UK: How Does The Future IMO Ship Recycling Convention Address The Issue Of The Cash Buyer?

TradeWinds Ship Recycling Forum, 19 January 2009

Holman Fenwick Willan is, as many of you will know, a law firm having close connections with the shipping industry: it was due to a 'chance encounter' while representing a Greek shipowner borrower 20 years ago that I met Arun Chauhan, then at the London branch of Fidelity Bank NA, one of whose specialist areas was the financing of ships being purchased for onward sale for demolition on the Indian sub continent. There has since followed 20 great years of involvement in this industry, representing banks, investors, ship sellers, cash buyers and ship recycling yards: resulting in a knowledge of an industry and a trade that I am very pleased to share with you today.

One year ago, I and a number of my colleagues in Holman Fenwick Willan's Ship Finance Group were giving lectures to representatives of shipowners on the optimum ways to structure newbuilding resale contracts: the maritime equivalent of buying and selling on an apartment bought off the plan in Dubai. At that time, in the columns of Fairplay and TradeWinds, there were reports of up to ten concluded newbuilding resales compared to one or two - a mere trickle - sales of ships for scrap.

One year ago, one of the cases in which we were instructed involved the giving of advice to a cash buyer concerning the description of the grade of stainless steel contained in a chemical tanker his company has bought at a price of US$975 per light displacement ton: almost a record price but not out of line at the time.

Five months ago, over a lunch meeting with Jon Chaplin to discuss the potential possible themes for this conference, I suggested that this could include the consideration of how to make the trade of the cash buyer a more 'bankable' activity. Again, in hindsight, what temerity possessed me to suggest, then or any other time, that the trade of the cash buyers and the ship recyclers of the Indian sub continent was lacking in reliability: au contraire, with the almost near complete collapse of the bulk shipping market, it is the enterprise and the confidence of the cash buyers that could be the perfect 'floor' for anxious shipowners, banks and investors. Whilst the effect of the credit crunch saw a significant drop in the price of ships sold for recycling, this has since stabilised around the mid US$200 per ldt level.

Occasionally, cash buyers are pejoratively referred to as 'middle men'. That is, however, exactly the same word as its French equivalent namely 'entrepreneur', defined in the Oxford English Dictionary as meaning "the owner or manager of a business enterprise who, by risk and initiative, attempts to make profits". Enterprise is defined as "a project or undertaking especially one that requires boldness or effort".

Today would, I believe, be a fitting occasion to pay tribute to those whose "boldness and effort" has not only produced a strong and viable industry in its own right but one which will also, I am convinced, prove to be the salvation of the current hard pressed bulk shipping sector¹.

One of the questions that is frequently asked is why it is that such cash buyers/entrepreneurs exist and flourish as they do, when the vessels could equally be acquired, either on an as is, where is, or delivered basis, by the relevant recycling yard. There are others attending this conference who are more qualified to answer this question than I: when I was starting out in this business some 30 years ago, such direct contractual arrangements were the norm, with shipyards in Taiwan doing business directly with shipowners, via brokers, as evidenced by this passage from Ocean Freights and Chartering which was published around that time. Aside from the Hamburg-based house of Eckhardts, there were no purely entrepreneurial buyers of ships for breaking of the standing and commercial presence that we see today.

There was an echo of that stated need for 'bankability' in a recent (5 December 2008) issue of "TradeWinds" with reports of a Greek shipowner "advocating the delivery of vessels going for demolition in countries other than their final destination after being forced to re-negotiate deals when scrap prices crashed"².

In the interview, which was unusual for its insight into the inner psyche, the shipowner concerned, Mr George Youroukos of Technomar, was complaining of being "an easy target" for renegotiated deals by agreeing to deliver his vessels to the scrapping beaches, believing owners stood a better chance of resisting such pressure "if they deliver ships at a neutral venue".

Welcome, Mr Youroukos, to the world of ship recycling : the answer to your problem is solved by the sale of your ship, wherever it is in the world, to the cash buyer, giving you both the ability that you require to deliver the vessel in a neutral location against security of payment and, if well advised, also providing an English law governed sale contract providing for London arbitration / English Court jurisdiction in the event of a dispute plus your right to retain the deposit of 10% or even 20% paid by your cash buyer. Plainly Mr Youroukos was tempted by the higher prices available from a "delivered basis" sale, finding to his cost the effect of a 25% to 30% re-negotiation in the contract price by reason of the collapse in the market between contract and completion.

Blaming the cash buyer for this state of affairs, i.e. expecting the cash buyer to stump up and suffer a massive loss (occasioned by the inability or unwillingness of the cash buyer's own onward purchaser to meet its original obligations) is perhaps an understandable reaction in times of such extraordinary market movements. From the viewpoint, therefore, of the trading shipowner, it is the sale of the vessel on a delivered basis that carries the risk, not dealing with a cash buyer per se.

Treatment of cash buyers under the new IMO Recycling Convention

At HFW we have been following the gestation process of the IMO Recycling Convention for some years: having a particular interest after seeing clients get caught by embargoes of exports of ships by governments applying the rules of the Basel Convention or its equivalent in domestic legislation.

The above Convention is a reference to the Basel Convention on the Control of Trans-Boundary Movement of Hazardous Wastes and their Disposal (UNEP), a treaty which was adopted on 22 March 1989 and entered into force on 5 May 1992. There is, as we know, a continuing debate going on between environmental groups and the shipping industry as to the applicability of the Basel Convention to ships destined for recycling. As has been observed, the recovering of metals is clearly within the disposal operations under the Basel Convention and therefore as long as a ship is destined for scrapping, there is, so it is argued, an intention to dispose and therefore a ship destined for scrapping is "waste" under the Basel Convention. If, in addition, a ship includes hazardous substances, either as cargo residuals or in the chemical composition of its structure, it is then hazardous waste for the purpose of the Basel Convention and its export must follow the provisions of the Basel Convention (including criminal charges for illegal traffic where the provisions are not observed)³.

That the IMO has responded as relatively promptly and co-ordinatedly that it has is commendable when one considers that the regulation of how ships are broken up, which is essentially a land based activity, is not at first sight within the IMO's original remit. Indeed, the new Convention will, if adopted, be the first IMO instrument to impose mandatory environmental standards and social norms covering workers' health and safety on land-based facilities, as well as on international shipping.

The purposes of the IMO, as summarised by Article 1(a) of the Convention on the International Maritime Organisation (1958) are:

The IMO (via the MEPC), recognising the needs of the shipping community to show itself as capable of making rules for the environmentally sound management of ship dismantling, took the recycling of ships on board as a key development area. The report of the correspondence group of the MEPC 49^th session of 28 March 2003 provides clear indices of the thought processes informing the development of what we now see in the draft Convention. At that time, the focus of the committee was not this Convention but the work on the development of the IMO Guidelines on Ship Recycling which were adopted as Reslolution A.962 (23) on 5^th December 2003.

What is interesting, however, from the point of view of the cash buyer, is that even at this early stage in the process, there was consideration of the responsibilities of this key stakeholder in the regulation of the recycling process.

When lawyers are called upon to comment on ambiguous provisions of laws or conventions, it is sometimes helpful to have access to the "travaux preparatoires" (also known as the "ash cans of the legislative process").

In the UK, this might be found in the report of the parliamentary debates as recorded in "Hansard" or a "white paper" published before the adoption of the relevant statute. In the case of the IMO Ship Recycling Convention, one of the places where this may be found is in the report of the co-ordinator of the correspondence group on ship recycling, i.e. Annex 1 to the report of the MEPC's 49^th session of 28^th March 2003 referred to above.

This report states four 'key principles', namely:

1. the minimalisation of hazardous materials and waste
2. the 'polluter pays'
3. the need to give priority to safety and environmental protection during the operational life of the ships
4. the recyclablity of materials is not the sole criteria for their acceptability

The report also introduced the three pillars of what we now see as the draft convention namely:

1. the 'green passport' concept;
2. the regulation and licensing of recycling yards; and
3. shipowners' responsibility.

The views of that report on the role and responsibilities of the cash buyer are worth noting. Some of these views found their way into the IMO Guidelines on Ship Recycling adopted in December 2003, and some did not.

In Article 1.5 of the Guidelines, it is stated:

As stated in clause 2.1:

In the definition section, 'shipowner' is defined as "the person or persons or company registered as the owner of the ship or, in the absence of registration, the person or persons or company owning the ship ... this term also includes those who have ownership of the ship for a limited period pending its sale to a recycling facility."

The Guidelines continue by recommending various steps that the shipowner 'should' take including:

• the selection of the recycling facility
• specifying the method of recycling in the recycling contract and reserving the right to monitor the recycling process
• having contractual provisions for incentive payments to ensure the recycling facility is carrying out the recycling in accordance with the guidelines
• responsibility for delivering the vessel with a 'green passport'
• removal of potentially hazardous materials.

Hardly surprisingly, there is no reference to the cash buyer as such nor any apparent deliberation as to the imposition of responsibility on the shoulders of the cash buyer. This is in contrast with the March 2003 draft Guidelines. Since the subject of this paper is the manner in which the Convention addresses the issue of the cash buyer, it is worth setting out this section in full:

Unfortunately, worthy and well meant as the guidelines are, they are just that, i.e. of non-binding status and just guidelines. Even the recommended standard contract 'the Demolishcon', published by BIMCO and recommended at Article 9.8.2. of the Guidelines, obliging parties to adhere to the obligations and endeavours recommended in the Guidelines, is very rarely used. After an involvement in over 500 ship recycling sales, I have only seen it being used twice, both those cases involving the recycling of 'high profile' ships.

What I find interesting, from the point of view of the cash buyer, is that, beyond the inclusion in the definition 'shipowner' of the company having "ownership of the ship for a limited period", there is no further guidance or recommendation contained in the IMO Guidelines pertaining to either cash buyers or, just as importantly, the flag states used by cash buyers for that limited period of ownership.

Indeed, in the footnote to that section in the March 2003 draft report, one member of the correspondence group observes, "the role of broker and/or intermediate buyer in respect of the Basel Convention should be discussed".

And so we come to the development of the Convention itself: "fast forward" to the MEPC 57^th session of 3 April 2008 containing the report of the working group on ship recycling having as its main task the completion of the review of the text of the draft International Convention for the Safe and Environmentally Sound Recycling of Ships.

What did the working group have to say then about the situation of the cash buyer?

Paragraph 21 refers to the suggestion made by India that "there may be a need to address situations in which a ship is sold to a "cash buyer" where the ship is no longer flying the flag of a particular state for a limited period immediately prior to delivery to the recycling facility." (i.e. the "delivered basis" situation).

The working group responded as follows:

Looking at the draft Convention as it is now, compared to the draft in the form attached to the MEPC's April 2008 report, there have been no evident changes to the draft designed to address either the problem raised by India or to make it clear just exactly which 'Shipowner' and which 'Administration' it is intended should be responsible for the performance of the several duties that the Convention seeks to impose.

We must, however, place some faith in the Convention and look to see how it will once in operation affect/impact current practices.

The draft International Convention currently exists as an annex (a "draft text") to a memorandum to the IMO, in plenary session, at the International Conference on the Safe and Environmentally Sound Recycling of Ships, which is due to take place in Hong Kong in May 2009. The draft submitted is the final draft as recommended by the IMO's Marine Environment Protection Committee held at its 58^th session from 6 - 10^th October 2008 "with a view to it being adopted by the Conference".

As Nikos Mikelis of the MEPC, has informed me, the process from here on is not by any means a rubber stamping exercise nor is it intended to be: on the contrary, the more constructive input and comment that is provided and the more debate that is held at the forthcoming International Conference, the more representative of international intention the treaty will be and the more legitimate for that debate.

The first part of the Convention is, seemingly, more of a mandating/enabling set of measures, whereby 'parties' to the Convention (i.e. signatory States) oblige themselves to bring into force suitable legislation to give effect to the provisions of the Convention.

The second part, i.e. the Regulations, is where the main detail is to be found.

These comprise 25 regulations (divided into 4 chapters) and 6 appendices.

This paper is not designed to be a line by line commentary on the Convention, therefore I shall confine my remarks to the key practical points.

First, some definitions:

The Convention has two focuses.

The first (Part A) relates to the design, construction, operation and maintenance of ships. This is to do with the construction of ships and the inventorisation of their hazardous materials and does not merit discussion in this paper.

The second (Part B - Preparation for Ship Recycling and the third, Part C - Surveys and Certification) relate to the process of ship recycling and are those which are of most concern to the cash buyer.

Preparation for Ship Recycling

Regulation 8 - General Requirements provides as follows:-

1. only be recycled at ship recycling facilities that are authorised in accordance with this Convention;
2. conduct operations in the period prior to entering the ship recycling facility in order to minimise the amount of cargo residues, remaining fuel oil and wastes remaining on board;
3. provide to the ship recycling facility all available information relating to the ship for the development of the ship recycling plan required by Regulation 9;
4. complete the inventory required by Regulation 5; and
5. be certified as ready for recycling by the Administration or organisation recognised by it, prior to any recycling activity taking place.

Apart from items 1 and 5 in the above list, it is not clear on whom the Convention is trying to place responsibility for the various requirements. The draft Regulation appears to be placing the burden of the various duties on the ship itself ("ships destined to be recycled shall") which is an impossibility given that a ship does not have its own legal personality.

Perhaps the Regulation is intended to be deliberately neutral, to reflect an acceptance that such responsibilities may be divided: for example, with the trading shipowner being responsible for running down operations in order to minimise cargo residues, waste, etc. with the cash buyer being responsible for the engagement of the authorised ship recycling facility.

Equally uncertain is which "Administration" is intended by Regulation 8(5) to be responsible for the certifying of the ship as being "ready for recycling". Is it the flag state of the operating shipowner or the flag state of the cash buyer?

The Ship Recycling Plan

Regulation 9 requires for a ship-specific ship recycling plan to be developed by the ship recycling facility(ies) prior to any recycling of a ship, taking into account the guidelines developed by the organisation.

Such recycling plan, "shall be developed in consultation with the shipowner".

The question arises again, which 'shipowner' is the relevant entity to whom to attribute responsibility for this key task.

Looking at the MEPC's March 2003 report and the accompanying footnotes, it is clear that there was (and no doubt still is now) considerable debate about which owner is expected to step up to the plate. The last paragraph in the section headed "Shipowner Responsibility" reads as follows:-

In the footnotes, there is stated the following comment by a member of the correspondence group:

Surveys and Certification

Regulation 10 (Surveys) again frames the scope of its various obligations in the passive tense. As far as the cash buyer is concerned, the relevant provision is Regulation 10, sub paragraph 4, providing that a ship shall be subject to a final survey prior to the ship being taken out of service and before the recycling of the ship has started. Such survey to verify:

1. that the inventory of Hazardous Materials as required by Regulation 5.4 is in accordance with the requirements of this Convention taking into account the guidelines developed by the Organisation; and
2. that the Ship Recycling Plan developed by the Ship Recycling Facility(ies) complies with the requirements of this Convention and ... has been approved by the competent authorities.

The responsibilities for the carrying out of this and the other surveys required by Regulation 10 is placed on 'officers of the Administration' (i.e. the flag state), taking into account the guidelines developed by the Organisation. The flag state is, however, empowered to entrust the surveys either to nominated surveyors or to recognised organisations.

In the list of definitions mentioned above, we stated the meaning of "Administration" in this context, namely the government of the flag state. It is unclear (perhaps having been deliberately left so) on which flag state the Convention is seeking to place responsibility for what may well be a very exacting verification process. I spoke recently to the administrator of one of the well known "open registry" flag administrations about how he would deal with this additional burden of responsibility. His resigned but practical response was "we will see what it looks like in due course and seek appropriate guidance on its implementation".

To the cash buyer fraternity, I would say that it is not in your interest to take such a relaxed approach because it is likely that all and any costs associated with these surveying and verification exercises will be passed on to you.

Reporting requirements

Regulation 24 (1) states :

When an operating shipowner wishes to dispose of his vessel for breaking, he places that vessel with a specialist scrap broker, who circulates the vessel to the pool of prospective cash buyers. A shipowner in this situation is aware that he is selling the vessel for recycling but has neither knowledge of nor interest in the recycling process nor any knowledge of where it is intended to recycle the vessel. He just wants to sell his vessel, ideally at a "neutral location", receive his cash and write down the vessel / close his books. Although he is aware that he is selling the vessel for one purpose (and may even have asked his broker to include a term in a contract to prevent further trading), does that mean, where the contract is not on a "Demolishcon" or other terms clearly evidencing the intention to recycle, that he is obliged to notify his flag state ("the Administration") of his intention to recycle the ship?

If the shipowner is selling the vessel to a cash buyer for delivery in a neutral location, the term 'shipowner' (based on the MEPC's alternative definition) could equally apply to the cash buyer.

In the case of most sales to cash buyers for intended recycling, it is the practice for such cash buyers to take advantage of the special three month ship registration regimes offered by certain flag administrations, eg. Panama, St Vincent and the Grenadines and St Kitts & Nevis. In the context of the notification and reporting requirements of the Convention, which shipowner (the shipowner selling with the "intention to recycle a ship" or the shipowner "who has ownership of the ship for a limited period pending it sale or handing over to a ship recycling facility") is responsible for the notification obligations stated in the Convention?

Similarly, which flag administration is responsible for the obligations (approval of recycling plan etc.): that of the intending seller for demolition (Mr Youroukos for example) or that of the cash buyer?

A Division of Responsibilities?

If this Convention is introduced in the terms as currently drafted, there will be, predictably, scope for uncertainty and argument over which party is responsible for ensuring compliance with the Conventions' various requirements.

It is not healthy for the convention for this issue to remain unclear: the apparent disagreement between the legislators has seemingly lead to a degree of 'fudging'. To solve the problem, could not the IMO consider the duties of the Convention to be a joint and several responsibility of the operating shipowner and the cash buyer. Could it not also specifically allow such responsibilities to be allocated by agreement between the parties: thus a contract for the sale of a vessel which is being disposed of for intended recycling could provide for the original selling shipowner to take upon himself the relevant notification and certification requirements, as well as impose the relevant certification obligations on the sellers' flag state. The cash buyer, meanwhile, would be responsible for liaison with the recycling facility and the completion of the Recycling Plan. This could possibly be of interest to environmentally conscientious shipowning companies who could report to their stakeholders on having taken a direct and personal interest in ensuring the safe and environmentally responsible recycling of their vessel.

'Delivered basis' sales

This is an area where considerable uncertainty remains: as mentioned in the example of Mr Youroukos referred to above, there are frequent cases where a shipowner sells his vessel to the cash buyer on a 'delivered basis', i.e. with delivery at Alang or Chittagong, it being envisaged that, immediately following such delivery, the vessel will be on-sold to the ship recycling facility by the cash buyer.

In such circumstances, the cash buyer actually 'owns' the vessel for a mere 'scintilla' of time. He certainly does not officially register his interest in the vessel and therefore there is no "Administration" in place for the period of such company's temporary ownership of the vessel.

And yet, according to the Convention, even such a 'delivered basis' cash buyer can be seen to be falling within the definition of 'shipowner' (i.e. being the owner of the vessel for a 'limited period' pending its sale or handing over to a ship recycling facility).

This key issue was one which was raised by India in the MEPC and reported on in April 2008. The working group observed that issues relating to registration/deregistration of ships "could be complex" and that "it would not be possible to develop a simple provision in the draft Convention to address the full range of possible situations".

The group decided it was "not necessary to have any special provisions in the draft Convention to address cash buyers".

Given that "delivered basis" sales are in such common usage, the Convention is, in my view, failing in its duties by not grasping this particular nettle more firmly.

Conclusion

The events of recent months have shown the need for ship recycling as never before. In an article in the Financial Times on 27 October 2008, the industry was referred to as "a key safety valve for regulating the world supply of ships". According to a commentator recently, wholesale scrapping is considered not only as capable of forcing a stabilisation of freight rates, but also to have the potential of warding off another potential problem, namely the crewing shortage that is already affecting the shipping industry.⁴

The recent severe drop in freight rates and the consequent downturn in recycling prices undoubtedly inflicted substantial losses on the capital base of a number of active cash buyers. Recessions, whilst painful at the time, have a certain Darwinian effect. In the ship recycling industry, no differently from any other, the fittest will survive. Those cash buyers still able to continue and enjoy the support of their banks will emerge in a stronger financial condition, buoyed by the sheer number of ships requiring recycling and the reduced volatility in prices.

Let us also not forget the positive effects that the Convention will have in this process of natural selection. The increased costs of compliance will make recycling facilities less of a "cottage industry" run by sole traders and family partnerships: because it will be only by means of substantial injections of capital that recycling facilities be able to afford to implement the measures required.

The same goes for the cash buyers. They also will be unable to ignore the requirements of the Convention, leading as these will to the need for greater investment in financial and human capital to ensure due compliance. We already see allegiances between cash buyers and recycling facilities. Who is to say that such allegiances might not be consolidated more formally?

In short, I see the effects of the Convention and the greater environmental awareness this represents as leading potentially to a new business model and, therefrom, a stronger and even more reliable counterparty to meet the shipping world's recycling needs.

Footnotes

^{1. "A key safety valve for regulating the worlds' supply of ships", Financial Times, 27 October 2008}

^{2. Issue of 5 December 2008}

^{3. "Liability and Compensation in the International Transport of Hazardous Wastes by Sea", article by Michael Tsimplis, Institute of Maritime Law, Southampton in article in the International Journal of Marine and Coastal Law, 2001.}

^{4. Editorial comment, Fairplay Solutions, January 2009}

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