The Reluctant Ship Owner

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1 The Reluctant Ship Owner Text 16/20 pt. Text 12/16 pt. Text 8/10 pt.

2 Tier 1 for Asset Finance: Shipping finance (Hong Kong) - The Legal 500 Asia Pacific ( & ) Band 1 for Shipping Finance (China) - Chambers Asia Pacific (2008-) International Shipping & Maritime Firm of the Year - China Law & Practice Awards 2015 Ship Finance Award - Seatrade Maritime Award Asia 2015 Global Shipping Crisis- What Does this Mean? Historically, trade growth has exceeded the growth in global gross domestic product by 2 or 3 times. This meant that new ships had to be ordered each year to meet at least double GDP growth. But according to recent WTO estimates, trade growth has slowed since 2009, causing the multiplier to soften to barely in line with GDP growth itself, yet at the same time the number of shipyards has ballooned beyond expectations over the last 15 years, as has the speed of construction. New ships are being delivered every day. As an example, in the first half of this year, with more and more shipping companies filing for bankruptcy, and despite losses from marine perils and increased scrapping, there has been a net growth of over 40 dry bulk carriers and 143 oil tankers delivered into the market. The number of new ship deliveries is less than 2015, yet still 5.4m dwt has been added to the global dry fleet and a massive 14.2m dwt to the oil fleet. As a consequence cargoes are harder to source, charter hire rates have slumped below operating costs, and ship values have fallen. For those who have taken delivery without a reliable charterer or their own cargoes to carry, they must gamble on interest rates and fuel costs staying low to continue trading their ships, or else lay them up. But what if their ships are mortgaged to a ship financier? How can the ship repay the loan if it is not working to earn revenue? Could someone else do better, such as the ship financier itself on account of its deeper reserves, and how would a non-ship operator take over a ship in practice? Legal History Hong Kong has a long history of financing ships. As a former British colony, Hong Kong was a port of registry of the British flag, and ship financiers were comfortable with their loan documents being governed by English law. They also placed their faith in the enormous body of case law and experience that English law provided. So they knew they had the right under English law to take back the ships they had financed. In 1990, whilst still a British colony, Hong Kong inaugurated its own shipping register, which gave birth to a new Hong Kong flag replacing the British Red Ensign, since when the register has grown into the fourth largest in the world after Panama, Liberia and the Marshall Islands. In 1997, when Hong Kong became a special administrative region of China, Hong Kong essentially maintained its English legal system and so financiers inherited the same set of case law and experience as their predecessors. The right to take back ships became a part of Hong Kong law as well. Re-Possessing a Ship Traditionally, the way a financier takes back a ship is to arrest it and sell it through the courts, or arrange a private sale. But a sale may not be attractive if the market is saturated with ships, or the terms of new bank financing are too onerous. Can a financier take back a ship and hold it until the market improves? 2 The Reluctant Ship Owner

3 They are excellent professional, diligent, punctual, innovative and they are problem solvers The firm is a go-to for shipping finance. They are experts in ship finance; they are commercial and proactive to find solutions for their clients. They are very good on client care they always put in extra work to accommodate timelines and challenging ideas and structures. Under English and Hong Kong law, the chief right of a mortgagee of a ship is the right to enter into possession as soon as the ship owner defaults in payment of the loan. In fact, a mortgagee may take possession even before any money falls due if the ship owner acts in a way that places the security in serious jeopardy, such as by working the ship to render it liable to arrest. On top of this right, the mortgagee s loan documentation will provide that the mortgagee may enter into possession upon the occurrence of many other types of default, and therefore the rights of the mortgagee will follow whatever is said in its contracts. So, how does this work in practice? Constructive or Actual Possession It is important to remember that until a ship is sold, ownership remains vested in the defaulting ship owner so the ship is subject to arrest by other creditors who have claims against the ship. It is crucial to carry out a Writ search before sailing to a particular port as this may reveal unpaid bills from previous voyages. Any that take precedence to the mortgage will have to be settled. A mortgagee enters into actual possession by placing its own representative on board and taking over physical control of the ship. Once done, the decision to employ, repair, lay-up or sell passes to the mortgagee. In cases where the ship is in the middle of the ocean, the mortgagee is not expected to fly its representative to the ship by helicopter. Instead, the method of taking control is to do so constructively, which means appointing someone already on board to act as the representative. A fax or is sent to the Master giving him the background to why he is to take instructions in the future from the mortgagee and not from the owner. Such an instruction can be alarming to Masters, and so reassurances need to be given as to the crew s rights being respected especially in respect of their salary and redundancy rights. In the communication the Master and crew are invited to enter into employment with the mortgagee until the vessel reaches her next port. As an incentive, they are guaranteed these wages, an attractive option for those who may not have been paid for several months. So, by making the Master the employee of the mortgagee, the mortgagee becomes the constructive controller. The wages that are paid can be added to the mortgagee s expenses of arrest and are recoverable from the sale proceeds. With the approval of the court, the mortgagee s priority in respect of the wages can leap-frog to the same status as the crew s maritime lien which is the highest ranked claim. Rights and Liabilities of a Mortgagee in Possession Once in possession, a mortgagee has the same potential liabilities as the ship owner. This is because the control of the ship passes to the mortgagee and the Master becomes the agent of the mortgagee subject to its orders. Even lying at anchor, ships can cause damage to third parties and their property, such as through oil pollution, so it is essential to continue or take out separate hull & machinery insurance and P&I cover. Unless the mortgagee has the technical expertise, the prudent course is to place the ship with professional ship managers. Most managers will arrange the replacement crew to be ready to board the ship on arrival, and for superintendents to survey the condition to check if it is seaworthy and if repairs are necessary. mayer brown jsm 3

4 The team takes commercial considerations into account to give us comprehensive advice. They are very efficient and the transactions are quick and smooth. It is a top-class firm. It has a dedicated team that is very knowledgeable on shipping finance and they understand what we need Although a mortgagee will sometimes take over possession solely to sail to a convenient port for arrest and sale, there is no obligation to sell the ship immediately. The mortgagee is entitled to trade the ship pending sale. If the earnings have been assigned to the mortgagee as part of its security, the mortgagee is entitled to all the earnings which have fallen due and remain unpaid, otherwise only the revenue received following possession can be retained and used to pay the ship s expenses, with any surplus being available to set off against the bank debt. Securing business is no easier for a bank than a ship owner, but many banks have a number of customers who are willing to take on ships for short periods especially if they are offered a profit incentive. Equally, there are many professional ship management companies that have customers who can offer the same service. In some cases the managers themselves can operate the ship because they have a commercial department to arrange business as well as technical services. The larger banks may even have affiliated companies that can lease the ships they re-possess. During the period of employment the ship remains in the ownership of the owner, and the mortgagee is not affected by the personal debts of the owner except in so far as they attach to the ship. The exception is where the Master orders the supplies as agent for the mortgagee, in which event he will bind the mortgagee to the same extent as if he were the owner. Similarly, a mortgagee cannot be held personally liable for an owner s contracts with shippers. So a charterer cannot enforce a charter party against a mortgagee unless it commits the tort of wrongful interference with its performance (more on this below), such as by selling the ship or re-employing it under another charter party. This absence of liability even extends to the contract of employment made with the crew, but the taking of possession does not affect their maritime lien for unpaid wages so the practical effect is that a mortgagee usually budgets for these first. Duties of the Mortgagee as a Ship Owner Although able to contract in the name of the owner, the laws of Hong Kong oblige the mortgagee to use the ship lawfully as a prudent man would use it, were the ship its own property. So, a duty exists upon the mortgagee not to use the ship without regard for losses arising, nor can it sell the ship at an undervalue. Most mortgages will exclude such liability but it is arguable that this is invalid. All sums spent and received must be accounted for because any surplus must be held for the benefit of the owner or anyone else who is entitled, such as a subsequent mortgagee. If the ship is carrying cargo at the time of taking possession, the most suitable port to sail to is one where the mortgagee has priority over the cargo interests. But the practical solution is to reach an amicable agreement with the cargo interests, providing for discharge and delivery of the cargo so as to avoid a claim for damages for wrongful interference with the bill of lading contracts. The cargo owners may be faced with some added costs of storage and transhipment if the ship is sent to a different port, but if the risk is complete loss (often the case with perishable cargoes) then transhipment may be the better option. In Anton 4 The Reluctant Ship Owner

5 Durbeck v. Den norske Bank [2005], an arrest at one end of the Panama Canal resulted in a cargo of bananas becoming rotten and having to be discharged at sea. The cargo owners had declined an offer to discharge and instead argued that the bank had caused the loss by arresting the ship, but the Panamanian judge decided that there was no bad faith or deliberate intention to harm the cargo owners behind the arrest, nor was there a duty of care owed to the cargo owners, so the mortgagee was entitled to look after its own interests. The same judge looked at what the position would be under English law, where the test turns on whether the contract of carriage impairs the security of the mortgage. At the time the owner had no P&I cover and the judge held that if the ship had been released to perform her journey to the original destination without insurance, the security would obviously be impaired, so the cargo interest s claim failed under English law principles as well. Where there is a charter party in place, the mortgagee is recommended to keep it going if it is lucrative, and to terminate it if it is not, but taking care not to induce a breach of contract or cause loss by unlawful means. The latter is hard for a charterer to prove when the breach of contract by the ship owner is the natural consequence of the mortgagee s conduct in enforcing its security. The steps taken by the mortgagee are not an intentional invasion of the charterer s rights, but steps under a valid contract. It is different if the owner is able and willing to perform the charter but in most instances the owner will be insolvent, from which the court will infer it is unable to perform, and that the mortgagee has not induced a breach of contract. Mortgagees should however watch for situations where the charterer holds a letter of quiet enjoyment, or where the charter party pre-dates the mortgage, as these can constrain the mortgagee s rights. It may be necessary to prove that the charter party imperils the security, perhaps because it is speculative or improvident, or that Writs and Warrants of Arrest await the ship at its destination, or that the charterer itself has defaulted in some way. Conclusion By signing a mortgage, an owner accepts that if the terms of the loan are broken his ship may be taken over by the bank. In practice, the natural reluctance of banks to become ship owners means that there is a lengthy period of discussion before that happens, but with monetary authorities constantly overseeing non-performing loans, not all banks are able to preserve the status quo forever. mayer brown jsm 5

6 Contact Us Let our network of offices advise you on every step of the way. For more information please contact: Maggie Cheung Partner, Hong Kong Dean Young Senior Consultant, Hong Kong Bill Amos Partner, Hong Kong San San Peh Head of Shipping Services, Singapore The Reluctant Ship Owner

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