Equipment leasing in the maritime industry – protection of legal title
Companies leasing out equipment for use on board vessels need to be mindful of the legal risks and challenges in protecting legal title to their equipment. In this article we have highlighted potential threats and possible measures of mitigation.
Leasing equipment for use in the maritime industry may be a practical means for shipowners (the “lessee”) to cover a short term need or avoid having to invest in expensive equipment. Typical examples of equipment being offered for lease include streamers for seismic operations, ROV’s, offshore cranes and gangways. Traditionally, leasing has been offered by specialized companies that have leasing as their main business. However, more recently we are seeing a trend towards a broader use of leasing as a business model, where the possibility of leasing equipment is also being offered by equipment manufacturers and others. When entering into this market it is particularly important for the equipment owner (the “lessor”) to be mindful of how to protect its legal title to the equipment.
A common feature of leasing is that whilst legal title in the equipment is retained by the lessor, physical possession of the equipment is handed over to and will be in the full care and custody of the lessee. In shipping this typically involves the equipment being installed on board a vessel and becoming an integrated part of the vessel’s operations and unless mitigating measures are taken, there are certain situations where the lessor risks losing legal title in the equipment.
Some typical examples as seen from a Norwegian law perspective are highlighted below. The same situations will also typically represent a risk for the lessor in other jurisdictions, including under English law.
Voluntary sale of the vessel to a bona fide buyer
In a situation where the shipowner voluntarily sells the vessel to a third party buyer with the equipment still on board, the question arises as to whether the lessor can enforce its ownership rights and demand that the equipment is returned to it by the third party buyer. In such a situation the third party buyer may argue that the vessel was purchased under the assumption that the equipment was part of the vessel and the property of the seller, and thus included in the sale.
According to the Norwegian Good Faith Acquisition Act section 1, if an object in the possession of the seller is sold to a bona fide buyer (i.e. a buyer “in good faith”), then the lawful owner’s legal title is extinguished and the bona fide buyer assumes legal title. Whilst the lawful owner will likely have a claim for damages against the seller, if the seller is insolvent such a claim may be close to worthless. Thus, an equipment lessor may lose legal title to the equipment if the vessel buyer in good faith assumes that the seller was entitled to sell the vessel including the equipment.
This risk of extinction in this situation may be mitigated by the lessor by clearly marking the equipment as the property of the lessor. Furthermore, the leasing contract should include specific obligations on the lessee to make such markings clear.
Creditors’ rights – enforcement of mortgages
The lessor’s legal title may also be threatened where a creditor with a lien against the vessel enforces its claim, e.g. where a bank enforces its mortgage due to default under the loan agreement. This will typically lead to a forced sale of the vessel. According to the Norwegian Maritime Code section 45, (the “NMC”) the ship mortgage comprises not only the vessel itself, but will also include the vessel’s “appurtenances”. In this case, the question would arise as to whether the equipment on lease would be considered as an “appurtenance” and thus encompassed by the mortgage, or not. If it is, then the mortgagee may include the equipment as part of the forced sale and the lessor’s legal title may be extinguished.
Whether the lessor’s equipment is or would be considered as an appurtenance turns on the facts and would of course need to be assessed on a case by case basis. A general guideline however is that all equipment intended for long-term use on board the vessel will likely be deemed to be an “appurtenance” and thus included as part of the mortgage/lien. There is no requirement for the equipment to be permanently mounted on board the vessel to be considered an appurtenance, nor does it need to be strictly necessary for the operation of the vessel.
A possible measure of mitigation is found in the act itself. According to the NMC section 45 second paragraph, if the lessee has a right to cancel the lease contract with no more than six months’ notice, then the equipment will not be deemed part of the mortgage/lien. Consequently, when leasing out equipment at risk of being deemed an appurtenance under section 45 of the NMC, it may be sensible to incorporate into the relevant lease contract a right of termination for the lessee with six months’ notice or less. Other possible alternatives of mitigation would require agreement with the mortgagee/creditors.
Finally, a situation may arise where the lessee becomes insolvent and enters into bankruptcy proceedings. The bankruptcy estate may claim that the equipment is part of the estate and that the value of the equipment is to be divided among the creditors of the lessee.
In this situation, the lessor may rely on the Norwegian Satisfaction of Claims Act section 2-2. According to this provision, the bankruptcy estate can only seek satisfaction in the property of the debtor at the time of attachment, i.e. when bankruptcy is declared. Since the lessor’s equipment has never belonged to the lessee – the lessee has only leased the equipment – the bankruptcy estate cannot dispose of the lessor’s equipment.
As the examples demonstrate, equipment owners should carefully consider the risks before entering into leasing arrangements in the maritime industry and retention and protection of legal title should be at the forefront of potential lessors’ minds. To achieve this objective, equipment owners should be aware of the need for careful and tailored drafting of the leasing contracts, including, where necessary taking local law advice.