The crisis in the shipping sector has involved non-profitability of shipping loans for banks. Indeed, a number of loans and, particularly, those granted to small shipowners were not repaid by them and much debt restructuring took place. This and other reasons have led some leading banks to withdraw their commitments in shipping finance. The limited access to financial resources has forced shipowners and other shipping operators to turn to new financing structures.
One of them, certainly the most widely used in 2018 (which can be expected also in 2019) is so-called “sale and lease back”.
Sale and lease back can be structured in various ways. If the ship to be financed is still to be built, the shipping company will order its construction from a shipyard under a standard shipbuilding contract. Upon delivery, the ship shall be promptly sold under a memorandum of agreement to a leasing company or, in any event, to a lender, who will officially purchase the ship through a special purpose vehicle entitled to carry out financial lease activity. At the same time, said special purpose vehicle shall charter the ship to the same shipping company that ordered its construction under a “bareboat charter”[1].
The main documents to be considered, negotiated and executed in such transaction are basically the following three: (i) shipbuilding contract, (ii) memorandum of agreement (whereby the ship is sold by the shipowner to the leasing company) and (iii) bareboat charter (whereby the ship is chartered by the leasing company to the shipowner).
Alternative structures can be provided. For instance, if the ship has already been built and is operating, there will be no shipbuilding contract. Another solution involves the leasing company taking over the shipbuilding contract by entering into a contract amending the same whereby the leasing company becomes a party to the shipbuilding contract together with the shipyard and the shipowner. In such a way, the leasing company shall pay the instalments set for the construction of the ship directly to the shipyard and directly become the owner of the ship upon delivery. In such case, the entering into the memorandum of agreement shall not be required.
The security package shall be consequently adjusted to the sale-and-lease back structure. The mortgage, if requested, shall therefore no be longer granted by the shipowner but by the leasing company in favour of the actual lender of the transaction (if different from the leasing company).
In the event that the ship is under construction, the security shall however include: (i) assignment of refund guarantees, i.e. all rights and interests arising from refund guarantees in favour of the leasing company (refund guarantees are the repayment guarantees that a bank usually grants as a security for payment of the instalments payable by the shipowner to the shipyard); (ii) general assignments of all earnings, insurance and requisition compensations relating to the ship; (iii) insurance assignments (limited to insurance); (iv) pledges over bank accounts to which the ship’s earnings are transferred; (v) any pledge over equity interests of the shipping company; (vi) first-demand guarantees of the shareholders and/or holding companies of the shipping company; (vii) manager's undertakings (i.e. a deed of commitment and subordination to the rights of the leasing company executed by the technical and/or commercial manager of the ship; (viii) any negative shares pledge (i.e. a commitment by the charterer’s shareholders not to dispose of their interest in the charterer or allow distribution of dividends until the debt to the leasing company is paid in full).
Furthermore, reference must be made to letters of quiet enjoyment. A letter of quiet enjoyment is a security document in favour of the shipowner/charterer involving an undertaking by the lender (which, as mentioned above, may even not coincide with the leasing company) not to enforce the securities in its favour until the owner / charterer has fully and timely paid the hires.
By sale and lease back, the instalments of the loan payable by the shipowner to the leasing company/lender of the transaction, including capital and interest, are in all respects hires of the charter. The advantages for the leasing / lender company are considerable.
Normally, shipping loans involve a shipowner retaining ownership of the ship. In case of non-payment by shipowners of loan instalments or any other default, the bank shall start an enforcement procedure aimed at recovery of the loan and enforcement of the mortgage. In certain countries like Italy, such action can take a long time and it is therefore customary to enforce the mortgage in "favourable jurisdictions".
Under sale and lease back, the leasing company or the actual lender is the owner of the ship and - in the event of non-payment of hires - may promptly terminate the bareboat charter and take possession of the ship in any part of the world.
Sale and lease back can also be used by companies undergoing financial restructuring under Article 67 and 182-bis of Italian bankruptcy law [2]. As is known, companies entering into debt restructuring agreements are bound by strict (financial and non-financial) covenants for a number of years. By the tool in question, the company under restructuring formally sells the ships to a leasing company and takes it back on a bareboat charter basis. By doing so, the company under restructuring releases itself, at least in relation to those ships subject to sale and lease back, from the strict covenants imposed by the restructuring agreement. On the other hand, the implementation of a transaction like the one described certainly gives rise to considerable doubt on the part the banks involved in restructuring because, as a matter of fact, they are deprived of the further securities associated with the ships involved in sale and lease back, which remain outside the “restructuring perimeter”. Consequently, if vessels generate earnings exceeding the amount needed for repaying the loan, such excess cash cannot be redistributed to the banks involved in restructuring.
In general, one can say, however, that sale and lease back is becoming the most widely used tool for international finance transactions involving cargo ships and one may also expect that it will remain the most widely used financing instrument in the near future.
This article is for information purposes only and is not intended as a professional opinion. For further information, please contact Emanuele Caretti.
[1]A bareboat charter is a contract whereby the shipowner provides the charterer with the ship, the relevant appurtenances and on-board documents required for navigation and the charterer provides all the other things (including the crew).
