Partner London
"The world of shipping has always had its traditions and unspoken conventions when it comes to performing sale and purchase transactions."
The world of shipping has always had its traditions and unspoken conventions when it comes to performing sale and purchase transactions. Before the pandemic, it was a matter of course that documents would be tabled and released against payment. Nothing written was required to establish between the parties exactly what “tabling” meant; it was commonly accepted this was understood between the parties (although the number of instances involving people in locked-up rooms seem to suggest there may have been disagreements). Even with the move to mostly virtual closings that started with the pandemic, this fundamental understanding has not changed.
These shipping traditions also include the way that a payment of the purchase price and extras can be made.
More recently, however, long established certainties as to how the payment will be made, have become uncertain, making life for both parties to a sale and purchase transaction harder. At least for one of the parties, there is a real risk involved if the payment mechanics are unclear
The established routes
- Some will remember a time, well before the 2009 financial crisis, when both the outgoing mortgagee and the seller would accept a simple payment letter from the buyer’s bank. Meaning, an original of a letter signed by the incoming mortgagee bank promising the outgoing mortgagee payment. In some rare cases, this method is still possible between certain banks, but for the most part it is now historic.
"More recently, however, long established certainties as to how the payment will be made, have become uncertain, making life for both parties to a sale and purchase transaction harder. "
- For many years, the predominant way of effecting payments has been by a SWIFT payment from bank to bank, either by a direct SWIFT transfer or by way of MT199 instructions.
a. MT199
This payment method requires a SWIFT message for the actual transfer of the funds (MT103) and a supplemental SWIFT message with instructions on what to do with the funds (MT199). At the core of this method is the order to the recipient bank to hold the funds in a suspense account and only to release the funds to the account of the counterparty (i.e. the seller or builder) once the conditions specified in the MT199 have been met. These conditions would typically be the presentation of a separate release letter or a protocol of delivery and acceptance signed by both parties to the underlying transaction (and, if an incoming mortgagee is involved, countersigned by its representative).
Many banks that were traditionally able to offer this payment method have stopped doing this in the last 10 years or so (or in some cases just certain branches of banks). The issue seems to be the fact that the funds go into a suspense account first, making compliance with KYC and other rules harder to evidence.
Some banks fix this issue by instructing their correspondence bank to stop the transfer until they have received instructions from the recipient bank to proceed (which they will give once the conditions set out in the MT199 message have been met). This, however, is not accepted by all remitting banks.
If it is not communicated clearly from the outset whether the recipient bank can work with a suspense account, valuable time can be lost in establishing the payment route.
b. Direct SWIFT transfer
A SWIFT transfer can also be used to effect a direct payment to the seller or builder into a closing meeting once the parties are ready to proceed. This of course depends on the overall duration of the closing meeting and the relative time zones of the outgoing ship register, the incoming ship register, the closing meeting and the ship, also bearing in mind the New York opening for the clearing of US dollar payments.
However, even this is not always possible, given that payment by SWIFT requires participating banks to conduct KYC checks on each other and to exchange authentication keys.
Not all financiers are willing or able to do this, especially if they are not a commercial bank but, say, a leasing house, and do not have a commercial bank involved. Even where parties on both sides of the table have banks that are able and willing to support a payment by SWIFT, it still takes time to set this up.
- The gap left by the demise of SWIFT in the maritime space has for a long time been bridged by escrow agreements. The escrow route requires agreements on the identity of the escrow agent and on the contents of the escrow agreement. Both can be painful to achieve. Depending on financing arrangements, the in- and outgoing lenders may need to be party to the escrow agreement. Often an escrow agreement is concluded, without lender participation or review, even before the incoming lenders are told of intended sale. Typically, this means that amendments will be required, but it can be difficult to convince the respective other party and the escrow agent to amend an agreement once signed.
"Shipbuilding contracts are usually very specific in their requirements, e.g. pre-positioning of funds three days prior to closing, use of MT199 etc. A buyer who is unable to comply with these requirements will have to negotiate its way of this situation, which may well come at price."
The issues
- shipbuilding contracts are usually very specific in their requirements, e.g. pre-positioning of funds three days prior to closing, use of MT199 etc. A buyer who is unable to comply with these requirements will have to negotiate its way of this situation, which may well come at price;
- for second-hand tonnage, a typical Norwegian Saleform MoA simply requires payment;
- the main issue is time: typically a fair amount of detail must be clarified even after the parties have already committed to the MoA: The time it takes to carry out KYC and other compliance checks on the counterparties that will inevitably be required by financiers and shareholders, the time is takes to liaise with any outgoing and incoming mortgagees to establish the order of closing steps, the time to agree on the closing procedure and then set it up, all eats up the period for completion that the parties signed up to in the MoA and moves the transaction close to or beyond the cancelling date;
- we see a trend that the established order of closing procedures (all parties confirm readiness in physical or online meeting, PDA is signed but not dated/timed, mortgage is deleted and receipt of proof of deletion triggers (release of) payment, PDA is timed, all docs are released) is being challenged by some players;
- this reinforces the importance of agreeing on as many details as possible before committing to a MoA. Often bespoke MoAs already contain closing procedures. This keeps the risks for the parties at bay provided they checked beforehand that they are able to commit to that procedure; and
- even if all details are agreed upfront, the application of sanctions provisions can mean funds are held up pending clearance of perceived issues. Common occurrences are the spelling of ship names in capital letters, or the specific name of a ship as such, that can trigger checks.
The risks
Which party bears the risk if the payment mechanics in relation to a ship sale and purchase transaction cannot be agreed? Or if they are agreed but funds are held up due to (perceived) sanctions issues?
- payment must be made to “Sellers’ Account” as defined in the MoA (Saleform 2012). According to Clause 3, payment must be made “on delivery of the Vessel, but not later than three (3) Banking Days after the date that Notice of Readiness has been given in accordance with Clause 5 (Time and place of delivery and notices)”;
"Which party bears the risk if the payment mechanics in relation to a ship sale and purchase transaction cannot be agreed? Or if they are agreed but funds are held up due to (perceived) sanctions issues?"
- notice of Readiness shall be given “when the Vessel is at the place of delivery and physically ready for delivery in accordance with [the MoA]”;
- if NoR is therefore duly given, the payment is due latest three banking days after receipt of the written NoR, even if the Vessel has not been delivered; and
- failure by the Buyers to pay the Purchase Price in accordance with Clause 3 (Payment) will result in the Sellers’ right to cancel the MoA, retain the Deposit and, if the Deposit does not cover their loss, to claim further compensation for their losses, viz. Clause 13.
This illustrates the importance of checking with the account bank that they are able to make a transfer to the “Sellers’ Bank”/“Sellers’ Account” before the MoA is signed.
How does a mortgage change the picture?
- Pursuant to clause 9 of the MoA (Saleform 2012), the Sellers warrant that the Vessel is free from encumbrances, including mortgages. Even though this is worded as a warranty, in this clause, this term should be regarded as “innominate” or “intermediate” term. If the promise was only a warranty, the Buyers would not be able to refuse to take delivery even if encumbrances, such as a mortgage, were known to the Buyers. By contrast, if the promise is “innominate” or “intermediate”, then whether the Buyers can reject delivery of the Vessel or terminate the contract, will depend on the nature and consequences of the Sellers’ breach of that promise. A registered mortgage remaining on the ship that is to be sold would certainly constitute a breach that is sufficiently serious to reject delivery.
- Usually, a lender would not be prepared to delete the mortgage before they are assured that the release will trigger the payment to them.
- We have recently seen cases where it was very challenging to agree on a closing procedure. What happens then if no agreement can be reached by the cancelling date?
"Parties should no longer take it for granted that an agreement on the payment mechanics will be agreed at a later stage."
- If by that time there is still a mortgage registered against the Vessel, and the Sellers are unable to discharge the mortgage by other means, the Buyers can reject delivery. In that case, the Sellers would have failed to validly complete the legal transfer of the Vessel, and therefore, the Buyers would be able to cancel the MoA under clause 14. Clause 14 requires the Sellers to return the Deposit and, if their failure to complete is due to proven negligence, to compensate the Buyers for their loss.
Conclusion
Parties should no longer take it for granted that an agreement on the payment mechanics will be agreed at a later stage. The payment mechanics should receive their full attention at the signing of the shipbuilding contract and/or MoA, and the relevant account banks and (if applicable) incoming and outgoing mortgagee banks should be roped in at an early stage, and if at all possible before signing, to make sure the chosen route is feasible.
Click here to view the articles in our Maritime Matters: Finance and Beyond series
Key contacts
Partner London
Partner Hamburg
