Ship Building Sale and Finance

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Lease finance and demise charters – lessors' risks and liabilities

Lease finance and demise charters – lessors' risks and liabilities

Professor Simon Baughen

12.1 Introduction

An alternative to financing the purchase of a ship by a loan secured by a mortgage is through lease financing. This will generally be used for tax reasons whereby the lender can obtain the benefit of capital allowances on the vessel and is thereby able to reduce the cost of the loan.2 Under UK taxation rules this was possible for finance leases entered into prior to 1 April 2006 unless there was an option for the borrower to purchase the vessel before the end of the loan.3 The new rules which apply to leases entered into on or after 1 April 2006 allocate capital allowances under long funding leases to the lessee, not the lessor, so that long funding lessors are taxed in a similar way to which the way in which they would have been taxed had they made a loan, and long funding lessees in a way that is similar to the way in which they would be taxed had they purchased the asset.4 Under a finance lease, legal title to the vessel being bought will be transferred to the lender who will then execute a bareboat charter to the borrower for the term of the loan.5 This will transfer possession of the vessel for the term of the charter to the borrower, who will crew the vessel. The lender’s primary security will be its ownership of the vessel, although this will be supplemented by guarantees from various parties associated with the borrower.

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The bareboat charter will reflect the fact that this is a conditional sale. Loan repayments will be made through payments of hire throughout the life of the charter at the end of which the borrower will obtain ownership of the vessel. Alternatively, a ship may, upon expiry of the financing charter, be scrapped or disposed of at her then current scrap or market value or at a price driven by tax considerations. The charter may include an option to acquire ownership before the end of the charter term. It may also provide the lender with a right to mortgage the vessel to obtain additional finance, together with an assignment of the ship’s earnings, insurances and requisition compensation as security for any loan that the owners take, subject to a direct undertaking from the mortgagee bank that they will allow the charterers quiet enjoyment of the vessel. The owners will usually be given the express right to sell or otherwise transfer their rights in the ship together with the charter to a third party provided that, in so doing, they do not increase the charterers’ obligations. The charter may also provide for a set fee to be paid on termination reflecting the remaining hire instalments due under the charter, discounted for early payment, and providing that on sale of the vessel any excess over this sum is to be paid to the charterers as a refund or rebate of rental.

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