Friday, November 4, 2011

Ship-owner refuge in Chapter 11 proceedings may prove a game-changer in bank foreclosure actions

Several high profile moves by beleaguered shipping companies dealing with their lenders by filing Chapter 11 proceedings in US courts may put shipping banks in a difficult position. In both the Marco Polo and Omega cases, the companies have succeeded to hold their senior lenders at bay. Faced with paying large professional fees that eat into depreciating equity on secured vessels already below loan outstandings puts banks in an extremely difficult position with few options.

If one goes by the book, Chapter 11 requires a company to file a credible plan for reorganization, failing that the lenders can move to Chapter 7 for dissolution of the company and disposal of the assets. The problem is that courts in this situation will give distressed owners considerable leeway and are ill equipped to assess the underlying economics. They regard the process as a means of pressing the parties to an amicable solution. In the meantime, the distressed company can finance the legal expenses from having ceased entirely loan payments. On the other side, the senior lenders are forced into high transaction costs in legal expenses.

One asks himself how US courts would have jurisdiction over these cases of foreign senior lenders and shipping companies with vessels under foreign flags on the high seas in the first place? To the shock of Credit Agricole and Royal Bank of Scotland (RBS) last week in the Marco Polo case, the US Court in New York retained jurisdiction, making Chapter 11 viable for international ship-owners even if they have minimal contacts in the US.

The New York law firm, Bracewell & Giuliani, as counsel for both the Omega and Marco Polo cases, have made a franchise in these actions. The US courts and legal profession have suddenly opened up a new bonanza.

Alternatively, the senior lenders could sell off their loans, but the market for distressed shipping debt has been very limited. Loans made under English law generally require ship-owner consent for any transfer of the debt to a party other than a shipping lender.

There are hedge funds and distressed asset investors, who have shown interest in bank portfolios, but at a steep discount. So banks and potential buyers are presently very far apart on price ideas. For distressed asset investors, English law on transfer of debt limits their ability to get control of the assets. Chapter 11 is now a new potential obstacle to this end as well.

Hedge funds increasingly have been scheduling sit downs with distressed owners offering to inject capital into the ailing company in return for an equity stake and a commitment by senior lenders to write down the loans by 10%. It is possible that this might offer a credible means for distressed shipping companies to recapitalize under Chapter 11 proceedings.

What needs to be clarified in the future is how effective US courts prove in facilitating company reorganization under Chapter 11 or they just prolong hopeless cases and make them worse by ‘pretend and extend’ and the US legal profession profits in the value destruction.

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