On 3 February 2016, an Appeals Court in Sao Paulo, Brazil, handed down a judgment in which it determined that a Liberian ship mortgage, granted in favour of Nordic Trustee, over the FPSO “OSX-3” (the OSX3 Unit), would not be recognised as a valid mortgage under Brazilian law. This decision has implications for those involved in secured lending transactions for offshore oil and gas assets and ships (Offshore OGAs) which are present (even on an occasional basis) in Brazil’s maritime economic zone.
- The OSX3 Unit is owned by a Dutch company (OSX3), which is part of a wider Brazilian group, and chartered to an affiliated Brazilian company.
- The OSX3 Unit is registered with the Liberian Registry and the finance is secured by, among other things,a Liberian law mortgage, which had been registered with first priority with the Liberian Registry.
- The mortgage was not registered with the Brazilian Maritime Registry (BMR) (it is only possible to register a mortgage with the BMR over a ship registered under the Brazilian flag) 1.
- A creditor of OSX3, BTG Pactual, brought a claim against the OSX3 Unit and argued that the mortgagee did not have a secured claim ranking pari passu or in priority to its claim.
- Both the first instance and Appeal Court decisions upheld BTG Pactual’s claim.
The basis for the Appeal Court’s decision was that Brazil will only recognise the validity of a mortgage (i) where it is registered with the BMR, or (ii) to give effect to Brazil’s international obligations for the recognition of mortgages. This requires the mortgage to be registered in a country which has ratified either the Brussels Convention of 1926 for the unification of certain rules relating to maritime liens and mortgages or the Bustamente Code of 1928 (together the Codes). As Liberia is not a signatory to either of these Codes and the mortgage was registered only in Liberia, the mortgage was held to be invalid and was accordingly afforded no priority as a matter of Brazilian law. The Appeal Court also appeared to be influenced by the fact that the OSX3 Unit is a FPSO and, therefore, is in the nature of infrastructure compared to, for example, an offshore supply or platform supply ship, which is more in the nature of a chattel. However, it would be prudent to assume that the judgment will apply more widely to other Offshore OGAs.
Although in Brazil, as a civil law country, court judgments are not strictly binding on other courts, the Appeal Court decision cannot be ignored. It is likely to be persuasive and may well be followed by other Brazilian courts.
Impact of the Appeal Court’s decision on financings of Offshore OGAs
The Appeal Court judgment is already affecting numerous on-going and future projects. Not only does it raise questions in relation to the security lenders have or will have in place, but also for existing financings, it could put the borrower in breach of various representations and warranties, and may even give rise to mandatory prepayment events. It is estimated that there are more than 200 ships in Brazilian waters flying the Liberian flag, of which around 140 are mortgaged.
As a result, some lenders are considering requiring the relevant Offshore OGAs to be reflagged in countries which are signatories to either of the aforementioned Codes; Panama being the most obvious candidate.
However, whilst flagging or re-flagging in Panama should be a legal possibility, there are a number of difficulties: there may be physical changes required to the relevant Offshore OGA, or changes to the operational and management contract, services contract or ship management agreement to comply with the requirements of the Panama Ship Registry.
In addition, the safety and other regulatory documentation for the relevant Offshore OGA would need to be re-issued by the Panama Ship Registry.
The consent of the charterer and/or any counterparty to key contracts is also likely to be required for the replacement mortgage, and possibly the re-flagging, and this may be difficult to obtain.
Mortgage enforcement in Brazil
It is worth noting that even before this decision, lenders would usually be loath to rely on their mortgage in Brazil in any event. Not only are there likely to be quiet enjoyment considerations, but also, enforcement through the Brazilian courts can be a slow and uncertain process.
Aside from the regulatory and field abandonment considerations by (among others) Brazil’s National Agency of Petroleum Natural Gas and Biofuels (ANP), even where counterparty consents and numerous regulatory approvals are obtained, taking possession as mortgagee of an Offshore OGA, particularly a long way offshore, can be difficult and costly.
The best option for lenders may be to require the owner, in accordance with their obligations under the finance documents, to move the Offshore OGA to a location outside Brazil, in which case the OSX3 Case would cease to be relevant.
However, an equally important aspect of taking a mortgage as security, is as a protective measure (a) to prevent others from having such security, and (b) to obtain priority over other creditors. It is the latter, in particular, that is a key concern resulting from the OSX3 Case, but it is worth noting that the position in relation to priorities (and arrest rights) of other maritime claims is also uncertain as a matter of Brazilian law.
In view of the points above, lenders may have good reason to request enhanced information regarding the status of outstanding amounts relating to the Offshore OGA or its operation or construction, both at the point of the request and indeed on an ongoing basis. Whilst the representations and warranties and information covenants in finance documents may be extensive, one area which may not be covered, for example, is possible claims or liabilities under sub-contracts entered into with the Engineering, Procurement, Construction and Installation (EPCI) contractor or shipyard, especially in the context of the construction of the Offshore OGA – noting that liabilities under construction contracts may, if not settled, allow an in rem claim against the Offshore OGA.
The mortgage is unlikely to be lenders’ only security. It is likely that lenders will have the benefit of assignments by the owner of rights under key contracts, or the receivables payable thereunder, as well as its rights under the insurances. If the owner fails to perform its obligations (e.g. to co-operate with the export of the Offshore OGA), lenders may be able to use security over the shares or other ownership interests in the owner to take over control of the owner. However, we expect that this may be a last resort for lenders - taking over ownership and control of an Offshore OGA is not a step to be taken lightly.
Provisions under the finance documents for the Offshore OGAs may be triggered as a result of the decision of the Appeals Court, resulting in a requirement for the loan to be repaid immediately or preventing further drawdowns of the loan.
A means of mitigating the effect of the judgment would be to re-flag the Offshore OGA under Panamanian law, although the costs and capability of doing this may be significant.
Lenders of Offshore OGAs are likely to have the benefit of a security package wider than a mortgage over the Offshore OGA. Lenders may also benefit from having a beneficial owner(s) of substance, who has a substantial equity investment and, therefore, an incentive to support lenders. Lenders should also consider using existing (or requiring expanded) covenants and undertakings in the finance documents to obtain information on possible claims from other creditors.
The Appeal Court decision is controversial and is expected to be appealed. Nonetheless, the decision and its implications cannot be ignored for now.