OSV OutlookI attended an excellent conference on March 3, 2016, put on by WorkBoat® exploring the “OSV Capital Outlook for 2016 and Beyond”. The conference featured a diverse and highly experienced panel of speakers including investment and marketing analysts and consultants, vessel operators, shipyard executives and WorkBoat® editors. You may want to read WorkBoat’s® own blog post about the conference; my takeaways from attending are as follows:

  • Praveen Narra, a Raymond James analyst, indicated that while oil prices appear to have bottomed and are beginning to climb toward an expected range of $65 to $70 per barrel in 2017 and 2018, a sustainable turnaround in OSV day rates and utilization should not be expected until at least 2018.
  • Mr. Narra stated that actual rig tendering activity will likely continue to decline in 2016 with no substantial uptick in day rates until 2017.
  • Richard Sanchez, a marine analyst with IHS Energy-Petrodata MarineBase, cautioned that when drilling activity does resume, it is likely to first rebound onshore rather than offshore, as onshore projects can be brought to production much faster, more efficiently and at less cost than offshore projects.
  • Sanchez is seeing that the downturn in OSV utilization is affecting shallow water platform supply vessels more than large PSVs and anchor handling tugs, with day rates for shallow water PSVs at below break-even levels.
  • Matthew Rigdon, a senior executive with Jackson Offshore Operators, cited as one of the lingering effects of this downturn the loss of trained, certified and licensed labor to operate vessels when the rebound finally does occur. Many mariners will move to jobs in other industries. Additionally, U.S. Coast Guard certification requirements necessitate expensive periodic training and recertification, the cost of which is traditionally shared between OSV operators and the mariners. Many out-of-work mariners may not have the means or inclination to maintain these certifications, which will shrink the pool of qualified labor available when their services are needed.
  • Allen Brooks, managing director at PPHB, LP, cited as the “elephant” in the rig market the degree of debt-load of drilling companies. This also is a significant concern for OSV operators. High debt service obligation coupled with diminished cash flows due to low utilization and low day rates will lead to substantial destressed asset activity. However, the amount of this activity is unknown. It is also unknown when investors will begin to seize the opportunity to acquire these assets.

Armed with knowledge of the bleak outlook, OSV operators should be pro-active in making decisions regarding stacking of vessels, redeployment or laying off personnel, cost cutting and restructuring debt-loads. Bankers are traditionally hesitant to repossess OSVs. There is significant costs in storing and maintaining them pending resale and these costs could mount if, as is the case now, prospects for an advantageous resale are dim. It should be emphasized that the current downturn in the OSV market does not only affect the Gulf, but is a global phenomenon. Thus, there will be no buyers for these vessels until the market begins to rebound. This gives OSV operators leverage in restructuring negotiations. [On that note, see my post of November 23, 2015.]

Vessel Purchase Agreements
Vessel sales are a constant in the marine industry, even during downturns in the market. In fact, some see adverse market conditions as an opportunity to find bargains on vessels and other marine equipment. Once the buyer has “kicked the tires” on a vessel and the parties have agreed on a price, there usually is great pressure from all sides to quickly sign a purchase and sale agreement and close the deal. However, signing an agreement that fails to or inadequately addresses a key issue can cause problems down the road.

Based on years of negotiating, drafting and reviewing vessel purchase and sale agreements for vessels large and small, here is a checklist of the key business and legal points that should normally be addressed in a vessel purchase agreement:

  1. Deposit – If there is to be a deposit, the parties should specify how much it will be and the condition under which it will be deemed forfeited.
  2. Inspection – These clauses vary widely depending on the circumstances. If the buyer has already inspected and is satisfied with the condition of the vessel, the contract may simply provide that the sale is outright and definite upon execution with no right of inspection. Usually, and especially with larger and/or classed vessels with specialized equipment, the buyer will want the right to inspect the vessel and its class records and have the ability to get out of the contract and receive back the deposit, or receive an adjustment in price, if dissatisfied with the condition of the vessel. If there is to be an inspection, the contract normally specifies the scope of the inspection and provides a strict timeline to accomplish it, and may also spell out the consequences for delaying or impeding inspection, insurance and indemnity for claims of inspectors, and allocation of inspection costs.
  3. Time and Place of Delivery – These clauses may include consequences, such as a right of cancellation and/or liability for damages, for failure to timely deliver the vessel.
  4. Total Loss Before Sale – These provisions normally give the buyer the right to cancel if the vessel becomes a total loss before delivery.
  5. Drydocking or Underwater Survey – Similar to inspection provisions, these clauses should address the circumstances under which the buyer may require drydocking or divers’ inspection and who pays for these inspections, which may depend on what is found during the inspection, and insurance and indemnity for claims arising during drydocking. These provisions may also address the buyer’s right to have the tail shaft or other vessel components surveyed during drydocking.
  6. Bunkers, Spares – These clauses typically address how and when bunkers are quantified and priced and paid for, delivery of spares and other items of vessel equipment and whether these are included in the price or paid for separately.
  7. Closing Documentation – The key issue on this point is that the buyer will want to ensure that the seller’s deliverables include all certificates and other documents necessary to meet the requirements of the registry the buyer plans to use. The contract should provide for these to be delivered as a condition of payment of the purchase price, so the buyer does not have to chase the seller after closing for a piece of paper needed to complete registration of the vessel in the buyer’s name.

Vessel purchase and sale agreements usually also have other customary provisions, such as those addressing:

  • Seller’s obligation to deliver the vessel free from all charters, encumbrances, mortgages and liens.
  • Seller’s indemnification for claims incurred prior to delivery that are asserted after delivery.
  • Allocation of responsibility for taxes, fees and expenses.
  • The required condition of the vessel and equipment upon delivery.
  • Default by the buyer or seller and the consequences of default.
  • Dispute resolution.

Numerous forms of vessel purchase and sale agreements are available publicly to use as templates in drafting agreements and specific clauses. However, when presented with any contract, whether based on an established template (e.g. BIMCO, Saleform) or drafted for the particular deal, you should never hesitate to negotiate what is important to you and revise the agreement accordingly.

Greece has finally imposed a tonnage tax on foreign-flagged vessels operated by shipping companies in Greece. It already had been taxing Greek-flagged ships, and the nation’s debt crisis left the government with no other choice than to tax foreign-flagged ships in an attempt to help raise its revenues. The government is hoping it will raise at least $106 million from the levy.

The Greek state is targeting an estimated 762 managers with the new laws, which went into effect as of January 2013. Fortunately, ship owners and management companies’ ship earnings are excluded from the tax, as it only applies to the tonnage of their ships.

The Greek Ministry of Finance has issued the following guidelines as to who is liable for this new tax and how to calculate it:

  • The tax is levied on ships managed by companies in Greece which own foreign-flagged vessels.
  • The tax will be calculated using the gross tonnage of the vessel and the age of the vessel.
  • The tax will be calculated in U.S. Dollars and converted into and paid in Euros.
  • The foreign ship owner and the ship management office will be jointly liable for payment of the tax.
  • The responsibility for filing the tax return lies with the ship owner, the ship manager and their representatives or their attorneys-in-fact.
  • The annual return must be filed by the end of February for the previous calendar year; 25% of the tonnage tax assessed must be paid at the time the return is filed (February) with the remaining 75% paid in three equal installments due in June, September, and December.

The first year the tax was implemented was for 2012, meaning to be in compliance with the new law, 2012 taxes should have been filed by the end of this past February, with additional payments made in June, this month and in December 2013. Ship owners or ship managers that have not yet filed their 2012 tonnage tax will accrue a 1.5% monthly penalty fee (interest) which will be added to their outstanding taxes for filing untimely. If Greek authorities feel that an owner cannot pay his taxes, they could revert to arresting the vessel, but this extreme measure is unlikely to be implemented. Those needing further guidance should contact their attorney and accountant.

The Union of Greek Ship Owners (EEE) informed its members that it had reached an agreement with the government to implement an extraordinary additional voluntary contribution to the tonnage tax, in addition to the mandatory amount owed, for the next three years. This voluntary tax applies to Greek-owned shipping companies, whether they have Greek- or foreign-flagged ships. This contribution is voluntary, but the Union hopes that many ship owners will participate to help increase the government’s revenues.

New Orleans Attorney Joanne Mantis

Guest blogger Joanne Mantis is an attorney in the New Orleans office of King, Krebs & Jurgens. She is a member of both the Louisiana and Greek Bar, and represents a variety of maritime clients both domestically and internationally.

 

 

The scenario may be all too familiar. A vessel owner is involved in a commercial relationship with a valuable customer, when a marine casualty involving the vessel occurs. The customer makes a written demand on the vessel owner to pay the costs of repair plus consequential damages. Liability on the part of the vessel owner is not a lock, but fairly clear. The quantum of damages is substantial, but the potential consequential damages are uncertain. Settlement negotiations are ongoing, and partial payments are made. Moreover, there is always the commercial relationship to consider. At what point should the vessel owner file a complaint for limitation of its liability, pursuant to the Shipowners’ Limitation of Liability Act, or risk it being found untimely for failure to file within six months of receipt of a written claim?

In In re: Marquette Transportation Company, L.L.C., No. 12 – 31182 (5th Cir. May 31, 2013), the Fifth Circuit concluded that if the customer’s initial demand letter revealed a “reasonable probability” that the claim will exceed the value of the vessel, then the vessel owner must file the limitation complaint within six months of receipt of that letter. “When there is uncertainty as to whether a claim will exceed the vessel’s value, the reasonable possibility standard places the risk and the burdens associated with that risk on the owner.”  Id. at 4. As I have previously cautioned, “If in doubt, file the Complaint for Limitation of Liability.”

Under the particular facts of this case, Great Lakes’ dredge ran aground while under the tow of Marquette’s tug, requiring repairs that were not completed until 17 days later. On February 24, 2011, Great Lakes made a written demand on Marquette, stating Marquette was negligent and that Great Lakes would hold Marquette responsible for repairs in excess of $600,000, as well as consequential damages. The parties engaged in settlement negotiations, and reimbursement for certain repairs were made, but it was not until December 7, 2011, that Great Lakes finalized its calculations of its consequential damages, and made written demand on Marquette in excess of $4.5 million. Within six months of receipt of the December letter, Marquette filed its limitation complaint and posted a bond for the limitation fund in the amount of $2.1 million.

The district court and Fifth Circuit concluded that Marquette should have filed the limitation complaint within six months of receipt of the initial demand letter, even though the quantum of consequential damages was uncertain. As a result, Marquette’s limitation complaint was dismissed as untimely.

Supreme Court of the United States
The Supreme Court of the United States may soon be deciding the definition of a vessel.

The very question of what makes a structure a “vessel”  under Section 3 of the Rules of Construction Act, 1 U.S.C. §3 is before the United States Supreme Court in City of Riviera Beach v. That Certain Unnamed Gray, Two-Story Vessel Approximately Fifty-Seven Feet in Length, 649 F. 3d 1259 (11th Cir. 2011). In Part 1 of this blog post, we looked at the position of the owner of the alleged vessel, who argued that use and intention should be considered and that a watercraft like his floating house should not be considered a vessel. The Eleventh Circuit, however, ruled otherwise.

In determining that the floating house was a vessel, the Eleventh Circuit distinguished and disagreed with jurisprudence from the Fifth and Seventh Circuits. According to the Eleventh Circuit, the Fifth and Seventh Circuits “focus on the intent of the ship owner rather than whether the boat has been ‘rendered practically incapable of transportation or movement.’” Compare Board of Commissioners of the Orleans Levee District v. M/V Belle of Orleans, 535 F.3d 1299 (11th Cir. 2008) with Pavone v. Mississippi Riverboat Amusement Corp., 52 F.3d 560 (5th Cir. 1995); Tagliere v. Harrah’s Ill. Corp., 445 F.3d 1012 (7th Cir. 2006). The Eleventh Circuit submitted that by injecting the owner’s intention into determining whether a floating structure was a vessel, the Fifth and Seventh Circuits have deviated from the United States Supreme Court’s decision in Stewart v. Dutra Construction Company, 543 U.S. 481 (2005).

In the amicus briefs filed by the National Marine Bankers Association and numerous maritime plaintiff attorneys, it was argued that the Eleventh Circuit’s decision should be upheld, and they too criticized the jurisprudence of the Fifth and Seventh Circuits. As argued by National Marine Bankers Association, under the Fifth and Seventh Circuits’ jurisprudence, “a once-valid marine security could at a later date be adversely affected because the craft is no longer deemed a vessel” by its owner, which would create uncertainty for lenders and banks. The plaintiff’s attorneys also supported the Eleventh Circuit’s decision as it potentially could expand admiralty jurisdiction to include, among other things, floating casinos, and other floating offshore installations.

The outcome of this case may have far reaching implications likely broader than those briefed, including whether the courts would revisit whether certain floating offshore installations used in the petroleum industry are vessels. That is, if the matter is decided at all. The U.S. Solicitor General has argued that the case is moot as the floating houseboat at issue has already been destroyed, and the Supreme Court has requested the parties further brief that issue. Stay tuned.

A feisty dachsund and its owner, Fane Lozman, have stirred up troubled waters regarding the definition of a “vessel” in City of Riviera Beach v. That Certain Unnamed Gray, Two-Story Vessel Approximately Fifty-Seven Feet in Length, 649 F. 3d 1259 (11th Cir. 2011). That case, which is now before the 2012–2013 session of the United States Supreme Court, started out with the City of Riviera Beach, Florida, attempting to evict Mr. Lozman and his floating home from the city’s marina because, among other things, he refused to keep his dog—a small Dachshund—muzzled.

The case may have far reaching implications. It has attracted interest and amicus briefs from the federal government, numerous floating home owners and their associations, lawyers, law professors, the Marine Bankers Association, carpenters, and owners and operators of riverboat casinos, all of whom claim they will be affected by the Supreme Court’s decision. In a two-part blog post, Offshore Winds will look at both sides of this argument over the definition of “vessel.”

The City of Riviera Beach claims Mr. Lozman’s structure is a vessel and brought an in rem proceeding against it. Mr. Lozman disputed that claim. The position of Mr. Lozman, along with the American Gaming Association, the carpenters, certain lawyers, and the floating homeowners, was that in determining whether a structure was a “vessel” under Section 3 of the Rules of Construction Act, 1 U.S.C. §3, the Court must take into account practical considerations such as historical use, its current use, and its reasonable intended use for the future. The matter is being watched closely within the Fifth and Eleventh Circuits, where employees of semi-permanently moored riverboat casinos are subject to workmen’s compensation laws, not federal maritime law. Additionally, floating homeowners argue that expanding the definition of vessel to include their floating homes would subject them to new federal laws, including maritime liens, which would frustrate certain local regulations. They argue that practically their homes are a mere extension of the land, and should be treated as such in the courts.

The United States Court of Appeals for the Eleventh Circuit agreed with the City of Riviera, disagreeing with jurisprudence from the Fifth and Seventh Circuits defining what is a vessel. In Part 2, we will look at why that Court held Mr. Lozman’s floating home was a vessel.

Oil Spill on the Mississippi River

The Coast Guard patrols a safety zone around a partially sunken barge. The motor vessel Tintomara and the tugboat Mel Oliver collided in the Mississippi River in New Orleans spilling approximately 419,286 gals.of number six fuel oil. 

 

(AP Photo/U.S. Coast Guard – Petty Officer 2nd Class Thomas M. Blue)

A judge’s recent decision on where legal liability lies for a maritime accident which released thousands of gallons of oil into the Mississippi River illustrates the benefits of being proactive in vetting operator quality when chartering vessels. The case involved a July 2008 collision near New Orleans between an oil barge and the vessel TINTOMARA. The collision damaged the ship and resulted in the barge splitting, sinking and spilling 282,000 gallons of oil into the river. The oil barge and her tug were both owned by American Commercial Lines (ACL). However, ACL had bareboat chartered its tug to DRD Towing, who in turn time chartered the tug back to ACL.

In Gabarick, et al. v. Laurin Maritime (America) Inc., et al., Case No. 08-04007, the U.S. District Court for the Eastern District of Louisiana found that the collision was caused solely by the negligence and statutory violations of the tug, for which DRD was liable. The owners of the TINTOMARA argued that ACL also was at fault because it failed to exercise proper control over DRD, which allegedly had a bad safety record. While the Court suggested that ACL’s liability could be premised on proof that ACL knowingly placed an unsafe vessel into the hands of an unsafe operator and such placement caused the collision, the Court found that the shipowner failed to meet its burden of proof on this issue.

Instead, the Court found that ACL’s vetting of DRD’s licensing, accident history and compliance with the Federal 12-hour watch rule, while imperfect, was nonetheless reasonable. There was evidence that DRD was involved in 17 accidents in the 18 months leading up to the collision and that ACL reviewed the accidents involving its vessels in order to determine the need for corrective action. ACL’s oversight also included a management audit of DRD, as well as quarterly meetings. These actions never revealed evidence that DRD was either using unlicensed operators or working crews in violation of the 12-hour watch rule.  However, the Court specifically found evidence that DRD concealed this information from ACL, and held that ACL was not accountable for such concealment. Based on these findings, the Court dismissed the TINTOMARA’s claims against ACL, and ordered DRD to pay ACL all of its stipulated recoverable damages, plus interest and costs.

Screening Critical
The case serves as a reminder that screening chartered vessels and their operators for quality and safety, and including and adhering to quality and safety standards in time charters, can reap benefits both in protecting against accidents and defending the charterer from legal liability if accidents occur.

In the unpublished opinion of  Adams Offshore, Ltd. v. Blake Marine Group, No. 11-12753 (11th Cir. Apr. 27, 2012), the Eleventh Circuit Court of Appeals adopted the Fifth Circuit’s suggestion in Beauregard, Inc. v. Sword Servs., L.L.C., 107 F.3d 351, 353 n. 8 (5th Cir. 1997), and affirmed the district court’s allocation of costs to each unsuccessful attaching party in proportion to the value that each party alleged was owed them by Oceanografia to the alleged value of all claims asserted against Oceanografia.  This decision addressed the infrequent scenario when significant expenses are incurred by a party in initially arresting/attaching the property, other creditors intervene in that suit, but the arrest/attachment of the property is subsequently vacated, resulting in there being no fund for which to pay the expenses of arrest/attachment and preservation of the property, more commonly referred to as custodia legis, literally expenses incurred “in the custody of the law.”

Oceanografia owned a modular diving system that had been installed on a vessel engaged in oil field work off the coast of Mexico.  Seizing on the opportunity to assert its claims against Oceanografia while the vessel and Oceanografia’s diving system were in Mobile, Alabama, Adams Offshore filed suit against Oceanografia and requested the attachment of the diving system under Rule B as security for its claims, alleged to be worth $7 million.  Thereafter, similarly situated creditors, Blake Marine and Cashman Equipment, intervened in Adams’ action, and asserted their respective claims of roughly $61 million and $1.7 million against Oceanografia.  Over one year after Adams had the diving system attached, the district court vacated the attachments of Adams, Blake and Cashman for equitable reasons.

During the time Oceanografia’s diving system was in the custody of the court, more than $200,000 in costs and expenses had accrued, including the Marshall’s fees, dockage, expenses to clear the diving system through customs, expenses to survey, oversee and remove the diving system from the vessel, storage and insurance, all of which had been initially borne by Adams as the first attaching creditor.  However, because the maritime attachments were vacated, there was no fund generated by the sale of Oceanografia’s property to pay the costs of attachment, much less the underlying claims of Adams, Blake and Cashman.

Local Admiralty Rule 6(c) for the Southern District of Alabama provided as follows:  “Intervenors under this rule shall be liable for costs together with the party originally effecting seizure on any reasonable basis determined by the court.”  S.D. Ala. Loc. Adm. R. 6(c).  The district court concluded that it was reasonable to assess the attachment costs against Adams, Blake and Cashman in proportion to the value that their respective claims bore towards the total of all claims asserted in the pleadings:  Adams – 10%, Blake – 87.5% and Cashman – 2.5%.  On appeal, the Eleventh Circuit affirmed the district court’s assessment of costs, concluding that allocating costs based on the respective value of the parties’ claims was reasonable.  Id. at 5 (citing Beauregard, supra.)

The Adams Offshore decision provides several lessons.  First, it is reasonable to share the costs of an unsuccessful attachment among all unsuccessful maritime claimants, not just the claimant that filed suit first.  Second, the days of a “costs free lunch” appear to be ending for creditors who subsequently intervene in another party’s action after the arrest/attachment of the property has been initially perfected.  Third, attorneys should avoid the temptation to “overstate” the value of their clients’ claims in cases of maritime arrest/attachment because the amount alleged is one basis a court could utilize in apportioning the costs of an unsuccessful maritime arrest or attachment.

One of the recurring issues in handling maritime wrongful death and personal injury claims is determining what information is sufficient to start the vessel owner’s six-month deadline to file a complaint seeking exoneration or limitation of liability under the Shipowners’ Limitation of Liability Act, 46 U.S.C. § 30501 et seq. from that claim.  It is clear that a written demand for payment/settlement before suit is filed which exceeds the value of the vessel will start the running of the six-month period.  Additionally, when the petition alleges recovery of damages in excess of the value of the vessel, the vessel owner’s receipt of that petition will start the clock.  However, it is less certain when the written notice of the claim is via service of a state court petition in which the plaintiff has not alleged a specific damages amount, as is generally the case in Louisiana and Texas state courts, but thereafter makes an initial settlement demand that exceeds the vessel’s value.

The U.S. Fifth Circuit, in In re Eckstein Marine Service L.L.C., No. 10 – 20600 (Feb. 22, 2012), recently examined this issue.  Jackson, a Jones Act seaman employed by Eckstein, filed suit in Texas state court.  Eight months after it was served with Jackson’s state court suit, Eckstein filed a limitation proceeding in Texas federal court.  The Fifth Circuit affirmed the federal court’s judgment dismissing Eckstein’s limitation proceeding for lack of subject matter jurisdiction, concluding that the limitation proceeding had been filed too late.  Although Jackson’s state court petition was silent on the quantum of damages, the Fifth Circuit concluded that pleading revealed a reasonable possibility that Jackson’s claim would exceed the value of Eckstein’s vessel, and therefore the clock started running for Eckstein to file a limitation suit upon its receipt of service of the state court petition.

Jackson’s state court petition had alleged that on February 28, 2009, Jackson had sustained serious and debilitating injuries on Eckstein’s M/V ST. ANDREW when his left leg became entangled in a line and was thereafter pulled into a mooring bit, causing him to suffer serious and debilitating injuries of a permanent nature.  The petition also alleged the standard laundry list of damages categories:  past loss of earnings, future loss of earnings capacity, past and future disability, past and future disfigurement, past and future medical and hospital expenses, past and future pain and mental anguish and maintenance and cure.  Moreover, as part of Eckstein’s cure obligation, it monitored Jackson’s medical treatment, which revealed multiple surgeries during Jackson’s initial two-week hospitalization to insert hardware to treat his bone fractures, as well as to perform debridement and skin graft procedures.  Based on the foregoing information, the Fifth Circuit concluded that the service of Jackson’s petition on April 28, 2009 started the six-month period for Eckstein to file its limitation complaint.

Eckstein, who filed the limitation complaint on January 18, 2010, argued that the six-month period should have started on December 2, 2009, when Jackson made his initial settlement demand for $3 million.  Under that theory, Eckstein’s limitation complaint clearly would have been timely.

The Fifth Circuit affirmed the federal district court, concluding that service of the Texas state court complaint on April 28, 2009, coupled with Eckstein’s knowledge of Jackson’s initial two – week medical treatment, raised a “reasonable possibility” that Jackson’s damages would exceed the value of the M/V ST. ANDREW.  As the Fifth Circuit explained:

Once a reasonable possibility has been raised, it becomes the vessel owner’s responsibility to initiate a prompt investigation and determine whether to file a limitation action.  The Limitation Act provides generous statutory protections to the vessel owners who reap all of its benefits.  When there is uncertainty as to whether a claim will exceed the vessel’s value, the reasonable possibility standard places the risk and the burdens associated with that risk on the owner.  In other words, if doubt exists as to the total amount of the claims or as to whether they will exceed the value of the ship the owner will not be excused from satisfying the statutory time bar since he may institute a limitation proceeding even when the total amount claimed is uncertain.

Id. at p. 9.  Accordingly, the Fifth Circuit concluded Eckstein’s limitation complaint should have been filed by October 28, 2009 and not on January 18, 2010.

Vessel owners – as the title suggests, when in doubt, file the limitation complaint.

When seeking construction financing for a proposed newbuilding, shipowners should understand and be prepared to address the particular concerns that lenders have in assessing risk and documenting vessel construction projects.

When deciding whether to approve a construction financing loan, lenders focus on certain key factors:

  • Does the shipyard have the requisite experience, manpower and financial wherewithal to complete the project?  To address this concern, shipowners should deal only with established builders with proven records of successfully completing vessel construction projects, preferably involving the type of vessel to be financed.
  • What is the credit strength of the shipowner?  If the lender will not be financing the entire cost of construction, the shipowner must be able to show that it can fund any unfinanced portion of the cost as well as any owner furnished equipment.  As with any loan, the financial strength and operating experience of the shipowner also will be important to the lender’s assessment of the shipowner’s ability to operate the vessel profitably and make debt service payments.
  • Is the shipowner overpaying for the vessel?  Shipowners should be prepared to demonstrate that the construction cost is in line with vessels of similar type. Prudent lenders consult with appraisers to help them evaluate the cost.
  • How strong will the market demand for the vessel be?  As with any business loan, the lender will want to see realistic and verifiable projections of the vessel’s earning potential after construction.  In optimal cases, a ship is constructed for a specific customer of the shipowner and committed under long-term services agreements or charters with firm competitive terms.

Once the lender has agreed to go forward with financing, it is a best practice to involve the lender in the negotiation of the construction contract so that issues that will be important to the lender can be addressed up front.   Nonetheless, in many instances, the shipbuilding contract already has been signed before the shipowner seeks financing.  In those cases, lenders will want to review the contract and may requests amendments to protect the lender’s interests.  Items of particular concern to lenders include:

  • when title passes to the shipowner;
  • the shipbuilder’s obligation to certify as to completion of milestones;
  • the scope of the shipbuilder warranties;
  • the progress payment schedule;
  • provisions relating to documentation of the vessel;
  • builder indemnities against lien claims of subcontractors as well personal injury, property damage and pollution claims arising during construction;
  • the adequacy of insurance coverage during construction; and
  • assignability of the contract as security for the loan.

In the typical construction loan transaction, the lender will take an assignment of the construction contract to secure repayment of the loan.  Under this assignment, if the shipowner defaults in repayment of the loan during construction, the lender will be entitled to take title to the vessel upon completion and sell the vessel to cover its loses on the loan.   The lender will also require that the builder consent to this assignment and agree to subordinate any lien it has in the vessel to the mortgage and other security interests taken by the lender.

As construction progresses, the lender will make advances for progress payments, which are usually repaid on an interest-only basis, until the vessel is completed.  To make these interim advances, lenders usually require supporting documentation that may include:

  • a shipbuilder’ certification that the milestone for which the progress payment is being made has been achieved;
  • invoices of the shipbuilder and other vendors or subcontractors for labor, material and equipment covered by such milestone;
  • releases of any liens in favor of any vendors, materialmen, or subcontractors the cost of whose services, work, equipment or materials is included in the advance;
  • a shipowner-certified advance request;
  • surveys, appraisals, certifications or other documents that a lender may require to establish that the advance is for a purpose authorized under the loan documents;
  • if an advance is made to reimburse the shipowner for owner-furnished equipment, proof of payment of the expenditures for which reimbursement is sought,

Once the vessel is completed, the construction-phase interim loan will convert to permanent term financing secured by a preferred ship mortgage on the vessel.  This conversion usually occurs in connection with the payment of the final milestone payment under the contract and delivery of the vessel.  At that time, the lender will require delivery of:

  • a term promissory note executed by the shipowner;
  • an Application for Documentation [form CG-1258];
  • Builder’s Certification and First Transfer of Title Document [form CG-1261] signed by the builder;
  • a Warranty Bill of Sale executed by the builder;
  • a Delivery and Acceptance Certificate, evidencing physical delivery of the vessel to the shipowner;
  • a preferred ship mortgage executed by the shipowner in favor of the lender; and
  • a certificate of insurance evidencing the coverages [hull and machinery, P&I, mortgagee’s interest] required by the preferred mortgage.

Depending on the structure of the deal, the lender may require other security documents such as a security agreement, assignment of charter hire and earnings and/or assignment of insurance policies.  The lender will require that the shipowner and shipbuilder coordinate the documentation of the vessel with the Coast Guard with the lender’s contemporaneous filing of its preferred ship mortgage, so that mortgage interest attaches at the time of documentation.