This article is the second of two articles focusing on taking collateral in ship finance transactions. This article focuses on interacting with third parties and considering their role when taking security in asset finance transactions. As in our first article, we focus here on asset financing transactions in the maritime sphere, however the principles and issues highlighted can be widely transposed to other forms of asset financing, particularly in the case of where the borrower is a securitization vehicle.
The nature of the security taken in relation to an asset and the asset itself dictate that the lender may need to have interaction with parties who are not parties to the financing but whose cooperation is required for the security of the lender is effective or at least desirable to provide the lender with the necessary degree of comfort with regard to its securities.
Third Party Considerations
In our first article “Security in Asset Finance Transactions – Documentation and Jurisdictional Considerations” we considered the form of security that would be taken in relation to vessel earnings, insurance and requisition compensation. (i.e., a general assignment). Here we look at the interaction with the third parties/counterparties to the underlying assets transferred under this general transfer.
Allocation – Earnings: A vessel will generate income through an employment contract, i.e. a time charter between the borrower/owner and the charterer, which will be used (in part) to repay the loan. The mortgagee/lender will want to agree to an assignment of income, because unless he actually takes possession of the vessel (which, for a variety of reasons, lenders are not always willing to do), he has no otherwise no automatic right to its income.
In practice, the Borrower/Owner and Lender will generally agree that a Notice of Assignment will only be sent (and thus fulfilling the final criteria that would create a legal assignment) to a charterer of long-term employment contracts/charters. For one-off charters, it often happens that, to lighten the load on the borrower/owner, a notice is only sent to the charterers concerned in the event of default. As with all legal assignments, it is not necessary for the lender to obtain an acknowledgment from the charterer at the notice to ensure the legal validity of the assignment. However, a lender will often request that an acknowledgment be provided as it is likely that there will be certain confirmations that lenders will want the charterer to provide, for example confirmations from the charterer that:
- upon receipt of a notice (usually served in case of default) from the lender that all income is to be paid into an account of the lender, the relevant counterparty will pay all income into such account;
- he has not been notified of another assignment (this goes back to the question of the priority of securities mentioned above);
- it recognizes the mortgage on the ship and the rights of the mortgage lender in respect of it.
The above are examples of confirmations that should (usually at least) not be controversial for a charterer. However, if the charter is a long-term charter or a bareboat charter, the lender may be advised to seek covenants from the charterer regarding its rights under the charter to the lender’s rights under the charter. as a mortgagee. For example, the lender may seek to covenant that the charterer will subordinate any claims it may have against the borrower/owner and the vessel to those of the lender as mortgagee and/or consent to the repossession by the mortgagee upon execution.
Commitments of this nature will likely require extensive negotiations between all three parties and are not straightforward (particularly where the charterer is unaware of/or concerned with borrower/owner financing terms) and documentation more complete in the form of a letter of calm the enjoyment between the lender and the charterer (and in some cases the borrower) may therefore be required.
However, where the Lender requires only certain acknowledgments and/or confirmations of the Assignment Notice from the Borrower/Owner, communication as to the service of the relevant Assignment Notice and any corresponding acknowledgments is likely to be business between the borrower/owner and the charterer only, without direct involvement of the lender. This is usually because there is usually a nuanced relationship between the borrower/owner and the charterer, regardless of any relevant financing agreement where (especially in “ordinary” financings where the charterer is a third party not linked to the borrower/owner), direct communication between the lender and the charterer may not be deemed appropriate.
Arguably, the above issues/practicalities are usually an issue or at least a consideration for lenders in “regular” financings. However, it should be emphasized that where the financing structure is one that includes a financial lease, the involvement and interaction with the charterer or “lessee” in the security package provided to the lender will be essential and will be therefore different from those stated above. The reasons for structuring a transaction in this way are varied and beyond the scope of this article and would require (among other things) any lender to take advice on the tax consequences of such a structure. However, the main reason for structuring the purchase of a vessel using a finance lease would be to shift the risk from that of the vessel and the SPV borrower (and its group company) to that of the charterer/lessee. In such a structure, the lessee is intrinsic to the transaction and, as such, some of the practical and technical obstacles to taking collateral on its part as “third parties” mentioned above would not be relevant.
Mission – Insurance: A Borrower/Owner’s insurance will typically be split into three policies covering hull and machinery, P&I (protection and indemnity) and war risk. As stated earlier, the primary recourse a lender will have to repay the loan in the event of default will be the vessel itself. If therefore the vessel became total loss or implied total loss, this remedy would no longer be available. Thus, lenders require the use of insurance proceeds.
It is also important to note that in some cases where a vessel has caused damage to third party property, this may result in maritime liens attaching to the vessel. In such cases, the lender will want access to insurance proceeds so that they can ensure that these claims are dealt with quickly in order to remove any maritime liens as quickly as possible.
Unlike the assignment of income or any charter, interaction with the relevant counterparty with respect to the assigned rights in and in relation to insurances will generally be conducted directly by the lender (or, more likely) by the solicitor of the lender. The lender’s attorney will contact the insurance brokers directly prior to the date the assignment is to be taken to request a number of confirmations in relation to the assignment, namely that the insurance brokers will arrange with the insurers to give effect to the Notice of Assignment (assignment of Borrower/Owner’s rights in and insurance to the Lender) and Loss Payable clause. The direct nature of this communication is a common practice in the market because the business relationship between the borrower/owner and the insurance broker is less nuanced and can be considered more standard than that which exists between the parties to a charter.
Assignment – Remuneration of the request: Requisition compensation essentially refers to any compensation that may be due to a borrower as a result of a vessel belonging to him being requisitioned for title or otherwise compulsorily acquired.
This does not include the demand for rental (the rental amounts of which would be included in the assignment of “income” and therefore the provision of the right to receive such rental should be included in the assignment of income clause).
The phrase “requisitioned for title” usually refers to the (rare) event where the flag state that registered the ship’s title requisitions a ship in time of war; the ownership of the vessel in such cases is effectively taken over by the Flag State and equated for all practical purposes to the borrower and lender that the vessel is a total loss. Any compensation so paid by the government of the flag State to the borrower shall be assigned to the lender.
A lender’s or borrower’s interaction regarding lease or title requisition rights would be with the relevant government/state and notice would be given to them at the time of their requisition of the vessel and/or its income. The general assignment will therefore generally contain undertakings by the borrower/owner to serve such notice at that time and will also contain a power of attorney granted by the borrower/owner in favor of the lender which would enable the lender to execute and to serve the notice of assignment if the borrower/owner fails to do so. Any interaction with any government or state in this regard is likely to be extremely rare.
In summary, the taking of collateral in ship finance transactions will often require the parties to consider factors that may not be obvious at first sight and go beyond the commercial intricacies of the agreement. The relationship a borrower/owner may have with the charterer of his vessel may have its own particularities of which a lender may need to be aware when negotiating the form of his collateral package.