Carel J H van Lynden, a partner in the Shipping & Offshore Department at AKD law offices in Rotterdam
Prospects for economic recovery in the shipping industry remain poor, with little or no sign of a recovery in the short term. Even Chinese shipowners are now reported to be making huge losses. The banks are frustrated by a lack of buyers and by the probable outcome of a re-valuation – or, rather, devaluation - of owners' assets. In many cases, they prefer to let their clients remain in business, even if they fail to pay due instalments or interest payments for extended periods of time, never mind that many of those same owners are also in default on the likes of their loan-to-value ratios.
But enough is enough. Basel III is looking ahead, and internal rules demand the restructuring of debt when a default situation continues for a certain period of time. When restructuring is not possible, the banks at some stage will have no choice but to pull the plug.
To avoid an enforced restructuring or acceleration and foreclosure, shipowners are increasingly looking for the protection of the courts, and in particular Chapter 11 protection under US federal law. Recent examples include Omega Navigation, Marco Polo Seatrade, and General Maritime, dating from July to November 2011. Comparatively little is required for a US federal bankruptcy court to accept jurisdiction. Indeed, the minimal requirements could be fulfilled with reference to, among other things, deposit accounts and retainers in the US, even where such deposits and retainers are for the purpose of instructing US bankruptcy counsel alone.
Athough, theoretically speaking, a Chapter 11 situation in the US would not preclude a bank from enforcing its mortgage rights in another jurisdiction, US law gives a Chapter 11 decision extra-territorial, international effect. Acting in breach of a ruling by taking action in another jurisdiction would be considered by the US Bankruptcy Court a violation of its order, and contempt of court.
No bank with international dealings (including those in the US) would risk a violation of a US bankruptcy order or contempt of court, with all the attendant consequences which that would entail for itself and its employees. Thus, a Chapter 11 application in fact precludes a bank from taking any action, and forces the bank (and other creditors) to the negotiating table to work out a restructuring plan, even when that is totally unrealistic. In the meantime, the shipowner can continue its business as a going concern, incurring more debts and increasing the exposure - and the potential deficit - of the bank.
Can a bank do anything to prevent this? The bank can try to defend the application. Grounds for rejecting an application for Chapter 11 protection include forum non conveniens, and bad faith on the part of the applicant. But even minimal points of connection make the US bankruptcy courts 'convenient', and a bad-faith defence is not easily made, with the result that there is little chance of such defences succeeding.
When there is a threat of a Chapter 11 filing, however, the mortgagee may steal a march on the owner by applying for bankruptcy in another country. When, for instance, the shipping company has a dedicated presence in the Netherlands, the Dutch courts have jurisdiction to hear a bankruptcy application. As is the case in the US, the filing of bankruptcy proceeding in, for example, the Netherlands, triggers an automatic injunction order against the pursuit of any other proceedings. When a shipping company is subsequently declared bankrupt, the management no longer has the authority to represent the company or to initiate a Chapter 11 application. Time, thus, is of the essence.
In the case of the Netherlands, the Dutch insolvency administrator will immediately investigate whether there is a realistic possibility of continuing the enterprise. If it is concluded that this is not the case, the company will be wound up under Dutch bankruptcy law. Unlike in the US, it will be clear within as short a time as one week whether the company can continue trading or will be wound up. Because US bankruptcy law as a general rule accepts the international character of a bankruptcy, it should recognise the authority of a Dutch trustee.
When there is jurisdiction by the Dutch courts, and where the criteria for bankruptcy have been met, the bankruptcy will be declared and an insolvency administrator will be nominated. Again, this may take place as quickly as within a week. The criteria are, briefly, that more than one debt is due but remains unpaid.
This scenario probably applies to many other jurisdictions as well as to the Netherlands. Thus, when the logical forum of a borrower is a jurisdiction other than the US, it may be worth applying for the bankruptcy of such a borrower in that jurisdiction in those cases where no solution can be found and when the borrower threatens to file for Chapter 11. By doing so, the bank may be able to avoid getting involved in a Catch-22 situation.
When a bankruptcy in a European country is in place, a mortgagee can exercise its mortgage rights as if there is no bankruptcy. Article 5 of the EU Insolvency Regulation states that security rights such as a mortgage may be exercised irrespective of a bankruptcy. In this way, it is possible for a lawyer in the Netherlands, for example, to sell a vessel for the banks in cases where the owner has been declared bankrupt by a German court.
Originally published in Marine Risk.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.