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The Malta flag: Shipping funds and sale and leaseback transactions

Tuesday, 15 October 2019 | 00:00

The popularity of sale and leaseback transactions is now evident to whoever is involved in the shipping industry. In the current global ship finance scenario, financiers and ship-owners now appear comfortable in selecting this method of finance for maritime assets.

Briefly, in a sale and leaseback scenario, the existing vessel owner sells the vessel to a third party and then leases it back again for a certain period of time, with the lessee sometimes enjoying an option to purchase the leased vessel at the end of the lease period. It is held that the economic effect is the same for a vessel owner as that of borrowing money secured on the vessel being financed.

Funds and other investment vehicles with an appetite for the financing of vessels and other maritime objects often use the sale and leaseback model as a preferred method of financing. Over the past few months, news items of shipping funds scooping up ownership of a select number of vessels within a larger fleet or acquiring an entire fleet keep appearing on various industry periodicals. The increased presence of shipping funds, together with their growing shipping portfolios, has therefore contributed to the popularity of sale and leaseback transactions.

It is generally acknowledged that a lessor in a sale and leaseback context has no interest in operating the vessel. It is the lessee who is effectively the operator of the vessel responsible for all matters concerning the vessel’s actual operation and management.

Constantly sensitised to the changing needs of the shipping industry, Malta has enacted legislation to facilitate the relationship between a lessor, typically set up as a wholly owned SPV of a shipping fund or other financing house, and a lessee being the original owner of the vessel and the trusted counterparty in the transaction based on his expertise and experience. In these cases, however, there cannot be a default as there is no loan. The contractual covenants all relate to the operation and maintenance of the vessel and the payment of the hire rather than loan repayments.

Emphasis will here be made on amendments to Malta’s merchant shipping legislation, primarily the amendment to Article 19A and the addition of Article 19B to the Merchant Shipping Act (Chapter 234 of Laws of Malta).

Consequent to amendments made through Legal Notice 210 of 2016, a lessor and a lessee party to a sale and leaseback transaction may avail themselves of the ‘dual’ registration option in the Maltese Register of Ships. Registration is wholly and exclusively retained within the Maltese Register of Ships and is not to be confused with bareboat charter registration in or out from the Maltese Registry, which is dealt with under separate provisions.

Article 19A essentially permits a person, such as the shipping fund SPV, to register title over the vessel as registered owner in the Maltese register of ships whilst simultaneously allowing another entity, as lessee, to have the operational certificate of Malta registry and any other certificates issued by the Maltese flag authorities, in its name as lessee. This option is also available in those instances were the lessee has subsequently chartered the vessel to a third party charterer that wishes to have the registration certificate issued in its name as charterer, subject of course to both the registered owner’s and the lessor’s consent.

The procedure is simple and efficient. Once title has been registered over the vessel, subject to the usual provisions applicable to any prospective owner of a Maltese vessel, a lessee or a charterer wishing to have the certificate of registry in its name may submit an application in this respect subject to the satisfaction of the following conditions: the consent of the vessel’s registered owner; the consent of any mortgagee (s); the submission of a copy of the lease agreement or the charter party (typically, a bareboat charter). This will not be made available for public inspection ensuring the confidentiality of the contractual relationship between the parties payment by the lessee or the charterer to the Registrar of an amount equal to the annual registration fee for that year in addition to that paid by the registered owner.

Article 19 B provides that the registered owner retains the right to withdraw its consent at any time during the period that a certificate is issued in the name of the lessee or the charterer. Whilst the applicable provision does not specify so, it is generally understood that such right may only be exercised on condition that there is an instance of default under the lease.

This right is also afforded to any mortgagee. This ensures that the grant of the lease does not create a burden on the vessel which affects third party rights such as those of the mortgagee who may have financed the original acquisition of the vessel.

Upon the withdrawal of either the registered owner’s or the mortgagee’s consent, the lessee’s or charterer’s certificate of registry will cease to have effect, and the lessee or charterer is obliged to surrender the certificate of registry to the flag authorities.

The Registrar is in turn obliged to inform the registered owner and any mortgagee on the surrender of the certificate to the authorities, therefore ensuring that the registered owner is kept abreast of developments in this respect.

It is clear that the amendments made through Legal Notice 210 of 2016 have made it more attractive and convenient for ship financiers to retain control over the financed vessel without added responsibility, whilst allowing the flexibility needed for a lessee or subsequent charterer to operate the vessel.

As registered owner, the lessor enjoys all of the advantages of owning the financed asset, yet is free from the usual obligations of a vessel owner including, amongst others, those of constantly ensuring that the vessel’s certificates are valid and in order, maintaining exchanges of correspondence and communi­cation with the flag authorities, engaging with professional third party managers for the technical management of the vessel and dealing with any hiccup at local ports.

On the other hand, a lessee (saving any operational covenants contained in the lease and other related agreements with the lessor) is afforded a free hand in the management and operation of the vessel in its name whilst being responsible for maintaining and insuring the vessel as well as generally being liable for any loss or damage to it.

In an enforcement scenario, a lessor (as registered owner) may make use of the power to withdraw the consent required for the issue and continued use of a lessee’s or charterer’s certificate of registry, therefore essentially “freezing” the movement of the vessel and allowing greater freedom for the lessor to re-possess the vessel on the strength of its proprietary rights.

As briefly mentioned above, any mortgagee present also has a role in an Article 19A registration. The mandatory support of a mortgagee through the granting of its required consent blends in well with those finance models in which a shipping fund only takes up a portion of the required funding with the remainder being provided by traditional lenders. The latter obtain comfort through the registration of a Maltese mortgage over the financed vessel with all of the statutory powers that come with it.

In addition to the amendments made to the Merchant Shipping Act, fresh provisions and amendments which support the shipping industry were introduced in virtue of Act No. LII of 2016. Amongst the legal instruments effected by Act No. LII of 2016, amendments and additions were introduced to the provisions governing the sale and letting of things in the Civil Code (Chapter 16 of the Laws of Malta).

A thorough examination of the amendments contemplated in Act No. LII of 2016 falls outside the scope of this paper. However, it is worth highlighting those amendments and insertions which effect the sale and letting of ships.

Any agreement concerning the sale and letting of ships, for instance in the context of a vessel sale and leaseback, is to be governed by the terms of the agreement reached between the parties and international usages of trade. Such terms will prevail over the provisions in the Maltese Civil Code in case of conflict. This ensures that any ill-suited provisions contained in the legal institutes of sale and of lease in the Maltese Civil Code, and which contextually do not apply to the realities of a modern sale and leaseback transaction, are effectively blocked from regulating the parties relationship and consequently being applied by the courts in a dispute. Of course, the choice of the usually selected foreign laws in a sale and/,or lease agreement will do this admirably well and Maltese law will recognise the choice. So this clarification on the subordination of Maltese law to the contract is essentially a defence against any purely local public policy arguments which could potentially upset the parties’ choice of law.

A lessor’s position in terminating the lease agreement and repossessing the leased vessel has also been facilitated given the tendency of Maltese law, as a civil law system, to discourage self help and requiring a court order to terminate the possessory rights emerging from a lease.

A lessor may immediately terminate the lease in the event of a default by serving notice (including through electronic means) notwithstanding the opposition of the lessee and without any prior court authorisation. The requirement to notify the lessee through a judicial act, typically applicable to all things under the Maltese Civil Code, has been removed. Moreover, what constitutes an “event of default” has been defined in the law seeking to mitigate any lengthy negotiations between the parties on whether an “event of default” exists or not. A default has essentially been defined as a change in the financial condition of the lessee, the fulfilment of a condition under which the dissolution of the lease was expressly covenanted as well as an action which deprives the mortgagee of the security expected from its own debtor, typically the lessor. Instances of default may of course be further amplified and supplemented in the lease agreement itself.

Once notice has been served, the lessor may immediately proceed with taking possession of the leased vessel and, upon the lessor’s request, the court is obliged to render its full support to the lessor. Essentially, the amendments again seek to empower lessors (qua financiers) by overturning the bias that exists in Maltese civil law in favour of the possessor of an object subject to lease.

The lessee retains its right to seek damages in the event of an unjustified termination of the agreement.

Parties involved in vessel sale and leaseback transactions now enjoy the comfort that, in instances where the laws of Malta do apply, since a foreign law is not selected by the contracting parties, or where a foreign law is chosen but for one reason or another cannot be applied, Maltese law is well suited to match the realities and demands of today’s modern vessel sale and leaseback models. This recalibrates the risk undertaken in financing transactions and that previously arose under the Maltese legal system, to produce calmer waters going forward.
Source: Times Malta

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