Shipowners’ skilful use of contract terms to guard funds

By Anna Lan, Co-effort Law Firm

Under a shipbuilding contract, the focus of the parties involved has always been on the way the funds are raised and also on ensuring the safety of the paid-in funds. Statistics from the China Association of the National Shipbuilding Industry show that, “between January and May 2018, shipbuilding enterprises had revenues from their main business totalling RMB78.8 billion (US$12.4billion), a decrease of 4.8% compared with the same period the year before, and large-scale shipbuilding enterprises realized total profits of RMB0.93 billion, a drop of 67.8% … At present, the main domestic financial institutions generally adopt a cautious attitude on providing credit support to the shipping industry.” It can be seen that shipbuilding enterprises face financing difficulties, and rely on shipowner financing for funds to build ships as one way of resolving the problem.

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When paying for the building of a ship, the ordering entity and its financing party need to ensure safety of such funds if the builder goes bankrupt, whether the shipowner has the right to request conversion of its expectant right into ownership of the ship or materials corresponding to the monies already paid, and whether it can assert a right to recover the ship or the materials. Also, it involves whether it has the right to request continued building of the ship or claim priority of repayment from the auction proceeds of the ship under construction. There is also the question of whether the shipowner is limited to being a general creditor participating in the distribution of the shipbuilder’s bankruptcy property.

Pursuant to Article 2(1) of the Judicial Interpretations (II) of the Enterprise Bankruptcy Law, if a shipbuilding contract is recognized as being a processing contract, the ship under construction does not constitute part of the debtor’s property and the party that ordered the ship has a right of recovery. However, it has long been debated in the Chinese shipping industry whether a shipbuilding deal is a sale-and-purchase contract or a processing contract. If the shipbuilding contract specifies that ownership of the ship during the building period is vested in the shipbuilder or the shipbuilding contract does not specify the ownership, the shipowner is bound to face difficulties in recovering the ship under construction by way of asserting ownership of the ship if the shipbuilder goes bankrupt and the shipbuilding contract is terminated. In such a situation, the shipowner’s only option is to participate in the distribution as a general creditor.

Taking China Huarong Financial Leasing et al v Zhejiang Hengyu Shipbuilding, a recovery right dispute appeal case, as an example, both the courts at first instance and appeal held that “a shipbuilding contract is a type of processing contract. In this case, where building of the ship was undertaken not entirely by processing supplied materials, the question of ownership of the ship under construction, i.e., does ownership of the ship vest in the party that ordered the ship or in the contractor, shall rely on the registration and delivery of the ship as the basis for consideration”. As shipowner Huarong had only paid RMB61 million of the total building price of RMB100 million and given that the ship had not been delivered in reality or in law and that ownership had not been registered under the name of the shipowner, the shipowner’s claim of the right of recovery was found to lack sufficient basis. The shipowner’s only option was to participate in the distribution of the shipbuilder’s bankruptcy property as a general creditor with the building monies it had paid.

This writer contends that the shipowner actively performed its contractual obligations, provided such information as the parameters, technical specifications for the ship it ordered; and, for the purpose of securing unimpaired ownership of the ship after construction and delivery, the shipowner continued to pay the building monies according to the shipbuilding schedule, as agreed. As the position of the shipowner under the shipbuilding contract surpasses the position of a buyer under a general S&P contract, it should have been accorded the corresponding legal protection. However, the existing legal framework does not protect a shipowner and ensure the safety of its building monies should the shipbuilder go bankrupt. It needs to use the provisions of the shipbuilding contract shipowner to protect its rights and interests.

Pursuant to Article 10 of Taiwan’s Maritime Law, “in case the shipbuilding undertaker is declared bankrupt during the construction of the ship and the liquidator does not undertake to complete the construction of the ship, the proprietor of the ship may retake possession of the ship and all other materials delivered to or ordered for the construction by paying for the assessed value of the ship deducting all monies it already paid, and may undertake to complete the construction of the ship, provided that he pay the costs for the use of the dockyard”. This implies that the shipowner enjoys two rights when the shipbuilder goes bankrupt and the bankruptcy administrator is unwilling to continue building of the ship. These are the right to recover the ship under construction and the materials for the building of the same; and the right to continue building the ship either on its own or through a third party by continuing to use for consideration the original shipyard that filed for bankruptcy.

Drawing on the Taiwan’s Maritime Law, shipowners and their financing parties may consider the following:

  1. Where negotiations permit, expressly specify directly in the shipbuilding contract that ownership of the ship under construction vests in the shipowner at all times, and also register the ownership of the ship under construction with the maritime affairs bureau of the port of registry. This is the most efficacious method as the shipowner may, if the shipbuilder goes bankrupt, assert the right of exception from the bankruptcy property, based on the express provisions of the contract and the ship ownership registration certificate.
  2. Specify in the shipbuilding contract that the materials for building the ship and the equipment are provided by the shipowner or that the shipowner entrusts the shipbuilder to procure the same specifically for the purpose of building the ship and the shipbuilder is to duly keep, use and install the same as required by the shipowner. If the shipbuilder goes bankrupt, the shipowner then has the right to recover the ship (in sections) and the property for which it has already paid. However, under such provisions, the shipowner needs to collect and keep the pertinent evidence as proof for purchase of the corresponding materials and equipment.

Anna Lan is a partner at Co-effort Law Firm

Co-effort Law Firm 35/F Huaneng Union Tower

No. 958 Lujiazui Ring Road

Pudong New Area, Shanghai 200120, China

Tel: +86 21 6886 6151

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