Hong Kong: Mortgagee Protection and Enforcement in Hong Kong

Last Updated: 23 September 2010
Article by Rory Macfarlane

The Hong Kong Shipping Register is currently one of the top registers in the world and has attracted significant international tonnage. Much of this tonnage has only been recorded in the last 10 year, making Hong Kong one of the fastest growing shipping registers. Undoubtedly, its proximity to China and favourable port state duties with Chinese ports contribute to the register's phenomenal success, but one of the key reasons for its success is the well developed legal system and admiralty jurisdiction in Hong Kong. Mortgagees and shipowners alike can be confident of a world-class legal maritime infrastructure in which the resolution of disputes may be quickly and fairly facilitated. Ship arrest is paramount to the Hong Kong admiralty jurisdiction and is a powerful tool for any mortgagee.

Banks Remedy Upon Foreclosure

Most loan documentation and security arrangements contain rights of foreclosure for the mortgagee. Key to this is the ability to take possession of the ship over which a mortgage has been obtained and proceed to deal with the asset in a way which would best allow them to mitigate their losses. The main remedies upon foreclosure (and after a well grounded declaration of default and notice to insurers are sent) are either:

  1. a private right of sale
  2. arrest and judicial sale
  3. possession and trading of the vessel.

For the purpose of this memorandum, we will concentrate on the private sale, and arrest and judicial sale of the vessel and touch briefly on possession and trading of vessels.

1. Private right of sale

The most likely remedy for a mortgagee will be to sell the vessel and realise its asset value with a view to minimising its losses. Once a mortgagee exercises its right of possession over the vessel, they may arrange to sell the vessel as the owner. A private sale will have many advantages over a judicial sale of a vessel; it is likely to be concluded much faster, will probably cost far less than the procedure relating to a judicial sale and will also likely achieve a higher final price than a judicial sale.

The main drawback of the private sale, however, is that it is likely to require the mortgagee to take a much more 'hands-on' approach by arranging for such matters as payment of trade creditors and crew, repatriation of crew and physical handover of ship. Further, as they are, in effect, the sellers, a mortgagee is likely to be asked to give warranties and an indemnity in respect of third party liens (in addition to possible issues relating to product liability, implied conditions and warranties). There is also a risk to the borrower from whom the ship was taken if the price achieved falls short of a "fair price".

In the event that a mortgagee does exercise a private right of sale, it should either not discharge the mortgage at all or only do so after it has conveyed title to the purchaser. It is the mortgage which contains the power of sale and, if the mortgagee discharges the mortgage before it executes and registers a bill of sale conveying title to the purchaser, the mortgagee may lose the right to convey title.

2. Arrest and judicial sale

Prior to arresting a vessel, a mortgagee will need to invoke the admiralty jurisdiction of Hong Kong. A typical ship finance scenario, where the mortgagee will have a mortgage over the vessel, falls within the jurisdiction. There is only one court in Hong Kong which has Admiralty jurisdiction, namely the High Court. The arrest is carried out by the Bailiff upon a warrant issued by order of the Registrar, both of whom are court officials.

The territorial jurisdiction of the High Court extends to any vessel in Hong Kong territorial waters. In practice, this means that the vessel has to be in Victoria Harbour or any other port, dock or harbour where the vessel is at berth or anchor. An in rem writ cannot be served outside the jurisdiction. It can only be served on the vessel if it enters Hong Kong, unless a defendant outside the jurisdiction decides either to instruct agents or solicitors in Hong Kong to accept service of the writ of summons voluntarily on his behalf or to enter an acknowledgement of service gratis.

A clear advantage to a buyer under a judicial sale is that they will receive title clear of all liens, charges and encumbrances. Unlike a private sale, the Court or Admiralty Marshal takes responsibility for the appraisal of the value of the vessel, bearing in mind the interests of all the creditors. This avoids any criticism of the mortgagee as to the manner in which the sale has been executed or as to the price realised.

The main problem with a judicial sale is that it will be seen as a distress sale, and therefore will likely not attract the price one could expect from a private sale of the vessel. The nature of the Court and Admiralty Marshal may mean that there is a greater delay between arrest and sale. During this time the continuing expenses of maintaining an arrest (including the fact that the vessel becomes a wasting asset) will be for the mortgagee to bear. Hong Kong court fees and expenses for the arrest, detention, appraisement and sale are generally not substantial. By way of a general illustration they might, typically, be as follows:

  1. Port charges: about US$6.50 per 100 tonnes per day
  2. Bailiff's expenses - security guard, etc: about US$90 per day
  3. Appraiser's fees: about US$5,000
  4. Newspaper advertisements: about US$8,000
  5. Legal costs for arresting and applying to sell: about US$5,000 - US$10,000
  6. Court commission - 1% of gross sale proceeds.

These are approximate estimates and could alter substantially if third parties tried to interfere or object to the sale. They also do not take into consideration the issue of priorities, although this is not a particularly large concern in Hong Kong as mortgagees enjoy a very high priority, ranking only behind possessory liens and maritime liens for unpaid crew's wages, collision and salvage.

A public auction or private treaty are the most usual methods of judicial sale. Under Hong Kong admiralty practice a sale is made on the Admiralty Marshal's Conditions of Sale and generally the sale is conducted by private tender through the Admiralty Marshal's brokers. Since the appraised value is not disclosed to bidders, this may be particularly awkward for a mortgagee who may want to bid himself or finance a bid by one of his other customers to ensure that the vessel will fetch a reasonable price.

In deciding whether to proceed by a private sale or judicial sale there are numerous factors to be considered, in particular, the level of trade debt, the trading pattern of the vessel and whether this includes jurisdictions which are suitable for foreclosure and judicial sale and the degree of co-operation received from the borrower.

3. Possession and trading of the vessel

Actual possession may be effected by a mortgagee putting his own representative on board the vessel and by dismissing the owner's master and appointing his own, or merely by reappointing the owner's master as the agent of the mortgagee. Banks should, however, be alert to the risk of unwittingly finding themselves in constructive possession. Constructive possession arises if the mortgagee does such acts as clearly evidences an intention on its part to intervene, take possession and assume ownership. A controversial issue which is often debated is the degree of interference and control which will constitute a bank mortgagee in possession. It may be a thin line to draw: certainly it is always preferable for a bank to advise its customer what it may not do rather than to tell it what it intends to do.

A key point to consider in regard to this is that the mortgagee will, in effect, be the owner of the vessel and will be so liable. The mortgagee would therefore be liable for any expenses and liability from the moment of taking possession, including liabilities arising out of collision or pollution and will take subject to existing possessory and maritime liens. In practice, a mortgagee must be prepared to deal with and to a large extent pay off the existing trade debt and other claims which have arisen prior to the time when the mortgagee goes into possession, otherwise the vessel will be subject to arrest and its operation interrupted.

The only situations in which there may be a real advantage to the mortgagee going into possession is to sail the vessel to a more amenable jurisdiction, with a view to a judicial sale or to preserve a valuable charter where the mortgagee already holds an assignment of all rights, title and interest in and to that charter and the charterer has consented to such assignment.

4. Conclusion

Generally, all the protection available to a mortgagee as one would expect from the typical established common law nations such as the UK and Singapore is available in Hong Kong, making it one of the prime jurisdictions out of only a handful in which a mortgagee can be confident that the judicial system will allow proper and due enforcement of mortgagee security. Moreover, the established admiralty jurisdiction of the Hong Kong High Court means that procedural measures to facilitate the enforcement of a maritime security are well in place and will aid a smoother enforcement process.

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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