EU ETS Cost Recovery:
Can The Island Archon Implied Indemnity Save Owners?

As the maritime sector enters the EU Emissions Trading System (ETS), a structural disconnect emerges between statutory liability and commercial operations. This article explores whether shipowners can rely on the implied indemnity principles of The Island Archon to recover carbon costs from charterers in the absence of an express contractual clause, highlighting the critical need for proactive drafting to mitigate arbitration risks.

The expansion of the EU Emissions Trading System (EU ETS) to the maritime sector has forced owners and charterers to revisit longstanding assumptions about cost allocation under time charters. Directive (EU) 2023/959 places the legal obligation to surrender emission allowances on the “shipping company” (typically the registered owner or the ISM-responsible entity). However, a vessel’s emissions are heavily influenced by the time charterer’s commercial orders, such as the chosen route, speed, and cargo.

This structural disconnect raises a critical question for modern shipping: If a time charter is silent on the allocation of carbon costs, can owners recover the costs of EU Allowances (EUAs) under an implied indemnity, relying on the landmark English law case The Island Archon [1994] 2 Lloyd’s Rep 227?

Because the intersection of the new EU ETS regulations and English common law is entirely untested, relying on implied terms presents a substantial legal hurdle. This is compounded by the escalating financial risk established by Article 3gb of the Directive, which dictates that shipping companies must surrender allowances for 40% of verified emissions in 2024, 70% in 2025, and 100% in 2026. A careful analysis of The Island Archon reveals strong arguments for both owners and charterers, underscoring the necessity of addressing this issue contractually.

1. The Framework of The Island Archon

In The Island Archon, the Court of Appeal confirmed that a time charter contains an implied right of indemnity whereby charterers must indemnify owners against the consequences of complying with the time charterers’ lawful orders as to the employment of the ship. Crucially, the Court held that this implied indemnity exists even if the charterer’s order is entirely lawful, permitted by the charter, and not a breach of contract.

However, this implied indemnity is not absolute. It is subject to two major limitations:

• Ordinary Expenses and Assumed Risks: The indemnity does not cover the “ordinary expenses and navigational risks of trading”. Furthermore, the loss must be one that the shipowner cannot be taken to have accepted under the true construction of the charter.

• Direct Consequence: There must be an unbroken chain of causation between the charterer’s order and the loss suffered.

In The Island Archon, the owners succeeded in claiming an indemnity because the vessel was subjected to the “Iraqi system”—a local legal regime resulting in automatic, unfounded cargo claims—which was an unforeseen, extraordinary hazard at the time the charter was concluded.

2. The Charterers’ Perspective: Why the Indemnity May Not Apply

Charterers seeking to resist an implied indemnity claim for ETS costs will likely build their defence on the limitations established in The Island Archon:

• Foreseeability and Assumed Risk: Charterers will strongly argue that the EU ETS is a public, well-known regulatory measure applicable to all ships trading in EU waters. For recently concluded charters, a tribunal is likely to conclude that owners were aware of the evolving legal landscape and accepted the ETS compliance risk when they agreed to the trading limits, thereby defeating an implied indemnity claim.

• Ordinary Trading Expenses: Charterers may categorise the cost of carbon allowances as an “ordinary expense of trading”. Just as owners cannot recover the costs of ballasting or heavy weather damage, charterers will argue that EU ETS costs are merely standard regulatory expenses inherent to navigating in European waters.

• Breach of Causal Chain: Charterers will assert that the liability to surrender allowances arises from a statutory duty imposed by public law on the “shipping company,” rather than being a direct legal consequence of the specific employment order.

3. The Owners’ Perspective: Arguments for Recovery

Conversely, owners possess several counter-arguments to demonstrate that The Island Archon can still offer protection, particularly under specific factual matrices:

• The “Older Charter” Exception: The foreseeability argument heavily depends on when the charter was signed. For long-term time charters concluded years before the maritime inclusion in the EU ETS was finalised, owners could strongly argue that carbon costs were exactly like the Iraqi system in The Island Archon—an unforeseen, extraordinary hazard that they could not have implicitly accepted at the time of contracting.

• Direct Consequence of Orders: Owners can argue that the specific order to sail to an EU port directly triggers the ETS liability. Just as the order to proceed to Basrah placed The Island Archon into the “Iraqi system”, an order to discharge in Rotterdam places the vessel into the EU ETS jurisdiction, establishing a direct causal link.

• Not a General Navigational Risk: Owners may resist the classification of ETS costs as “ordinary expenses”. Article 3gc of the Directive explicitly defines the ‘operation of the ship’ as ‘determining the cargo carried or the route and the speed of the ship’. Because the Directive recognises that emissions are dictated by the entity making these operational decisions, owners will argue that ETS costs are a variable levy inextricably linked to the charterer’s distinct commercial choices, rather than a general risk of navigation.

4. The Statutory Right vs. English Arbitration

To complicate matters, Article 3gc of the EU Directive explicitly requires Member States to enact laws ensuring that the shipping company is entitled to claim reimbursement from the entity ultimately responsible for operating the ship. However, this creates a statutory right under the national laws of EU Member States. It does not automatically create a contractual indemnity under an English law-governed charterparty. In a strict London arbitration context, a tribunal will look to the terms of the contract and English common law principles, meaning owners cannot simply rely on the existence of the Article 3gc of the EU Directive to bypass the contractual hurdles of The Island Archon.

5. Conclusion: The Importance of Express Clauses

The interplay between the EU ETS regulations and The Island Archon creates a landscape of significant legal uncertainty. While owners may have viable arguments under an implied indemnity—especially for historic long-term charters—charterers have equally robust defences based on foreseeability and the ordinary risks of trading. Because this specific intersection of public environmental law and private maritime contract law remains untested by the courts, relying on the silence of a charterparty invites only arbitration risk.

The paramount takeaway for the industry is to entirely avoid the unpredictability of implied indemnities. Owners and charterers must educate themselves on their respective exposures and allocate EU ETS responsibilities through clear, express, and carefully drafted contractual clauses. The BIMCO ETS – Emission Trading Scheme Allowances Clause for Time Charter Parties 2022 gives a framework for allocation of ETS costs by a transfer model that parties may use as a starting point and consider adoption with carefully thought of modifications required.