Ship arrest and judicial sale in China: update, 2015

A number of changes to ship arrest and judicial sale have taken effect in the People’s Republic of China, impacting shipowners and their financiers around the world. The Supreme People’s Court of China¹ has clarified the rules on ship arrest in a new set of Provisions on Arrest and Judicial Sale of Ships (Fa Shi [2015] No.6) (the Provisions) which came into force on March 1, 2015 and replace all earlier judicial provisions issued by the Supreme People’s Court concerning ship arrest.

Although not the most popular jurisdiction for ship arrest, China is a jurisdiction where ship arrest is relatively uncomplicated. China is not a party to the 1999 Convention on Arrest of Ships, nor the 1952 Convention on Arrest of Sea-Going Ships. However, China’s law on ship arrest is modelled on the 1999 Convention and the relevant rules are codified in the Special Maritime Procedure Law (1999). Under Chinese law, only maritime claims give rise to ship arrest. The qualifying maritime claims are the same as those 22 categories listed in the 1999 Convention, which include (among others) claims arising out of maritime lien, charterparty, mortgage, ship sale, unpaid insurance premiums and ship broker’s commission. The new Provisions are a restatement of the law and practice of ship arrest in China.

Under the 1999 Convention, "arrest" means any detention, or restriction on removal, of a ship by order of a court, to secure a maritime claim. Over the years, “arrest” in China has come to mean either (a) the physical detention, or restriction on removal, of the ship by order of the court, or (b) in the case of Chinese flag ships, restriction on changes in title and registration documents, which prevent a transfer of ownership and mortgage interests without affecting the normal employment of the ship (title arrest).

Under the Provisions, both measures are available to an applicant, with the result that an arrest may take the form either of a physical arrest, or a title arrest. Only Chinese flag ships can be subject to a title arrest.

There are two aspects to be considered – arrests by multiple claimants, and multiple arrests of a ship by the same claimant. The Provisions allow different maritime claimants to arrest the same ship for their respective maritime claims, irrespective of whether the ship is already under arrest by other claimants.

However, the same claimant is not allowed to arrest the same ship a second time for the same claim, unless one of the following three circumstances arises: (1) the respondent did not provide adequate security, (2) the guarantor of the obligations of the owner or bareboat charterer has defaulted, or (3) the ship arrested, or the security previously provided, was released upon the application or with the consent of the claimant, acting on reasonable grounds, or because the claimant could not prevent the release by taking reasonable steps.

The Provisions also clarify that, where the claimant who obtained an arrest order in respect of the ship before other claimants, has failed to apply to the court for an order to sell the ship, any other claimant may apply for an order for the sale of the ship, notwithstanding any opposition by claimants who obtained arrest orders ahead of that claimant.

Under Chinese law, an applicant for ship arrest is required to provide counter-security to the court, in the form of a cash deposit or guarantee. This constitutes a fund, out of which the respondent may be paid compensation in the event that the arrest is later found to be wrongful.

In the past, the required amount of counter-security was fixed at the court’s discretion and common practice was to set it at the equivalent of 30 days’ hire. The reasoning behind this practice, was that a claimant has 30 days from the date of arrest to commence litigation or arbitration and may then apply for an order for sale, if the respondent does not provide the required amount of security within the specified time period.

The Provisions require that the amount of the counter-security shall be assessed so as to reflect the cost and expense of maintaining the ship under arrest; the loss of earnings during the arrest; and the cost incurred by the respondent in providing security for release of the ship.

The Provisions further state that, if the counter-security provided subsequently proves to be insufficient to cover the loss potentially suffered by the respondent, the court may order the applicant to provide top-up security.

The only exceptions to the requirement that a claimant must provide counter-security, are in respect of claims arising out of crew employment contracts and claims in respect of personal injury and death. In these cases, claimants are regarded as being in a disadvantaged financial position.

The answer to this question was not clear in the past. The Provisions now clarify that the owners, or bareboat charterers, continue to be responsible for the maintenance and management of the ship during the period of the arrest. The costs so incurred, are to be borne by the owners or bareboat charterers.

If the owners or bareboat charterers fail either to maintain the ship, or to pay the crew, the court may appoint a third party service provider, or the party who applied for the arrest order, to take over the management of the ship while it remains under arrest. In such cases, the costs incurred will eventually be deducted from the sale proceeds of the ship.

Chinese law allows the arrest of a bareboat chartered ship, in respect of claims against the bareboat charterer.

In the past, it was not clear whether the applicant was also entitled to apply to the court for the judicial sale of the arrested ship, given that the bareboat charterer does not have ownership of the ship. The Provisions clarify that the applicant is entitled to apply to the court for the judicial sale of the arrested ship under bareboat charter, in respect of the liabilities of the bareboat charterer.

Owners should therefore ensure that they have the protection of carefully-drafted indemnities in the bareboat charter. For example, clause 17(a) of Barecon 2001 provides that the bareboat charterer shall indemnify the owner, if the ship is arrested for liens or claims resulting from the charterer’s operation of the ship.

However, there remains the risk that the bareboat charterer will have insufficient assets to honour the indemnity, or becomes insolvent. Other forms of security may be sought.

Sale by public auction is the only available method of judicial sale in China. Under the Provisions, the sale must be conducted by an auction committee constituted by the court. The court will not appoint professional auctioneers, or brokers, to sell the ship.

If the public auction fails after two attempts, the court may arrange a private sale of the ship at not less than 50 per cent of the reserve price, which is kept confidential to the court at all times. If the ship is still not sold, the court will require two-thirds of registered creditors to agree, before sanctioning a sale at less than 50 per cent of the reserve price. If no sale is achieved after all these attempts are made, the court will release the ship from arrest.

Creditors must register their claims against the ship with the court within 60 days after the court publishes the announcement of the public auction. If a claim is not registered at court within the 60-day period, the creditor is deemed to have waived all and any rights to receive a share of the sale proceeds in respect of the claim in question.

The proceeds of sale will be applied, first, to pay legal expenses for which the respondent is responsible; expenses incurred in connection with the arrest and sale of the ship; and expenses and costs incurred in the common interests of creditors generally.

After deduction of these expenses, the remaining proceeds are distributed to meet claims secured by way of maritime lien, possessory lien, or mortgage, in that order. (Maritime liens exist under Chinese law in respect of claims for (i) crew wages; (ii) crew personal injury; (iii) port dues; (iv) salvage remuneration; and (v) liability in tort for collision and other damage.)

Any remaining surplus is applied towards other registered maritime claims relating to the ship. If the surplus is not adequate to meet all maritime claims, the proceeds are distributed pro rata, according to the total amount of unpaid registered claims.

China is not a common law jurisdiction. The concept of in rem liability is not part of Chinese law. Maritime proceedings are brought against corporate bodies, or persons, as defendants (and not against the ship itself). However, the Provisions have, in several respects, brought Chinese law more into line with the practice in common law jurisdictions.

Owners who have ships trading to China under bareboat charters should have regard to the risk of their ships being arrested and auctioned, in China, in respect of claims against their bareboat charterers.

Mortgagee banks considering enforcement of mortgages by arrest and auction sale in China, should be aware (i) that the ship sale proceeds will be distributed, first, to pay legal expenses and costs of arrest and sale, maritime liens and possessory liens, before their mortgage claims, and (ii) that counter-security must be provided, as a pre-condition to the arrest of a ship in China.

The Provisions have also had the effect of increasing the amount of the counter-security which must be provided. The Chinese authorities appear to be bringing greater certainty to this important aspect of law and practice. It is important that the Provisions come to be regarded as having reformed the law successfully, because China is of growing importance as a maritime nation.