As many Commodity Markets Update readers know, Brown Brothers Harriman (BBH) is a financier of energy, metal and agricultural commodities. Our clients help balance global supply and demand in these markets by purchasing commodities in areas where there is surplus production and transporting them to areas where they are consumed. They also provide storage, financing, insurance and price hedging services for producers and consumers of physical commodities. In the course of their businesses, these commodity merchants are increasingly filling the role of “bankers” to their suppliers and customers – either providing advanced payments to suppliers to help with working capital needs or extending payment terms to their customers.
As commodity merchants take on the role of capital provider to the supply chain, the lines between financing and commercial activity become blurred. Many clients have sought advice on structuring financial transactions, trying to minimize the risks of nonpayment and nondelivery that can create significant economic loss. One key aspect of managing these risks involves understanding where commodity merchants – who are typically unsecured trade creditors – rank in the capital structure. Special statutory liens often come into play and must be understood by merchants prior to structuring transactions that involve credit risk with a commercial counterparty. Given the increasing importance of these matters to our clients, BBH sat down with John Keough, a Partner at the New York office of Clyde & Co, an international law firm headquartered in London and specializing in shipping and commodities. Mr. Keough co-heads the firm’s maritime, trade and commodities practice in North America.
Brown Brothers Harriman: You have represented banks, shipping operators, insurance companies and commodity traders in various financial transactions. What are the key legal risks commodity merchants face when extending credit to their customers?
John Keough: The key legal risks facing commodity merchants often arise from a merchant’s failure to conduct basic due diligence to know its customers and to consider details of executing the transaction. These risks generally include:
- Solvency-related problems of the counterparty, such as cargo shipment delays caused by bankruptcy or financial nonperformance of the counterparty, a supplier or purchaser in the supply chain, a parent company guarantor or an intermediate charterer of an ocean vessel
- Arrests or attachments of vessel or cargo, particularly in foreign ports, and the exercise of statutory maritime liens that may be unknown to the merchant or creditor
- Fraudulent or unauthorized ocean bills of lading
- Cybersecurity breaches in the supply chain, including brokers, causing the wrongful diversion of ocean freight or cargo sales payments
- Governmental regulatory, or other interference, in transaction performance, such as those resulting from foreign regulations or orders controlling exports and U.S. trade sanctions
The risks can cause problems in any number of scenarios. For example, if a vessel arrest or cargo attachment occurs based on a maritime lien that is not recorded anywhere and can be unknown to the merchant or the vessel owner, a merchant’s shipment can be delayed or require additional legal costs to discharge, transship or replace a shipment.
BBH: What important strategies can merchants use to protect themselves against the risk of nonpayment?
JK: Key strategies to protect against the risk of nonpayment, in our experience, include the following:
- Know your customer’s business and the transaction counterparties. Exercise due diligence, with legal guidance if appropriate, to best protect your interests in defining the structure of the transaction.
- Require letters of credit issued by reputable banks.
- If you are a U.S. merchant, require a contractual choice of New York law and New York federal or state court or arbitral forum for dispute resolution – or alternatively, the law and forum of another U.S. state, as appropriate, on the advice of legal counsel – instead of the law and forum of a foreign jurisdiction.
- Confirm commercial and marine insurance coverages, including trade credit risk coverage if appropriate. In addition, confirm that the coverage scope extends to delay of shipments – or specifies when a delay becomes an insurable loss – as well as additional named assureds on policies and any waiver of subrogation provisions.
- If chartering an ocean vessel, obtain legal guidance on the charter structure and terms, identifying the charterparty chain to the extent possible.
- Request a contractual counterparty to assign any lien rights.
- Require charterers and sub-charterers to identify the vessel owner before contracting for shipment so that proper risk analysis may be considered by the merchant.
- If the merchant is servicing the vessel itself, direct contractual privity with the vessel is the best way to ensure the merchant’s rights are protected.
- Consider requiring a parent company guarantor of performance and payment by the counterparty.
- Provide vessel and vessel interests with a notice of lien in favor of bunker suppliers to vessel prior to delivery.
- Require the shipper to provide a copy of the relevant charterparty to allow the merchant to assess what country’s law may govern any disputes arising under the charter.
- Identify the flag state of the vessel. The law of the flag state is often an important factor that courts weigh in determining the governing law to a charter dispute if the parties do not otherwise agree on a choice of law.
BBH: Describe the main categories of special or secret liens, or similar tools, that can protect commercial traders in the event of a credit problem with one of their customers.
JK: Commercial traders may have a wide range of such protections, depending on the trade. In ocean shipments where the merchant is entering a charterparty for a vessel, the merchant may have a maritime lien for claims relating to the charter. The lien is against the vessel itself for breach of the charter by the counterparty. The merchant may also have a right to attach the vessel or other assets of the shipowner or the disponent owner – or chartered owner vis-à-vis the merchant charterer – for breach of the charter under U.S. law, which can allow the prejudgment seizure of bank accounts, debts owed by third parties to the merchant’s counterparty, real property and other assets. In addition, the merchant may have a maritime lien on the cargo in question in the transaction under U.S. maritime law.
If a shipment is detained, the merchant may have a right to arrest the vessel or to seek an attachment under U.S. maritime law where a shipment is detained or delayed in transit. Such issues could arise, for example, where goods are stopped during or after loading at a foreign port due to unforeseen export controls by the foreign government or by insolvency issues. Similar rights to secure a claim for breach of a contract of carriage may exist against forwarding agents and non-vessel operating common carriers, or NVOCCs, that issue bills of lading for shipments.
Depending on the connection to the U.S., other methods of security may be considered under applicable state law, such as the Uniform Commercial Code’s Article 9.
BBH: How do banks get comfortable that they are secured in instances where they may be trumped by a creditor they thought would be unsecured in bankruptcy?
JK: Banks can find that comfort level by obtaining sound legal advice at the pre-deal stage on the transaction structure and by ensuring diligent reporting on the intermediaries and any maritime aspects on the deal. Some creditors, usually considered unsecured, can on occasion receive protection under the federal statutes authorizing maritime liens under U.S. law. Indeed, federal district courts can withdraw a maritime claim from a bankruptcy court proceeding in the U.S. under limited circumstances.
BBH: You have been active in several recent bankruptcy situations involving banks and trade creditors. What have you learned in this process? What lessons can commodity merchants take away from recent legal decisions?
JK: We often see that the mistakes clients make in structuring a transaction without legal advice can be costly. Early advice on key legal issues can typically help to avoid some traps for the unwary. Insolvency and government-related issues often can introduce unexpected risks in a transaction and lead to costly legal disputes, particularly in foreign courts. Lessons learned include the value of taking steps to ensure the security a merchant believes it holds is in fact effective, as well as that foreign law issues and contracts containing foreign choice of law and forum selection provisions can disrupt a merchant’s commercial risk expectation and profit-maximizing plan.
BBH: Why are maritime liens called secret liens?
JK: Maritime liens are considered “secret” since there is no filing requirement to obtain, perfect or enforce a valid lien, such as under Article 9 of the UCC. The maritime lien is in effect an inchoate lien, attaching immediately upon a provision of necessaries (such as bunkers) to a vessel, for example, or upon a breach of a charterparty or contract of affreightment, or commission of a maritime-related tort. It is generally not recorded before enforcement. Vessels may be encumbered by entities extending beyond the owner’s control, so the owner is not always aware of liens on its vessels.
BBH: In a nutshell, what is the risk of maritime liens to commodities traders and charterers? Why are they a trap for the unwary?
JK: Maritime liens often exist “below the radar” until they are enforced by an arrest or attachment; however, when enforced, they may substantially disrupt commodities traders and charterers who face extensive delays due to the debts of a key counterparty or vessel operator in a transaction.
BBH: Do the liens arise only on trade to or from the United States?
JK: Not necessarily. The maritime liens arise under U.S. law. Some contracts for trade to and from foreign ports, however, expressly incorporate U.S. maritime law with the intent to invoke maritime liens created by U.S. statute. This issue has been under recent review by courts in a number of jurisdictions. Some maritime liens exist under foreign law, but generally to a lesser extent than U.S. law.
BBH: What is the current state of the U.S. law facing marine fuel traders? What does it take to have a maritime lien for marine fuel delivered to a ship?
JK: U.S. law on this issue confounding marine fuel traders is under active review by a number of appeals courts across the country, with conflicting decisions issued by the district courts so far. Given the state of judicial play, no simple answer exists to the question of what it takes to have a maritime lien these days for fuel delivered to a ship. Distilling the decisions so far in a conservative manner, the rule may be summarized as this, at least for courts in New York: A maritime lien for marine fuels delivered to a vessel arguably arises under the applicable federal statute where a bunker supplier (1) provides necessaries (fuel), (2) to a vessel, (3) on the order of the owner or someone authorized by the owner, with a direct contractual relationship between the supplier and the vessel’s owner. The law remains subject to appellate review, and it is unsettled whether a contractual relationship between the owner and the physical supplier is required.
The courts are wrestling with the plain meaning of the statutory language “on the order of the owner.” Does it mean a contract with the owner is required? Or is it sufficient that the fuel was delivered on an order of the owner, though the owner communicated the order through intermediaries and not directly to the physical supplier? Although a maritime lien may arise from a contract with a charterer of the vessel, some risk also exists if the supplier is provided notice of a “no lien” clause in the charter or knows that the owner or charterer of the vessel does not authorize the supply to the ship.
At any rate, we suggest taking legal advice on the issue when drafting supply contracts, charterparties and bunker fuel delivery receipts.
BBH: John, thank you for sitting down with us to share your expertise on this important topic.
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