Introduction
Impact on financiers of Malta flagged vessels
Navigating fallout from imposition of sanctions
Ship financiers' rights under Maltese law
Comment
The ship finance industry, as with all other industries, has been actively evolving to the new realities ushered in by the covid-19 pandemic. While the financing sector appears to have weathered the storm, with the dawn of the Russia-Ukraine crisis it may be heading toward a fresh period of uncertainty as a result of the latest wave of sanctions being imposed against the Russian Federation, Russian entities and Russian individuals.
Sanctions are tools of foreign policy designed primarily to condemn transgressions, to deter similar future behaviour and to cause a change in policy of a particular state or individual. The effectiveness of sanctions in achieving their goal is ultimately a contentious matter, which is dependent on several important considerations. Indeed, whereas the imposition of sanctions against Russia might appear a futile affair with respect to producing the desired abandonment of Russian military presence in Ukraine, these sanctions certainly do have the capability of producing economic effects of a certain significance.
It is in this context that the Russian attack on Ukraine elicited a decisive reaction by nations across the global, including Malta, with a considerable number of sanctions being imposed against Russia, Russian individuals and Russian entities. As more severe and far-reaching sanctions are being discussed, it is clear, even at this early stage, that the attack on Ukraine will have several consequences upon the ship finance industry, possibly impacting security and enforcement measures available to financiers of Malta flagged vessels.
Impact on financiers of Malta flagged vessels
A ripple effect to the sanctioning of individuals and entities and their restricted access to the global economic and financial system is the looming possibility of borrowers and obligors defaulting on ship finance loan facilities. The ship finance industry is no stranger to defaults as a direct result of sanctions. Between 2017 and 2018, international investment banks experienced several loan defaults on aircraft and yacht loans with reports suggesting that the loan defaults were directly linked to sanctions imposed by the European Union and United States against numerous Russian individuals and entities. Sanctions may, therefore, provoke unwelcomed complications in financial arrangement. In instances of ongoing financings, sanctions may result in obligors failing to meet their financial obligations across loan facilities or causing acceleration clauses to be triggered. In the case of new financing projects, sanctions could significantly limit the confidence and ability of financiers to lend to Russian entities and individuals, particularly at a time where the remit and extent of sanctions is fluid.
Ship finance loan facilities typically cater for instances in which the provision of a loan would become illegal following the imposition of sanctions on the borrowers, obligors or charterers who consequently become prohibited persons. The designation of a prohibited person will also extend to instances where the said obligors are owned whether directly or indirectly by such prohibited person. In addition to this, no proceeds of the loan may be made available, directly, or indirectly for a purpose prohibited by sanctions, without triggering an event of default. Accordingly, financiers will require that the obligors comply at all times, with all applicable sanctions. In those instance that sanctions do become applicable, an event of default would take place and the financiers may, by notice to the obligors, immediately cancel the availability of the loan and declare all or part of the loan and all amounts outstanding to be due and payable.
Navigating fallout from imposition of sanctions
Ship finance transactions may be subject to multiple sanctions regimes according to the manner in which the transaction is structured. For instance, the sanctions may impact shipowners incorporated in Russia even if operated out of another jurisdiction, as well as lending banks and insurers even if similarly based in other jurisdictions. Vessel owners who have chartered and sub-chartered their vessels to prohibited persons may also need to cancel or terminate their charter agreements. This is of particular significance to sale and leaseback financings whereby the continued cash flow generated from the lease is the underlying principle upon which the financing is based and the indebtedness secured.
Different sailing routes may also need to be considered by owners and charterers, depending on the extent to which sanctions are imposed. This, in turn, could lead to longer lead times and increased costs.
Liquidity issues arising due to sanctions could also potentially give rise to additional claims and arrests against vessels, which could further impact the ability of obligors to fulfil their repayment obligations.
In these circumstances it is imperative for financiers to conduct extended know-your-customer due diligence exercises on the owner or group of entities participating in any intended project that they are financing and to further ensure that specific sanction clauses are included in their loan agreements. This also applies to insurance policies, by ensuring that cancelation clauses voiding the policy are widened to include sanctions-related breaches.
Ship financiers' rights under Maltese law
As part of ship finance transactions involving Malta flagged vessels, the main form of security granted in favour of a financier would generally constitute the ship mortgage and deed of covenants collateral thereto. At the outset, upon giving notice of default, Maltese law grants the mortgagee several statutory self-help remedies, which would include the rights of the mortgagee to take possession of the mortgaged vessel and to seek the private sale of the mortgaged vessel, irrespective of where it lies.
Furthermore, a ship mortgage registered over a Maltese flagged vessel serves as a powerful enforcement tool as it grants an executive title in favour of the mortgagee. Under Maltese law, an executive title may be enforced without the requirement of lengthy judicial proceedings, thereby making the Maltese mortgage an attractive security document to financiers. Faced with a defaulting mortgagor, and upon notice of default being given, the mortgagee need only file a judicial act in court to demand payment of the due amounts from the debtor mortgagor. If payment is not forthcoming within two days from due service, the mortgage is rendered enforceable.
Whenever the vessel is lying or arrested in Maltese waters, the mortgagee would be entitled to immediately demand a judicial sale of the vessel either by means of a court auction or alternatively, by a court-approved private sale of the vessel. Meanwhile, if the vessel is arrested outside of Maltese waters but within an EU member state, a mortgagee may still possibly rely on the swift enforcement procedures envisaged under Maltese law. In such scenarios, it would be possible for the holder of a Maltese mortgage to enforce its security in Malta and to obtain a European Enforcement Order (EEO) in accordance with the provisions of EU Regulation 805/2004. The financier may subsequently use that EEO in that other EU member state, where the vessel is arrested, to demand a judicial sale of the vessel. However, in cases where a Maltese flagged vessel is arrested in any other jurisdiction, any eventual enforcement of the mortgage would depend largely on the domestic laws of the jurisdiction wherein the vessel is arrested.
Maltese law has aptly catered to providing various securities that protect financiers in the case of defaulting owners. The law regulating registered mortgages is founded on the possibility for swift enforcement of rights. This aspect of Maltese law mortgages should provide some level of comfort to financiers that are envisaging potential defaults by their mortgagees as a result of the latest round of sanctions.
The latest sanctions in response to Russia's transgressions are far more stringent and far-reaching than those imposed in recent years. These sanctions are expected to produce intensified financial burdens on sanctioned persons and entities and the shipping industry will be on its toes to map out what these sanctions might mean for ship owners and financiers. While the full extent of the implications of ever evolving sanctions remains a speculative matter, the expectation is that they will become increasingly potent as the Ukraine-Russian conflict intensifies and financiers should reassess their extended due diligence procedures and understand their legal rights and remedies to ensure that the necessary safeguards are in place to cater for any eventuality.
For further information on this topic please contact Peter Grima, Matthew Cassar or Adrian Attard at Fenech & Fenech Advocates by telephone (+356 2124 1232) or email ([email protected], [email protected] or [email protected]). The Fenech & Fenech website can be accessed at www.fenechlaw.com.