Ship finance basics: All you need to know from a shipping lawyer’s perspective
Purpose of the financing
Shipping is a capital-intensive industry, where depending on the type and size, a single ship can cost millions of dollars to construct or acquire. Traditionally, ship-owning groups have relied on bank financing to finance either the construction of new ships or the purchase of second hand vessels. Another common finance structure in shipping is also the utilisation of a new bank financing (granted on more favourable terms) to refinance an existing loan already linked to the construction or acquisition of the vessel. Whilst the structure of each deal may be slightly different depending on the current market or the credit worthiness of the shipping group, nevertheless, most ship finance deals will still follow one of the above structures.
Typical structure of a ship finance loan
Ship finance loans are by default secured asset-based financings. Therefore, as one would expect, the bank expects the loan to be repaid through the income of the ship and the bank’s security does primarily focus on the asset itself. A ship finance loan is normally structured as a term rate loan with equal quarterly or semi-annually instalments and a large balloon instalment payable at the maturity of the loan. The tenor of such loans does largely vary and is very much linked to the age of the ship and its scrap value.
A lender typically lends only a certain per cent. of the ship’s value and, given that the security is largely based on the asset, the lender normally requires in return that the asset maintains during the tenor of the loan a certain value to loan ratio (VTL). This effectively means that the market value of the asset, as may be determined by valuations obtained frequently by independent valuers, should not fall beyond a certain per cent. of the outstanding loan.
The borrower – owner of the ship
Shipping groups normally comprise of various special purpose vehicle companies (SPVs), all usually being under the ownership of the same holding company. Each of such SPVs is set up by the shipping group with the sole purpose of owning a particular ship. Each SPV does not normally own other assets, save for the ship in question and any assets required for the operation of that ship such as bank accounts where the income of the ship is credited. This corporate structure is so common in shipping because the value of each ship is significant, and a shipping group would normally seek to minimise the risk of each financing to a particular ship. Most shipping companies set up their SPVs in jurisdictions which are attractive from a tax law and ship registration perspective with the most common options being Marshall Islands and Liberia.
Security
Below is a security package commonly encountered in ship financings:
• Ship mortgage
This is a financier’s most important security. It effectively allows a financier to arrest the ship and sell it through private sale or through auction, so that the borrower’s debt can be satisfied through the sale proceeds.
• Assignment of earnings and charterparty
The primary source of a ship’s income is a contract of employment (normally called “charterparty”). A financier would normally seek an assignment of the ship’s earnings under such contract, and in case of long term charter, an assignment of all rights which the ship owning SPV might have under such contract.
• Assignment of insurance proceeds
A ship is a high-risk asset susceptible to loss incurred upon the ship itself (for instance, damage to a ship’s hull if the ship is involved in a collision incident) or to loss caused by the trading of such ship to third parties (for instance, liability to other ships from collision, environmental liability in case of oil spills etc.). Therefore, it is critical that a ship is insured for the said risks and a prudent financier would normally seek to obtain an assignment of such insurance proceeds, so that it can be reimbursed from the insurers, in place of the owner, if the ship is damaged beyond repair.
• Security over bank accounts
The ship owning SPV normally maintains a trading account, out of which the ship’s trading costs are paid and where the earnings from charterparties are credited. This account is normally maintained with the financing bank and will be charged in favour of such bank.
