Letters of Indemnity for Missing Bills of Lading in Oil

In oil trading, a tanker often reaches the discharge port before the original bills of lading have passed through the chain of sellers and banks. To avoid delay, the ship releases the cargo against a letter of indemnity (LOI), in which the party asking for delivery promises to compensate the shipowner for any loss caused by delivering without the original bill. For trade finance, the LOI matters because the bill of lading is usually the lender's main control over the cargo, and discharge against an LOI means that control is replaced by a promise.

Why original bills of lading are late

A crude or product cargo can be sold several times while it is at sea. Each sale may be paid by letter of credit, with original documents passing from the seller to its bank, to the buyer's bank and then to the buyer. Under UCP 600, banks have up to five banking days after presentation to decide whether documents comply, and original transport documents must be presented no later than 21 calendar days after shipment. On a short voyage the ship can arrive long before that process ends.

What a letter of indemnity does

The Swedish Club, a P&I insurer, explains that an LOI shifts exposure to additional risks from the carrier to the party that signs it. It also notes that where delivering without the original bill prejudices the shipowner's P&I cover, the LOI stands as a replacement for that cover, not a complement to it, and should not be treated as protection equal to or as reliable as P&I cover.

The standard forms

The International Group of P&I Clubs publishes standard LOI wordings. The Swedish Club guide describes them as:

The Swedish Club notes that a bank countersignature is ideal but often costly, time consuming and only rarely achievable. In a 2010 circular following an English Commercial Court decision, the International Group recommended that members take further precautions if they choose to accept an LOI for delivery without production of the bill of lading.

How LOIs appear in oil sale contracts and letters of credit

Oil sale contracts often let the seller claim payment against its own letter of indemnity if original bills are not available at the time payment is due. The buyer pays, and the seller promises to deliver the originals later and to indemnify the buyer meanwhile. A letter of credit can mirror this by accepting the seller's LOI in place of the bills. Whether a buyer's bank accepts that depends on the seller's credit and, sometimes, on a bank countersignature. See letters of credit for refinery crude oil purchases.

Why lenders care

Loss of control

A lender financing a trader usually holds, or controls through its bank, the original bills of lading. If the cargo is discharged against an LOI before the lender has been paid, the lender's security over the oil may be lost. What remains is the trader's sale receivable and the LOI chain. See how commodity finance lenders treat goods in transit.

Credit of the LOI giver

An LOI is only as good as the party that signs it. If a small trader signs an LOI to a shipowner and later fails, the indemnity may be worthless. Lenders will look at who gives each LOI in the chain and whether any bank stands behind it.

Misdelivery and fraud

Delivering against an LOI creates room for misdelivery if the wrong party receives the cargo. Lenders want to see delivery instructions matched to the sale contract and to the party that will pay.

Controls lenders ask for

• A clear rule in the facility on when discharge against an LOI is permitted, and to whom.
• Delivery only to the named buyer under the financed sale contract.
• Sale proceeds paid into an account controlled by, or assigned to, the lender before or at discharge.
• Use of the International Group standard wording, with any changes reviewed by counsel.
• A bank countersignature where the LOI giver's credit is weak, if obtainable.
• A process to retrieve and cancel the originals once they arrive.

Who signs the LOI in a chain

In a chain of sales, each seller usually gives its buyer an LOI, and the last buyer gives the shipowner an LOI to obtain delivery. If one party in the middle fails, the parties on either side may have claims only against it. A lender financing one link should know who sits on each side of its borrower and how strong they are, because a weak counterparty elsewhere in the chain can still affect whether the borrower is paid.

Electronic bills of lading

Electronic bills of lading can shorten the document chain and reduce the need for LOIs, because control can transfer in hours rather than days. Adoption depends on every party in the chain, including banks, agreeing to the same platform and legal rules. See electronic bills of lading and letter of credit transactions. For LNG, see bills of lading and title control in LNG trade finance.

Practical checklist before you rely on an LOI

1. Check that the sale contract and the letter of credit allow payment and delivery against an LOI.
2. Confirm who signs each LOI in the chain and their financial standing.
3. Agree with your lender, in writing, how LOI discharge will be handled.
4. Use standard International Group wording.
5. Track the originals and retrieve them as soon as possible.

Financely helps traders and refiners build document and control arrangements into the financing structure before lender review. Financely is an advisor and arranger only. See the oil and gas trade finance advisory and letter of credit structuring pages. This article is general information, not legal advice; counsel should review LOI wording for a specific trade.

Frequently Asked Questions

What is a letter of indemnity in oil shipping?

A promise by the party requesting delivery to compensate the shipowner for any loss caused by delivering cargo without the original bill of lading, or at a different port. It shifts risk from the carrier to the signer.

Why are oil cargoes discharged without original bills of lading?

Because cargoes are often sold several times at sea and paid by letter of credit, and the original documents can take longer to pass through banks than the voyage takes.

What is the difference between INT GROUP A and AA?

Both cover delivery without the original bill of lading. AA includes a bank's countersignature and its agreement to guarantee the LOI. Bank countersignature is often hard to obtain.

How does an LOI affect a lender's security?

If the cargo is discharged against an LOI before the lender is paid, the lender may lose control of the oil. Lenders therefore set rules on LOI discharge and require proceeds to flow to a controlled account.

Financely is an advisor and arranger. It does not lend, issue instruments or take title to cargo, and no financing outcome is promised. This article is general information, not legal, tax or sanctions advice.