Ships costs millions of dollars and represent significant capital investments. Ships have anticipated trading lives of about 25 years. Rarely, ship owners may be able to self-finance, but many ship owners need to borrow funds to finance the acquisition of ships. Some ship owners may choose to borrow so to preserve sufficient liquidity for ship operations. Financial institutions or banks that provide funds to ship owners, demand security for their investments in order to to protect the lenders (financial institutions or banks) against the possibility of defaults by the borrowers (ship owners).
Preferred Ship Mortgage
Preferred Ship Mortgage is vital component of marine financing and financial security which was established by individual flag-state laws. Preferred Ship Mortgage are duly recorded in the ships’ flag-state registries and are generally recognized world-wide.
Ship Mortgage is a document by which a Shipowner (Mortgagor) conveys a security interest in the ship to a Creditor (Mortgagee). Ship Mortgage gives the Creditor (Mortgagee) rights in the ship, as security for a debt owed by the Shipowner (Mortgagor) to the Creditor (Mortgagee).
Generally, a Ship Mortgage gives a number of rights and remedies to Creditor (Mortgagee), in the event of a default by the Shipowner (Mortgagor).
Ship Mortgage that satisfies the specific requirements of the flag-state’s law on ship mortgages and is duly recorded with the ship registry may be granted the status of a preferred ship mortgage. Two most significant consequences of making a ship mortgage a Preferred Ship Mortgage are:
- Right to enforce the mortgage in maritime courts worldwide
- Priority of the rights given by the ship mortgage against third parties
Ship Mortgage is enforceable by Creditor (Mortgagee) against Shipowner (Mortgagor) as a matter of contract. Foreign court may or may not be willing to entertain a foreclosure action, or may not recognize the mortgage claim against the ship in a ship arrest proceeding brought by a third party. Third parties who may not be aware of the ship mortgage may also obtain rights in the ship that could defeat the interests of Creditor (Mortgagee.
On the other hand, when a ship mortgage that has been granted preferred status (Preferred Ship Mortgage), Preferred Ship Mortgage will be enforceable in almost all maritime courts world-wide, with a High Priority, above liens for supplies, but below liens for salvage and crew wages.
When Preferred Ship Mortgage is duly recorded with the Ship’s Registry under the relevant statute, preferred ship mortgage gives presumptive notice to the world of the Creditor’s (Mortgagee) interests. Preferred Ship Mortgage allows an internationally recognized preferred priority against certain liens on the ship and other rights.
Ship Mortgage Act
In United States, Ship Mortgage Act 1920, amended as Commercial Instruments and Maritime Lien Act, governs:
of Preferred Ship Mortgages on U.S.-flag ships.
In order to create a valid preferred ship mortgage under U.S. law:
- Ship Mortgage must include the whole of the ship
- Ship Mortgage be filed in substantial compliance with the recording requirements of the Ship Mortgage Act
- Ship Mortgage must cover a ship that is documented under the U.S. flag or that has filed an application for documentation under the U.S. flag.
United States Preferred Ship Mortgage, enforceable against third parties, recording requirements:
- Ship Mortgage must identify the ship, which means that it must state not only the name, but the ship’s official number
- Ship Mortgage must state the name and address of each party to the mortgage Creditor (Mortgagee) and Shipowner (Mortgagor)
- Ship Mortgage must state the amount of the direct or contingent obligations that is or may become secured by the mortgage, excluding interest, expenses, and fees
- Ship Mortgage must expressly state the interest of the Shipowner (Mortgagor) in the ship
- Ship Mortgage must state the interest mortgaged
- Ship Mortgage must be signed by Shipowner (Mortgagor)
- Shipowners (Mortgagor’s) signature must be acknowledged by a notary public
In United States, in order to record a preferred ship mortgage so that it can be perfected as against third parties, ship owner must file the mortgage with United States Coast Guard at its National Ship Documentation Center in West Virginia (NVDC).
Ship owners can file a Preferred Ship mortgage by filing electronically through email. But, National Ship Documentation Center in West Virginia (NVDC still accepts paper filings for preferred ship mortgage. When Shipowner (Mortgagor) files a preferred ship mortgage electronically, Shipowner (Mortgagor) must hold the original document, and may also need to hold evidence that a person signing the mortgage was authorized to do so by Shipowner (Mortgagor).
United States Coast Guard may reject a mortgage filing as defective. Under the Ship Mortgage Act 1920, preferred mortgage by definition must be filed in substantial compliance (prospective creditors can find the pre-existing preferred ship mortgage lien with reasonable effort) with section 31321 of this title. Hence, United States Coast Guard may reject a mortgage that is not filed in substantial compliance with Ship Mortgage Act 1920 requirements. Minor mistake in the name of the creditor (mortgagee) or other clerical errors will not render a preferred ship mortgage invalid.
Generally, Creditor (Mortgagee) does not have to be United States citizen for a U.S.-flag ship mortgage. But, fishing ships with U.S.-flag that are over 100 feet in length and Jones Act ships (United States coast-wise trade), must have to be United States citizen for a mortgage recorded. Before 1996, Ship Mortgage Act 1920 required that Creditor (Mortgagee) must be United States citizen if it was not a state, the federal government or a similar entity.
Before 1996, in order to accommodate non-citizen Creditor (Mortgagee), trusts were interposed between Creditor (Mortgagee) and the ship known as Westhampton Trusts. In United States, Westhampton Trusts came from 1965 federal court decision finding that the sale of bonds to non-citizen secured by a mortgage on a U.S.-flag ship constituted a transfer of interest requiring federal government approval. Amendment 1996, eliminated the further need for Westhampton Trusts for non-citizen mortgagees.
Special Requirements for Fishing Ship Over 100 Feet, the person must be:
- eligible to own a ship with a fishery endorsement, generally meaning that the person is United States citizen individual, or a business entity with over 75% of its equity owned and controlled by United States citizens)
- a state or federally chartered financial institution that is insured by the Federal Deposit Insurance Corporation
- a farm credit lender
- established under Title 12, chapter 23 of the United States Code (a farm credit bank or credit association)
- a commercial fishing and agriculture bank established pursuant to state law
- a commercial lender organized under the laws of the United States or of a state and eligible to own a ship under the United States flag
- a mortgage trustee under subsection that is authorized under United States law to exercise corporate trust powers and meets certain other financial requirements
Ship Mortgage on a non-U.S. ship can be a preferred mortgage under United States law. United States recognizes foreign preferred ship mortgages that are valid under the relevant flag-state law as valid preferred mortgages for enforcement under United States law.
Preferred Ship Mortgage represents an ownership-like interest in a ship and is commonly enforceable in the maritime courts of most maritime nations.
Ship Mortgage Default
In the event of mortgage default by Shipowner (Mortgagor), Creditor (Mortgagee) may have a number of rights under the ship mortgage:
- Right to have the ship seized and sold by a maritime court, with the proceeds to be applied to the outstanding debt
- Right to exercise self-help, right to take over the operation of the ship, to carry out a private sale of the ship, right to bring suit for damages.
Preferred Ship Mortgage can cover more than one ship. Preferred ship mortgages are typically single ship documents. Many national registries permit a preferred mortgage to apply to more than one ship. Generally, preferred ship mortgages that cover more than one titled is called preferred fleet mortgages.
Ship Mortgages are not recognized as creating Maritime Liens under common law. Ship mortgages are creatures of statute, not common law.
In United States, under traditional Admiralty Law (maritime common law) financial lender to a ship owner had no special rights to obtain security in a ship. But, many maritime nations maintaining ship registries have enacted such statutes or laws granting ship mortgages a special maritime status. Furthermore, international conventions are developed to govern treatment and enforcement of ship mortgages.
Preferred Ship Mortgages Usual Terms:
- Representations, warranties and covenants of both borrower (mortgagor, ship owner) and lender (mortgagee, financial institution)
- Recordation of the mortgage
- Maintenance of the ship
- Registration of the ship
- Insurance of the ship
- Requirement to post a notice of the mortgage on the ship
- Rights of lender (mortgagee, financial institution) in the event of default
- Requirement that no avoidable liens arise against the ship, and compliance with the law
- Other miscellaneous terms
Standard Terms of a Preferred Ship Mortgage:
- Ship and Official Number
- Ship Owner Borrower (Mortgagor) and Address
- Percentage Owned
- Interest Mortgaged
- Mortgagee (Lender, Financial institution) and Address
- Type of Instrument
- Obligations Secured by Mortgage
- Evidence of Obligation
- Date of Mortgage
- Names of Parties and Date of the Mortgage
- Whereas (basis for the Mortgage)
- The Granting of the Mortgage
ARTICLE 1 Covenants of The Shipowner
- Section 1.1 Performance of Obligations
- Section 1.2 Ship Documentation
- Section 1.3 Ownership and Liens
- Section 1.4 Valid Mortgage
- Section 1.5 Citizenship of Mortgagor
- Section 1.6 Change of Flag
- Section 1.7 Legal Compliance
- Section 1.8 Payment of Fees and Taxes
- Section 1.9 Notice of Mortgage
- Section 1 .10 Arrest of Ship
- Section 1.11 Maintenance of the Ship
- Section 1.12 Access to Ship
- Section 1.13 Location of Ship
- Section 1.14 Discharge of Liens
- Section 1.15 Insurance
- Section 1.16 Requisition
ARTICLE 2 Events of Default And Remedies
- Section 2.1 Event of Default
- Section 2.2 Consequences of Default
- Section 2.3 Sale of Ship
- Section 2.4 Conveyance
- Section 2.5 Earnings of Ship
- Section 2.6 Receiver
- Section 2.7 Defense of Liens
- Section 2.8 Cumulative Remedies
- Section 2.9 Offer of Remedy by the Shipowner
- Section 2.10 Abandonment of Foreclosure Action
- Section 2.11 Application of Proceeds
- Section 2.12 Expenses Incurred in Mortgage
- Section 2.13 Possession of Ship
ARTICLE 3 Sundry Provisions
- Section 3.1 Amount of Mortgage
- Section 3.2 Amendments
- Section 3.3 Release of Secured Ship
- Section 3.4 Separate Discharge (fleet mortgage)
- Section 3.5 Supplemental Documents
- Section 3.6 Invalid Provisions
- Section 3.7 Successors and Assigns
- Section 3.8 Notice
- Section 3.9 Agents
- Section 3.10 Governing Law
- Section 3.11 Consent to Jurisdiction
- Section 3.12 Waiver of Jury Trial
- Section 3.13 Headings
- Section 3.14 Exhibits and Schedules
- Section 3.15 Related Agreements
- Section 3.16 Preferred Status
Ship Mortgage Documents
Preferred Ship Mortgages are usually not a stand-alone documents. Typically, preferred ship mortgage is part of a package of documents and agreements for a loan or other credit agreement. Transaction documents for a credit agreement will usually include:
- Credit Agreement (main document governing the transaction)
- Promissory note (document confirming the loan and the agreement to pay it back)
- Various security documents (provide some assurance to the lender)
In United States, Preferred Ship Mortgages can be enforced by the filing of a suit in the federal district court in whose territory ship is physically located, thereby giving the court jurisdiction over the mortgaged ship. Only federal district courts have jurisdiction to enforce a preferred ship mortgage filed with United States Coast Guard. Preferred ship mortgage can also grant rights to lender (mortgagee, financial institution) to enforce the mortgage by taking possession of the ship without court intervention which is called self-help.
Generally, self-help provisions can only be undertaken, if self-help provisions do not conflict with state law where the ship is located at the time. A lender (mortgagee, financial institution) can also sue borrower (ship owner, mortgagor), if the sale of the ship is insufficient to pay off the mortgage seeking a deficiency judgment. This action is also subject to the federal Ship Mortgage Act 1920. In order to enforce a mortgage, a maritime court will arrange to maintain custody of the ship and arrange for ship sale. When a ship sold by a maritime court with jurisdiction over the ship pursuant to the Ship Mortgage Act 1920, ship is sold free and clear of all liens. But, once the court starts the judicial sale, all other parties who have claims against the ship may come forward to claim a share of the proceeds of the ship.
There is the priority of a preferred ship mortgage with regard to other claims against the ship. Maritime court will allocate the proceeds of a ship sold by the court at a judicial sale in accordance with the Ship Mortgage Act 1920. Preferred ship mortgage will take priority over all claims against the ship, except:
- Court expenses and fees allowed by the court
- Preferred Maritime Liens
Preferred Maritime Liens that will take priority over the preferred mortgage include:
- maritime liens arising before a preferred mortgage was filed with the ship’s registry
- maritime liens for damage arising out of maritime tort
- maritime liens for wages of a stevedore when employed directly by the owner, master, ship manager, bare boat charterer, an agent, or a buyer in possession of the ship
- maritime liens for wages of seafarers of the ship
- maritime liens for general average
- maritime liens for salvage (including contract salvage)
Generally, here above rules are same whether the preferred ship mortgage is a United States preferred ship mortgage or another ship registry. For a non-U.S. preferred ship mortgage, a maritime lien for the provision of necessaries in the United States will take priority over the preferred ship mortgage, even if lien for the necessaries arose after the preferred mortgage was recorded.
Preferred Ship Mortgage covers the whole of the ship and all of ship appurtenances (equipment). Typical language in a preferred ship mortgage will also state whether the mortgage has a clause permitting the separate discharge of ships under the preferred fleet mortgage.
In United States, preferred ship mortgage can be assigned and retain its original priority so long as the assignment is filed and recorded with National Ship Documentation Center in Virginia. Preferred ship mortgage under the laws of registries other than the United States is also usually assignable. A person who is not a United States citizen can be a lender (mortgagee, financial institution) of a U.S.-flag ship in the coast-wise trade. Generally, non-U.S. citizen cannot operate a coast-wise qualified U.S.-flag ship upon foreclosure of a ship mortgage except if it is necessary for the immediate safety of the ship, for ship direct return to the United States or for ship movement within the United States, or for ship movement within the United States for repairs, dry docking or berthing changes, but only under the command of United States citizen.
Termination and Release of a Preferred Ship Mortgage:
Once borrower (ship owner, mortgagor) pays all underlying debt lender (mortgagee, financial institution) should execute a document releasing preferred ship mortgage. Satisfaction of Mortgage (Release of Mortgage) must identify the preferred ship mortgage precisely, by reference to its recordation information including:
- Batch Number (Document ID)
- Date and Time of Preferred Ship Mortgage Recorded
- Above information for any amendments or assignments of the preferred ship mortgage
Lender (mortgagee, financial institution) who does not file a release of the preferred ship mortgage on request of borrower (ship owner, mortgagor) violates the Ship Mortgage Act 1920 and may be subject to a civil penalty, in addition to liability for damages to borrower (ship owner, mortgagor). Lender (mortgagee, financial institution) may release some preferred ship mortgage, but not all of ships under a Preferred Fleet Mortgage. Ship mortgage may have a clause permitting the separate discharge of ships under the preferred fleet mortgage.
Generally, rules governing Preferred Ship Mortgages tend to be same, regardless of the registry. Rules governing preferred ship mortgages typically require an agreement containing certain required, specific information about the ship, with an unequivocal grant of an interest in the ship to lender (mortgagee, financial institution), and must be executed by an official of borrower (ship owner, mortgagor), with the signature acknowledged by a notarial act.
On the other hand, preferred ship mortgages are particularly subject to very Specific Rules, in whatever registry they are to be recorded. Certain registries require certain specific language to make the mortgage one that may be recorded.