Creditor v. liquidator – The conflict between the enforcement of maritime claims and cross-border insolvency procedures in the US and South Africa
Conflicts arise when well-established maritime law rights to enforce claims, by way of procedures such as ship arrest or Rule B attachment, are exercised where a defendant company has sought, or is about to seek, protection from its creditors through the courts in bankruptcy or rehabilitation proceedings. Gard News examines this conflict and reviews and contrasts the positions in the US and South Africa.
Tough operating conditions in recent years, due to a combination of globally declining trade volumes, an oversupply of available tonnage and high bunker and operating costs, have resulted in financial hardship for many companies in the shipping industry. There is, as a result, certainly a heightened risk of counterparty default in these market conditions. By way of stark reminder of these default risks, there have also been a number of high profile insolvencies or instances where court protection from creditors has been sought.
Creditor v. liquidator
The focus of many of these recent high profile cases in the shipping industry has been on the rehabilitation of the insolvent company by restructuring its debt. So, where the company has been facing severe cash flow issues, this process enables it to reduce and re-negotiate its delinquent debts to improve and restore liquidity whilst it continues to trade. Where the insolvent company has obtained such court protection, then its individual creditors are for the most part compelled to take part in the proceedings often receiving far less than they are owed.
Maritime laws by contrast are often creditor-friendly. They recognise the difficulties that creditors in the shipping industry face in enforcing their claims where often the only asset of a debtor is a single ship, bunkers or a bank account. Maritime laws are therefore frequently focused on assisting the individual creditor to secure or enforce their claims. Many jurisdictions have well-established procedures which allow maritime creditors to secure their claims relatively easily and before liability has been determined. The most common ways of enforcing maritime claims are by way of ship arrests or the attachment of property.
Given the difference in focus between maritime and international insolvency laws, it is easy to see how conflicts arise where a creditor might try to enforce claims in one jurisdiction by exercising established maritime rights of arrest or attachment, but the debtor company has entered a court-sanctioned administration elsewhere. Where a ship has been arrested or property attached, then, in practice, it can work against the international insolvency law principles of protecting the debtor and not giving particular creditors priority.
The UNCITRAL Model Law on Cross Border Insolvency
Due to the globalisation of markets over the last 20-30 years, there has been a need to address and co-ordinate cross-border insolvency issues internationally. The UNCITRAL Model Law on Cross Border Insolvency1 is intended to do just that. UNCITRAL says:
“It is designed to assist states to equip their insolvency laws with a modern legal framework to more effectively address cross-border insolvency proceedings concerning debtors experiencing severe financial distress or insolvency”.2
However, local legislators have been slow to act. To date, roughly only 20 countries world-wide have adopted the Model Law. These include the US, UK, Poland, Japan, Korea, South Africa and Australia.
Some adopting countries have not adopted the Model Law in full or have adopted it with certain modifications, whilst others, such as South Africa, have yet to implement it fully in their local laws. Notable absences from adoption include preferred ship arrest jurisdictions such as Singapore and Hong Kong, and the EU states (with the exceptions of the UK and Poland).3
The US is a good example of a country that has implemented the UNCITRAL Model Law on Cross Border Insolvency into its local laws and where this is operating relatively successfully alongside pre-existing maritime laws. South Africa, a jurisdiction well known for its liberal ship arrest laws favouring creditors, has yet to fully implement the Model Law into its local laws. Gard News reviews and contrasts the positions in these jurisdictions.
The US: Chapter 15 provides some certainty in cross-border insolvency cases (…but what about the creditors?)
Cross-border insolvency issues in the US are effectively handled by Chapter 15.4 This was added to the US Bankruptcy Code in 2005 and gives effect in turn to the UNCITRAL Model Law on Cross Border Insolvency.
The purpose of Chapter 15 is to effectively handle cross-border insolvency matters. It is typically invoked by a foreign representative of a foreign reorganisation or liquidation proceeding in order to obtain the assistance of the US courts to protect the interests of the creditors and the debtor in those proceedings. They are ancillary proceedings requesting recognition of “foreign main proceedings” or “foreign non-main proceedings”.
Where foreign proceedings are recognised by the US bankruptcy courts, Chapter 15 provides a mechanism which enables the foreign liquidator or representative to gain control over the assets of a non-US debtor that are located in the US. Provided that the proceedings in the non-US jurisdiction are considered to be “foreign main proceedings”, a stay in respect of any US bankruptcy proceedings could be obtained.
Chapter 15 is therefore aimed at achieving greater co-ordination between jurisdictions and will allow the debtor company’s global assets to be brought under the legal framework of one jurisdiction.
However, there is still a tension between the operation of Chapter 15 and US maritime laws, in that, prior to their recognition in the US courts, the mere existence of foreign bankruptcy proceedings does not in itself provide protection from an arrest or attachment of property in the US.
The recognition of foreign insolvencies is not automatic. Objections may be raised by the debtor, creditors or others. However, the US courts retain a strong discretion to decide. In some instances, the US courts have been known to refuse to recognise the foreign proceedings even though no objections have been raised.
However, after notice and a hearing, the US courts may recognise the foreign insolvency proceedings. Once recognised, the foreign representative will have full access to the US courts and the interests of the debtor, including rights to participate in proceedings or litigation where the debtor may have an interest. Full access to the US courts also means that the foreign representative will be able to take advantage of the liberal discovery tools available in the US.
If a vessel has been arrested, and even if a foreclosure sale has been scheduled, the filing of a subsequent Chapter 15 petition will not automatically cancel the sale. However, the US courts retain a strong discretion and may be persuaded to provide injunctive relief, postponing the sale, while the petition is pending. If the court has had its hearing and has decided to recognise the foreign proceedings, then the sale will be cancelled and the vessel (asset) will be considered part of the bankruptcy estate.
South Africa: Section 10 of the AJRA means that the individual arresting creditor is still king (…but only if they act first)
Whilst South Africa is a signatory to the UNCITRAL Model Law on Cross Border Insolvency and has enacted the Cross Border Insolvency Act 42 of 2000,5 it has not designated any countries under the Model Law or the Act whose insolvency or bankruptcy orders would be reciprocally recognised in South Africa.
So, the South African Cross Border Insolvency Act itself is of no practical assistance to a party wishing to enforce a foreign bankruptcy order, to apply a debt standstill or an automatic stay of proceedings worldwide.6
Under South African common law, the liquidation, judicial management, debt standstill, reorganisation or any other similar order in respect of a foreign-registered company, has no judicial status in itself. The mere existence of these types of foreign proceedings is therefore not a bar per se to the arrest or attachment of vessels either under the South African Admiralty Act7 or under parochial (non-Admiralty) procedure.
Equally, foreign liquidators (or similar representatives) have no inherent legal standing under South African law. This means that they can not take possession of moveable property within South Africa even though it belongs to an insolvent company which they represent, nor can they sue or defend actions on behalf of the foreign insolvent company in the South African courts. That is, unless the foreign liquidators concerned have first applied to the South African courts for the recognition and acknowledgement of the powers vested in them under the relevant foreign bankruptcy (or similar) law.
Where applications for recognition have been made by foreign liquidators to the South African courts in parochial non-Admiralty cases, the courts, in recognising the powers of foreign liquidators, have taken into account issues such as the comity of nations, convenience and equity. The South African courts have, however, tended to apply the law inconsistently. This has resulted in uncertainty for parties interested in such applications in the South African parochial courts.
However, maritime creditors in South Africa are afforded special protection in respect of the arrest and judicial sale of maritime moveables, such as a ship or cargo. Section 10 of the South African Admiralty Act 105 of 1983 (AJRA) provides that:
“Any property arrested in respect of a maritime claim or any security given in respect of any property, or the proceeds of any property sold in execution or under an order of a court in the exercise of its admiralty jurisdiction, shall not… vest in a trustee in insolvency and shall not form part of the assets to be administered by a liquidator or judicial manager of the owner of the property or of any other person who might otherwise be entitled to such property, security or proceeds, and no proceedings in respect of such property, security or proceeds, or the claim in respect of which that property was arrested, shall be stayed by or by reason of any sequestration, winding-up or judicial management with respect to that owner or person.”
The effect of Section 10 is such that, where a vessel has been arrested before the commencement of the liquidation, judicial management or insolvency proceedings, the property under arrest falls outside the administered/insolvent estate. Similarly, under Section 10, if a vessel has been arrested in South Africa before an application is brought for the recognition of a foreign liquidator or representative, it will be excluded from the insolvent estate as well.
There have until fairly recently been no reported or known instances of orders being given by the South African courts generally prohibiting the arrest of vessels or the attachment of property in advance of those vessels calling in South Africa.
However, since 2011, there have been two significant South African maritime cases developing the position:
(i) KLC’s receiver’s 2011 order
In 2011 the joint receivers in the estate of Korea Line Corporation (KLC), approached the KwaZulu-Natal High Court in Durban for recognition as the duly appointed receivers (in terms of the laws of the Republic of Korea) and in effect an interdict against anyone arresting KLC assets in South Africa.
The order was granted on terms and was served on one known creditor8 in Richards Bay and published in two daily newspapers. It was not challenged by the various creditors of KLC who might otherwise have arrested vessels to obtain security or enforce arbitration awards previously obtained.
As such, the order stood as a sort of non-binding precedent, even though there were those in the South African legal fraternity at the time that believed that it had a number of aspects which could have been distinguished, challenged or opposed.
(ii) OSG’s 2012 order
In December 2012 another ex parte application was brought in the Kwazulu Natal High Court in Durban, Overseas Shipholding Group Inc. (OSG) and 180 associated and allied entities sought and were granted an order recognising an order granted by the US Bankruptcy Court in Delaware the previous month.
The order was significant in its effect as it not only stated that the provisions of the US (Chapter 11) order, and in particular the automatic stay and related provisions contained in Section 362 of the US Bankruptcy Code, would apply and be of full force and effect, but that they would apply throughout South Africa, not only in the Kwazulu Natal Division (which in itself is unique).
So, the order granted a stay against the commencement or continuation of any proceedings, including an interdict against any attachment of moveable property or the arrest of any OSG vessels in South Africa. The order was served on all Registrars of the South African courts of the various divisions and it was advertised in various newspapers.
The order, which so far has remained unchallenged, sets a precedent for the recognition of US bankruptcy orders in South Africa. However, it also establishes for the first time in South Africa the precedent that the insolvent themselves may apply and obtain such an order where no liquidator or representative has yet been appointed.
The KLC and OSG cases do represent significant developments in South African insolvency law. However, the orders were obtained prior to the arrest of any KLC/OSG vessels in South Africa.
These precedents therefore co-exist with, and most likely do not displace, the provisions of Section 10 of the South African Admiralty Act. It therefore remains possible for creditors to take advantage of the special protection offered by Section 10 if they can arrest a vessel prior to any application for an order.
Many of the issues in relation to the US and South Africa described in the paragraphs above also apply to other jurisdictions world-wide. As the shipping crisis continues with no immediate relief in sight, the cash reserves of many shipping companies are being squeezed. There is speculation in the market that if the lending banks, in particular, do start to take more aggressive enforcement action against defaulters, further insolvencies are inevitable.
Against this background, cross-border insolvency regimes throughout the world continue to evolve. However, even though the trend in some jurisdictions, such as the US and the EU member states, is towards greater co-ordination of insolvency regimes, a tension remains between insolvency and maritime laws and there is still considerable scope for creditors and shipping companies to “forum shop” for a jurisdiction which best suits their needs.
The choice of jurisdiction affecting the outcome of the battle between creditors and liquidators may then ultimately be left to the party who acts first.
We are grateful to Shane Dwyer of Shepstone & Wylie for his assistance in preparing the portions of this article dealing with South African law.
1 Adopted by the United Nations Commission on International Trade Law on 30th May 1997.
2 See www.uncitral.org.
3 The EU countries are bound by the EC Regulation on Insolvency Proceedings No 1346/2000 of 29 May 2000. These are of similar effect in many respects to the UNCITRAL Model Law on Cross Border Insolvency.
4 Chapter 15, Title 11, United States Code.
5 Which came into effect during 2003.
6 There is legislation recently passed (the new Companies Act and the Business Rescue regime it introduced) which has provisions equivalent to a debt standstill or automatic stay, but these provisions relate solely to South African companies.
7 The Admiralty Jurisdiction Regulation Act 105 of 1983.
8 A ships agency that was owed a nominal amount.
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