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Not All “Contracts” Are Contracts – And That’s a Good Thing

SCFI spot rates have now dropped to $3,050/FEU to US WC and $3,545/TEU to Europe. Overall spot rates are down 27% from a month ago. At this point most shippers who signed contracts on the major global trade routes are looking at spot rates much lower than their contract rates. Many are wondering if they can either renegotiate their contract rates, or simply syphon contract cargo into spot bookings. After-all, this would have been common practice in the years prior to 2020…

Then we recently saw completely opposite signals from two major carriers:

Chang Chao-feng, the COO of Yang Ming, said “We will discuss the contracts with our customers… we’ll make necessary adjustments, depending on the contract.” (The Loadstar)

Rolf Habben Jansen, the CEO of Hapag-Lloyd, has clearly explained that Hapag-Lloyd would not be renegotiating their contracts. (JOC.com)

How can this be?

Basically the contracts that Rolf Habben Jansen is referring to are likely different to the contracts that Chang Chao-feng is referring to.

FMC Commissioner Dye alluded to this in her testimony to the Senate in March when she said: “I have been concerned that many service contracts for carriage of cargo entered into between shippers and ocean carriers lack mutual commitment.  This ambiguity about mutual enforceability in these so-called “contracts” may cause severe consequences…”.

Generally speaking, there are two contract categories in the market today.

Firstly, there are traditional contracts that are ambiguous. For example, these contracts may have a minimum quantity commitment (MQC) the parties agree to fulfil over the course of the contract, but with no commitments as to which week the cargo will be shipped, or on which service. These contracts may even include penalties, or liquidated damages for non-performance, but without clear commitments it is practically impossible to prove who was at fault – thereby rendering these contracts unenforceable.

Secondly, there are a growing number of new contract types where the commitments are clearly laid out on a weekly basis and the ports or routes are specified. This makes it possible for the carrier to understand exactly what its obligations are, and same for the shipper. Where these obligations are clear, then it’s possible to track each party’s performance, and consequences can be applied of non-performance. These consequences may be financial, such as liquidated damages, or tied to future allocation cuts etc. Nonetheless, the consequences are clear and agreed on by both parties going into the contract, thereby creating real incentives for both the carrier and the shipper to perform.

Based on this, Chang Chao-feng may be referring to the traditional unenforceable contracts in the 1st category, whereas I believe Rolf Habben Jansen may be referring to more modern and enforceable contracts in the 2nd.

Is this a good thing?

I actually think this is a very good thing, especially for shippers.

Shipper procurement managers now have a new set of contracting tools which they can use to better manage their supply chain risk. For example, if a shipper needs predictable landed cost and consistent service levels, then she or he can enter an enforceable contract with the appropriate consequences, or incentives for performance. Alternatively, if the shipper wants the flexibility to take advantage of low spot rates when the market softens, then the shipper can make a more traditional unenforceable contract, but then accepts the risk that the carrier may also curtail the unenforceable contract allocations when spot rates rise.

The more innovation in contract types offered, the more choice shippers have to select the contract type that meets their business needs.

So at the end of the day, the more choice the better…

– by Gordon Downes, CEO and Co-Founder of NYSHEX

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