Legal Issues in Supplying and Financing Maritime Energy Saving Technology9 August 2021

As to the industry players, the supply of EST could involve tech start-ups and joint ventures, possibly with direct or indirect government support – a constituency different from ship financers. The suppliers are quite likely also to be the financiers, sometimes with separate financiers behind them –taking in turn a varying degree of risk on, and involvement with, the supplier and its contractual arrangements with the shipowner/operator.

The nature of the equipment and the nature (and appetite for risk) of the suppliers will each have an impact on contractual arrangements which will differ from the up-sizing financing model so far seen with the retrofitting of scrubbers. The arrangements contemplated assume the installation of EST on trading ships, that EST does not come with a newbuilding as part of the specification and, even when installed, may not form a fully-integrated part of the ship at all. Indeed, the appetite for such financings may increase to the extent that EST, once installed, does not form a fully integrated part of the ship and can cost-effectively be removed, transported and re-sold.

Issues for the EST Supplier

An EST supplier which does not have security over the ship itself is at first sight in a weak position regarding security over EST. It may either acquire title to the equipment and become a lessor to the shipowner/operator (or sell it outright on terms that include a “retention of title” provision, under which title will pass on payment, rather than earlier delivery), or become the holder of some kind of security interest over the EST (in English law terms, a chattel mortgage). It is likely that the former will be more popular than the latter. Chattel mortgages cannot usually be registered, leaving the EST financier with an unregistered, equitable mortgagee interest with rights that will not be recognised at all in many jurisdictions to which ships trade and, even in those jurisdictions in which such interests are recognised (such as the UK) such a chattel mortgage may still not give full protection. Lessors will by contrast at least have title, i.e. a proprietary interest that ought to be recognised wherever the ship trades.  However, in either case the EST supplier is potentially looking to repossession of, or enforcement against, equipment which is on a ship that could in some cases be arrested in any part of the world by other maritime creditors of the shipowner.

An EST supplier should, however, have a right to arrest the ship in order to obtain security for the sums owed to it (i.e. as distinct for its claim for repossession of property to which it retains title) if the shipowner defaults under the EST supply contract. The 1952¹ and 1999² Arrest Conventions (the “Arrest Conventions”) give a right of arrest for a claim in respect of “goods or materials wherever supplied to a ship for her operations or maintenance“³ and almost all countries in the world, even those that have not ratified either Arrest Convention, such as the USA, permit the arrest of ships for sums owed to suppliers of goods or materials or, as known in the USA, “necessaries”⁴. Maritime claims for the supply of goods under the Arrest Conventions will rank below a registered mortgage. In a few jurisdictions, however, (most notably the USA) the position is different. Claims for “necessaries provided in the United States” are treated as preferred maritime liens⁵. Such claims will also usually prime ship mortgage claims in South Africa⁶. These claims do not normally survive a change of the ship’s ownership, at least in Arrest Convention jurisdictions. Further, if the lessee or purchaser of the EST is a lessee operator or a commercial bareboat charterer who then redelivers the ship to its registered owner, the EST supplier then loses its right of arrest. An EST supplier which has lost a right to arrest the ship may be able to seek an injunction or attachment to recover its goods outside the usual ship arrest framework, but this is likely to be cumbersome and expensive.

Nevertheless, ship mortgagees will be wary of third-party EST financing due to the rights to arrest it may confer on the EST supplier. A third-party charterer may also want to curb the EST supplier’s rights to arrest and could insist on its own quiet enjoyment rights from an EST supplier in addition to those it may require from a mortgagee of the ship.

Issues for the Ship Mortgagee

Consent from a mortgagee ship financier will almost invariably be required for EST financing to be put in place because of the typical restrictive undertakings which the shipowner will have agreed with the mortgagee. Restriction on structural modifications is the most obvious, but restrictions on the incurring of financial indebtedness could also be engaged (if the EST supply arrangement falls within the applicable definition of “financial indebtedness” and outside the scope of any permitted levels of indebtedness for operating the ship etc.). Further, if the EST supplier is to look to the cashflow from the ship’s earnings to service the shipowner’s EST obligations, the mortgagee will need to allow an exclusion from the comprehensive assignment of earnings it will invariably have. This might seem like a “big ask” of a ship mortgagee: watering down the restrictive undertakings and diluting its security over earnings in order to accommodate a third party which may have a right to arrest the ship in the event of the shipowner defaulting under its EST obligations.

Towards Resolution?

If the demand for EST continues to grow – as seems likely if not inevitable – the stage will soon be set for ship financiers and EST suppliers to try to resolve the inherent tensions between their competing rights and interests. Shipowners will surely be involved in encouraging and promoting those solutions. Any solution will inevitably involve coordination or intercreditor arrangements between the ship financier/mortgagee and the EST supplier. One avenue to explore in terms of supply  might be an arrangement around granting the ship mortgagee the right (and/or, possibly, the obligation) to step into the shipowner’s EST supply arrangements on shipowner mortgage enforcement and/or EST supply default, in return for the supplier conditionally agreeing to waive its rights to arrest the ship. Such a mutual accommodation would reflect that EST enhances the value of the mortgaged ship and that any right of the EST supplier to arrest the ship in which the mortgagee will usually have both a prior-ranking claim and a much greater economic interest might, in practice, be seen as no more than a nuisance right. Even if this is a model which has potential traction, the devil will inevitably be in the detail and there is unlikely to be a “one size fits all” solution that obtains market acceptance.

[1] International Convention for the Unification of Certain Rules Relating to the Arrest of Sea-going Ships, 1952
[2] International Convention on Arrest of Ships, 1999
[3] Article 1(1)(k) of the Arrest Conventions
[4] 46 U.S. Code § 31342
[5] 46 U.S. Code §31326(b)(2)
[6] s. 11(4)(c) Admiralty Jurisdiction Regulation Act, No. 105 of 1983 as amended by the Admiralty Jurisdiction Regulation Act, No. 87 of 1992