The world financial markets are in trouble, which has affected the shipping world through lower freight rates and less demand for tonnage. Coupled with an aging fleet, maritime companies are struggling. This problem in the market has led to early redeliveries of vessels with charterers seeking more favorable rates, an increase in vessel arrests seeking security for maritime claims, and eventual bankruptcy filings.
Since many maritime companies are either listed on the NYSE, or have offices and assets in the U.S., they are able to seek bankruptcy protection by filing in the U.S.
But litigation in the U.S. can be complicated and expensive. The unique structure of American jurisprudence creates a complex interplay between federal and bankruptcy courts, which is enough to dumbfound even the most seasoned jurists. Specifically, due to a “hiccup” in the U.S. Constitution, leaving undecided the powers accorded to certain types of judges, maritime bankruptcies carry a host of complex and unresolved issues for maritime debtors, creditors and purchasers of maritime assets.
This article focuses on one aspect in American jurisprudence – maritime bankruptcies.
II. World Financial Pressures
Like all businesses, the shipping industry waxes and wanes relative to the global market. While there have been a smattering of maritime bankruptcy rushes throughout American history – notably after the American Civil War and during the Great Depression – the common prevalence of reorganization under a Chapter 11 Bankruptcy Petition is a relatively recent development in the maritime industry.
Currently, several external forces exert pressure on the industry that could force a new wave of maritime bankruptcies and insolvencies:
- The Great Recession: This factor needs no explanation. Despite market reports and political grandstanding, there can be no doubt the global economy is in a serious and prolonged recession, which to no one’s surprise has left its mark on shipping.
- Banking Industry Crisis: Financial liquidity problems among shipping companies has lowered the value of vessels and discouraged banks from issuing new loans or extending lines of credit. This is exacerbated by stricter global regulatory standards under Basel III. In fact, in June this year, Commerzbank, the world’s second largest provider of maritime financing, announced the cessation of its maritime funding operations.
- The End of War (Maybe). There is one constant on which the American shipping industry can rely: boom during war; bust after war. As combat winds die down in Iraq and Afghanistan, we can expect a decline in vessel demand.
- Oil Shortages. Market reports show that oil shortages in the Middle East have caused a 50% drop in tonnage carried by oil tankers.
- Pirates! Even in 2012, we face the scourge of piracy. The well-publicized actions of Somali pirates have caused a loss in revenue due to their practice of taking vessels or cargo hostage and demanding millions of dollars in return.The combination of these five factors, each formidable in their own right, have left many maritime companies with growing debt and declining sources of revenue. In the new political/economic reality, maritime companies will be left with fewer options for the future and many are turning to bankruptcy proceedings in the U.S.
III. Options in U.S. Bankruptcy Court
A. “Chapter 11” Proceedings
Any corporate entity, partnership or individual may file a Chapter 11 Petition in a U.S. bankruptcy court for “reorganization;” the goal is to salvage the profitable portions of the business while distributing available assets and discharging other debts (via a “Chapter 11 Plan”). Depending on the complexity of the issues and size of the debtor, a Chapter 11 proceeding may take months or even years to complete.
B. “Chapter 15” Proceedings
Chapter 15 of the U.S. Bankruptcy Code was promulgated in 2005 as a mechanism to deal with insolvency cases involving parties-in-interest in multiple countries (incorporating the “Model Law on Cross-Border Insolvency”). It codified a procedure by which U.S. courts could interface with foreign courts to reorganize or liquidate a bankrupt estate abroad.
1. Recognition Hearings & Center of Main Interest
After a debtor files a Chapter 15 Petition1, the first hearing is typically a “Recognition Hearing” which determines the location of the “foreign main proceeding,” i.e. whether the debtor filed its insolvency action in its “center of main interest (“COMI”).
Recognition of foreign main proceeding is critical because, if the court recognizes the filing jurisdiction as the “foreign main proceeding,” the debtor is then entitled to an automatic stay under §362. If not, the debtor is not entitled to a stay and must make a special application to the court for the same.
2. Some Case Examples
In In re Tri-Continental Exchange, Ltd. (2006), an alleged unscrupulous insurance carrier, with its sole office located in St. Vincent and the Grenadines (“SVG”), sold policies exclusively in the U.S. and Canada. U.S. Creditors argued that its insolvency proceeding in SVG should not be considered the “foreign main proceeding” as it conducted all its business in the U.S. and Canada (thereby allowing creditors to commence action in a U.S. court). However, the court looked to the “principal place of business.” And since the debtor’s only office and all its employees were located in SVG, SVG was held to be its COMI – the debtor was thereby able to avail itself of the protection under the §362 automatic stay.
In In re Pro-Fit International Ltd. (2009), three U.K. entities filed bankruptcy in the UK; one party claimed rights to certain patents and licenses in the U.S. and the other two were parties to pending civil actions in California: in one of those cases, a secured creditor obtained an order attaching U.S. assets, which prompted the U.K. administrators to seek an automatic stay under §362 to halt execution of the attachment. In a case of first impression in California, the court held that a stay was proper “provisional relief” while the foreign administrator’s Chapter 15 recognition hearing was pending.
In re Atlas Shipping A/S (S.D.N.Y. 2009), an international shipping company in Denmark filed for bankruptcy, with its assets vested in the appointed trustees. Before and after the Danish filing, various creditors filed Rule B actions in the U.S. and attached the debtor’s funds in New York. The Danish trustees then filed a Chapter 15 Petition in New York, requesting recognition of the Danish case as the “main proceeding,” and that the attached funds be turned over to the trustee’s U.S. counsel pending a final determination. When the Danish trustee asked that the attachments be vacated during the recognition hearing, the Court rejected the creditors’ argument that the trustee first had to commence a Chapter 7 or 11 proceeding and then file an avoidance action; it then vacated the attachments.
An administrator or trustee could file a Chapter 15 Petition in the U.S. and ask the court to recognize its bankruptcy proceeding as the foreign main proceeding. Then, while the court considers the Petition, it could ask for a stay by way of a temporary restraining order of any action by any other entity (e.g. to enforce a maritime lien under Rule C or for security for a maritime claim by attachment under Rule B).2
IV. Automatic Stay
The automatic stay in U.S. bankruptcy stops all proceedings during the pendency of a bankruptcy procedure. Its broad reach extends to all other litigation, lien enforcements, attempts to collect on judgments and any other conduct that would interfere with the estate or property of the debtor.
The purpose of the stay is two-fold:
First, it allows the debtor to focus its time, energy and resources on reorganization, and prevents the debtor from having to deal with lawsuits throughout the country (or world); and second, it promotes a fair distribution of the debtor’s assets to all creditors, as all creditors must bring their claims to the bankruptcy court for a fair distribution among creditors. The absence of a stay would cause a race to the courthouse, and allow creditors to file claims in various courts in various jurisdictions to “get a piece of the pie” in front of other creditors with equal or greater claims.
Due to the Supremacy Clause of the U.S. Constitution, all pending State Court actions are immediately stayed; similarly, non-maritime federal actions are also stayed.
V. Tension Between the Courts
The rise in bankruptcy petitions among maritime companies has exposed a tension inadvertently created by the structuring of the U.S. judicial system under the U.S. Constitution: the respective authority of the Bankruptcy Court and the District (i.e. federal) Court. This tension has left 3-parties susceptible to uncertainty: (1) maritime debtors; (2) creditors of maritime debtors; and (3) purchasers of maritime assets through judicial foreclosure e.g. vessels.3 The net effect could change the way maritime companies conduct business in the industry.
The U.S. Constitution gives exclusive jurisdiction over Admiralty cases to “Article III judges,” who are appointed by the President, confirmed by the U.S. Senate, and preside over District Courts, whereas Bankruptcy Courts are created under Article I of the U.S. Constitution. Further, Bankruptcy courts (while a unit of the District Courts) have original and exclusive jurisdiction over all bankruptcy proceedings and a debtor’s property, wherever located, and over the estate.
VI. Maritime Liens
Under U.S. maritime law, a lien is automatically created by operation of law when a vendor provides “necessaries” to a vessel to “keep it going.” What constitutes a “necessary” is subject to broad interpretation, tends to be expansive, and need not be recorded to be effective. Such liens can only be discharged by a District Court under Admiralty Jurisdiction by an Article III Judge. So if a District Court sells a vessel by judicial auction via an action brought by a creditor, the vessel is sold “free and clear of all liens and encumbrances.”
VII. Dueling Authority under Current U.S. Law
Various groups (courts, legislature, debtors and creditors) have engaged in a struggle to reconcile the conflict between the dueling authority of the Bankruptcy Court and the District Court:
One side argues that the broad power of the Bankruptcy Court and common sense principles of jurisprudence provide jurisdiction over maritime assets. The other side contends that the U.S. Constitution has given original and exclusive jurisdiction over maritime issues to Level III District Courts, leaving the Bankruptcy Court without jurisdiction over maritime matters.
Who will win? The current state of the law is unclear. In a 2nd Circuit decision (Aug 2005), In Re Millennium Seacarriers, Ltd., the Court held that as the lienors voluntarily submitted to the jurisdiction of the Bankruptcy Court, that court had jurisdiction over the maritime assets. The determining factor appeared to be that lienors voluntarily agreed to the jurisdiction of the Bankruptcy Court.
But Millennium is not the end of the discussion: then Judge Sotomayor (now U.S. Supreme Court Justice) stated that “only a federal admiralty court acting in rem” can “conclusively” extinguish maritime liens.
VIII. Going Forward
How will the law reconcile the Bankruptcy Court vs. District Court issue?
One view is that a rational, pragmatic approach suggests Bankruptcy Courts will eventually have authority to not only stay pending maritime proceedings in District Court, but also exercise authority over a debtor’s maritime assets and remove maritime liens on the sale of a vessel by judicial sale.
But at least one commentator has suggested that the only way to resolve this issue is by Congressional act, giving exclusive jurisdiction to the District Court pre-petition on foreclosure proceedings and, where applicable, jurisdiction over maritime bankruptcy proceedings. Theoretically, this would mean that a District Court would handle maritime bankruptcies (a novel approach but likely not effective)! U.S. Bankruptcy proceedings are very much their own “animal” and few outside the bankruptcy field have a sophisticated understanding of its laws and procedures sufficient to effectively apply them.
A solution may be based on a “logical, balanced” approach granting Bankruptcy Courts jurisdiction over maritime proceedings and assets to avoid conflicting rulings. Arguably, Bankruptcy Courts would be better able to enforce maritime foreclosure proceedings than a District Court would to administer bankruptcy law.
So what should you do if asked by a client whether to purchase a vessel without a release from a U.S. District Court? Tread lightly – the vessel may still be subject to maritime liens and the most conservative approach would be to avoid such a purchase, no matter how tempting the bargain.4
1 Maritime bankruptcies are filed almost exclusively in the Southern District of New York (Manhattan). Surprisingly, we have not been able to identify a single maritime bankruptcy petition filed in California. And while Chapter 15 is a recent development, there have been only 34 such filings in California since 2005, with only 3 published cases.
2 Under Chapter 15, the stay is not automatic (only on recognition of the foreign main proceeding). In 2011, a Los Angeles court held that a Rule C arrest was stayed in light of a Chapter 15 Petition filed in New York by Korea Line Corporation after recognition of the main proceeding in Korea (security was then transferred to NY court registry).
3 The complexity of this tension first came to a head when one of the world’s largest shippers, Hellenic Lines, declared bankruptcy in 1983; two critical issues emerged: the Bankruptcy Court’s authority to (1) grant an “automatic stay” pursuant to 11 U.S.C. §362; and (2) discharge a maritime lien.
4 Some recent maritime bankruptcies in the U.S.:
- Sanko Steamship Co. Ltd – Chapter 15 (New York – July 2012)
- Trailer Bridge, Inc. – Chapter 11 (Florida – Jan 2012)
- General Maritime Corp [U.S. entity] – Chapter 11 (New York – 2011)
- Marco Polo Seatrade B.V. [Netherlands entity] – Chapter 11 (New York – 2011)
- Omega Navigation Enterprises, Inc. [Greek Entity] – Chapter 11 (Houston – 2011)
- The Containership Corp [Danish Entity] – Chapter 15 (New York – 2011)
- B+H Ocean Carriers – Chapter 11 (New York – 2012)
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