Ship Mortgage and Vessel Arrest Laws in Mainland China, Hong Kong and Taiwan: a Comparative Analysis

Abstract

Bank and other financial institutions providing ship finance require legal protection just as much as other entrepreneurs. When a bank finances the purchase of a ship, the borrower has to execute a ship mortgage in favour of the bank. By definition, a ship mortgage is a security over the ship which enables the bank, on default by the borrower, to take possession of the ship and sell it to discharge the debt. In order to enforce the ship mortgage, the bank may ask a maritime court to arrest the ship and, through judicial procedure, sell or auction it. This paper comparatively explores the legal and practical issues regarding the nature and the enforcement of ship mortgages in Mainland China, Hong Kong and Taiwan. When a bank finances the purchase of a ship, the borrower has to execute a ship mortgage in favour of the bank. By definition, a ship mortgage is a security over the ship which enables the bank, on default by the borrower, to take possession of the ship and sell it to discharge the debt. In order to enforce the ship mortgage, the bank may ask a maritime court to arrest the ship and, through judicial procedure, sell or auction it. Ownerships and mortgages of ships may be registered with any registries located in jurisdictions such as Panama, Liberia, Bahamas, Vanuatu and the Marshall Islands. These registries are often referred to as the “flags of convenience”. As these countries depend significantly on income from shipping, they open their registers to non-nationals. Anyone can register a ship on one of these open registers, and a link between the nationals of the flag state and the ship is not required (1). On the other hand, a ship is a highly mobile vehicle of carriage. It may not return to its home base nor visit the same port again. It is a well-established international shipping practice that ship mortgages can be enforced world-wide, regardless of where the mortgages are registered. This paper comparatively explores the legal and practical issues as regards the nature and the enforcement of ship mortgages in Mainland China, Hong Kong and Taiwan. The introduction of laws on ship mortgages and registration were prompted by the China’s need to purchase more vessels and obtain shipping finance through various finance structure such as equity, debt or charters that are consistent with international standards. In fact, most major shipping companies in China expand their fleets by adopting these types of financing structures or arrangements. The Rules of the People’s Republic of China Governing Registration of Ships came into force on 1st January 1995 (the Registration Rules). Under the Registration Rules, the following ships shall be registered: ships owned by citizens of the PRC whose residence or principal places of business are located within the territory thereof; ships owned by enterprises with legal person status established under the laws of the PRC and whose principal places of business are located within the territory thereof, provided that if foreign investment is involved, the proportion of registered capital contributed by Chinese investors shall not be less than 50%; public service ships of the PRC Government and ships owned by institutions with legal person status; and other ships whose registration is deemed necessary by the competent authority of harbour superintendency of the PRC. The Bureau of Harbour Superintendency is the competent authority in charge of the registration of ships, but the Ship Registration Administration (situated at various ports) is the agency in control of actual registration. Before registration can occur, the Harbour Superintendency requires submission of proper documentation (2). Having examined and verified the application for registration of ownership, the Ship Registration Administration shall issue to the shipowner whose application meets the requirements of the Rules, a Certificate of Registration of Ship’s Ownership and a Certificate of Ship’s Nationality. Where mortgage is established with respect to a ship of 20 tons gross tonnage or over, the mortgagee and the mortgagor shall apply to register it with the Ship Registration Administration (3) to obtain a Certificate of Registration of Ship Mortgage. Where two or more mortgages have been established on the same ship, the authority will make the registration in sequence of dates on which the applications were registered, and indicate the respective dates in the register of ships. Special provisions covering the making of commercial loans also exist. Thus, a Chinese shipping company wishing to borrow foreign currencies in its own name directly from a foreign entity for the purpose of purchasing vessels, must first seek approval from the State Administration of Foreign Exchange (SAFE). This is governed by the Administration of Borrowing of International Commercial Loans by Domestic Organisations Procedures promulgated by SAFE in 1997. Under the laws, all international commercial loans (4) require SAFE approval or risk being declared void. In addition, all international commercial loans must be registered with SAFE which will then issue a Foreign Debt Registration Certificate, to be presented to authorised banks. This will enable borrowers to open foreign exchange bank accounts and undertake procedures for remitting foreign exchange abroad. Bearing in mind that some overseas lenders may be reluctant to take a mortgage over a vessel under the PRC flag, there has been a recent tendency for domestic shipping enterprises wishing to avoid the red tape of the above procedures, to set up subsidiaries in developed maritime countries such as Liberia and Panama. Under such schemes, loans are advanced to these subsidiaries for the purchase of ships, but once the transactions are completed, both the ownership and mortgages must be registered with the appropriate Liberian or Panamanian authorities. The offshore subsidiaries may then charter the ships back to their mother companies in China (5). As part of the transaction, the Liberian or Panamanian shipowners must also assign all their rights and benefits (e.g. assignment of insurance proceeds, charter, sub-charter and freight) in favour of the overseas lender as security. When a foreign mortgagee enforces his foreign registered mortgage in China, the law of the flag state (not Chinese Law) shall apply to the mortgage of the ship (6). It is speculated that this strategy will continue to dominate the market of ship financing in the PRC, unless the relevant authorities relax the control of foreign exchange. Although cutting down on the red tape, the SAFE may not be entirely excluded from these proceedings, as the overseas financial institutions involved may require guarantees from the parent companies in China for the loans advanced to their overseas subsidiaries in addition to taking mortgages of the ships. Assignment by the Chinese companies, the bareboat charter, rights in relation to the various insurances of the ship, and the sub-charter freight may also be regarded as guarantees which require SAFE approval. Under the Rules Governing Guarantees, only qualified financial institutions authorised by the central government can provide guarantees to foreign lenders for foreign debts. Government departments and unincorporated institutions cannot issue guarantees for foreign debts. Any subsequent amendment to the principal loan agreement shall be subject to the consent of the guarantor and to the approval of SAFE.