Reed Smith Client Alerts

Mortgage foreclosure through vessel arrest is the maritime enforcement tool most commonly used by financiers. Under U.S. maritime law, other enforcement tools exist that are less known, yet also powerful. They serve different purposes and are subject to different conditions. Understanding the differences helps optimize the enforcement strategy and maximize the recovery by using the full array of enforcement tools.

It is particularly important in the current economic context: the COVID-19 crisis has led to more frequent defaults, and more challenging enforcement exercises. Liquidity is lacking, and many courts and other public institutions remain closed. Even in these difficult times, and even when a vessel-backed loan is among non-U.S. parties and governed by non-U.S. law, U.S. maritime law may offer some valuable enforcement opportunities. We explain below the main tools that are available under U.S. maritime law.

1. Arrest

Vessel arrest is the remedy traditionally used to enforce a vessel-backed loan. In the United States, the procedure is governed by Rule C of the Supplemental Rules for Admiralty or Maritime Claims and Asset Forfeiture Actions (the Supplemental Rules).1 Rule C allows creditors to bring an action against the collateralized vessel in rem, without notifying its owners or naming them as defendants.2 U.S. federal courts may issue arrest orders on an ex parte, emergency basis, and when exigent circumstances so require, an arrest warrant may be issued by the clerk without any court review.3 The arrest complaint only needs to allege that the vessel is present in the U.S. federal district where and when the action is commenced, and to make a prima facie showing that the vessel is subject to a valid maritime lien.4

This is the main limitation on the availability of the tool: only a limited number of claims create maritime liens. A financier is unlikely to have a maritime lien other than a preferred ship mortgage5 – or maybe a financing bareboat charter lien. Two popular ship registries, the Marshall Islands and Liberia, have both revised their maritime laws to permit the recordation of such liens,6 but we have not yet seen any Rule C arrests executed in the United States on this basis. When a financier has a claim that does not create a lien, another type of tool may be available under U.S. maritime law.

For a more detailed discussion of vessel arrest in the United States, we refer to our recent posts linked in the footnotes below on the current trends in U.S. arrest cases,7 and the steps that a mortgagee should take to successfully arrest in the United States. 8

2. Attachment

Maritime attachment is a hybrid remedy, often referred to as quasi in rem: it allows maritime creditors to enforce in personam claims against the property of the defendant, when the latter is not present within the U.S. federal district where such property is located and where the action is brought.9 The procedure is codified in Rule B of the Supplemental Rules.10 Rule B imposes the additional requirements that the owner must not be present at the time of the arrest, and must be subsequently served, but the rule is otherwise more flexible than Rule C.11 Unlike arrest, maritime attachment can be used to assert and enforce any type of maritime claim, regardless of whether such claim gives rise to a maritime lien, and the claim can be enforced on any type of property, regardless of whether such property is maritime. A prima facie showing is also sufficient, and the clerk may issue an attachment warrant without court review if exigent circumstances so require.12

Rule B’s flexibility allows for more creative uses, including in connection with the enforcement of non-traditional loans. For example, when a vessel is financed through a sale-and-leaseback transaction, arrest may not be an option due to the absence of a mortgage giving rise to a maritime lien. Instead of being mortgaged, the vessel is often sold to the creditor, and then leased back to the debtor under a bareboat charter party that gives the debtor an option to re-purchase the vessel at the end of the charter period. Some creditors have relied on Rule B to attach a sold and leased-back vessel (or a sister vessel) after a default of the debtors.13 These creditors obtained orders of attachment because they had a prima facie maritime claim based on the default under the leaseback agreement, which was in the form of a bareboat charter party.14 In several cases, however, the federal court subsequently vacated the attachment order on the ground that the charter party was a disguised purchase agreement between the creditor, as seller, and the charterer, as buyer: under U.S. law, claims for breach of a charter party are maritime, but claims for breach of ship purchase agreements are not, and do not entitle to maritime attachment.15

Therefore, a prudent financier should carefully structure its sale and leaseback documentation to avoid the recharacterization of the leaseback agreement as a disguised purchase agreement. In particular, the borrower should (ideally) not have the option to repurchase the vessel at a nominal price at the end of the charter period: U.S. courts have found this to be the first indication that the leaseback agreement is not a true bareboat charter.16

There are many other ways in which Rule B may be helpful. While the case law makes it questionable that a leaseback agreement will be considered maritime under U.S. law, another type of modern financial instrument has recently been recognized as such: freight forwarding agreements (FFAs). Shipping companies use FFAs to hedge their exposure to the risk of shifts in shipping market prices, and trade them as derivatives.17 Because FFAs are maritime, a claim for breach of an FFA provides a basis to attach a defendant’s ship or other assets in the United States. The saga of New York federal decisions on FFAs also emphasizes another important characteristic of maritime attachment: the remedy is available to enforce a foreign judgment on U.S. assets, provided that the underlying claim would be considered maritime under U.S. law.18