Ship And Yacht Construction - From A Turkish Law Perspective

With the considerable increase of investments in the shipbuilding industry, Türkiye has become one of the leading countries in the world within the field of ship and yacht building. According to the Maritime Sector Report published by the Chamber of Shipping, the number of active shipyards increased to 84 from 37 in 2002, the majority of which are concentrated in the Marmara and the Western Black Sea regions. Moreover, currently, 9 shipyards are in the investment phase and 13 areas are designated as shipyard areas.¹

In addition to the above, ship and yacht exports from Free Zones in Türkiye amounted to USD 410 million in 2021, and to USD 280 million in 2022. A significant part of these exports have been made from the Kocaeli and Antalya Free Zones, and there are also exports made from the European, Adana Yumurtalık, İzmir, Aegean, İstanbul Trakya and İstanbul Industrial Free Zones.²

As a legal consequence of such positive developments, ship and yacht building contracts ("shipbuilding contracts") are increasingly concluded between domestic and foreign buyers, and Turkish shipyards for the construction of various types of ships, yachts and other watercraft. In addition to the legal consequences between the parties, such contracts bring along various issues such as environmental impacts of the sector, sustainability, strategy, national income, quality, innovation, customer satisfaction and trust in the builder.

In this study the general principles of shipbuilding contracts are examined from a Turkish law perspective, taking into consideration that all these developments in the Turkish shipbuilding industry also reveal the importance of analysing shipbuilding contracts within the framework of Turkish law.

I. Legal Nature, Parties and Elements of Shipbuilding Contracts

Entering into a shipbuilding contract is not subject to any statutory formalities. The general provisions of the Turkish Code of Obligations No.6098 (the "TCO") and the Turkish Commercial Code No.6102 (the "TCC") are applicable to the signing and execution of shipbuilding contracts, whereas builders who wish to commence any construction work are required to obtain relevant permits as stipulated under the Regulation on the Construction, Refit and Maintenance-Repair of Ships and Watercraft.

The nature of shipbuilding contracts is not statutorily defined in the Turkish law. However, according to the precedents of the Court of Appeal and scholarly opinions, in principle, shipbuilding contracts are regarded as contracts for works and services, which fall within the scope of the general provisions of the TCO. Having said that, there may be different interpretations of shipbuilding contracts, due to their sui generis nature of bearing obligations both on the sale of goods as well as services. However, if making an evaluation is required within the scope of Turkish law, according to certain scholars' opinions, those contracts, the subjects of which are the construction of a specific ship based on an order, and in which the obligation to work stands out, are in the nature of work contracts.

The concept of vessel, which may be subject to a shipbuilding contract, includes not only the vessels defined in the TCC, but also other watercraft. In this sense, all vessels and watercraft capable of floating in water may be subject to a shipbuilding contract. In the light of these explanations, the construction of military and commercial vessels, cargo and passenger vessels, tugboats and yachts, as well as vessels such as barges, launches, icebreakers, floating cranes, canoes, motorboats and offshore platforms may also be the subject matter of these contracts.³

Shipbuilding is a branch that requires technical and special expertise as a whole. For this reason, the construction of a vessel needs to be carried out by companies that are specialised in this field. The Regulation Relating to Shipyards, Boatyards and Dry Dock Areas defines the concept of a shipyard as; "a facility with technical and social infrastructure that enables the construction, maintenance-repair and modification of one or more of ships and watercraft of all types and sizes, and a shipbuilding capacity determined with a sea front of at least fifty metres".

In a shipbuilding contract, the "shipbuilder" is the person who undertakes to build a vessel and deliver it in return for the consideration undertaken to be paid to the same. In this sense, it is not necessary to own a shipyard in order to be a shipbuilder. The shipyard owner may operate the shipyard and use it for shipbuilding activities, or a third party who has the right to use the shipyard as a result of a lease agreement concluded with the shipyard owner may also manufacture vessels after obtaining the necessary operating licence.⁴

In this regard, it is worth noting that as per Article 471/3 of the TCO, the builder is obliged to construct the vessel either itself or have it constructed by others under its own supervision, unless the builder's own qualifications are essential in the building of the relevant vessel. It is important to stipulate in the contract whether the buyer allows the builder to subcontract the whole or a part of the works or not. The builder will be responsible for the works carried out by its subcontractors as if these were carried out by the builder itself, unless it is agreed otherwise in the contract. Even though including a maker's list in the contract completely depends on the negotiations between the parties, it is very frequently used.

The "buyer" who is, under the provisions of the TCC, deemed to be the owner of the work, is the person on the counter side of the contract and is under the obligation to pay a price in return for the delivery of the vessel to be built by the shipbuilder. The method of payment of the price, and the maturity of this payment will be determined by the agreement to be reached between the parties, and in practice, certain stages such as the keel laying, the launching of the vessel and/or the delivery date can be determined as the maturity date.

In order to avoid any dispute that may arise from the construction stage until delivery, and to cover all the necessary issues to protect the potential buyer's rights in the widest manner, shipbuilding contracts must be carefully examined and drafted taking both the mandatory provisions of Turkish law as well as International law into consideration.

II. Guaranteed Standards of Performance

As per the principle of freedom of contract, the parties can freely incorporate guaranteed standards of performance in a shipbuilding contract. In case of a breach of the guaranteed standards of performance, as per Article 475 of the TCO, the buyer may (i) request a reduction in the contract price, (ii) request the elimination of the defect, if possible, or (iii) use its rescission rights, provided that the acceptance of the vessel cannot be expected from the buyer under the breach of such standards of performance.

The parties may also agree on a clause in the contract regarding liquidated damages or penalties in the case certain performances or remedies are breached, as they deem appropriate.

Furthermore, if a contract includes provisions regarding liquidated damages or penalties for late delivery or failure to meet the guaranteed performance criteria drafted in line with law, these will be applicable and binding on the parties. The liquidated damages claim is not dependent on damages actually being sustained. The parties are free to determine the amount of the liquidated damages or penalties and can determine a cap for liquidated damages or penalties payable.

Accordingly, it is recommended that a liquidated damages or a penalty clause be determined by the parties, whereby it shall be explicitly stated that any party's right to claim damages shall be reserved if the actual damages exceed the amount of the mutually agreed penalty or liquidated damage amount.

As provided under Article 22 of the TCC, Turkish law does not accept the intervention of the court to the amount of penalties set out in the contracts between merchants, save for certain limited exceptions such as the possibility that the penalty amount might lead to the economic destruction of the merchant (as worded by the Court of Appeal). However, these are determined on a case-by-case basis.

III. Registration

A vessel under construction ("VUC") can be registered with the newbuilding registry ("NBR") upon request of the owner, or if a ship mortgage is to be established, or in the event of a precautionary or final attachment of such newbuilding, or if an annotation is placed at the registry for the purpose of securing the right to claim of the builder for the establishment of a ship mortgage in accordance with Article 986 of the TCC. Registration can be made in the name of the builder or the buyer, which can be agreed upon in the contract.

Along with the request for registration, the type of the VUC, its title or hull number or any distinguishing mark, the place of construction, the shipyard where the vessel is being built, and its owner should be notified.

The hull number is one of the key elements to distinguish a vessel from the others. Therefore, the reference made to the hull number in a shipbuilding contract shall serve the easing of identification and proof. The hull number is one of the alternatives (including its name and any other identification mark) required for the registration of a hull with the VUC as set out in Article 988/1(a) of the TCC. Thus, the hull number can be considered as an essential element of the contract from the point of view of registration and identification.

Within this framework, it should be noted that the registration of the VUC with the NBR in the name of the buyer provides extra protection for the buyer.

IV. Mortgage

As per Article 1054/1 of the TCC, a mortgage over the VUC can be established from the date of its keel-laying until the date of its launching, beginning from the time of the vessel becoming clearly and permanently distinguishable by placement of its name and number on a visible spot. Article 1055 of the TCC stipulates that the mortgage on a VUC shall be established upon written agreement of the owner and the creditor, the signatures of which should be certified by a notary public and by registration of the mortgage with the NBR. Alternatively, an agreement may also be made before the Ship Registrar.

In accordance with Article 1056 of the TCC, a ship under construction is deemed within the scope of the mortgage at every stage of the construction if and once the ship mortgage is established over her.

V. Title and The Passing of the Risk

The parties are free to agree upon whom the title will be during construction. In the event that the parties have not clearly agreed on this issue in the contract, it is disputed under Turkish legal doctrine whether the buyer or the builder shall be entitled to the title of the VUC until delivery. This matter was discussed during the drafting of the TCC, currently in force, where some legal scholars opined that the title should belong to the buyer until delivery, whereas the builder should have a statutory mortgage right over the VUC. Ultimately, this view was upheld in the TCC, where Articles 986/1 and 987/1 of the TCC clearly distinguish between the "owner of the VUC" and the "owner of the shipyard who is granted a statutory mortgage over the VUC".

In practice, however, it is usually the builder who obtains the building licence in its name from the harbour master. If so, the title of the VUC will be deemed to be held by the builder. It is strongly recommended that the parties register the VUC with the NBR to clarify the title issue. The parties are also free to agree on the gradual passing of the title, upon the progress of the vessel's construction, or at a certain stage. The buyer can obtain title to the vessel by means of registering the vessel in the NBR when the construction level of the vessel is sufficient to distinguish the vessel from other vessels.

It should also be noted that in shipbuilding contracts, in cases where the VUC is registered in the name of the buyer, the risk shall remain with the builder until the delivery of the vessel, whereas such risk shall pass to the buyer upon the delivery and acceptance of the vessel, save for the hidden defects and/or defects concealed by the builder on purpose.

VI. Price

The general principle in vessel and yacht construction contracts is the turnkey practice, thus the price is a "fixed price". Needless to say, the parties may choose to include an adjustment clause to determine the situations when the fixed price will be altered, such as a change in material and class requirements. According to Article 480/1 of the TCO, if a fixed price is determined in the contract, there will be no statutory remedies for the builder to charge the buyer for price increases of labour and materials unless otherwise agreed in the contract.

VII. Default of the Parties

The parties are free to determine a specific date for performance and a cure period for default, as well as the buyer's rights and remedies in cases of delay in the performance. If the parties have already agreed on a specific date for the performance, there is no legal requirement to serve an official notice to put the builder in default; if not, then an official notice requesting the performance will be necessary to determine the date when the buyer's remedies begin to accrue. In the event that both parties are merchants, such notice should be served; either by a notary, or other specific methods listed in Article 18/3 of the TCC.

According to Article 124 of the TCO, there is no need to grant a period for remedy of defaults if: (i) the current status or behaviour of the debtor proves that granting a period will be ineffective (and will not yield the requested result); (ii) owing to the default of the builder, the performance of the obligation has become useless for the buyer; (iii) or it is understood from the contract that due to non-performance of the obligation at a certain time or within a certain period, its performance will no longer be acceptable.

If the builder defaults in the performance of the shipbuilding contract, then the buyer may; request the performance of the contract and a compensation for the delay or request the compensation of the damages arising from non-performance of the contractual obligation, or rescind the contract, by notifying that it waives its right to request the performance and the compensation for delay (Article 125 of the TCO), unless otherwise agreed in the contract.

In the event of a rescission of the contract, the parties are discharged from their contractual obligations, and the buyer may request compensation for those damages caused due to the invalidation of the contract, unless the defaulting builder proves that it had no fault.

Furthermore, Article 473/1 of the TCO stipulates that, if it is clearly determined that there is no longer any prospect of completion of the work on time due to: (i) the builder's failure to commence the works on time, (ii) or the builder's delay in the works contrary to the contractual terms, (iii) or delays not attributable to the buyer, then the buyer may rescind the contract without waiting for the delivery date. This provision grants the buyer the right to rescind the contract.

If it becomes apparent in the course of the performance that the work is going to be defective or not in compliance with the contractual specifications due to the builder's fault, the buyer may serve a warning on the builder in accordance with Article 473/2 of the TCO whereby it grants an adequate period for remedying the defect or non-compliance and warns the builder that failing which such remedy works shall be contracted to a third person while all the damage and expenses will be borne by the builder.⁵

If the buyer defaults in the performance of the shipbuilding contract (namely, in the payment

terms), then the builder may request the performance of the contract and interest and compensation for delay, request the compensation of damages arising from non-performance of the contractual obligation or rescind the contract, by notifying that it waives its right to request the performance and the compensation for delay.

In the event of rescission of the contract, the parties are discharged from their contractual obligations, and the builder may request compensation for damage caused due to the invalidation of the contract, unless the defaulting buyer proves that it has no fault. The builder may claim interest for monetary debts and request damages exceeding the interest amount.

Whether the title of the VUC will be on the buyer or the builder determines the practical consequences of the builder's cancellation of the contract. It is also important to agree in the contract the remedies of the builder in cases of the buyer's default, whether the default of the buyer will grant the builder the right to sell the VUC to a new buyer or to enforce its statutory mortgage right under the law. The consequences of a default of the buyer or the builder should be considered on case-by-case basis in accordance with the terms of the contract and whether the VUC is registered in the name of the buyer or the builder.

VIII. Delivery and Exportation

Another crucial milestone of the shipbuilding contracts is the delivery and the exportation of the VUC following the completion of the construction stage. Once the parties have carried out the necessary surveys and reach the delivery stage;

• physical delivery of the VUC by means of execution of a protocol of delivery and acceptance,
• the necessary formalities for the de-registration of the VUC from the NBR, and
• the exportation formalities in compliance with the Turkish customs legislations,

need to be carried out simultaneously which necessitates the preparation, issuance, and submission of voluminous documentation, most of which are to be provided by the builder, especially if the vessel is being constructed within a free zone.

The fact that, both the buyer and the builder work under very tight schedules during the delivery stage, and in order to ensure that all the necessary documents are prepared in full and in a timely manner, it is always recommended that the list of all the necessary documents required for the de-registration of the vessel (if this is the case), safe delivery and exportation of the VUC should be clearly listed in the contract and the responsible party should be determined.

IX. Assignment

The parties to a shipbuilding contract may assign the contract to a third-party in accordance with Article 205 of the TCO, which stipulates that assignment of an agreement is a tripartite agreement between the assignor, assignee and the other contracting party to the shipbuilding contract. With the assignment agreement, the assignor transfers all rights and obligations arising from the shipbuilding contract to the assignee, together with the capacity of being a party to the agreement. The assignment may also be made by way of notifying the shipbuilder and obtaining its acknowledgement. If the shipbuilding contract allows its assignment, then no prior consent from the other party is necessary. However, if the assignment is subject to the prior consent of the other party, this consent should either be obtained in advance or be ratified by the other contracting party after its signature.

X. Applicable Law to Shipbuilding Contracts and Arbitration

The parties to a shipbuilding contract are free to agree on the law to be applied to the shipbuilding contract as per Article 24/1 of the Code on International Private and Procedural Law ("IPPL"). According to Article 2/1 of the IPPL, the courts shall ex officio apply the law agreed by the parties. Pursuant to the relevant Article 24/1 of the IPPL, the choice of law that is clearly understood under the provisions of the contract or under the present conditions of the case shall also be deemed valid and binding. If the parties to the contract have not expressly chosen a governing law, then the contract shall be governed by the law of the country with which it is most closely connected pursuant to the conflict of laws rule as set out in Article 24/4 of the IPPL, which shall be the law of the jurisdiction where the shipyard is located and incorporated and wherein the vessel is constructed. In any case, as per Article 31 of the IPPL, the court may also choose to apply the overriding mandatory provisions of a state that is most closely connected with the contract.

In practice, the parties to a shipbuilding contract usually prefer to insert an arbitration clause. Foreign arbitration, such as the London Maritime Arbitrators Association ("LMAA"), is the most common agreement reached by the parties in this regard.

In case the parties agree on foreign arbitration, it is important to note that arbitration awards do not automatically become enforceable in Türkiye, and in order to enforce foreign arbitration awards in Türkiye, a separate legal action for the recognition and enforcement must be initiated against the counterparty. Even though, this procedure does not involve the re-examination of the merits of the relevant dispute, the recognition and enforcement request may be refused by the Turkish courts, based on the requirements set forth under Article V of the New York Convention and/or Article 62 of the IPPL.

XI. Conclusion

Since there is no special regulation on shipbuilding contracts under Turkish law, there is no consensus among scholars in terms of their legal nature. However, due to the parallelism of such contracts with the legal nature of the work contract, in case of a dispute, the provisions on the work contracts regulated in Articles 470 to 486 of the TCO are generally applied.

Shipbuilding contracts, which are for the construction of technically complex structures, must be drafted very carefully. Contracts that are not drafted with sufficient care may jeopardise the interests of the parties from the moment the contract is concluded until the delivery of the vessels. For this reason, the contract should include the obligations of the parties, contract price, maturity dates if this price is due, technical modifications, plans and drawings, tax obligations, insurance during the construction phase, default provisions and penalties, warranty against defects, commencement and completion dates, registration in the new building registry and the transfer of ownership. Issues such as guarantee obligation, launching and delivery of the ship, termination of the contract in some cases, and the return of payments should be examined in detail by the parties in accordance with the law applicable to the contract and the mandatory provisions of Turkish law for the construction of ships in Türkiye.

Türkiye is currently among the leading competitive players in the global ship and yacht building market. Due to the fact that high tonnage and high technology equipped ships are produced, and there are no restrictions on foreign participation in the shipbuilding industry, it is preferred by industry stakeholders all over the world.

footnotes

1. Istanbul & Marmara, Aegean, Mediterranean, Black Sea Regions Chamber of Shipping, Maritime Sector Report 2022, (https://www.denizticaretodasi.org.tr/media/SharedDocuments/sektorraporu/2023/maritimesector_report_2022_21.08.2023_web.pdf)

2. T.C. Ticaret Bakanlığı, İhracat Genel Müdürlüğü, Makine, Otomotiv, Elektrik-Elektronik Ürünleri Dairesi Başkanlığı (https://ticaret.gov.tr/data/5b87000813b8761450e18d7b/Gemi%20%C4%B0n%C5%9Fa%20Sanayii%20Sekt%C3%B6r%20Notu%202023.pdf)

3. Dr. Öğr. Üyesi Aslıhan ERBAŞ AÇIKEL, Gemi İnşa Sözleşmesi, 2013, s.11

4. Dr. Öğr. Üyesi Aslıhan ERBAŞ AÇIKEL, Gemi İnşa Sözleşmesi, 2013, s.15

5. The buyer's alternative rights provided under Article 475 of the TCO may also apply.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.