Shipbuilding projects – exit strategies and pitfalls

In rising markets, it is not unknown for shipbuilders to try to re-negotiate upwards the price of shipbuilding contracts, so as to try and benefit from increasing ship values. In the current uncertain environment, the reverse has predominantly been true, and we are seeing buyers, facing gloomy market prospects, limited or expensive access to capital and balance sheet stress, trying to reduce their newbuilding commitments.

Whilst changing the terms of the contract to reflect the new commercial agreement may be an effective solution, there are, however, circumstances in which one or both parties may find that an exit from a shipbuilding project is unavoidable – for example because of non-performance or financial difficulties – or indeed desirable. Against the current global backdrop of reduced demand and the continuing oversupply of ships, cancellation and exit can be, and frequently are, commercial options for both parties to consider.

In this article, which is the second in our series of articles on shipbuilding projects, we examine issues relating to the cancellation of a shipbuilding project and discuss some common exit strategies. Comments made in this article as to matters of law and interpretation are confined to English law and practice as at the date hereof.

Where commercially practicable, buyers seeking to re-negotiate contractual commitments can achieve this by means of “without prejudice” discussions (the buyer will need to avoid giving the impression of actual or intended non-performance, which may otherwise give the builder an opportunity to terminate the contract for repudiatory breach), with a view, ultimately, to agreeing with the builder to do one or a combination of the following: reduce the purchase price, cancel a number of existing orders (rolling instalment payments made to date into the retained contracts), and defer payment of certain remaining instalments.

The incentive for the builder in entering into such discussions, is principally to hold on to both its buyer and future orders, in a soft and competitive market, particularly in circumstances where it has already commenced construction (stage payments are generally heavily loaded towards the time of delivery, and this was especially true in many shipbuilding contracts entered into before the 2008 financial crisis).

In discussing such arrangements, buyers may need to be prepared to consider additional termination payments, which may, or may not, replicate the position on buyer default that has been agreed under the shipbuilding contract. Agreements in relation to any such additional termination payments may set out appropriate conditions, for example, that any payment deferred will be accelerated upon the buyer obtaining applicable pre-delivery loan financing, and increased financial monitoring requirements.

The builder (or the selling company, acting as intermediary) would also need to consider carefully the size and scope of any termination payment in light of potential “clawback” arguments, whereby a future insolvency officer of the buyer may seek to recover amounts retained by the builder, and possible techniques to reduce such risk, such as the sharing of future upside payments (from sale proceeds) with the buyer.

The current market has also given rise to circumstances in which some builders are facing a financial squeeze, and accordingly may not be prepared to re-negotiate existing deals. Indeed, builders may find themselves in a position where they themselves (sometimes at the request of their financiers) need to ask for additional support from their buyers, such as an acceleration of stage payments. The resulting pressure on existing buyers has given rise to opportunities for third parties to pick up newbuilding positions at a discount to present prices.

Buying into an existing shipbuilding project will require careful due diligence on the (new) buyer’s part, as, for example, much will depend on the agreed specifications when it comes to determining whether the ship is ready for delivery, and (among other things) the licencing of all required intellectual property will need to be confirmed. The level of due diligence required for a current shipbuilding project will depend on the level of construction progress, but legal due diligence will certainly include at least a review of the current shipbuilding contract (and any amendments) and an assessment of its interaction with the refund guarantee.

Very often the contractual position will provide that an assignment of rights under the shipbuilding contract by either party will require the prior written consent of the other party (this is a position often replicated in the refund guarantee).

An assignment of rights alone, without an accompanying transfer of obligations, does not create a clean break for the seller, who would remain liable under the shipbuilding contract (relying on a counter-indemnity from the buyer). A transfer of the seller’s obligations to a buyer is therefore normally achieved by way of novation of the shipbuilding contract, which will always require the builder’s and refund guarantor’s consent. As such, both being dependent on third party consent, neither assignment nor novation will always be achievable outcomes.

In such circumstances, the parent company of an existing buyer may nevertheless be able to exit by selling the shares in the special purpose company (SPC) who is the contractual counterparty (as buyer) to the shipbuilding contract, to a third party, subject to any change of control provisions in the documents (which are rare), and agreement on the terms of the sale.Such terms are open for negotiation, but would be expected to include the seller giving certain warranties with respect to the condition of the SPC and its assets at the point of sale (implying an element of continuing liability), and might also include (for example) an agreement to return any discount that the purchase price represents on moneys then paid down by the seller under the shipbuilding contract in the event of a claim being paid under the refund guarantee.

Taking on the assets and liabilities of the SPC can be more challenging for a third party than a novation of the shipbuilding contract and associated re-issuance of the refund guarantee, and will require an additional layer of legal and financial due diligence. However, this may well be worth the effort as it allows the sale of the project in circumstances where one would not otherwise be available, and allows a new buyer (who may not be able to secure the same commercial terms with the builder) to take over the seller’s agreed contractual position.

We have included a summary of some of the key differences between (i) a sale by assignment, (ii) a sale by novation, and (iii) a sale of shares in the following table:

Authors

Jason Lemann, Of Counsel
Tokyo
Jason.Lemann@nortonrosefulbright.com

Paul Coggins, Senior Associate
Tokyo
Paul.Coggins@nortonrosefulbright.com

This article does not constitute legal advice. Please note all legal advice provided in Japan by Norton Rose Fulbright Gaikokuho Jimu Bengoshi Jimusho (the Norton Rose Fulbright Tokyo Office, which is an independent operating unit within Norton Rose Fulbright (Asia) LLP) is provided by or under the supervision and control of the registered foreign lawyers (Gaikokuho Jimu Bengoshi), details of whom are available on the Tokyo page at www.nortonrosefulbright.com