Current challenges with international recognition and enforcement of mortgages on ships – is the solution found in the aviation sector?
News | 19.05.17Aviation
Shipping and offshore
Having practised both as a shipping lawyer and an aviation lawyer for many years, I do find the experience and practice with the Cape Town Convention and aviation finance transactions to be interesting when experiencing the challenges faced by the shipping industry with respect to recognition and enforcement of mortgages. The shipping industry does not have a global legal regime governing these issues in the same way as the aviation industry, and when looking at the OSX-3 matter from last year, where the Brazilian courts have set aside the Liberian first priority mortgage, the need for a global legal regime becomes quite evident.
The fact that the shipping world is yet to adopt an international legal scheme governing recognition and enforcement of rights in ships and offshore units is complicating the financing of such objects, and the mentioned court case in Brazil has cast a shadow over the Brazilian offshore sector which should trouble the international banking community. In this brief article I would like to discuss a little more in detail the challenges caused by the Brazilian judgment and how these challenges could be solved by looking towards the aviation finance sector and the Cape Town Convention.
The OSX-3 concerns a FPSO which was owned by a Dutch company and chartered to an affiliated Brazilian company. The OSX-3 was registered with the Liberian Ship Registry and its financing with bondholders represented by Nordic Trustee was secured by a Liberian law mortgage. The mortgage was registered with first priority with the Liberian Ship Registry. The vessel was operating in Brazilian waters.
Whilst the vessel was in Brazil, an unsecured creditor brought a claim against the vessel and argued that the first priority mortgagee did not have a secured claim. Both the first instance and appeal court decisions upheld the claim made by the unsecured creditor. This seems to indicate that the Brazilian Courts rejected the Liberian mortgage as a first priority mortgage – something which of course is devastating to the bank with the secured claim, but also to the entire ship finance world. The Brazilian Courts seem to have attached importance to the fact that there was no legal treaty in place between Liberia and Brazil governing recognition and enforcement of mortgages. The reason for addressing this case is only to illustrate the need for an international legal regime regarding recognition and enforcement of mortgages, and I am not doing any more detailed analyses of the Brazilian judgments in this article. The matter was settled early this year, and we will probably not have the benefit of any further hearing of the Brazilian courts on this case.
The OSX-3 case is probably the best example of the need for a global legal regime governing recognition and enforcement of ship mortgages, but it is not the only example. Food for thought should also be the recent Hanjin bankruptcy. Hanjin was a South Korean container line with more than 100 vessels in operation when it went into insolvency. This kind of international insolvency with ships in many different jurisdictions with different legal regimes unsurprisingly resulted in chaotic situations all over the world where some vessels were seized by authorities and creditors, and others refused entry to ports unload after Hanjin lost it support of the banks. This kind of international insolvency opens the door for forum shopping, as all creditors are seeking the best jurisdiction to enforce its individual security.
By referring to the OSX-3 case and the Hanjin bankruptcy, I am trying to highlight the legal challenges caused by the lack of a global regime governing recognition and enforcement of security, which leads to legal uncertainty and unnecessary problems for the banks. It is in this context I believe it is helpful to look towards the aviation finance sector and what has been achieved by the Cape Town Convention.
The Cape Town Convention
The convention was signed in Cape Town in November 2001. The convention itself is a general convention which sets out rules for security in mobile assets. However, the convention needs to work together with a protocol which sets out more specific rules for the type of asset in question.
Currently, there exist three different protocols – governing security over
- Aircraft Equipment (airframe and engines)
- Railway Rolling Stock
- Space Assets
As of today, the only protocol in force is the Aircraft Protocol, which was ready together with the convention back in 2001. However, rumours have it that the work with getting sufficient countries to sign up for the protocol regarding Railway Rolling Stock is far advanced, and we may see the light of a new international rail registry, said to be placed in Brussels, in the not so distant future.
The convention has been ratified by 72 countries, and 65 countries have also ratified the Aircraft Protocol. The Convention and the Aircraft Protocol have been in force in Norway since 2011. With the ratification of Canada in 2013, UK, Egypt and Australia in 2015 and Spain, Denmark and Sweden in 2016, the Convention and the Aircraft Protocol now cover the majority of countries involved in larger aviation finance transactions, and is applicable for the vast majority of transactions today.
As a result of this, we have had a fully working International Registry for security over aircraft since 2006. The registry is placed in Dublin, and is a modern registry where all entries are made electronically. No physical documents are being filed with the registry, and users of the registry need to register and be approved users of the registry. Everything happens online.
What takes place in practice is that the creditor who wants to register security over an aircraft makes the filing on line with the registry. This will create a request to the airline to log on to the web site of the registry and accept the filing. It is only after the airline has accepted the filing that the registration of the mortgage becomes effective. Users of the registry may also search for aircraft and see which security have been registered on each individual aircraft.
The really great advantage to the Cape Town Convention and the Protocol is that security registered over the aircraft may be enforced in all countries that have ratified the convention. It is true that there have been a couple of issues, e.g. in India and the implementation in Spain, but it is fair to say that in practice we now have one reliable global system when it comes to security over Aircraft.
This is an enormous advantage for banks providing security worldwide – and for the airlines needing third party financing. Such global and uniform system is quite different from the situation with respect to financing ships, where the enforcement of security may vary from each jurisdiction.
From the banks perspective, there are two additional features of the convention which provides for a safe environment with respect to enforcing the security, namely the self-help remedy and the maximum stay period of 60 days in case of insolvency. These two features are options the ratifying countries have to choose, and are key elements in the OECD discount for export financing which may be available for airlines purchasing aircraft.
The self-help remedy means that the security may be enforced without any assistance from the courts in case of enforcement. In those countries having signed up for this option (including all the Scandinavian countries), the mortgagee does not need to go to the local courts in order to obtain a decision giving him the right to enforce the security over the aircraft. The local authorities would also be under an obligation to assist with the repossession and export of the aircraft.
The second feature that speeds up matters is the maximum stay period. In case of insolvency of an airline, the bankruptcy estate will normally seize all assets of the airline, and to start with, this may also include aircraft and engines over which security has been registered. In countries which have incorporated the provision of a maximum stay period, this means that the bankruptcy estate would be obliged to hand out the secured object to the creditor within a period of 60 days.
Having participated in numerous aviation finance transactions the last ten years, I am confident that the ratification of the Cape Town Convention has become a very important tool for aircraft financing, and has created a safe environment for banks in many different jurisdictions where the banks may have been more cautious with providing financing if it has not been for the Convention. This has been particularly important for start-up airlines with a delivery programme of new aircraft that has to be financed.
The Cape Town Convention and shipping
This brings me to my final question; to what extent may the ship finance community benefit from the Cape Town Convention and the practice found in the aviation finance sector?
From a legal or technical point of view it is fully possible to see the Cape Town Convention as the solution. When the Convention was drafted, it was initially discussed whether it should aim for covering security over ships as well, but this was thought not to be realistic by its drafters (UNIDROIT). It was argued that the preparation of international rules governing ships and shipping was traditionally the preserve of specific international organisations with full participation of shipping circles. Moreover, there was concern about possible conflict with already existing conventions.
This decision not to include ships in the Convention is most likely not due to any severe difficulty in drafting the necessary legislation, as all that it is needed is probably some small amendments to the Convention itself together with a new Protocol that governs security over ships. Regardless of existing national ship registries, which would need to continue to exist for registration of the ship itself and legislation following the flag of the ship, it should be fully possible to establish an international registry with respect to security over the ships in the same way that has been done with Aircraft.
In my opinion, the reason for the extension of the Cape Town Convention to shipping not being far advanced, is two folded. Firstly, previous attempts of establishing international conventions regarding mortgages and liens on ships have not been very successful. There have been several attempts since 1926, and the latest attempt is the 1993 Geneva Convention on Maritime Liens and Mortgages. However, this convention has not achieved any widespread acceptance, and has not been ratified by the major shipping nations. One of the reasons for this is the lack of international uniformity when it comes to maritime liens, i.e. claims to which a statutory security is being attached, e.g. crew claims. The 1993 Geneva Convention does also only address the question of recognition of mortgages and liens, and does not deal with the question of enforcement. This is a big difference from the Cape Town Convention which also establishes international rules regarding enforcement of the security.
Secondly, and probably the main obstacle against a swift acceptance of the Cape Town Convention in the shipping community, is the fact that the Convention is quite unknown among the players in the shipping community. The players in the aviation finance transactions, including banks and lawyers, are normally others than those dealing with ship finance transaction. I therefore believe that it is important to start marketing the Cape Town Convention in the ship finance community if we are going to see any real progress with respect to adopting the Convention.
Traditionally, new international shipping legislation has come from within, e.g. from organisations like CMI (Comite Maritime International), and CMI has traditionally worked on drafting new legislation on its own, rather than adopting existing conventions. However, CMI has established a working group that is looking at the Cape Town Convention. Perhaps this is the start of a new era with respect to secured ship finance transactions? The Convention has quickly been internationally accepted in the aviation sector, and one of the reasons for this is probably the regime of discounted export credit financing to countries which has adopted the Convention in the most creditor friendly manner. This system is probably more difficult to establish with respect to ships, as ships are built in many jurisdictions around the world, not only by 3-4 manufacturers as with commercial aircraft.
Nevertheless, I am of the opinion that extending the Cape Town Convention to shipping would be a great advantage to both banks and shipowners. The current market for secured finance in shipping is enormously huge, and this market is traditionally riddled with difficulties stemming to a large extent from an unsatisfactory legal framework, especially as regards differences between the legal systems concerning the use and status of security in cross-border business. This is where the Cape Town Convention can be tool for solving these problems.