China: Validity Of Mortgages Established On Vessels Owned By Company In Bankruptcy

Last Updated: 30 May 2014
Article by Ik Wei Chong and Leslie Shen

On 21 October 2013, the financially troubled company Hainan PO Shipping applied for bankruptcy and winding up before the People's Court of Hainan Yangpu Economic & Development Zone ("Yangpu Court"). The Yangpu Court approved the application on 31 October 2013, and the Court has since nominated the administrators of Hainan PO Shipping. The first Creditors' Meeting was convened on 3 March 2014, wherein the administrators informed the creditors that they have filed formal applications before the Yangpu Court and requested the Yangpu Court to set aside the mortgages established on 4 container vessels owned by Hainan PO Shipping.

Claims registered before the Yangpu Court

Hainan PO Shipping was established by Hainan State-owned Assets Supervision and Administration Commission in 2009 and had 25 subsidiaries in several major port cities. The company suspended all of its shipping services at the end of September 2013, and they had been trying to resume operation through financial support from the government or via a restructure plan before the commencement of the bankruptcy proceedings.

All the creditors were asked to register their claims before the Yangpu Court by 20 February 2014, and nearly 80 entities have registered their claims against Hainan PO Shipping by the deadline. The total amount of the registered claims is around RMB 880 million (or around USD 140 million).

Secured claims

The said registered claims include a "secured claim" of around USD 65 million registered by a container company and another of around USD 32 million registered by the Yangpu Branch of a state-owned bank. The container company's claim had been secured by a mortgage established on the "LONG MU WAN", and the bank's claim had been secured by the mortgages established on the "SHEN TOU WAN", the "XIANG SHUI WAN" and the "XIN YING WAN". All the mortgages were registered in Yangpu, where the said 4 container vessels flying Chinese flags are registered.

The 4 vessels had been arrested by the Haikou Maritime Court, the Guangzhou Maritime Court and the Tianjin Maritime Court respectively before the commencement of the bankruptcy proceedings, and the said Courts have now released the vessels from arrest upon the request of the administrators. This means that the vessels are currently under the control of the administrators and so are deemed to be the assets of Hainan PO Shipping. In fact, the 4 container vessels are perhaps the only assets which may eventually be realised to settle creditors' claims.

However, under Chinese law, if the validity of the said mortgages is eventually recognised by the Yangpu Court, the container company and the bank would then be granted priority when the sale proceeds of the vessels are realized and distributed in due course. The claims registered by the container company and the bank amount to around USD 100 million, whilst the highest valuation (on the 4 vessels) given by Shanghai Vessel Insurance & Survey Co Ltd (backed by Shanghai Shipping Exchange) is around USD 32 million, which means that the "unsecured creditors" may not be able to obtain any actual recoveries via the bankruptcy proceedings in the circumstances.

Administrators' arguments and the uncertainty of the outcome of their applications

The administrators pointed out in their applications that the mortgages established on the 4 vessels had been registered in Yangpu (where the said 4 container vessels flying Chinese flags are registered) "within a time period of 6 months before the commencement of the bankruptcy proceedings before the Yangpu Court", and they argued that the mortgages should therefore be deemed to be invalid. If the administrators succeed, the sale proceeds of the said 4 vessels would then be distributed to all the "unsecured creditors" (including the container company and the bank who will not be entitled to a priority in distribution process of the sale proceeds) in proportion (pari passu basis) in due course, which means that the possibility for "unsecured creditors" to obtain an actual recovery during the bankruptcy proceedings may increase significantly.

Pursuant to Article 13 of the PRC Bankruptcy Law, the administrators are entitled to file applications and request the Court to set aside securities "provided" by the debtor for "unsecured claims" within a time period of 1 year before the commencement of bankruptcy proceedings, i.e. after 30 October 2012.

What is interesting is that the said mortgages were registered "within a time period of 6 months before the commencement of bankruptcy proceedings", whilst the corresponding mortgage agreements had been signed earlier than 30 October 2012.

Therefore, the prospects of success of the administrators' applications may largely depend on whether the Yangpu Court takes the view that the mortgages should be deemed to have been provided to the container company and the bank only when the mortgages were duly registered with the Yangpu Registry rather than when they were actually entered into.

There are no specific statutory provisions or judicial interpretations in this regard, and it is therefore difficult to anticipate the potential outcome of the administrators' applications. A hearing in relation to the mortgages established in the bank's favour was convened on 17 February 2014, whilst the relevant litigation documents in relation to the mortgage established on the "LONG MU WAN" (in the container company's favour) have not been served on the container company to date – the administrators indicated that the container company has intentionally refused to accept the Yangpu Court's service of relevant litigation documents with a view to delaying the progress. The latest development is that the administrators, with the alleged purpose of preventing a huge amount of vessel maintenance fees and expenses to be incurred, have requested the Yangpu Court to issue a specific order to facilitate a quick commencement of the auction of the 4 vessels, and the outcome of the administrator's this application is also pending.

Suggestion

Whilst general global financial conditions have improved during the past few years, the shipping crisis has deepened due to overcapacity in the market. As a result, the market has witnessed a significant increase of the number of shipping companies who are involved in bankruptcy / insolvency and restructuring proceedings. This story of Hainan PO Shipping reveals that, before the perfection of relevant rules of Chinese Bankruptcy Law and other related statutes (for example, the Chinese Civil Procedural Law, the Chinese Property Law, the Chinese Maritime Code and the Chinese Specific Marine Procedure Law etc), all the parties involved in the relevant Chinese proceedings (vessel owners, cargo owners, charterers and mortgagees etc) may have to live with the uncertainty brought by the current situation. In future, providers of credit and loans to Chinese shipping companies will be forced to give much more thought as to what precautious and measures could be taken to minimise potential risks and/or protect their rights and interests. 

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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