whether the vessel remains so far away from the nominated port that the charterparty is frustrated.

It is likely, given the trading importance of the Strait and the apparent naval superiority of the US and others, that any blockade would only be temporary. As such the danger posed to shipping would also be temporary. In Knutsford v Tillmanns [1908] A.C. 406 (H.L.), Lord Loreburn stated that temporary dangers only render a port unsafe if the delay caused by them amounted to an "inordinate delay". In Unitramp v Garnac Grain (The Hermine) [1979] 1 Lloyd's Rep. 212 (C.A.) the Court of Appeal held that a delay caused by temporary dangers would only be inordinate, and therefore make the port unsafe, if it were long enough to frustrate the charter. Temporary dangers, therefore, only make a port unsafe if they cause "inordinate delay" and delay will only be inordinate if it is long enough to frustrate the charterparty.

Deviation

Charterparties should be reviewed to see whether they allow deviation to a different port although, absent an express provision, the ship-owner/master has an implied right to deviate to avoid danger to the vessel, cargo and those on board. Parties may wish to vary their charterparties to allow for discharge at ports outside the Persian Gulf.

Bills of lading

If it has been agreed that cargo is to be delivered at an alternative port, owners and carriers should be aware of the potential problems posed by an issued bill of lading which names a specific discharge port. It may be that a bill of lading incorporates the terms of the charterparty, or permits discharge at a port other than the one named on the bill. If no such provision exists, however, delivery to an alternative port may constitute a breach of the bill of lading contract.

War risk clauses

Most charterparties include specific provisions relating to the outbreak of war or war-like situations. Such clauses generally allow that the contract may be cancelled/terminated in the event of war/hostilities/warlike operations breaking out, either between any of a number of specified nations, or involving the flag state of the vessel. If a vessel is being ordered to proceed to a war risk area, some charterparties will provide that the owner has the right to refuse the order, although owners cannot refuse orders if it would be unreasonable to do so. Other charterparties will not permit owners to refuse orders if war risk insurance is available. Parties to charterparty contracts involving the Persian Gulf should review the terms of their charterparty carefully in order to establish what their position would be should the situation in the Gulf deteriorate.

For war risk clauses to be relied upon, it is generally not necessary for war to be formally declared and whether a state of war exists for the purposes of these clauses will be a question of fact. Under English law, consideration will be given to the following factors, among others, when determining whether or not a state of war exists:

• whether there is a conflict between identifiable opposing sides;
• whether these sides have identifiable objectives; and
• the scale of the conflict and its impact on public order.

The meaning of "hostilities/warlike operations" is, of course, wider in scope than "war". A blockade of the Strait and the repercussions likely to flow from that action may well fall within this meaning. Whether or not this would be the case would likely depend on the nature and duration of the blockade, as well as the surrounding political and military circumstances.

It should also be noted that whilst some war risks clauses will operate to exclude the charterers' safe port warranty, others will not. Furthermore, unless the off-hire clause in the charterparty expressly provides otherwise, hire may continue to run during any periods of delay associated with war risks.

When a war risks clause is invoked and discharge occurs at an alternative port to the one originally nominated, whether the owner will be entitled to additional freight will depend on whether or not the substitute port is within the range specified in the charterparty. If it is, then freight will be paid as per the charterparty, but if it is not then the charterer will be obliged to pay all of the additional costs associated with proceeding to and discharging at the alternative port. It may be possible, however, to have war risks cover which incorporates detention or diversion expenses. This would cover the daily running expenses of a vessel in the event of her being detained or the extra running expenses incurred as a result of her being diverted. It may also cover a pro rata portion of the vessel's insured value after a certain period of detention.

Insurance

War risks

In the absence of express provisions to the contrary, responsibility for, and the costs associated with, insuring the vessel will fall upon owners rather than charterers. Should charterers wish to order the vessel to, or through, an area of heightened war risk, the vessel's insurers will require the payment of additional premiums to compensate for the additional risk. The issue will arise as to who is responsible for any additional premium and it will depend on the charterparty provisions whether owners can claim to be reimbursed by the charterers for any additional premium paid. In relation to voyage charters, it is worth noting that charterers' liability to pay additional premiums will ordinarily end at the conclusion of the adventure, i.e. at the completion of discharge. Therefore, ordinarily,  charterers would not be liable to pay the additional premium after the vessel has left the discharge port but before she has left the Gulf. Depending on the arrangement in place for the subsequent employment of the vessel, owners considering voyage charters to the Gulf may, therefore, wish to extend the period for which charterers will be liable for additional premiums to the point when the vessel leaves the Gulf.

Blocking and trapping

Blocking and trapping insurance is a form of war risk insurance and is aimed at giving owners a right to compensation where their vessel is prevented from leaving port as a result of war risk extending over a considerable period of time, usually over 12 months. It is aimed both at physical hindrances e.g. where a vessel is trapped because the way out of the port has been blocked, but will also usually cover a foreign State power detaining the vessel in port. Once a vessel has been detained for the period set out in the policy, the assured is deemed to have been deprived of the vessel's use without any likelihood of recovery for the purposes of ascertaining whether she is a constructive total loss. The availability of this type of insurance should be kept in mind when negotiating current and future charterparties where the vessel might be trapped at port due to the closure of the Strait.

International trade aspects

Cargo insurance

Traders dealing in goods which originate in, or are destined for, the Persian Gulf would be well advised to check that their cargo insurance covers the risks associated with their cargo being trapped in the Gulf or stuck outside it. This would include additional forwarding costs and deterioration due to delay.

Frustration

Traders who wish to argue that their sale contracts have been frustrated due to the closure of the Strait may struggle to do so successfully unless the goods are expressly stated to originate in the Persian Gulf. This is because where the origin of the goods has not been specifically identified in the sale contract, e.g. "oil" but not "oil from the Persian Gulf", and a potentially frustrating event occurs, the trader will usually be obliged to source the goods elsewhere. Even where the sale contract expressly specifies the goods as oil to be sourced in the Persian Gulf, a blockade in the Strait (as opposed to a full-scale war on land and sea) would not necessarily amount to a frustrating event since an alternative route may be available using a different mode of transport. That said, sale contracts may specify the mode of transportation to be used and if that mode is not available, the contract could be frustrated. 

The fact that the parties have a war risks clause in their contract will not necessarily prevent frustration bringing the contract to an end. It is not the fact that a war or war-like situation exists which would frustrate the contract, rather it is the effects of the war on the performance of contractual obligations.

Comment

Regardless of whether or not Iran does attempt to blockade the Strait, the bubbling tensions between the west and Iran mean that trade and shipping in the region could be overtaken by politics at any time. As such contractual parties would be well-advised to be certain that their interests will be protected should the situation deteriorate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.