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26 June 2013
Where a seller grants a buyer the right to defer payment of part of the purchase price, the seller is in effect giving the buyer a credit for the part of the purchase price which is deferred. Seller's credit is commonly used in the sale of goods in shipping and offshore construction contracts.
Shipyards typically offer seller's credit to assist buyers in obtaining mainstream secured financing. In a sale leaseback transaction, the seller (who charters the vessel back from the buyer) may grant the buyer a seller's credit. Such credit has the dual purpose of assisting the buyer in the purchase of the vessel and providing security for the seller's fulfilment of its obligations under the charter. Seller's credit can also be used by secondhand sellers to assist buyers that have difficulties in obtaining sufficient bank financing. More recently, seller's credit has been offered by subcontractors or equipment suppliers to yards or buyers in order to facilitate financing requirements.
Although versatile and functional, the use of seller's credit may give rise to legal challenges which are best addressed at an early stage.
The best means by which a yard or seller of a secondhand vessel can secure seller's credit is by a mortgage registered over the vessel. However, in most cases, banks which are financing a substantial part of the purchase price will have the benefit of a security package that includes a first-priority mortgage. Hence, the only security that a yard or seller may obtain is a second-priority mortgage, ranking after the bank's mortgage. Even with the priorities agreed between the bank and the seller, the actual terms of subordination of the seller's mortgage to the bank's mortgage may result in extensive discussions (see below).
An alternative option is to provide the yard or seller with an equity conversion right. Under this option, the credit granted by the yard or seller can be converted into equity in the shipowning company. To be effective, adequate corporate decisions must be put in place by the shipowning company, usually through a shareholders' resolution. From a seller's perspective this alternative can be far more challenging. There are risks associated with being a shareholder, and the seller may have limited decision-making power and control over the shipowning company's performance.
For equipment suppliers, the registration of a charge over the equipment as a means of securing the seller's credit is often not a viable option. This is because, in most cases, the equipment installed on board the vessel will form an integral part of the vessel and will thus be treated as being part of the vessel mortgage. As an alternative, seller's credit granted by an equipment supplier may be secured by a parent company or other form of guarantee.
Once it has been agreed that the seller's credit provided by the yard or seller of a secondhand vessel is to be secured by a registered mortgage, discussions with the bank begin to determine the question of priorities and the terms of subordination.
It is common for the seller's credit to be agreed as part of the shipbuilding contract or the memorandum of agreement, whereas the bank financing is typically negotiated subsequently. If mortgage priority has not been addressed in the shipbuilding contract or memorandum of agreement, this is bound to become an issue once the bank financing terms are negotiated. It is therefore important that this point is addressed at the time when the terms of the seller's credit are being negotiated between the yard or seller and the buyer.
Even with the priorities agreed, a common scenario is that when the delivery date is upcoming, the buyer approaches the yard or seller with strict subordination terms, imposed late in the day by the bank. Moreover, the bank may demand not only that the seller's credit mortgage be subordinated in priority, but also that repayment of the seller's credit be subordinated to the repayment of the bank's long-term facility. As the bank financing will usually have a longer repayment period than the seller's credit, it is unlikely that a yard or seller will find this acceptable. An acceptable solution is often reached by allowing partial repayment of the seller's credit during the term of the long-term facility.
To avoid such problems, the best solution for all parties (including the bank) is to agree in advance all the seller's credit terms, including the subordination to the bank's mortgage and facility repayment. Alternatively, the buyer should seek to agree a seller's credit agreement that is as bankable as possible and then present it to the bank from the outset as an agreed package.
In cases where the seller's credit is used to secure the buyer's future obligations, it is not uncommon that where there is an event of default leading to termination, the seller's credit is to be "forfeited". This is typically found in most sale leaseback transactions where a seller's credit is used, and it is intended that the seller's credit stand as security for the seller's obligations under the charter.
Where the sale leaseback transaction is governed by English law, it is important to avoid any suggestion that the forfeiture of the seller's credit operates as some kind of penalty. Under English law, a contractual provision that inflicts a penalty on one party for committing a breach of contract is invalid and unenforceable. To avoid this risk, any forfeiture of the seller's credit should be described in terms of being a commercial agreement between the parties, reflecting a fair and genuine estimate of the buyer's losses in the event of breach.
Under Norwegian law, the problem is less acute because any invalidation of contractual provisions must be assessed by reference to Section 36 of the Norwegian Contracts Act (on unfair contract terms). Between professional parties, there is a high threshold for invalidating an agreed contract term on the grounds that it is "unfair".
Another challenge that can arise is in areas where the seller's credit secures the fulfilment of the seller's future obligations, and the buyer wishes to terminate in circumstances where the unpaid amounts are less than the amount of the seller's credit. The question is whether the buyer will be prevented from terminating the contract for a payment default.
In general terms, under both English and Norwegian law, the existence of security does not prevent a party from exercising its right to terminate. Unless there are clear terms to the contrary, a party's legal rights are not prejudiced or diminished by the fact that security has been provided for a potential claim.
Thus, the seller may terminate the charter even if the accumulated outstanding charter hire does not exceed the seller's credit. However, to avoid any discussion on this point, clear language should be used in the seller's credit agreement to enable the buyer to terminate during periods when the amount of the seller's credit is available to meet the claim in full.
In times of tight financing and increased competitiveness, seller's credit plays an important role in the financing of shipbuilding contracts. It is also frequently seen in sale leaseback transactions where it is important that the seller retains an interest in the venture going forward and that the buyer has some security for the seller's performance of the charter. However, to be effective in terms of both ensuring repayment to the seller and as a means of providing security for the buyer, a seller's credit agreement must be carefully drafted.
For further information on this topic please contact Hendrik Hagberg or Ena Barder at Wikborg Rein's Oslo office by telephone (+47 22 82 75 00), fax (+47 22 82 75 01) or email (firstname.lastname@example.org or email@example.com). Alternatively, please contact Øyvind Axe at Wikborg Rein's Bergen office by telephone (+47 55 21 52 00), fax (+47 55 21 52 01) or email (firstname.lastname@example.org).
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