The disposal of a ship after it reaches the end of its useful life (which may vary depending on the type but is typically around 20 years) is an important matter that has far-reaching ESG consequences. While some of the regulatory framework developed in relation to ship recycling has not become effective for international application, lenders and insurers have started to require some of the terms of that framework by contract, and this note discusses the contractual provisions that might be found in a loan agreement relating to the various ship recycling regulations.
The Obligors shall ensure that any scrapping of a Vessel is conducted in compliance (1) with the Hong Kong International Convention for the Safe and Environmentally Sound Recycling of Ships, 2009, and with the guidelines issued by the International Maritime Organization in connection with such convention; and (2) with Regulation (EU) No 1257/2013 of the European Parliament and of the Council of 20 November 2013 on ship recycling and amending Regulation (EC) No 1013/2006 and Directive 2009/16/EC.
What is the Hong Kong Convention?
The main architecture for the regulations governing the ship recycling practice stems from the principles adopted at a diplomatic conference held in Hong Kong in May 2009, known as the Hong Kong International Convention for the Safe and Environmentally Sound Recycling of Ships, 2009 (the “Hong Kong Convention”). Among the issues that the Hong Kong Convention addressed are the working and environmental conditions at many of the world’s ship recycling locations and the hazardous substances (including asbestos) contained in the ships sold for scrapping. The Hong Kong Convention requires (upon entry into force) that ships carry an inventory of hazardous materials, which will be verified by an initial survey and updated by additional surveys during its life and a final survey prior to recycling. In addition, ship recycling yards will be required to provide a “Ship Recycling Plan” detailing the manner in which a ship will be recycled, taking into account its inventory of hazardous materials.
What is the EU SSR?
While the Hong Kong Convention is pending its ratification, the European Union has passed its own legislation aimed at facilitating early ratification of the Hong Kong Convention via the European Ship Recycling Regulation (EU) No 1257.1033 (the “EU SRR”), which became effective on December 31, 2018, with some of the requirements staggered for effectiveness on December 31, 2020.
How do the Hong Kong Convention and EU SRR affect the borrower?
As the Hong Kong Convention has yet to be ratified and the EU SRR applies only to ships that are flying a flag of an EU member state or calling at an EU port, some borrowers are not within the reach of these regulations. However, realizing the importance of the matter, several shipowners have voluntarily adopted the Hong Kong Convention through the “Responsible Ship Recycling Standard” initiative (the “RSRS”), and in response, a number of financial institutions have also signed onto the RSRS with an aim to promote the standards promulgated by the Hong Kong Convention on ship recycling. Therefore, some lenders in their standard form loan agreements have started to include contractual provisions that require the borrower and other obligors to comply with the Hong Kong Convention.
How do they affect the lender?
There appears to be an increasing scrutiny among EU authorities to ensure that the EU SRR is observed, and institutions offering products to shipowners (including lenders and insurers) may be on the hook to carry out due diligence to ensure that its products do not facilitate an illegal recycling activity. Therefore, it is increasingly important that lenders protect themselves by including necessary contractual provisions obligating their borrowers to abide by applicable regulations on ship recycling.
How is the ship recycling provision in a loan agreement negotiated?
The planning, time and cost involved in ensuring a responsible ship recycling process are not necessarily something that every ship owner can afford. The contractual provisions requiring compliance with the Hong Kong Convention or the EU SRR may therefore sometimes be limited. It may be that the obligation is only on a “best efforts” or “commercially reasonable” basis only, or to develop and maintain a policy that promotes the responsible ship recycling practice.