The mystery of finance lease contract

1 Acquisition of ships

There are roughly two ways for the lessor to acquire a ship according to the characteristics of the ship. The first is to place an order to the shipyard to build the ship according to the requirements of the shipowner, that is, the ship used as the lease is a new ship. The second is to purchase the ship in the second-hand ship sale market according to the requirements of the shipowner, that is, the ship as a lease is a second-hand ship.

The first approach should include the awarding of ship construction contracts to other shipowners. We can often see that ship finance leasing is negotiated after the shipowner has placed an order to build the ship at the shipyard. Since the ship is already under construction but not yet delivered, the shipowner does not need to conclude a separate ship construction contract with the shipyard, but through the contract between the transferee shipowner and the shipyard.

2. Lessor's relationship with shipyard and seller

In practice, although the identity of banks or financial institutions is the lessor, that is, the person who provides the ship to the shipowner, they usually do not participate in the activities related to the selection of ships, the negotiation and negotiation of transactions, the inspection of ships construction or the inspection of ships in the sale and purchase, because banks and others do not have professional knowledge and skills in these issues.

In fact, before the shipowner starts to contact with the shipyard or seller, the shipowner often has already had contact with the shipyard or seller, and some have even concluded a ship construction contract or a ship sale agreement.

In practice, although it is the lessor who enters into the contract with the shipyard or seller and pays the price, since it is the shipowner who ultimately uses the ship, the specific details of the construction or sale of the ship are often determined through negotiations between the shipyard or seller and the shipowner.

But this does not of course mean that the shipyard or the seller is the agent of the lessor, acting on behalf of the lessor in contact with the shipowner. The shipyard or the seller shall not represent the lessor unless authorized to do so. Whether there is an agency relationship between the lessor and the shipyard or the seller shall be determined according to specific facts.

Warranties between the shipowner and the shipowner, given by the shipyard or seller to the shipowner regarding the quality, performance, functionality, etc. of the vessel shall likewise not bind the shipowner.

Branwhitev Worcester Works FinanceLtd is a car hire purchase case in which the lessee owned a Talbot but wanted to exchange it for a Rapier. The car dealer sold a Rapier to the lessee for £430 and acquired the lessee's Talbot car for £130.

The balance is paid by the tenant at £5 per month. The lessee signed the financial company documents provided by the automaker without even looking at them, and there were no numbers in the documents. The dealer entered £649 as the price of the car in the documents signed by the tenant. The total price of the hire purchase, plus other expenses, was £805, with a down payment of £130 and a monthly payment of £18.14.

The finance company bought the Rapier for £649 and paid £519 to the dealer after deducting £130. The finance company signed the hire purchase agreement and sent a copy to the tenant, who ignored it and did not pay.

The finance company repossessed the car and demanded that the lessee pay all the rent. The court rejected the financial company's request on the grounds that there was no valid contract between the financial company and the lessee. The lessee's request for the refund of the deposit was rejected by the court of first instance, and his appeal was also rejected by the Court of Appeal. The case went to the House of Lords, which ruled that the financial firm should return £130.

Lord Morris did not base his ruling on the existence of an agency relationship between the carmakers and the financial firms, but he appeared to treat the money received by the carmakers as if it were money received by the financial firms. LordMorris's view was supported by the majority, but Lord Reid and Lord Wilberforce disagreed. Lord Wilberforce agreed that the finance company should return £130, but said there was an agency relationship between the car company and the finance company.

The above cases involve general equipment financial leasing, and although the general equipment financial leasing and ship financial leasing apply the same law, there should be a more obvious difference between the two. In general equipment financial leasing, the lessee may purchase the equipment through the lessor, or the equipment supplier may also provide financial leasing services while providing the equipment.

In the MercantileCredit case, the sale and purchase transaction was established long before the financial lease. Although there is not necessarily an agency relationship between the lessor and the equipment supplier, there may be an agency relationship between the two.

However, in the ship finance leasing arrangement, whether the shipowner negotiates the finance leasing with the lessor after seeing a suitable ship and making initial contact with the other party, or begins to look for the ship after negotiating the financial leasing relationship with the lessor, the ship, including its quality, performance, price and many other details are the contents of the negotiation between the shipowner and the other party, and the lessor usually does not participate in it.

Therefore, in ship finance leasing arrangements, it should not be very likely that either the shipyard selling the new vessel or the seller selling the second-hand vessel will be regarded as the lessor's agent. In addition, if the way of ship finance leasing is to buy the ship from the owner and then lease it to the owner, the so-called problem will no longer exist, because the seller is actually the owner.

3 Relationship between shipowners, shipyards and sellers

Under normal circumstances, the shipowner only has a contractual relationship with the lessor, and has no contractual relationship with the shipyard or the seller. According to the relative principle of contract, shipowners cannot directly claim rights against shipyards or sellers based on contracts.

In other words, the shipowner can neither make claims or claims against the shipowner regarding the quality, performance and functionality of the ship, nor can he make similar claims or claims against the shipyard or the seller, which is obviously quite unfavorable to the shipowner.

The practical solution is: in the case of a new ship, the shipowner can ask the shipyard to provide the warranty directly to himself or allow the lessor to transfer the warranty to the shipowner, so that he can directly claim the warranty from the shipyard. If the leased vessel is a second-hand vessel, the shipowner may require the seller to assure him that the quality, performance and functionality of the vessel are not in question.

In view of the problems in the process of ship construction, the shipowner can participate in the whole process of ship construction as the supervisor, and can put forward claims and claims according to the ship construction contract between the shipyard and the lessor.

The shipowner may also persuade the shipowner to agree to enter into a construction or purchase contract directly with the shipyard or the seller. Since the ownership of the ship will not change, the shipowner should agree to this request. Where English law applies, shipowners should also have the opportunity to assert their rights directly against the shipyard or seller under the Contracts (Rights of Third Parties) Act 1999.

The law applies naturally unless the parties to the contract agree to an exclusion, so all the shipowner needs to do is ask the lessor not to exclude the application of the Contracts (Rights of Third Parties) Act in the contract with the shipyard or the seller.

In practice, the shipowner's claim against the shipyard or the seller is often transferred to the shipowner's side along with the ship, in other words, the shipowner can file a claim against the shipyard or the seller in his own name. In this regard, the 1988 UNIDROIT Convention on International Financial Leasing clearly provides the right of shipowners to claim compensation directly against shipyards or sellers.

4 Delivery of the vessel

Ship delivery here refers to the shipowner delivering the ship to the shipowner. If the ship finance lease involves a new ship, the shipyard usually delivers the ship to the shipowner according to the ship construction contract, which is also the time when the shipowner delivers the ship to the shipowner according to the finance lease contract.

Even if the finance lease is a used ship, the time when the seller delivers the ship to the lessor in accordance with the sale and purchase agreement is usually the time when the lessor delivers the ship to the charterer in accordance with the ship finance lease contract. If the ship finance lease adopts the sale-and-leaseback method, although the ship owner becomes the charterer from the owner, the actual delivery of the ship does not actually occur.

Because the shipowner sells the ship in order to obtain money, the shipowner does not give up possession of the ship. Therefore, the so-called delivery of the ship is actually virtual, and the delivery of the ship under the sale and purchase agreement is carried out at the same time as the delivery of the ship under the financial lease contract.

All the parties need to do is to determine a time point as the delivery time of the ship, the quantity and condition of the fuel oil, lubricating oil and equipment on board, the class of the ship, the class of the ship and the insurance are determined in accordance with the agreed time point, and the corresponding rights and obligations of the parties are also determined in accordance with this time point. Although the shipowner always owns the ship, his status changes from owner to charterer.

5 Lease Term

Although for the lessor, the shorter the lease term, the better, the shorter the lease term means that the lessor is exposed to the risk of the shorter period. On the contrary, the longer the lease term, the greater the risk to the lessor.

However, the reality that the shipowner must face is that the total rent that the shipowner should pay during the financial lease period is the sum of the ship acquisition cost and the profit of the shipowner. For short leases to be possible, the market must be on the shipowners' side. Ensure that the shipowner can earn all the acquisition costs of the vessel and the profits of the shipowner through operation in just a few years.

In fact, the lease period is relatively long is one of the basic characteristics of ship finance leasing, ship leasing period is generally more than 10 years, 15 years or even longer. The long lease period is not an accident, but should be a necessity.

As one of the ship financing methods, ship financial leasing is different from other financing methods such as bank loans. In most ship loan arrangements, the shipowner as the borrower must provide repayment guarantees, including the mortgage set on the ship and the guarantee provided by the third party.

However, in ship finance leasing arrangements, ship mortgage is no longer meaningful because the lessor is the registered owner of the ship. Although the essence of financial leasing is financing, the form of financing is leasing.

In the ordinary case of time chartering, the shipowner's remedy against the charterer's failure to pay the agreed rent should be to withdraw the ship, that is, to refuse to allow the shipowner to continue to use the ship. As long as the shipowner withdraws the ship in time, the outstanding debt is usually not very large.

This relief is a more practical relief for shipowners. However, for the shipowner in ship finance leasing, this relief may no longer be very effective, because the ship is not the shipowner wants to keep, and owning the ship is not the shipowner's purpose, but the means.

In the absence of performance guarantee, whether the lessor is willing to provide leasing financing to the shipowner depends on the shipowner's ability to pay rent and its reliability. If the shipowner is a company with good credit standing and low credit risk, the lessor will not have too much concern in providing financing.

However, this does not mean that the credit status of shipowners is the only basis for ship finance leasing transactions. As long as the shipowner can find a reliable charterer for the ship, the lessor can also provide financing in the form of financial leasing. In this case, although the lessee found by the shipowner has no credit risk, if the lease term is much shorter than that of the financial lease, the interests of the lessor are still not well protected.

Therefore, the lessor should not only see that the shipowner has entered into a reliable lease with a third party, but also ensure that the term of the lease is equal to or longer than the term of the ship finance lease. As long as the shipowner transfers the lease between himself and the third party to the lessor, the lessor actually does not need to care about the credit status of the shipowner, even if the shipowner is bankrupt, the lessor can still require the third party to perform the lease. This is why ship finance leases are usually long.

From a shipowner's point of view, there also seems to be no reason not to accept a ship finance lease arrangement with a longer charter period. Because the longer the lease limit means that the shipowner should pay the amount of rent for each period is lower, so the pressure on the shipowner is less.

Sometimes the owner may wish to become the true owner of the ship before the expiry of the agreed charter period, for example, due to changes in the market, the sale of the ship can achieve a greater profit, or the owner needs to set a mortgage on the owner to service other financing.

What the shipowner needs to do is to add in the financial lease contract the option to obtain the ship by paying all the rent in advance. Such option should not be opposed by the lessor as long as the conditions for exercising it are clearly specified.

6 Rent

The rent that the shipowner should pay in accordance with the financial leasing contract is calculated according to the lessor's total investment and investment rate of return, and then divided into each phase according to the length of the lease term. The specific factors affecting the rental level include: ship purchase price, lessor financing cost, tax incentives, lease term, risk compensation and profit of lessor.

Ship price refers to the price paid by the lessor to order or purchase the ship, which is the main component of the rental. It is difficult to imagine that the lessor can purchase the ship without financing, so the financing cost of the lessor will also be reflected in the rent. Financing cost usually includes interest and fees, etc. The level of financing cost first depends on the overall supply and demand state of the capital market at the time of financing, but the financing ability of lessors will also have an impact on the level of financing cost.

As a financing method, financial leasing is often based on tax incentives, and lessors will transfer the tax deductions and other advantages they can enjoy to shipowners, so as to make the financial leasing conditions they provide more attractive to shipowners. The greater the tax incentives that the lessor transfers to the shipowner, the lower the rents tend to be.

Since the rent paid by the shipowner throughout the lease term usually covers all costs and reasonable profits of the lessor, the shorter the lease term, the amount of rent per period tends to be higher. On the contrary, the longer the lease period, the shipowner should pay the rent will tend to be lower.

The lessor's own financing is not back-to-back with the financial lease provided to the shipowner, and the risk borne by the lessor in its own financing arrangement cannot be directly transferred to the shipowner in the financial lease arrangement.

For example, the lessor's own financing usually adopts floating interest rate, while the rent in ship finance leasing is fixed. In other words, the lessor bears the risk of losses that may be caused by adverse changes in interest rate. Another example is that the shipowner is the owner of the ship throughout the whole charter period, so he bears the risk that the loss of the ship may bring losses to the shipowner.

Lessors usually respond to these risks, which is usually a certain amount of price compensation eventually reflected in the rent. The purpose of the lessor engaged in ship finance leasing is to pursue profit, so the profit level pursued by the lessor will directly affect the specific amount of rent in each period.

In most ship finance leasing arrangements, the owner usually pays the rent on a monthly basis and, like the time charter of the ship, the rent is usually paid in advance, i.e. before the owner begins to use the ship. While the monthly rental amount calculated in terms of the lessor's costs and profits is often not a whole number, the monthly rent paid by the shipowner is almost always a whole number.

The difference is usually adjusted through the final installment of the lease, so the amount of the final installment of the lease is generally larger than the previous amount, and is paid by the shipowner at the end of the lease term, somewhat similar to the end of the balloon payment in a ship loan. However, in practice, there are also ship finance leasing arrangements that stipulate that the shipowner should pay several periods of rent or an agreed amount before the lease begins.