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Reformation of the Marine Salvage Industry

Captain Mark Hoddinott F.N.I. (speaker/author), General Manager, International Salvage Union

Paper Synopsis ITS 2016 Boston

The past decade or so has seen some dramatic changes in the marine salvage industry’s commercial and operating environments.  The use of Lloyd’s Open Form has continued to decline with alternative contracts becoming more popular. Vessels have become much larger with the potential for making salvage more difficult and expensive.  Salvage companies have continued to move from private to corporate ownership and we are seeing mergers and consolidation.  Protection of the environment has become more important than ever and remains the priority above saving of property.

This paper analyses the changes and what they mean for the future of the international marine salvage industry.

Introduction

How many people have the perception that time is going faster? It seems to me that no sooner has a new year begun than it is ending and we are preparing for the next one. The international marine salvage industry is moving just as fast as it steps up to the challenges of a rapidly changing shipping industry.

When I started in the marine salvage industry in 1982 as a trainee Salvage Master there were no mobile phones, satellite communication was evolving but was too expensive for most people, and the World Wide Web was in its embryonic stages and more than a decade away from coming into public use.  In 1982 there were 289 LOF cases and it was a great time to be a Salvage Master.  Casualty reports were received either by telephone or telex and Lloyd’s Open Form often agreed between the casualty’s master and the tug master. The Salvage Master and his team would be despatched and conduct the salvage operation relatively free of microscopic media attention, overly demanding national authorities and aggressive environmental pressure groups. The Salvage Master would reappear in the company office sometime later with an armful of paperwork and the report of a salvage job successfully completed.

In 1982 there were still a significant number of salvage companies prepared to put salvage tugs on station at strategic locations.  The decline in this practice was already underway, with the growth in offshore multi-purpose vessels a contributory factor.  Nowadays, there are only two or three companies prepared to put salvage tugs on station, and even those companies have smaller fleets.

In the last 30 years the independent, family-owned salvage company has almost disappeared.  Many have been absorbed into larger corporations which has its pros and cons. Due to the cyclical nature of the marine salvage business the family-owned company was content to view its salvage operations over a five-year period and, provided it made a profit, was happy to continue.  Corporations operate much stricter financial controls which are beneficial to a degree, but can stifle free enterprise. However, it is fair to say that most corporations fully support their salvage divisions and recognise that continuous investment is needed to maintain a reasonable market share.

Commercial Environment – Emergency Response

Since 1982 there have been two main expressed changes in the emergency response commercial environment. The first was the introduction of the 1989 International Salvage Convention which came into force in July 1996. The Convention fundamentally changed the dynamics of marine salvage by formalising the ‘safety net’ principles first seen in the 1980 edition of Lloyd’s Open Form, through the introduction of a compensatory regime, which mitigated the strict ‘no cure, no pay’ principle that is a key feature of Lloyd’s Open Form.  The Convention was welcomed by the shipping, marine insurance and marine salvage industries although it is thought by some to be one of the contributory factors to the decline in the use of Lloyd’s Open Form.

The Convention’s compensatory regime was set out in Article 14 and proved to be far from perfect.  It led to the second main expressed change, the introduction of SCOPIC, the Special Compensation P&I Club Clause. SCOPIC has replaced Article 14 as the compensatory regime under Lloyd’s Open Form and was introduced in August 1999.  Article 14 remains an option, however, to my knowledge there have been no Article 14 claims since 2003.

It is agreed by both the marine salvage industry and the International Group of P&I Clubs (IG) that SCOPIC has worked very well and has overcome many of the problems associated with Article 14 claims.  It should be recognised that it is only used in 22% of Lloyd’s Open Form cases, meaning that the vast majority of Lloyd’s Open Form claims rely on the ‘no cure, no pay’ principle.

The ISU and IG meet regularly to review SCOPIC and any issues that have arisen. They have developed a system for an automatic increase in SCOPIC rates every three years based on the US CPI rate. There are currently two main issues, the capping of equipment rates and termination of SCOPIC. Salvors have long been dissatisfied that their equipment no longer has any earning capacity during an operation once the revenue earned exceeds twice the purchase price. Their argument is that it is a disincentive for salvors to own their equipment because hired in equipment does not have any such cap.  The P&I Clubs are entering into negotiations with the ISU to amend the termination provisions. The driving factor is the alleged unethical behaviour of some salvors which leads to P&I Clubs being denied the ability to terminate SCOPIC by national authorities.  I will come back to the issue of alleged unethical behaviour later in this paper.

Lloyd’s Open Form has been the staple contract for salvage services for over 100 years.  It is fair to say that it has been amended to reflect market changes and keep it fit for purpose except for one area, which I will address later. Its use has been in decline for over 30 years for a number of reasons. The introduction of the SOLAS Convention in 1980 was a major step in the improvement of ship quality and operational standards. This was followed by other initiatives including the introduction of Vessel Traffic Separation (VTS) schemes and Safety Management Systems (SMS), all which have led to a reduction in the number of casualties. The following graph, reproduced from the annual Lloyd’s Report, shows the decline in Lloyd’s Open Form cases since 2000.

As an industry we became aware of a growing dislike of Lloyd’s Open Form by some shipowners and NW European marine insurers during the 2000s who perceived it as an expensive contract in terms of both award and legal costs. Lloyd’s took the unprecedented step of terminating the appointments of the entire panel of Lloyd’s arbitrators, including the Appeal Arbitrator, and running a new election process. The newly formed panel has served for just over 6 years and it is generally agreed that awards are consistent.  I do not believe the change in the panel has improved the use of Lloyd’s Open Form.  It should be recorded that 75% of all Lloyd’s Open Form cases are amicably settled without recourse to arbitration which is testament to the robustness of the Lloyd’s Open Form system.  I also find it hard to accept the accusation that legal costs are high.  There have been cases where legal costs have been disproportionate to the final award and the Fixed Cost Arbitration Process (FCAP) is designed to deal with the smaller value cases.  In any industry legal costs are market rate, although we may all argue that they are too high for all industries! I will defend the Admiralty Solicitors and their rates for Lloyd’s Open Form cases which I believe are fair.  If any law firm was to try and charge rates above market rate they would soon lose clients and possibly go out of business.

A further cause for the decline in the use of Lloyd’s Open Form lies with the salvage industry.  In the last 10+ years there has been an increase in the number of salvage companies with some of them, particularly from the United States, operating internationally.  It has led to overcapacity in the industry so that shipowners and their insurers have been able to negotiate salvage contracts on non- Lloyd’s Open Form terms such as lumpsum or daily rate when Lloyd’s Open Form was the most appropriate contract. This may appear to be good commercial practice for shipowners but it will lead to problems in the medium to long term.  I am also aware of Lloyd’s Open Form being agreed in cases where the parties have agreed that salved values and awards would be “capped”. The following graph from the ISU Annual Statistics show a sharp increase in non-LOF contracts for 2014, coloured in green.

Turning to the one area where I believe Lloyd’s Open Form has not kept pace with market changes. Prior to the introduction of the 1989 Salvage Convention the priorities relating to a casualty were:

  1. Safety of life
  1. Saving of property
  1. Protection of the environment

However, since the Salvage Convention became incorporated into Lloyd’s Open Form there has been a fundamental change in priorities to:

  1. Safety of life
  1. Protection of the environment
  1. Saving of property

There is not a single Lloyd’s Open Form case nowadays that does not feature protection of the environment as the number one priority before the saving of property. The Lloyd’s Open Form process is well structured to make an award against property with its known values.  However, unless the salvor puts together a detailed and compelling case it lacks any focus for a Lloyd’s Arbitrator to make an award for the environmental services undertaken by the salvor.  It is a matter of record that Lloyd’s Arbitrators can separate out the environmental services from an Article 13 claim but they need the details on those services in order to do so.

There are a number of salvors who are concerned that they are not properly recognised and rewarded for the environmental services they undertake on an Lloyd’s Open Form contract. Further, with the current Lloyd’s Open Form and its associated processes, it is impossible for a satisfactory award for environmental services to be made.  As it stands, under an Article 13 claim, property underwriters will pay for the environmental services not the liability underwriters. Therein lies a problem, for as long as this remains the case the reward for environmental services under Lloyd’s Open Form will never be clearly identified but will be lost amongst the award for the saving of property.  It will also remain dependent upon there being a sufficient salved fund.  It surprises me that property underwriters are not more vocal on this point, after all they are paying for action that benefits the liability insurer.  With the protection of the environment being such a high priority, some people might say that there is a strong case for a review of Article 13 element of the Lloyd’s Open Form contract.

The problems I foresee where Lloyd’s Open Form is not used, and should be, are as follows. Firstly, it is often forgotten that Lloyd’s Open Form awards contain an element of ‘encouragement’. This element is to recognise the investment the salvor has made in his personnel and equipment and the readiness he has maintained to deploy them in urgent situations.  It is also to ensure that the salvor will continue to invest and maintain readiness.  No other salvage contract contains the element of ‘encouragement’.  If the salvage industry is continually denied ‘encouragement’ then it will shrink to a level where investment is minimal and readiness to respond is severely compromised. This is not a threat or idle prediction, it is a business reality. The Admiralty Judge, the late Sir John Nicholl, when referring to the assessment of a salvage award, once said:

The amount of remuneration must depend upon all the circumstances. It is not a mere question of work and labour, not a mere calculation of hours, though time is undoubtedly an ingredient; but there are various facts for consideration – the state of the weather, the degree of damage and danger as to ship and cargo, the risk and peril of the salvors, the time employed, the value of the property; and when all these things are considered, there is still another principle – to encourage enterprise, reward exertion, and to be liberal in all that is due to the general interests of commerce, and the general benefit of owners and underwriters, even though the reward may fall upon an individual owner with some severity.“

Sir John Nicholl made that statement in 1835 and it is as true today as it was 180 years ago. Secondly, a Lloyd’s Open Form contract places an onerous burden upon the salvor to use ‘best endeavours’ whilst executing the contract. In other words, the majority of the commercial risk, if not all, lies with the salvor.  Salvors are extremely good risk managers and innovators and it is correct that the vast majority of the risk should lie with them.  However, alternative salvage contracts do not contain the burden of ‘best endeavours’, as a result shipowners and their insurers are expected to take more of the risk.  I am sure that many shipowners and their insurers do not understand the risks they are taking when negotiating alternative non-Lloyd’s Open Form contracts in urgent situations.

Thirdly, I can never understand why shipowners would want to take on the sole financial burden of a salvage case when negotiating an alternative salvage contract to Lloyd’s Open Form.  Under a Lloyd’s Open Form payment to the salvor is made by all parties, the shipowners, cargo owners and charterers (in many cases), in proportion to the value of their property salved.  I am sure that cargo owners and charterers are very grateful but it does not make any commercial sense.

Finally, and as an additional point, we have seen an increase in the use of marine consultants, particularly sole operators, as ‘salvors’. Whilst this may be a cheap and attractive option to owners and insurers they should be reminded that consultants have little capital to enable them to carry substantial risk.

Commercial Environment – Wreck Removal

The contractual environment for wreck removal has remained virtually unchanged for the last 15 years.  First introduced in 1999 the BIMCO suite of wreck removal contracts, to cover lumpsum, stage payment and daily rate terms, has served both insurers and salvors very well. The contracts were updated with 2010 versions and remain the contracts of choice in the industry.

Revenue, in real terms, from Lloyd’s Open Form and alternative emergency response contracts has fallen. However, revenue from wreck removal has significantly increased over the last 7-8 years as can be seen in the graph below drawn from ISU Annual Statistics.

Statistically wreck removal has produced more revenue than Lloyd’s Open Form and alternative emergency response contracts combined for 2013 -2014.  High profile casualties such as the ‘Costa Concordia’ off Italy and ‘Rena’ off New Zealand have raised concerns from marine insurers and reinsurers about the increasing costs of wreck removal.  The International Group of P&I Clubs (IG) has formed a Large Casualty Working Group to research the causes of the increased costs of wreck removal focussing on around 25 cases going back to 2002.  Conclusions so far point to the requirements of national authorities as being the main cause of increased wreck removal costs.

It is difficult to predict what insurers can do to curb the increase in wreck removal costs. The International Group are engaged in an ‘Outreach’ programme with key national authorities in an effort to set up a series of MOUs which will lead to early, direct communication between national authorities and liability insurers in the event of wreck removal.  I hope it works and only time and experience will prove its worth.

The introduction of the Wreck Removal Convention will eventually provide insurers with some protection from unreasonable demands from national authorities. There is provision to limit liability but owners and operators will need to provide evidence of their party insurance. The insurers will have the ability to challenge any unreasonable demand in the courts but within the jurisdiction of the national authority. This will be fair in many countries but will not achieve much in others.

It is difficult to predict whether the Wreck Removal Convention will lead to an increase in wreck removal activity.  Wreck removal orders will have to be qualified to avoid unreasonable and unnecessary demands from coastal states.  However, it can be reasonably assumed that wreck removal revenue will continue to be the major contributor to salvage industry revenue.

What can salvors do to assist the insurers when they are faced with unreasonable demands?  It has between discussed between ISU and the IG but the salvor has no more leverage than the insurer and can do little more than show support for the insurer in his efforts to overturn any unreasonable demand. In short, owners, insurers and salvors ask that requirements be proportionate.

Operational Environment – Emergency Response and Wreck Removal

There is no doubt in my mind that the acquisition of family-owned salvage companies by larger corporations has been a factor in the decline of the station salvage tug.  Looking for better utilisation the tugs were moved into other markets which made them unavailable for salvage.  They are not being replaced either, and I can foresee a salvage market in the future without any dedicated salvage tugs except when supported through government sponsorship. Vessel support for salvage operations will be wholly dependent upon the open market.

There have been two major changes that have dictated the way in which emergency response salvage is conducted. The first is the decline in the station salvage tug, which I have mentioned in the previous paragraph, which has led to the widespread development of rapid response salvage teams with portable equipment. As a modus operandi it has proved to be very effective.

The other major change has been the rapid development of large vessels which will pose difficult, though not unsurmountable, problems for the salvor in future. When talking about large vessels I am referring to container ships, LNG carriers, ore carriers and passenger ships.  It is their sheer, physical size that will make salvage more difficult.

There have been accusations from the marine insurance market that the salvage industry has not kept pace with world fleet development and is unprepared to offer effective salvage assistance to the new generation of large vessels. It has gone further to state that there has been no investment.  These are very provocative statements that have highlighted the reality surrounding modern day salvage.

In response, the ISU has pointed to declining profits in the emergency response sector, driven in part by the decline in the use of Lloyd’s Open Form, as one reason why investment in new equipment is not apparent. Another reason is the uncertainty of the type of equipment that will be required and where it would be positioned.  However, I know of two major salvage companies who are researching and developing methods to offload containers from a mega-container ship aground in a remote location. This is seen as a significant problem but will be unlikely to help an ore carrier, LNG carrier or large passenger vessel aground in similar circumstances.

The Future Salvage Industry

I believe we will see further consolidation of the international marine salvage industry through acquisitions and mergers.  In recent years Boskalis has acquired three ISU members, SMIT Salvage, Fairmount Marine and URS.  Last year (2015) saw the merger of two of the industry’s giants, Titan Salvage and Svitzer Salvage, to form Ardent Global LLC. If media reports are to be believed the merger saw a 25% redundancy in personnel and the closure of two salvage depots.  I know one other major salvor which is up for sale but, I am assured, not at any price. The only conclusion to be drawn is that further consolidation will lead to further reduction in salvage capacity within the international marine salvage industry but not to a dangerous level. There will always be a requirement for a salvage industry to manage the large casualties, which will inevitably occur, even if it is concentrated in a small number of international operators.

We must also take account of the impact of the oil price. Current low oil prices are expected to remain for some time and this tends to depress capital investment and exploration activity in the offshore sector. It means charter rates are depressed for offshore vesels that are also more available to be pressed into salvage service. Along with a shift towards the shipping industry showing an increasing “cultural acceptance” of the use of offshore craft in salvage it is a factor in the future structure of the industry.

When it comes to large vessel casualties the salvage industry will always respond. Salvors are great innovators and will always come up with solutions even if they are viewed as expensive.  Large vessels will always be inherently expensive to salvage or remove because of their physical size.  If the owners and operators of large vessels believe there are cheap options for salvage then they have been misinformed or are delusional. The ‘Costa Concordia’ and ‘Rena’ casualties were expensive and they were only modest in size compared to the modern leviathans.

I also believe that there is still a place for Lloyd’s Open Form.  It is inconceivable that it will disappear because there is no suitable alternative available that will provide the rewards to sustain a viable salvage industry.

In 2015 the ISU held its AGM in New York and held an Open Forum amongst its members on the main issues in the salvage industry.  This was preceded with a questionnaire from which the main issues were identified. There was a surprise on the main issue currently concerning the membership. It was not the decline in Lloyd’s Open Form, as expected, or difficulties with wreck removal contracts. The main issue was the reputation of the industry and the relationship between salvors and their clients, namely shipowners and insurers.  I referred to alleged unethical behaviour by some salvors in SCOPIC cases earlier in this paper and it has become apparent that industry reputation is a big issue.

The ISU does have its Rules, including a Code of Conduct, which all members are obliged to comply with, as a condition of membership. There is an established disciplinary procedure which was followed recently to reprimand one ISU member for unethical behaviour. The ISU will always investigate legitimate complaints and enforce its Code of Conduct when a complaint is proven.

Cargo owners and insurers have been unhappy with the structure of Lloyd’s Open Form for some time although only in certain cases. These cases involve settlement between the salvor and the shipowner leaving the cargo owners and insurers holding the balance of the claim, often with little information about the casualty and no evidence of the scope of the salvage services provided. The ISU has sympathy with the cargo owners and their insurers as it does seem to be unfair. There is a requirement under SCOPIC for the Salvage Master to produce a Daily Salvage Report (DSR) but there is no such obligation under Lloyd’s Open Form when SCOPIC has not been invoked.  The ISU, on its own initiative, brought in a requirement for its members, through the Salvage Master, to provide a Daily Salvage Report to Lloyd’s for all Lloyd’s Open Form cases. This was already common practice and therefore fairly straight forward to introduce.  Lloyd’s, through the Salvage Arbitration Branch, circulate the DSR to all interested parties including cargo owners.  It has provided a solution to the complaint of lack of information.

I have also heard of recent Lloyd’s Open Form cases where SCOPIC was invoked and the salvors allegedly behaved unethically when faced with termination of SCOPIC.  It is reported that the salvors colluded with the national authorities to instruct the P&I insurers not to terminate SCOPIC.  If true, this is clearly unethical behaviour at the very least. The normal process is for the salvor to enter into a ‘caretaker’ contract on the termination of SCOPIC whilst the P&I insurers engage in the tender process which leads to the award of a wreck removal contract.

I have also heard accusations of salvors ‘milking’ SCOPIC cases to maximise their earnings by submitting false accounts. Again, there has been no proof forthcoming.

However, there is certainly enough hearsay about unethical behaviour for the ISU to take notice. As a reminder, perception is reality.  To quote the ISU President in a recent address to marine journalists:

Trust and transparency should be the foundation of good business relationships. The ISU Executive Committee and management team are determined to do what is necessary to ensure that being a professional salvor is seen as an honourable role providing vital services to the shipping industry. There will inevitably be commercial disputes between clients and their contractors, it happens in all industry. But what we cannot have is general assumption that salvors are not to be trusted. After all, in many situations peoples’ lives depend on our actions.

So the message today is simple: ISU will not tolerate bad behaviour and will enforce its code of conduct if necessary.

Conclusions

To conclude, what the future will bring is a very capable international salvage industry, of somewhat reduced capacity and invested in fewer companies.

Wreck removal will continue to be the major source of revenue for the salvage industry.

Lloyd’s Open Form will continue to be the industry contract of choice for emergency response and may improve in use with consolidation of the salvage industry and improvement in the salvage industry’s reputation.

Work has begun on regaining the reputation of the salvor and the salvage industry.  The hardest part is always to recognise that there is a problem and we, the ISU, have done that even if the problem is only perception at this stage.  We will engage with shipowners and their insurers and if any proof is forthcoming of unethical behaviour we will take the appropriate action that is within our scope and capability.