Security and enforcementi Financing of contractsShips
In many cases, newly built ocean-going vessels are registered in Panama or other tax-haven countries and are owned by SPVs established there, and below we outline examples of foreign-registered vessels. The finance schemes for such vessels depend on the laws of the countries in which they are to be registered, as the enforceability and effect of the security interests can be governed by such laws. There are two major schemes that are used to finance these vessels: ship-owner finance schemes and JOLCO schemes.
Under a ship-owner finance scheme, the vessel is owned by an SPV established and controlled by the ship-owner, the financer makes the loan to the SPV and the loan is guaranteed by the ship-owner and secured by the vessel mortgage, insurance assignment and charter hire assignment. Typically, the following agreements are prepared:
- a loan agreement between the loan financer and the SPV;
- a loan guarantee between the loan financer and the ship-owner;
- a mortgage agreement between the loan financer and the SPV;
- a charter hire assignment between the loan financer and the SPV; and
- an insurance assignment between the loan financer and the SPV.
Under a JOLCO scheme, the vessel is purchased from the ship operator by an SPV established in a flag of convenience country and controlled by a leasing company, which then becomes the registered owner. The registered owner SPV then sells the beneficial ownership of the vessel on an instalment sale basis to an SPV established under Japanese law and also controlled by the leasing company and obtains funds to purchase the vessel through a loan from loan financers and a silent partnership investment from Japanese investors. Further, the vessel is bareboat chartered from the Japanese SPV to the ship operator (or its SPV). The loan is secured by the vessel mortgage, insurance assignment and charter hire assignment or other security interests. For a JOLCO scheme, typically the following agreements are prepared:
- a loan agreement between the loan financer and the Japanese SPV;
- a bareboat charter agreement between the Japanese SPV and the ship operator;
- an instalment sale agreement between the registered owner SPV and the Japanese SPV;
- a silent partnership agreement between the investors and the Japanese SPV;
- a mortgage agreement between the registered owner SPV and the loan financer;
- a charter hire assignment between the loan financer and the Japanese SPV; and
- an insurance assignment between the loan financer and the Japanese SPV.
Railway construction is characterised as public infrastructure development, even if it is operated by a private railway company. Railways are constructed by the JRTT and sold to each railway company on an instalment basis, and there is a railway mortgage system in place to secure such loans. Under this system, the railway, rolling stock, and any other facilities necessary for railway operations are treated as a monolithic property known as a 'railway foundation' to prevent railway facilities from being sold off in pieces by public sale.
So far, in most cases, rolling stock is self-financed and lease schemes have not been used often in Japan.Aircraft
In general, there are a number of varieties of aircraft finance transactions; however, given the space constraints, we focus on two typical schemes: (1) where a foreign SPV has economic ownership of the aircraft and leases it to a Japanese airline; and (2) where Japanese investors, directly or through an SPV or partnership, have economic ownership of the aircraft and lease it to a Japanese or non-Japanese airline.
With respect to scheme (1) above, as described in Section II.ii above, to enable an aircraft to be registered in Japan while the economic ownership thereof remains with a foreign SPV, the aircraft must be sold by a foreign SPV to a Japanese SPV that is wholly owned by a local Japanese entity (usually a Japanese trading company). Meanwhile, the Japanese SPV sells back its beneficial ownership to the foreign SPV pursuant to a conditional sale arrangement but continues to hold the legal title to the aircraft during the lease period for registration purposes, and the Japanese SPV also grants a priority mortgage in favour of the foreign SPV to secure the obligation to transfer the ownership to the foreign SPV. This scheme also requires a lease agreement, an aircraft sales agreement, a participation agreement, a share pledge agreement and (in the case where loan finance is additionally obtained) a loan agreement, a mortgage agreement and a security assignment agreement for the loan financer. Please refer to the following breakdown:
- an aircraft operating lease agreement between the foreign SPV and the lessee;
- a (second priority) mortgage agreement between the Japanese SPV and the foreign SPV;
- an aircraft sales agreement between the foreign SPV and the Japanese SPV;
- a conditional sales agreement between the Japanese SPV and the foreign SPV;
- a share pledge agreement between the foreign SPV and the parent company of the Japanese SPV;
- (in case of loan financing) a loan agreement between the loan financer and the foreign SPV;
- (in case of loan financing) a first priority mortgage agreement between the loan financer and the Japanese SPV;
- (in case of loan financing) a security assignment agreement regarding lease and insurance receivables between the loan financer and the foreign SPV; and
- a participation agreement between, inter alios, the Japanese SPV, the foreign SPV, the lessee and, as the case may be, the loan financer.
With respect to scheme (2) above, as described in Section I.ii above, it is typically the case that the investors directly own the aircraft or a voluntary partnership or a silent partnership is set up and the voluntary partnership or the operator (usually a Japanese SPV) of the silent partnership (collectively, 'owner') owns the aircraft. In either case, the aircraft is leased to an airline (or its SPV), and a loan financer makes a loan to the owner and the loan is secured by the aircraft mortgage, assignment of insurances and lease receivables, and airframe and engine warranties, and typically the following agreements are prepared:
- a loan agreement between the loan financer and the owner;
- an aircraft operating lease agreement between the owner and the lessee;
- (in case of a silent partnership) a silent partnership agreement between the investors and the owner;
- a mortgage agreement between the loan financer and the owner;
- a security assignment regarding lease and insurance receivables between the loan financer and the owner;
- an airframe warranties agreement between the airframe manufacturer, the lessee, the owner and the loan financer; and
- an engine warranties agreement between the engine manufacturer, the lessee, the owner and the loan financer.
Ship mortgages may be established and registered in Japan only for ships registered in Japan. Ship mortgages may not be enforced against third parties unless they are registered under Japanese law. However, maritime liens on vessels arise with respect to claims for pilotage, towage, bunker expenses, crew wages, and salvage, and also claims in connection with marine casualties such as collisions or oil pollution, and these have priority over ship mortgages.Rolling stock
The Railway Mortgage Act provides the railway mortgage system. Under this system, railway mortgages should be placed on the railway foundation, which is the collateral railway facility, and may be registered.Aircraft
The Aircraft Mortgage Act and Civil Execution Act provide the aircraft mortgage system, which is only available for aircraft registered in Japan. Under this system, aircraft mortgages may not be asserted against third parties unless they are registered.Effect of insolvency proceedings
There are three types of insolvency proceedings under Japanese law: bankruptcy proceedings pursuant to the Bankruptcy Act, civil rehabilitation proceedings pursuant to the Civil Rehabilitation Act, and corporate reorganisation proceedings pursuant to the Corporation Reorganisation Act. The object of bankruptcy proceedings is the dissolution of the company, while the purpose of civil rehabilitation proceedings and corporate reorganisation proceedings is reconstruction of the company. The requirement for use of corporate reorganisation proceedings is very restrictive (i.e., only a joint stock corporation is permitted to utilise these proceedings).
Mortgages on vessels or aircraft, security interests in railway facilities, and any other perfected security interests can be enforced outside bankruptcy proceedings and civil rehabilitation proceedings (however, with respect to civil rehabilitation proceedings, a claim for removal of security interests may be made by a bankruptcy administrator or a court order for stopping the exercise of security interests may be issued). On the other hand, with respect to corporate reorganisation proceedings, security interests are dealt with as secured reorganisation claims, and they can be exercised within the corporate reorganisation proceedings in accordance with the reorganisation plan.
In addition, with respect to mortgages on vessels or aircraft, not formal registration but provisional registration is often used because of the high charges of formal registration incurred in the registration process, and provisional registration reserves the priority order as a security right of the mortgage, subject to the condition that the provisional registration is transformed into a formal one. However, if insolvency proceedings commence in relation to a vessel or aircraft on which a mortgage is created but the transformation process from provisional registration to formal registration has not been completed, there remains a risk that the validity of the mortgage may be avoided by a court or trustee on the grounds that the registration of the mortgage is still a provisional one.
Further, certain types of lease agreements or bareboat charter agreements that include, for example, full pay-out clauses or those prohibiting intermediate termination may be interpreted as finance lease transactions, in which case, the lease transactions are dealt with like the above-mentioned secured reorganisation claims if corporate reorganisation proceedings are in progress. Additionally, in this case there is a possibility that repossession or disposal of the leased property will be restricted.iii Arrest and judicial saleShips
Even if a vessel and mortgage are registered in a foreign country, the mortgagee may apply for arrest and judicial sale of the vessel by submitting documentation proving the existence of the mortgage on the vessel to a court, as long as the vessel is in Japan. Usually, the mortgagee will get a court order to obtain the certificate of the vessel's nationality and any other documents necessary for its sailing before its arrival at a Japanese port; upon arrival, an enforcement officer will then confiscate the foregoing documents from the vessel so that it cannot sail from the port. Within five days of the documents being apprehended, the mortgagee must formally apply for commencement of the judicial sale of the vessel to the court that has jurisdiction where the vessel has been arrested. The court has the discretion to decide to commence the judicial sale proceedings, and then, upon the mortgagee's application, to appoint a trustee to manage the vessel until completion of the sale. By this stage, the mortgagee will have had to pay the advance anticipated costs and expenses for the proceedings, which amount will be returned out of the proceeds of the sale. For example, a mortgagee paid about ¥13 million in a case of judicial sale under a ship mortgage before the Hakodate District Court. It usually takes about six months from the commencement of the judicial sale to distribution of dividends.
In addition to the length and high costs of the judicial sale process, taking into consideration that: (1) a vessel or aircraft is movable and it is necessary to check its location prior to applying to a court; (2) in case of a foreign registered vessel, procedures in the nation where the vessel is registered may also be required; and (3) negotiation with the lessee or charterer may be necessary because the compulsory arrest and judicial sale process has a material effect on the lessee's or charterer's rights or interests, a private sale process is taken in normal practice.Rolling stock
The mortgage on a railway foundation is enforceable by auction or compulsory administration, at the mortgagee's choice. If the mortgagee selects auction proceedings, the railway foundation will be sold to a winning bidder as a single property.Aircraft
Basically, the arrest and judicial sale procedures for an aircraft are similar to those for a vessel. Thus, if a mortgagee applies to a court for enforcement of a mortgage through judicial proceedings, the mortgagee has to submit to the court documentation proving the existence of the mortgage on the aircraft. Further, the mortgagee may ask the court to issue a court order to obtain the certificate of registration of the aircraft and any other documents necessary to prevent the aircraft from leaving the parking apron.
Unlike in the case of a vessel, the enforcement procedure for an aircraft mortgage as stipulated in the Civil Execution Act is restricted to aircraft registered with the Japanese aviation authority; therefore, foreign registered aircraft should be subject to the enforcement procedure for ordinary movable assets. However, since such provisions are not meant to cover assets as large as aircrafts, it will be highly difficult to proceed with an arrest and judicial sale procedure for a mortgage on a foreign registered aircraft.
Further, as is the case with vessels, a private sale process is taken in normal practice rather than the compulsory arrest and judicial sale process.