New vessel arrest rules bring risks for financial leasing companies

By Grace Zheng and Tony Zhang, Co-effort Law Firm
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In recent years, the financial leasing of vessels has been increasing, but the business is generally deemed to be highly specialized and relatively risky. Particularly in a shipping market that continues to lie in the doldrums, shipping companies are tied up in debt, meaning that financial leasing companies face difficulties in recovering rent, and even instances where chartered vessels are arrested by the courts or auctioned off, making recovery impossible.

郑蕾 GRACE ZHENG 协力律师事务所高级合伙人 Senior Partner Co-effort Law Firm
郑蕾
GRACE ZHENG
协力律师事务所高级合伙人
Senior Partner
Co-effort Law Firm

The vessel arrest system is a unique one under maritime law and a particular risk faced in the vessel financial leasing industry. The Provisions of the Supreme People’s Court on Several Issues Concerning the Application of the Law in the Arrest and Auctioning of Vessels implemented on 1 March 2015 add a few new provisions beyond the Special Maritime Procedure Law.

So, what effect do the new provisions of the vessel arrest provisions have on the management of risks by financial leasing companies? And how should financial leasing companies respond to such risks? Following are some proposals on how to address these issues.

New provisions to which financial leasing companies should pay attention. As compared with the maritime procedure law and its judicial interpretations, the most obvious changes in the vessel arrest provisions, in terms of the arrest of vessels and repayment from the proceeds derived from the auctioning of vessels, are as follows:

  1. They expressly provide that a vessel may be subjected to repeated arrest, and the later applicant for arrest may apply for auctioning of the vessel; for a maritime creditor, this increases the possibility of vessel arrest and application for auctioning of the vessel, further ensuring the realization of its claim;
  2. If a bareboat chartered vessel is arrested, the applicant for arrest of the vessel may apply for the vessel’s auctioning to repay the debt arising in connection with the bareboat charterer’s operation of the vessel;
  3. They expressly provide that the proceeds derived from the auctioning of a vessel are to be used to repay the debts relating to the auctioned vessel on a priority basis, and only then can any balance be used to repay other debts unrelated to the vessel. This provision shatters the principle of equality of claims in civil law, reflecting the principle that claims relating to the vessel in question take priority over claims unrelated to the vessel in question. For an ordinary creditor whose claim relates to the vessel, the advantage is obvious, enhancing the probability of being repaid and the amount that it will be repaid.
张振安 TONY ZHANG 协力律师事务所高级合伙人 Senior Partner Co-effort Law Firm
张振安
TONY ZHANG
协力律师事务所高级合伙人
Senior Partner
Co-effort Law Firm

RISK PREVENTION

Under the new regulations for the arrest of vessels, financial leasing companies should pay attention to, and guard against, the risk of the vessels being arrested and auctioned off. Clearly, the new provisions of the vessel arrest provisions are, to a certain extent, more conducive to a creditor realizing its rights in its claims through applying for the arrest and auctioning of the vessel, but for a financial leasing company, as the owner and lessor of the vessel, the risk of its vessel being arrested and auctioned off has increased.

Once a chartered vessel has been arrested, it signifies that the financial leasing company, as the owner, has no means of recovering the vessel, and if the vessel is auctioned off, the proceeds from the auction will be used to repay the debts arising in the course of the operation of the vessel. At such time, even if the financial leasing company waives its right in rem and asserts a rent claim, such a claim does not have priority, and will receive repayment in the same order as other ordinary claims of the same rank, after priority rights, liens
and mortgages.

If the amount of the debt arising during the period of operation of the vessel is very large, the financial leasing company’s rent claim and claim in rem will usually be difficult to realize. Accordingly, for a financial leasing company, the arrest and auction of a vessel are things to be avoided to the greatest extent possible in project operation and risk management. The implementation of the vessel arrest provisions means that a financial leasing company must place particular emphasis on, and pay particular attention to, the risks set out below.

The first paragraph of article 23 of the maritime procedure law specifies that a maritime claimant may, in connection with the debt of a bareboat charterer, arrest the vessel in question. However, as the debtor is not the vessel owner, in judicial practice two opposing arguments have arisen as to whether a bareboat chartered vessel can be auctioned, one saying that it can be arrested and auctioned and the other saying that it can be arrested but cannot be auctioned. Article 3 of the vessel arrest provisions expressly provides that if a vessel is arrested as a result of the bareboat charterer being liable for a maritime claim, the maritime claimant may apply for auctioning of the vessel to discharge the relevant debts arising from the bareboat charterer’s operation of the vessel. This provision draws from the features of actions in rem under common law and is more conducive to protecting a maritime claimant in realizing the remedies for its claim by applying for the arrest and auction of the vessel in question.

As China lacks specific legislation that addresses the financial leasing of vessels and the maritime law does not set out special provisions for the financial leasing of vessels, in practice, financial leasing is usually treated as bareboat chartering and registered as such with the vessel registrar. The vessel arrest provisions also do not differentiate between bareboat chartering and financial leasing. Accordingly, provisions on bareboat chartering will, in judicial practice, be applied to the financial leasing of vessels.

Given this, the express provisions that a bareboat chartered vessel can be auctioned off clearly increases the risk of a vessel leased out by a financial leasing company being arrested. How to avoid and guard against such risks is then particularly important for financial leasing companies.

In the next issue, the author will further analyze the risk of the arrest and auctioning of the sister vessels of a chartered vessel that a financial leasing company should pay attention to under the new regulations for the arrest of vessels.

Grace Zheng and Tony Zhang are senior partners at Co-effort Law Firm

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