Shipowners’ skilful use of contract terms to guard funds

Under a shipbuilding contract, the focus of the parties involved has always been on the way the funds are raised and also on ensuring the safety of the paid-in funds. Statistics from the China Association of the National Shipbuilding Industry show that, “between January and May 2018, shipbuilding enterprises had revenues from their main business totalling RMB78.8 billion (US$12.4billion), a decrease of 4.8% compared with the same period the year before, and large-scale shipbuilding enterprises realized total profits of RMB0.93 billion, a drop of 67.8% … At present, the main domestic financial institutions generally adopt a cautious attitude on providing credit support to the shipping industry.” It can be seen that shipbuilding enterprises face financing difficulties, and rely on shipowner financing for funds to build ships as one way of resolving the problem.

When paying for the building of a ship, the ordering entity and its financing party need to ensure safety of such funds if the builder goes bankrupt, whether the shipowner has the right to request conversion of its expectant right into ownership of the ship or materials corresponding to the monies already paid, and whether it can assert a right to recover the ship or the materials. Also, it involves whether it has the right to request continued building of the ship or claim priority of repayment from the auction proceeds of the ship under construction. There is also the question of whether the shipowner is limited to being a general creditor participating in the distribution of the shipbuilder’s bankruptcy property.

Pursuant to Article 2(1) of the Judicial Interpretations (II) of the Enterprise Bankruptcy Law, if a shipbuilding contract is recognized as being a processing contract, the ship under construction does not constitute part of the debtor’s property and the party that ordered the ship has a right of recovery. However, it has long been debated in the Chinese shipping industry whether a shipbuilding deal is a sale-and-purchase contract or a processing contract. If the shipbuilding contract specifies that ownership of the ship during the building period is vested in the shipbuilder or the shipbuilding contract does not specify the ownership, the shipowner is bound to face difficulties in recovering the ship under construction by way of asserting ownership of the ship if the shipbuilder goes bankrupt and the shipbuilding contract is terminated. In such a situation, the shipowner’s only option is to participate in the distribution as a general creditor.

Anna Lan is a partner at Co-effort Law Firm