Third-party ship managers are often required to issue letters of undertaking to financiers of a managed vessel on relatively unfavourable and financier-friendly terms. The Baltic and International Maritime Council's (BIMCO's) new standard ship manager's letter of undertaking, which was published on 28 January 2019, seeks to redress the balance and gives ship managers a more equitable set of terms, which may be used as a starting point for negotiations.
When financing a vessel, shipowners are often required to procure that any third-party manager of the vessel issues a letter of undertaking in favour of the owner's financiers in order to put the financiers in the same position as they would have been under the financing documents had the vessel been managed and operated by the owner. These "letters of undertaking typically include all-encompassing subordination clauses", which, in a distress scenario, means that the manager receives payment for services and reimbursement of expenses only once the shipowner's debt has been paid in full. In addition, these letters of undertaking usually contain a requirement for the manager to assign its rights under the vessel insurances to the financiers. For a third-party manager with no economic interest in the vessel, these terms may be hard to swallow.
The management costs of a vessel may quickly add up to substantial amounts of money (particularly in distress scenarios) and, while financiers are well advised to seek limitations on a manager's ability to make claims against the shipowner, the vessel and its other assets in competition with the financiers, for third-party managers it will be unsatisfactory to provide services and be potentially out of pocket for disbursements if there is any risk that such amounts may not be paid by a client in economic distress.
The new BIMCO letter of undertaking seeks to address this issue by specifying a level of permitted credit that the manager can extend to the shipowner in connection with management of a vessel, including:
- management fees;
- general management expenses;
- victualling; or
- other costs, expenses and disbursements.
Credit that has been extended below the specified level is unsubordinated and may be pursued by the manager against the owner, including in situations where a default also exists under the shipowner's financing arrangements. However, credit that has been extended above the specified level will be fully subordinated to the shipowner's debt to its financiers. The starting point for the permitted credit level set in the BIMCO letter of undertaking is $750,000, but the exact threshold for the permitted credit is up for negotiation and should be adjusted to suit the management agreement in question.
Under the new BIMCO letter of undertaking, the manager also agrees to make no material amendments to the management agreement without the relevant financiers' consent; however, the manager can terminate the management agreement as provided therein. Contrary to what is often seen in the financier's standards, the BIMCO letter of undertaking contains no right for the financier to step into the management contract where the shipowner has defaulted under the same. Instead, the manager must provide the financiers with 15 days' notice prior to termination; this gives the financier a window within which to find a resolution with the ship manager and potentially get them to continue providing management services. However, this quid pro quo situation means that the financiers may require the manager to terminate the management agreement on a default under the shipowner's debt.
Managers are often named as an assured under insurance policies for the vessels that they manage and, while financiers' standard letters of undertaking often include an assignment of the manager's rights under the relevant insurances, from a manager's point of view, such assignments should be avoided as they represent a charge over the manager's property, which may be prohibited under the manager's own financing arrangements. However, the BIMCO letter of undertaking contains no assignment of the manager's rights under the insurances. Instead, the BIMCO letter of undertaking includes a confirmation that the manager's interest in the owners' insurances will be limited to covering certain claims (eg, out-of-pocket expenses incurred on behalf of the owner and third-party claims or liabilities discharged on behalf of the owners (to the extent covered by the relevant insurances)), and specifies that such limitations may be endorsed in the loss payable clauses of the shipowner's insurances.
The BIMCO letter of undertaking also requires ship managers to provide the financiers, on request, with certain documentation relating to the management of the vessel and other customary requirements.
The extent to which the new BIMCO letter of undertaking will be accepted by ship financiers remains to be seen, but it will nevertheless provide a useful benchmark which can be relied on by managers when negotiating letters of undertaking and hopefully assist in avoiding protracted negotiations of such documents.
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