Credit bidding is the process whereby a lender, with a secured charge over a borrower’s asset, bids on that asset using the very debt that is owed by the borrower to the lender. The circumstances are usually foreclosure of a lending position against a borrower.
In the maritime sector, this process often takes place in the context of forced judicial sales of vessels pendente lite (i.e., during the course of litigation) and frequently before judgment is obtained against the borrower shipowner.
However, why would or should the secured lenders be bidding on a distressed asset in the first place? How does the process work, where can it be done, and who might object?
This article seeks to explore some of these questions in the context of judicial sales of ocean-going vessels and looks at some of the differing jurisdictional approaches to credit bidding.
A typical credit bid scenario in the maritime industry may occur where a borrower defaults on a loan secured by a mortgage over a vessel. That vessel is then arrested and ultimately sold under the supervision of the courts in the arrest jurisdiction.
Often, the borrower’s default is a payment default; however, it might equally be a breach of covenants in the facility, such as the obligation to maintain a minimum value of collateral to the loan amount.
In these circumstances, the lender usually serves a notice of the default. Sometimes, the borrower will cure the breach, and sometimes the parties might otherwise renegotiate or restructure the facility. Sometimes, however, the parties are unable to find a mutually acceptable path forward. This latter scenario becomes more likely where the lender has lost confidence in the borrower’s long-term ability to service the loan or where the lender has concerns relating to the integrity of the vessel (which, of course, serves as the main collateral for the facility).
Where a default scenario cannot be resolved to the mutual satisfaction of the parties, a lender may arrest the subject vessel to put further pressure on a borrower to cure the default (i.e., to make the missing payments or to prepay the loan to re-balance the loan-to-value obligations) or to re-negotiate commercial terms.
Where consensual agreement cannot be reached, a lender may apply for judicial sale of the vessel in the jurisdiction in which it was arrested. In terms of timing, each jurisdiction differs; however, it would not be unusual for a lender to obtain a sale order within two to three months of arrest.
Why would a lender bid at all?
Why, you may ask, would a secured lender be inclined to bid in a judicial auction for a vessel that secured its loan? There are a number of reasons why this would seem unlikely. The lender may be unlikely to count ship owning or operating amongst its core activities or commercial ambitions. Further, vessel ownership or operation comes with commercial and technical challenges that the lender is unlikely to be able to service in-house. Finally, it may be difficult to square the risk profile of vessel ownership (including significant exposure to third-party risks, such as pollution), with the usual risks with which the lender is associated, the most obvious being credit risk. Of course, where a lender is determined, none of these reasons are insurmountable, particularly with the assistance of third-party commercial or technical managers, insurers, and good legal advice.
The usual reason why a mortgagee lender might bid on the vessel is the same as why the lender might foreclose the loan position in the first place – to protect its financial investment. The borrower and registered owner of the vessel is likely to be a single-ship-owning special purpose vehicle (being the traditional manner in which ships are owned and operated). It is, of course, possible that the lending party may have the benefit of a facility with multiple borrowers whose obligations are joint and several (i.e., another party to go against for the balance of the debt). It is also likely that the lending party will have the benefit of some sort of corporate or personal guarantee. Nevertheless, the judicial sale of the subject vessel is likely to represent the most direct and effective means by which the lender can recover at least some of its investment from the borrower.
The lender’s position will therefore be severely prejudiced if the sale of that vessel does not yield the anticipated return, and the lender will either be forced to crystallise and absorb that loss or look elsewhere to make up the shortfall. In other words, it is in the lender’s interests to maximise the recovery from the vessel being sold and to pro-actively prevent it from being sold at too low a price. The risk of a vessel selling at too low a price and thus preventing a lender from maximising its recovery position is usually compounded both by market conditions and the borrower’s distressed financial position. Simply put, if depressed market conditions have contributed to forced judicial sale, then those same distressed market conditions mean that the vessel is unlikely to achieve the best price at auction (although notwithstanding the volatility of the shipping markets).
Equally, the standard rule of thumb is that vessels being sold at judicial auction usually achieve 20 percent to 25 percent less than equivalent trading sales. This is, in part, because prospective purchasers build in a margin for the fact that a vessel operated by a distressed owner may not have been maintained as highly as it might have been and, depending on the location of the arrest (particularly in warmer waters), the vessel might have deteriorated during its time under arrest. The purchaser in the auction will acquire the vessel “as is, where is” and so the depressed bid valuations will likely reflect the element of risk for any purchaser here.
It is our experience that lenders credit bidding in judicial sale environments do so in order to protect their investment, rather than to become shipowners (although, who wouldn’t want to own a ship!). Accordingly, a lender will not usually want to remain the owner of the vessel for any longer than it takes to restore the vessel to a seaworthy condition fit for a trading sale. In depressed conditions, it may involve the lender weathering the market conditions until there is an upturn in the sector or wider market.