Speculators snapping up bargain detained ships

Third parties have been moving in to buy ships detained in Ukrainian ports that have been declared constructive total losses (CTLs), revealed Richard Neylon, partner at global sector-focused legal firm HFW, where he is head of Complex Environments.

Neylon said that HFW had been responsible for negotiating for 18 of the ships detained that were declared a CTL (although this is an English term and the actual phrase used varies from county to country) on the first anniversary of the outbreak of war on February 24th 2022. “On the first day we received CTL claims worth $250m, and by the Monday we had another $150m, which gives you some idea of the total hit to the sector.” However, he later said that one had to be cautious about extrapolating mathematically> Nevertheless, the total loss had to be in excess of $500m, probably closer to $700m, and maybe even more than that. “I will be interested to see what the Facts & Figures Committee says about that this time next year”. He said that he was not sure that these numbers had really fed their way through to the published statistics on the finances of the sector.

Once a CTL has been declared the insurer has several options.

As a war risk underwriter, you pay the claim. You can then “disclaim the vessel”. Neylon noted that HFW saw this quite a lot for major casualties, for example when a vessel sank or was scuttled. But in war risks the matter was less straightforward. The vessel was still there, often in reasonable condition and maintained by at least a skeleton crew. In such a situation it can make financial sense for insurers to take over the interest of the assured.

Neylon noted that during the Somalia period, most of the time the vessel wasn’t in that great a condition. But in detention losses, such as with most of the vessels locked in the Ukraine, the intrinsic value was still there.

  1. One option is a “Compromised total loss”. The insurer comes to an agreement with the insured to pay a proportion of the value.
  2. Another option is to sell the vessel to a third party. Neylon said that, of the 18 vessels that HFW worked with, about 14 were sold to a third party, with two, three or four retained by the original assured. “You might ask”, said Neylon “who on earth would be interested in buying a ship that was locked up in a Ukrainian port? Well, the answer is, quite a few people”.

The speculators in these vessels undertake a risk analysis that estimates the free-of-detention value of the ship and guesses at the likely length it would likely remain locked up.

If an insurer takes over a vessel and sells it to a third party, there are challenges.

  1. The Crew. In the early days of the conflict, many of the crew were evacuated, but before too long some replacement crew were employed to keep the vessel ticking over, basically in warm lay-up.
  2. The cargo. An interesting challenge for the insurer and/or the new owner is what to do about the cargo. “You may not know who owns it. It is a challenging situation.”
  3. Mechanics of the sale.

Neylon said that this was a complex process. There were two options, but Neylon said that one option was preferred over the other.

  • The first option when a CTL was declared was to transfer the title from the insured to the insurer.
  • However, the preferred option was to arrange it so the assured sold the vessel directly to a third party.

Even in this second, preferred situation there were challenges. For example, what does the insurer do as the process of transfer continues. As Neylon observed, selling a ship is a complex process. “Do you ask the assured to pay running costs, to get the number of crew that are required and, indeed, to get it insured? There are ongoing obligations.”

Any ship sale includes a Memorandum of Agreement (MoA). Neylon observed that the constituents of the MoA — usually based on an existing form such as that from BIMCO — were very different when you were selling an “ordinary” ship.

Fundamentally, a large number of the guarantees put forward by a seller in ordinary times, cannot be maintained. Beyond guaranteeing that you have the right to sell the ship and that you are not aware of any outstanding liens, the legal (and physical” status of the ship is as is and as known. Any survey would have to be undertaken by the buyer, who would also need to do considerably more due diligence. On the plus side for the buyer, a big discount is being obtained.

Neylon observed that any such sale would usually consist of negotiations between the buyer and the seller on various matters. But the legal problems can begin when it comes to cargo. Neylon said that the Ukrainian ship situation was now in the phase after the CTL declarations, with legal disputes arising between charterers and owners over cargo interests.

Present Position

Neylon said that total losses had been claimed and mostly paid, with a few disputes still knocking around. These ongoing disputes tended to be interesting because they revolved around whether a vessel was a genuine CTL. The general principle was that if a ship was carrying, say, steel, or even coal, but was in one of the three Black Sea Corridor designated ports, then it would have been possible to take off the cargo, clean up the ship, load it with Ukrainian grain, and get it out of the port under the Black Sea Grain Corridor Initiative. Neylon did not underestimate the problem in achieving such a “switch”, but noted that technically it could be a factor in eliminating the declaration of a CTL.

As mentioned above, there were also legal disputes between charterers, ship owners and cargo owners about the legal position of the cargo owner. For example, the new owner might offer to take the cargo to its original destination, but the owner would still be required to charge freight, even if the cargo owner had already paid freight pre-war.

Neylon said that one reason most of the assureds agreed to a sale was that after a year they were just “very tired”.

A lot of vessels in Ukraine now have new owners and insurers, and all are looking to depart, and looking for insurance to get out, he said.

On a later panel, Neylon said that the legal situation of the cargo was also interesting. The obligations on the new owner are somewhat minimal. The contract is usually frustrated. What actually happens is that the new shipowners will start a conversation with the cargo owner. Litigation between charterers, cargo owners is “phase 5” which we are in now.

Lessons Learnt

One was over-insurance. With the volatility of vessel prices, dependent both on demand and commodity prices, vessels were not infrequently insured for a greater value than the owner could realize if he sold it. But when there was vast over insurance it was almost inevitable that difficulties would arise.

Neylon said that it was quite fair that the mortgagee wants to protect its position, “but when there is a big difference we always have CTL difficulties”.

When the operation was in process, Neylon said that communication was important “because if there isn’t communication, people suspect conspiracies. Getting the insurer and the insured into the crisis management team is always a good idea, because people know why things happen.

“It’s against the philosophy of shipowners and against the philosophy of some insurers, but we have found it to be a good idea”, he concluded.