This article is the first of two articles focused on taking security in asset finance transactions in the maritime sphere. This article focuses on certain documentational and cross jurisdictional issues when taking security. Whilst the focus here will be on the maritime sphere, the principles and issues highlighted can be largely transposed to other forms of asset finance, particularly in circumstances where the borrower is a special purpose vehicle.
The value of the vessel in ship finance transactions is a key element (and in "plain vanilla" financings, the key element) in a financier's loan/financing profile and as such a lender's focus is often, understandably, on the vessel's mortgage. However, there is other security which albeit not providing the lender with direct recourse to the physical asset itself (as is the case with the mortgage documents) nevertheless provides the lender with avenues of recourse which relate to the asset's value.
Form of Documentation
In any financing arrangement it would not be atypical to find a standalone security document which creates security over a myriad of certain assets and rights held by the borrower in favour of the lender. For example, a debenture may incorporate charges over certain accounts, shares, and other assets as well as assignments of various contracts and earnings/rental income derived from them if the jurisdiction governing all such assets were the same– all assets could be subject to this one singular "umbrella" security document.
In ship finance transactions, however, the borrower/owner will often be a single vessel-owning company so will therefore typically have no material assets other than the vessel, and the insurances and the earnings emanating from that vessel
The mortgage document in asset financings where the asset is of a moveable nature (i.e. a vessel or an aircraft) will differ from other forms of security over "fixed" assets or those of an immoveable nature; the mortgage over a vessel will be governed by the laws of the flag state or in the case of aircraft, the laws of its state of registration under which in each case, it is registered rather than (for example) the laws of where the asset is situated. Where a vessel (or indeed an aircraft) is registered therefore will be of paramount consideration for lenders as they will need to consider (how the law of the mortgage will interplay with the vessel/aircraft's area of operation; that is to say whether the law governing the mortgage is one which is widely recognised by other jurisdictions as recognition of the mortgage by a foreign jurisdiction will be paramount in any enforcement proceedings that may arise. Lenders may also look to contractually restrict the area of operation of a vessel/aircraft to creditor friendly jurisdictions. We go into greater detail on the cross jurisdictional considerations in relation to the mortgage document in asset finance transactions in our series "Cross Jurisdictional Considerations".
The form of security taken over a vessel's insurances and earnings (and any charter), will typically be provided in a separate security document to that of the mortgage document/, and will take the form of an assignment (often referred to as the "general assignment"). The general assignment operates to assign the borrower's/owner's right to the vessel's earnings, insurances, requisition compensation, and sometimes, any time charter/bareboat charter to the lender.
Cross Jurisdictional Considerations
The law governing the security and terms of any assignment will follow the law that governs the assets over which the security is to be taken (eg the insurance contracts), and this in marine finance transactions and in aircraft finance transactions will typically be English law.
English law is the market standard in governing charter forms (in the case of marine finance) and as London is still the main centre for the insurance market, English law will typically govern the insurances. As each of these "assets" is a chose in action the form of the security will take the form of an assignment and to that end the usual criteria would need to be met as to whether the assignment is characterised as legal or equitable.
Legal or Equitable Assignment
In practical terms for lenders and borrowers, this typically translates into whether notice of the assignment is given to the third party/counterparty from whom the borrower's right to the benefit is owed, i.e. to the insurers in respect of the insurances and to any charterer of the vessel in respect of any earnings under any charter.
There are a number of reasons why a lender may insist on the notice of the assignment being served on the relevant counterparty and thereby creating a legal assignment. Key factors are that:
- the date on which notice is served may determine the priority against later security interests; and
- by creating a legal assignment the lender would also be able to bring any action against the relevant counterparty in its own name and not have to join the borrower/owner as a party to that action.
As any notice of an assignment is to be served on a third party/counterparty in relation to the rights that the borrower/owner is assigning to the lender, the lender may need to be mindful of the relationship which its borrower/owner has with that third party/counterparty when considering whether a notice of assignment should be served and if so the manner by which this is done and whether it is appropriate that any acknowledgment is required. We focus on these issues in our article "Security in asset finance transactions –Interplay with third parties".
Our Banking & Finance and Shipping & Marine teams regularly advise on taking security in finance transactions.
