The Red Sea crisis will bring ship finance arrangements sharply into focus, according to lawyer Amy Lindemann.
Drone and rocket attacks by Yemen’s Houthi militia have forced an increasing number of ships to reroute away from the Red Sea, while some war risk insurers have sent rates skyrocketing and introduced exclusion clauses for US and UK-related ships.
The crisis has raised concerns over ship financing and insurance terms.
In the most extreme circumstances, financiers could even use the crisis to withdraw funding, warned Lindemann, managing associate at UK firm Campbell Johnston Clark.
Financiers — perhaps already looking for grounds to withdraw investment — could claim that the risks in the Red Sea, and the increased cost of rerouting vessels, constitute a “material adverse effect” on the business of the borrower or its wider group, giving rise to a right to accelerate and terminate the financing.
“While unlikely, prudent shipowners will want to be alive to the small print in their loan documentation,” she said.
The threat of hijacking is an issue for ships trading through the region.
The hijacking of the 5,100-ceu Galaxy Leader (built 2002) in November by Houthi rebels has raised the key issue of whether such an incident represents a total loss and would require the owner to immediately prepay outstanding debt on the vessel.
Lenders will want to see loans prepaid immediately, while owners will want to secure a payout from insurers first.
“From the financier’s perspective, the obligation to prepay should arise as soon as possible following a hijacking,” Lindemann said.
“The mortgage over the vessel will be worthless while the vessel is in the hands of hijackers and it is impossible to exercise any right of enforcement.”
Whether a hijacked ship is considered a total loss, and the length of time a shipowner will have to wait before a total loss claim is met, will depend on the terms of its insurance contract. But it could run as long as 12 months without the use of the vessel.
Financially ruinous
It could be “financially ruinous” to prepay loans, she suggests, without first being paid by insurers.
The compromise could be met if financiers agree to accept additional security, such as a mortgage over another group vessel until insurers pay out or the vessel is released.
Financiers will be keen to keep an eye on the insurance terms of ships and could call for additional reports to ensure cover is “robust”.
Finance terms could require the shipowner to notify the lender when it enters a war zone and may require additional insurance.
“Notification obligations will arise,” Lindemann said. “At the least, these will include the obligation to notify the financier of any event which will, or is likely to, give rise to a major casualty.”
She believes the Red Sea crisis will have ramifications for the ship finance market. With lenders keen to ensure the right insurance cover and terms, it could lead to “complex negotiations with owners”.
