Lenders’ power to arrest – limited duties against owners upheld

A mortgagee bank has obtained summary judgment in respect of its claims under a loan agreement, where the loan was secured by mortgages over vessels owned by the borrowers. 

The Court dismissed numerous arguments by the borrowers and their guarantors that sought to extend the scope of the bank’s equitable duties to the borrowers. In circumstances where the bank only arrested the vessels but did not take possession of them, nor exercise a power of sale, its duty was only to effect the arrest in good faith for the purpose of obtaining repayment under the loan guaranteed without imposing or extending borrowers’ fiduciary duties to lenders.

The background facts

The first to third defendants were one-ship companies (SPVs) that took out a loan with the claimant bank. The loan agreement provided for a facility of just over US$12 million, for which the borrowers were jointly and severally liable. 

The fourth to sixth defendants were shareholders in the borrower’s SPVs and had granted as security under the loan (among others) mortgages over the vessels owned by them. The shareholders had also granted several personal guarantees.

In breach of the loan agreement, the borrowers failed to make two payments. They further failed to cover the insurance premiums under the various insurance policies that they  had covenanted to maintain and thus, said policies were terminated for non-payment of premiums. These were events of default under the loan agreement that entitled the claimant to accelerate the repayment of the sums lent. On 18 October 2019, the claimant demanded repayment of the sums then outstanding of about US$4.7 million, plus interest and expenses. The claimant also made a demand on the guarantors under the guarantees. However, despite demands for repayment, the outstanding sums were not paid by the borrowers or the guarantors, except for a minor payment from a corporate guarantor. Due to the breaches constituting an event of default under the loan agreement, the bank decided to accelerate the loan and enforce its security.

From June 2019, two of the mortgaged vessels were arrested in Djibouti by various third-party creditors. One of the vessels was the subject of ten different arrests from various trade creditors, and the other was subject to eight different trade creditor arrests. The vessels were abandoned by their owners on or about 15 September 2019. Subsequently, they were arrested by or on behalf of the Djibouti Port Authority. At the time that the claimant arrested the vessels, in February 2020, the vessels were subject to multiple prior arrests.

The Djibouti Port Authority obtained an order for the forced sale of the vessels, which the claimant challenged because it was concerned for its security. This order was set aside for lack of jurisdiction and instead, the Djibouti Court of Appeal ordered a sale by a court-supervised process. Notwithstanding this order, the Djibouti Port Authority arranged for a private sale of the vessels to an intermediary in Dubai for US$3.2 million. The vessels were then apparently sold for scrap in Pakistan. 

The claimant maintained that it had no prior knowledge of the private sale, that it found out too late to do anything about it and that it had received nothing from the proceeds of sale. It sought summary judgment against the borrowers and their guarantors. During the proceedings, the defendants argued that the claimant had an equitable duty to act reasonably in the realization of the mortgaged property and to obtain a true market price for the vessels. 

The Commercial Court decision

The Court awarded the claimant summary judgment on its claims. On the clear evidence, the only step that the claimant took in respect of the vessels was to arrest them when they were already under arrest for claims brought by several other trade creditors. The claimant had no involvement in the private sale of the vessels or their subsequent sale for scrap. As the Court  stated while dismissing defendants’ arguments, the claimant’s only action was to arrest the vessels, which did not impose any additional equitable duties on claimant beyond acting in good faith to enforce the loan agreement.

In particular, the Court made it clear that where all that a marine mortgagee does is to exercise a power to arrest the mortgaged vessel, its sole duty in effecting the arrest is to do so in good faith for the purpose of obtaining repayment under the loan agreement secured by the mortgage. In this case, the claimant fulfilled that duty by: (i) applying to the Djibouti Court to set aside the order for forced sale and replace it with an order for a court-supervised sale, which was the more conventional form of sale following an arrest; and (ii) attempts it made to stop the vessels being broken up once it found out that they had been sold for scrap.

It was only if a mortgagee either took possession of the mortgaged property or exercised a power of sale in respect of it that it assumed a duty to take reasonable care of the property. A mortgagee had, however, no duty to take possession or sell. Here, on the evidence, the claimant did not take any form of possession of the vessels. Arresting a vessel did not amount to taking possession of it. Arrest was the first step taken by a ship mortgagee who wished to enforce its security by having the vessel sold by an Admiralty Court in whichever jurisdiction arrest was affected.  It did not involve either taking actual or deemed possession of the vessel concerned.

Further, it was only when a mortgagee decided to exercise a power of sale that a mortgagee came under any equitable duties concerning how that sale was to be conducted, and the duty was confined to a duty to obtain the true market price at the date of the sale. Again, the sale in this case was not by or on behalf of the claimant.

The Court also dismissed the submission that the claimant arguably had a duty to force a sale where offers had been received. A mortgagee had an unfettered discretion whether to sell or not and, if it decided to sell, when to sell. The fact that the claimant received offers for the vessels and that they were not accepted was not to the point. There was also no legal basis for saying that the claimant had a duty to prevent the Djibouti Port Authority from selling the vessels privately or any explanation of how it might have stopped the sale, when it did not even know of it nor was involved in such sale. The claimant also had no duty to collect, or attempt to collect, the proceeds of sale from the Djibouti Port Authority.

Finally, the Court dismissed the suggestion that the claimant was under a duty to discharge the liability of all the creditors who had purported to arrest the vessels that were outstanding, and then take possession of the vessels before moving them to another jurisdiction where sale at a higher price might be obtained. This was unarguable because: (a) that was not what an arrest entitled a mortgagee to do; (b) taking those steps would be at least potentially adverse to the commercial best interests of the claimant; and (c) there was no duty to take such steps, even if the equitable duty arising on the sale of the vessel (which was the highest level of equitable duty that could be imposed on a mortgagee) applied, which it did not.

Comment

The decision is a useful reminder of a marine mortgagee’s rights and equitable duties when dealing with a defaulting owner. It seems that lenders should first attempt to exercise their power to arrest before trying to enforce their right to sell or take possession of the mortgaged vessels, as they could thereby still protect their interests without having to face any claims from borrowers for breach of extended fiduciary duties. 

Owners, on the other hand, when facing difficulties in meeting their financial or other obligations should endeavour to engage with their lenders in an effort to find an amicable solution and save their assets – and, in some instances, their reputation in the shipping market.