Pricing, payment and financing for shipbuilding in USA

Pricing, payment and financing

Does the law in your country have different provisions for ‘fixed-price’ contracts and ‘labour-and-cost-plus’ contracts?

US laws do not restrict parties to commercial shipbuilding contracts from negotiating fixed price or cost-plus priced contracts, although the latter are virtually non-existent. However, in commercial shipbuilding contracts it is not uncommon to see escalation or economic price adjustment clauses based on increases in costs of materials, steel or labour, calculated by reference to published indices such as the CRU Plate Index (steel) or indices published by the Bureau of Labor Statistics may be incorporated into the contract to provide objective standards for periodic price escalation.

Does the builder have any statutory remedies available to charge the buyer for price increases of labour and materials despite the contract having a fixed price?

Fixed-price contracts are just that; once agreed, the parties are contractually obligated even if prices for labour, steel or any vessel components increase substantially.

Can a buyer retract consent to an increase in price by arguing that consent was induced by economic duress?

If a buyer has consented to a price increase and later attempts to assert that its consent was induced by economic duress, the buyer will have to prove by a preponderance of the evidence that such was the case - a very difficult burden. See In re Toscano, 799 F Supp 2d 230 (EDNY 2011) where it was determined that a claim of duress sufficient to vitiate a contract under New York law requires a showing of a threat, that was unlawfully made, and caused involuntary acceptance of contract terms, because the circumstances permitted no other alternative. Moreover, in Vanguard Packaging Inc v Midland Bank, 871 F Supp 348, 352 (WD Mo 1994) it was held that:

[i]n sum, to establish its claim of economic duress, Plaintiff must prove to this Court, by a preponderance of the evidence, that Defendant created a situation of economic exigency for Plaintiff by performing a wrongful act which, in light of all relevant circumstances, overcame Plaintiff’s free will and forced it to do something it would not have otherwise done.

May the builder and the buyer agree to exclude the buyer’s right to set off, suspend payment or deduct certain amounts?

Shipbuilding contracts generally provide that each instalment is to be paid in full when due when certain events have occurred or stated milestones have been satisfied without any deduction whatsoever; however, some contracts do provide that amounts of progress payments in dispute may be deposited by the buyer in an escrow account, at the same time as the buyer pays the undisputed amount of the progress payments. In contracts that contain such provisions an escrow account will be opened at the time the contract is entered into. Any amounts escrowed are then paid out at the time the dispute is resolved.

If the contract price is payable by the buyer in pre-delivery instalments, are there any rules in regard to the form and wording of refund guarantees? Is permission from any authority required for the builder to have the refund guarantees issued?

Refund guarantees are uncommon in the case of US shipbuilding contracts. Parent company guarantees, both for the builder and the buyer are common. Generally, as a condition of any payment by the buyer to the builder, the builder grants the buyer a continuing first priority security interest in the whole of the vessel and to all of the builder’s right, title and interest to the whole of the vessel and all parts thereof, to all inventory, work in progress and all documentation relating to the vessel and in conjunction therewith the builder will execute and deliver UCC Form 1 financing statements in favour of the buyer, the filing of which perfects the buyer’s first priority security interest in the vessel and all parts thereof.

What formalities govern the issuance of advance payment guarantees and parent company guarantees?

The shipbuilding contract will specify when and what conditions have to be satisfied before the buyer is obligated to make each progress payment. See question 21 with respect to parent company guarantees. Statutory company formalities governing authorisation for the issuance of such guarantees are dictated by the type of structure of the entity issuing such guarantee and the jurisdiction of its incorporation or organisation.

Can the builder or buyer create and register a mortgage over the vessel under construction to secure construction financing?

See question 12.

Financing alternatives available to US shipowners

Through two US Merchant Marine Act programmes US shipowners may avail themselves of two alternatives to traditional financial institutions financings - the Capital Construction Fund programme and Title XI Federal Ship Financing Program as described below.

Capital Construction Fund programme

The Capital Construction Fund (CCF) programme is designed to encourage owners of US-flagged vessels built in the US and at least 75 per cent owned by US citizens to accumulate large amounts of capital to acquire additional US-built and flagged vessels by providing tax incentives to do so. The shipowner who wishes to take advantage of this programme applies to the Maritime Administration (Marad) for enrolment, and after its application has been approved enters into a CCF agreement with Marad. These agreements provide that the shipowners may deposit into a CCF amounts up to its taxable income earned by ‘eligible agreement vessels’, which are listed on the CCF agreement plus the amount of depreciation allowed as a deduction on such vessels. The CCF agreement will also require the CCF holder to make minimum deposits to the CCF unless a waiver is obtained from Marad. Vessel owners are entitled to an income tax deduction for the amount deposited into the CCF attributable to income from eligible agreement vessels. Earnings on funds in the CCF are tax deferred in a similar manner to funds in an individual retirement account.

The holder of a CCF may make a tax-free ‘qualified withdrawal’ for the acquisition or reconstruction of US-flagged vessels in a US shipyard and to pay indebtedness in connection with such acquisition. US-flagged vessels acquired with qualified withdrawals are ‘qualified agreement vessels’, which are subject to several restrictions - they must be documented under the laws of the US and must be operated in the US foreign, Great Lakes or non-contiguous domestic trade (trade between the contiguous 48 states and Alaska or the insular territories), or short sea transportation trade (carriage by vessel of cargo that is contained in intermodal cargo containers and loaded by crane on the vessel or loaded on the vessel by means of wheeled technology and that is loaded at a port in the United States and unloaded either at another port in the United States or at a port in Canada located in the Great Lakes St Lawrence Seaway System or vice versa) (as per America’s Marine Highway Program). These new qualified agreement vessels include platforms and rigs attached to the sea bed of the outer continental shelf beyond the three-mile limit. All qualified agreement vessels must operate in such trades for 20 years from the date of acquisition. Second-hand qualified agreement vessels must operate in such trades for 10 years from the date of acquisition. That portion of the costs of building a vessel funded by CCF is not eligible to be depreciated for income tax purposes (ie, the tax basis of such vessel is reduced accordingly).

Title XI Federal Ship Financing Program

The primary purpose of the Program is to promote the growth and modernisation of the US Merchant Marine and US shipyards. The Title XI Program enables owners of eligible vessels and eligible shipyards to obtain long-term financing with attractive terms relative to commercial financing alternatives.

Vessels eligible for Title XI financing include, inter alia, US-flagged bulk carriers, tankers, towboats, barges, offshore oil rigs and support vessels.

The amount of the obligations (debt) guaranteed by the US government in a Title XI financing is based on the ‘actual cost’ of the vessels, which generally includes those items that normally are capitalised as vessel costs under usual accounting practices, such as cost of construction or reconstruction, including design, inspection, outfitting, equipping, shipyard supervision, interest during construction and the Title XI guarantee fee.

The Title XI Program provides for a guarantee of up to 87.5 per cent of the actual cost of most eligible vessels and up to 75 per cent of the actual costs of certain other vessels. The shipowner must provide from its own sources a minimum of 12.5 per cent of the equity for the project. The maximum guarantee term provided is the lesser of 25 years or the remaining economic life of the vessel and the interest rate of the obligations guaranteed is determined by the private sector, generally the benchmark rate being the interest rate carried by the US Treasury obligations comparable to the average life of the proposed debt issue. As part of the application process the shipowner must demonstrate to Marad the economic viability of the project. In 2014, Marad published a notice of a proposed policy to further promote the modernisation of the US Merchant Marine and US shipyards through the construction or reconstruction (to include repowering) of vessels. Marad proposed the consideration of various environmentally friendly initiatives such as alternative fuel system designs, fuel cells, hybrid propulsion systems, air emissions reductions technologies or ballast water treatment technologies that may improve the environmental sustainability of vessel operations to the extent that such initiatives lead to future cost savings as ‘other relevant criteria’ in its evaluation of the economic soundness of applications made under the Title XI loan guarantee programme. Marad has implemented this policy, albeit for a very limited number of projects.

Marad charges a number of fees to shipowners that avail themselves of the Title XI Program. The applicant must pay a non-refundable fee of US$5,000 when the application is filed. Prior to the issuance of the commitment letter, the applicant must also pay an investigation fee of 0.5 per cent of the obligations to be insured up to and including US$10 million plus 0.125 per cent on all obligations to be issued in excess of US$10 million. Marad may also impose additional fees to offset the cost of external advisers used in the review process. Finally, there is a guarantee fee, which is generally based on the ratio of net worth to long-term debt of the shipowner or shipyard and is generally between 0.25 per cent to 0.5 per cent per annum from the period prior to delivery or during construction and between 0.5 per cent to 1 per cent per annum from the period after delivery. No guarantee fees paid will be refunded.

The above descriptions of the CCF and Title XI Program touch upon certain highlights only.