Ship acquisition, pre-delivery and post-delivery finance

  • Ship acquisition, pre-delivery and post-delivery finance

    Author: Zoran Tasić

    Not many forms of transport have such specific features of asset finance like shipping. The main reason being the substantial amounts of money involved (often tens and hundreds of millions of US Dollars or Euros); shipping industry is very sensitive to global trade, financial and political changes in the world; ships are elusive and trade between various jurisdictions and subject to various legal systems; loan documentation, as well as documentation relating to carriage of goods and passengers by sea, is governed by different laws; sea transport is regulated by a number of international conventions and regulations imposed by relevant states and regulatory bodies.

    1. Pre-delivery ship acquisition finance

          (i)   Who is the borrower?

    The borrower is (since the second part of 19th century), more often than not, a limited liability company incorporated with the purpose of acquiring a ship for commercial use (also known as “special purpose vehicle”). The borrower is often incorporated in a jurisdiction that is different from the jurisdiction of its members/shareholders and which has legal and tax regime not only attractive to the shipping investors but also safe enough and acceptable for the banks prepared to provide finance it and keep such a borrower in their books as “acceptable risk”.

    The most acceptable risk for the banks is the fact that their newly incorporated borrower does not have any liabilities to third parties (save for fiscal duties towards the state of its incorporation) or any assets (e.g. a ship) which could create liabilities to third parties (e.g. maritime claims). At the time of the loan the only asset of the borrower/buyer of a new ship (in addition to its share capital) are its rights under a shipbuilding contract made with a shipyard acceptable for the bank.

    • Shipbuilding contract

    Pursuant to English law (English law is the most common governing law for international shipbuilding contracts chosen by the contract parties) a shipbuilding contract is an agreement for the construction and sale of a ship by description. More specifically it is an agreement for sale of future rather than existing goods, like a building contract.

    Pursuant to a shipbuilding contract the fundamental right of the buyer is to demand that the ship that complies with the contract and its specifications is constructed for and delivered to him on a contractual delivery, and, if the shipyard fails to do so, to claim refund of all installments paid to the shipyard in advance of the contract price.

    • Shipbuilding (pre-delivery) fiancing

    It is common that under a shipbuilding contract the contract price is payable in a number of installments (often 4 or 5 installments), the last and the biggest installment payable on the ship’s delivery. The biggest portion of the contract price is not paid the buyer is not paying from its own capital but from the moneys borrowed from the bank.

    In order to make decision to provide such financing the bank must be capable to evaluate the risks that might jeopardize the repayment of the loan. At that stage the highest risk for the bank is the risk if the shipyard fails to perform the shipbuilding contract. However, the banks providing ship finance are normally well equipped with knowledge, experience and technology required for evaluation of such risks.

    Since the only assets of the borrower/buyer under the shipbuilding contract are its rights under the shipbuilding contract, it is extremely important for every bank that such rights are well established, valid and, at any time, enforceable.

    • Securities

    One of the conditions for utilization of the loan is providing securities satisfactory to the bank.

    In addition to corporate securities (such as pledge of the borrower’s shares, corporate guarantees given by the borrower’s shareholders), financial securities (such as pledge over the borrower’s bank accounts) and payment instruments (such as bills of exchange, debentures), the most common security is an assignment of the borrower’s rights under the shipbuilding contract and the refund guarantee provided issued by the shipyard’s bank.

    Although in certain shipbuilding countries (like Croatia) a mortgage over the ship under construction is available, it is not common that the buyer grants a mortgage over the newbuilding simply because most commonly it is the shipyard, not the buyer, who owns the ship under construction.

    Assignment of the newbuilding insurances is an optional form of security for the bank but requires very detailed analysis.

    • Loan facility agreements and securities

    Governing law in most of ship finance documentation is English law and the chosen forum for settling any disputes arising thereunder is either jurisdiction of English courts or London arbitration.

    Certain essential provisions of each loan facility agreement include definitions and interpretations, borrower’s representations and warranties, the facility availability period, the purpose of the loan, repayment of the loan, interest, flag of the ship, termination provisions, insufficient payments, increased costs of the facility, provision of the borrower’s corporate documents, payment of the borrower’s share capital, borrower’s covenants, no distribution of profit, events of the borrower’s default , conditions precedent for utilization of the facility such as execution and registration of the securities, law and jurisdiction.

    Certain securities are pure contractual covenants and without creating any property rights, and some are creating property rights over the borrower’s or the borrower’s shareholders’ assets and are subject to proper registration in special registries.

    Governing law of the securities created by an agreement, such as assignments for security purposes, is the same as the governing law of the underlying contract. Hence the assignment of the shipbuilding contract shall be governed by English law, while an assignment of the refund guarantee issued by a Croatian bank under Croatian law shall be governed by Croatian law.

    The governing law of the securities creating property rights over certain assets, such as mortgages and pledges, shall be the law of the country where such assets are situated or registered. For example, governing law of a mortgage over the newbuilding registered in the Croatian Registry of Ships Under Construction shall be Croatian law.

    Certain legal issues that will be analysed in this, first part of my presentation:

    • Borrower’s corporate and fiscal matters;
    • Legal issues related to refund guarantees; and
    • Validity and enforceability of each of the loan securities from the governing law point of view. 
    1. Post-delivery ship acquisition finance
    • Title over the vessel

    Subject to terms of the shipbuilding contract the buyer purchases the ship from the shipyard and acquires the title over the ship upon payment of the contract price and upon ship’s delivery to and acceptance by the buyer.

    Prijenos vlasništva na brodu nastaje izdavanjam potvrde brodogradilišta o prodaji broda naručitelju, te brisanjem broda iz Upisnika brodova u gradnji i upisom broda u Upisnik pomorskih brodova odredjen Ugovorom o gradnji broda temeljem svjedodžbe klase broda.

    Time naručitelj gradnje broda postaje vlasnik broda u plovidbi.

    Od tog trenutka svi rizici broda prelaze s brodogradlišta na naručitelja/korisnika kredita, te postojeća polica osiguranja broda u gradnji prestaje važiti, a naručitelj pribavlja novo osiguranje broda u plovidbi, kako za osiguranje trupa i stroja broda, tako i za osiguranje odgovornosti prema trećima.

    The transfer of title over the ship is evidenced by execution of a protocol of delivery and acceptance of the ship, the shipyard’s bill of sale, deletion of the ship from the Registry of Ships Under Construction and entry of the ship into a Register of Seagoing Vessels (defined in the shipbuilding contract) in the name of the buyer, providing the class certificate for the ship has been issued.

    Upon the above evidence has been provided the buyer of the newbuilding shall become the owner of the seagoing ship.

    • Finance and securities

    On delivery of the ship the bank disburses the biggest amount of the loan in order to finance the payment of the delivery instalment of the contract price, returns the refund guarantee back to the shipyard and instead takes new and different securities for the loan, takes the borrower’s risk instead of the shipyard’s risk, and the risk of ship’s employment and the shipping market in general, together with all other related risks, the risk of the ship’s insurance, etc.

    Usual securities taken by the bank at that stage include a mortgage over the ship and assignment of all ship’s earnings and insurances.

    • Certain legal issues that will be analysed in this, second part of my presentation:
    • Legal aspects of ship acquisition;
    • Legal relationship among the parties involved in transfer of title over a ship;
    • Legal aspects of the ship’s flag affecting the validity and enforceability of the loan securities;
    • Statutory regulations v. contractual provisions of the loan securities.