Investing in shipping companies

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Investing in
shipping companies
A guide
A guide
Norton Rose Group has a market leading transport practice with a particular
focus on shipping. This Guide draws on our extensive experience in
conducting and co-ordinating due diligence for corporate transactions in
the shipping sector, to provide a checklist of key issues for investigation
by investors active in, or considering an entry into, this sector.
If you would like to discuss any aspects of this Guide or would like further
information, please contact your usual Norton Rose Group contact or any
of the individuals listed on the contacts page at the end of this Guide.
Financing
Given current challenges in securing
debt financing for acquisitions of existing
businesses and, in particular, the marked
decline in the availability of bank lending to
the shipping sector over the last three years,
a key item to be considered early on in any
process is the source and character of any
necessary debt financing.
If existing financing is to remain in place,
it will be important to review the terms
of the financing, swap and other hedging
arrangements to identify any unusual
covenants which could trigger an increase
in the margin or impose impossible
operational constraints. Equally important
will be establishing that loan to value and
other financial covenants in the financing
arrangements have not been breached, as
well as reviewing any history of covenant
breach and the need for any waivers from
lenders in relation to such breaches or as a
consequence of the proposed transaction.
This process will also establish the outstanding
amount of the existing financing and so the
amount of any additional equity required to
be provided by the purchaser. It should also
establish the mark to market exposure under
existing hedging arrangements.
02 Investing in shipping companies Norton Rose Group
Investigating title to and condition
of the fleet
Understanding the composition of the fleet,
and whether it is owned by the target group
or subject to some other arrangement, will
drive the due diligence priorities. For example,
some or all of the target group’s fleet may be
chartered in under bareboat charter, where a
third party shipowner provides only the ship to
the target group but the target has commercial
control over the ship and responsibility for
all its operational costs. Many modern fleets
have a mix of owned and chartered tonnage
and a different due diligence approach is
required for each category.
For a fleet of owned ships, key points to
check will include:
• the age profile, ship type, size, flag and
registered owner – this information will
say much about a fleet and its value even
before inspection of the Classification
Society records for each ship;
• Classification Society records – these
bodies provide services to the owners of
ships as well as insurers and flag states
as regards construction, maintenance and
safety. An inspection of class records of a
ship will help determine the condition of
the ship and its maintenance history but is
not always conclusive;
• mortgages and other encumbrances
– to what extent does the target enjoy
unencumbered use of the ships? In
addition to registered mortgages put
in place pursuant to the financing
arrangements, trade creditors may have
unregistered maritime or other liens over
the ship which may only become apparent
from the seller’s responses to due
diligence enquiries;
• trading, arrest and port state control
detention history – do the ships have
a good compliance history as far as the
maintenance, condition and operation
of the ship is concerned? Has a ship been
arrested by trade creditors recently, which
might indicate that others may have claims
which are yet to become apparent?
• incident, accident and near-miss reports
– whilst this is likely to be an area of
primary focus for experts in technical
ship management, a review of these
records will be a crucial element in any
assessment of the competency of the
managers, the crew and the approach they
take to the safe and efficient operation of
the ships. The contents of such reports
might be early warning of a fleet that
has been deprived of operating and
maintenance funding, leading to a general
deterioration in the fleet;
• are there any commercial documents
granting purchase options over ships
owned by the target group in favour of
third parties? Such agreements are most
frequently seen in charterparties in which
the target group has committed the use of
ships to third parties. If such arrangements
exist, are the purchase terms significantly
above or below the current market
valuation of the ship?
For ships on bareboat charter to the target,
additional points to check will include:
• the terms of the charterparty agreement,
the remaining charter term, and the flag
of the ship (including any parallel flagging
arrangements), as these will determine
whether and for how long the target group
has the full use of the ship at its disposal,
and whether it is at a charter rate that is
economic. Reviewing the remaining charter
term will be critical because a seemingly
large available fleet may be considerably
reduced if a number of charters are due to
expire and there is no option to extend the
charter or purchase the ship;
• the identity and financial standing of the
owner of the ship and, if the owner gets
into financial trouble, whether there are
sufficient quiet enjoyment rights in the
terms of the charterparty to protect the
charterer’s position against interference
by mortgagees wishing to enforce their
security; and
• other key terms of the charter such as the
liability of the charterer for defects at the
end of the charter term, any rights to extend
the charter term beyond the redelivery date
(and, if notice can be given to extend, when
and how such notice can effectively be
given) and whether the charter contains a
purchase option.
An important point to establish, both
in terms of establishing the scope of
due diligence and determining risk
apportionment in the transaction, will be
the extent to which the seller of the target
group might be prepared to “stand behind”
or warrant the condition of the ships in the
fleet, both owned and bareboat chartered.
Although a buyer on a corporate transaction
(whether of shares or assets) would usually
seek to have the benefit of extensive
warranties regarding the underlying assets
of the target’s business, this is not standard
practice on ship sales. In normal ship sales,
the ship is thoroughly inspected before the
memorandum of agreement (MoA) is signed
and the ship must then be delivered to the
buyer in the condition it was in at the time of
the inspection, fair wear and tear excepted,
but the MoA will not contain warranties as to
the condition of the ship, its maintenance,
etc. The expectations of a corporate investor
and the seller of the fleet are therefore
likely to differ in relation to the contractual
protection to be offered by the seller.
Norton Rose Group Investing in shipping companies 03
Although a seller will look to the investor to
rely on its own inspections in relation to the
condition of the fleet, in a large corporate
acquisition, rigorous inspection of all the
ships in the group may be impracticable.
In such circumstances, the condition of the
fleet will be evaluated largely from inspection
of class records and other documents
provided in due diligence by the seller.
However (even if the seller is prepared to
warrant their accuracy) such documents
can only give a snapshot of the condition of
the ship. If only limited warranties or other
contractual comfort is to be given about the
physical condition of the ships, a buyer will
need to consider at an early stage what kind
of technical inspection or survey it should
commission, and whether such a review
would extend to every ship in the fleet or
whether the logistics and cost of such an
exercise may necessitate inspection on a
“sample” basis. Such an exercise is likely
to be expensive and time consuming, and
the time taken to conduct such inspections
will need to be taken into account in the
transaction timetable.
A buyer should ensure that the scope of
the review or survey by technical advisers
includes identifying major items of upcoming
capital expenditure, including dry dockings,
special surveys and any modifications to
the ships that may be required as a result
of impending regulatory changes. These
may include modifications to exhaust gas
systems in order to comply with emission
control regulations, the fitting of costly
ballast water treatment systems and changes
which may flow from evolving regulatory
requirements (such as the Maritime Labour
Convention 2006, which lays down standards
for crew accommodation which may require
expensive modifications to older ships).
It will also extend to reviewing documents
relating to the performance of the fleet to
identify any technical problems regarding
deficiencies in performance as a result of
breakdowns, off-hire periods, excessive
operating costs and systemic problems
which may affect “sister” ships in the fleet.
04 Investing in shipping companies Norton Rose Group
Ship employment
It will be important to understand the
employment profile of the fleet. In other
words, for what period and on what terms
has the target group been able to find
“fixtures” or “charters out” for its fleet and
are these on profitable terms? Key points to
check include:
• the identity of the charterer and whether
it is likely to be able to perform and has
performed, particularly by way of hire
payments, throughout the fixture;
• the commencement and expiry dates
of the relevant charter or contract of
affreightment;
• terms of charterparty contracts, including
change of control provisions, optional
periods, ability to sub-let, charterer
termination rights, and whether the
governing law and jurisdiction clauses
permit reasonably straightforward
enforcement of those rights, should this
prove necessary;
• the actual performance of ships under the
employment contracts and, in particular,
off-hire days, excessive demurrage claims
and any other disputes with charterers –
has any event occurred that might let the
charterer terminate the charter or threaten
to do so as leverage to renegotiate lower
charter hire rates?
• unusual or particularly onerous terms
in charters or terms required in certain
sectors/by certain customers – eg, trading
restrictions, oil majors’ approvals, bribery
and corruption procedures/compliance –
which may allow charterers a pretext to
escape long term charter commitments
if the performance of the ships has
declined or changes in market rates
compared with the rate in the charter
mean that that alternative fixtures are
available at better rates;
• details of all forward freight agreements
(FFAs) or other hire or bunker hedging
arrangements – and whether these are
advantageous or have become liabilities;
• the trading routes of the ships, and whether
this could cause any issues for sanctions
compliance, as discussed below;
• review of any pooling arrangements
(whereby ships of different owners and
fleets are grouped together to provide
economies of scale and maximise earnings
and employment), including pool
performance, pool keys (which determine
the allocation of pool income among the
participating ships), representation by the
company on the pool committee, ability of
the company to block new entries into the
pool, and the ability of participants to
leave the pool and on what terms.
Ship management
Some shipping companies will conduct
full technical and commercial management
of their owned and chartered ships for
their own account; others may engage
independent third party ship managers
for either or both commercial and technical
management of their fleet. Ship managers,
who may manage hundreds of ships, are
able to take advantage of economies of scale
that a smaller operator cannot achieve. For
instance, an owner may retain responsibility
for commercial management in house – that
is, the negotiation of charters and contracts
of affreightment, but delegate technical
management – namely the day to day operation
and maintenance of the ship – to a technical
manager. Some owners may only outsource
crewing management of the ships. Where
ship managers are employed, due diligence
on the terms of these arrangements would
typically include:
• a review of the management agreements
and the scope of the services being
provided. Who is the third party technical
manager – are they considered reputable
in the industry and known as having high
operating standards and access to good
crews? If the target group is delegating
only some parts of the ship management
services (such as crewing or technical
management) how are the other services
being provided in-house by the target
group, and how do these elements
interrelate with duties of the third party
ship manager? Do the arrangements in
place make commercial sense and do they
operate well in practice?
• a review of management fees to determine
whether there is value leakage from the
target group – could management be
undertaken more efficiently and cost
effectively?
• identifying all commissions payable to
management, related companies, third
party managers and third party brokers,
including commissions for the sale and
purchase of ships, commissions for
chartering ships, bunker commissions
and address commissions. Are these all
properly accounted for and legitimate
(particularly where the services are
provided by service providers related
to the target group)? Are they at normal
market rates?
• identifying any exposure of the target
group to crew social security payments
and severance pay, notice periods and
termination fees;
• assessing the quality of fleet management,
which may include an audit by technical
advisers of the target group’s operating
procedures, safety management system,
records of emergency response drills,
and other key performance indicators,
such as, for example results of the Tanker
Management and Self Assessment (TMSA,
a voluntary best-practice guide for enabling
tanker owners and operators to assess
their management systems).
Norton Rose Group Investing in shipping companies 05
Newbuildings
Where the fleet includes ships under
construction, the following key areas of
concern must be reviewed:
• the quality and track record of the
shipyard. Where is the shipyard located
and can contractual remedies be enforced
effectively against it?
• the key terms of the shipbuilding contract
(including the contract price and payment
terms), instalments of the price paid to
date, rights of the builder to subcontract,
quality of subcontractors, construction
progress reports, the specification
of, and the quality of suppliers of,
machinery and equipment specified in
the maker’s list and owner’s supplied
items (those items that the owner will
supply during construction, such as
specialist equipment). Is the shipbuilding
contract well drafted so that disputes and
disagreements over its terms are limited
and it protects the buyer of the ship
sufficiently? Is the ship being built to the
building schedule or have any permissible
delays occurred (such as force majeure
events which will cause delay without
compensation)? Finally is the shipbuilding
contract subject to a reliable choice of law
and dispute resolution mechanism (eg
an arbitration process with a recognised
arbitration body).
• in relation to the refund guarantee (ie
a guarantee of the shipyard’s refund
obligations under the shipbuilding
contract), the credit worthiness of any
bank or other refund guarantor and terms
of the refund guarantee, expiry date, and
any required registration with any national
authority (such as SAFE for Chinese
newbuildings);
• quality of the supervision team on site,
including technical advisers conducting an
audit of inspection records, quality of steel
work, welding, coatings and oufitting and
performance of the Classification Society.
06 Investing in shipping companies Norton Rose Group
• any delays in construction and delivery
which have led to a right for the buyer of
the ship to receive liquidated damages
– has any cap been reached on these
damages which would mean that no
further amounts are payable even if there
is further delay? What other remedies are
available if this is the case?
• technical or performance problems with
any ships delivered earlier in the series,
including poor quality coatings and antifouling, vibration, shaft alignment issues,
excessive fuel consumption, deficiencies
in the service speed, cargo capacity or
capacity of cranes; and
• the extent of the yard’s responsibility
for remedying defects after completion.
How long is the warranty period? Are
consequential losses able to be claimed
for loss of time/business?
Ethical and regulatory issues
Those active in, or considering entry into, the
shipping industry will no doubt appreciate
the challenging nature of the global operating
environment. The instances of risk are
obvious: interaction with public officials
(such as customs and port authorities), a
reliance on third party agents to source and
maintain business and trades which may of
necessity include countries with “customs
and practice” at odds with the constraints
of the Foreign and Corrupt Payments Act
of the US or the UK Bribery Act. Facilitation
payments are outlawed by the UK’s Bribery
Act but are a common and often unavoidable
currency in the shipping world – usually
required to get officials to perform their
duties properly and in a timely manner.
Refusal to pay can result in delays, unmerited
claims for damage to infrastructure and
unofficial blacklisting.
Due diligence will be an essential part of
testing the culture and compliance record
of the target group and identifying practices
which will need to change once the acquirer
gains control of the business.
Sanctions compliance
It is important to find out how the target
company deals with the issue of sanctions
compliance and how it ensures that it is not
in breach of sanctions laws, especially as
these are constantly evolving. Is there an
effective system to deal with this important
issue? What records are there and do they
record the following:
• any blacklisting of ships by the Arab League,
including any trading of ships to Israel;
• any trading to Iran, North Korea, Myanmar,
Libya, Iraq, Syria and other countries
which are the subject of sanctions.
Where such trading takes place, what due
diligence is done to identify counterparties
and ensure they are not in fact fronts for
sanctioned entities?
It will also be important to confirm that no
officers, directors or shareholders of the
target group:
• appear on the Specially Designated Nationals
and Blocked Persons List of the US Office
of Foreign Asset Control; or
• appear on any EU or UN lists of designated
person in relation to sanctions; or
• are identified as a “designated terrorist
organisation” under the US State
Department’s terror list (or support
any such organisation).
Environmental
The owners and/or operators of ships may
be subject to both civil and criminal liability
for damage caused to the environment by
such ships.
It is therefore advisable to engage
appropriate technical consultants to review
environmental policies and procedures,
pollution incidents, spills, ongoing claims
and fines. It will be necessary to look at
P&I Club claims records, the provision of
Certificates of Financial Responsibility (COFR)
and the identity and competence of spill
response providers when trading to the US.
Regulatory compliance and
operational incidents
Given the international nature of the shipping
industry, the target’s ships are likely to
visit all types and nationalities of port and
will be scrutinised by port state control
and other national inspection agencies
(eg, quarantine, customs and immigration)
as well as non-governmental bodies such
as the International Transport Federation
(essentially an international seamen’s trade
union). Where failures or non-conformities
are found, the ship may be detained.
Commercial entities, such as mortgagees
(who have priority as a secured creditor) and
suppliers of goods and services to the ship
(unsecured creditors in most part, although
their status changes depending on which
jurisdiction the ship is in), also have the
right to detain (arrest) the ship to secure their
claim. It is vital that details of any arrest, port
state control detention or material claims
in respect of each ship are obtained and
considered as these give a good “snapshot”
as to how the fleet is performing and the
nature and number of obstacles that may
impact on the future efficient use of the
fleet. This is particularly important if the
owner of each ship in the fleet will not
change because the claims will remain with
and against the owner and the ship may be
arrested by trade creditors to obtain security
for those claims.
Litigation
The shipping industry generates a large
number of disputes – small and large.
London and Singapore arbitrations are
commenced for surprisingly small claims
through the accelerated and cheap “small
claims procedures”. A busy fleet may have
many of these ongoing which may or may not
be a sign of problems in the management of
the fleet.
Norton Rose Group Investing in shipping companies 07
Other disputes (such as shipbuilding
disputes) will be more complex, costly and
time consuming, and will need proper risk
and legal management. Is the target group
resourced for this? Are good claims thrown
away and other claims paid which need not
be due to a lack of legal or other resource?
Are there any major claims being brought
against the target and what merits do they
have? It may be necessary to review the
legal advice provided to date or even ask for
counsel’s opinion to be sought in order to
assess the merits of the claim and the likely
exposure of the target group. If the dispute
is lost, will the principal sum and costs be
covered by insurance? It will be important to
review carefully all material litigation claims
currently underway or threatened/suspected.
Competition
Reliance on a parent group
It will be apparent from the above that in
addition to the usual requirements for legal
and financial due diligence, on a shipping
transaction it will also be necessary to
co-ordinate external technical consultants
on a number of aspects of the technical
due diligence including inspections of
ships, a review of class records and ship
operating records, and assessment of the
condition of machinery and coatings. Only
technical consultants with a wide experience
of all types of due diligence exercise will
understand what is required.
Many shipping groups are organised on the
basis that each ship is owned by a separate
special/single purpose company (SPC)
usually incorporated in the flag state of the
ship. This is designed to stop major liabilities
incurred by one ship from spreading to
the whole fleet. These companies are then
beneficially owned by a parent which may,
in turn, be a subsidiary of a parent company.
SPCs, because of their nature, will usually
require the support of a parent by way of
guarantee for any contracts it enters into.
The extent, nature and total exposure must
be considered and whether replacement of
such guarantees will be necessary.
Where a subsidiary/group is separated from
its parent, separation issues may include
loss of pooled assets or services of the group
eg, real estate, HR, IT, and (importantly in
the shipping context) group purchasing of
the group’s requirements for commodities
such as fuel oils, lubricating oils, and
spare parts. Other separation costs may
include rebranding, changing names, funnel
markings, colour schemes and badging
on ships. Determining the cost of sourcing
necessary goods and services on a stand
alone basis may be a significant issue for
the financial modelling of any transaction.
08 Investing in shipping companies Norton Rose Group
Over 100 jurisdictions around the world
now have competition or anti-trust laws.
Whether acting for a buyer or a seller,
it will be important to establish at an
early stage whether the buyer requires
competition clearance under compulsory
notification procedures because of the size
and the geographic reach of the buyer and
the target business. Even if there are no
substantive competition issues that arise
from the transaction, the requirement for the
preparation of a compulsory filing and the
time period for any clearance will need to be
built into the transaction timetable.
External consultants
Additional action required by the technical
inspection team will include writing to
the classification society authorising the
technical advisers to access classification
records for the ships and obtaining consents
and permissions by the builder and the
owner’s site supervisor to allow inspection
of any newbuilding(s).
It is advisable that insurance advisers
be appointed to advise on the terms of
insurance policies, and the quality of the
security provided under those insurance
policies. The claims record will also need to
be assessed as prompt payment of claims is
important to the solvency and cash flow of
a fleet. Are claims being scrutinised unduly
and is this taking too long? This may be a
result of the choice of underwriter or the
result of the underwriter being concerned
about the level of claims being generated by
the fleet. An experienced insurance adviser
will be able to look through the data to give
a true picture. He will also identify old claims
made which are yet to be paid and may be
able to provide “windfalls” for the buyer if
these claims are paid after the deal is closed.
Norton Rose Group Investing in shipping companies 09
A world-class shipping practice
We are one of the world’s leading international shipping practices. Shipping has been at our core
throughout our 200 year history.
The scale of our global shipping practice sets us apart from the rest of the field. We are experts
in shipping finance, corporate and capital markets, marine and cargo insurance, commodities
and trading, mergers and acquisitions, competition and regulation, tax, admiralty and casualty
response, infrastructure, energy and shipping litigation. We advise on all aspects of risk in
relation to shipping and the movement of goods including environmental risk, commercial risk
and legal liability risk; we also support good corporate governance in mitigating such risks.
Our clients include owners and operators, banks, trading houses, lessors, charterers, oil majors,
LNG operators, brokers, ship builders, container shippers and cruise ship operators. We are
qualified to handle everything from the most complex tax lease structures to anti-competition
actions, from ship conversion disputes to offshore disputes.
Norton Rose Group
Norton Rose Group is a leading international legal practice. With more than 2900 lawyers, we
offer a full business law service to many of the world’s pre-eminent financial institutions and
corporations from offices in Europe, Asia, Australia, Canada, Africa, the Middle East, Latin
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Norton Rose Group Investing in shipping companies 11
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Norton Rose Group
Norton Rose Group is a leading international legal practice. With more
than 2900 lawyers, we offer a full business law service to many of
the world’s pre-eminent financial institutions and corporations from
offices in Europe, Asia, Australia, Canada, Africa, the Middle East, Latin
America and Central Asia. We are strong in financial institutions; energy;
infrastructure, mining and commodities; transport; technology and
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