Update on Vessel Leasing Issues

The demolition of vessels at the end of their useful lives has many economically positive aspects. Anti-polluting technology, fuel efficiencies, and other desirable characteristics can be incorporated more economically into vessel newbuildings than into older vessels. Steel and other reusable materials are recycled. Demolition saves the vessel operator the expenses and risks involved in laying-up the vessel. Removing vessels from the world fleet creates demand for new vessel construction that is safer and more energy efficient with all of the economic activity that is associated with new construction, and helps regulate world charter rates for vessel cargo-carrying capacity. And of course, vessel recycling is an important job source in some geographic locations.

However, older vessels can contain many different hazardous materials including asbestos, ozone-depleting substances, polychlorinated bi-phenyls (“PCBs”), and heavy metals. South Asia ' particularly India and Bangladesh ' have been scrapping centers, and the processes used there often have been quite basic ' taking apart a vessel by hand. Health risks to workers and safe disposal of hazardous byproducts often have been ignored.

In the United States, the interplay of certain of these issues was highlighted by the desire of the U.S. Maritime Administration (“Marad”) to sell for export some of the so-called “ghost ships.” These are obsolete vessels, some built prior to 1979 when PCBs were banned in the United States in vessel construction, that were originally purchased by Marad on behalf of the United States as part of the military national defense reserve fleet. Initially in the early 1990s, Marad sought to sell several of these vessels to a demolition and recycling shipyard in the United Kingdom. Marad stripped all PCBs out of the initial group of vessels to be sold. However, the prospect of demolition and recycling in the UK was vigorously contested both in the UK and in the United States, and Marad was sued by environmental groups in the United States. Issues included unsafe disposal abroad of PCBs and other hazardous materials, and whether the rotting vessels were seaworthy enough to be towed across the Atlantic without environmental incident. While Marad ultimately prevailed in the lawsuits filed in the United States, the local British council whose consent was needed refused to permit the demolition and recycling of more than an initial group of vessels.

One consequence of the issues raised by the “ghost ships” has been increased sensitivity to properly recycling vessels in a more environmentally sensitive manner both in the United States and abroad.

The following is a current illustration of why a prudent U.S. vessel lessor should be concerned about vessel demolition. Under the U.S. Toxic Substances Control Act, 15 U.S.C.A. ' 2601 et seq. (2008), and accompanying regulations (40 C.F.R. Pt. 761 (2008)) (collectively, “TSCA”), the export of PCBs over certain concentrations for disposal outside the United States is unlawful unless covered by an exemption. Prior to 1979, PCBs were not prohibited from being used in vessel construction in the United States, and there is substantial risk that U.S.-built vessels prior to that date contain PCBs at a level that would make it unlawful to export them for demolition. The U.S. Environmental Protection Agency (“EPA”) has stepped up its enforcement activities in this area. One example is the EPA's civil administrative complaint respecting the former cruise ship Oceanic. See EPA Document No. TSCA-09-2008, Complaint and Notice of Opportunity for Hearing in the Matter of Global Shipping, LLC, and Global Marketing Systems, Inc., and related EPA News Release dated Jan. 29, 2009, available at http://epa.gov. There, the EPA alleged that the vessel contained a higher content of PCBs than the 50 ppm permitted by regulation and that the towing of the vessel out of the United States constituted a violation of TSCA's prohibition against exporting PCBs for disposal outside the United States. The shipowning entities settled EPA's objections by executing a consent agreement (filed on Jan. 28, 2009) not admitting a violation, but paying an administrative fine of $518,500.

On the international level, discussion of ship recycling by a joint working group of the International Maritime Organization, the International Labor Organization, and others over a several-year period has resulted in the May 2009 adoption of a new convention on ship recycling ' the Hong Kong International Convention for the Safe and Environmentally Sound Recycling of Ships, 2009. The United States has not adopted this new Convention, and therefore the Convention does not override U.S. laws such as TSCA. But the Convention begins to synthesize an international consensus for dealing with vessels that no longer have an economic operational use. The new convention calls for an inventory of hazardous materials to be developed for each vessel to be sent for demolition and recycling, and for the relevant ship recycling yard to create a specific recycling plan for each vessel based on that inventory.

Risk to a lessor of liability or unanticipated costs in connection with disposition of a vessel at the end of a long-term lease is an increasingly important topic for lessors. Long-term leases entered into by financing entities as lessors as recently as a few years ago may not adequately address vessel disposal issues in their text. Furthermore, the cost of disposal and recycling may not have been factored into a lessor's (or residual value holder's) calculations. Recycling costs and benefits should be factored into vessel residual values and end-of-lease options. We suggest lessors examine their end-of-lease provisions well in advance for how they address vessel demolition in the event the lessee returns the vessel to the lessor.

Criminalization

Increasingly, environmental incidents have become the basis for criminal (not just civil) prosecution of the lessee/operator as a corporate matter and of individuals having vessel operational responsibilities, primarily vessel engineers but also occasionally vessel masters. One fact pattern has emerged as a lightning rod in the past few years. This relates broadly to oil ' either the dumping of waste water containing oil residue (primarily from engine operations) not properly treated through the required oily water separator and/or falsification of entries in a vessel's oil record book. Both fact patterns constitute violations of the Act to Prevent Pollution from Ships, 33 U.S.C. ” 1901-1915 (“APPS”).

The Department of Justice routinely announces significant fines; criminal prosecutions of vessel engineers and ship operators are not uncommon. The targets of these actions have included both U.S. and non-U.S. ship operators. Of note, these prosecutions often relate to foreign-flag vessels or to incidents that occurred in international waters. The basis of U.S. prosecution for events occurring outside the United States is the presentation to the U.S. Coast Guard of false logs (usually not reporting dumping at seas accurately) when a vessel enters a U.S. port.

Although relevant statutes such as APPS and the Refuse Act of 1899 (33 U.S.C. ” 407, 411) are broadly drafted, to date under their provisions, the Department of Justice has pursued only vessel operators (including owners who actively operate), but not passive financial lessors.

What is common to these and other similar incidents is the extremely heightened sensitivity of U.S. regulatory authorities and courts to environmental transgressions involving ships. Even a passive vessel lessor should be sure that its demise charter to the operator contains adequate covenants mandating compliance with applicable laws and strong indemnity provisions. In addition, a lessor would be wise to require the lessee to have in place an adequate and complete environmental compliance plan.

However, while compliance programs are important, especially in the context of the possible reduction of the sentence of a convicted corporate defendant, such programs will not shield the corporate defendant from vicarious liability for the acts of its employees acting within the scope of their employment. A recent decision of the federal appellate court in New York illustrates the point. In United States v. Ionia Management S.A., 555 F.3d 303 (2d Cir. 2009), the criminal conviction of a vessel's managing company was affirmed. The basis for the conviction was the vicarious liability for the acts of the vessel's engineering personnel in intentionally falsifying the vessel's records pertaining to the disposal of oily waste at sea. The court held that however extensive a corporate compliance program, its existence could not shield a corporation from liability when its employees, acting within the scope of their employment, violate the law. In other words, no matter how well-written a compliance program may be, if there is a violation, the operator may well be prosecuted.

Nonetheless, a passive financial lessor neither actually nor actively involved in vessel operations is not likely to be held liable criminally for oil record-book falsification or other false records respecting operational matters. However, both because of the history of strict liability on the owner under original Oil Pollution Act of 1990 (33 U.S.C. ' 2701 et seq.) until amendments in 2004 and increasing criminalization of vessel-related environmental incidents, a financial lessor should be aware that even if an operator has in place a sound compliance program, there may be facts under which the operator will be held criminally liable.

Section 1110

Section 1110 (11 U.S.C.A. ' 1110) provides a special exemption from the automatic stay provisions of the Bankruptcy Code that permits a lessor to take possession of certain equipment not later than 60 days after the lessee files for bankruptcy unless the lessee's trustee agrees to perform the lessee's obligations and cures all pre-bankruptcy defaults within such 60-day period. This is a powerful club for lessors, and as such, Section 1110's repossession rights are central to aircraft and rail financings. Section 1110(a)(3)(A)(ii) ostensibly is applicable to U.S.-flag leased vessels by providing a stay exemption for “a vessel documented under chapter 121 of title 46 that is subject to a security interest granted by, leased to, or conditionally sold to a debtor that is a water carrier that, at the time such transaction is entered into, holds a certificate of public convenience and necessity or permit issued by the Department of Transportation.” This provision sounds seductively similar to the comparable provisions relating to aircraft and rail equipment. However, Section 1110 is a trap for the unwary insofar as it relates to vessels. This is because the holding of a “certificate of public convenience and necessity or permit” is a prerequisite to the applicability of Section 1110(a)(3)(A)(ii) by the text of Section 1110 itself, and for all practical purposes, no U.S.-flag commercial vessel holds, or can apply for and receive, such a certificate or permit.

The Department of Transportation has never been granted the authority to issue such a certificate or a permit with respect to vessels. Originally, the Interstate Commerce Commission (“ICC”) had the authority to issue certificates to operators of vessels engaged in common carriage (See 49 U.S.C. ' 10102(30) (repealed 1995)) and permits to vessels engaged in contract carriage (See 49 U.S.C. ' 10102(29) (repealed 1995)). The terminology was carried over from the railroad industry. When the ICC was terminated in 1995 and certain functions transferred to the Surface Transportation Board (“STB”), the power to issue certificates and permits to vessels was not transferred. As the shipping industry had largely been deregulated by 1995, continuing oversight such as the ICC had previously exercised was no longer thought to be necessary. The STB continues to issue certificates of public convenience and necessity for aircraft, railroads, and pipelines, but not for vessels. Even if a vessel had been issued a certificate or a permit by the ICC prior to the ICC's abolishment, such a certificate or permit would not meet the statutory test under existing Section 1110 of having been issued by the Department of Transportation. Research does not indicate any case law respecting the application of Section 1110 (or its predecessor provisions such as 11 U.S.C. ' 516(6)) to vessels, and consequently, the issue of whether a bankruptcy court would find a way to apply Section 1110 to U.S.-flag vessels appears to be a case of first impression.

As a result, no lessor should assume the powers granted by Section 1110 respecting aircraft or railcars may also be invoked by a vessel lessor. The lack of Section 1110 powers for vessel lessors is a significant factor for any lessor analyzing its position in a vessel lease financing.

Piracy

The capture and holding for ransom of vessels and their crews has become an increasing phenomenon, particularly off the Horn of Africa. For the vessel lessor, protection against resulting crew loss of life or damage to vessel or cargo will primarily depend upon the breadth of the lease indemnity running from the lessee (charterer) to the lessor. However because of the unique factual circumstances of piracy of vessels, a short discussion of the piracy risk is appropriate.

Acts of violence directed at vessels and their crews generally fall under three categories: piracy, armed robbery, and acts of terrorism. By custom and law, and as defined in Article 101 of the 1982 United Nations Convention on the Law of the Sea (“UNCLOS”), “piracy” refers to acts occurring on the high seas and such acts are limited to “any illegal acts of violence or detention, or any act of depredation committed for private ends ' ” By limiting piracy to acts “ committed for private ends,” the UNCLOS definition thus excludes acts of terrorism. Furthermore, when piratical-type acts occur within territorial waters or ports, such acts are generally considered to be criminal offenses such as armed robbery, and local law applies.

The number of recent piracy incidents has led to an increasing discussion concerning appropriate responses, including the use of armed private security personnel to defend vessels and mariners. On June 18, 2009, the U.S. Coast Guard issued Port Security Advisory 5-09, providing minimum guidelines for contracted security services on U.S.-flag commercial vessels in high-risk waters. However, on June 26, 2009, the International Maritime Organization (the “IMO”) issued a circular recommending that flag states strongly discourage the carrying and use of firearms by seamen for personal protection or for the protection of a vessel. See Piracy and Armed Robbery Against Ships: Recommendations to Governments for preventing and suppressing piracy and armed robbery against ships, MSC. 1/Circ. 1333 (26 June 2009), available at www.imo.org. The IMO circular recognizes that the use of privately contracted security companies on board vessels may lead to an escalation of violence. However, it notes that the presence on board vessels of such personnel and their weapons is subject to flag-state legislation and policies.

The experience of the Maersk Alabama in 2009 is illustrative of these issues. In April 2009, this U.S.-flag vessel was taken by pirates but ultimately was re-taken and the vessel's master rescued by naval personnel, who killed three pirates. In November 2009, pirates attempted to take this vessel again, only to be repelled by the efforts of an on-board private security team ' small arms were used by that team. Nevertheless, the debate about the use of such measures continues.

Where a vessel has been taken by pirates, complicated and protracted negotiations typically lead to the payment of ransom (usually exceeding $1 million) for the release of the vessel and crew. Despite the number of incidents, issues of insurance coverage for ransom payments and related expenses are not clear. It had been generally thought the ransom was covered by the vessel's hull policy and if not, then by its war risks policy. Yet, more than one vessel owner has been surprised to discover that, when its vessel has been captured, some underwriters have asserted policy exclusions to deny contribution to a ransom payment, let alone the associated expenses, which can be considerable.

Moreover, while there is logic in recognizing that the ransom payment and associated expenses should be part of a general average adjustment, recognition of this precept is not yet established.

As such, a prudent lessor should be proactive as far as the review of the lessee/operator's insurance cover and also consider (depending on the trading pattern of the vessel) a requirement that the operator procure kidnap and ransom (extortion) cover (which includes the service of specialized consultants) as well as additional costs cover.

From the lessor's viewpoint, costs associated with piracy, including a ransom amount, fall clearly within vessel operating risks, and, consequently, should be covered by a reasonably well-drafted but standard indemnity in favor of the lessor. Of course, if the bareboat charter contains a “hell or high water” payment clause, there should also be no diminution of charter hire payable by the lessee to the lessor because of the vessel's loss of earnings capacity while being held by pirates. Nonetheless, a prudent lessor should consider requiring that the ship operator maintain a loss of earnings insurance policy.

Note, however, that standard commercial charter provisions (which may be relevant if the lessee subleases the vessel in the commercial market) are under constant review. One recent suggestion from the respected Baltic and International Maritime Council (“BIMCO”) is to limit to 90 days the maximum charter hire payable respecting a pirate-detained vessel. If adopted in the marketplace, this new clause may have spillover effects respecting the commercial cash flow that underlies a finance charter's “hell or high water” payment obligation.

Nancy L. Hengen and James H. Hohenstein are partners in the New York office of Holland & Knight LLP. Hengen's practice focus is “big ticket” leasing and commercial vessel finance, and Hohenstein's practice focus is maritime litigation. Hengen may be reached at [email protected] or 212-513-3255. Hohenstein may be reached at [email protected] or 212-513-3213.

This article covers several vessel-leasing-related topics that have increasing prominence in today's world. The first topic highlights ship recycling issues, and the second discusses the increasing tendency to treat environmental events as criminal at both the individual and corporate levels. The third topic is a short discussion about Section 1110 of the Bankruptcy Code and why it is tantalizing to vessel lessors, but not applicable to commercial vessels. The final topic is a brief discussion about what a lessor of vessels operating in the international trade should know about piracy.

Vessel Recycling

Recycling of vessels has become an increasingly urgent environmental topic, not only in the United States, but also internationally. The public discussion generally falls into two interrelated categories: 1) safe working conditions of workers who do the actual breakup of the vessel itself and environmentally safe disposal or recycling of a vessel's constituent parts, and 2) the export of vessels containing hazardous substances from (chiefly) Western developed countries to underdeveloped countries.

The demolition of vessels at the end of their useful lives has many economically positive aspects. Anti-polluting technology, fuel efficiencies, and other desirable characteristics can be incorporated more economically into vessel newbuildings than into older vessels. Steel and other reusable materials are recycled. Demolition saves the vessel operator the expenses and risks involved in laying-up the vessel. Removing vessels from the world fleet creates demand for new vessel construction that is safer and more energy efficient with all of the economic activity that is associated with new construction, and helps regulate world charter rates for vessel cargo-carrying capacity. And of course, vessel recycling is an important job source in some geographic locations.

However, older vessels can contain many different hazardous materials including asbestos, ozone-depleting substances, polychlorinated bi-phenyls (“PCBs”), and heavy metals. South Asia ' particularly India and Bangladesh ' have been scrapping centers, and the processes used there often have been quite basic ' taking apart a vessel by hand. Health risks to workers and safe disposal of hazardous byproducts often have been ignored.

In the United States, the interplay of certain of these issues was highlighted by the desire of the U.S. Maritime Administration (“Marad”) to sell for export some of the so-called “ghost ships.” These are obsolete vessels, some built prior to 1979 when PCBs were banned in the United States in vessel construction, that were originally purchased by Marad on behalf of the United States as part of the military national defense reserve fleet. Initially in the early 1990s, Marad sought to sell several of these vessels to a demolition and recycling shipyard in the United Kingdom. Marad stripped all PCBs out of the initial group of vessels to be sold. However, the prospect of demolition and recycling in the UK was vigorously contested both in the UK and in the United States, and Marad was sued by environmental groups in the United States. Issues included unsafe disposal abroad of PCBs and other hazardous materials, and whether the rotting vessels were seaworthy enough to be towed across the Atlantic without environmental incident. While Marad ultimately prevailed in the lawsuits filed in the United States, the local British council whose consent was needed refused to permit the demolition and recycling of more than an initial group of vessels.

One consequence of the issues raised by the “ghost ships” has been increased sensitivity to properly recycling vessels in a more environmentally sensitive manner both in the United States and abroad.

The following is a current illustration of why a prudent U.S. vessel lessor should be concerned about vessel demolition. Under the U.S. Toxic Substances Control Act, 15 U.S.C.A. ' 2601 et seq. (2008), and accompanying regulations (40 C.F.R. Pt. 761 (2008)) (collectively, “TSCA”), the export of PCBs over certain concentrations for disposal outside the United States is unlawful unless covered by an exemption. Prior to 1979, PCBs were not prohibited from being used in vessel construction in the United States, and there is substantial risk that U.S.-built vessels prior to that date contain PCBs at a level that would make it unlawful to export them for demolition. The U.S. Environmental Protection Agency (“EPA”) has stepped up its enforcement activities in this area. One example is the EPA's civil administrative complaint respecting the former cruise ship Oceanic. See EPA Document No. TSCA-09-2008, Complaint and Notice of Opportunity for Hearing in the Matter of Global Shipping, LLC, and Global Marketing Systems, Inc., and related EPA News Release dated Jan. 29, 2009, available at http://epa.gov. There, the EPA alleged that the vessel contained a higher content of PCBs than the 50 ppm permitted by regulation and that the towing of the vessel out of the United States constituted a violation of TSCA's prohibition against exporting PCBs for disposal outside the United States. The shipowning entities settled EPA's objections by executing a consent agreement (filed on Jan. 28, 2009) not admitting a violation, but paying an administrative fine of $518,500.

On the international level, discussion of ship recycling by a joint working group of the International Maritime Organization, the International Labor Organization, and others over a several-year period has resulted in the May 2009 adoption of a new convention on ship recycling ' the Hong Kong International Convention for the Safe and Environmentally Sound Recycling of Ships, 2009. The United States has not adopted this new Convention, and therefore the Convention does not override U.S. laws such as TSCA. But the Convention begins to synthesize an international consensus for dealing with vessels that no longer have an economic operational use. The new convention calls for an inventory of hazardous materials to be developed for each vessel to be sent for demolition and recycling, and for the relevant ship recycling yard to create a specific recycling plan for each vessel based on that inventory.

Risk to a lessor of liability or unanticipated costs in connection with disposition of a vessel at the end of a long-term lease is an increasingly important topic for lessors. Long-term leases entered into by financing entities as lessors as recently as a few years ago may not adequately address vessel disposal issues in their text. Furthermore, the cost of disposal and recycling may not have been factored into a lessor's (or residual value holder's) calculations. Recycling costs and benefits should be factored into vessel residual values and end-of-lease options. We suggest lessors examine their end-of-lease provisions well in advance for how they address vessel demolition in the event the lessee returns the vessel to the lessor.

Criminalization

Increasingly, environmental incidents have become the basis for criminal (not just civil) prosecution of the lessee/operator as a corporate matter and of individuals having vessel operational responsibilities, primarily vessel engineers but also occasionally vessel masters. One fact pattern has emerged as a lightning rod in the past few years. This relates broadly to oil ' either the dumping of waste water containing oil residue (primarily from engine operations) not properly treated through the required oily water separator and/or falsification of entries in a vessel's oil record book. Both fact patterns constitute violations of the Act to Prevent Pollution from Ships, 33 U.S.C. ” 1901-1915 (“APPS”).

The Department of Justice routinely announces significant fines; criminal prosecutions of vessel engineers and ship operators are not uncommon. The targets of these actions have included both U.S. and non-U.S. ship operators. Of note, these prosecutions often relate to foreign-flag vessels or to incidents that occurred in international waters. The basis of U.S. prosecution for events occurring outside the United States is the presentation to the U.S. Coast Guard of false logs (usually not reporting dumping at seas accurately) when a vessel enters a U.S. port.

Although relevant statutes such as APPS and the Refuse Act of 1899 (33 U.S.C. ” 407, 411) are broadly drafted, to date under their provisions, the Department of Justice has pursued only vessel operators (including owners who actively operate), but not passive financial lessors.

What is common to these and other similar incidents is the extremely heightened sensitivity of U.S. regulatory authorities and courts to environmental transgressions involving ships. Even a passive vessel lessor should be sure that its demise charter to the operator contains adequate covenants mandating compliance with applicable laws and strong indemnity provisions. In addition, a lessor would be wise to require the lessee to have in place an adequate and complete environmental compliance plan.

However, while compliance programs are important, especially in the context of the possible reduction of the sentence of a convicted corporate defendant, such programs will not shield the corporate defendant from vicarious liability for the acts of its employees acting within the scope of their employment. A recent decision of the federal appellate court in New York illustrates the point. In United States v. Ionia Management S.A. , 555 F.3d 303 (2d Cir. 2009), the criminal conviction of a vessel's managing company was affirmed. The basis for the conviction was the vicarious liability for the acts of the vessel's engineering personnel in intentionally falsifying the vessel's records pertaining to the disposal of oily waste at sea. The court held that however extensive a corporate compliance program, its existence could not shield a corporation from liability when its employees, acting within the scope of their employment, violate the law. In other words, no matter how well-written a compliance program may be, if there is a violation, the operator may well be prosecuted.

Nonetheless, a passive financial lessor neither actually nor actively involved in vessel operations is not likely to be held liable criminally for oil record-book falsification or other false records respecting operational matters. However, both because of the history of strict liability on the owner under original Oil Pollution Act of 1990 (33 U.S.C. ' 2701 et seq.) until amendments in 2004 and increasing criminalization of vessel-related environmental incidents, a financial lessor should be aware that even if an operator has in place a sound compliance program, there may be facts under which the operator will be held criminally liable.

Section 1110

Section 1110 (11 U.S.C.A. ' 1110) provides a special exemption from the automatic stay provisions of the Bankruptcy Code that permits a lessor to take possession of certain equipment not later than 60 days after the lessee files for bankruptcy unless the lessee's trustee agrees to perform the lessee's obligations and cures all pre-bankruptcy defaults within such 60-day period. This is a powerful club for lessors, and as such, Section 1110's repossession rights are central to aircraft and rail financings. Section 1110(a)(3)(A)(ii) ostensibly is applicable to U.S.-flag leased vessels by providing a stay exemption for “a vessel documented under chapter 121 of title 46 that is subject to a security interest granted by, leased to, or conditionally sold to a debtor that is a water carrier that, at the time such transaction is entered into, holds a certificate of public convenience and necessity or permit issued by the Department of Transportation.” This provision sounds seductively similar to the comparable provisions relating to aircraft and rail equipment. However, Section 1110 is a trap for the unwary insofar as it relates to vessels. This is because the holding of a “certificate of public convenience and necessity or permit” is a prerequisite to the applicability of Section 1110(a)(3)(A)(ii) by the text of Section 1110 itself, and for all practical purposes, no U.S.-flag commercial vessel holds, or can apply for and receive, such a certificate or permit.

The Department of Transportation has never been granted the authority to issue such a certificate or a permit with respect to vessels. Originally, the Interstate Commerce Commission (“ICC”) had the authority to issue certificates to operators of vessels engaged in common carriage (See 49 U.S.C. ' 10102(30) (repealed 1995)) and permits to vessels engaged in contract carriage (See 49 U.S.C. ' 10102(29) (repealed 1995)). The terminology was carried over from the railroad industry. When the ICC was terminated in 1995 and certain functions transferred to the Surface Transportation Board (“STB”), the power to issue certificates and permits to vessels was not transferred. As the shipping industry had largely been deregulated by 1995, continuing oversight such as the ICC had previously exercised was no longer thought to be necessary. The STB continues to issue certificates of public convenience and necessity for aircraft, railroads, and pipelines, but not for vessels. Even if a vessel had been issued a certificate or a permit by the ICC prior to the ICC's abolishment, such a certificate or permit would not meet the statutory test under existing Section 1110 of having been issued by the Department of Transportation. Research does not indicate any case law respecting the application of Section 1110 (or its predecessor provisions such as 11 U.S.C. ' 516(6)) to vessels, and consequently, the issue of whether a bankruptcy court would find a way to apply Section 1110 to U.S.-flag vessels appears to be a case of first impression.

As a result, no lessor should assume the powers granted by Section 1110 respecting aircraft or railcars may also be invoked by a vessel lessor. The lack of Section 1110 powers for vessel lessors is a significant factor for any lessor analyzing its position in a vessel lease financing.

Piracy

The capture and holding for ransom of vessels and their crews has become an increasing phenomenon, particularly off the Horn of Africa. For the vessel lessor, protection against resulting crew loss of life or damage to vessel or cargo will primarily depend upon the breadth of the lease indemnity running from the lessee (charterer) to the lessor. However because of the unique factual circumstances of piracy of vessels, a short discussion of the piracy risk is appropriate.

Acts of violence directed at vessels and their crews generally fall under three categories: piracy, armed robbery, and acts of terrorism. By custom and law, and as defined in Article 101 of the 1982 United Nations Convention on the Law of the Sea (“UNCLOS”), “piracy” refers to acts occurring on the high seas and such acts are limited to “any illegal acts of violence or detention, or any act of depredation committed for private ends ' ” By limiting piracy to acts “ committed for private ends,” the UNCLOS definition thus excludes acts of terrorism. Furthermore, when piratical-type acts occur within territorial waters or ports, such acts are generally considered to be criminal offenses such as armed robbery, and local law applies.

The number of recent piracy incidents has led to an increasing discussion concerning appropriate responses, including the use of armed private security personnel to defend vessels and mariners. On June 18, 2009, the U.S. Coast Guard issued Port Security Advisory 5-09, providing minimum guidelines for contracted security services on U.S.-flag commercial vessels in high-risk waters. However, on June 26, 2009, the International Maritime Organization (the “IMO”) issued a circular recommending that flag states strongly discourage the carrying and use of firearms by seamen for personal protection or for the protection of a vessel. See Piracy and Armed Robbery Against Ships: Recommendations to Governments for preventing and suppressing piracy and armed robbery against ships, MSC. 1/Circ. 1333 (26 June 2009), available at www.imo.org. The IMO circular recognizes that the use of privately contracted security companies on board vessels may lead to an escalation of violence. However, it notes that the presence on board vessels of such personnel and their weapons is subject to flag-state legislation and policies.

The experience of the Maersk Alabama in 2009 is illustrative of these issues. In April 2009, this U.S.-flag vessel was taken by pirates but ultimately was re-taken and the vessel's master rescued by naval personnel, who killed three pirates. In November 2009, pirates attempted to take this vessel again, only to be repelled by the efforts of an on-board private security team ' small arms were used by that team. Nevertheless, the debate about the use of such measures continues.

Where a vessel has been taken by pirates, complicated and protracted negotiations typically lead to the payment of ransom (usually exceeding $1 million) for the release of the vessel and crew. Despite the number of incidents, issues of insurance coverage for ransom payments and related expenses are not clear. It had been generally thought the ransom was covered by the vessel's hull policy and if not, then by its war risks policy. Yet, more than one vessel owner has been surprised to discover that, when its vessel has been captured, some underwriters have asserted policy exclusions to deny contribution to a ransom payment, let alone the associated expenses, which can be considerable.

Moreover, while there is logic in recognizing that the ransom payment and associated expenses should be part of a general average adjustment, recognition of this precept is not yet established.

As such, a prudent lessor should be proactive as far as the review of the lessee/operator's insurance cover and also consider (depending on the trading pattern of the vessel) a requirement that the operator procure kidnap and ransom (extortion) cover (which includes the service of specialized consultants) as well as additional costs cover.

From the lessor's viewpoint, costs associated with piracy, including a ransom amount, fall clearly within vessel operating risks, and, consequently, should be covered by a reasonably well-drafted but standard indemnity in favor of the lessor. Of course, if the bareboat charter contains a “hell or high water” payment clause, there should also be no diminution of charter hire payable by the lessee to the lessor because of the vessel's loss of earnings capacity while being held by pirates. Nonetheless, a prudent lessor should consider requiring that the ship operator maintain a loss of earnings insurance policy.

Note, however, that standard commercial charter provisions (which may be relevant if the lessee subleases the vessel in the commercial market) are under constant review. One recent suggestion from the respected Baltic and International Maritime Council (“BIMCO”) is to limit to 90 days the maximum charter hire payable respecting a pirate-detained vessel. If adopted in the marketplace, this new clause may have spillover effects respecting the commercial cash flow that underlies a finance charter's “hell or high water” payment obligation.

Nancy L. Hengen and James H. Hohenstein are partners in the New York office of Holland & Knight LLP. Hengen's practice focus is “big ticket” leasing and commercial vessel finance, and Hohenstein's practice focus is maritime litigation. Hengen may be reached at [email protected] or 212-513-3255. Hohenstein may be reached at [email protected] or 212-513-3213.