China is not a jurisdiction a mortgagee would choose for mortgage enforcement. If the mortgaged vessel is a China flag vessel it will be manned by a Chinese crew and if it is engaged in China cabotage trades (thereby precluding the chance of her being arrested elsewhere), the mortgagee will have no choice but to look to the Chinese Maritime Courts for relief.
Chinese law does not give mortgagees the right to take possession (some commentators doubt whether the right can arise by contract) and a Chinese crew may not be disposed to comply with directions from a foreign mortgagee to sail the vessel to a foreign port. In practice a mortgagee will have no choice: if it wishes to enforce its security, it must arrest the vessel in China and sell her through the courts.
The lack of a ship watch service makes it difficult to trace vessels in Chinese waters. Knowledge of a vessel’s employment is important as it enables the mortgagee to anticipate her movements. Her arrival at a particular port may be confirmed by the local port authorities. This will be necessary as the court will require details of the vessel’s exact location. Preparations for arrest will involve Chinese translations of the underlying loan agreement, mortgage and other documents, the execution of a power of attorney in favour of the mortgagee’s local lawyer and arrangements to furnish counter-security in an amount and form determined by the court at the time the application is made (see further below). The court will need a few days to consider the papers before issuing a warrant of arrest. One should allow at least 48 hours for this process.
The requirement of counter-security is not a feature of more popular jurisdictions for mortgage enforcement, such as Hong Kong or Singapore, and it is one of several reasons why foreign claimants avoid taking arrest action in China. Counter-security, which is provided to the court in the form of a cash deposit or guarantee, constitutes a fund out of which the mortgagor can be paid compensation in the event that the arrest is later found to be wrongful. Theoretically the amount of counter-security can be any figure at the court’s discretion but in practice it is often set at the equivalent of thirty days charter hire. The amount of security may later be reduced by the court upon application. Counter-security may be required even when the mortgagee is the branch office of a foreign bank in China.
The arrest procedure is clearly stated in the Maritime Procedure Law and ancillary provisions and is administered by Maritime Courts which are, as the name suggests, specialist courts. The procedure for arrest and sale is not dissimilar to that in other jurisdictions. Briefly, the mortgagor may seek a review of the arrest within the first five days; the mortgagee may seek security for the claim not exceeding the value of the vessel; the mortgagee is required to commence proceedings within 30 days of arrest, failing which the vessel may be released; after 30 days, the mortgagee may apply for an order for sale, which is by public auction (a method adopted in several other systems including the US but not Hong Kong, which prefers public invitation to tender instead); notice is then given inviting claimants to come forward within 30 days (the two 30 day periods usually run consecutively although sometimes they overlap); the sale procedure is interrupted if the mortgagor provides security for the claim. Security is for an amount and in a form determined by the court.
Sister ship arrests are permitted except in the case of state-owned vessels. Many ocean going vessels under the Chinese flag are state-owned but managed and operated by companies authorized for this purpose by the state. If a managing or operating company contracts liability for a maritime claim, a state-owned vessel managed or operated by that company may be arrested for the claim against the company; however other state-owned vessels managed or operated by other companies cannot be arrested for that claim. There is no concept of in rem action in China.
A difficult question for foreign parties in China is whether or not to submit to the jurisdiction of the Chinese courts or to agree to arbitration before a Chinese arbitration commission such as CIETAC or CMAC. As a general observation, foreign banks that own and operate businesses in China tend to be more familiar with Chinese law; they may feel more comfortable with Chinese law and with litigation or arbitration in China to resolve disputes over mortgages or other commercial matters. While alternative arrangements can be agreed in loan and mortgage documents (for example, for the arbitration of disputes or for court proceedings in Hong Kong), the subsequent arrest of the mortgaged vessel with a view to judicial sale in China means that the mortgagee must return to China to enforce the award or judgment at the end of the day, so he will be faced with two consecutive sets of proceedings, additional legal costs and the risk of challenge on points taken by the mortgagor or the court in relation to the foreign proceedings. If local protectionism is a concern, it will not be entirely avoided by having substantive issues decided elsewhere, since enforcement remains in the hands of the Maritime Court seized of the case in China.
It may be thought unsatisfactory to have one system of law governing the loan agreement and Chinese law the mortgage. A Chinese court will receive evidence of foreign law but a common perception is that the court will strive for a result that is consistent with Chinese law. A mortgagee may therefore wish to base its case on simple and easily provable events of default, such as non-payment or vessel arrest lasting more than thirty days. It may also take comfort from the tendency of mortgagors to allow enforcement proceedings to go by default, which often happens when the mortgagor sees his interests coinciding with the mortgagee’s, especially if he has given a personal guarantee.
The method of judicial sale in China is usually by public auction. One advantage not available to mortgagees in judicial sale in Hong Kong or Singapore is that, in China, they can bid debt (that is to say the mortgagee will offer a price constituted by the forgiveness of the mortgage debt) if they intend to buy the vessel back from the court, which they will usually wish to do if they plan to sell the vessel on at a higher price (a common plan in mortgage enforcement). This is subject to the condition that the mortgagee must pay into court an amount sufficient to meet any claim which threatens to rank ahead of the mortgage claim on determination of priorities (e.g., a collision claim). The ability to bid debt is also subject to timing: the mortgagee must obtain judgment on its claim in order to crystallize the debt due to it; provided it has judgment, however, it or its legal representative should be in a position to arrange with the court that it bids debt instead of new money.
The Property Law provides that, where the parties fail to agree the manner of enforcing the mortgage, the mortgagee may apply to the court for enforcement by sale or auction without first obtaining a judgment or arbitration award.
Judicial sale in China has the effect of transferring title to the buyer free and clear of all liens, mortgages, claims and encumbrances.
The chief disadvantage of judicial sale in China is the length of time it takes to complete. The procedure is reasonably clear but estimates of the time it takes to complete vary from five to six months or even longer (compared with eight or nine weeks in Hong Kong with the sale proceeds remaining on deposit in court for a further three months or so pending determination of priorities). Arrest expenses are an additional problem and can be substantial. There appears to be no formal procedure for challenging them as there is in Hong Kong and Singapore.
Enforcement of China flag mortgages outside China should present no difficulty at all, except perhaps in Taiwan. However it is possible that the MSA will decline to delete a vessel from the register solely upon the basis of an application of a buyer relying on a foreign judicial bill of sale. The buyer may be obliged to commence proceedings before the Chinese courts for an order confirming that the effect of the sale is to transfer clean title, and this can take several months. The practice of the MSA and the courts in this area is unclear.3
Chinese bankruptcy law presents risk for a mortgagee in that it is required to register its claim like any other creditor notwithstanding it has security, and the mortgagee must do so within a certain period after the court issues a notice declaring the mortgagor bankrupt. The time limit specified in the notice may be as short as thirty days and if it is missed by the mortgagee, and is not extended by the court upon the mortgagee’s application, the mortgagee may be precluded from proving its claim against the bankrupt mortgagor’s estate and effectively deprived of the benefit of its security.
Enforcement of foreign flag mortgages in China proceeds as outlined above.
China has not acceded to the 1952 Arrest convention. However it is a party to many conventions relating to safety and environmental protection. It is also a party to the New York Convention on the Recognition and Enforcement of Arbitral Awards. It has reciprocal enforcement arrangements for judgments with a few countries (including the Hong Kong SAR); China has concluded bilateral investment treaties with a number of countries.
3. We note that a similar concern with the Turkish flag has resulted in a number of banks rejecting security over Turkish flagged vessels.