• Of Liens and Letters of Undertaking: The Third Circuit Gets It Right
  • March 27, 2009
  • Law Firm: Blank Rome LLP - New York Office
  • The Third Circuit’s recent precedential decision in Petroleos Mexicanos Refinacion v. M.T. KING A, 554 F.3d 99 3d Cir. 2009), reversing the New Jersey District, has narrowly averted a major misdirection of U.S. admiralty lien law and the efficacy of P&I Club letters of undertaking. The fact that one judge dissented only demonstrates the narrowness of a major upset to U.S. maritime law.1

    The Facts

    In 1992, Pemex chartered the M/T TBLILISI (renamed M/T KING A after her sale) to carry diesel oil and unleaded gasoline between several Mexican ports. The cargoes become cross-contaminated upon discharge, in December 1992, because of the fault of the Vessel, which was undisputed. Pemex withheld $530,320 of charter hire as security for its cargo claim.

    In April 1993, the shipowner demanded arbitration to obtain the withheld hire. Pemex was aware at that time that its claim, including for mitigation costs, would exceed the withheld hire. Accordingly, in agreeing to accept a club LOU in standard wording in exchange for payment of the hire, and to avoid the award against it, Pemex specifically reserved the right to arrest the Vessel to the extent the cargo claim exceeded the hire withheld, which at that time it knew it would.

    The charter was governed by the U.S. COGSA and the one year statute of limitations. Approximately seven months of that prescription period remained for Pemex to arrest the Vessel or otherwise secure the balance of the claim. It failed to do so.

    While Pemex’s claim was adjusted in Mexico with its Mexican cargo underwriter, the New York arbitration stagnated. In 1995 the shipowner sought to have that proceeding dismissed. The tribunal ruled that Pemex’s nomination of an arbitrator in respect of the shipowner’s claim of withheld hire preserved its own claim. Pemex finally submitted that claim, for approximately $2 million, in 1996.

    During the protracted course of the arbitration it emerged that the fully subrogated Mexican underwriter had paid Pemex in full. Irrespective of Pemex’s assertion that it could claim “in the alternative” either $2 million or the subrogated sum, it was clear that the Club LOU, which included costs and attorneys’ fees in the principal amount, and limited interest to $94,000, would not be sufficient.

    During the course of the arbitration the Vessel had made at least ten documented port calls in the U.S. and had been delivered to her new owners in Houston in 2000. Only in 2002 did Pemex, in its own name, file a complaint in New Jersey naming solely the Vessel, in rem, and seeking its arrest. To avoid that arrest the new owner and its P&I Club, which happened to be the same, posted a second LOU for $707,819 to cover the balance of (reduced) claim plus all interest, costs, and attorneys’ fees.

    In 2006 the tribunal awarded Pemex $434,896 on its principal claim plus interest of $411,821 and attorneys’ fees of $100,000. After application of and payment under the first LOU, this left the award to be satisfied in respect of the balance of the principal, interest, and fees against the second LOU. A consent judgment in the sum of $395,265 with interest was entered in order to perfect the Vessel’s right of appeal from an earlier decision from the New Jersey district court denying its motion to dismiss the complaint, discussed below.

    The Lower Court’s Decision

    After the New Jersey arrest action the new shipowner, making a limited appearance to defend its vessel, sought to vacate the arrest and dismiss the in rem complaint on the basis that Pemex’s claim was governed by COGSA’s one year period that had expired in 2002 so that no lien existed and, therefore, there was no admiralty in rem jurisdiction.

    The lower court’s ruling upholding the arrest was truly baffling. It relied on the Second Circuit decision in Thyssen, Inc. v. Calypso Shipping S.A., 310 F.3d 102 (2d Cir. 2002) to hold that the “in rem and in personam claims are closely intertwined” so that “the Court agrees with [Pemex’s] assertion that the action was timely filed as it was initiated pursuant to an ongoing arbitration and pursuant to the [first] LOU … [a]n arbitration was timely commenced and the arrest was sought in order to protect [Pemex’s] interests during that arbitration.”

    In summary, the District Court’s ruling would permit the in rem arrest of a vessel, irrespective of any statute of limitations, provided that a proceeding, arbitral or otherwise, had been timely commenced. Charterers or cargo interests could, under that reasoning, arrest a vessel in the U.S. to collect on a London arbitration award at any time, irrespective of whether they had timely perfected their in rem rights. Further, the traditional “reservation of rights” language in Club LOUs would be nugatory.

    The Appellate Review and Reversal

    The Majority’s Reasoning

    The majority started with first principles: “A maritime lien and a proceeding in rem are correlative; ‘where the one exists, the other can be taken, and not otherwise’ [citing The Rock Island Bridge, 73 U.S. 213, 215 (1867)]. They continued that “[w]hen a maritime lien exists, the district court has admiralty jurisdiction and it is proper for the district court to issue a warrant of arrest” under Supplemental Rule C.

    Next, they reached the important and precedential holding that the COGSA statute of limitations is “one which extinguishes the cause of action itself, and not merely the remedy” (quoting a New York district court decision, reversed on other grounds).

    Their conclusion was that if the in rem action was time-barred by COGSA the lower court had “no grounds upon which to issue a warrant of arrest.”

    Turning to the arguments of Pemex and the Lower Court, the majority addressed the law relating to LOUs, as developed by case law: (1) LOUs are usually a complete substitute for the res; and (2) if the LOU is insufficient to satisfy a judgment re-arrest may only be ordered if there was fraud or mistake of the court in the posting of the original security.

    The first LOU obtained by Pemex had the “unique” provision allowing for later arrest. “Pemex, however, failed to take such action to increase its security until nine years had passed.” This “seemingly unlimited right to later arrest the vessel,” the majority reasoned, had to be reconciled with the “reservation-of-rights clause.” The District Court’s decision, in asserting that the arrest was “pursuant to the LOU.” The majority noted that the lower court “did not explain what it meant” by that and had entirely ignored the “critical” reservation-of-rights clause. In considering the issue they first reviewed the “interact[ion]” between the reservation clause and “late arrest” provision and concluded that, read together so as not to conflict, the right of later arrest was “subject to the well-known one-year COGSA statute of limitations.”

    Next the majority reviewed the holding in Thyssen, agreeing that in rem and in personam claims are often closely linked. However, the lower court’s extrapolation of that decision to permit some sort of “relation back” or “tolling” statute of limitations for the 2002 in rem action to the 1993 in personam arbitration was entirely without any support in “any case law.” The majority agreed with the shipowner that the “arbitration and in rem proceeding are separate actions”–a seemingly obvious but nonetheless crucial holding. They discussed the law relating to vessel arrest under the Federal Arbitration Act and the rationale in Thyssen of preventing “two bites of the apple” (an in rem proceeding after loss of the in personam claim) but “Thyssen did not sanction relation back of these distinct, albeit related, actions” and “close interrelation” of claims provided no grounds to do so.

    Likewise, the Third Circuit precedent made it clear that an earlier, timely filed action in one court, could not make a later untimely action on the same claims against different parties.2 The “personification theory” of the vessel “remains fundamental to American admiralty practice and is the theoretical foundation of the maritime lien” [citation omitted]. In holding that the parties, i.e. the shipowner and the vessel, are different, the majority made the refreshingly clear statement of law despite this being a “formalistic distinction.”

    The Lower Court was directed to vacate the arrest warrant and order the cancellation and return of the second LOU and to dismiss the complaint.

    The Dissent

    A lengthy dissent was based on: (1) the arrest action “relating back” to the arbitration; and (2) the right to later arrest in the first LOU.

    The argument for “relating back” made by the dissent was that the Federal Arbitration Act “clearly states that the in rem and the in personam claims are one proceeding, with the in rem claim serving as security for the in personam claim. Based on “the law” of Thyssen the dissent considered “Pemex is entitled to enforce the lien it has held on the vessel for over sixteen years.” The dissent came to this opinion on the basis that “[h]ad Thyssen succeeded … the Second Circuit’s rationale would have permitted him to pursue his claim against the vessel.” In this reasoning the dissent was no doubt correct but failed to note that Thyssen had arrested the vessel in a timely in rem action, which had been stayed pending the outcome of the in personam London arbitration.

    The dissent’s second “independent” basis for sustaining the arrest action was the assertion that the majority elevates the “boilerplate” reservation-of-rights clause over the specific right to later arrest the vessel, which right would be “virtually useless.” This conclusion is, presumably, based on the dissent’s own view of the difficulty of arresting a ship within seven months. More surprisingly, the dissent, contrary to any evidence in the record, considered “Pemex entered the [first] LOU aware that its right to arrest the vessel was preserved indefinitely”, given the timely commenced arbitration. The dissent had no basis for making that factual assertion. Pemex’s argument on the second appeal was not one of “relation back” but that the first LOU had been a “constructive arrest.” Thyssen, by which this “interrelation” theory developed, was also decided years later.

    1. The decision is the subject of a pending petition for en banc rehearing.
    2. Claussen v. Marie Grande Oil Co. C.A., 275 F.2d 108 (3d Cir. 1960).