LESSONS LEARNED DURING THE PURCHASE OF MY NEW OUTER REEF 70 TRAWLER

(And now for a posting from FRED'S point of view!)

OR 70 "JAMBO"

Once the decision has been made to build a new yacht, the focus shifts from the myriad details of equipment and décor selections to anticipation of delivery, commissioning, and finally the enjoyment of the yacht.

Several builders were researched before deciding which should build the new boat.  There are essentially two types of boat builders, those who own their own yard and those who contract out the build process.  Outer Reef Yachts (Outer Reef) is the latter, and use Tania, a yard in Kaochung, Taiwan to construct its boats.   Sea Time Global, Ltd., a BVI Company, was formed to take title to the boat. The purchase contract was negotiated with Outer Reef, which then contracted with Tania to build the boat to the specifications agreed in the contract.

Negotiating a build contract can be frustrating and time consuming, depending upon your experience and relationship with the builder.  Any purchase contract promulgated by any boat builder will protect the builder first and foremost, as expected.  The business terms found in many yacht build contracts, not just Outer Reef’s, can be confusing and ambiguous.  There are nuances that have serious financial consequences, which became more evident at the end of the build, commissioning, and warranty process.  In my opinion, Jambo’s contract was poorly negotiated and the legal advice from Sea Time Global. Ltd’s attorneys was incomplete, failed to focus on several critical conditions, and their suggestions were not always accepted.  Negotiations dragged on delaying the start of construction.  Impatience proved to be very costly.

Nothing observed herein is intended in any way as legal advice.  It would be prudent for any yacht buyer to employ a knowledgeable marine attorney to provide advice and insight, especially on the legal and financial consequences of the contract’s terms and conditions.

The first page of the Jambo contract included the Payment Schedule.  Upon “Substantial Completion of the Joiner Work”, 90% of the Purchase Price was paid to Outer Reef.  Before Jambo was shipped to the US, 98% of the total purchase price was paid to Outer Reef.  Boat builders’ warranties are subject to many interpretations and have been the subject of numerous horror stories in the industry.  [See Passage Maker January/February 2014 “Walk the Walk” by Steve D’Antonio, p24 for more insight] In my opinion, it would be prudent to hold back at least 5% of the total purchase price for a Warranty Reserve in case the builder failed or refused to fix any construction problems covered under its warranty.  The reserve should be kept in place until the expiration of the warranty period to ensure that all warranty issues were addressed. Following the completion and acceptance of all warranty work, the warranty reserve, or its remaining balance, would be released. It is my opinion that without a provision of this nature, the builder may have little interest, other than his reputation, in performing warranty repairs.  In these days of economic stress, several builders have been known to change their warranty policy unilaterally, usually to the determent of the boat owner.

Based on information and belief from people in the industry, a word about the economics of boat construction.  Boat builders normally have a profit of approximately 20+% of the gross sales price.  If this standard were correct for Jambo, Outer Reef’s gross profit would amount to about approximately $500,000, from which it pays its overhead and warranty expenses.  The problem with a builder not owning its manufacturing facility is the builder’s interest may be different from the buyer’s interest.  The builder wants to contract with the yard at the lowest price and the yard may find ways to reduce its costs but produce a lower quality product.  If there is limited quality control at the construction yard,  latent problems can surface during commissioning, during the warranty period, or worse, shortly thereafter.  At some point in time, the builder may make the decision that he will not correct any additional defects in a particular boat.  Without a Warranty Reserve, there is little security for the new boat owner to address construction defects.   In the case of a builder that owns his own yard, there is a mutual interest to minimize the warranty costs by addressing construction problems early and completely so these will not come back as warranty claims and impact his total profit.

Change Orders are a normal event in buying any new boat.  The cost of making changes depends on the status of construction and any modifications necessary.  While there is usually an increased cost of making a change, care should be provided that any credit for what is being replaced or modified is netted against the new cost.  In Jambo’s contract, a 17% discount was negotiated with Outer Reef on all change orders with certain caveats.  Auditing this discount became problematic, as there was no contractual provision to confirm costs from 3^rd party vendors or on items that were considered to have a marginal profit to Outer Reef, two of the caveats specified. If a general discount has been negotiated with the builder, in my opinion it should be obligated to supply their invoices to verify the amount charged.

The Commissioning Process varies greatly among builders and this depends on whether a buyer has utilized the services of a surveyor during the construction of the yacht.  It is my opinion that engine installation, alignment, shafts, couplings, exhaust systems, props, cutlass bearings, etc. should be checked by a buyer’s surveyor at the time of installation.  The double check of these items during the acceptance survey will provide additional security that the running gear and operation of these essential elements were all installed properly and are without major defects.  Jambo’s contract provided for the “repair or replacement” of defective parts.  Jambo was a new boat and, in my opinion, no piece of equipment should be repaired as opposed to replaced.  Jambo had both couplings repaired as opposed to replaced which resulted in additional cost and frustration when one coupling failed just outside of the one year warranty period.

A pre-purchase survey was done in the water following the commissioning of Jambo, and before Closing.  The discussion was to have a surveyor perform a complete survey, but not try to “rebuild the boat”.   With hindsight, the cost of a more thorough pre-purchase out of the water survey would have repaid the additional cost many times over.  The survey performed did identify many issues with Jambo’s systems that needed to be addressed. In my opinion, ownership should be delayed until all warranty issues are fully repaired and verified by the surveyor.  The excitement of the new boat and immediate travel plans to the Bahamas prompted a very poor decision to close the purchase and have several warranty issues addressed later by the builder.  Many repairs were taken care of but some were not resolved either by the builder or by suppliers/manufacturers of installed equipment.  It is amazing how quickly the one-year warranty period can pass.  In my opinion, any major repairs, especially equipment repairs or replacements, should have their warranty period extended for an additional 12 months from the date of the repair or replacement.  At the end of the warranty period, if there were any open warranty items, the Warranty Reserve would come in very handy to convince the builder to address these issues or use the Reserve to complete the warranty repairs still outstanding.

It is significant to note that a major defense of any builder to warranty claims is that the owner, or his crew, caused the problem.  Once the owner takes title to the boat and moves the vessel from the builder’s dock, any builder can claim that the owner’s operation caused whatever problem was subsequently discovered.  The ensuing argument can be very expensive to resolve.

It is critical to have clear title to your boat, free of all liens and encumbrances.  The poor economy has caused several boat builders to close or has placed them under financial stress.  One person, who has other business interests, owns Outer Reef.  As an entrepreneur, there could be a financial exposure from several sources that could cause problems.  As a private company, Outer Reef’s financial condition is not a matter of public record. Without a review of the Company’s finances, it is prudent, in my opinion, to add a contract provision that allows the replacement of Outer Reef, or any other private builder, should that company go out of business or cease operations.  This would allow the completion of the build.  A UCC filing was also added to the contract’s terms to protect the asset from claims as much as possible.

Outer Reef contractually required that Jambo be available for 4 boat shows within a 24-month period from delivery.  Apparently, one owner who had a similar provision in his contract, failed to make his yacht available and Outer Reef apparently initiated legal action to enforce this provision.   My opinion is that a new boat should be used for the owner’s enjoyment and not be exposed to any claims from any other party for its use.   Should the owner choose to allow the use of his boat for marketing, this should be his option.

In the case of a construction yard (in this instance the “Builder) independent from the Seller (Outer Reef), who is responsible for construction defects?  Without a Warranty Reserve, major issues of hull and running gear components could cost a buyer substantial sums.  Outer Reef assigned “any Builder’s warranty with respect to defects in materials and workmanship in the hull and superstructure, as well as any other manufacturers’ warranties that may exist on the Vessel’s engines, machinery and other component equipment” to Sea Time Global, Ltd.  In my opinion, it was not clearly stated in the Contract whether Outer Reef warranted anything, as there was an alternative to Outer Reef of the Builder or equipment manufacturers to Outer Reef’s warranty.  My opinion is that whatever entity signs the Contract should be responsible for everything that was part of the vessel’s construction or was installed by the builder.  This warranty should include all equipment, material, and installation. 

With no experience to Binding Arbitration, this dispute alternative seemed to make sense, especially with a short time frame to conclusion of 60 days from the appointment of an arbitrator.  Reading about binding arbitration, the purpose of this alternative dispute resolution procedure to the courts is to reduce costs, time, and effort.  Perhaps the Warranty Reserve suggested above could have prevented any need for Jambo’s warranty dispute to go to binding arbitration.  Sea Time Global, Ltd’s claim in the amount of about $25,000 for disputed warranty issues would have been more than covered by the reserve and the reserve itself may have modified the stance taken by Outer Reef.  Sea Time Global, Ltd. failed to prove its warranty claims to the arbitrator.  To defend against paying any part of the $25,000 repairs at issue, Outer Reef incurred more than $118,000 in legal fees and costs.  Outer Reef’s costs included $21,500 for  an expert surveyor who specializes in litigation and was very effective in helping Outer Reef prevail. In my opinion, the costs and legal fees recoverable in binding arbitration should be limited, perhaps to the amount of the claim as a maximum.

The lessons learned out of inexperience, impatience, and ignorance were frustrating and expensive.  Perhaps the above will help others avoid similar problems.  I wish you calm seas and fair winds.