Mechanisms to Protect Against the Risk of Non-Payment by Shipyards and Shiprepairers

I. Introduction

In any commercial or industrial activity involving the exchange of goods or services, there is a risk for the supplier that he will not be paid for his goods or services. To avoid these risks, market operators can take appropriate contractual measures or assert the rights that the legal system, the law, grants them.

The risks of non-payment are not particularly higher in the shipbuilding or ship repair sector than in any other sector under consideration. However, due to the type of asset on which the entire maritime shipbuilding or ship repair business is based, the ship, sometimes under foreign flag and ownership, protection against such risks of non-payment deserves special attention.

Many shipowners are organised under single-ship corporate structures, which means that with the vessel gone, the shipping company is undercapitalised and collection of claims against it becomes impossible.  The mobility of ships, which can easily change jurisdiction, can also add complexity to the recovery of claims in cases where there are no other known assets of the shipping company in the jurisdiction where the shipbuilder or ship repairer operates.

In order to protect their interests, both shipbuilders and ship repairers can implement contractual mechanisms that best protect their claims. There are also legal mechanisms that the legislation provides to these operators with the same protective purpose. In this article we will try to explain some of these mechanisms.

II. Contractual Mechanisms:

When we talk about contractual mechanisms, we refer to preventive measures that can be agreed in shipbuilding or ship repair contracts. There is no legal limitation to adopt this type of contractual covenants, so the will of the parties and the creativity of their legal advisors are the limit. The most common mechanisms that shipbuilders or ship repairers usually adopt are:

(a) Advance payments:

The provision of funds by the shipowner prior to the execution of the work is a common preventive solution to ensure that the shipbuilder or repairer has the necessary resources during the shipbuilding or repair process.

Most commonly, milestone payments are agreed. Through this mechanism, the shipowner makes advance payments based on the achievement of milestones during the construction or repair process, ensuring that the operator receives funds as the work progresses.

This system usually involves the issuing of refund guarantees by the builder/repairer in favour of the shipowner in case the work for which the latter has made the advance payment is not executed as agreed.  The mechanism therefore has a banking/financial cost for the shipbuilder/repairer.

(b) Requiring Sureties or Enforceable Guarantees:

Payment guarantees are another effective form of protection for shipbuilders and ship repairers.  Through this mechanism, the shipowner provides the shipbuilder/repairer with a separate payment guarantee, so that in the event of non-payment by the shipowner, the guarantor, under the guarantee contract, is obliged to make payment on first demand. The most common guarantees are:

  • Bank Guarantee: In this case the guarantor is a bank that will issue a guarantee on first demand in the event of non-payment and up to the agreed monetary limit.

If certain requirements are met, this type of bank document is directly enforceable before the Spanish courts.  The cost of this banking instrument is generally borne by the shipowner.

  • Personal Executive Payment Guarantee: With due formalities, this instrument functions in a similar way to a bank guarantee. In this case the guarantor is a natural or legal person whose solvency is known to the constructor/repairer. By means of this guarantee this person guarantees with his present and future assets the non-fulfilment of the payment obligation by the shipowner.

(c) Retention of Ownership of the Ship.

Finally, we would like to comment on this mechanism of retention of ownership of the ship until the shipowner pays the price. Due to its nature and operation, this contractual solution is reserved for shipbuilders, as it will be difficult or impossible for ship repairers to implement.

It involves retaining ownership of the vessel built until full payment by the shipowner. So that in the event of non-payment the shipbuilder can sell the ship to the highest bidder in order to collect the amount owed. If the market value of the ship is less than the price owed by the shipowner, the contractual arrangement should provide that the shipbuilder will continue to have a claim against the shipowner for the remainder.

In order to guarantee its effectiveness and proper operation, it is advisable to register the construction project in the name of the builder. In this way, if the shipowner’s non-payments are widespread, the registration of the ownership of the project in favour of the builder will prevent third party creditors of the shipowner from enforcing their claims against the vessel.

III. Legal Measures.

Spanish legislation provides shipbuilders and ship repairers with additional mechanisms that they can articulate without having to expressly agree on them. These mechanisms are mainly the following:

(a) Retention of possession of the vessel.

Article 7 of the International Convention on Ship Mortgages and Privileged Maritime Claims 1993 together with section 139 of the Shipping Act 2014 enables the builder and repairer of a ship to retain possession of the ship until they are paid what is due to them in respect of its construction or repair.

Certain requirements must be met:

  • In order to be retained, the ship must be in the possession of the shipbuilder or repairer. That is, the detention must operate prior to delivery and as long as the ship is on the premises or in the possessory custody of the shipbuilder’s or repairer’s personnel.
  • Retention is to be exercised for claims arising from the shipbuilding or ship repair contract, not for other claims.
  • The vessel that has generated these unpaid claims should be retained, not against another vessel.

It is important that all these requirements are scrupulously respected, otherwise there is a risk of improperly exercising the retention, which could lead to civil and even criminal liability.

Certain rules of the Civil Code apply to this lien which result in a lien on the ship. Some authors therefore argue that the shipbuilder or repairer of the ship can ask for the ship to be sold at public auction once the shipowner’s obligation to pay has expired. Thus the measure is sufficiently effective to persuade a shipowner to pay.

The Maritime Navigation Act 2014 only states that, if the compulsory sale occurs while the ship is retained by the shipbuilder or repairer, ‘the latter shall deliver possession of the ship to the buyer, but may obtain payment of his claim with the proceeds of the sale after satisfying those of the holders of maritime privileges… and before mortgage claims and other registered or noted encumbrances’. Thus, the shipbuilder or ship repairer will have preference of collection over ship mortgages and ordinary creditors, but not over privileged maritime claims (accruals in favour of the crew, compensation for death or personal injury caused by the ship, prizes for maritime salvage, port and pilotage fees and material damage caused by the ship due to non-contractual fault).

Since possession of the ship is a prerequisite for the lien, once the ship is delivered the lien and its collection preferences are extinguished.

(b) The Preventive Vessel Attachment:

The freezing of ships is a legal tool that enables the shipbuilder or repairer to secure the immobilisation of a ship wherever it is located in order to guarantee the collection of his claim.

This precautionary, preventive and urgent judicial measure can also be qualified as a burdensome measure due to the economic damage it can cause to the operator of the vessel, such as delays in its navigation, unforeseen costs due to its stay in a port, etc. It can also be a costly measure for the person requesting the seizure if it is wrongly or improperly proposed.

This measure is regulated by the International Convention on Arrest of Ships (Geneva 1999), the LNM and the Spanish Civil Procedure Act.

The immobilisation of the ship may be replaced by the provision of security by the shipowner/shipowner to the seizing court, since the ultimate objective of the attachment is to ensure the effectiveness of a subsequent judgment on the merits of the claim (‘maritime claim’) and thus to guarantee the creditor/shipper the possibility of enforcement.

In the event that the lien is unjustifiably or improperly applied for, the shipowner/shipowner of the vessel is entitled to claim any damages resulting from the lien.

The requirements are as follows:

  • Allegation of a ‘maritime claim’: The list of so-called ‘maritime claims’ is contained in Article 1(1) of the 1999 Geneva Convention, which includes, in paragraph (m), shipbuilders‘ or ship repairers’ claims;
  • attachment of the ‘offending ship’: attachment of the ship causing the claim is permitted provided that the person who was the owner/bareboat lessor of the ship at the time when the claim arose is still the owner/bareboat lessor at the time the attachment is requested. Under certain conditions it also provides for the possibility to seize other vessels owned by the person liable to pay (‘sister ships’).
  • the obligation for the attaching creditor to deposit a security: its purpose is to guarantee that in the event that the attachment is improperly requested, the damage caused to the shipowner/shipowner can be economically alleviated. At present, the minimum amount for this security is 15% of the alleged claim.
  • Where the application for attachment is made as an interim measure prior to the filing of the claim on the merits, it will lapse if the builder/repairer fails to commence proceedings on the merits before the competent court within the time limit set by the attaching court.

In short, this is a very effective precautionary measure that allows the builder or repairer to obtain sufficient security for his claims.

IV. Conclusions

It is a fact that shipbuilders and ship repairers face risks of non-payment by shipowners in their day-to-day business.

To protect against this risk there are a variety of solutions, both contractual and legal, which it is always and in any case advisable to bear in mind in order to minimise the risks to which builders and repairers are subject, all the more so when we are talking about foreign vessels and shipowners without a presence in our territory with complex corporate structures.

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