New Lease, Financing Options Opened By Congress
Recent changes in U.S. vessel documenting laws present new opportunities for shipowners, operators, and financial institutions both in the U.S. and overseas. The FY 1997 Coast Guard Authorization Act broadened the sources of capital for U.S. vessels by creating new lease financing options, including a limited cross-border leasing provision, and by removing a number of prior impediments to financing such vessels.
The full impact of certain provisions, such as the apparent new ability of vessels owned by section 883-1 ("Bowaters") corporations to engage in unrestricted coastwise commerce, may, however, not be certain until after the U.S. Coast Guard (USCG) issues implementing regulations.
Within Congress at least, the underlying motivation for virtually all changes made was the members' desire to encourage modernization and revitalization of the maritime industry in the U.S., on its shipbuilding and shipowning and operating sides, by eliminating restrictions on vessel ownership and financing to enable U.S.
shipowners to take increased advantage of modern methods of vessel financing and to encourage the flow of investment capital into the U.S. fleet. This report surveys key changes made and identifies areas where such change presents opportunities (or risks) for those involved with the financing or operation of U.S. documented vessels.
Changes to U.S. law governing the documentation and financing of vessels or otherwise intended to encourage investment in such vessels made by Pub.L. 104-324 include: Allowing a vessel owned by a documentation act citizen corporation (i.e., one having no limitation on foreign stock ownership), which is related to a financing entity, to engage in coastwise trades through a demise charter to a U.S. citizen qualified to operate a coastwise vessel (i.e., one who meets the 75 percent U.S. citizen stock ownership test in section 2 of the Shipping Act, 1916, as amended (the "Shipping Act") ('vessel lease financing'); Permitting cross-border leasing by allowing a vessel that is owned by an ownership trust having a non-U.S. citizen beneficiary to obtain a registry endorsement for operation in U.S. foreign commerce based on charter to a U.S. citizen qualified under section 2 of the Shipping Act (although subject to limitations as to participation in the newly-enacted Maritime Security Program) ('cross border financing'); • Authorizing foreign sale and transfer approval for a non-U.S. documented vessel prior to it becoming documented under U.S. law; • Eliminating restrictions on who may be a mortgagee for a U.S.-documented vessel, which, in turn, eliminates both the need to establish a Westhampton Trust to be able to obtain foreign source financing and the need for Secretarial approval for use of a foreign mortgagee; and, • Expressly recognizing the availability of extra-judicial remedies to enforce preferred ship mortgages.
(NOTE: The following are intended only to provide a general introduction to each of the above to permit the reader to gain an appreciation for the magnitude of the change and its potential application or impact for vessel financing institutions, shipowners and operators.) Vessel Lease Financing/Section 883-1 Owned Vessels Section 12106 of title 46, U.S. Code (Coastwise Endorsements), now permits coastwise endorsement of a vessel eligible for documentation under section 12102(a) of title 46 (i.e., one that is owned by a 'documentation act citizen' whose stock may be 100 percent foreignowned if a corporation), provided: (i) the owner, a parent, or another subsidiary of that same parent is engaged primarily in leasing or other financial transactions; and (ii) the vessel is demise chartered to and operated by a U.S. citizen eligible to engage in the coastwise trades under section 2 of the Shipping Act (i.e., 75 percent U.S. citizen owned and controlled).
This change eliminates the U.S. citizen stock ownership requirements previously applied to the owner of a vessel seeking coastwise endorsement while maintaining the same degree of U.S. citizen control over the vessel itself as under prior law through the demise charter requirement. Thus, a U.S. bank or other financing institution is no longer required to establish its own corporate U.S.-citizen ownership to finance a vessel in the coastwise trades (thereby eliminating the premium often associated with such ownership). Provided vessel title rests with a U.S. owner as defined by section 12102(a)(in the case of a corporation, one having a U.S.-citizen chief executive, chairman and board majority), that financing institution may itself now be located outside the U.S. A potential further application of this new leasing provision arises for a vessel operating in the coastwise trades under the narrow 'Bowaters' authority of section 883-1 of title 46 or a foreign-owned corporation that otherwise would be required to qualify under that provision to operate in coastwise trades. By meeting the requirements of this provision (e.g., related to a financing entity even if that entity played no role in the financing of the vessel in question) such a corporation may now alternatively qualify for a coastwise endorsement under this provision. As a result, such corporations can avoid the requirements of section 883-1 (e.g., 90 percent U.S. employees, 75 percent U.S.-origin raw materials) and any restrictions on the use of owned vessels in coastwise common or contract carriage (provided demise chartered to a qualified coastwise operator). In either case, key issues for the financing institution and for the vessel owner will include ensuring that the demise charterer qualifies under section 2 of the 1916 Act and that the charter itself includes no impermissible control over the vessel or its operations.
Cross Border Financing Section 12102 of title 46, U.S. Code (Vessels Eligible for Documentation), now permits U.S. documentation under a registry endorsement only for a vessel owned by a trust having a non-U. S. citizen beneficiary, provided: all trustees are U.S. citizens; the trust restricts control by any non-citizen; and the vessel is demise chartered to a U.S. citizen qualified to engage in foreign trades under section 2 of the Shipping Act.
Whereas under prior law and Coast Guard interpretation 'all members' of a trust, including beneficiaries, had been required to be U.S. citizens for a vessel to be eligible for documentation, this change conforms to the long-standing practice of the U.S. aviation industry respecting such ownership trusts.
Notably, however, a vessel owned in this manner qualifies for the new Maritime Security Program (the recently enacted successor to the soon to expire operating differential subsidy program) only under specified circumstances keyed primarily to existing vessels and operators eligible for that program.
Such a limitation appears to reduce the utility of this financing mechanism, particularly for the liner side of the U.S. fleet. Prior Approval For Foreign Transfers The Secretary of Transportation may now provide investors in vessels not yet documented under U.S. law advance approval for the foreign sale and transfer a vessel prior to its documentation under U.S. law. This change is intended to assure such investors that their asset could not be forced to remain under U.S. flag under different economic circumstances than those that existed when the vessel was so documented. Because the provision granting such authority simply specifies the timing of the approval required under section 9(c) of the 1916 Act, such approval may be subject to such conditions as the Secretary may require as under prior law.
Although the subsection making this change is included under the heading of 'Cross-Border Financing' and is discussed in legislative history solely in those terms (e.g., to allow foreign transfer upon default of the charter), as enacted it applies to any transfer into U.S. registry, irrespective of whether linked to an ownership trust.