On the register

UNDER Korean law, any Korean vessel of twenty gross tons or more, propelled by an engine, must be entered in the vessel registry. Even though ownership is one of the items to be described in the registry, purchase and acquisition of ownership of a vessel does not require registration in order for it to be effective.

Transfer of ownership may become effective only by an agreement between the seller and the purchaser. Registration, therefore, is merely a condition governing validity of the transaction in instances involving a third party. In other words, it is possible to purchase a vessel from the person who appears on the registry as the owner even if that person does not own or has already disposed of the vessel to somebody else.

The concept of transfer of ownership in a vessel by an agreement between the seller and the purchaser is unique under Korean property law insofar as concerns the property to be registered. For example, the transfer of ownership of real estate and automobiles subject to registration under Korean law only becomes effective upon registration.

This legal principle was subject to much contention when two vessels registered to a Korean shipping company ('X') were arrested in Hong Kong and the US by claimants after the Korean company became insolvent. The purchase of the vessels was financed by Korean leasing companies under financing agreements whose terms and condition provided; (1) the leasing companies conclude sales contracts and pay the sales price to the seller with regard to the vessel X wishes to purchase; (2) the company agrees that ownership shall remain with the leasing companies as security for the financing and that ownership will pass to the company only upon payment of the entire amount of financing; and (3) the leasing companies may request X to be registered as the owner in the vessel registry with a mortgage being created on the vessel in favour of the leasing companies to secure the financing.

The case took a very unexpected turn.

One vessel arrested in New Orleans was registered under the name of the leasing company, with a mortgage created in the name of the leasing firm. When the vessel was sold at auction, the leasing company insisted on priority as a mortgagee. The question for the decision of the US court was whether or not the leasing company was a mortgagee when it was recognised as the owner in the leasing agreement.

The other vessel, arrested in Hong Kong, was registered under in the name of X with a mortgage created in favour of the leasing company only one day before the arrest, but after X became insolvent. When the claimant arrested the vessel, the leasing company contended that it was the beneficial owner of the vessel even though X's name appeared in the registry as the owner.

The issue before the Hong Kong court was whether or not the leasing company was a beneficial owner, therefore justifying the release of the vessel from X's claimant. The leasing company alternatively argued that, even if it were not the owner, it had first priority over the proceeds from the vessel as a mortgagee. The next question for the Hong Kong court to decide was whether or not the leasing company could be recognised as a mortgagee in its own property under the leasing agreement, which specified the owner as the leasing company.

The Korean company's claimant started a separate legal proceeding in Korea, contending that creation of a mortgage by X after it became insolvent constituted a fraudulent transfer. As a result, the Korean court was faced with the same issues that the courts in the foreign jurisdictions had had to deal with.

There was no Korean judicial precedent available directly addressing this legal issue insofar as ownership of a vessel was concerned, although both the Hong Kong and the US courts were willing to rely on Korean law. The relevant parties then produced expert opinion from practicing lawyers and professors who expressed to the court their own opinions based on basic Korean legal principles and presented relevant case law to support their views. However, there was no unified opinion, and indeed some of the opinions were in sharp contrast to each other.

It was the US court that first issued its judgment, in 1998. Relying on the opinions of experts on Korean law, the court held that:

Only X appears to be the registered owner in the vessel registry, and the leasing company being the mortgagee in the vessel does not create any inconsistency;

Even if the leasing company is recognised as the owner under the leasing agreement, the leasing company is recognised as the owner only between X and the leasing company ('internally' according to the expert opinion that the court relied on) and X is the owner of the vessel between X and a third party ('externally' according to the same opinion), and

Korean law permits the leasing company to be recognised as a mortgagee in this particular case where the leasing company is recognised as the owner merely between X and the leasing company ('internally') even though a basic principle dictates that you cannot become a mortgagee in your own property.

On the other hand, relying on Korean law, the Hong Kong court held two years later that:

Ownership was first transferred to X, and the leasing agreement was intended to transfer ownership from X to the leasing company;

However, the leasing company merely enjoyed personal rights against X arising from the leasing agreement, and no rights of ownership by the leasing company were valid against a third party. Between X and a third party, the ownership was vested in X, who appears in the vessel registry as the owner; and

If the leasing company became the legal owner of the vessel by transfer of ownership from X, it is merely a legal title devoid of the characteristics of beneficial ownership.

The parties later settled, and the Hong Kong court did not need to rule further on the issue of whether or not the leasing company legitimately became the mortgagee.

The Korean court eventually handed down its judgment, which was not entirely identical to the decisions reached by the Hong Kong and US courts. It is summarised as follows:

Given the terms and conditions of the leasing agreement, the leasing company was originally intended to become the owner when the ownership was directly transferred from the seller, and it became the owner even though the ownership was registered under X, and the leasing company's ownership could not be insisted against a third party;

A third party in this case included only those who obtained legal interests in the relevant property inconsistent with the interest of the transferee (the leasing company in this case) before the registration under the name of the transferee took place. X's claimant in this case did not obtain such legal interest in the vessel; thus, it was not a third party entitled to rely on the registration; and

Even though a mortgage was later created in the vessel, this was not enough to invalidate the arrangement in the leasing agreement whereby the leasing company became the owner while X would be registered as the owner in the vessel registry.

The Korean company's claimant referred this case to the appellate court, raising many legal issues with regard to the court ruling on the definition of a third party entitled to rely on the registration. But the case was subsequently settled. These issues are yet to be judicially reviewed in other cases of a similar nature because, under Korean law, the decisions reached by this court - which is a lower court - do not bar the court itself from holding differently in other cases.

Given that Korean law on these issues is still unclear, it is worth noting that a South African court touched on the same issue in 2001 in another case and expressed entirely different views. It held that (1) if the leasing company were the owner, it would be impossible to become a mortgagee in the vessel that was its own property; (2) if the shipping company were to be recognised as the owner, the leasing agreement would be fraudulent because the shipping company leased the vessel to itself under the leasing agreement; and therefore, (3) the leasing company's interests were not recognised in the vessel either as the owner or the mortgagee.

It is clear that, when considering ownership of a Korean vessel in an international transaction, the international shipping industry should take a very cautious approach.