"He hath founded it upon the seas" is the motto found under the Cayman Islands crest which appears on most official documentation.
It is therefore of no surprise that this tiny island situated in the middle of the Caribbean Sea in the triangle between Florida, Cuba and Central America enjoys a rich seafaring heritage and is host to a first class international shipping registry catering for vessels of all sizes and classes from small yachts to super tankers.
In this article, I explore the reasons why ship financing transactions using Cayman Islands vehicles are and remain a popular option although it must be noted that registration of vessels in the Cayman Islands is beyond the scope of this article and is covered elsewhere.
The Cayman Islands enjoy a stable legal and economic relationship with Britain monitored through the Foreign and Commonwealth Office. Unlike England and Wales, however, the Cayman Islands have a written constitution and enjoy a large measure of autonomy and self-regulation whilst, in tandem, Britain assumes responsibility for their defence and appoints a Governor.
The legal system in the Cayman Islands has developed its own legislation and, where such legislation is silent, relies on the common law of England and Wales which is of persuasive authority in the Cayman Islands. In particular, The Merchant Shipping Law of the Cayman Islands, although primarily based on the corresponding law of England and Wales has been adapted to accommodate issues unique to the Cayman Islands and is extensive in nature.
Consequently all the legal principles essential for ship financing transactions such as trusts, chattel mortgages, charter arrangements, conditional sales, instalment sales, loans and joint venture arrangements exist under Cayman Islands law. Cayman courts will also recognise and enforce contractual agreements and security interests created under laws other than Cayman Islands law if validly created under the relevant laws.
Cayman Islands legislation is responsive to the needs of the financial community and has been quick to introduce changes to enable business to be conducted more effectively, for example, the recent legislation referred to below. Much innovative legislation in other dependencies stems from legislation drafted in the Cayman Islands.
The Cayman Islands is a jurisdiction which is user friendly for financiers. For instance:
- There is no equivalent under Cayman insolvency law to English administration proceedings. Therefore it is unlikely that a creditor with valid security created over a vessel will become embroiled in lengthy insolvency proceedings. Except in exceptional circumstances, no court proceedings are necessary to enforce a lender's ownership rights granted pursuant to a charge over the shares in the special purpose vehicle ("SPV") or a mortgagee's security interest, and repossession of a vessel from a Cayman vehicle should not be unduly affected by Cayman Islands legal proceedings. Financiers may therefore concentrate on securing physical repossession of the vessel in the jurisdiction where the vessel is located/flagged.
- By virtue of recent changes in law, the principle of contractual subordination has now been given statutory recognition so it is no longer necessary to revert to artificial techniques for these purposes. Furthermore, set-off provisions and netting arrangements will be taken into account on the insolvency of a Cayman company.
- Loans may be written with interest rates that vary with profits without such arrangements resulting in the financier being subordinated to the rights of other creditors.
- Recent statutory provisions have clarified the uncertainties created by the English decision in "Charge Card" about the validity of banks taking charges from customers over accounts held with the bank itself. Such charges may now be created validly under Cayman Islands law and, as such, may be of relevance where an SPV grants a charge, for instance, over a charterhire earnings account held with and in favour of, the lending bank in a transaction.
Structuring And Administration Of Cayman Islands Special Purpose Vehicles
The Cayman Islands are the domicile of a significant number of subsidiaries of first class financial institutions providing local administrative services to SPVs. A first class offshore administrator, coupled with the typical "security package", should afford the lender a high degree of confidence in adopting the offshore structure.
The typical offshore leasing structure vests ownership of the vessel with an SPV which acquires the vessel through funding by way of loan from the lender or alternatively the vessel may be the subject of a bareboat charter to the Cayman SPV. The vessel is then chartered to the shipping company/end user. The SPV will typically be established as an "off-balance sheet vehicle" with its issued share capital held by an offshore trust company on charitable or purpose trusts. The lender will take security over the vessel, over the SPV’s rights as owner/charterer and usually security over the issued share capital of the SPV itself. Typical powers or discretions included in the charitable or purpose trust would restrict any disposition of the shares in the SPV or its winding up. These tend to be drafted as provisions prohibiting the trustee from taking such actions without the consent of the lender. This is usually not thought to be a degree of control that would give a lender control or consolidation issues in its home jurisdiction. Following the termination of the transaction the trust will terminate and the trust property (namely, the net asset value of the SPV, which will be the issued share capital and any transaction fees earned by the SPV net of its expenses) will be distributed by the trustees to such one or more charities as the trust document provides.
The attraction of this structure from a lender’s perspective is as follows:
Ownership of the vessel does not vest with the shipping company/end user but with an SPV owned and controlled by a trust company which holds title in off-balance sheet capacity. Ownership therefore vests in a vehicle which is unlikely to be hostile to the lender in a default scenario when the lender seeks to enforce its security. From the lender’s perspective this "ownership" arrangement may provide the lender with advantages that are closer to those that would come with retaining title to the vessel itself whilst avoiding the consolidation of the vessel on its own balance sheet. The assignment by the SPV of its rights under the charter agreement with the shipping company/end user will also give the lender effective control of the enforcement of rights of the SPV as against the shipping company/end user under the charter.
In the event of a default, if the lender seeks deregistration in the shipping company/end user’s jurisdiction, the lender should be able to count on the exercise of the deregistration rights rather than having to rely solely on a mortgagee’s rights. Certain jurisdictions do not recognize the mortgagee’s right to deregister and may otherwise limit the mortgagee’s remedies (for example to a local judicial sale), thus making exclusive reliance on a mortgagee’s rights potentially unsatisfactory for the lender.
The principal loan and security documentation will generally be entered into by the SPV rather than the shipping company/end user, thereby avoiding potential enforcement problems in the shipping company/end user’s own jurisdiction where the legal system may be very different from the English system.
In addition to legal certainty, ownership of the vessel will be in a jurisdiction with political, economic and social stability which may give comfort to a lender in cases where the vessel is chartered to a jurisdiction where there is perceived risk.
Ownership of the vessel will vest in a bankruptcy-remote structure which should be unaffected by the bankruptcy of the shipping company/end user, thus avoiding the significant difficulties that could arise if title to the vessel vested with the shipping company/end user or in a special purpose subsidiary or affiliate established by it.
Taxation or, more properly, the absence of direct taxation and therefore the absence of withholding tax on account of any charge to tax is a principal reason for establishing the SPV in an offshore jurisdiction. The Cayman Islands currently have no direct forms of taxation but instead have a system of indirect taxation in the form of import duty, licence fees, incorporation fees and stamp duties some of which may not apply in the context of a ship financing transaction. There is therefore no taxation of charterhire payments, of interest or principal on loans. In order to give comfort that the no-tax regime will continue, certain types of SPV may obtain from the Cayman Islands Government a guarantee against the imposition of taxation in the future, known as the "Undertaking as to Tax Concessions", which undertakes to exempt the recipient SPV and its shareholders, for a period of twenty years, from most forms of relevant taxation if introduced in the Cayman Islands during that period. Thus, the lender may be assured not only that the SPV structure will not involve adverse tax consequences based on current legislation but that that will remain the situation for the duration of the transaction.
Types Of SPV
The most popular type of SPV used in ship finance transactions is the exempted limited company which may benefit from the tax exemption undertaking referred to above. This type of vehicle (as well as the other vehicles mentioned below) may be established cheaply and very quickly. However there are various other types of vehicle which may be used according to the requirements o the transaction parties in question. Cayman limited duration and limited life companies possess the relevant criteria to enable the vehicle to be treated (notwithstanding its corporate status in the Cayman Islands) as a partnership in certain other jurisdictions for tax purposes and to enable the shareholders to benefit from the tax transparency of such vehicle for their own purposes.
Unit trusts are often used as alternative vehicles for the benefit of investors in jurisdictions where participation in a unit trust is more attractive than shares in a company. There may, for example, be less regulation of an offering of units in a unit trust rather than shares in a company or more favourable tax treatment for the investor may be achieved.
The Cayman exempted limited partnership, where the business of the partnership is managed by a general partner and the investors as limited partners benefit from limited liability, incorporates the most attractive features from limited partnership laws of other jurisdictions, including the USA. As in the case of unit trusts, a limited partnership may offer a more attractive regulatory regime and tax treatment for investors in certain jurisdictions. Additionally, the exempted limited partnership may also obtain a tax exemption undertaking, valid for a period of up to fifty years from its date of issue.
These are then, in brief, some of the reasons why the Cayman Islands are and remain one of the most popular offshore jurisdictions for ship financing transactions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.