Shipping newsletter - Legalseas
May 2012

Export credit finance - a solution to the funding gap?

Author: Helen Davies

Introduction

The Norton Rose Third Transport Survey highlighted that poor bank liquidity is a major issue for shipping companies with 61 per cent of respondents reporting that this was the issue which was mostly restricting the availability of funding for them. Lack of finance was considered by 42 per cent of respondents in the shipping industry to be the greatest threat of stability to their business.

Whilst not necessarily an available solution in every case, export credit financing can be one way of overcoming the issues currently being experienced with the traditional financing model.

What is export credit financing?

Export credit financing is a government-driven technique for encouraging manufacturing, industry and employment in its country. The criteria applied by an export credit agency (ECA) in deciding whether to be involved in the financing of a ship being built in that country may therefore be coloured by that policy perspective and vary from country to country. However, while they have a public policy function in promoting local industry, ECAs also have a commercial function in seeking to ensure that the export credit scheme does not lose money and a balance between the two must be sought.

ECA financing is a form of state aid to shipbuilding and can take various forms. Countries which are members of the Organisation for Economic Co-operation and Development (OECD) have sought to control and regulate ECA financing by joint agreements to try and achieve a level playing field between those OECD members who wish to provide state aid to their shipbuilding industry in this way.

The OECD Guidelines (known as the Consensus Arrangement) provide a framework for the orderly use of officially supported export credits under a “gentlemen’s agreement” between parties. The participants to the Consensus Arrangement are Australia, Canada, the EU, Japan, South Korea, New Zealand, Norway, Switzerland and the United States. The principal provisions of the Consensus Arrangement relating to ships are outlined in the Sector Understanding on Export Credits for Ships (also known as the “shipping protocol”).

The shipping protocol:

• 12 years maximum repayment term
• minimum 20 per cent cash paid by purchaser no later than delivery date
• repayments of the loan to be in equal instalments at regular intervals
• interest periods to be at least 6 months, maximum 12 months
• ECA premium to be adjusted to reflect credit risk of export country and political risk

Other criteria can also be set by the relevant ECA.

What types of support are available?

The ECA support can take various forms and can vary according to the country and will be influenced by the parties involved and the reason for the required support. That said, the following key ingredients in an export credit financing will be found, to a greater or lesser extent, in all structures:

• Credit Support - the ECA assumes the risk of borrower default - this may take the form of an “insurance policy”, “buyer credit guarantee” or “export credit loan” (if given directly by the ECA itself).
• Interest subsidy - the ECA takes risk on the interest rate for the funding either by subsidising rates or offering a long term low fixed rate. The Commercial Interest Reference Rate (CIRR) is the official fixed lending rate and is calculated by reference to the preceding month’s average rates for the relevant currency. ECAs allow the CIRR to be “locked-in” whilst transaction documentation negotiations take place.

Whatever the type of support being offered, ultimately it is the ECA that takes some or all of the risk and often more than a commercial bank would be willing to take, especially in the current market conditions. One or more ECAs in the same country may also be involved to make up the component parts of the relevant support; for example one may provide an insurance policy and other may provide interest support.

What are the advantages for a shipowner?

ECA financing may provide the shipowner with access to finance which would not otherwise be available. Further, it may also allow a greater spread of finance sources for banks as the ECA support may reduce the impact of bank limits in relation to a particular company or group of companies and also country (see Basel III below). The cost of ECA financing is often lower than would be the case with a commercial bank, particularly where fixed interest rate support is available. An ECA will typically charge a premium or fee for the support which will need to be factored into the cost although many banks will allow this to be funded by the commercial loan.

What about Basel III?

Under the new Basel III proposals, ECA backed loans will no longer have a zero-risk weighting. This will therefore need to be taken into account by banks because pre-Basel III, ECA backed loans would be zero weighted and thus would not affect a banks’ capital adequacy requirements. This is likely to increase the cost of ECA funding but it is hoped will not restrict its continued availability.

Current trends

In addition to the ECAs which are members of the OECD listed above, ECA activity is also regularly seen in other jurisdictions. For example, recent reports show that CEXIM (China) is increasing ECA support for its own shipowners and is also planning to offer funding support to overseas shipowners acquiring Chinese built ships.

Although perhaps most commonly seen in relation to newly built ships, ECA financing can also be sought in relation to ship conversions thereby enlarging the range of countries providing the export and, thus, the export credit.

Export credit financing, of varying forms, continues to play a major part in the strategic approach of many in the shipping industry, relied on by both shipowners and builders alike to maintain the order book and bring new ships on to the seas. It can be a highly attractive form of financing and potentially for some, the only form of fundamental financing for current projects.

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A new storm brewing? Ports and competition law

Author: Ian Giles

All ship operators must navigate the relationship with the port authorities at the ports at which they call. Where the port in question is the only realistic port of call, then the port authority has significant leverage in negotiations on port charges, while port users may have little choice in finding suppliers of the various port services, such as stevedoring, warehousing, pilotage and tugs.

A recent trend has also been toward shipping companies themselves investing in ports, meaning that other port users may be dealing with a port authority who is on the one hand a supplier, but on the other a competitor. These companies will want competitive rates, but also have to recognise the investment the port operator (their competitor) may have made in developing port infrastructure.

Both of these scenarios give rise to potential competition law issues. This article briefly explores how these can affect both ship operators and port owners, and the views of the regulatory authorities.

Is there behaviour in breach of competition law?

In disputes between shipping companies and port owners or operators, the relevant competition law provisions will typically be those relating to abuse of a dominant position. This will be the case in most situations where the port user is alleging that prices are too high (excessive pricing), that it is paying higher rates than other port users (discriminatory pricing), or that it is being refused access to the port (refusal to supply).

EU competition law also prohibits illegal arrangements between companies (or “undertakings”) which will be relevant where there is a suggestion of anti-competitive contacts between ports or between port service providers. For example, if two stevedoring service providers within a port are alleged to be colluding in their offers to customers, this could be an illegal arrangement between undertakings.

But is the port dominant?

Actions by a port operator or authority will only be capable of amounting to an abuse of dominance if the port itself is in a “dominant position”. This is essentially a question of geography - are there other ports in the vicinity which are suitable substitutes and which have available capacity to meet the demands of the vessels in question? In relation to deep sea container vessels, for example, the European Commission has previously found that ports in the Hamburg-Le Havre range constitute a single market in relation to hinterland container traffic, making a dominance finding more difficult.

However, where a port has no obvious substitutes due to its geographic location, or where an operator is tied to using a particular port by virtue of a long-term contract, then it may be easier to establish the dominance of the port operator.

And how to you demonstrate or refute the suggestion of an “abuse”?

Abuse of dominance is a complex legal area and parties considering asserting an abuse need to think carefully about the arena in which they wish to do so - competition authorities have more expertise in dealing with such allegations, and costs may be lower than in litigation, but there is no guarantee the authorities will prioritise investigation of the allegation. National courts and arbitrators on the other hand are in many cases still only developing their expertise in this area and this can often influence the approach of the parties in presenting their arguments, and make outcomes less predictable.

As regards the various types of abuse which can arise in the context of port/port-user relations, price discrimination is a relatively common claim (notably where the port-operator/owner is also active as a downstream port-user, but also where this is not the case), while excessive pricing has been found very hard to establish - largely due to the difficulty for a court or competition authority determining the level at which a price becomes “excessive”. The uncertainties and long-term nature of investments in port infrastructure make this calculation particularly complex. Termination of an existing port-user’s access rights can also lead to competition law disputes, usually centred on whether the “objective justification” for the termination cited by the port authority was in fact justified.

In all cases, factual and economic evidence are critical to establishing both the dominant position and the existence of abuse, and the incentive for the port to act anti-competitively will need to be considered (meaning cases where the port-owner is also active downstream as a port-user will be far more likely to raise concerns).

What about port services?

An area the European Commission has had a keen focus upon for years, but been frustrated, is in trying to increase the level of competition within ports for the various services required by port-users (such as stevedoring, warehousing, pilotage, tugs, etc). The European Commission has just announced a further consultation in this area with a view to making new proposals by Spring 2013 on how to increase competition, transparency and growth in EU ports.

In the absence of competing ports (or regulation) port services can effectively be charged at monopoly prices, and the European Commission had previously sought to require ports wherever possible to ensure there were at least two providers for each type of service. Although these efforts failed with the abandonment of the Ports Services Directive a few years ago, what is increasingly common is for port users to use the threat of litigation on competition law grounds to challenge the behaviour of port services providers.

Final thoughts

The backdrop to port operator/user relations in Europe remains one of a long-term trend toward far higher volumes of activity and increasingly capacity constraints on aging infrastructure with inevitable delays and difficulties with establishing further infrastructure. In this context, parties on both sides need to be aware of the role of competition law in these relationships.

The European Commission and governments, recognising the limited resource of competition authorities to take forward complaints, are actively advocating increased use of the courts in competition law matters. This is leading to a growth in both the number of cases heard and awards made, but also in the use of competition law arguments in disputes which are settled outside court. As the long history of competition cases in relation to ports shows, a port in an isolated position may be exposed to more than just the weather.

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“Hell and high water” provisions - has the storm abated?

Authors: Charlotte Winter and Claire Berwick

Introduction

On Monday 30 April 2012, the English High Court delivered its judgment in the case of ACG Acquisition XXLLC v Olympic Airlines (in special liquidation) [2012] EHWC 1070 (Comm.).

The case has attracted a high level of interest from the wider asset finance community, in particular as to when and in what circumstances rental provisions in a structured lease financing may be subject to challenge. In this article we pick out the main points of interest for those in the shipping industry.

Background facts

In 2008, ACG Aquisition XX LLC (the Lessor) had entered into an operating lease with Olympic Airlines SA (the Lessee) for the lease of a Boeing 737-300 aircraft for a term of five years, following redelivery of the aircraft from AirAsia.

The Lessor had given an undertaking in the lease that the aircraft would be airworthy and comply with detailed delivery condition requirements specified in the lease schedule. The aircraft was delivered on 19th August 2008, the Lessee having signed a certificate of acceptance in accordance with the delivery terms of the lease.

The Hellenic Civil Aviation Authority issued the aircraft with a certificate of airworthiness and the aircraft went into service on 23rd August 2008. On 6th September, the aircraft was grounded following the discovery of broken cables which controlled the spoilers in one wing. During repair, the Lessee discovered a number of defects leading to the suspension of the aircraft’s certificate of airworthiness on 11th September. By July of the following year following year, despite extensive repair work, the CAA was still unable to reissue the certificate of airworthiness.

The Lessee claimed that the cost of repairs to make the aircraft airworthy would exceed the value of the aircraft and refused to pay rent. In September 2009, the Lessor issued proceedings against the Lessee for payment of outstanding rent and maintenance reserves under the lease and for damages. The Lessee issued a counter claim against the Lessor for damages for breach, in particular in relation to the delivery provisions of the lease.

The application for summary judgment took place in May 2010. Our aviation team issued a short briefing which can be found here. At the time, the judge refused to grant the Lessor summary judgment for the outstanding rent on the basis that the Lessee had established an “arguable” case both for breach of contract by the Lessor as to the delivery condition of the aircraft and as to whether there was a complete failure of consideration due to the poor state of the aircraft delivered. The case proceeded to full trial.

Full trial

At full trial, the Lessor claimed that it was entitled to rental and maintenance reserves under the lease terms which included a “hell and high water” type clause to pay rental in all circumstances. The Lessor argued that the aircraft was delivered in an airworthy condition in accordance with the delivery provisions of the lease, but in the alternative, the Lessor argued that even if the aircraft was judged to be unairworthy, the Lessee was estopped from alleging that the aircraft did not comply with delivery conditions and claiming damages as the Lessee had signed the certificate of acceptance which stated inter alia that the Lessee was “satisfied” with the aircraft and that the aircraft “complied in all respects with condition requirements at delivery” under the relevant provisions of the lease.

The Lessee contested the claim and counterclaimed for damages on the grounds that the aircraft had been delivered in an unairworthy condition in breach of the lease delivery conditions. The Lessee also sought to argue two further alternative arguments, one that by delivering an unairworthy asset, there had been a total failure of consideration and two, that the withdrawal of the aircraft’s certificate of airworthiness had frustrated the lease.

Decision

The Court found in favour of the Lessor at full trial. It was accepted that the aircraft was not delivered in an airworthy condition. However, the Lessee had clearly accepted delivery of the aircraft under the certificate of acceptance, had signed the certificate before redelivery of the aircraft, and the Lessor’s affiliate had relied on the signed certificate to its detriment, by accepting redelivery of the aircraft back from AirAsia in that condition. A link to a full briefing by our aviation team on the judgment can be found here.

The following points will be of particular interest to those in the shipping finance industry.

Drafting of delivery conditions

The case illustrates the importance of clear drafting as to the obligations of a lessor and the lessee on delivery of the ship. A well drafted lease should oblige a lessee to accept the asset in the “as is, where is” condition at delivery, without further recourse to the lessor after the date of delivery.

In Olympic, the Lessor undertook to deliver the aircraft in the condition set out in detail in Schedule 2 of the lease. This undertaking potentially cut across the “as is, where is” basis on which the aircraft was intended to be delivered to the Lessee.

Inspection of asset by the Lessee

In practice a lessee may have a limited time to inspect and take delivery of an asset. Nonetheless, the case underlines the importance of a lessee carrying out satisfactory checks as to any defects identified in pre-delivery inspections and/or agreement on any outstanding defects with the lessor before accepting delivery of the asset.

In Olympic, the Lessee had had the opportunity to inspect the aircraft prior to redelivery of the aircraft from AirAsia to the Lessor. A long list of discrepancies was agreed at the inspection. Although the subsequent maintenance carried out by AirAsia’s MRO was the subject of some debate at trial, the fact that the Lessee was aware that the certificate of acceptance was to be signed and relied upon by the Lessor’s affiliate before accepting redelivery of the aircraft from AirAsia prevented the Lessee from claiming damages on the facts.

“Hell and high water” provisions

Hell and high water provisions are intended to ensure that rental is payable in all circumstances and are a common feature of lease financing in shipping where dependence on a rental income stream is key to the financing structure.

Olympic was of interest to the asset finance community as it called into question whether such commercially agreed terms might be challenged where the condition of the asset delivered was so poor as to be beyond economic repair, making it impossible for the lessee to perform the contract. In Olympic, the Lessee had tried to argue that there had been a total failure of consideration in failing to provide an airworthy asset but this argument was rejected by Teare J. It was determined that the obligation to pay rental and maintenance reserves remained intact because the Lessee has “irrevocably and unconditionally” accepted and leased the aircraft from the Lessor pursuant to the wording contained in the certificate of acceptance.

Whilst the case gives some comfort to lessors as to rental obligations of this nature being upheld, Olympic has nonetheless tested assumptions as to when such provisions might be challenged. In shipping a challenge is more likely to occur in the context of a time or voyage charter, where a shipowner will have ongoing obligations as to the maintenance and operation of the ship.

The “classic” common law test : is a ship seaworthy?

The Olympic case was of interest to aviation financiers as the Court considered the meaning of “airworthiness” for the first time. In considering the meaning of “airworthy” the Court did not accept that the existence of a certificate of airworthiness was sufficient but relied on the classic test of seaworthiness being: “Would a prudent owner have required that the defect should be made good before sending his ship to sea, had he known of it. If he would the ship was not seaworthy?”¹

The test is a reminder of the common law test when using the definition of “seaworthiness” in finance documentation. In a ship lease financing, a shipowner will typically confirm to the lessor that the ship is in a “seaworthy” condition on delivery of the ship. In turn, a shipowner will have an obligation to deliver the ship to a third party charterer in a seaworthy condition. In the next edition of Legalseas we will look at the meaning of “seaworthiness” in more detail and what this means in practice.

Conclusion

Overall the judgment in Olympic should not cause undue concern for the shipping finance community given that the facts of the case were quite unusual and specific to the parties involved. However there are some cautionary lessons that can be drawn from the judgment as illustrated above. As to the challenge to “hell and high water” rental obligations, the storm may have eased for the moment now but perhaps has not fully abated.

Footnote

1.  Scrutton LJ, FC Bradley & Sons v Federal Steam Navigation Co (1926) 24 LI. Rep 446

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BIMCO Saleform 2012

Authors: Kelli Bodal Hansen and Helen Davies

At the end of 2011, BIMCO approved, in consultation with the shipping industry, a new version of the memorandum of agreement for ship sale and purchase, SALEFORM 2012.

The revision process, undertaken by BIMCO and the Norwegian Shipbrokers’ Association, sought to identify the key clauses most commonly amended, remove ambiguity from the previous version and reflect current commercial practice.

The principal differences between SALEFORM 2012 and its predecessor, SALEFORM 1993 are summarised below:

• Deposit arrangements have been modernised. Parties may choose their own percentage of the Purchase Price as the Deposit (or a default figure of 10% of the Purchase Price applies if not specified). A Deposit Holder is introduced (which may not necessarily be a bank, but with the default position being the appointment of the Seller’s Bank if another entity is not specified) and the trigger for lodging the Deposit is more clearly fixed.
• The trigger for payment of Purchase Price is now tied into the issuing of the Notice of Readiness, with the Purchase Price being paid 3 Banking Days after the Notice of Readiness is tendered.
• Notice of Readiness provisions have been updated to include a requirement that notice is given at specified intervals of (i) the date on which the Notice of Readiness is intended to be given and (ii) the intended date and place of delivery to assist Buyers to make delivery arrangements.
• A new provision requires Buyers to declare their option to complete a divers inspection 9 days prior to delivery, which must take place in the presence of a Classification Society surveyor. A further revision ensures Sellers cannot tender Notice of Readiness before the divers inspection is completed. The allocation of costs in connection with the divers inspection is more clearly delineated.
• Cancelling Date - the time period for Buyers to accept or reject a new Cancelling Date (if the original Cancelling Date has been missed) has been shortened to three Banking Days.
• Any repairs necessary as a result of the divers inspection which do not affect class are now permitted to be deferred until the next scheduled drydocking. The Purchase Price will be reduced accordingly and the method of calculating such reduction is explained.
• The costs connected with survey of the tailshaft system have been clarified, and the perceived ambiguity in SALEFORM 1993 relating to costs of drydocking the Vessel has been addressed.
• Sellers must now more clearly identify spares and excluded items in clause 7. Further, hired items and those belonging to third parties on board at inspection which have not been excluded from the sale are to be replaced at Sellers’ expense prior to delivery unless specifically excluded.
• The calculation method for bunkers and lubricating oils now offers two alternatives, being Seller’s actual net price or current market price at port of delivery.
• Changes to clause 8 regarding documentation have been made largely to reflect market practice. In addition, the grace period to allow such documentation to be put in place following Notice of Readiness has been removed in clause 14.
• The scope of the Seller’s warranty regarding encumbrances in clause 9 has been expanded.
• The Condition on Delivery clause now provides that the Vessel is to be delivered free of cargo and stowaways.
• Buyers’ representatives on board will now be required to sign Sellers’ P&I Club’s standard letter of indemnity.
• The Arbitration provisions have been expanded in clause 16, particularly where the Agreement is to be governed by English law.
• New clauses to deal with Notices and Entire Agreement have also been added.

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Global contacts

Emma Giddings Abu Dhabi	Simon Hartley London
Dimitri Sofianopoulos Athens	Neil Q Miller London
Nigel Ward Beijing	Philip Roche London
Ernest van Buuren Brisbane	London
Andrew Robinson Durban	Gennaro Mazzuoccolo Milan
Gordon Hall Hamburg	Richard L. Desgagnés Montréal
Davide Barzilai Hong Kong	Christine Ezcutari Paris
Jim James Hong Kong	Gervais Green Singapore
	Jeremy Gibb Tokyo

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