Shipping insolvency forecast

More shipping companies are using US Chapter 11 filings, but the trend could run aground soon

David Osborne and Alfred Yudes
David Osborne and Alfred Yudes

Chapter 11 of the US bankruptcy code has become the debtor-friendly bankruptcy regime of choice for international shipping companies in distress, whether or not they have a substantial connection with the US. The bankruptcy courts there have shown a readiness to accept ­jurisdiction that has surprised some.

In the Marco Polo Chapter 11 filing in July 2011 the payment by the debtor to its US lawyers of an amount on account of legal fees for the bankruptcy filing was held, along with ­certain other minimal New York contacts, to be a sufficient basis for the exercise of bankruptcy jurisdiction.

The adoption of Chapter 15 of the US code in 2005, implementing the United Nations Commission on ­International Trade Law model of ­international insolvency, appeared to indicate a less US-centric approach by introducing a regime for US ­proceedings ancillary to main proceedings outside the US. Case law in the first half of the last decade also showed a tendency away from the ­aggressive seizing of jurisdiction by the US courts.

This trend seems to have been ­reversed recently.

The willingness of the US courts to accept jurisdiction has been coupled with a growing awareness by the management of international shipping companies of the perceived ­benefits of Chapter 11 – not least as an express or implied threat to lenders. However, despite the well-known ­advantages of Chapter 11 for debtors and the corresponding disadvantages for secured lenders, it is not a process for a debtor to entertain lightly and without a clearly ­formulated plan of reorganisation. A Chapter 11 filing entered into hastily or ill-advisedly could result in a Chapter 7 liquidation.

Chapter 11 has been preferred by international shipping companies to the bankruptcy regimes of their home jurisdictions, or centres of main interests, in European insolvency regulation terms.

Many European jurisdictions do not have rehabilitative bankruptcy regimes comparable to Chapter 11. A point to consider for secured lenders concerned about the possibility of Chapter 11 is taking pre-emptive ­action under the insolvency regime of the debtor’s home jurisdiction to reduce the chances of an opportunistic Chapter 11 filing.

It is anomalous that Section 1110 of the US code gives aircraft lessors and secured lenders an opportunity to enforce despite the automatic stay, whereas there is no equivalent ­protection for the financiers of ships. This protection was embedded in Chapter 11 as a result of lobbying by US banks with substantial aviation ­finance portfolios. The absence of an equivalent for ships is perhaps ­explained by shipping finance and shipping itself being less significant in US terms than aviation.

Whether the resort to Chapter 11 by international shipping companies continues to be a trend will depend on a number of factors: the length and severity of the downturn in the industry; whether the US courts ­continue to be aggressive in taking bankruptcy jurisdiction; and whether ­filings by non-US based shipping companies are successful from the debtor’s perspective.