Know your risks

Duncan Bateson of Lawrence Graham LLP looks at what steps can be taken to reduce the country risk when investing in Russian shipping

LENDING to Russian shipping companies raises the spectre of country risk and the resulting problem of availability and pricing of finance for the acquisition of ships. The country risk relates to what lenders perceive as inadequate protection for loans and specifically for mortgages. This in turn relates to the laws and regulations of the Russian Federation on the one hand and their application in practice.

The other side of the coin to the lender's risk is the risks taken by the borrower. The shipping company is not just bearing the risk of being unable to repay the finance but, if customs issues are not dealt with properly and the ships are arrested and/or sold off by the lenders for non-payment, the shipping company may face large penalties imposed by the Russian authorities. So what can be done to mitigate the country risk associated with Russian shipping company borrowing?

Financial information

Russian companies are not required by Russian law to prepare accounts to standards equivalent to international accounting standards, although many shipping companies will be familiar with them for the purpose of obtaining finance. The lender will therefore be reliant on vetted auditors and the borrower’s financial warranties in the loan documentation.
The borrowers should remember that the bank may choose or at least agree the auditors, but it is the borrower that gives the warranties and coventants that the financial information the accountants prepare is true and correct.

Lending to offshore subsidiaries.

The usual first step to mitigating country risk is to lend to a subsidiary registered in a jurisdiction that provides more familiar and acceptable protection to lenders in that the company and insolvency laws will be better understood and more predictable. Companies based in those jurisdictions should also be more easily served in proceedings there and elsewhere.
Russian companies require customs permission to transfer Russian-registered vessels to offshore companies. The permissions, if not handled correctly, may contain conditions concerning the repatriation of assets transferred abroad. If such conditions are imposed and the loan cannot be repaid, the shipping group will be in double jeopardy. Foreclosure on the loan and sale of the mortgaged vessels will cause a breach of terms of the permission. Fines for breach of the terms of permission can be very large.
Secure loan by mortgage registration in offshore jurisdiction
The lender will want the mortgage to be registered outside Russia for the same reason that it will want the borrower to be offshore. Lenders consider their mortgage is more effectively protected. The law applying to the interpretation of the mortgage and related deed of covenants will give it priority over other encumbrances and debts, especially those owed to the Russian state by the shipping group. The offshore law should also be more certain and more predictably applied in the flag state and elsewhere.

Bareboat charter vessel to Russian company

The vessel and the lender’s mortgage are registered offshore, but the vessel can still fly the Russian flag if it is bareboat-chartered to a Russian company. The bareboat charter is registered under the Russian ship register with the consent of the owner and underlying register. The Russian register of ships then becomes responsible for technical/safety matters, and the vessel is entitled to fly the Russian flag.

Western banks are becoming more prepared to lend where the vessel over which security is taken is to remain in Russian waters, such as Russia’s extensive inland waterways and cabotage trades. Funding of domestic activity is given where other aspects of country risk are sufficiently mitigated, such as the financial strength of the shipping company, the profitability of the trade or an assured income stream from a non-Russian source.

A lender will principally be concerned to ensure the bareboat charter terms do not conflict with the loan terms and the charterer's right to quiet enjoyment will cease in the event of a default. The lender will also want to ensure that the Russian bareboat registration can be terminated on a default.

Parent guarantee subject to non-Russian law/jurisdiction

If the borrower cannot repay the loan and the sale of the vessel is not sufficient to reimburse the lender, the fallback is the parent guarantee from the Russian shipping company itself. Parent guarantees can be made subject to choice of foreign law and jurisdiction to resolve disputes outside Russia. However, the Russian company giving the guarantee will still be subject to the law of the Russian Federation. Furthermore, judgments and arbitration awards may still have to be enforced in Russia. If the proper steps are not taken to authorise the granting of the parent guarantee, it is possible that it will not be enforceable in Russia.

Russian law on corporate decision-making is not simple and there are pitfalls for even the most experienced. Russian legal advice should be sought beyond the usual legal opinion.

Insurance

Insurance will usually come at a price. The insurance may buy out country risk and reduce the lending rate/margin but will add to the finance cost. However, some countries’ export credit agencies can offer insurance with newbuildings that switches the country risk from the borrower’s country to the builders.

Politics
The Russian state considers shipping to be of strategic importance. The government or one of its departments may have a stake in a shipping company that could give it special rights. Apart from central government, there is also regional government to consider. It was not so long ago that a Russian regional governer intervened in a ship arrest by an unpaid lender to prevent the ships from being sold or removed from a Russian port where he was concerned that the loan was being used to strip the shipping company of assets.

It pays to be familiar with the specific country risks involved when structuring a loan to a shipping company, and there is no substitute for real local legal advice.