The container ship sector is the main focus in ship financing, due to the tax law framework conditions in Germany. However, the segment of highsea yachts with an average purchase price of 25 – 100 Euro million is also frequently the subject of structured financing1. Oftentimes, a special purpose company domiciled abroad enters into a vessel construction agreement with the shipyard. For financing purposes, the special purpose company in turn concludes a loan agreement with a financing bank. As security for the vessel to be laid on keel in Germany, the bank generally, among other things, requires a mortgage on vessels under construction (Schiffbauwerkshypothek). Additionally, the loan documentation usually provides that a ship mortgage on the completed vessel (Schiffshypothek) must be created. The ship mortgage is generally governed by the law of the country in which the vessel is predominantly located (homeland statute). This can be the country of the vessel’s flag or the country of the homeport or hometown in which the vessel is registered. This is usually the country in which the special purpose company is domiciled. The financing bank’s comprehensive security interests must be kept in mind when a shipyard that concluded the vessel construction agreement with the special purpose company charges another shipyard as a subcontractor with the vessel’s construction. This may require different parts of the vessel to be constructed at different locations.

Hence, the mortgage on vessels under construction (Schiffbauwerkshypothek) is the financing bank’s usual security for ship financing in Germany. The following text explains in more detail the mortgage on vessels under construction, the procedure for granting this type of mortgage and typical problems arising in this context.

Basics

The legal basis for the creation and registration of a mortgage on vessels under construction (Schiffbauwerkshypothek) can be found in the act on rights in registered vessels and vessels under construction (Gesetz über Rechte an eingetragenen Schiffen und Schiffbauwerken) dated November 15, 19402 (hereafter referred to as Act on Vessel Rights, Schiffsrechtegesetz), as amended by the Act on the Modernization of the Law of Obligations (Gesetz zur Modernisierung des Schuldrechts) dated November 26, 20013and in the Vessels Register Act (Schiffsregisterordnung) dated December 19, 19404 in the version as published on May 26, 1994,5 last amended by the Seventh Ordinance on Changes in Competences (Siebente Zuständigkeitsanpassungs-Verordnung) dated October 29, 20016. The Act on Vessel Rights (Schiffsrechtegesetz) contains the key provisions of substantive law regarding material vessel rights of registered seagoing and inland navigation vessels, as well as vessels under construction. They include in particular provisions regarding the acquisition and loss of ownership, mortgages, and usufruct. The Vessels Register Act (Schiffsregisterordnung) contains the formal law in rem regarding vessels, comparable to the regulations of the Land Register Act (Grundbuchordnung). This includes provisions addressing the competences of the vessels registers (Schiffsregister) or, as the case may be, the registers for vessels under construction (Schiffsbauregister), and the requirements for the registration of mortgages for vessels under construction.

Due to the legal nature of the mortgage on vessels under construction as a register lien, only such vessels under construction (seagoing and inland navigation vessels) can be encumbered with a mortgage on vessels under construction which are registered in the register for vessels under construction (Schiffsbauregister). Conversely, vessels under construction can only be entered into the register for vessels under construction if a vessel mortgage is simultaneously registered on the vessel under construction, or alternatively, if a foreclosure sale of the vessel under construction has been filed for (Section 66 Vessels Register Act (Schiffsregisterordnung)). Since registration of vessels under construction is not compulsory, encumbrances on vessels under construction which are not registered are governed by the provisions of the German Civil Code (Bürgerliches Gesetzbuch, BGB) (Sections 929 et seq. German Civil Code). However, the special provision of Section 929a German Civil Code is not applicable.

Register for Vessels under Construction (Schiffsbauregister)

While under Section 3 Subsection 1 Vessels Register Act (Schiffsregisterordnung) different registers are kept for seagoing and inland navigation vessels, vessels under construction can be entered into the register for vessels under construction (Schiffsbauregister) (Section 65 Vessels Register Act (Schiffsregisterordnung)). The provisions applicable to the vessels register (Schiffsregister) set forth in Section 1 Vessels Register Act (Schiffsregisterordnung) (register court), Section 2 Vessels Register Act (Schiffsregisterordnung) (jurisdiction) and Section 7 Vessels Register Act (Schiffsregisterordnung) (register folio) apply analogously to the register for vessels under construction (Schiffsbauregister). The vessel under construction must be entered into the register of the construction location (Section 67 Vessels Register Act (Schiffsregisterordnung)).

Upon completion of the vessel under construction, the vessel must be registered in the competent vessels register (Schiffsregister). To the extent that a vessel was constructed in whole or in part in the Federal Republic of Germany, double entries as both a vessel under construction and simultaneously as a vessel, are avoided by requiring a clearance certificate from the competent register for vessels under construction (Schiffsbauregister) for the construction location upon the application of the completed vessel. After completion of the vessel, the mortgage on vessels under construction (Schiffbauwerkshypothek) granted for the vessel under construction persists with its previous ranking as a ship mortgage (Schiffshypothek) (Section 81 Act on Vessel Rights (Schiffsrechtegesetz)). Formal-legally, the mortgage on vessels under construction is transferred ex officio with its previous ranking into the vessels register (Schiffsregister).

Structure and Contents of the Register for Vessels under Construction (Schiffsbauregister)

The register for vessels under construction (Schiffsbauregister) consists of three departments. In department I, the respective vessel under construction is registered and described in detail. The name, number or other nomenclature, class, construction location, shipyard, and registration date of the vessel under construction are recorded therein. Department II contains information regarding the owner, correspondent ship owner, proof of ownership, basis of entry, limitations of ownership and changes. In department III (vessel mortgages), encumbrances are registered, particularly the mortgage on vessels under construction in favor of the financing bank, and the mortgage on vessels under construction in favor of the shipyard pursuant to Section 648 Subsection 2 German Civil Code (including the respective amounts of these mortgages).

Formal Requirements for Entry into the Register for Vessels under Construction (Schiffsbauregister)

In order for the vessel under construction to be entered into the register for vessels under construction (Schiffsbauregister), the owner of the shipyard on which the vessel is being constructed must apply for the vessel under construction’s entry in the register. If the owner of the shipyard is not the owner of the vessel under construction, the vessel under construction’s owner may apply for registration. Furthermore, the vessel under construction can be registered by the person who holds an enforceable title and can thus demand entry into the register for vessels under construction (Schiffsbauregister) or can pursue the vessel’s foreclosure sale (Section 68 Subsection 2 Vessels Register Act (Schiffsregisterordnung)). For registration, miscellaneous information is required, including the name, number, or other nomenclature, the class of the vessel under construction, the construction location and the shipyard on which the vessel is being constructed, and the owner of the vessel under construction. If someone other than the shipyard’s owner is indentified as the vessel under construction’s owner, a publicly notarized declaration by the shipyard’s owner, stating how the person designated as owner acquired ownership, must be submitted with the application for registration (Section 69 Subsection 2 Vessels Register Act (Schiffsregisterordnung)).

The parties’ contractual relations must also be taken into account. Vessel construction agreements between shipyard and purchaser, under which the purchaser acquires ownership of the vessel under construction by consent and delivery in fulfillment of the construction agreement, are common. Usually, delivery is replaced by an agreement that the shipyard holds the vessel under construction in custody for the purchaser until completion and delivery. In this case, the requirements of Section 69 Subsection 2 Vessels Register Act (Schiffsregisterordnung) must be met.

Furthermore, proof must be provided that the prerequisites established in Section 76 Subsection 2 Act on Vessel Rights (Schiffsrechtegesetz) are fulfilled. Accordingly, the creation of a ship mortgage is permissible as soon as the keel has been laid and the vessel under construction has been marked by name or number clearly and durably in a place which is visible until the launch of the vessel. However, a mortgage on a vessel under construction cannot be created if, after completion as a seagoing vessel, the vessel does not have more than 50 cubic meters gross tonnage, or if it is not registrable as an inland navigation vessel in the register for inland navigation vessels (Binnenschiffsregister). In case of the construction of seagoing vessels, this can be proved by a certification by the Federal Office for Maritime Navigation and Hydrography (Bundesamt für Seeschifffahrt und Hydrographie).

When the vessel under construction is registered in the register for vessels under construction (Schiffsbauregister), the shipyard’s owner and the owner of the vessel under construction must immediately notify the register of every change to the registered facts and the completion of the ship (Section 71 Vessels Register Act (Schiffsregisterordnung)).

Transfer of Ownership of the Vessel under Construction

If the vessel under construction is entered into the register for vessels under construction (Schiffsbauregister), transfer of ownership is governed by the rules applicable to registered inland navigation vessels. According to Section 3 Act on Vessel Rights (Schiffsrechtegesetz), agreement and delivery are required for a transfer of ownership. Insofar it is irrelevant whether the vessel under construction is a seagoing or inland navigation vessel, since Section 78 Act on Vessel Rights (Schiffsrechtegesetz) refers to Sections 3 to 7 Act on Vessel Rights (Schiffsrechtegesetz) without distinguishing between seagoing and inland navigation vessels.

Mortgage on Vessels under Construction

As far as terminology and form are concerned, the mortgage on vessels under construction generally adheres to the model of mortgages on immovable property. Specific issues regarding mortgages for vessels under construction are illustrated below.

Mortgage on Vessels under Construction and Claim to be Secured – Accessoriness (Akzessorietät)

The mortgage on vessels under construction is an accessory right to the secured claim. As such, the mortgage requires the existence of a valid claim. The claim remains with the mortgage on vessels under construction even after its creation, and the expiration of the claim induces the expiration of the mortgage on vessels under construction (Section 77, 57 Act on Vessel Rights (Schiffsrechtegesetz)). Accordingly, the claim cannot be transferred without the mortgage, and the mortgage cannot be transferred without the claim.

The claim to be secured by the mortgage can also be a future, fixed-term, or conditional claim (Sections 77, 8 Subsection 1 Clause 2 Act on Vessel Rights (Schiffsrechtegesetz)). The underlying contractual relationship (zugrundeliegendes Schuldverhältnis), which is the basis of the claim and which can also be subject to foreign property law, is not relevant. However, a legal relationship must exist from which a future claim may arise.

Type of Mortgage on Vessels under Construction

It is also possible that a maximum amount mortgage (Höchstbetragshypothek) is granted in order to secure the financing bank’s claims (Section 77, 75 Act on Vessel Rights (Schiffsrechtegesetz)). Under this type of mortgage, the liability is capped, the secured claim is initially undetermined, and the determination of the amount owed occurs at a later point in time. This type of mortgage is mostly used as a mean of securing claims arising from an existing business relationship. However, this type of mortgage has the disadvantage that, due to the accessoriness of the mortgage, the mortgage depends upon the existence of the secured claim. If the scope of the secured claims is to be extended at a later point in time, or if claims are to be exchanged, a formal exchange of claims which must be registered becomes necessary (Sections 77, 55 Act on Vessel Rights (Schiffsrechtegesetz)).

In case of structured financings, this issue is usually resolved by using a mortgage on vessels under construction that secures an abstract reason for indebtedness (abstrakter Schuldgrund).

According to Sections 77, 8 Subsection 1 Act on Vessel Rights (Schiffsrechtegesetz), claims of any type can be secured by ship mortgages. Therefore, instead of loan receivables, claims under a promise to fulfill an obligation (abstraktes Schuldversprechen) according to Section 780 German Civil Code can also be secured by a mortgage on vessels under construction. Pursuant to Section 8 Act on Vessel Rights (Schiffsrechtegesetz), the claim which is to be secured can be based on any legally permissible reason for indebtedness and, thus, also on a promise to fulfill an obligation (abstraktes Schuldversprechen).

For several reasons, the promise to fulfill an obligation is advantageous for the financing bank. Secured claims can be exchanged at any time without requiring an entry into the register for vessels under construction (Schiffsbauregister). A further advantage vis-à-vis the maximum amount mortgage is the shifting of the burden of proof. The financing bank does not have to prove the existence of the claim, but instead, to the extent of the promise to fulfill an obligation, the borrower has to prove that the respective debt does not exist. The promise to fulfill an obligation can moreover be declared enforceable via the debtor’s certified submission to immediate enforcement. Regarding a maximum amount guarantee, this is only possible if the submission refers to a specific amount. Usually, the submission will occur in the form of a submission clause.

Regularly, in the course of granting the mortgage on vessels under construction, the financing bank will demand representations and warranties (Zusicherungen) regarding compliance with certain rules of conduct by the borrower. These rules of conduct, or, as the case may be, conditions (so called “covenants“), are used by the bank to minimize credit risks by imposing obligations on the borrower which protect the lender’s interests. A violation of these covenants generally permits the bank to terminate the loan, as the loan agreement usually contains a termination clause in case of a culpable breach of the security documentations’ covenants. To begin with, information obligations vis-à-vis the bank can be considered insofar as the debtor attains knowledge of events which could lead to an impairment of the vessel under construction’s value, or in case third party enforcements are threatening.

Furthermore, covenants are advisable under which the borrower is obliged to meet certain insurance related standards for the vessel under construction. Moreover, an obligation should be included which allows the bank to inspect the vessel under construction and to examine the ship's documents. This obligation is relevant as the conditions for the drawing of individual loan tranches usually require the completion of contractually determined construction stages of the vessel under construction.

Mortgage According to Section 648 Subsection 2 German Civil Code (Sicherungshypothek)

In addition to the financing bank’s security interests, the shipyard also has a considerable interest in securing its outstanding claims regarding the construction of the vessel. Section 648 Subsection 2 German Civil Code allows for this security interest. Pursuant to this provision, the owner of a shipyard may demand the creation of a mortgage on the vessel under construction or the purchaser’s vessel as a security for his claims arising from the construction or repair of the vessel. These conflicting security interests must be considered when drafting the contracts.

Contractual solutions are possible; for example, the shipyard can waive its right pursuant to Section 648 German Civil Code. Due to the dispositive nature of Section 648 German Civil Code, waiving the right is generally possible.

However, the financing bank will in any case insist on the registration of a first-ranking mortgage on vessels under construction in its favor prior to the disbursement of the loan or individual loan tranches. Therefore, it is not important whether the owner of the shipyard waives his claims according to Section 648 Subsection 2 German Civil Code or not, as he is only entitled to the creation of a lower-ranking mortgage in his favor.

Since the mortgage on vessels under construction secures a promise to fulfill an obligation (abstraktes Schuldversprechen) in favor of the financing bank, the lower-ranking mortgage in favor of the shipyard owner may, under certain circumstances, de facto not constitute any security. A wide security purpose (e.g. all claims arising from the business relationship) may lead to a “perpetual” mortgage in favor of the financing bank. Hence, the shipyard would be exposed to a higher risk of shortfall with its lower-ranking security mortgage.

In order to avoid this and to adequately safeguard the lender’s as well as the shipyard’s security interests, an agreement should be reached by the parties including the purchaser that the financing bank will enforce the mortgage on vessels under construction only to the extent that secured claims are claims for the repayment of the loan or related interest or costs.

Scope of the Mortgage Liability

Pursuant to statutory law, the mortgage on vessels under construction encompasses not only the vessel under construction, but also certain objects and claims.

According to Section 79 Act on Vessel Rights (Schiffsrechtegesetz), the mortgage on vessels under construction relates to the vessel under construction in its respective construction stage. This extension of the mortgage also covers components located in the construction yard intended and marked for integration into the vessel (e.g. plates, machines, boilers, propellers), except for those components which have not become the property of the owner of the vessel under construction. As vessel components are generally delivered subject to retention of title, these components only become liable when the claims of the suppliers have been satisfied, or if rights are extinguished according to Section 950 German Civil Code.

For liability under Section 79 Act on Vessel Rights (Schiffsrechtegesetz), the components must be located on the construction yard. However, it is possible that components which are intended to be integrated into the vessel are, as contractually agreed between the parties, located on the property of a sub-contractor of the construction yard. For example, this would be the case with the prefabrication of larger parts of the vessel which are only later on brought to the construction yard. Therefore, not all components for the construction of the vessel fall under the statutory extension of the mortgage (Haftungsverband) as set forth in Section 79 Act on Vessel Rights (Schiffsrechtegesetz). The financing bank must consider this fact regarding its security interests. If it becomes apparent to the financing bank from the vessel construction agreement that these prefabricated components have a substantial value and that they are already the purchaser’s property while they are still located at the sub-contractor’s premises, it is advisable that such components are separately assigned by way of security to the lender pursuant to Sections 929 et seq. German Civil Code. To ascertain that such components become the property of the purchaser under such circumstances, agreements to this effect with the sub-contractor are possible. In this manner, these components can also be assigned by way of security to the financing bank.

According to Section 80 Act on Vessel Rights (Schiffsrechtegesetz), the mortgage on vessels under construction only extends to insurance claims if the owner of the vessel under construction has concluded an insurance specifically for the vessel under construction. The insurance usually concluded by the construction yard regarding the entire yard inventory, which generally also includes the vessels under construction, is not liable for the mortgage on vessels under construction.