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FORMATION OF THE SHIPBUILDING AGREEMENT

Government Role in Commercial Contracts

There are several reasons why there may be direct or indirect participation by a government agency in a
contract involving a commercial shipowner and a commercial shipyard.

1. One possibility is that the vessel is being constructed for long-term charter to a government
agency, so the agency may have technical representatives in the shipyard or examining shipyard
drawings in parallel with the commercial Purchaser’s representatives. I
2. A more common possibility is that a government agency is providing some form of financial
support in order to encourage the domestic shipbuilding industry. That financial support may be
in the form of a mortgage guarantee, perhaps predicated on the ship’s construction meeting
certain criteria.
 Another form of governmental financial support may be a direct shipbuilding subsidy,
where the agency pays for a certain percentage of each progress payment, again perhaps
predicated on the ship’s construction meeting certain criteria.
 A third form of government financial support may be an indirect subsidy, in which the
government agency has a relationship with the shipyard in order to help offset some of
the shipyard’s costs.

Formation of the shipbuilding Agreement

Contract Deliverables and Communications

During formation of the Agreement and other components of the contract, a fundamental principle of
contract management should be borne in mind:

“Contract management should commence the moment a contract is contemplated, not after it is signed.”

The significance of that principle during Agreement formation is that it reminds the parties that any
contract rights, obligations, communications or inspections, among other considerations, that either party
may wish to be able to exercise during contract performance, have to be built into the contract documents
from the outset.

After the contract is signed, it is too late to ask the other party to give you contract rights that are not
already spelled-out in the Agreement or other components of the contract.

Every contract has a set of contract deliverables, in addition to the ship itself. Some of these deliverables
may include drawings, correspondence, comments, inspection reports, calculations, test results, and
similar documentation. Other deliverables may be spare parts, manuals, or other hardware-related items,
in addition to training of vessel operating personnel on the use of ship-specific equipment. It is essential
that the parties anticipate what the entire set of contract deliverables is to be prior to contract execution.

Introduction of Agreement

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This component of the Agreement first identifies the parties, their corporate names, the legal form of the
organization (corporation, partnership, privately-held, non-profit, state or federal agency, etc.), the
jurisdiction of their existence, for example, incorporated in the State of______, and the nature of their
business as it pertains to this particular contract.

This section of the Agreement goes on to describe the nature of the project which is guided and controlled
by this Agreement (new ship construction, ship conversion, etc.), and then describes the general role of
each party. The principle location of the work is also included, but this does not necessarily bind the
Contractor to performing all work at that location.

This part of the Agreement should mention that the Contractor has responsibility to complete the design,
as necessary, thus implying that its engineering and drafting responsibility is not limited only to producing
detail plans and working drawings, but begins where the Contract Specifications and Contract Plans leave
off.

Entire Agreement

This section of the Agreement reminds the parties that only this Agreement and the other documents to
which it refers constitute the binding contract; and that any pre-contract agreements or understandings,
whether written or oral, have no standing with regard to this contract. However, it is not quite that simple
and straightforward.

First, underlying all contract law are legal requirements that the parties cooperate with each other, and
that the parties always take actions to mitigate damages in the face of untoward events, regardless of
which party will incur those damages. These underlying legal requirements, among others in different
jurisdictions, are binding, though unstated in any commercial contract.

Second, it has to be appreciated that pre-contractual agreements or understandings may, in fact, serve to
interpret, but not add to, the current contract, as long as those other agreements and understandings are
not in conflict with the current contract. Pre-bid correspondence between bidders and the Purchaser, as
well as pre-bid meetings, may form the basis for development of a common interpretation of an
otherwise-ambiguous specification requirement. If the contract documents contain an ambiguity that is
not resolvable by reference to a component of the contract listed in the hierarchy clause, it may already
have been resolved in advance of contract execution, in the form of an interpretation or an expression of
the intent of the parties.

As an example, suppose the contract documents state that the final hull color shall be selected by the
shipowner’s representative; but during contract negotiations, the parties have already agreed that the
shipyard can paint it blue because the shipyard has excess blue paint and is offering a lower price if the
blue paint can be used instead of some other, as yet unidentified color. If the parties agreed in writing, in
advance of contract execution, that the bid price would be reduced in exchange for acceptance of blue
paint, then that pre-contract understanding constitutes a binding interpretation of the contract language,
because the contract language does not preclude the color selection being accomplished prior to contract
execution. Both parties are benefiting from that pre-contract agreement, and it is not inconsistent with
the contract, but rather serves to interpret the otherwise-ambiguous contract language.

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Street Sta. Mesa Manila, 1035 Metro Manila

Coordination of Contract Documents

This section of the Agreement primarily identifies all of the other components of the contract with the
greatest specificity available. Do not state, for example, that the Contract Specifications are the most-
recently revised edition; rather, identify the authors and give the exact date of that revision because there
may be later revisions that are not widely disseminated.

Persons who prepare this section of the Agreement must ensure that all of the identified components of
the contract are applicable, current, up-to-date, and easily available to the other party.

The Agreement has to address the possibility that the Contract Specifications may require less than is
required by the identified regulations or classification rules. To cover such situations, it is best to state
that it does not constitute an inconsistency, but that the Contractor must comply with both of them; the
ship shall include the greater of the two sets of requirements.

This section of the Agreement should also state that the inclusion of information in one component of the
contract and its absence in another component does not, in fact, constitute an inconsistency or error;
rather, it shall be interpreted to be equally present in all components of the contract.

Definitions, Abbreviations, Interpretation of Terms

In order to ensure that there are no misunderstandings of how certain terms or words are intended to be
used, it is common to have a section of the Agreement which states the interpretations and definitions
that are contractually binding. Typical definitions, interpretations and abbreviations are listed in Table 9.III

Some of the technical definitions may appear in the Contract Specifications instead of the Agreement,
which does not present a problem as long as there are, no inconsistencies between the two lists of
definitions.

As an example, the word Install can be defined to include the requirement that the item of equipment
also be furnished or provided by the Contractor, even if such inclusion may not be apparent in non-
contractual language.

Install or Installation—When the Contract Documents state that the Contractor is to install an item, the
Contractor shall be responsible to Furnish the item and for providing all labor, tools, equipment, and
material necessary to perform such installation, and for which the Contractor shall at no additional cost
to Purchaser:

• provide all appropriate structural or other foundations, electrical power, water service, piping,
lubrication, lighting, ventilation, operating fluids and other facilities or means required for the installation,

• shall effect any and all connections to electrical service, water supply, drains, ventilation, and structural
or other foundations, and

• shall deliver to Purchaser complete, tested and operable machinery, equipment or systems, including
operating fluids.

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Street Sta. Mesa Manila, 1035 Metro Manila

Other interpretations, definitions and abbreviations should be considered to ensure that there is no
opportunity for misunderstandings between the contracting parties.

Source: Lamb, T. (2021). Ship Design and Construction Volumes I & II (2 Volume Set ed.). SNAME.

Delivery of Vessels, Options for Additional Vessels

This section of the Agreement establishes the Delivery Date of the Vessel and the place of delivery.
Sometimes the place of delivery is other than at the shipyard in order to address taxes, operational
limitations, costs of delivery to the region of intended use, or other factors. In the event a single contract
covers the construction and delivery of more than one vessel, it must be clearly addressed within the
Agreement.

If the number of vessels is fixed but more than one, the construction starting date and the Delivery Date
for each will have to be defined. (The price for each additional vessel must also be defined in the section
on Contract Price.)

Whether or not the Contractor has to submit separate drawings for the Purchaser’s approval for each
vessel must be considered and addressed. Sometimes details for sister ships are not the same (they are

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Street Sta. Mesa Manila, 1035 Metro Manila

not identical twins, only sister ships). The parties must agree as to how much variance can exist without
calling such variance to the particular attention of the Purchaser, and if there are some areas for which
no variance is acceptable.

Scope of Work and Representations

Usually there are two major aspects to the statement of the Scope of Work, and several lesser ones.

 The first major segment focuses on the creation of the “hardware” aspects of the ship
construction project. It assigns certain responsibilities solely to the Contractor, with Purchaser
having no concurrent responsibilities.
o These include the provision of all engineering, labor, equipment, materials, fuel,
lubricants, electricity, energy, machinery, facilities, services and supervision necessary for
the completion of the design, the construction, outfitting, completion, testing, delivery
and documentation of the Vessel in accordance with the requirements of the Contract
Documents.
o It should be clearly stated that Purchaser has no responsibility to provide any engineering,
labor, equipment, materials, electricity, energy, machinery, facilities, services or
supervision, unless there is some well-defined shipowner-furnished information and/or
equipment.
 The second major segment of the Scope of Work addresses the non-hardware, or documentation,
aspects, which are a vital part of the completed ship. This part addresses the necessary and/or
requested certifications, documents, booklets, letters, drawings, calculations and other contract
data deliverables that are to be provided both during construction and upon Delivery of the Vessel
by the Contractor, again at no additional cost to the Purchaser.
 It is important for shipyards to appreciate that the development and acquisition of this
documentation must be carefully budgeted, because it can account for a measurable portion of
the total contract price.

A list of typical Contractor-provided certifications to be provided with the Vessel is shown in Table 9.IV.
Other contract data deliverables are not included in that list (see Table VII in Section 9.3, Specifications,
for a suggested list of such documentation).

The secondary aspects of this section of the Agreement can include supplementary requirements for
fulfillment of the work scope, such as that all engineering, labor, equipment, materials, fuel, lubricants,
electricity, energy, machinery, facilities, services and supervision that may be reasonably inferred from
the Contract Documents by professional ship builders/repairers as being required to produce the intended
result as contemplated by the Contract Documents shall be supplied by the Contractor, whether or not
specifically called for in the Contract Documents, and Purchaser shall not be liable for any increase in
Contract Price or Contract Time as a result therefrom.

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Source: Lamb, T. (2021). Ship Design and Construction Volumes I & II (2 Volume Set ed.). SNAME.

Intellectual Property Rights

A sometimes overlooked aspect of contracting is the matter of ownership of the vessel’s design or selected
aspects of the vessel’s design that are not already controlled by copyright laws and/or patents.

Some aspects may be as general as the basic ship design or the hull form, or may be as specific as the
design of the computer hardware and software for either the propulsion control system or the dynamic
positioning system.

The Purchaser may expect that it has sole ownership of those intellectual property rights because the
Purchaser paid for their development through the contract price. On the other hand, the Contractor may
expect that it has sole ownership because it has invested more than the design portion of the contract
price into the development of those features. The parties should ensure that these matters are addressed
in the Agreement

Some commercial agreements have stated that the Purchaser owns the title to the Vessel Design, but
Contractor can use it for other purchasers provided a royalty fee is paid to the Purchaser for each

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additional vessel constructed for other purchasers, thus recovering, in part, the portion of the Contract
Price for the initial design costs.

Materials and Workmanship

This section of the Agreement typically sets forth the requirement that all materials, machinery and
equipment furnished by the Contractor and incorporated into the vessel shall be new, of current
production and currently supported by spare parts available in a designated geographic region.
Additionally, the Contractor warrants that all design engineers, workmen, subcontractors and others,
engaged by the Contractor in the performance of the Contract Work possess suitable professional skills
and are appropriately certificated.

This section usually addresses several other aspects of the materials and workmanship, including, among
others, the Purchaser’s right to reject, and the Contractor’s obligation to correct, at no additional cost,
any materials or workmanship whenever found to be defective, or otherwise not in accordance with the
requirements of the Contract Documents.

Broad requirements pertaining to the materials and equipment can also be addressed in this section of
the Agreement. Some of these may be:

• the flushing of all piping,

• the provision of all working fluids in systems,

• the provision of all fuel for testing,

• the installation of safety guards around rotating and sliding equipment,

• the use of only materials and equipment approved by the designated regulatory or classification
organization, and

• the use only of certified welders; among other possibilities.

Regulatory and Classification

The Agreement should state with which particular sets of regulations the design and construction of the
ship must comply. These regulations will usually include both domestic and international requirements;
domestic because the ship will fly the flag of a particular nation, and international because the ship will
be trading with other countries, for which port entry is keyed to compliance with certain international
regulations.

These two segments often are then supplemented by the requirement, if it is not an unusual contract,
that all engineering, all arrangements for plan approval, all arrangements for inspections and any other
requirements of the regulatory agencies and the classification organization are to be carried out by the
Contractor, again, at no additional cost to the Purchaser

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Street Sta. Mesa Manila, 1035 Metro Manila

Contract Price

Under fixed-price contracts, the price for the Vessel has to be established, and the currency in which it is
payable has to be stated as well.

Some Purchasers may wish to have the Contract Price stated in several components, but for new ship
construction that is best addressed in the progress payments

For ship conversion or repair, line item pricing is often used, so that if the entire item is canceled, the
adjustment of the Contract Price is known if cancellations are limited.

Unit Prices

Scope, negotiated through Change Orders, the Purchaser will have to utilize additional materials,
subcontractor efforts, engineering and production labor. Further, extensions of the project schedule may
necessitate the provision by the Contractor of additional days of shipyard services. If there will be
significant shipowner-furnished equipment, the necessity of such additional items is more likely.

The cost impact of a Change Order may require negotiation of at least nine elements:

1. material costs,
2. subcontractor costs,
3. additional engineering hours,
4. production labor hours,
5. mark-up of material costs,
6. mark-up of subcontractor costs,
7. hourly rate for engineering,
8. hourly rate for production labor at straight time and overtime,
and
9. daily cost of shipyard services.

Delivery of the Vessel(s) to Purchaser

The place and condition of delivery of the completed ship should be identified in the Agreement. Usually,
the place of delivery is alongside the shipyard’s dock; but sometimes for tax or financial reasons, the place
of delivery may be at another location

Project Schedule

The purpose of a shipbuilding project schedule is to give the shipyard a project monitoring and control
mechanism. If properly developed and maintained (updated), it will enable the shipyard to see where it
needs to redeploy its resources in order to keep the time-critical activities on schedule, and not
inadvertently give priority of resources to non-critical activities.

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The Agreement usually requires that the Contractor develop a detailed project schedule within a certain
period of time after contract award, and that the Contractor provide copies of it to the Purchaser.
Thereafter, the Contractor is usually obligated to update the schedule both periodically and if there are
significant impacts due to Change Orders, and to timely provide copies of the updated schedules to the
Purchaser.

This requirement in the Agreement is sometimes supplemented by some technical details in the Contract
Specifications. The maintenance of a project schedule can become quite important if the Purchaser is
going to allege Contractor default as evidenced by comparing the actual status to a planned schedule.

There are several reasons, however, to include this requirement within the Agreement.

 First, by putting into the Agreement some minimum scheduling and updating requirements, the
Purchaser is assured that the Contractor has allocated within its budget the resources for those
actions.
 Second, this assures the Purchaser that it will be entitled to see copies of the schedule and all
updates.
 Third, this enables the Purchaser to identify the Contractor’s interpretation of latest requested
dates for the arrival of shipowner-furnished equipment or materials or for other shipowner-
responsible actions
 Fourth, this allows the Purchaser to plan any necessary variations in the staffing of its inspection
staff and, ultimately, the ship’s crew.

Some agreements call for a Key Event Schedule. Key events could be the start of engineering, start of
fabrication, start of hull erection, launching, sea trials and delivery.

Liquidated and Actual Damages (Delivery)

The purpose of this section of the Agreement is to set forth an acknowledgment by the Contractor that if
the ship is delivered later than either the original Delivery Date or any agreed upon contract extensions,
the Purchaser will incur financial damages; and the parties agree in advance that the damages are
approximated by a certain sum per day of delay, payable by the Contractor.

For legal reasons, this is not necessarily a penalty clause, although it may give the Contractor similar
incentive to achieve timely delivery. If, however, it is phrased as a penalty clause for late delivery, then
there should be a bonus clause for early delivery. If it is phrased as a liquidated damages clause, a bonus
clause is unnecessary. Some contracts may include a clear statement that the Contractor is not entitled
to any bonus for early delivery.

The purpose of this section of the Agreement is to set forth an acknowledgment by the Contractor that if
the ship is delivered later than either the original Delivery Date or any agreed upon contract extensions,
the Purchaser will incur financial damages; and the parties agree in advance that the damages are

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approximated by a certain sum per day of delay, payable by the Contractor. For legal reasons, this is not
necessarily a penalty clause, although it may give the Contractor similar incentive to achieve timely
delivery.

If, however, it is phrased as a penalty clause for late delivery, then there should be a bonus clause for early
delivery. If it is phrased as a liquidated damages clause, a bonus clause is unnecessary. Some contracts
may include a clear statement that the Contractor is not entitled to any bonus for early delivery.

Liquidated Damages (Performance, Design)

The Contract Specifications and Contract Plans may provide target quantities, amounts, or dimensions for
various aspects of the ship. Many of them will undoubtedly be achieved because of the design process.
Some of them, however, may not be exactly achieved, such as maximum trial speed, minimum continuous
operating speed, fuel consumption rate at design speed and draft, maximum deadweight, draft at
maximum deadweight, or liquid capacity in certain tanks, among other possibilities. These possibilities are
more likely to arise if the ship incorporates a new hull form, new technology or significantly greater
powering than routinely installed in a similar ship, or if the shipyard has not previously constructed a
similar vessel.

When the completed vessel does not achieve all of its intended design or performance parameters for
which the Contractor was responsible, the Contractor and Purchaser have to negotiate a resolution to the
discrepancies because the requirements of the contract strictly have not been fulfilled and the Purchaser
is not getting all that was bargained for. Absent a harmonious negotiation, litigation is a distinct likelihood.

To avoid litigation, the Agreement can identify liquidated damages that would be payable by Contractor
to Purchaser if the specific design or performance parameters are not achieved. For example, a certain
sum of damages could be payable for each one-tenth knot less than the intended trial speed for up to a
half knot deficiency. Then twice that amount per tenth of a knot for a speed deficiency between a half-
knot and a full knot. Similar progressive liquidated damages could be stated for greater deficiency.

Reference:

 Lamb, T., 2004. Ship design and construction. Jersey City, NJ: Society of Naval Architects and
Marine Engineers.

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