PRC flag vessel - registration, mortgages and enforcement

March 2012

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Registration

With very few exceptions only vessels owned by Chinese legal entities or nationals, or bareboat chartered to them, can be registered in China and fly the Chinese flag.1

The Maritime Safety Administration of the People’s Republic of China (中华人民共和国海事局, MSA) is the competent authority for all vessel registrations in China, except for special categories of vessels such as naval, fishing and sports craft. There is no central register of ships. The function of registering nationality, ownership and mortgages is devolved upon local MSA offices.

Fees are payable upon registration. There are no annual fees. Further information (in Chinese only) on fees for different types of registration can be found at the website of MSA.

The regulations are clear: a vessel may be registered at only one port. The appropriate port of registry is the port closest to the owner’s residence or principal place of business. All applications relating to title and mortgages must be made to the port of registry of the vessel concerned; any application made to the wrong registry will be rejected.


Footnote

1. References in this Memo to “China” or “Chinese” are references to The People’s Republic of China excluding Hong Kong Special Administrative Region, Macau Special Administrative Region and Taiwan.

Mortgages

There is no prescribed form of mortgage in China but the document should be signed by both the mortgagor and mortgagee. It should state the amount secured by the mortgage and the tenor of such amount. These details appear in the mortgage register along with details of the parties, of the vessel and of the MSA office which issues the vessel’s ownership certificate and the serial number of the certificate.

As a general principle under the Property Law, mortgages on vessels or on any other types of assets should be used to secure payment obligations arising from civil or commercial activities only. The amount secured by a mortgage can be denominated in a foreign currency or multi-currency. However, if the secured amount constitutes a loan to a PRC entity from an offshore entity, then such amount will be deemed as a “foreign debt”, and the mortgage to secure repayment of such amount will constitute a “foreign security”2, which will in turn be subject to foreign exchange control regulations.

A Chinese mortgage can be used to secure a third party obligation in the absence of a guarantee. In practice, mortgages have been granted to an agent for a lenders’ syndicate or a group of creditors. However, as the trust law in China is still developing, the general view is that the agent for a Chinese mortgage is somewhat different from the security trustee under the common law concept. This may create uncertainties in terms of entitlement to proceeds derived from an enforcement of a Chinese mortgage.

Mortgages on Chinese flag vessels are governed by Chinese Law. The obligations that are secured by them may be governed by any system of law.

Under the Property Law, a mortgage takes effect upon execution and gives the mortgagee rights to enforce against the mortgagor. The validity of the mortgage as between those two parties is no longer conditional upon registration as it was previously. However until the mortgage is registered the mortgagee will not be able to challenge the claims of bona fide third parties. Registration with the MSA therefore remains essential.

Applications for registration of a mortgage are made jointly by the mortgagee and the mortgagor at the MSA office where the vessel’s register is held. Documents must be accompanied by Chinese translations. If both parties to the mortgage are PRC entities, their signatures to the mortgage document need not to be notarized, but the relevant MSA office will require documentary proof of the parties’ identities and authorities for executing the mortgage. However, if one of the parties is an offshore entity, the signature of such party to the mortgage document may, subject to discretion of the relevant MSA office, be required to be notarized.

Within seven days of receiving the application, the MSA office enters details of the mortgage in the vessel’s register and issues a mortgage registration certificate. While this time lag between application and registration will not be an issue where an owner is mortgaging a previously un-mortgaged vessel it will be an issue for a lender providing finance for the delivery instalment of a new building or in the case of sale and purchase of a second-hand vessel under mortgage. A builder will not usually release documents of title until it is paid and a mortgagee will not advance the funds to pay the builder until it has a registered mortgage. Similarly the mortgagee of a seller of a second-hand vessel will insist on being paid before it discharges its mortgage and the buyer’s mortgagee will not fund the purchase price until it has a registered mortgage. There are ways to mitigate the risks for the seller, buyer and their respective mortgagees.

Once registered, a mortgage document may be amended by an amendment registration. To effect an amendment registration, the mortgagor and the mortgagee submit to the relevant MSA office the vessel’s ownership certificate, the mortgage registration certificate and the duly executed amendment agreement. Upon receiving these documents, the MSA office will examine them and decide, at its sole discretion, whether to accept or reject the submission. If the amendment is accepted, the MSA office will make the amendment to the vessel’s ownership certificate, the mortgage registration certificate and the registry’s book.

The MSA does not have offices outside China at which it is possible to register a mortgage, nor is it possible to register a mortgage outside the normal office hours of the relevant MSA in China.

The mortgage register is open for public inspection. It is important to ensure that mortgage details appearing in the application forms are entirely correct because in the event of a discrepancy between the register and the mortgage, the register prevails.

More than one mortgage can be established over the same vessel. The MSA will record mortgages in the sequence in which they are received for registration. Mortgages lodged for registration on the same day rank equally. Amendments to a first registered mortgage require the consent of subsequent mortgagees; in the absence of such consent, the first registered mortgage may be deleted. Although it may be re-registered without the consent of subsequent mortgagees it will lose its previous level of priority. This undesirable effect can be managed through a covenant prohibiting further mortgages and/or through co-ordination agreements between mortgagees.

The mortgagor cannot sell the vessel without producing the mortgagee’s written consent to the MSA. Rights under the mortgage may be assigned by the mortgagee without the mortgagor’s consent. The transferee (whether by assignment or novation) should register himself as mortgagee, and he can do this without affecting the ranking of the mortgage.

There is no concept of provisional registration in respect of Chinese ship mortgages. A mortgage registration once made does not need to be renewed; it remains until the vessel is deregistered. Deregistration is only permitted upon production of the mortgagee’s written consent.

Mortgages may be granted by the builder in respect of vessels under construction. In 2009, the MSA issued a tentative rule, which is still in effect, to govern the registration of vessels under construction. In principle, such mortgages can only be granted to financial institutions lending to a builder, and the registrations must be made with the designated local MSA office where the builder is located.


Footnote

2. “Foreign security” means the security provided by a PRC entity in favour of an offshore entity.

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Enforcement

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.


Footnote

3. We note that a similar concern with the Turkish flag has resulted in a number of banks rejecting security over Turkish flagged vessels.

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