Sale-Leaseback Financings and Ship Mortgage Loans
What is a sale-leaseback?
A sale-leaseback is a form of financing whereby the original owner of an asset raises capital by selling the asset to a financier and immediately leases it back (thereby retaining control and use of the asset). The terminology can be a bit confusing; the financier that provides capital is called the “owner-lessor” as it nominally owns the asset and leases the asset back to the original owner, whereas the original owner of the asset is called the “seller-lessee” as it sells the asset and receives it back through a lease.
A typical sale-leaseback, in its most basic form, involves an owner-lessor purchasing title to the ship from the seller-lessee under a memorandum of agreement, and then immediately bareboat chartering the ship back to the seller-lessee. The seller-lessee is typically responsible for insuring, operating, maintaining, and employing the ship in accordance with the transaction terms set out in the bareboat charter. Sale-leaseback financings will often also include either a purchase option or purchase obligation at the conclusion of the charter term whereby the seller-lessee may, or must, repurchase the ship.
Why are sale-leasebacks important?
Over the past several years, sale-leaseback financings, particularly involving Chinese owner-lessors, have grown to become a significant source of capital in international ship finance. While several traditional lenders have reduced their exposure to ship finance, or exited the sector entirely, sale-leaseback financings have grown substantially and are now a common structure for financing ships.
How are sale-leasebacks negotiated?
While a sale-leaseback structure is straightforward, the bareboat charter terms can be extensively negotiated, similar to a loan agreement. Owner-lessors and seller-lessees should be mindful of the risks unique to sale-leaseback financing structures, including those discussed below. Careful drafting of the transaction documents is critical to protect both the owner-lessor and seller-lessee.
What are the risks to consider from a seller-lessee perspective?
In a sale-leaseback financing, the owner-lessor will typically be the registered owner of the ship. Seller-lessees should be aware of the risk that a third-party creditor or claimant could seek to arrest the ship in connection with a claim against the owner-lessor. Owner-lessors generally do not provide significant undertakings to a seller-lessee under the bareboat charter. To help address the owner-lessor arrest risk, it is not uncommon for a seller-lessee to insist that a bareboat charter provide that the owner-lessor indemnify the seller-lessee against any harm resulting from a ship arrest due to a claim against the owner-lessor.
Owner-lessors in sale-leaseback transactions will often finance the ship with a traditional ship mortgage loan. A seller-lessee should seek to ensure that the bareboat charter provides that any such financing be subject to the seller-lessee receiving a quiet enjoyment letter from the lender. A quiet enjoyment letter helps ensure that, so long as the seller-lessee is in compliance with its obligations under the bareboat charter, the lender will not interfere with the bareboat charter.
What are the risks to consider from an owner-lessor perspective?
Security Interests and Events of Default
In a traditional ship mortgage loan, the lender’s security interest in the ship is perfected by recording a ship mortgage with the relevant flag state. In a sale-leaseback financing, registered title to the vessel typically remains with the owner-lessor. In the event of a default in a ship mortgage loan, the lender may pursue a foreclosure action against the ship and seek to have the ship sold at a foreclosure auction. In the event of a default in a sale-leaseback financing, the owner-lessor may terminate the charter and seek to retake possession and control of the ship. The owner-lessor is the registered owner and not a mortgagee and the owner-lessor’s enforcement rights may not involve a foreclosure auction. As such, careful attention to the default and termination provisions of a sale-leaseback is particularly important to ensure the bareboat charter appropriately reflects both the owner-lessor’s and seller-lessee’s expectations for whether and how the ship is to be redelivered, operated or sold following a default and how any such proceeds will be applied.
A number of jurisdictions, including the Marshall Islands and Liberia, allow bareboat charters in a sale-leaseback transaction to be recorded against the relevant ship to provide notice to third party creditors. To the extent such security devices are available, the owner-lessor should ensure such recordings are made.
Sale-leaseback financing structures have different bankruptcy recharacterization risks from traditional ship mortgage loan structures that owner-lessors must pay careful attention to. See a further discussion of the bankruptcy recharacterization risks in a previous Simply Speaking here. Note, as discussed above, that some flag states have begun to allow owner-lessors to record their sale-leaseback transactions as financing charters as additional protection against potential recharacterization.
The attorneys on the Seward & Kissel Maritime Practice Team have extensive experience in negotiating and documenting sale-leaseback financings and traditional ship mortgage loans. If there are any questions regarding sale-leaseback financings or the differences between sale-leaseback financings and traditional ship mortgage loans, please contact any attorney on the Seward & Kissel Maritime Practice Team.