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Maritime Legal, Regulation & Insurance

Who killed LOF?

Posted by on 04 August 2017
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This article was originally posted on Lloyd's List.

Insurers have undermined the world’s most famous salvage contract but are they also pummelling the salvage industry to the brink of insolvency?

When Euronav-owned very large crude carrier Alex ran aground in the Java Sea in April this year, the news would have spread rapidly among today’s diminished community of marine salvors.

Reportedly no-one was hurt and the ship was virtually unscathed in the navigational mishap.

But the very image of a laden VLCC stubbornly stuck in soft, muddy shallows between Borneo and Sumatra would be enough to make any salvage man salivate.

Traditionally, the combined value of a newly-built VLCC not long out of the building dock at Hyundai Heavy Industries in South Korea, together with a full cargo of crude oil for China, would represent a prize that might lead to a huge award for a lucky salvor.

For decades, it was exactly this kind of potential for an exceptional payday that helped keep most salvors motivated in one of the toughest and most unpredictable of businesses.

Unsurprisingly, several salvage firms offered to handle the casualty.

But the days when those providing emergency assistance could look forward to windfall in salvage awards appear increasingly to be in the past.

In the case of Alex, Euronav agreed to engage Smit Singapore and local ally PT Samudera Indonesia for salvage works.

Refloating, after lightening of the big tanker by ship-to-ship transfer of cargo, took three weeks.

The salvors were engaged under a Lloyd’s Open Form of Salvage Agreement.

“There is some unease, brought about by the fact that the client — be it shipowner, property underwriter or P&I club — does not want disclosure,”

Originating in the late 1880s, LOF has often been described as the world’s most widely used and trusted salvage contract.

Backed by the authority of Lloyd’s of London and a panel of expert arbitrators for the mere one-quarter of cases under the contract that are not amicably settled, LOF has been a bedrock of the salvage industry for more than a century.

Traditionally it has been supported by all maritime stakeholders as being a vital tool for safety as well as for protection of property at sea and protection of the marine environment.

The 1978 Amoco Cadiz accident, one of the first modern "supertanker" spills, served as the poster-child case for LOF in our more environmentally sensitive times.

Carrying 69m gallons of oil, the tanker broke up off the coast of Brittany, polluting the shoreline for 300 miles and generating the very first television footage of oil-soaked wildlife in the wake of a tanker accident.

The tragedy was partly blamed on the owners’ refusal to engage a nearby German salvage tug under an LOF contract — because of cost concerns.

According to sources close to the Alex incident, the LOF signed by the owners was subject to a private side-agreement that had the effect of restricting salvage remuneration. Lloyd’s List has been told that the deal capped the salvors’ pay at about $4m.

At that rate, speculate industry sources, the salvors may have made little or no profit at all from the job.

Neither Euronav or Smit themselves were able to confirm that information for this article.

A representative of Euronav cited confidentiality as a reason for not being more forthcoming.

At Netherlands-based Smit, the management declined to comment and said it preferred not to participate in this article generally.

Tim Fuller, chief operating officer of the Britannia P&I Club, which covered liabilities for Alex, said the club had nothing to do with the addendum to the LOF contract as it had no exposure to the salvage claim.

However, as in all such cases, clubs might be involved big-time if things go wrong.

Britannia P&I “breathed a sigh of relief” when the refloating went according to plan, said Mr Fuller.

That the use of LOF as a salvage contract is in decline is no secret and warnings about the viability of the salvage business should come as no surprise.

They have been heard commonly enough for the last 20 to 30 years.

Now, however, the numbers are adding up to an unmistakably dark picture for the emergency salvage sector in particular.

‘Mutant’ contracts on the rise

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Historic Lloyd’s data shows that prior to 2003, there had never been any calendar year when fewer than 100 new LOF contracts were signed worldwide.

But since then, usage of LOF has crumbled rapidly and in 2016, just 48 new cases were recorded, the second-worst year ever following the 37 new LOFs inked in 2014.

Last year also saw a record low of just eight original arbitration awards published, with an aggregate of just $17m in LOF salvage awards.

Those seem to be pitiful numbers for a system over which so much anxiety and spleen has been vented, mainly behind the scenes, in recent years.

One of the reasons for the reduction of LOF salvage cases is a stronger industry safety culture and a reduction in serious casualties.

But there has also been a growing aversion to use of LOF among marine insurers.

In the first half of 2017, 26 new contracts were reported to Lloyd’s, including some that had yet to be included on the Lloyd’s Salvage Arbitration Branch website.

This is marginally up on 22 last year and 20 in 2014 at the same stage.

Unfortunately, the depths of insurers’ aversion to the contract and hence the depth of the crisis enveloping LOF are no longer fully captured by those statistics.

In the past two to three years, there has been a growing fashion for private side-deals, such as that in the Alex case, that alter the fundamental nature of the contract.

"Salvors would prefer to operate on unamended LOFs — and Scopic — but commercial pressures, particularly from insurers, often make that impossible."

These bespoke arrangements take as many forms as there are epithets for them — hybrid, amended, doctored, mutant or zombie LOFs being among the possibilities.

They may include capping of remuneration for the salvor or basing remuneration on a costs-plus formula, and have increasingly been accepted by many salvors with various degrees of reluctance.

But they are generally agreed at the behest of insurers.

Today no-one knows for sure how many of the new LOF contracts reported to Lloyd’s are “clean” LOFs and how many of those in Lloyd’s tally of new cases are LOFs in name only.

Experts from all sides agree the proportion of amended LOFs is significant. Some estimate they are now the majority.

In the past, a complaint of some factions in the insurance community was that under the umbrella of LOF, salvors could earn good money for a salvage case that was a glorified rescue-tow.

But now it appears common for even the most challenging and high-profile salvage operations to be subject to a secret side-agreement, or to avoid LOF altogether.

A case that had much in common with the salvage of Alex was that of the vehicle carrier Höegh Osaka in the Solent outside the port of Southampton in January 2015.

The commonalities include a three-week operation, competently managed with a complete avoidance of pollution, carried out under an LOF that was curbed by a side-agreement with the salvor, in that instance Svitzer.

As with Alex, the combined value of hull and cargo, consisting mainly of new luxury cars, was well over $100m.

Pictures of the vessel listing severely after grounding on a sandbank were alarmingly dramatic, and the salvage challenges complex.

Word on the salvage grapevine is that Svitzer eventually received about $7m for the job.

The amount of actual remuneration remains unconfirmed, although a source close to the salvage operation told Lloyd’s List the figure, so far as he could recollect, was “in the right ball park”.

To put this in context, in 2009, $7m was merely an average amount for an LOF award.

Admittedly, that year was an aberrantly expensive one for insurers, containing as it did the two largest awards ever made.

It was also the year that pushed certain insurers to make de-fanging LOF a business priority.

Meanwhile Gard, as lead hull insurer and P&I Club of Höegh Osaka, won a prestigious London market insurance award for its handling of a major claim event.

The Norway-based insurer said it brought to the incident in the Solent a "holistic and hands-on approach, founded on Gard’s broad competence and practical experience”.

Lloyd’s confirms it currently has no information about addenda to LOF contracts, although the matter is very much on its radar.

Earlier this year, Lloyd’s raised its concerns over the matter at the Lloyd’s Salvage Group, a consultative forum representing all stakeholders.

It requested that all sides ask their members if they would agree to confidentially notify Lloyd’s when a side-agreement to the LOF contract exists.

It will be discussed further at the next meeting of the LSG in November. However, so far the response to even this modest initiative to shed a sliver of light on the subject, for the benefit of statistics, appears underwhelming.

Typically, such agreements are made between shipowners and salvors.

The International Group of 13 main international P&I clubs acknowledges that LOFs are being made subject to side agreements, and says it has its own concerns about this.

But not being party to LOF or any side agreement, clubs will not be able to notify Lloyd’s of the existence of such agreements.

“The clubs are indeed concerned that poorly drafted LOF side-letters may undermine the Scopic clause or potentially prejudice club cover,” said the IG in a statement. Scopic — the Special Compensation P&I Club Cause — was introduced in 1999 as a replacement for a previous mechanism for providing salvors with compensation for preventing pollution. “The clubs are working with their industry partners, through the Lloyd’s Salvage Group, to address these concerns.”

The IG clubs “remain committed to supporting LOF through the funding of Scopic claims”. The clubs were also “keen to see a viable salvage industry remaining”.

You might think that salvors would be more strongly motivated to draw attention to a practice that is severely curtailing their earnings. But on their side, there are also qualms about notifying Lloyd’s.

“There is some unease, brought about by the fact that the client — be it shipowner, property underwriter or P&I club — does not want disclosure,” said Mark Hoddinott, general manager of the International Salvage Union, which represents the international marine salvage industry.

“In a tight market, there is greater concern about upsetting a client.

“I can safely say that salvors would prefer to operate on unamended LOFs — and Scopic — but commercial pressures, particularly from insurers, often make that impossible,” he added.

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A clearer picture of the impact of weakened LOF contracts, and of the sector’s wider financial woes, is provided by the ISU’s own statistics, which are compiled annually through a survey of members.

Including both awards and the higher number of settled cases, last year average revenue from LOF services, including Scopic cases, sank by 40%.

Total revenues from LOF cases of $69m were the lowest since 2003, while revenue derived from Scopic fell by 54% to $64m.

As a proportion of all salvage cases, the number of LOFs — even though propped up by a significant but unconfirmed number of mutant LOF cases — fell from 16% in 2015 to an all-time low of 11% last year.

This reflects an ongoing shift in favour of using other commercial contracts in place of LOF. Similarly, LOF revenues are losing ground, slumping to 33% of all salvage remuneration, excluding wreck removals, in 2016. This is down from 46% in 2015 and more than half the total as recently as 2014.

But the grim news for the salvage sector is by no means confined to LOF.

Revenue from operations under contracts other than LOF was also down by 23% to $75m, whereas a year earlier the ISU had noted a gently rising trend for non-LOF income. Average pay from non-LOF jobs was halved to $277,000.

In parallel, wreck removal generated $380m in 2016 — little more than half the revenue from this source in 2015.

Wreck removal had been seen as a more reliable source of business for some of the bigger industrialised salvors, in some cases effectively subsiding their emergency salvage capabilities.

The wreck business had been growing over the past decade but 2016 was the first time in four years that it accounted for less than half of all ISU members’ revenue.

This dramatic slump in revenues across the board means that all types of salvor, no matter what their business mix, are likely to have been hit.

There should be no delusion that increased safety is the benign reason behind this collapse in revenues.

The figures are all the more shocking because services provided by ISU members increased.

During 2016, the 306 salvage operations, excluding wreck removals, represented an increase of almost 50% compared with the previous year and was the highest number since 1999. Wreck removals, meanwhile, doubled.

To Mr Hoddinott, the implication of the numbers is obvious. “They indicated to me that we are being squeezed,” he said.

According to ISU president John Witte: “One bad year does not make a trend and these statistics again show the variability of our industry and the fluctuations in the sources of revenue.”

But he added: “It seems there has been a fundamental shift downwards.”

A divided membership?

“Some will say that there will always be tugs around and there will always be someone at the end of the phone to help when a casualty occurs. But for how long will that remain true?”

Although the marine salvage fraternity is a tight circle, it is split in a number of ways.

Of the current 59 members of the ISU, just seven private sector salvors can be classed as truly international players. In addition, there are four state-owned members from China, Cuba, Russia and Turkey.

The other 48 members are more regional outfits and many may not be dependent on salvage as their core business.

Until relatively recently, the mantle of leadership in international salvage could be claimed without fear of contradiction by northern European salvors, although there was also a strong parallel tradition in North America.

In the 1960s, though, a Greek salvage sector was taking its first fledgling steps.

While northern Europe also remained home to major hull underwriting markets and P&I club management, ownership of the European merchant fleet began to tilt towards southern Europe.

When push came to shove, the approach to the salvage business began to diverge along exactly those lines, with a number of major northern European salvors seeing the insurer as their underlying customer.

By contrast, Greek salvors, in particular, focused primarily on relationships with owners in their backyard.

The success of Greece-based salvors became particularly galling for the established giants and can be gauged by the fact that one year, Greek salvors won about 60% of the LOFs reported to Lloyd’s.

In 2000 Piraeus-based Tsavliris alone was engaged in 50 LOF cases, an all-time record.

It was able to punch above its weight by its preparedness to charter-in tugs and co-operate in a friendly fashion with all comers, from direct competitors to smaller regional salvors. Moreover, it received increasing recognition for the standard of its emergency services, with glowing assessments made by Lloyd’s arbitrators that equalled those hailing the professionalism of their blue-chip Dutch rivals.

While the top firms battled for various types of business, henceforth the top northern salvors put their faith in diversification and doubling down on their connections with the insurance community, including the P&I clubs.

Meanwhile the Greek upstarts made the traditional LOF system their raison d'être.

Prior to the 1989 International Salvage Convention, the clubs had sat on the sidelines as hull and cargo underwriters paid traditional salvage awards.

Since then, the clubs have become a powerful voice in the salvage market, first of all due to latter-day recognition that salvors need special compensation for their role in preventing or minimising pollution, and secondarily because of a modern trend, led from Scandinavia, for P&I insurers to become involved in the hull and machinery market as well.

As early as 1989, Smit’s then-managing director, who was at the time also ISU president, expressed concerns about the salvage industry dying, in a paper entitled Salvage in Crisis.

It proposed a joint venture between the P&I clubs and Smit to ensure viable salvage capacity around the world.

Historically, the ISU has not supported favoured relations between insurers and certain salvors, let alone a monopoly.

A decade ago, Donjon Marine founder Arnold Witte, as ISU president, acknowledged that “some voices” were calling for a new model — either with insurers themselves assuming responsibility for salvage or perhaps supporting a “favoured few” operators.

“Future calamities at sea, with rare exception, should be dealt with on a competitive basis.

To have a single responder or a chosen few will not be successful,” Mr Witte wrote.

Today, though, the jury is out on that particular subject.

One group of salvors may have overestimated the benefits of longer-term servitude to insurers.

The slump in the offshore market and an increased flood of tugs that can be pressed into salvage work has contributed to driving down rates.

Insurers’ hands have also been strengthened by the availability of many ex-salvage masters who can be engaged as consultants to insurers either on retainer or for particular projects.

Meanwhile, another group of salvors may have failed to predict how determinedly the LOF system could be circumvented.

From salvor to ‘mitigation partner’

“LOF is in trouble. But I believe LOF is worth fighting for. It is the only contract that recognises the need to encourage salvors, an important element in maintaining a viable salvage industry.

At company level, a good indicator of the current plight of the sector is Ardent.

Ardent was formed as recently as May 2015, when Svitzer Salvage — part of the AP Moller-Maersk Group since 1979 — merged its operations with those of Titan Salvage, owned by long-established Crowley Maritime.

Svitzer by itself was a veritable Russian doll formed by previous rounds of consolidation, including its 2001 takeover of Wijsmuller and 2007 acquisition of Adsteam.

The new move created easily the world’s largest salvor, with every right to be considered an industry leader.

In its first two years, celebrated in May 2017, Ardent carried out 125 contracts, apparently fulfilling its huge operational potential.

But it has not escaped asphyxiating pressure on terms and rates.

Ardent so far this year has axed about 30% of its employees, leaving a global workforce of about 100.

It has also diversified further out of pure salvage, with more offshore decommissioning and subsea services.

Non-salvage work is predicted to account for about 30% of Ardent’s remuneration in 2017.

Earlier this year, it was entertaining buyout offers and held talks with at least one potential suitor, said to be a private equity fund that was looking to consolidate a number of players in the field.

In response to an inquiry from Lloyd’s List, Ardent chairman and Crowley general manager Todd Busch declined to address the question of whether Ardent was up for sale, but reaffirmed that Crowley and Maersk continued to support the company.

“There is no doubt the salvage industry is facing some significant challenges,” he said. “This market segment has too many salvors for the amount of activity. There is opportunity for further consolidation.”

Ardent chief executive Peter Pietka said: “There is no doubt that a consolidation is happening.

“We are transforming from being a salvor to a diversified marine services company. We feel that is part of what will make us sustainable for the future. We have been quicker and proactive in adjusting our business model to existing circumstances in our industry. I see that as a sign of strength, not weakness.”

According to Mr Pietka, survival for salvage companies now comes down to “who has the best business model”.

Here, he noted differences between the ‘Big Three’ of Ardent, Smit, part of the diversified Boskalis Group, and US-based Resolve, which is also already quite diversified in marine services.

There is also a schism between those salvors and the “pure, traditional salvors”.

He said: “There is a commercial angle and a cultural angle to this. The traditional salvage view is to go and maximise revenues from a particular salvage job.”

Coming from a background of shipping and shipmanagement makes Ardent less comfortable with “popping a bottle of champagne” to celebrate a big salvage claim.

“We have moved quite away from this opportunistic model and we see ourselves more as mitigation partners for the marine and insurance industries. It is as much a matter of self-definition as commercial strategy.”

Hardship is widespread throughout the industry, though. “It is fair to say that both models are suffering.”

Mr Pietka acknowledged that within the sector, “there is a lot of criticism of the clubs”.

Ardent is not complaining about its insurers, he said, citing clubs’ right to benefit from market conditions that may be unfavourable to salvors.

“But they need to think about how they would like to see a sustainable salvage industry in the years to come,” he added.

Cut-throat competition

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The salvors that adhere more to the traditional model have a very different perspective on why the industry finds itself in such bad shape.

Like Ardent, Greece-based companies Tsavliris and Five Oceans Salvage can claim to have the interest of owners in their culture. In the past, the Tsavliris family has owned its own cargoships, while Five Oceans, formed by executives who broke away from Tsavliris in 2006, was established with the backing of several leading Greek shipowners.

Cut-throat competition among salvors themselves is not so much a consequence of overcapacity, they say, and more a result of competitors bypassing LOF to cosy up to insurers and gradually tighten the noose around the last remaining pure LOF salvors.

They, too, are bleeding heavily.

As of mid-2017, two of Five Oceans' fleet of six salvage tugs were laid up, with two more said to be on the brink of being mothballed.

It is understood that certain Tsavliris units have also been laid up.

The number of dedicated salvage tugs on permanent station in strategic international locations worldwide is now said to have fallen below 10.

Mutant LOF contracts are just the latest wrinkle in a concerted campaign to marginalise LOF and shun salvors loyal to the traditional form of salvage contract, they say.

The implication is that pressure from insurers would be less successful if certain major salvors were not willing to serve them on the cheap for the sake of market share.

According to their story, the most brazen move in this campaign came in 2008-2009, when Lloyd’s caved in to underwriters, led by Scandinavian clubs, and controversially ousted its two most experienced arbitrators, including the appeal arbitrator.

The arbitrators’ wrongful dismissal suit was privately settled by Lloyd’s, but laid bare some of the tensions and plotting in the background.

The suit said insurers had been unjustifiably complaining about LOF for many years.

Complaints that salvage awards made by the two arbitrators were too generous or even biased towards salvors were “without justification”, it claimed.

The most incendiary allegation made in the suit was that the controller of agencies at Lloyd’s, who has responsibility for the salvage branch, had promised Scandinavia’s largest club, Gard, that the society would “get rid of” appeal arbitrator John Reeder, QC.

Despite insurers’ success in influencing the line-up of the arbitration panel, the antipathy towards LOF has only intensified.

A number of key insurers have flexible arrangements with salvors such as Ardent, Smit and T&T Salvage that are prepared to offer their services on daily hire based on Scopic day rates and a small uplift.

But, if necessary, even more competitive terms can be offered in order to keep the job.

Some insurers wield a virtual veto over use of LOF, despite the back-up option of insisting on a side-agreement.

According to Nicolas Tsavliris, one of the principals of the Tsavliris Group, the firm is regularly denied emergency response work because of insurers’ aversion to LOF.

“It is disappointing that these practices are bringing about the demise of the salvage industry. They are rapidly killing the DNA of our industry,” he said.

“Salvage may have become a lot cheaper, but there is nothing left to invest in the industry and very soon you will no longer have the know-how or the experience.”

Scandinavian underwriters were picked out as sometimes bullying and attritional over salvage matters.

“They warn owners not to engage salvors under LOF on peril of them not covering the insurance recovery claims,” said Mr Tsavliris.

“Generally they use a lighter touch with the biggest owners but they will be warned that their premiums may go up.”

Tsavliris managed to be among the leading salvors under LOF last year with six contracts and was engaged for four in the first six months of 2017.

Generally it has resisted side-deals. But on the one occasion it succumbed, in the salving of product tanker Spottail in Indonesia last year, the company said it has yet to be paid anything by the Scandinavian insurers.

“We regret having done it,” said Mr Tsavliris. Meanwhile, in one of the recent “clean” LOF cases it has won, the insurer — again Scandinavian-based — demanded that the company revoke the contract or be “blacklisted”.

Similar stories emerge from Five Oceans, which performed 10 salvage operations under LOF last year but none in the first half of 2017.

“The P&I clubs are stepping into the shoes of the shipowners, which I believe is completely out of order,” said managing director Xenophon Constantinides, adding that Norwegian and Swedish insurers had become “so aggressive”.

"The question is, who decides? Underwriters are supposed to serve the owner. They are not in the best position to decide what is best for the casualty. Their only consideration is what is best for them to pay less. And even then they are not on sure ground, as what they think is cheaper might in the long run lead to paying more.”

According to Mr Constantinides, “there is no doubt that one day there will be a disaster”.

He argued the preference for cheaper relationships with competitors is “simply shortsighted” as it provides no profit for any company to reinvest in the business and cannot be efficient as it is prejudicial to salvors who may be best-placed for the particular casualty.

“They don’t want to pay for LOF but what is the alternative?” he said.

“LOF is accepted by everyone as beneficial to the industry, not only to owners but to underwriters as well. With less objection from underwriters, the level of awards would be reduced as arbitrators take into account the overall workload.”

Need for encouragement

Many onlookers are concerned the salvage business is being pummelled to the brink of insolvency. Although all sides mouth words of support for LOF on the conference circuit, the reality is very different.

Underlying the battles over different forms of contract and levels of cost is the question of whether salvage remuneration should be guided by applying the criteria laid down in the 1989 International Salvage Convention which, as is the case with LOF, stresses the need for awards that encourage committed salvors.

This principle is also enshrined in English law and has been arrived at as a matter of public policy over many decades.

Or, alternatively, should salvage, like most other services, be at the whim of the market and what is commercially acceptable?

It is in the latter direction that activities have been travelling for a while now, although the full picture has largely been hidden from view.

According to Mr Hoddinott at the ISU: “LOF is in trouble. But I believe LOF is worth fighting for. It is the only contract that recognises the need to encourage salvors, an important element in maintaining a viable salvage industry.

“Working on day rates will not support the salvage industry.”

As to the question of who killed LOF, there are almost as many suspects as in Agatha Christie’s Murder on the Orient Express, where it is revealed they all did damage to the victim in various ways.

Here the cast of characters who have had a hand in threatening the health of the salvage industry can conceivably be widened to almost all sides of the maritime industry, from hull insurers and P&I clubs, to owners, lawyers, salvors themselves and even Lloyd’s.

However, suspicion points to certain Scandinavian underwriters as the ones that cut a vital artery.

“All this has been brewing for some time,” said Martin Hall, head of marine casualty for lawyers Clyde & Co.

“But things seem to have become very stark very quickly. It is hard to believe that we may be going back to an Amoco Cadiz type of situation.

“Some will say that there will always be tugs around and there will always be someone at the end of the phone to help when a casualty occurs. But for how long will that remain true?”

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