The conventional types of securities taken for asset based financing are insufficient when the asset is a ship. Due to the ship's movable and international nature, it is susceptible to claims from third parties who are, by law, conferred in rem rights (i.e. rights against the vessel itself, as distinct from those against its often elusive owner). Looking to the ship itself as the collateral for financing should never be sufficient for a prudent financier.
The primary form of insurance protection financiers almost always require is a security assignment of the shipowner’s rights and interests under the vessel's hull and machinery insurances. However the financier's position as an assignee (and often, as loss payee as well) is only as good as that of the original assured. In the event of total loss of the vessel, and if the shipowner's insurance policies do not respond, or if unpaid liabilities exceed the ship's value, the financier will be left with no alternative security.
Since 28 December 2009, we have seen increased cross border loans from banks and financial institutions in Singapore participating in the Internationalisation Finance ("IF") Scheme sponsored by IE Singapore. This has allowed access to financing for many Singapore based shipowners who are looking at increasing their fleet for operations or for charter to overseas projects.
The availability of insurances for the financier-mortgagee has helped ease the concerns of financiers in such cross border financing. There are basically three insurance policies designed to protect the mortgagee's interest, namely, Mortgagee's Interest Insurance ("MII"), Mortgagee’s Additional Perils (Pollution) Insurance ("MAP") and Mortgage Rights Insurance ("MRI").
While financiers are familiar with MII and MAP, MRI has recently gained popularity as more and more Singapore assets, including ships, are being positioned or chartered in emerging third world countries, notably in the Middle East.
Mortgagee's Interest Insurance
The assured is the mortgagee (not the shipowner). The risk insured is the mortgagee's losses in the event that the hull and machinery insurance, war risks insurance and/or protection and indemnity club ("P&I Club") insurance (collectively, the "Owner's Policies and Club Entries") do not respond to a claim in certain circumstances: typically, if the shipowner is in breach of its seaworthiness, trading or class warranties, or its duty to disclose, which results in nonpayment under the Owner's Policies and Club Entries, in whole or in part. Since the mortgagee's position as an assignee and loss payee is only as good as that of the original assured shipowner, the mortgagee is exposed to nonpayment risks, and MII steps in to protect the mortgagee against such risks. The sum which can be claimed would be the mortgagee's losses, i.e. the loan outstanding, at any point of time, subject to a maximum sum insured.
Mortgagee's Additional Perils (Pollution) Insurance
MAP came about in 1990 in the United States of America following the Exxon Valdez oil spill catastrophe, in which liabilities came up to a whopping US$3 billion. MAP indemnifies mortgagees to the extent of their loss under a loan caused by the ship responsible for pollution incidents where the liabilities against the shipowner exceed the liability limit insured by the shipowner. P&I Clubs' cover for oil pollution is limited to only US$1 billion for any one incident.
To mortgagees, the MAP cover is important because these risks arising out of pollution related claims against a ship are very real:
- the risk that a pollution related claim will exceed the shipowner's financial resources, thereby putting its mortgaged ships in risk of seizure under a maritime lien (which rank ahead of registered mortgages); or
- the risk that the ship's financier may be found liable for environmental claims.
MAP insures the financier for the amount of its nett loss under the loan, in the event that the ship is seized to satisfy the pollution liabilities which exceed the limit of liabilities under the Owner's Policies and Club Entries.
Mortgage Rights Insurance
If a mortgaged asset or ship is deployed to, or flagged or chartered into, jurisdictions with cross border sovereign problem, there are risks:-
- that the asset or ship will be confiscated, deprived, seized, compulsorily acquisitioned, appropriated, expropriated, detained, nationalised, or restrained;
- of refusal by the foreign government to allow the mortgagee to exercise its rights of repossession in the event of default;
- of refusal by the foreign government to allow the mortgagee to remove the insured asset or ship from the foreign country;
- of refusal by the authorities of the flag country to allow the mortgagee to deregister the insured ship, including refusal to issue a deletion certificate or a closed transcript;
- of refusal by the authorities in the foreign country to allow the mortgagee to obtain or to remit the proceeds of sale following a sale or disposal;
- of refusal by the foreign government and/or authorities of the flag country or the United Nations to allow the mortgagee to exercise its rights to repossess and/or remove the insured asset as a result of sanctions being imposed on the foreign country or flag country by or at express instruction of the United Nations or any future supranational authority embodied with similar powers.
MRI insures the mortgagee against risks which prevent the mortgagee from enforcing its security and recovering its losses. Before accepting the risk cover, insurers would have to be assured that no such risks exist under the prevailing laws or regime of the foreign country or flag. Invariably, insurers will insist, prior to accepting the risks, that the mortgagee provides a legal opinion, from a suitably qualified independent lawyer in that foreign country, confirming that the prevailing laws of the foreign country do not prevent or hinder the mortgagee from enforcing the mortgage nor will the existing laws impair the mortgagee's priority rights. In many cases, the challenge lies not only in getting a legal opinion confirming that no such risks exists under the prevailing laws or regime, but in finding "a suitably qualified independent lawyer" in such countries.
Parting note to financiers
In order for the three mortgagee insurances to respond to any claim, the mortgagee has to ensure that it has a valid mortgage under the relevant jurisdictions' laws. Mortgagees must also ensure that adequate Owner's Policies and Club Entries are always in place, endorsed to the extent of the mortgagee's interest and maintained throughout the currency of the covers, for insured values no less than the sum insured under the mortgagee insurances.