Ship Sale and Leaseback Transactions

The shipping industry has experienced a very turbulent and somewhat negative decade since the 2008 financial crisis. The banking industry is a lot more regulated post-recession era and risk management is paramount. Many of the traditional shipping banks have either sought to leave the shipping industry altogether or have drastically reduced their exposure in response to a significant number of defaults and non-performing loan portfolios. As a result, traditional financing is at most only available to the minority of “blue chip” shipowning companies, and this has led to a significant number of shipowners pursuing alternative methods of financing for the acquisition of vessels, including sale and leaseback transactions.

With vessel prices rising in light of regulatory demands, particularly in the area of environmental protection, shipowners are increasingly considering these types of transactions as a means of freeing up capital whilst maintaining the ability to operate a vessel and trade as owners under a long-term lease, typically a bareboat charter. In particular, lease financing provided by Chinese companies, primarily for new vessels built in China, has, in recent years become a hugely important feature of global financing for shipping.

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Decarbonisation: new opportunities for financiers

If the shipping industry were a country on its own, it would be the sixth largest greenhouse gas emitter worldwide. Economic and regulatory pressures, including the much-discussed IMO 2020, have been building up and there is no question that it is time for all maritime stakeholders to start preparing for new decarbonisation challenges. In this blog we explore an internal pricing mechanism and an external collaboration, which each provide new opportunities for financiers to aid and profit from decarbornisation initiatives.

The main obstacle to industry-wide decarbonisation lies with the industry’s composition; it is largely privately owned, and both shipowners and charterers are driven by short-term cyclical patterns. So far, public environmental concerns have not effectively been translated into any tangible pressure.

Incentivising shipowners is further complicated by the fact that they are responsible for investing in fuel-efficient technologies whereas it is the charterers who, in most cases, pay for fuel. As a result, only a small part of the fuel savings are passed back to the shipowners.

Nevertheless, financiers have an important role to play in helping the industry move towards effective decarbonisation. There has been an increasing desire to hold greener portfolios, which stems from a practical need to mitigate against the risk of future (and more stringent) environmental regulations that could directly impact the value and liquidity of vessels, as well as the profitability of potential loans. The two strategies we explore below, could be the first steps towards financiers incentivising shipowners to invest in cleaner technologies. Continue Reading

LNG for 2020: IMO Sulfur Limits and the LNG Alternative

This blog post compares the uses of liquefied natural gas (LNG) as a marine fuel with other options for complying with the more stringent sulfur emission requirements of the International Maritime Organization (IMO) beginning in 2020 and then discusses the development of LNG as a marine fuel.

The IMO 2020 sulfur limit

The IMO is the United Nations agency tasked with setting global standards for safety, security and environmental performance in global shipping. In 1973 the IMO signed the International Convention for the Prevention of Pollution from Ships (MARPOL), and on May 19, 2005 the provisions for preventing air pollution from ships (Annex VI of MARPOL) came into force. Over the past decade the IMO’s Marine Environment Protection Committee (MEPC) has been lowering the emission limits set forth in Annex VI for sulfur as well as other pollutants such as nitrogen oxide. Ships had originally been permitted sulfur emissions of 4.5 percent, but after several incremental reductions the MEPC confirmed in October 2016 that the new sulfur emissions limits effective January 1, 2020 are 0.5 percent globally and 0.1 percent in IMO-designated emission control areas (ECAs). Continue Reading

Bankruptcy Hypotheticals for Equipment Lessors to Consider

No equipment lessor wants to find itself a creditor of a lessee in a reorganization case under chapter 11 of the U.S. Bankruptcy Code (the Bankruptcy Code).  However, when such a situation arises, a lessor is not without recourse – even where the facts give rise to situations not specifically addressed by the Bankruptcy Code.  This post considers two scenarios highlighting the exposure creditor-lessors may face in the bankruptcy context and provides guidance for minimizing risk of losses: first, when a debtor-lessee continues to use the subject equipment without payment; and second, where the debtor-lessee no longer uses the subject equipment but has not rejected the underlying lease.

The treatment of unexpired leases and executory contracts (which encompasses equipment leases) is codified in section 365 of the Bankruptcy Code.  Section 365 provides, in relevant part, that a chapter 11 debtor-lessee is required to perform under the equipment lease after 60 days from entry of the order of relief until the lease is assumed or rejected.[1]  A chapter 11 debtor-lessee may assume or reject an equipment lease any time before confirmation of the chapter 11 plan.[2]  The time period between the bankruptcy filing and the time the equipment lease is assumed or rejected is, in effect, the “limbo period.”  With the exception of the debtor-lessee’s obligations under section 365(d)(5), during the limbo period, the lease is enforceable by, but not against, the debtor-lessee.  Accordingly, it is in this limbo period where equipment lessors can be most vulnerable to non-payment and depreciation in the value of the equipment, for example through continued use or lack of maintenance.  It is this exact potential exposure that section 365(d)(5) should minimize.  Yet, as the hypothetical scenarios illustrate, provisions of the Bankruptcy Code may assist in minimizing lessors’ potential losses, but lessors must play an active role to maximize the protections afforded by the Bankruptcy Code.

Consider the following:

  1. A lessee files for bankruptcy protection, continues to use equipment subject to a lease, but does so without making payments (or without making the full contract-rate payment) to the lessor during the limbo period. What recourse, if any, does the lessor have?
  2. A lessee files for bankruptcy protection, does not make any payments to the lessor, but is not using the subject equipment. What can the lessor do?

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Republic Airways Holdings, Inc.: Liquidated damages under attack in U.S. Bankruptcy Court (again)

In a decision with sweeping consequences for equipment lessors, the bankruptcy court (SDNY) in Republic Airways held that a liquidated damages provision in a true lease is an unenforceable penalty if it provides for the unconditional transfer of residual value risk or market risk only upon default, without a cognizable connection to any anticipated harm caused by the default itself. Importantly for lessors and lenders alike, the bankruptcy court held that the unconditional guaranties of such obligations in favor of the lessor violated public policy and were unenforceable.

Background

The agreements at issue were true finance leases (aircraft leases) that had been rejected in the bankruptcy case. The leases provided that, upon default, the lessee must pay (i) any unpaid basic rent for the aircraft plus (ii) liquidated damages. The leases calculated liquidated damages in one of three ways:

  1. the stipulated loss value minus the present fair market rental value of the aircraft for the remainder of the lease term; or
  2. the stipulated loss value minus the fair market sales value of the aircraft;1 or
  3. the present value of the rent reserved for the remainder of the lease term minus the fair market rental value of the aircraft for the remainder of the lease term.

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The Greek Civil Code visits the English High Court: Personal guarantees, defences and competing applicable laws

Whenever interrelated contracts apply, different laws, issues and defences may arise owing to the discrepancies between the applicable legal systems. In HSBC Bank PLC v. Pearl Corporation SA and Ors, the High Court had to consider Greek law defences to a personal guarantee, governed by Greek law, in the context of a loan agreement governed by English law. It was held that on the particular facts the defences under Greek law failed. Nevertheless, such defences may be available in a future similar case in the context of different circumstances.

Personal guarantees in the Greek shipping market

It is not uncommon in the Greek shipping market, for personal bank guarantees to be governed by Greek law in the context of loan agreements governed by another legal system, usually English law. Why, one may ask, would someone do this? There are several reasons put forward for such an arrangement. First, as a matter of Greek law, consideration is not a prerequisite for contracts. A valid guarantee may be issued without referring to actual or ‘iconic’ consideration. Secondly, in the context of the Greek shipping market, the guarantors are usually domiciled in Greece, with personal assets there. Thirdly, Greek banks and the Greek branches of international banks are usually more familiar with Greek guarantees. Therefore, for various largely practical and historical reasons, such a practice prevails in the Greek shipping market. However, such an arrangement gives rise to potential issues and arguments that would not have arisen if the guarantee was governed by the same law as that of the loan agreement.

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California’s new commercial financing disclosures

Newly-effective California law requires a non-bank provider of commercial financing to present its financing recipient with certain consumer lending-style cost disclosures at the time when making an offer of commercial financing, and to obtain the recipient’s signature on the required disclosure before consummating the financing. While effective now, parties need not comply with the new law for an undetermined period of time.

California Senate Bill 1235 was approved and filed on September 30, 2018, creating a new Division 9.5 of the California Financial Code effective on January 1, 2019. However, financing providers need not comply with new Division 9.5 (the “Commercial Disclosure Requirement”) until the effectiveness of final regulations to be adopted by the Commissioner of Business Oversight, for which no deadline has been established.1 The Department of Business Oversight (“DBO”) invited comments on the content of such regulations, which comment period closed on January 22, 2019.2 No such regulations (either in draft or final form) have been adopted to date; no guidance has been provided by the DBO as to when such regulations will be issued.

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UK insolvency shake-up

On August 26, 2018, the UK government issued its response to its consultation on insolvency and corporate governance. The consultation sought views on how the risk of company failure could be reduced by improving the corporate governance and insolvency framework. The response summarized the views and comments received during the consultation, and sets out a number of proposals that will have significant implications for English companies and their creditors and investors. At the heart of the proposals is a desire to ensure there are a range of transparent rescue procedures that allow companies to restructure or seek new investment, in order to give them a greater chance of survival, while also ensuring fair and efficient procedures to protect the interests of creditors. The proposals mean that the government will seek measures that:

1. Ensure greater accountability of directors in group companies when selling subsidiaries in distress:

  • This measure will apply to large subsidiary companies.
  • Directors of the holding company who do not give due consideration to the interests of stakeholders of a financially distressed subsidiary when it is sold may be subject to disqualification action if that subsidiary enters insolvent liquidation or insolvent administration within 12 months of sale.
  • Directors of the holding company will need to provide evidence that they had a reasonable belief at the time of the sale that the sale would likely deliver a no-worse outcome for the stakeholders of the subsidiary than putting it into a formal insolvency process in order to avoid disqualification.

2. Enhance existing recovery powers of insolvency practitioners in relation to value extraction schemes: Continue Reading

TRAC leases as disguised financing transactions: recent developments and a reminder about TRAC neutral statutes

For many decades, companies in the business of leasing “over-the-road” vehicles such as trucks, tractors, and trailers, have used terminal rental adjustment clause (TRAC) leases to maximize the value they can provide to their customers. Traditionally speaking, TRAC leases combine the tax advantages of leasing with an option to purchase the equipment at the end of the lease term for a residual amount determined at the inception of the lease. Since 1981, it has been well-settled that TRAC leases constitute “true” leases, and not disguised financing transactions, for federal tax purposes. See, e.g., Swift Dodge v. Commissioner, 76 T.C. 547 (1981); affirmed Swift Dodge v. Commissioner of Internal Rev. 692 F.2d 651 (9th Cir. 1982). By contrast, however, whether TRAC leases are treated as true leases or disguised financing transactions in the context of a bankruptcy case is anything but settled.

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Financing of Scrubber Units and Emissions Technology

As part of a concerted move by the shipping industry community to reduce the environmental impact of shipping, the International Maritime Organization (IMO) has introduced regulations to reduce sulphur oxides emissions. These regulations require ships operating outside designated emission control areas to burn marine fuel with a limit of up to 0.5 per cent sulphur content by January 1, 2020, or install scrubber units into exhaust stacks to continue to burn High Sulphur Fuel Oil (HSFO) bunkers. As a result, the financing of scrubber units alongside other emissions technology is an increasingly important topic and this blog sets out some of the key issues in what remains a relatively novel asset class for financing.

Scrubber units

Scrubber units are one of the more prominent emissions technology options that aim to reduce component gases such as nitrogen and sulphur oxide in exhaust emissions from vessels. Marine scrubber units remove sulphur oxides from exhaust emissions in part by mixing these exhaust emissions with a water-based solution. Generally, scrubber units come in one of three forms: open, closed and hybrid. Open systems take on and discharge seawater. Closed systems use a freshwater solution in the ‘scrubbing’ process before discharge into the sea. Hybrid systems have both capabilities. In the process of treating the solution, prior to discharge, sludge is created and this sludge must be retained onboard before disposal onshore.

The cost of fitting scrubber units will vary based on whether they are retrofitted or installed onto newbuilds, but most analysts expect these costs to be recouped within several years of fitting. An important consideration for these assumptions will be the availability of HSFO bunkers and the price spread of high and low sulfate bunkers, which will be a key factor for the expected returns on scrubber units. As scrubber unit technology becomes more cost efficient and improves over time, the installation of scrubber units may become an increasingly attractive option.

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