Dede Law and Business Series: Debt financing for medium sized shipping company (1)

By Foluke Akinmoladun

A medium size shipping company may because of operations and revenue have a smaller revenue base than a larger shipping company with greater assets particularly fleets or vessels. This means that the options for finance may be relatively less. However, every business in developing its performance strategy will have some form of funding strategy as well. One of such strategies is debt funding. Here, we will analyse debt funding for a medium size shipping company and also look into the various forms of security it may make available to potential lenders.

For a medium size shipping company, the risk of default may be generally higher than a larger shipping company that has more assets to pledge in security. Therefore, the first step in a debt funded expansion strategy is to determine what the funds will be utilised for. It could be to finance working capital of the company particularly shipping operations. On the other hand, funding could be to expand the number of trade routes that the company engages in by either buying new vessels that are already trading or order for new vessels to be built. The capital requirement for ordering a new ship is considerably higher and the complexities in terms of the securities required and the documentation and institutions involved are higher as well.

Once the company has determined what it requires the funding for, the next thing is to determine what the source of that funding should be. Here we are considering debt financing. The types of debt finance potentially available to medium-sized company wanting to diversity the risk component in its funding portfolio, ranges from cash flow finance, bank overdrafts, secured loan, mezzanine loan, sale and leaseback transactions, senior bank loans, leasing/hire purchase agreements to venture capitalists and stock market listing(bonds).

The focus here is on the types of securities that a medium size shipping company will give to guarantee the loan since lending to it may pose a higher risk than a larger shipping company. For banks and financial institutions, the most important security is a ship mortgage.
A ship mortgage is an arrangement whereby, a ship owner or ship owning company, gives the lender (referred to as the mortgagee) an interest in the ship as security for a loan. The ship owner then becomes the mortgagor. A ship mortgage arrangement has three main component parts- the mortgage loan, the mortgage deed and the rights derived from the mortgage deed attributable to the lender.

A lender needs to be sure of its rights as a mortgagee in the flag ship of the vessel as this may affect the ability of the lender to exercise its rights over the mortgage in case of a default. The jurisdiction where the mortgagee wishes to execute its interest on the ship mortgage is equally important. In some jurisdictions, the mortgagee has equal rights with the ship owner while in other jurisdictions; the mortgagee’s rights could rank lower than some unsecured creditors because of the operation of the law. Priorities are variously determined by the lex fori- (The law of the country in which an action is brought), the lex causae (Lex causae is the law or laws chosen by a forum court from among the relevant legal systems to arrive at its judgment.

This is mostly used in international or interjurisdictional cases), the lex registri (The law of the port of registry of the ship) or the lex situs (In law, the situs is where the property is treated as being located for legal purposes. This may differ for a ship depending on where it is located as, the situs of a ship within territorial waters is where it is located, but the situs of a ship in international waters is its port of registry). A number of jurisdictions apply the lex fori.

In the United Kingdom for instance, a mortgagee has the right to arrest a ship within the jurisdiction of the Admiralty Court irrespective of the country of registration due to the Admiralty Courts Act of 1840. In Nigeria, there is no distinction between the places of registration of a mortgaged vessel for the purpose of enforcement by way of arrest proceedings according to section 3 of the Admiralty Jurisdiction Act. In China, under Article 21 (21) of Special Maritime Procedure Law of the People’s Republic of China 1999, there is no distinction between mortgage claims arising from a domestic registered ship and from a foreign registered ship. Where there is a ship mortgage claim, according to Article 21(21), it can be brought by way of arrest of ships.

Foluke Akinmoladun is a lawyer, accountant, mediator and arbitrator. She is the Managing Solicitor of Trizon Law Chambers and can be reached at: