Don't Lien on Me — Identification and Mitigation of Maritime Lien Risks in Marine Lease/Loan Transactions
Due to their increasing size, specialization and technological sophistication, today’s vessels present attractive “big-ticket” financing opportunities. However, commercial vessels, regardless of type, will inevitably incur maritime liens, which are priority claims that arise by operation of law, and are enforceable against the vessel in rem. Lenders therefore must be cognizant of, and account for, the special attributes of maritime liens in evaluating and documenting these types of transactions, whether structured as loans or leases.
This article discusses the characteristics of maritime liens, the priority of these liens in relation to the desired first-priority secured position of a lender or lessor, and prudent practices for assessing and mitigating the risks posed by such liens. The focus of this article is on transactions involving commercial (as opposed to recreational or fishing) vessels documented under the laws of the United States.
The Nature of Maritime Liens
Maritime liens are a contrivance of admiralty law, which has been developed over centuries. Unlike lien laws that apply to land-based assets, which are primarily statutory state laws, maritime lien law is a non-statutory body of law developed in federal admiralty courts. A fundamental distinctive feature of U.S. maritime lien law is commonly referred to as the “personification of the vessel.” This means that a vessel is considered to be a person separate and distinct from its owner or operator, that can itself cause injury, incur debts and be sued independently. Thus, a person claiming to hold a maritime lien against a vessel may file suit in rem against the vessel in federal court, and have the court order the arrest and sale of the vessel so the claim can be satisfied from the proceeds of sale.
While maritime lien claimants’ powerful right to cause the seizure and sale of the vessel is concern enough to a prospective lender, the “secret” nature of these liens may be of even greater concern. Maritime liens on vessels are not possessory and need not be recorded or registered to come into existence. Thus, for example, a shipyard may perform repair work on a vessel and allow the vessel to depart the yard following completion of the work, but still retain its lien on the vessel until it has been paid for the work. Similarly, a bunker (fuel) supplier may provide fuel to a vessel at a port anywhere in the world, and thereafter allow the vessel to leave the port, but retain its lien against the vessel until paid for the fuel.
A maritime lien claimant may, but is not required to, file a notice of lien claim with the United States Coast Guard National Vessel Documentation Center (NVDC). If it does so, the claim will be noted on any abstract of title issued by the NVDC for the vessel. However, because maritime lien claimants are not required to record their claims in order to perfect their maritime lien, a “clear” abstract of title cannot be relied upon as evidence that a vessel is free of all liens. In fact, there is no central registry that lenders can search to determine what maritime liens exist on a
Maritime liens are extinguished only by payment of the underlying claim, laches, expiration of any applicable statute of limitation or by sale of the vessel in a foreclosure action in United States district court. Notably, maritime liens are not extinguished by sale of the vessel even if to a bona fide purchaser without notice of the lien claims. Instead, any maritime liens in existence at the time of sale remain and the vessel continues to be subject to arrest and sale to satisfy such preexisting maritime liens even after a sale.
The Preferred Ship Mortgage
Marine finance transactions are generally structured as either loans or leases. When they are structured as a loan, the lender secures its interest in the vessel by perfecting a preferred ship mortgage under the federal Commercial Instruments and Maritime Liens Act (CIMLA); see 46 U.S.C. §§ 31301 to 31343. A preferred ship mortgage must be granted by the record owner of the vessel. In order to attain “preferred” status under the CIMLA, a ship mortgage must:
- include the whole of the vessel;
- be filed with the NVDC in substantial compliance with the filing and recording
requirements of 11 U.S.C. § 31321; and
- cover a documented vessel or a vessel for which documentation has been applied in substantial compliance with the documentation regulations.
46 U.S.C. § 31322(a)(1)-(3); Economy Stone Midstream Fuel, LLC et al., 2009 WL 2767681 at *3.
A properly filed preferred ship mortgage is valid against third parties from the time it is filed. 46 U.S.C. § 31321(a)(2); see also United States v. Trident Crusader, 366 F.3d 391, 393 (5th Cir. 2004) (finding that the determination of whether a mortgage is a “preferred mortgage” is based on whether the vessel was “documented” as provided in the applicable statutory law, as opposed to whether the vessel is a “vessel,” which would require it to be capable of being used as a means of transportation on water). By perfecting a “preferred ship mortgage” on a vessel, the lender creates a maritime lien against the mortgaged vessel, enforceable by an action in rem in admiralty, 46 U.S.C. § 31325(b)(1), which, as discussed infra, is accorded priority over certain other maritime liens against the vessel pursuant to the CIMLA.
Unfortunately, the priority status attained by perfecting a preferred ship mortgage is not available to a lessor in a marine finance transaction structured as a lease. In maritime parlance, leases are referred to as charters and vessel leasing transactions are documented as demise or bareboat charters (with those terms synonymous).
The lender takes legal title to the vessel and becomes its record owner by documenting the vessel in its name with the NVDC. The lender charters the vessel back to the customer (the charterer) under a bareboat charter by which the owner transfers all rights and obligations of use, control, crewing, maintenance, operations, and insurance to the bareboat charterer (lessee). The owner, in turn, receives charter hire (rent) payments from the charterer and is entitled to have the vessel returned at the end of the charter term.
As the lessor is the owner of the vessel, it cannot also be the holder of a preferred ship mortgage on the vessel. Under the CIMLA, a preferred ship mortgage can only be granted by the record owner of vessel, not a lessee. Absent execution of an enforceable waiver or subordination by a maritime lien claimant, which is usually difficult to obtain for known liens and impossible for liens that arise in the context of ongoing vessel operations, the lessor is exposed to maritime liens arising against the vessel, and the lessor’s equity interest remains ever subordinate to those liens.
Priority of Maritime Liens
Rules on priority and ranking of maritime liens have evolved under the common law applied in federal courts, as altered by the CIMLA. As a general rule, maritime liens are paid in the following order until the proceeds available to pay claims are exhausted:
- Expenses of justice while the vessel is in custodia legis after the vessel’s in rem arrest. Although “custodia legis” expenses are frequently referred to as the highest class of maritime liens, they actually do not give rise to a maritime lien, but instead are given their priority status as a cost of court.
- Seamen’s liens for wages, maintenance and cure.
- Salvage and general average liens.
- Maritime tort liens, which include nearly all maritime torts, such as collision, personal injury, death or cargo damage.
- Contract liens.
- State-law-created maritime liens. Due to federal supersession of state maritime lien law under 46 U.S.C. § 31307, this is a relatively limited category of claims, many of which overlap with the classes of maritime lien claims established under federal law, with a notable exception being state-conferred liens for vessel construction.
- Tax claims.
- Non-maritime liens, including ship mortgages that have not attained “preferred” status under the CIMLA, state ship mortgages and security interests perfected under UCC Art. 9. United Shipping Svcs. Three, Inc. v. U.S. Express Lines, Ltd., No. 98-950, 2002 WL 1773041, at *2 (E.D.Pa. 2002).
- Maritime claims that are not secured by maritime liens.
Under the “inverse order rule” applied by admiralty courts, later lien claims within each class have priority over earlier ones based on a legal fiction that earlier lien holders benefit from the services provided by later claimants that enable the vessel to continue operating and earn money. Moreover, as admiralty courts are courts of equity, ranking rules may be modified if warranted by the particular circumstances presented in a given case. General creditors of the owner of the vessel, who do not possess a maritime lien, are not entitled to intervene in an action in rem against the vessel. However, such claimants can bring an action in personam against the owner and seek recovery of their claims from any excess funds remaining after the above-listed claims have been paid.
Under 46 U.S.C.A. § 31326(b)(1), particular rules apply when a vessel is subject to a preferred ship mortgage. The CIMLA designates a class of “preferred maritime liens,” which, along with custodia legis expenses, take priority over the lien created by a preferred ship mortgage. A preferred maritime lien is defined as a maritime lien:
- arising before a preferred mortgage was filed under CIMLA (e.g., a lien for necessaries or breach of a maritime contract that arose before the preferred mortgage is filed with the NVDC);
- for damage arising out of maritime tort;
- for wages of a stevedore when employed directly by a person listed in 46 U.S.C.A. §31341 as being presumed to have authority to incur liens (this includes the owner, master or an officer appointed by a charterer);
- for wages of the crew of the vessel;
- or general average; or
- for salvage, including contract salvage.
46 U.S.C. § 31301(5); Economy Stone Midstream Fuel, LLC et al., 2009 WL 2767681, at *3.
Thus, in terms of ranking, the following order applies when the vessel is subject to a preferred ship mortgage:
- expenses of justice;
- preferred maritime liens;
- the preferred mortgage;
- other maritime liens; and
- UCC security interests and ship mortgages perfected under state law.
See Southwest Bank of Texas, N.A. v. M/V The Whippler, No. 4:03 CV 1816SNL, 2005 WL 2647948, at *4 (E.D.Mo. 2005) (stating that a prior in time preferred mortgage is entitled to priority over all subsequently arising liens against the subject vessel, with the exception of “preferred maritime liens”).
Maritime Liens for Necessaries
Vessels are constantly exposed to maritime liens for necessaries arising in favor of providers of supplies, equipment, and services needed for operation. A supplier of necessaries has a maritime lien against the vessel that arises from the time the supplies or services are provided. The term “necessaries” has been expanded to encompass “any item or service which is reasonably needed for the venture for which the ship was engaged.” Trico Marine Operators, Inc. v. Falcon Drilling Co., 1996 WL 96883, at *5 (E.D. La. 1996) (Schwartz, J.) (citing Foss Launch & Tug Co. v. Char Ching Shipping U.S.A., Ltd., 808 F.2d 697, 699 (9th Cir.), cert. denied, 484 U.S. 828 (1987).
The jurisprudence has interpreted “necessaries” quite broadly to include any “goods and services reasonably needed in the ship’s business, such as [those] that are useful to the vessel, keep her out of danger, and enable her to perform her particular function.” Triton Marine Fuels, Ltd. v. M/V Pacific Chukotka, 671 F.Supp. 2d 753, 760-61 (D.Md. 2009) (citing Bradford Marine, Inc. v. M/V “Sea Falcon,” 64 F.3d 585, 589 (11th Cir. 1995)) (internal citations omitted); see Marine Oil Trading Ltd. v. Motor Tanker Paros, 287 F.Supp. 2d 638, 641 (E.D.Va. 2003) (stating that
“necessaries” include fuel bunkers). The determination of what qualifies as a “necessary” is particular to the vessel in question. Gulf Marine and Industrial Supplies, Inc. v. Golden Prince M/V, 230 F.3d 178, 180 (5th Cir. 2000) (citing Equilease Corp. v. M/V Sampson, 793 F.2d 598, 603 (5th Cir. 1986) (holding that “[i]t is the present, apparent want of the vessel, not the character of the thing supplied, which makes it a necessary”)).
Priority of a Charterer’s Lien: the Mr. Dean Decision
The decision of the U.S. Court of Appeals for the Fifth Circuit in Bank One, Louisiana N.A. v. Mr. Dean MV, 293 F.3d 830, 831 (5th Cir. 2002) has presented lenders with an additional challenge in ensuring the priority of their preferred ship mortgage in relation to maritime liens in favor of charterers of the vessel. In Mr. Dean, the court held that a maritime lien that arises out of a breach of time charter (a form of maritime contract) attaches at the moment the vessel owner places the vessel at the charterer’s disposal; and, any subsequent breach of the charter agreement relates back to the date the vessel was placed at the charterer’s disposal. Bank One, Louisiana N.A. v. Mr. Dean MV, 293 F.3d 830, 831 (5th Cir. 2002).
In that case, the plaintiff, Bank One, filed suit to foreclose on a preferred ship mortgage granted by the vessel’s owner, Global Towing. Id. at 831. Prior to the execution of the preferred ship mortgage, BargeCarib, Inc. had executed a time-charter agreement with the original owner of the Mr. Dean, Offshore Supply Ships. Id. Following the sale of the vessel, Global Towing failed to deliver the vessel or a suitable substitute to BargeCarib, thereby breaching the time charter agreement. Id. BargeCarib intervened in Bank One’s foreclosure suit and asserted a maritime lien based on the previous breach of the time charter agreement. Id.
In analyzing the ranking issue between Bank One’s preferred ship mortgage and BargeCarib’s maritime lien, the court noted that it has consistently been held that a maritime lien “attaches at the commencement of an undertaking and any subsequent breach perfecting the lien relates back to that time.” Id. at 834 (citing The Bird of Paradise, 72 U.S. (5 Wall.) 545 (1866); The Edwin, 65 U.S. (24 How.) 386 (1860); The Freeman, 59 U.S. (18 How.) 182 (1855)).
The court determined that the Mr. Dean had been placed at BargeCarib’s disposal, and was employed pursuant to the time charter agreement before Bank One recorded its preferred ship mortgage. Id. at 838. As such, BargeCarib’s maritime lien “arose” before the mortgage was filed, even though it did not become enforceable until after the recording of the preferred ship mortgage, when the charter was breached. Id; see also Vinmar Int’l Ltd. v. M/T Clipper Makishio, No. 09-3829, 2009 WL 6567104, at *1 (S.D.Tex. 2009) (citing Mr. Dean for the proposition that maritime liens for charters and shipping contracts attach at the beginning of the contract and remain inchoate until breached, and further stating that “the ‘beginning of the contract’ in the case of contracts for affreightment and voyage charters means when the cargo is loaded on board, or at least placed into the custody of the vessel’s personnel”).
The practical effect of the Mr. Dean decision is that if a vessel is under charter when a lender’s preferred mortgage is recorded, the lender faces the risk that a subsequent breach of that charter will result in a charterer’s lien that has priority over the ship mortgage.
Mitigation of Maritime Lien Risks
The reality of maritime commerce is that vessels cannot be operated without incurring maritime liens. Liens for vessel necessaries, such as fuel, supplies and repair work, will inevitably attach. The only way for operators to avoid these types of liens is to pay for supplies and services in advance, which almost never happens. In fact, the existence of a supplier’s maritime lien rights incentivizes the supplier to rely on the “credit of the vessel” rather than that of the operator or owner. Additionally, the chartering of vessels is the primary manner in which vessel owners and operators make money. Furthermore, as discussed above, other types of maritime liens attach from non-commercial events, such as personal injuries, cargo damage, collisions or marine pollution. However, there are measures lenders can take that will largely mitigate the potential adverse impact of maritime liens. Maritime tort liens are generally insurable through marine liability insurance (often referred to as protection & indemnity or P&I insurance) or by protection & indemnity associations (often referred to as P&I clubs). For this reason, it is of paramount importance for a lender to ensure that appropriate maritime liability insurance with reputable and financially solvent underwriters and in sufficient limits (with manageable deductibles) is in place before lending on marine vessel collateral. Moreover, a prudent lender should ensure, as a precondition to funding, that
(i) marine liability coverage has been continuously in force on the vessel for a minimum of three years pre-closing (the statute of limitations for maritime personal injuries is generally three years with some exceptions),
(ii) a report of all known claims (asserted or threatened) that may exceed policy limits is obtained and reviewed by the lender, and
(iii) the written assurance of the borrower’s broker is obtained that (a) there are no claims for which coverage has been denied, (b) there are no known claims which may potentially exceed policy limits, and (c) there are no known problems with the financial condition or solvency of any insurer.
As to maritime liens for wages or for stevedores, these maritime liens are not generally a significant risk, since seamen and stevedores will quickly stop working if they are not paid on time. With respect to “necessaries” that give rise to maritime liens, a prospective lender should verify the outstanding payables of the borrower that are related to the procurement of necessaries.
Liens arising from a breach of certain other maritime contracts (such as charters or ship management or ship repair agreements) are more problematic. In light of Mr. Dean holding that the lien ranking for a breach of a charter or similar maritime contract dates back to the date the vessel was placed at the charterer’s disposal as opposed to the date the owner breached the charter, a ship mortgage lender should ascertain, before funding, whether a vessel is subject to any charter (bareboat, time, voyage or space charter), ship management, ship repair or similar
agreement. If so, the prudent lender should require that any charterer, ship manager or repairer, or other party that currently has possession or control over the vessel waive its maritime lien on the vessel or subordinate it in favor of the lender’s preferred ship mortgage lien and agree not to enforce such lien until either the lender is fully paid or the lender grants its consent to enforcement.
In obtaining lien waivers, the lender should be cognizant of the high legal standard applied in enforcing such waivers. “Such a strong presumption in favor of a lien places a ‘heavy burden’ on parties seeking to show a waiver of the lien, forcing them to show that a creditor ‘deliberately intended to forego the valuable privilege which the law accords’ and look solely to the owner’s personal credit.” Maritrend, Inc. v. Serac & Co. (Shipping) Ltd., 348 F.3d 469, 474 (5th Cir. 2003); see also Puerto Rico Ports Authority v. Barge Katy-B, O.N. 606665, 427 F.3d 93, 103 (1st Cir. 2005) (A court will only find a waiver when there is a showing that a creditor “deliberately intended to relinquish its lien rights,” which inquiry is necessarily fact-intensive.) The precautionary steps described above may not be feasible where the borrower has many charters of short duration in place at the time the loan is made. Further, there is no assurance that a charterer or ship manager will voluntarily give up or subordinate its lien rights and superior interest in the vessel vis-à-vis a preferred ship mortgagee. When a waiver or subordination is impossible to obtain, the lender should require, at a minimum, that the charterer or ship manager be required to provide it with written notice of any alleged breach at the time such alleged breach is discovered.
Lenders financing marine transactions must accept the reality that vessels offered as collateral likely already have maritime liens, which if they remain unsatisfied, will have priority over the lender’s secured position. Vessels also will continue to incur maritime liens post-funding, some or all of which (in the case of leases) will have priority over the lender’s interest.
By understanding the unique nature of maritime liens and employing sound underwriting and documentation practices, lenders should be able to identify and mitigate the potential impact of particular risks involved in a given transaction. Proper analysis of these risks should be viewed simply as yet another iteration of the “know your customer” rule practiced by all prudent lenders.
Robert Stefani practices in the areas of marine finance and other financial, corporate transactions and maritime and commercial litigation and government regulation.
Reprinted with permission from the December 2017 edition of the “LJN”© 2017 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or firstname.lastname@example.org.