Admiralty Law Part 6

Pursuant to the earlier topic of Introduction to Maritime Law in Malaysia, published on 22 February 2021, in the coming series the basis and elements of Admiralty Law will be explored.

Ship Mortgages

1. Nature Of A Ship Mortgage

   The nature of a ship mortgage is statutory under most legal systems. Under English law it is governed by the statutory provisions of the Merchant Shipping Act 1995, Schedule 1, and the accompanying Merchant Shipping (Registration of Ships) Regulations 1993. The registration of a ship mortgage under the Act perfects the mortgage and creates a statutory security. This is necessary to protect the lender, mortgagee and their property rights on the ship and has the effect of giving notice to others of those rights. The registration date is important and determines the priority of the registered mortgagee over other secured creditors, except maritime liens. Maritime lien holders have priority over the registered mortgagee.

2. Priority Of A Ship Mortgage As A Secured Creditor And Conflict Of Laws

   The contractual obligations of a mortgage agreement apply from the date of its creation. However, the statutory provisions prescribe priority on the basis of the time of registration over other mortgages.
   Unregistered mortgages are equitable under English law (The Angel Bell); The Shizelle (concerning unregistered mortgages of unregistered ships)). This is a practical arrangement which ensures clear priority rules.
   The interests of the financiers of the ship are naturally of very high priority. However, maritime liens are of higher priority in public policy aspects as well as of necessity. Sometimes shares in the ship or the certificate of registration of the ship may be pledged to a lender as a security. This is a lower form of security in terms of priority but its strength is that the lender has possession of the very thing that will be needed in case the ship is agreed to be sold. You should read about the position of a pledgee of goods in The Odessa.

   A difficulty in priorities of claims has arisen in relation to some maritime claims which attract a maritime lien in some jurisdictions but not in others. For example, the claim of a ship repairer against the ship for a debt does not attract a maritime lien under English law, although it does under the law of the USA. Thus, it has taken priority over a mortgage in those jurisdictions. If the ship repairer’s contract is subject to the law of the USA, and the court which decides the priorities is in England, a conflict of laws issue arises. This conflict has been resolved by the Privy Council, applying English law, in favour of the mortgagee; The Halcyon Isle.

3. Rights And Obligations Of A Mortgagor

   Apart from the statutory provisions governing the rights and duties of the parties to the loan agreement and the security for the loan, the contract also contains a series of covenants (contractual terms) which outline the obligations of the borrower (the mortgagor) until the loan is discharged. The purpose of the covenants is to ensure that the object of the security is not depreciated by the occurrence of various insurable risks. Thus, one of the covenants obliges the borrower to insure the ship and assign the benefit of the insurance policy to the mortgagee, as a collateral security, in case the ship is lost by perils of the sea.
   Another important covenant is that the borrower will discharge claims, particularly those which attract a maritime lien and, thus, would take priority over the mortgagee. In addition the borrower must employ the ship in a prudent manner and assign the benefit of the earnings to the mortgagee as an additional collateral security. There are further obligations stipulated in the covenants which you will find below.
   The consequences of a breach of these covenants will be specified in the contract. Usually a default in payment or impairment of the security would entitle the mortgagee to take steps, as permitted by the statute and the contract, to realise their security by taking possession of the ship, and subsequently proceed with enforcing their power of sale.

   Save for these obligations, the borrower can employ their ship, subject to giving the required notices to the mortgagee, and their ownership rights are not restricted unless they are in breach of the contract and pose a threat to the security of the mortgagee.

   Once the debt is discharged, the mortgagor has a right of redemption of their property, which means they have a right to take their property free of the burden (encumbrance) of the mortgage.

4. Rights And Obligations Of A Mortgagee

   The mortgagee has a right to take possession of the mortgaged ship and interfere with the mortgagor’s possession, control and operation of the ship, when there is a default in payment of the capital or interest of the loan, or a threat to their security (The Blanche; The Myrto).The mortgagee can either choose to manage and trade the ship, or proceed with private or judicial sale (The Calm C; Cuckmere Brick Ltd v Mutual Finance Corp; Downsview Nominees v First City Corp). These rights are exercisable only to the extent that it is necessary to enforce the mortgagee’s security.
   Whether an increase in default interest amounts to a penalty so as not to be a valid reason for taking possession, see First Commercial Bank v Mandarin Container.

   For agreed liquidated damages to amount to a penalty there must be unconscionable, oppressive or extravagant conduct by the party seeking to enforce the provision.

   While in possession, the mortgagee has certain rights on the earnings of the ship (Liverpool Marine Credit Co v Wilson) as well as obligations to use the ship as a prudent man (Marriott v Anchor Reversionary Co). If the mortgagee proceeds with the sale of the ship, although they do not owe a general duty of care towards the mortgagor, they do not have a duty to achieve the best price on sale, and the mortgagee can use their best endeavours to obtain the market price (Tse Kwong v Wong Chit Sen); it is in fact a duty to act in good faith (China and South Sea Bank v Tan Soon Gin; Den Norske Bank v Acemex Management, The Tropical Reefer; Close Brothers Ltd v AIS (Marine) 2 Ltd (The Ocean Wind 8 of Hartlepool)).

   In case of a surplus in the price after payment of the loan to themselves, the mortgagee is in a fiduciary relationship to hold the surplus in trust for the mortgagor (Downsview Nominees v First City Corp). The effect of a private sale by the mortgagee is that it does not extinguish maritime liens, although a sale by the court does.

   In the case where there is a shortfall from the sale the claim can be brought against the guarantor (see for example Close Brothers Ltd v AIS (Marine) 2 Ltd (The Ocean Wind 8 of Hartlepool)).

5. Possession

   You have now learned that the mortgagee has certain rights by statute and contract when their security is threatened. However, when the mortgagee exercises those rights, it is likely that third parties, such as charterers of the ship, have contractual rights under a contract with the mortgagor.
   The issue here is this: if the mortgagee enters into possession, it will inevitably result in the interruption of the performance of the charterparty unless the mortgagee decides to continue the trading of the ship as a manager. Does the law or equity protect the rights of charterers, and what would be the solution if there is a conflict between their rights and those of the mortgagee?

If you have any questions or require any additional information, please contact our lawyer that you usually deal with.

This article is written by our Principal Associate, Chakaravarthi