Legal Business. Problems Relating To Mortgage Enforcement. Memoranda on legal and business issues and concerns for multiple and business communities

Transcription

1 Memoranda on legal and business issues and concerns for multiple and business communities Problems Relating To Mortgage Enforcement 1 Steven Chong, SC Rajah & Tann 4 Battery Road #26-01 Bank of China Building Singapore Tel: Fax: eoasis@sg.rajahandtann.com Website:

2 Problems Relating To Mortgage Enforcement RISKS INHERENT IN TAKING SHIPS AS SECURITY Under Singapore law, ships can be mortgaged or charged in the same way and by the same means as any other chattel. However, there are certain risks inherent in taking ships as security, which set ship mortgages apart from other property of comparable value and commercial value. The first is the nature of the asset itself. They are of a fluctuating but ultimately depreciating capital value. They do not automatically generate income yet they incur heavy operating costs, whether running or kept idle. Further, they are subject to the perils of the sea, with the consequences that they face risk of partial or complete destruction. In such an eventuality, the lender may not always be able to rely on insurance moneys where the insurance is terminated on the ground of breach of warranty. The charterparties and shipbuilding contracts may also be subject to the risk of termination. All this makes the ship not a very good form of security. Then there is the risk of the ship being forfeited by a governmental authority for some offence connected with the ship, eg drug trafficking, terrorism, or serious regulatory contravention. This risk is probably more remote. A further uncertainty relating to the enforcement of the mortgagees rights under the mortgage is the issue of priority, since this would depend on the prevailing laws in the port where the mortgage is enforced, and not the port where the ship is registered or the mortgage created: THE HALCYON ISLE [ ] SLR 14. This is discussed in greater detail in this paper in the section headed 'Pre-Enforcement Considerations'. To add to the unsuitability of ship mortgages, interests that arise subsequent to the creation or registration of the mortgage may overreach the rights of the lender, such as in the case of nonconsensual maritime liens. Maritime lines attach to certain claims and these may have priority to the lender in relation to the proceeds of sale of the ship. Such liens over ships are common in maritime jurisdictions and there is little that the lender can do to protect himself against such liens. In view of the risks, it is imperative to obtain other forms of security (these are noted in the following paragraph). OTHER SECURITIES APART FROM MORTGAGE Due to the risks inherent in the nature of a ship mortgage, lenders routinely take other form of securities. These include: Page 1

3 personal or corporate guarantee; charge or assignment over cash deposits or balances with financial institution; charge or pledge over shares in the borrower company; assignment of the borrower s insurance; assignment of the ship's earnings; and debenture over all the assets of the borrower. Where the borrower is part of a group, security may extend to other assets, including other ships of the borrower. ENCUMBRANCES Registered Charges and Mortgages In Singapore, the Companies Act provides for the registration of certain prescribed types of charges created by companies. Specifically, a 'charge on a ship or any share in a ship' is registrable. A charge, if registrable, must be registered with the Registry of Companies and Businesses within 30 days after the creation of the charge. If the charge is not registered, it will be void against the liquidator or any creditor of the company in the event of insolvency. Thus, mortgages, charges and any other registrable security in a ship financing transaction where the borrower is a company, must be registered. While the requirement of registration applies to foreign companies in Singapore (ie, companies not incorporated in Singapore), a charge on property outside Singapore in respect of a foreign company, is not registrable [section 141 of the Companies Act]. Thus where the mortgage is created over a ship owned by a foreign company, the ship mortgage need not be registered if at the time of creation of the mortgage, the ship is outside jurisdiction. If she subsequently sails into Singapore, this does not impose any duty to register. This principle was explained by the Singapore High Court in THE AMERICAN OKLAHOMA [1988] 3 MLJ 461. In that case, the plaintiffs had made loans to the defendants secured by a first preferred ship mortgage. The ship was registered in New York, and the mortgage was created when the vessel was not in Singapore although it did call in Singapore a few times subsequently. The mortgage was not registered in Singapore although the company that owned the vessel became registered in Singapore as a 'foreign company'. The plaintiffs commenced an action in the Singapore High Court to enforce the mortgage. Page 2

4 The Court held that the first preferred ship mortgage having been created at a time when the vessel was in the Republic of Korea, some two and a half months before it called at Singapore, was a charge on property outside Singapore within the meaning of section 141 of the Companies Act and there was no duty at any time thereafter to register the mortgage. Maritime Liens They arise by operation of law. Under Singapore law, maritime liens are restricted to certain claims such as collision, salvage and crew wages. These maritime liens are created irrespective of personal liability of the shipower an d will survive any change of ownership without the issuance of a writ. Statutory Liens As the name implies, these liens are created by statute. If a writ is issued against a vessel for various categories of claims such as cargo claims, repairs, necessaries etc prior to the change of ownership, the claim in the writ would survive the change of ownership. The claimant would be entitled to pursue the claim against the ship notwithstanding the change of ownership. A writ issued against the vessel would operate as an encumbrance. EVENTS OF DEFAULT A lender can enforce his security as soon as the borrower is in default of the mortgage. A typical Events of Default clause will include the following circumstances as events of default: failure to pay any sum of money due under the mortgage / loan agreement; failure to perform or observe any of the covenants in the security documents; the borrower, guarantor (if there is any) or any other related party becoming insolvent; the ship becoming a total loss; impossibility or illegality of performing any of the terms in the mortgage / loan agreement; and a breach of the shipbuilding contract - in the case of a loan to a shipbuilder to finance the construction of a new ship or a purchaser of a ship under construction. There is no implied term that money under the loan agreement must become due, in addition to an event of default occurring, before the lender can exercise its powers: BANQUE WORMS V OWNERS OF THE SHIP 'MAULE' [1997] LMLN 15 MARCH. Page 3

5 PRE-ENFORCEMENT CONSIDERATIONS Locating the Vessel This can be effected through: Ship watch; Lloyd s Intelligence; or Network of foreign lawyers. Where to Enforce Choosing a Favourable Location In most default cases, one of the most important factor in the decision to enforce is the location of the ship, assuming that the lender has the option and the ship has not already been arrested. The prevailing laws and legal systems of the various ports differ and these will impact on the lender in several ways as follows. Can the lender enforce the security the way he wishes? Not all jurisdictions may allow the lender to enforce the way he wishes. For example, the lender may be entitled under the loan agreement to the self-help remedy of repossession of the vessel. Some jurisdictions, however, will not permit the lender to take possession without a court order. What priority will the lender enjoy? The choice of jurisdiction will affect the priority that the lender will enjoy. Where a shipowner is in financial difficulties, there would well be others who are owed money, such as the crew, ship suppliers or repairers. The order of priority will be determined by the law of the place where the ship is arrested. Further, while in almost all jurisdictions the claim of the lender is subordinate to maritime liens, there is a difference as to what claims are accorded the status of maritime liens. In other words, different countries recognise different claims as amounting to maritime liens. For example, in the US a maritime lien will exist in respect of a large number of claims which would not be awarded that status in other jurisdictions. Since such liens will rank ahead of the mortgage, a lender will wish to avoid arrest in the US unless it is absolutely necessary. On the other hand, the legal concepts of the US and England are very similar, whereas arrest in some non-common law jurisdictions may pose problems of whether the security interest will be recognised. In this regard, Singapore is part of the common law jurisdiction and its admiralty jurisdiction has many similarities to that in England, hence making it a favourable location to arrest a ship or enforce a mortgage. Page 4

6 The importance of jurisdiction and the impact it has on priorities was illustrated in THE HALCYON ISLE [ ] SLR 14. A British ship was repaired by an American ship repairer and the repair bill was not paid. The ship sailed to Singapore where she was arrested and sold by order of court, but the proceeds of sale were not sufficient to pay all the creditors. The question for the Singapore court was whether the claim of the repairers should be given recognition as a maritime lien so as to have priority over the mortgagee. In the place where the claim of the repairers had arisen, USA, the claim had a maritime lien status but it did not have such a status under the law of the forum, ie, Singapore. The matter went up to the Privy Council which held that the question of whether a claim has a maritime lien status is to be decided by the law of the forum. Thus, unless the claim had maritime lien status under Singapore law, the Singapore court would not recognise or enforce it. Accordingly, the mortgagees had priority over the repairers claim. This case should be contrasted with the decision in THE IOANNIS DASKALELIS [1974] 1 LLOYD S REP 174 where on almost similar facts, the Supreme Court of Canada took a different approach. In that case, the repairers claim had maritime lien status, having also arisen in the USA. The ship was arrested and sold in British Columbia, and in that jurisdiction, the repairers claim did not have maritime lien status. The Supreme Court of Canada nonetheless gave recognition to the maritime lien status of the repairers, although it was acquired under the law of a foreign state. The repairers thus had priority over the mortgagees. Will the nature of the security be recognised? The lender has to also consider whether the enforcing State will recognise the nature of the security interest. This is not likely to be a problem with a registered mortgage, but other security devices of one legal system (for example, a floating charge or an equitable mortgage) may not be readily recognised in another system. Other Considerations Other considerations that the lender has to take into account include the following: length of time to enforce - escalating port dues; legal costs; and recovery of expenses. PRINCIPAL REMEDIES OF MORTGAGEE UPON BORROWER'S DEFAULT Generally, the principal remedies available to a lender are the right to take possession and sell the vessel. He also retains his right to sue the borrower. Page 5

7 Possession Sources of right to take possession At common law, a mortgagee under a legal mortgage has a right to possession that is not dependent on there being a default by the mortgagor. It arises by virtue of the transfer of legal ownership in the ship from the mortgagor to the mortgagee. In practice, possession is not normally taken unless the mortgagor has defaulted on the loan. As regards statutory mortgages, the mortgagee s powers to take possession is conferred by statute, namely section 29 of the Merchant Shipping Act, Chapter 179 ( Merchant Shipping Act ). Apart from the common law, the right to possession will also be given under the relevant security documentation. In fact, the mortgagee s power to take possession is more often than not regulated by the terms of the deed of covenants with the mortgagor. It is not uncommon for the deed of covenants to extend the mortgagee s powers to take possession (and sell the ship) beyond the powers conferred by common law and the Merchant Shipping Act. For example, it is not uncommon for the deed of covenants to have cross-default clauses giving the mortgagee the power to take possession of the ship upon default in payment of a debt owing by a related company of the mortgagor, even if the debt owing by the related company is not owed to the mortgagee but to someone else, and there has otherwise been no default by the mortgagor. Actual possession is not necessary, but where constructive possession is being taken, which may be by giving notice, then it must be unambiguous. Disadvantage of taking possession Taking possession may be an unattractive option as the lender may not wish to take on the burden of performing existing obligations. In this respect, a mortgagee in possession is bound to perform all contractual obligations incurred by the mortgagor and assumes liability for all expenses incurred in the future operation of the ship. Thus claims for wages and disbursements for operating the ship have to be met by the mortgagee in possession, but these can be recovered from the mortgagor. Further, the lender will have to make appropriate insurance arrangements. Benefits of taking possession Taking possession may, nevertheless, be a useful option for a short period of time; it may enable the mortgagee to ensure that the ship proceeds to a favourable jurisdiction for arrest and sale by court order. Moreover, a mortgagee in possession is entitled to the benefit of all outstanding contracts made by the mortgagor. As such, he is entitled to be paid freight (and other earnings such as hire) due to the mortgagor after he has taken possession. However, the mortgagee in possession is not entitled to unpaid freight (and other earnings) due to the mortgagor before the mortgagee took possession. Page 6

8 Alternative to taking possession As an alternative to taking possession of the vessel, the mortgagee may enforce the pledge of shares of the shipowning company, thus taking possession of the company. This, however, would make the lenders owners of a company which might have substantial debts. Sale Sources of power of sale A power of sale is statutorily provided for under the section 30 of the Merchant Shipping Act for every registered mortgage. Although section 30 of the Merchant Shipping Act does not expressly provide that the mortgagee s power of sale is only exercisable to enforce the security, it is commonly accepted that unless there is default, the power of sale under section 30 is not available to the mortgagee. In addition, every well drafted mortgage or deed of covenants would give the mortgagee the right to sell the ship. As with the power of possession, it is not unusual for the deed of covenants to extend the mortgagee s power to sell the ship beyond the powers conferred by common law and the Merchant Shipping Act. Whether to exercise self-help or resort to the courts Although ship mortgagees have the power of sale that can be exercised without recourse to the courts, it does not have the same importance that it has for mortgagees of other types of property, notably real property. Ship mortgagees, like other creditors, have the option to arrest the ship and have it sold by order of court. This remedy is often preferred over the extra-judicial sale. For the mortgagee, sale by order of court offers two advantages. First, the mortgagee does not have to take possession of the ship himself, and thus avoids the risk of liability which may, in certain circumstances (such as oil pollution claims) attach to the owner. Second, when the ship is sold, it will be with clean title. A judicial sale removes all other encumbrances. By contrast, a private sale may leave the ship open to certain pre-existing claims and thus make it an unattractive purchase. Further, the mortgagee may have to give an appropriate indemnity. It is probable that the clean title granted by sale by the Singapore court will be recognised throughout the world; Singapore courts will usually give similar recognition to sales by foreign courts. There is, however, a disadvantage of arrest and sale by order of the court in that it gives the lender less control of the transaction, and may involve expense and delay and realises a lower price being a forced sale. Even where the sale has been completed, it may be some time before the mortgagee sees any money, as there will be other claims against the sale proceeds which will have to be resolved. Page 7

9 Charterparty may restrain mortgagee from exercising his rights and remedies A mortgagee may be restrained by a charterer, including one who entered into a charterparty subsequent to the mortgage, from exercising his rights and remedies: THE MYRTO [1977] 2 LLOYDS LR 254. Where the charterparty was entered into before the mortgage, the charterer may obtain an injunction to restrain the mortgagee from doing anything that interferes with the performance of the charterparty, provided that mortgagee had notice of the charterparty: see DE MATTOS V GIBSON (1858) 4 DE G & J 276. Where the charterparty was entered into after the mortgage, the charterparty (as well as the shipowner) can restrain the mortgagee from exercising his rights and remedies as long as the security of the mortgagee is not impaired: COLLINS V LAMPORT (1864) 4 DE G & J S 55. Circumstances where a court may consider the security of the mortgagee impaired include where: the owner is impecunious; he can only perform the charterparty on credit; and the ship is already subject to pressing liabilities and charges. Thus, when deciding whether to exercise his rights, the lender has to be mindful of the rights of other contracting parties, although he is not a party to that contract. Mortgagee's duty of care when exercising power of sale In relation to land, the cases have established that a mortgagee exercising its power of sale has two duties: duty to act in good faith; and duty to take reasonable care to obtain the true market value of the property. These would arguably also apply to a mortgagee selling a ship although there is no clear case law establishing this. In any event, a mortgagee would be well advised to take proper independent advice to get the best price reasonably obtainable in the circumstances of the case. The sale must be a proper sale. The mortgagee cannot sell to himself, at least not without leave of the court. There is no restriction, however, on a mortgagee selling to a related party, such as a company of which it is a shareholder. However, in such cases, where the sale is by private treaty, the courts will scrutinise the sale carefully, and the onus will be on the mortgagee to show that it has fulfilled the two duties of good faith and reasonable care. Page 8

10 Foreclosure Foreclosure is a judicial procedure by which a mortgagee can deprive a mortgagor of the equity of redemption and take absolute title for himself. Thus the legal title becomes vested in the mortgagee as owner of the property. It is unclear whether it is available under a statutory mortgage, and there is no provision for foreclosure under the Act. Further, there is a dearth of case law on foreclosure of ship mortgages. Even if it was available, a court would not grant it where there is a possibility that the mortgaged property may realise more on a sale than the amount outstanding under the loan. The court would order a sale instead and deny the mortgagee the opportunity of making a profit. CREW No one would buy a vessel with the crew remaining onboard. Further, when the mortgage is being enforced, the owners would usually be financially insolvent. Wages are thus likely to be outstanding for some months. Enforcement of a mortgage would also usually take a few months and crew wages have priority over the mortgage. Thus, to protect the mortgage, it is important to pay off the crew as soon as possible so that they can be repatriated. The mortgagee bank should obtain a Court Order for liberty to pay off the crew with the bank s funds and for such advance pay ment to rank as Sheriff s expenses. ACCIDENTS DURING ARREST It is advisable to take out port risk insurance during period of arrest. The assured should be the Sheriff, the owners and / or the mortgagee. PRIORITIES In Singapore, the following claims have priority over the mortgage: port dues; sheriff s expenses; salvage; collision; Page 9

11 wages; and possessory lien for unpaid repairs. Rajah & Tann is one of the largest law firms in Singapore. It is a full service firm and given its alliances, including US premier firm Weil, Gotshal & Manges, is able to tap into a number of countries. Rajah & Tann is firmly committed to the provision of high quality legal services. It places strong emphasis on promptness, accessibility and reliability in dealings with clients. At the same time, the firm strives towards a practical yet creative approach in dealing with business and commercial problems. The information contained in this newsletter is correct to the best of our knowledge and belief at the time of writing. Specific professional advice should be sought before any action is taken. In this regard, you may call the lawyer you normally deal with in Rajah & Tann or e -mail the Knowledge Management team at eoasis@sg.rajahandtann.com Rajah & Tann Knowledge Management. All rights reserved. Page 10