International arbitration report
In this issue, we cover a broad spectrum of ‘hot button issues’ for boards and companies operating internationally.
The withdrawal of major shipping banks from maritime industries has been a feature of the market for a number of years. This is the result of a combination of factors including a change in the overall strategy of many banks following the collapse of Lehman Brothers, and increasingly stringent regulatory requirements put in place since 2008. An additional driver, for some European shipping banks, is the increased scrutiny of their shipping loan books by the European Central Bank (ECB), which now has supervisory responsibility for banks within the Eurozone. While this has created challenges for the banks, it is also opening up opportunities for other financial institutions and investors to enter the shipping industry at a time when many believe the bottom of the market has now been reached.
A number of European banks have already stepped away from the shipping market. Some, including Commerzbank, Lloyds Banking Group and, more recently, RBS, have done so very publically and others have been less open about their strategy. Coupled with this, we have seen a number of major shipping banks disposing of their loan assets, either individually or through portfolios sales and there are persistent reports of other banks (particularly in the UK and Germany) planning or, in some cases, being in the latter stages of completing a loan portfolio disposal.
The key motivation for a number of banks is simply to unload assets no longer regarded as part of the bank’s “core” business. Even those banks who continue to lend to the industry have been disposing of exposures to customers with whom the bank does not expect to have a long term future relationship. In all of these cases, however, regulation plays a key role. In this era of tighter regulatory capital rules imposed under Basel III, all banks are under pressure to closely manage their balance sheets and free-up regulatory capital for other activities. Ship finance (like aircraft finance, trade finance and project finance) is a regulatory capital intensive business and the competition within banks for the use of capital can be intense. In Europe, pressure exerted by the ECB over the last 12 months has resulted in certain well-known shipping banks in Germany having, in effect, been instructed to start offloading assets in order to reduce the size of their balance sheets..
At the same time, there continues to be a wide range of banks, funds and other financial institutions seeking to acquire exposure to an industry which, in some quarters, is perceived as having value at the present time. This is principally because ship prices have fallen from their pre-financial crisis highs and, in most sectors, have remained (in historic terms) relatively low. Many of these investors are North American funds who are principally interested in distressed or near distressed loans. However there have also been a number of banks, insurance companies, pension funds and other financial institutions showing an interest in acquiring the better quality loans that have come to market.
There are a variety of legal issues that buyers of shipping loans are concerned about when they look at individual shipping loans or loan portfolios, and a number of legal issues associated with transferring a shipping loan and its security from one party to another.
The first stage of a transaction involves due diligence. The seller needs to establish whether the loan documents allow the loan to be sold (and to whom), what consents will be needed from the borrower and other parties and what information the seller is entitled to disclose to a prospective buyer. The buyer (and its legal counsel) will want to conduct a more detailed review of the legal documentation and related papers. The starting point is always the loan agreement itself, the mortgage and other security documents and, where applicable, any intercreditor agreement. These documents need to be reviewed carefully to establish that the basic contractual terms are robust (and broadly in line with market standards), that the security is enforceable and that the contracts reflect what has been represented to the buyer about the principal terms of the loan (amount, tenor, margin and other key terms, such as the loan to value ratio covenant). The buyer will also want to see any material correspondence that throws light on recent developments with the loan – for example, the existence of any default or any outstanding waiver request. It will ask to see the most recent financial statements provided by the borrower, ship valuations reports (if there are any) and current insurance documentation. All of this drives the price which the borrower is prepared to offer to acquire the loan and a seller will fully expect to receive requests for this type of information.
Some prospective buyers will dig even deeper. For example, it is not uncommon for a buyer (particularly those based in the US) to include due diligence on the movements of a mortgaged ship during a period or one or two years prior to the sale. They will have tracked the ship’s movements to check on compliance with UN, EU, US and other sanctions. Where a ship is found to have entered a port in a country subject to sanctions, the buyer will ask for evidence that the visit fell within an appropriate exemption or was otherwise authorised. Sellers need to be prepared to answer these questions.
Once a price has been agreed, the buyer and seller move forward with documenting the sale and executing the loan transfers. There are two styles of sale documentation that are prevalent in the market. Individual loan sales are customarily documented under standard secondary debt trading documents published by the LMA (or, in the United States, the LTSA). This documentation has the virtue of allowing the parties to proceed quickly in accordance with a well-trodden procedural path and there is generally very limited negotiation of terms because the documentation itself is so widely used between industry participants trading loans in a variety of industry sectors. However, standardised debt trading documents, whilst commonly used for individual loan trades, are perhaps less appropriate for portfolio sales.
Almost all portfolio sellers have preferred to adopt documentation more in the style used in M&A transactions. This is not so surprising when you consider that the sale of a loan portfolio is effectively the sale by a bank of a portion of its business and, in some instances, will also involve a transfer of employees and other assets (as well as corresponding liabilities). A bespoke sale and purchase agreement allows the seller to dictate the process and the allocation of risk. In an auction sale, the seller will commonly present its draft sale and purchase agreement terms to all bidders prior to the submission of their best and final bids for the portfolio. This ensures that the seller can compare the offers it receives based on a uniform set of terms. The portfolio sale and purchase agreement will commonly include a number of protections for the seller, including time limitations and minimum amounts for claims by the buyer for breaches of representations and warranties relating to the assets being sold. It will also commonly include caps on the amount of the seller’s overall liability for such claims. These types of protections are not available in the standard secondary debt trading documents used for individual loan trades, but have been successfully established as being “market practice” for portfolio sales. It will also provide for a single financial closing date when the entire purchase price for the portfolio will be paid by the buyer. Those loans that can be fully legally transferred to the buyer on that date will be transferred. Those that cannot (for example, because a third party consent is outstanding) will be transferred to the buyer by way of a funded sub-participation pending completion of the full legal transfer.
Where the borrower’s consent to a full legal transfer is required, the seller will often not approach the borrower for that consent until the sale and purchase agreement has already been signed and so both parties need to accept that the funded sub-participation may have to remain in place for some time (and potentially, if the borrower never consents, for the remaining term of the loan). Even if the borrower’s consent is not formally required under the terms of the loan agreement, its co-operation in the transfer process may still be necessary. For example, if a shipping loan has a swap attached to it and the buyer is acquiring the swap (as well as the loan), the swap will need to be transferred by way of novation or otherwise terminated and re-established with the buyer. In either case, the active participation of the borrower (who is the swap counterparty) will be required.
The legal transfer of a shipping loan can be more complicated than other loan asset classes, mainly because of the need to ensure that security interests remain in place and fully perfected. Perhaps surprisingly, it is actually far easier to transfer a participation in a syndicated shipping loan than in a bilateral shipping loan. In a syndicated loan, all of the security (including the mortgage over the ship, share security, account security and assignments of earnings and insurances) is held by a security agent or trustee for the benefit of all of the lenders from time to time. When a participation in a syndicated loan is assigned by one lender to a new lender, the corresponding beneficial interest in the security is assigned with it, but the security agent continues to hold the security for all of the lenders and all that has changed is the identity of the group of lenders. The position is more complicated in the case of a true bilateral loan because the security, here, is granted directly to the lender, rather than to a security agent or trustee on behalf of the lender. In these cases, the benefit of the security needs to be assigned separately at the same time as the loan is assigned. The ship loan agreement may be governed by English law (or any other law chosen by the parties). However, the governing law of the mortgage will depend on where the ship is flagged and the account security will be governed by the law of the place where the relevant bank accounts are maintained. So, as an example, it is quite conceivable that the loan will need to be assigned under English law, the mortgage will need to be assigned under Panamanian law because the ship in flagged in Panama and the account security will need to be assigned under Greek law because the bank accounts are held in Greece. In addition, the mortgage register will need to reflect the change in the identity of the mortgagee and so arrangements will need to be made to ensure that the mortgage assignment is filed and recorded at the same time as the loan is assigned. The transfer of a bilateral loan can, therefore, require multiple documents and the involvement of lawyers in several jurisdictions.
The buying and selling of a shipping loan portfolio is a complex process. However, continuing pressure on banks to reduce their exposure to the maritime industry, and the opportunities presented by asset values at historic lows means that there remains strong motivation for banks and new market entrants to agree deals.
In this issue, we cover a broad spectrum of ‘hot button issues’ for boards and companies operating internationally.
It is impossible to ignore that climate change and sustainability issues are scorching hot topics (pardon the pun).
© Norton Rose Fulbright LLP 2021