First International

Let’s throw a massive bankruptcy party


Reasons why filing for Chapter 11 may be a shipping company’s best route to survival.

With freight markets likely to remain soft for some considerable time, and with investors selling off shipping stocks across the board, there are many companies that need seriously to consider major restructuring to stay alive.

The larger companies with expensive new fleets will come under increasing pressure to bring their balance sheet values into line with the Standard & Poor’s markets.

They also need to think about reducing their debt in line with the revised ship values and issuing more equity to achieve this.

The banks are far less inclined now to grant default waivers than during the last two years, as they need to get rid of all their non-performing loans by the year- end or face allocating capital to cover them.

They also see little hope of the situations improving in the next year or two and are therefore more prepared to cut their losses and liquidate the assets.

This will cause secondhand prices to fall further because buyers will be able to raise less debt than before and will only pay prices that can be supported by freight rates.

Liquidation is really the only route offered by the UK or European bankruptcy system in which receivership is the norm and businesses are closed down and the assets sold.

In the US, we have Chapter 11, which is a voluntary bankruptcy filing used to protect debtors from specific actions by individual creditors while the company seeks to reconstruct its affairs.

The bankruptcy court collects all the information from creditors and requires the debtor to present a reorganisation plan and then seeks to get approval of it from a majority of creditors, thereby enabling the company to continue operating and hopefully recover — or at least dispose of its assets in an orderly and timely fashion.

We have recently seen two non-US tanker shipping companies, Omega Navigation and Marco Polo/Seatrade, seek protection from their creditors by filing for Chapter 11 bankruptcy in the US. This is in direct response to the fact that, in both cases, certain European banks have taken actions to foreclose on their loans following months of negotiations.

Three years ago, after the 2008 market collapse, I suggested private and public shipowners should explore the US bankruptcy system to achieve financial restructuring, but this was soundly rejected then. However, the choice of filing in the US does raise a large number of issues which need to be addressed.

Bank financing for shipping companies has followed a traditional structural pattern for the last 30 years, which was founded in the UK and adapted to meet the particular requirements of lending banks based outside the UK.

With shipping shares having been decimated in the past few weeks, this is the right time to restructure.
Shipping, being an international business, has tended to base its corporate entities in offshore jurisdictions, along with registering the ships in “open registries” such as Liberia, Panama etc.

The traditional ship mortgage loan was made to the ship’s individual owning company (to avoid cross default between ships) and the mortgage registered in the particular open registry of the ship.

The loan documentation is usually in English and, in most cases, English law is the chosen system that applies to the loan and the mortgage, with UK arbitration also chosen in most cases.

Thus when a borrower defaults, the bank can apply for a judgment to the UK Admiralty Court and obtain the right to arrest the particular ship and sell it. Specific preferred claims and liens would be settled from the proceeds and the balance applied to the outstanding loan.

Prior to the arrival of shipping companies on to the public stock markets, bank lending to consolidated packages of ships was still essentially based on the traditional ship mortgage finance structures and most of the new public companies continue this practice today.

Established companies such OSG and TK have avoided specific ship loans and instead gone for large corporate loans secured with a general charge over the company’s assets, which has avoided the problems of loan to value covenants.

In the US, the debtor files a petition with the court and provides a list all of its assets and liabilities with the petition. The Chapter 11 filing creates an automatic stay against all creditors, secured and unsecured, from enforcing their rights in any other court.

Creditors can challenge the rights of the debtor to use the US system, but until the court rules, creditors that pursue specific assets proceed at their peril.

This appears to fly directly in the face of a bank’s rights under its loans and mortgages as recognised by the UK Admiralty Court.

When shipping companies default on their loans, banks invariably resort to foreclosure, arrest and sale of the ships, as the operating companies rarely have any value other than the ships.

The recent cases coming before the US bankruptcy courts are interesting, as the debtors are hoping to stop the banks arresting and selling the ships, even though they have the legal right to do so under UK law.

The Chapter 11 process is designed to allow companies that are already in financial difficulty — or foresee they will be so in the near future — to reorganise their operations and restructure their finances in an orderly fashion and obtain the court’s approval of their new plans while preventing creditors taking unilateral action over specific assets.

Companies that succeed in this process are able to emerge from bankruptcy under the new court-approved plan and permanently erase all prior claims of creditors, but usually with a new management team and with the original equity substantially reduced in value.

Applications to the court to allow such cash as there is in the company, revenues from operations and any funds it may be able to borrow as “debtor in possession (DIP) financing”, to be used to fund operations, will be granted where the debtor can show it can operate the company successfully as a going concern.

This is not as easy as it sounds, particularly when the companies are losing money daily in the spot markets, owe money to crews and suppliers and are not paying interest or principal on their loans.

The banks will likely resist any attempts to do this unless a viable plan is produced, as it could create further debts that would rank ahead of the mortgages.

Given the history of these current cases and the problems the banks have had with the debtors for the last couple of years, it is unlikely any reorganisation plan will be easily approved — and the company would then have to consider liquidation under Chapter 7.

While these current cases appear to have serious jurisdictional issues, and secured debts that exceed the liquidation values of the ships, they should be closely monitored by other shipping companies to see how the process works.

The US system may not suit everyone, but it does have its merits where reorganisation can be shown to be effective in keeping the company operating and in so doing improve the values of the ships as they continue to trade and are then sold other than under arrest or on the steps of the court.

In most cases, however, the original equity value is greatly reduced by the injection of new funds or the banks converting some of their debt to equity, and usually new management is installed to run the company.

With shipping shares having been decimated in the past few weeks, this is the right time to restructure, as it gives new equity a greater upside outlook, at the price of watering down existing investors.

Waiting until the cash runs out is a bad idea, but taking action now requires courage and conviction, as well as an admission that things will only get worse if nothing is done.

Paul Slater - chairman of First International

Source: Lloyds List, 17 August


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