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Things to Know Before Contracting to Build a Yacht

Andrew High

The current worldwide economic climate has forced shipyards to reduce prices for new construction in order to compete in an increasingly crowded marketplace.

Oftentimes, prospective purchasers will find it more cost-effective to purchase new construction with warranties, as opposed to a comparably priced brokerage boat. As such, purchasing a newly constructed vessel has become an attractive option for both experienced boaters and first-timers to the world of yachts.  

When constructing a new vessel, the shipyard will inevitably ask you to sign a purchase agreement detailing the build. These contracts can range from fairly simple for production boats to extremely complex for completely custom boats. 

Regardless of complexity or type, purchasers should keep in mind three important factors prior to signing an agreement.  First, where is the boat being delivered?  Second, how will you handle change orders and progress payments?  And third, how will you handle a default by the shipyard?

Where in the World

The first major issue we see in new construction is where will the vessel be delivered upon completion?  In today’s global marketplace, boats may be purchased from points all over the world.  Oftentimes the shipyard where the vessel is built is in a different location than where it will ultimately be delivered. 

In certain circumstances, depending on the shipyard, the yard will ask the purchaser to take delivery at the yard with it being the owner’s responsibility to move the boat to its ultimate destination.  In other cases, the yard will agree to deliver the vessel to a point chosen by the purchaser.  This can have major implications with regards to warranties and sales or value added tax.  

For instance, a vessel delivered in the popular yachting destination of Florida would be subject to an $18,000 capped tax, whereas a vessel delivered in many European Union countries can be subject to up to a 20 percent value added tax (VAT).  The delivery point can have major influence on a purchaser’s decision making because, depending on the jurisdiction, it can add a significant amount to the cost of the vessel. 

It is best to consider the tax ramifications of delivery prior to signing the purchase agreement in order to provide the most favorable terms to the purchaser.  If you have not had a chance to speak with a maritime attorney or tax professional prior to signing the contract, you might consider leaving the delivery location as “to be determined” until you have had a chance to speak with a qualified professional. 

The second point to consider with regards to delivery is when the warranties will begin to run.  Typically, warranties on the vessel do not begin to run until the owner takes delivery of the vessel.  It becomes important to know when and where that delivery will take place in order to know when the warranty period begins.  As issues come up in your first year of ownership, as oftentimes happens, this date may become important in the future.  

Change Orders and Progress Payments

The second major issue we see in new construction is how to handle change orders and progress payments.  Change orders are common in new construction agreements as owners continue to see the progress of their vessel and decide that they want to add or change features that they did not originally contemplate.  Shipyards are typically happy to accommodate the purchaser but often will only do so at an added cost in either money, time, or both. 

However, sometimes the shipyard will allow an owner to make insignificant changes at no additional cost. It is important for the contract to specify which changes will be considered to be significant and which changes can be accomplished at no charge. Depending on how change orders are handled, it can have substantial implication on the overall cost of the vessel.  

In addition to any increase in cost of the vessel, change orders can affect the amount of time it takes to complete the vessel.  Prior to making a change order, the purchaser should request that the shipyard provide a clear estimate of the amount of time that will be assigned to each change.  While it is expected and understandable that changes can add to the time it takes to complete a vessel, change orders should not give the shipyard a blank slate to complete the vessel whenever it wants to or drag out the construction. The contract should contemplate changes and assign reasonable amounts of time and cost for the changes to be completed.  

Defining Milestones

The contract also needs to contemplate at what point progress payments are due. This can sometimes be a set of defined milestones the shipyard must meet prior to the next or final payment being made.  In some contracts, it calls for every single milestone to be met in each stage of the construction prior to payment.  In other contracts, a certain percentage of milestones must be met prior to the next payment. 

There are benefits and drawbacks to each type of agreement. When it is necessary that 100 percent of milestones be reached prior to payment, the purchaser is guaranteed to have the entire stage completed before he makes a payment. The drawback is that if there is a delay or backorder on parts, a stage may be nearly completed but construction will have to stop until the part is received and installed and the next payment is tendered. 

On the other hand, if the purchaser can be satisfied that a predetermined certain percentage of a progress stage is complete in order to make the next payment, progress can continue on schedule without being delayed by backordered materials or similar issues.  The drawback of this type of agreement is that the purchaser may have made a progress payment while a significant part of the vessel remains unfinished while the shipyard waits for materials to arrive. A prospective purchaser should weigh the pros and cons of each option prior to purchase. 

Default by the Shipyard

The final issue we see involving new construction contracts is how to deal with default by the shipyard. Default typically happens in two ways; either the shipyard goes bankrupt or the shipyard fails to complete the vessel in a timely manner in compliance with the agreement. 

Each purchaser should ensure that there are provisions in their purchase agreement that protect them in the event of default.  The easiest way to accomplish this is to include a per diem penalty clause for each day the completion date is pushed back because of a default by the yard.  The total delay cost can then be subtracted from the final payment made by the purchaser.  It is important to carefully define scenarios in which the shipyard will be penalized for their delay.  

Possession Under Construction

Another consideration to include in the contract is which party will retain possession of the vessel under construction and any materials purchased for the vessel in the event of a default or bankruptcy by the builder.  Many purchasers may have an interest in retaining both the hull under construction and already purchased materials to take to another shipyard for completion. 

Oftentimes, if a shipyard reaches the point of bankruptcy, it will not have any other assets available for the purchaser to recover the purchaser’s costs already incurred.  This means the vessel, as is, and any materials are the only way to recover for the purchaser. 

The purchase and construction of a brand new vessel can be a very exciting time and one that the purchaser can easily get caught up in the excitement.  New vessel construction contracts can be very complex agreements with a number of provisions that have serious monetary ramifications for the prospective purchaser.  In spite of the excitement, purchasers would be well advised to enter the agreement with caution and to seek professional counsel before signing any shipyard agreement. 

*The information offered in this column is summary in nature and should not be considered a legal opinion.

Andrew J. High is a partner at Hill, Betts & Nash, LLP, specializing in litigation and transactional matters within the yachting and pleasure boating community. He has worked on a wide range of maritime matters, including managing vessel closings, new construction contracts, charter agreements, crew agreements, yacht documentation, and litigation and arbitration.

Andrew is a member of the Florida Yacht Broker's Association and the Fort Lauderdale Mariner's Club, along with others. Hill, Betts & Nash has offices in Fort Lauderdale and New York City. Visit: www.hillbetts.com

Mr. High may be contacted at +1 (305) 586 5708 or [email protected]  

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