FuelEU Maritime Series – Part 6: Legal issues

In the final instalment of our six-part series uncovering the FuelEU Maritime Regulation, we take a look at the legal issues that could potentially arise between various parties, such as owners, charterers, ship managers, bunker suppliers, and ship builders, as a result of the compliance requirements imposed by the Regulation.

What legal issues might arise from the contractual re-allocation of costs related to FuelEU compliance and fuel provision arrangements?

The FuelEU Maritime Regulation (the FuelEU Regulation) provides that the company (as previously defined in FuelEU Maritime Series – Part 2: Exemptions and Responsibility) remains responsible for the payment of FuelEU penalties.

The company may, nevertheless, conclude contractual agreements with the commercial operators of the vessel whereby the latter agree to reimburse the company for the payment of FuelEU penalties, in situations where said commercial operators assume the responsibility for the purchase of the fuel or the operation of the vessel (namely, by determining the cargo carried, the route to follow, and the speed of the vessel).

However, it is important to note that the conclusion of such contractual arrangements will not relieve the company from its liability to pay the penalties. 

Where the company fails to pay, and the risk of a ship expulsion order arises, the shipowner (if it is not itself the company for the purpose of the FuelEU Regulation) and any other entity with an interest in the continuing operation of the vessel within the EU/EEA, may have little choice but to meet such liability themselves, while pursuing whatever contractual recourse they might have against the company or others under the relevant contractual arrangements. Such contractual arrangements should include the specific allocation of liability for FuelEU penalties under time, voyage, or bareboat charters, or under ship management agreements. 

BIMCO have been working on model clauses to that effect, and,on 25 November 2024, adopted their FuelEU Maritime Clause for Time Charter Parties 2024 to help stakeholders align their contracts in relation to compliance obligations under the FuelEU Regulation. The Clause is also intended to assist shipowners, charterers, and other parties, assign liability for potential penalties that might be incurred.

What legal issues may derive from bunkering supply arrangements and shipbuilding contracts?

As discussed in one of our previous articles (FuelEU Maritime Series – Part 5: RFNBOs, OPS and Penalties : Clyde & Co), one of the key objectives of the FuelEU Regulation is to encourage the use of renewable fuels by the shipping industry.

To achieve this aim, there will need to be significant investment in bunkering infrastructure for the supply of renewable fuels, as well as the construction of new vessels capable of consuming said fuels.

Part of the purpose of the FuelEU Regulation is to financially incentivise the shipping industry to switch from consuming traditional oil-based bunker fuels to renewable fuels. However, it would be worthwhile for those in the shipping industry to also consider the wider legal issues arising from changes to bunker supply contracts and to shipbuilding contracts, where vessels are to consume alternative fuels. 

Bunker supply contracts - legal issues

Both vessel owners and bunker purchasers will want to ensure that they are able to take advantage of the preferential treatment provided under the FuelEU Regulation for consuming renewable fuels, including biofuels and renewable fuels of non-biological origin (RFNBOs) (such as methanol and ammonia).

Article 10 of the FuelEU Regulation states that such fuels must be certified in accordance with the Renewable Energy Directive (RED) 2018/2001. If the fuel consumed by the vessel does not meet the applicable standards or have the appropriate certification, then it “shall be considered to have the same emissions factors as the least favourable fossil fuel pathway for that type of fuel”[1].

In order to confirm that the fuel complies with greenhouse gas (GHG) intensity and sustainability requirements, the vessel owner and bunker purchaser will want to ensure that the bunker supplier provides the appropriate certification required under the FuelEU Regulation. The EU has required certification of such fuels, with the aim of guaranteeing “the environmental integrity of the renewable and low-carbon fuels that are expected to be deployed in the maritime sector.”[2]

The FuelEU Regulation provides that the GHG intensity of fuel is to be assessed on a “well-to-wake” basis, with emissions calculated for the entire lifespan of the fuel, from raw material extraction to storage, bunkering and then use on board the vessel.

Vessel owners and bunker purchasers will, therefore, need to be mindful of the importance of establishing how “green” the fuel actually is, and of the risk of bunker suppliers providing alternative fuels that will not allow for preferential treatment under the FuelEU Regulation.

It would, therefore, be advisable for bunker purchasers to consider whether the wording of their bunkering supply contracts is sufficient to ensure that the fuel is properly certified under the FuelEU Regulation. This could include contractual provisions that require the supplier (i) to provide a bunker delivery note (BDN), setting out the relevant information regarding the supply (such as the well-to-wake emission factor), and (ii) to provide the necessary certification under a scheme recognised by the EU.

Bunker purchasers should also be mindful that bunkering supply contracts often contain short claims notification time bars and provisions restricting claims for consequential loss. Issues could therefore arise where a purchaser tries to advance a claim against the supplier for consequential loss due to a lack of certification, but the bunker supplier argues that such losses are excluded under the terms of the bunker supply contract.

Bunker purchasers should therefore consider the wording of their bunker supply contracts carefully and ensure that they are comfortable with the contractual provisions.

Shipbuilding – legal and practical issues

The FuelEU Regulation, together with other international legislation, provides a significant incentive for the construction of vessels which are capable of consuming renewable fuel. As a consequence, the shipbuilding industry is seeing an increase in the number of vessels on order or under construction which are capable of consuming alternative fuels, particularly methanol, with increasing focus on ammonia and hydrogen technology likely in future.

The risk for shipowners is that if a vessel is not able to consume renewable fuels (or able to pool  allowances across a fleet (see FuelEU Maritime Series – Part 4: Compliance and Adjustment Mechanisms : Clyde & Co)), then it could in future become prohibitively expensive to operate in voyages to and from EU ports given the increasing penalties the vessel will face under the FuelEU Regulation. 

Whilst production of alternative fuels is increasing, currently the costs of alternative fuels are high, and availability is low. Therefore, many customers are ordering vessels with dual-fuel engines, which are also capable of consuming traditional oil-based bunkers, in order to “future proof” their fleet and give optionality in respect of fuel use.

However, the implementation of innovative technologies which allow vessels to consume renewable fuels also poses its own risks, particularly when such technology is nascent and developing (we refer you to our previous article on Shipbuilding Contracts: Legal Issues Arising from Technological Change and Innovation : Clyde & Co).  As a result, it is worth both shipyards and buyers giving careful consideration to the allocation of design risk as well as the warranty regime in respect of post-delivery defects.

Another important issue relates to fuel consumption efficiency, particularly given that renewable fuels are generally less efficient by volume than traditional oil-based bunker fuels. This means that vessels consuming renewable fuels are likely to require more frequent bunkering and/or greater fuel storage capacity.

Shipyards and buyers should also give careful consideration to the performance guarantees in respect of alternative fuel consumption under shipbuilding contracts, and the extent to which liquidated damages and/or cancellation rights apply if the vessel fails to meet those performance guarantees during sea trials.

FuelEU - Who is liable? The registered owner or the DoC holder?

As we mentioned earlier in our Series, the clock is ticking: on 1 January 2025, the provisions of Regulation (EU) 2023/1805 of the European Parliament and of the Council of 13 September 2023 on the use of renewable and low-carbon fuels in maritime transport and amending Directive 2009/16/EC (the FuelEU Regulation) will come into force.

If the energy consumed on board a vessel exceeds certain limits for the GHG intensity of the energy consumed on board a vessel, this will result in a deficit that will have to be offset either by (i) borrowing or pooling surpluses or (ii) by paying a penalty to the competent authority. But who is liable to the competent authority as the responsible entity? In principle, the shipping company is the responsible entity, it being liable to the competent authority.

In order to further define the shipping company in connection with the EU Emissions Trading System (EU ETS), the EU legislator stipulated in a Commission Implementing Regulation that the registered owner should, in principle, be the responsible entity for the EU ETS obligations, unless the ISM company (the Document of Compliance (DoC) holder) expressly assumed the EU ETS obligations, as the responsible party, from the registered owner on the basis of a contractual agreement with the registered owner, and this change was notified to the competent authority.

It would have been expected that in the case of FuelEU, the registered owner would also be the responsible entity vis-à-vis the competent authority. However, the EU legislator actually stipulated that for FuelEU the ISM company (the DoC holder) should always be the responsible entity.

This regulation is surprising because it does not reflect the commercial interests of the parties involved. First, the technical manager, as DoC holder, is only a service provider for the registered owner. Secondly, if the vessel is chartered out by the registered owner to a time charterer, it is beyond the control of the technical manager which bunker the time charterer uses and whether the time charterer exceeds the above-mentioned limits for GHG intensity.

It is, therefore, difficult to justify why the technical manager should be regarded as the responsible entity vis-à-vis the competent authority, in particular regarding the payment of any penalty under the FuelEU Regulation. It may, however, make sense to regard the technical manager of a vessel who is affiliated with the registered owner as the responsible entity.

In the case of technical managers who offer their services as third party managers, it is not justifiable to impose such a risk on them. The EU legislator merely states succinctly that the parties should enter into contractual agreements to address this risk (for example, through cost reimbursement claims by the technical manager against the registered owner).

At the same time, however, the EU legislator also states that the technical manager remains liable to the competent authority even if it is unable to enforce a claim for reimbursement of costs against the registered owner. Be that as it may, however, there is no indication that the EU legislator will transfer the FuelEU obligations towards the competent authority from the technical manager to the registered owner (as is the case with EU ETS).

The technical manager, therefore, bears the risk that if the registered owner has payment difficulties (because it may no longer receive payments from the time charterer, for example), it will be stuck with the costs of any penalties.

In order to minimise its risk, it will therefore be essential for the technical manager to agree with the registered owner, in the management agreement, to receive any payments, including advance payments, which correspond to the amount of the penalties that the technical manager may have to pay to the competent authority, as regularly as possible and at short intervals.

It remains to be seen whether technical managers, as third-party managers, will be able to obtain further security from a registered owner, for example, in the form of a valuable guarantee from a holding company.

It is expected that BIMCO will publish shortly the template of an addendum to ship management agreement SHIPMAN 2024 with provisions on FuelEU. In any event, it is critical for the above considerations to be clarified between the registered owner and the technical manager.

What legal issues might shipowners and charterers face when dealing with penalties and expulsion orders?

As explained in our section on penalties for failure to comply with FuelEU Regulation obligations (FuelEU Maritime Series – Part 5: RFNBOs, OPS and Penalties : Clyde & Co), there will be penalties imposed on vessels that exhibit a compliance deficit of GHG intensity or that have made a non-compliant port call during the reporting period.

The method of penalty collection will be determined by each Member State and will be payable by 30 June of the verification period.

The payment of the penalty may cause friction between the company responsible for its payment under the FuelEU Regulation and the entity whose decisions directly or indirectly caused the non-compliance with the Regulation.

For example, if a vessel is time chartered, the shipowner (the default company responsible for compliance with the FuelEU Regulation, assuming it is also responsible for compliance under the International Management Code for the Safe Operation of Ships and for Pollution Prevention) does not have control over the fuel purchased by the charterer, in the absence of contractual terms on the subject. Therefore, the charterer’s decisions to purchase more polluting fuel may cause the shipowner to miss the GHG intensity target and the vessel to be subject to penalties.

In order to avoid potential disputes caused by non-compliance with the FuelEU Regulation and discussions around whose fault it was that penalties were imposed, it is worthwhile including a clause in charterparties and other shipping contracts, such as ship management agreements, as to who is responsible for ensuring compliance with FuelEU Regulation and whether such a company should be reimbursed by another party to the contract, such as the charterer of the vessel, if their actions caused the non-compliance.

An even bigger concern for parties to shipping contracts would be the non-payment of penalties or the continuous non-compliance with the FuelEU Regulation. The consequences are set out in Article 25(3) and include the discretionary right for ports of call to issue expulsion orders addressed to vessels flying a flag other than their own, in circumstances where those vessels have failed to hold a valid FuelEU Document of Compliance for two or more consecutive reporting periods.

Until the company responsible for compliance fulfils its obligations, non-flag Member States will refuse entry to the vessel subject to such an order and the Member State whose flag the vessel flies will order a flag detention when it enters one of its ports.

If a vessel is subject to an expulsion order or a flag detention, the parties to a charterparty should consider whether off-hire provisions should apply and ensure that any termination rights are documented properly. The absence of such provisions could lead to prolonged expulsion orders and flag detention, affecting the vessel beyond the charterparty period under which the non-compliance with the FuelEU Regulation occurred, not to mention the occurrence of avoidable disputes. A well-worded FuelEU Regulation clause could avoid these problems.

Late last month, BIMCO released a FuelEU clause for time charterparties (as mentioned earlier in the article) and it is in the process of drafting a clause for ship management agreements, which may be useful starting points for negotiations between parties. However, given the individual characteristics of each agreement, it may be advisable to review these clauses to reflect the parties’ positions through a bespoke FuelEU Regulation provision.