Notes
5.3 Security Package
A critical consideration for the lender in terms of determining its assessment of the risk in any particular transaction is the security package that it can receive from the borrower and its group. A notable development in this area is the increase in corporate, rather than personal, guarantees, owing to the increase in shipping groups adopting a corporate structure, together with the
increasing frequency of pledges of shares being demanded as part of a lender’s security package. Lenders will always need to check with local counsel any perfection requirements in the relevant jurisdictions, as these will be critical in ensuring a lender’s priority over unsecured creditors in an enforcement situation.
5.3.1 The Ship Mortgage
Th e ship mortgage is the cornerstone of a lender’s security as, critically, it gives the lender rights against the vessel itself, rather than personal rights against the owner. Th ese rights give the mortgagee the invaluable right to take possession of, and sell, the ship in a default situation, although the usefulness of these remedies may be complicated by the jurisdiction in which the mortgagee tries to enforce its security.
(i) Types of Mortgage and Registration
Ship mortgages are usually governed by the law of the ship’s fl ag state and fall into two categories, statutory mortgages and “preferred” mortgages.
Statutory mortgages are usually brief, summarizing the particulars of the ship and the basis of the secured debt. Th is is the English form of mortgage which has been adopted in most jurisdictions which have a legal system based on that of England, such as Cyprus, Malta, Hong Kong, the Bahamas, Malta and Singapore. Given the limited scope of adapting a statutory form mortgage to the transaction parties’ needs, a practice has developed in those jurisdictions, which employ statutory mortgages of entering into separate “deeds of cov- enant”. Th ese contain the covenants and other provisions, which one fi nds in the form of mortgages that do not base their legal system on English law, nota- bly mortgages over ships registered in Greece, Liberia, the Marshall Islands and Panama. As with all security, the perfection and registration requirements vary from one jurisdiction to another and lenders are advised to obtain, and follow, local law advice to ensure the mortgage security maintains its prior- ity (in England, as with most jurisdictions, the priority of a ship mortgage is determined by reference to the date and time of registration) and the valuable rights conferred by the mortgage.
(ii) Th e Principal Rights of a Mortgagee
One of the principal remedies of a lender is the right to take possession of the mortgaged ship, which can be done either actually or constructively through the giving of notice to the owner and any charterer. However, this
right is rarely exercised by lenders in practice as, whilst taking possession of the ship entitles a lender to receive the ship’s earnings, a mortgagee-in- possession becomes responsible for its trade debts which often cannot be accurately determined by a lender. Th e lender can also usually choose to enforce its mortgage by arresting the mortgaged ship and selling it, usually at an auc- tion or through a diff erent court-approved procedure. Th e enforcement of a mortgage is however an option of last resort for a lender; and it is rare for the latter to take such a decision unless it has lost total confi dence in the borrower and/or its ability to run its business and repay the loan. Both the publicity sur- rounding a hostile enforcement, the practical risks and diffi culties of enforce- ment and the likely crystallization of signifi cant book losses are important reasons to discourage a lender from taking such action. For every mortgage enforcement, there are dozens of other solutions involving a refi nancing of the debt, a restructuring or other workout of the debt, the transfer of the ship(s) to a diff erent customer (often referred to as a “white knight”) of the lender and, in some cases, settlements involving debt forgiveness.
5.3.2 The Assignment of Earnings, Charter Hire, Insurances and Requisition Compensation
To ensure that, on default, a ship’s charterer, and any others from whom earn- ings may be due, can be called on to pay any earnings to the lender (free of any claim from the borrower or its liquidator), a lender will usually demand an assignment of the earnings and the benefi t of the insurances of a mort- gaged ship. Such assignment will generally cover the following categories of income: earnings, charter hire (in the case of a long-term charter, this is docu- mented by way of a separate specifi c assignment of the charter), insurances and requisition compensation. Th ese must, in order to take eff ect as a legal rather than an equitable assignment under English law, meet the following requirements. Th e assignment must be:
(a) in writing;
(b) signed by the assignor;
(c) absolute;
(d) notifi ed to the debtor (being, in the case of the earnings, the charterer, and in respect of the insurances, the insurer(s)).
Th e fi nal requirement determines the date that the assignment takes eff ect and determines the priority of such assignment.
5.3.3 The Charge or Pledge Over Accounts
Another means by which the lender controls the ship’s earnings is through a charge or pledge of sums standing to the credit of the account to which the earnings are paid, from which the lender may also request that the bor- rower make regular payments into a blocked retention account. Lenders may require that a minimum balance must be standing to the credit of an earnings account throughout the term of a facility.
5.3.4 The Shares Charge or Pledge
It is becoming increasingly common for lenders, as part of their security pack- age for ship fi nance transactions, to receive a charge or pledge over the shares in single-purpose ship owning companies. Although rarely exercised, such charges or pledges enable the lender to sell the ship owning company on the borrower’s default, and thereby permit a benefi cial charter of the ship to remain in place (as such a charter may have to be terminated on the sale of a ship or following its arrest).
5.3.5 The Pre-delivery Security Assignment
As mentioned above (and although less frequent in the current climate), lenders who advance pre-delivery fi nance will seek to control and preserve the value of their security in an asset that is still under construction. Th is is usually done by way of an assignment of the shipbuilding contract, through which the lender aims to limit any amendments to the shipbuilding contract which could aff ect the value or specifi cations of the ship or the availability and eff ectiveness of the lender’s security, and also the refund guarantee.