China: Rights of the Mortgagee of a Vessel and General Information as to Arrest in China

Last Updated: 22 September 2010
Article by David Beaves

PRC Ship Registry & Maritime Court Structure in China

According to the Regulations of the PRC on ship registration, a vessel's port of registry should be chosen by a shipowner depending on the proximity of the port of registry to its place of registration or principal place of business. In practice, the place of registration and principal place of business are likely to be the same location. The MSA (China Maritime Safety Administration) at the vessel's port of registry will handle registration of mortgages.

There are fourteen MSA offices in the major ship-registry ports in China, including Shanghai, Dalian, Tianjin, Qingdao, Ningbo and Guangzhou. Although the MSA is headquartered in Beijing and overall control is exercised from there, the individual MSA offices at each port of registry appear to have a degree of autonomy in the practice and procedure to be adopted. The financing of a PRC flag vessel will most likely involve the registration of a mortgage at one of those registries and specific advice on individual registries (on matters such as the registry's track record concerning registration mortgages) can be given at the relevant time.

The importance of having a specialised court dealing with maritime matters has not gone unappreciated in China. A specialist maritime court structure has been in place since 1984. China presently has 10 main maritime courts and 39 branch courts. This number is constantly on the rise. One of the newest branch courts is Yangkou dispatching court which was set up in September 2009 and located next to Nantong Port.

We are receiving repeated requests for advice on the arrest of vessels in Chinese ports. Specific advice would have to be sought at the time, but generally, it is advisable to carry out an arrest in one of the 10 main maritime courts as they are more experienced in dealing with an arrest and subsequent steps for mortgage enforcement.

To give an idea of the number of cases that the maritime courts handle, Shanghai Maritime Court dealt with 1,642 cases in 2008, compared to 1,480 cases in 2007. Most of those cases involve disputes between Chinese parties, with about a quarter of the cases involving an overseas party.

Rights of Foreign-registered Mortgagees of Vessels

The applicable maritime legislation is "The Maritime Code of the People's Republic of China" (CMC) which came into force in 1993. This is a comprehensive set of rules and regulations governing all matters of maritime law in China. Unlike common law jurisdictions, China's legal system is based on continental civil law and the CMC is therefore a definitive authority in the regulation of maritime law in China.

Undoubtedly, given the current economic climate, many banks will be concerned about how to exercise their rights as a mortgagee of a vessel in China. In a case in which the vessel is registered (and mortgaged) outside China, the mortgage over the vessel under the primary flag is, for all intents and purposes, a foreign-based mortgage under PRC law and will be recognised and respected as such. In other words, the rights and obligations of the mortgagee and mortgagor are governed by the law of the original flag state.

If enforcement of a mortgage is sought in China for a vessel registered in a foreign registry, Article 271 of the CMC provides that the rights and obligations of the mortgagee and mortgagor are governed by the law of the flag state. The article goes on to clarify that if the mortgaged vessel has a second flag state as a result of a bareboat charter registration, then the law of the original country of registry of the ship will apply to the mortgage.

The Arrest Process

If the vessel is in a Chinese port when a mortgage is intended to be enforced, the arrest and enforcement proceedings should rightly be initiated in China. The arrest of the ship is the usual first step in any enforcement case (an arrest in China can occur even before a substantive action has been commenced). The arrest procedure is very well established and vessels (both domestic and foreign) are arrested on a regular basis for all types of maritime claims, including those that have no connection with China. Increased trade with China and the corresponding increased calls to the country has seen China become an increasingly popular jurisdiction of choice among foreign claimants.

An application to effect an arrest of a vessel in China is usually filed with the maritime court of the place where that vessel is located. It is possible to commence proceedings in the court of the port of registry and for that court to seek the assistance of the court where the vessel is located to carry out the arrest. As a result of this, the choice of the port to arrest falls within the vessel's trading area and is not inextricably linked to the port of registration.

In the past, typical advice in relation to an arrest would have been to avoid certain of the 10 main maritime courts. In recent years, however, all the main courts have gained experience in the arrest of ships for a wide range of claims. Generally the speed and response of the courts has improved markedly. Notwithstanding this, if there is a need to arrest, we would still give preference to the ports in this order – (1) Shanghai, (2) Dalian, (3) Tianjin, (4) Qingdao, (5) Guangzhou and (6) Ningbo.

Since the CMC was introduced, China has moved from among the bottom rung of Asian countries in which one would think to effect an arrest to (arguably) 4th place (in Asia), after Hong Kong, Singapore, and Malaysia (with China already having certain advantages over Malaysia).

The maritime courts have a good track record in enforcing foreign mortgages and the applicable regulations meet international standards.

The general enforcement proceedings are as follows:

  1. apply for arrest of the vessel in the maritime court which has jurisdiction over the vessel (there are 10 main maritime courts in China with 38 branch courts);
  2. the arrest period is 30 days, unless the claimant lodges a formal lawsuit or arbitration within that period;
  1. if the shipowner provides security within 30 days, the vessel will be released and the security will be held by the court pending the results of the substantive proceedings; and
  2. if no security is provided (the most likely result in a case of mortgage enforcement) and the claimant has lodged a formal lawsuit or arbitration within the 30 day period as required, the claimant can apply for a judicial sale of the vessel.

Once a maritime court accepts an application for arrest, it will order the applicant to provide counter security. The security provided by the applicant can be in the form of a bank guarantee, cash, or other guarantee. The security covers a possible claim for wrongful arrest and can typically range from a significant portion of the claim amount to a figure representing a notional 30 days hire of the vessel. In our recent experience, the security required by the courts tends to be less than in previous years. However, there is no uniform practice among the courts and the figure can sometimes be a matter of negotiation with the judge who will handle the case. If an arrest is prolonged, the court may require a larger counter security.

At this point it is worth commenting on the practice which usually precedes the arrest of a vessel. It is common for the lawyer making the arrest application to discuss the application with the judge not only to determine the amount of counter security, but also the nature of the claim. This discussion can be important if the court does not have much practical experience of the matters pertaining to the substantive part of the claim.

In the 17 years since the CMC has been in force, our office in Shanghai has been involved in a number of arrests and court sales by overseas mortgagee interests. The most recent of these matters were in Qingdao and Tianjin and in both cases, the overseas mortgagee was successful in arranging the sale of the vessel.

Chinese Law generally does not impose restrictions regarding who can bid for a vessel being sold at auction. The applicant and the party against whom an application is filed are both allowed to bid for the vessel. A bidder may take part in bidding himself or authorize his agent to participate on his behalf.

A point which mortgagees will want to be aware of is that, generally speaking, there has not been a large number of mortgage enforcement actions in China. The main reason for this is that it has always been preferable (and will likely remain so) to arrest in established jurisdictions such as Hong Kong or Singapore. That being said, with the increased necessity in times of economic uncertainty for a bank to enforce its security and with the increasing number of vessels calling at Chinese ports, mortgage enforcement actions in the PRC are becoming increasingly more common and are likely to become even more so in the future. Indeed, this has been evident even from our own experience. Apart from our experiences with the courts in Qingdao and Tianjin, we have handled mortgagee enforcement actions in Ningbo, Haikou, Wuhan and Shanghai for both overseas and domestic mortgage enforcements.

It will no doubt, be a relief to mortgagees and other potential claimants to note that wrongful arrest claims in China are rare. In practice, the court would have dissuaded the applicant from going ahead with the arrest, if it appeared to the court that the grounds of the arrest could be successfully challenged.

Dealing with the process following a court sale of a vessel under Chinese law, it is the responsibility of the original owner of the vessel to apply to the original local registry for registration of ownership of the vessel or cancellation. The documents required for cancellation are: written application, identification, original ship registration certificate, and other related certificates. However, the fact that the original owner of the vessel does not apply for registration of cancellation of the ownership of the vessel will not affect the transfer of the vessel.

If a buyer intends to re-register in China, the buyer will need to go through the title registration process with the vessel registration authorities after taking delivery of the vessel. Registration will be subject to the submission of a letter of confirmation of transaction and relevant materials including identification, as well as the vessel's photo and technical information, certificates proving no mortgage or that the mortgagee has agreed on the transfer of the vessel, co-ownership identification document, etc.

In practice, if the vessel is to be re-registered under a foreign flag after the sale of the vessel by the court, the committee set up by the court will arrange the necessary documentation. Further, and again in the Mortgagee's favour, the court will not allow its order for sale to be compromised or frustrated by the action or inaction of any party including the former shipowner. We would expect that the relevant MSA which had originally registered the vessel and the mortgage would cooperate with the Court.

Is a PRC court sale of a vessel likely to be recognised by foreign courts?

An indication as to how foreign courts will approach the sale of a vessel ordered by a PRC court was given recently by the High Court of Singapore which considered the merits of an application by the (former) owners of a Turkish-flagged vessel challenging the sale of the vessel made pursuant to an order of the Tianjin Maritime Court. The (former) owners' challenge failed and the Singapore court accepted the decision of the Tianjin Maritime Court. This decision serves as an indication of the treatment that an order of the PRC courts can expect to receive in foreign jurisdictions. The significance is even greater considering that the legal system and principles applied by the Singapore judiciary is in line with most other common law jurisdictions.

Conclusion

Foreign mortgagees are increasingly well-placed to enforce their rights under a ship-mortgage, whether foreign or domestic in China. The main difference between domestic and overseas lenders relates to the fact that, on a court sale, the overseas lender will require the proceeds to be remitted overseas. From past experience, this has not proven to been a problem since the Chinese courts will generally take a pragmatic and practical approach in this situation and will approve the amount payable to the lender to be remitted out of the country. Nevertheless, for the peace of mind of a foreign mortgagee, it would be wise to review what the applicable tax position may be.

In summary, the laws and regulations relating to mortgage enforcement apply across the board to all types of mortgages, domestic and foreign irrespective of the nationality of the lender. The Chinese maritime courts have become increasingly practical and commercial in their approach. The number of maritime courts are increasing, and as more sea-trade is conducted in and around China, their experience of foreign parties in general and foreign mortgagees in particular is expanding. Foreign parties should be open to arresting ships in China both to secure maritime and mortgage claims.

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.

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