Mr. Lianjun Li is a solicitor admitted in Hong Kong, England and Wales and a partner at Richards Butler in association with Reed Smith LLP, a well-known international law firm.  Mr. Li has been working in the areas of international trade law, shipping law, admiralty law, ship’s sale and purchase, ship finance, arbitration and dispute resolution.  Mr. Li is a fellow of Chartered Institute of Arbitrators, a Panel  Arbitrator of China Maritime Arbitration Commission and China International Economic and Trade Arbitration Commission. He is also a Council Member of the China Maritime Law Association and a visiting professor to Dalian Maritime University.  Mr. Li has been instructed by some major trading and shipping clients in dispute resolution and non-contentious matters.  His clients include major P&I Clubs, traders, banks, shipping and chartering companies.  Mr. Li has written articles in various legal journals or publications.  He also regularly speaks in the seminars or conferences.
Mr. Peter Lee was admitted as a solicitor in Hong Kong in 2003 and in England & Wales in 2008. His primary experience is in non-contentious shipping transactions, including extensive experience in acting for shipowners (in particular Chinese shipowners) in sale and purchase and financing of second-hand tonnage and newbuildings, as well as advising shipowners, builders and banks on shipbuilding contracts and refund guarantees. Peter also has experience in other syndicated secured and unsecured lending and asset financing transactions, acting for banks and financial institutions, borrowers, project companies and investors in Hong Kong, mainland China and throughout Asia.

SHIPBUILDING CONTRACTS & NEWBUILDING VESSEL

Note: This presentation has been prepared for reference only. The information contained in this presentation should not form the basis of any decision as to a particular cause of action, nor should it be relied upon as legal advice or regarded as a substitute for detailed advice in individual cases.  If advice concerning individual problems or expert assistance is required, it is strongly recommended that professional advice be sought.

INTRODUCTION
Nowadays, most shipowners require financing institutions to provide financing for the pre-delivery instalments of the contract price of newbuilding vessels.  Financing institutions (in particular their credit committee), as always and as in any other types of financing transactions, require or expect both the shipbuilding contract and the financing documentation to be of a particular form and substance before credit approval would be granted.
This paper intends to provide an overview of the nature, form and main terms of the shipbuilding contracts and financing documents as generally accepted by international financing institutions.  The last part of this paper is a discussion on a particular financing structure for newbuilding vessels where bank refund guarantees and payment guarantees are not available.

PART I. SHIPBUILDING CONTRACTS
1. Nature of Shipbuilding Contract
Subject to the terms of individual contract, the general position under Hong Kong law and English law is that a shipbuilding contract is:-
A. primarily an agreement for sale and purchase of goods…
A shipbuilding contract provides for the sale and delivery of a vessel to the buyer upon her completion.  In most cases, the terms provide that title of the vessel would only be transferred to the buyer at the time of delivery and therefore this is usually classified as sale of future goods.
B. …with characteristics of a construction contract for supply of workmanship, service and materials
Apart from the sale, purchase and delivery of a vessel, the seller of a shipbuilding contract will also undertake to perform a manufacturing process for which the buyer is entitled to supervise, inspect and participate (cf. agreement for sale of second hand tonnage).  Please see below sections regarding the shipbuilding process and the buyer’s rights to supervise and inspect.
C. an “agreement to sell” under Sale of Goods Act 1979 and Sale of Goods Ordinance (Cap. 26)
Subject to satisfying the conditions thereunder and the governing laws, a shipbuilding contract would be governed by the rules and principles under the Sale of Goods Act 1979 and Sale of Goods Ordinance (Cap. 26), e.g. the rules regarding sale of goods by description.
D. a “maritime contract” that falls within the admiralty jurisdiction
(i) in England under s. 20(2)(n) of the Supreme Court Act 1981
(ii) in Hong Kong under s. 12A (2)(m) of the High Court Ordinance (Cap. 4)
One major implication for being a maritime contract is whether the shipyard is entitled to take admiralty actions under the relevant jurisdictions, such as arrest of the buyer’s vessel(s).  This right of the shipyard is, on the other hand, a risk from the buyer’s financing bank’s point of view.
E. an agreement which should comply with maritime conventions, the laws and rules of the flag state, port states and classification societies.
An ocean going vessel cannot trade unless she complies with the applicable maritime conventions, as well as the laws and rules of the flag state, port states and classification societies.  Certain aspects of those conventions, laws and rules relate directly to the design and structure of a vessel which is impossible to be altered after a vessel is built.  These include, without limitation:-
- SOLAS (The International Convention for Safety of Life at Sea)
- MARPOL (The International Convention for the Prevention of Pollution from Ships)
- Common Structural Rules of IACS (primarily for bulk carriers and tankers)
- Load Lines Convention 1966
- Tonnage Convention 1969
- COLREG 1972 (The International Convention for the Prevention of Collisions at Sea 1972)
- rules regarding mandatory use of pilots and tug boat in certain trading ports
Not only that a vessel’s compliance with these conventions, laws and rules would be audited and enforced by the port states, flag state and classification societies (with sanctions and fines to follow in case of non-compliance), it would also be looked upon and required by the vessel’s financing bank and insurance companies.  This again is a factor for which the buyer’s financing bank would consider when assessing the risk of the shipbuilding project and the pricing and maturity period of the loan.
2. Major Standard Form of Shipbuilding Contract
There are a number of well-known forms of shipbuilding contracts, namely:-
A. SAJ (Shipbuilders’ Association of Japan) standard form shipbuilding contract of 1974;
B. AWES (Association of European Shipbuilders and Shiprepairers) standard form shipbuilding contract of 1999; and
C. BIMCO (the Baltic and International Maritime Council) NEWBUILDCON 2008 (standard newbuilding contract).
In general, all of these forms are acceptable to international financial institutions.
3. Major parties involved in the construction of a newbuilding vessel
In most cases, a shipbuilding project would involve many parties and the financing bank would require specific representations, warranties and events of default provisions to address the operational risk and credit risk as may be imposed by these parties upon the shipbuilding project.
A. Shipyard

The place of incorporation of the shipyard would determine how and where the pre-delivery security (e.g. assignment of shipbuilding contract) should be structured, registered and, when necessary, enforced.  This is an element which a buyer’s financing bank would take into account when assessing the commercial and legal risk of the financing transaction, as well as the choice of the governing laws of the relevant pre-delivery security documents.
B. Buyer
It is usually a special vehicle company nominated by the original buyer (usually the parent company) as the ultimate buyer under the shipbuilding contract.  The laws of the place of incorporation of the buyer is the foundation of the buyer’s legal existence, which would determine how and where the financing documents (e.g. the loan agreement and the share mortgage) should be structured, registered and, when necessary, enforced.  This is an element which a buyers’ financing bank would take into account when assessing the commercial and legal risk of the financing transaction and it is also relevant to the choice of flag state of the vessel and the governing laws of the relevant financing documents.
C. Shipyard’s trading agent
A trading agent is usually acting as a co-seller in the project and would be responsible for handling the commercial, import/export, banking and foreign exchange matters for the shipyard, as well as applying for refund guarantees.  The participation of trading agent is quite common in newbuilding projects in the PRC or in countries where there are stringent control in import/export trade or foreign exchange.  Similar to the position of the shipyard, the place of incorporation of the shipyard’s trading agent would affect the legal risk of the financing transaction.
D. Classification society / Class Surveyor
E. Buyer’s supervisor / manager
F. Designer / naval architect
G. Shipyard’s supplier, in particular, the engine maker (cf. aircraft manufacturing) and loading gear supplier
H. Suppliers for buyer’s equipments (cf. “BFE” in aircraft manufacturing)
I. Shipyard’s sub-contractors
J. The financing bank / refund guarantor of the shipyard / trading agent
K. The financing bank / payment guarantors of the buyer
L. Insurance companies (for shipyard and for buyer) and
M. Flag state of the buyer and "flag state of the shipyard"
4. Major construction stages
Subject to the type of vessel being constructed, the major stages in the construction of a newbuilding vessel are as follow, according to which the drawdown period, the drawdown amount and the security arrangement under the financing documents would need to match.
 A. Design (pre-signing)
 B. Arrival of buyer’s supervisor at the shipyard / approval of plans and drawings
 C. Commencement of construction - steel cutting
 D. Setting up the moulding bed and fabrication of section blocks

 E. Keel laying
Traditionally, the keel is a large beam or skeleton around which the hull of a ship  is built. The keel runs in the middle of the ship, from the bow to the stern, and serves as the foundation or spine of the structure, providing the major source of structural strength of the hull.

The keel is generally the first part of a ship’s hull to be constructed and laying the keel traditionally means placing the keel in the construction site or in the drydock  (graving dock or floating dock) in which the ship will be built.
However, modern ships are now largely built in a series of pre-fabricated, complete hull sections rather than being built around a single structural keel.  Hence, the concept of "keel-laying" in a modern shipbuilding could be quite different from the traditional concept and could mean merely the laying of the first hull section in the building site.
F. Assembly of section blocks (subject to vessel type)

G. Launching*  (sometimes together with naming/christening ceremony)
This generally means conveying a newbuilding vessel from the building site into water.
H. completion of superstructure  and installation of equipments
I. sea trial
J. arrival and installation of the usual buyer’s supplied items in the shipyard
K. delivery*
5. Major technical documents
There are many technical documents in a shipbuilding project.  Some of the following form part of the shipbuilding contract and are usually assigned as security in favour of the buyer’s financing bank as well:-
A. Specifications
- Hull Specification
- Machinery Specification
- Electric Specification
- Paint Specification
B. Maker List - setting out the suppliers for major equipments
C. General Arrangement Plan
D. Midship Section Plan
E. Plans and drawings - including “working” drawings subject to approval by the buyer’s supervisor on site
F. “Technical Memorandum” and “Tripartite Agreement” - including agreements between the shipyard, the buyers and the Class/the supplier
G. Type Approval by classification society (in respect of equipments and materials)
H. Sea Trial Report
I. Technical Protocols (to be executed between shipyard and buyer)
J. Technical Certificates (to be issued by Class and Flag State)
6. Overview of major terms of the SAJ Form and its variations
A. General
While some provisions in a shipbuilding contract are purely technical (e.g. the Specifications) and some are purely commercial (e.g. payment terms), most terms of a shipbuilding contract are combinations of technical and commercial issues (e.g. adjustment of contract price and delivery date due to change in technical rules) and any change to the so-called “purely commercial terms” may sometimes result in serious implications on technical side of the newbuilding project.
 Therefore, the negotiation or amendment of any shipbuilding contracts, as in the negotiations of any other shipping contracts or contracts for other tangible assets like real property and aircraft, will require the participation and communication between the technical team, the commercial team, the legal advisors, the accountants and the tax advisors.  Similarly, when assessing the financing bank’s potential exposure before credit approval is granted, the buyer’s financing bank will require the relevant technical, commercial, legal, accounting and tax experts to participate.
The headings used in this section briefly follow the article headings customarily adopted for SAJ Form shipbuilding contracts.  However please note that it is rather uncommon for shipbuilding contracts nowadays to strictly follow the original SAJ Form and most of them are variations of the original (cf. the use of NSF 93 in secondhand tonnage).
B. Description / Principal Particulars and Dimensions
While detailed specifications would be set out in the Specifications (which by definition would include Maker List and the major plans), details of the hull number, major dimensions and equipments (e.g. main engines, cranes) would be set out in the main text of the shipbuilding contract.
C. Class, Rules and Regulations
This section provides that the newbuilding shall meet the standards of a particular classification society and shall be designated with class notation reflecting the major specifications of the newbuilding, as well as other rules and regulations and conventions that are applicable to the constructions of the newbuilding vessel.
D. Guaranteed Performance Standard
Under SAJ Form, a shipyard would provide warranty or “guarantee” on the following technical performance standards of the newbuilding that would have major impacts on the trading and commercial value and profit-making ability of the vessel:-
(i) Guaranteed Deadweight - This directly reflects the amount of cargo a vessel could carry and thus her ability to generate revenue. Please note the relevant technical assumptions.
(ii) Guaranteed Speed - Under this clause the shipyard warrants the speed of the vessel, which would also affect her ability to generate revenue.  Please note the relevant technical assumptions.
(iii) Guaranteed Fuel Consumption - Under this clause the shipyard warrants the fuel consumption rate of the main engine, which is the major expenses in the operation of a vessel.  Please note the relevant technical assumptions.  There is usually a corresponding warranty by the engine maker in favour of the shipyard under the engine purchase contract.
(iv) Other Guaranteed Technical Performance Standards - these could be warranty regarding the TEUs capacity (for container ships), cubic capacity (for chemical tankers) or noise and vibrations level in cabins and public area (for cruise ships and passenger ferry).
E. Payment

Most shipbuilding contract would provide that the contract price shall be adjusted upward or downward upon:-
(i) delay or early delivery - however, please note that the contract price will not be reduced if delays are under the category of "permissible delay"
(ii) the actual deadweight or cargo carrying capacity being different from the guaranteed amount
(iii) the actual speed at sea trial being different from the guaranteed speed
(iv) the actual fuel consumption rate as tested during shop test being different from the guaranteed fuel consumption rate
(v) modifications of Specifications
(vi) fluctuation in exchange rate.
G. Cancellation by buyer and repayment

A shipbuilding contract usually would specifically provide that the buyer shall have the right to cancel the contract upon the occurrence of the following events, upon which the builder is obliged to refund any instalments paid plus interest and return the buyer’s supplied items:-
(i) total loss of the vessel prior to delivery
(ii) material delay
Subject to negotiation, "material" could range from 180 days to 300 days after the contractually agreed delivery date.  In certain shipbuilding contracts, delays under the category of permissible delay would not be counted towards material delay. 
(iii) material deficiency in speed (as demonstrated in sea trial)
(iv) excessive fuel consumption (as demonstrated in shop test)
(v) material deficiency in the actual deadweight
(vi) the winding up of / occurrence of credit events upon the shipyard / shipyard’s trading agent
Subject to the terms of the contract, according to certain authority, such cancellation clause does not necessarily exclude the buyer’s other rights under common laws to terminate the shipbuilding contracts, nor the buyer’s right to seek remedies under common laws following such termination .
The drawdown period, maturity period, security arrangement and the mandatory prepayment provisions (or sometimes events of default provisions) under the financing documents must take into account the precise definition and possible timing of these cancellation events.
H. Refund guarantee and Payment Guarantee
In light of the usual payment terms, during the construction period, the buyer of a newbuilding vessel would take on the credit risk and the performance risk of the shipyard.  To address the issue, apart from the shipyard’s own undertaking to refund, the shipyard shall procure security to the buyer against those risks.  The most common type of security is a refund guarantee issued by a shipyard’s bank acceptable to the buyer (and the buyer’s financing bank), so that the buyer (and the buyer’s financing bank) can seek refund directly from the shipyard’s bank if the shipyard fails to refund.  However, please note that in certain cases, a refund guarantee may not cover all of the cancellation events as set out in (G) above.
As some leading text may suggest, the terms of most refund guarantees used in shipbuilding transactions, in order to be more to the advantage of the buyer and the buyer’s financing bank, tend to operate more like a standby on-demand letter of credit rather than a conventional guarantee.
The form of the refund guarantee usually would be agreed by the shipyard, the buyer and pre-approved by the shipyard’s bank and attached to the shipbuilding contract as schedule.   However, please note that none of the original SAJ Form nor and the original AWES Form impose the shipyard any obligation to provide any form of the refund guarantee to the buyer.
Similarly, since work will be done by the shipyard before full purchase price is paid by the buyer, the shipyard would take on the credit risk and performance risk of the buyer as well, in particular when the buyer is only a special purpose vehicle.  It is common for shipyard to request for payment guarantee from the buyer’s financing banks  or buyer’s parent company, as well as performance guarantee from the buyer’s parent company.
I. Supervision and Inspection
These provisions give the buyers the rights to send supervisors to the shipyard to participate and supervise the construction of the newbuilding vessel.  The buyer’s supervisors usually would have the right to:-
(i) inspect all equipments and materials that are designated for the newbuilding
(ii) inspect the workmanship
(ii) approve or review all plans and drawings
(iii) attend all tests, trials and the sea trial
(iv) free access to the newbuilding vessel, work shop, drydock, places where equipments and materials designed for the vessel are stored, as well as the premises of the relevant sub-contractors
In addition, the shipyard shall provide office space, accommodation, telephone line and internet access to the buyer’s supervisors, as well as to assist the buyer’s supervisors to apply for visas.
J. Modifications and Changes / Substitution of Materials
These provisions set out the detailed procedures as to how the Specifications, along with delivery date and contract price, could be modified and adjusted.  Change to Specifications could either be raised by the shipyard or the buyer or following corresponding changes in the rules and regulations applicable to the vessel.
K. Buyer’s supplied items and equipment
These set out the rights, title, and liability of the shipyard and the buyer towards the buyer’s supplied items and equipments. In certain circumstances, the buyer’s supplied equipments could be more valuable than the vessel (e.g. floating crane where the buyer supplies the crane and the shipyard construct only the barge).
L. Sea Trial / acceptance or rejection
These set out how the sea trial is to be conducted and the buyer’s rights to attend.  Detailed procedures for the buyer to declare acceptance or rejection of the vessel following sea trial would also be included.
M. Delivery
The delivery clause sets out the agreed date of delivery and the documents to be delivered by the seller to the buyers at the time of delivery of the vessel, including the bill of sale, builder’s certificate, protocol of delivery and acceptance and other technical protocols, certificates and drawings.  However, it is noted that certain documents which a buyer may usually need for the purposes of financing or registration of the vessel are often missing from such list.
N. Title and Risk
In most cases, this clause provides that title and risk of the vessel shall remain with the seller until delivery of the vessel.
O. Warranty of Quality
Usually the shipyard will agree to provide a 12-month warranty, covering all defects found during the said period, for which the buyer may bring a warranty claim against the seller.  If a shipowner, after taking delivery of the vessel from the shipyard, sells and delivers the vessel as a seond hand vessel to a third party buyer during the warranty period, it is rather common for that shipowner to assign all its rights and benefits in the warranty in favour of such third party under the second hand sale.
P. Guarantee Engineer
This clause provides that the buyer may request the shipyard to send engineer(s) to serve the vessel onboard during the warranty period at the costs and risk of the buyer.
Q. Insurance
This clause provides that the shipyard is responsible for keeping the newbuilding and all materials and equipments designated to that newbuilding fully insured, including the buyer’s supplied items/equipments.
R. Disputes and arbitrations
This clause usually provides that the shipbuilding contract shall be governed by English laws and any disputes arising out of or in connection therewith shall be settled by arbitration.  This is a clause which a buyers’ financing bank would take into account when assessing the legal risk of the financing transaction and choosing the governing laws of the relevant pre-delivery security documents.

PART II. NEWBUILDING VESSEL FINANCING STRUCTURE
Ship finance encompasses the raising of funds by the buyer for the construction and acquisition of a ship, or for the purchase of a second hand ship or simply for working capital purposes. These differences result in various different structures of ship finance transactions. 
The structure for newbuilding financings is different from that of second hand ship financings. Given that the building of a vessel takes several months to years and the purchase price is payable by instalments, the loan will need to be drawn down in stages to correspond with the payment date for each such instalment.  Also, guarantees are particularly important in newbuilding financings because a ship mortgage is not available in most jurisdictions until the vessel is actually built and delivered.  In this part, we will highlight some of the main aspects of typical newbuilding finance transactions.
1. Loan Agreement
Depending on the amount of the loan, it is rather typical that a loan for the financing of a newbuilding project will mature years after the delivery of the vessel.  Therefore, apart from the usual loan terms in setting out the procedures and mechanism for drawdown, payment, repayment, prepayment and calculation of interests, as well as specific changes and additional provisions to cover the post-delivery issues such as registration of the vessel under the buyer’s ownership title, validity of the ship mortgage, prevention of pollution and arrest, application of earnings of the vessel for repayment of the loan, appointment of ship manager etc., there are specific terms and conditions addressing other newbuilding related and pre-delivery issues. These pre-delivery issues will include:-
•  events of default in respect of shipyard and refund guarantor;
•  lender’s right to appoint buyer’s on site supervisors;
•  multiple drawdown periods and interest periods (and the consolidation thereof) matching the due dates of the relevant instalment of the contract price
•  conditions precedent documents under the loan agreement matching those documents that may trigger payment of contract price under the contract (e.g. certificates by classification societies confirming steel cutting, keel laying and launching, protocol of delivery and acceptance, builder’s certificate, etc.)
2. Pre-delivery Security Documents
A. Assignment of Shipbuilding Contract
Without a ship mortgage during the pre-delivery period, the buyer’s financing bank would instead take an assignment of the rights of the buyer under the shipbuilding contract, so that in case of the buyer’s default under the loan agreement, the buyer’s financing bank would have the option to continue with the construction and take delivery of the vessel or on-sell their rights under the contract.  Notice of assignment to the shipyard is required under English laws to "perfect" the assignment and it is advisable for the lender to also require the shipyard to execute an acknowledgement of the assignment.  However the wording of the notice and acknowledgement would need to be pre-approved by shipyard, without which shipyard may refuse to acknowledge.  It is noted that obtaining the shipyard’s pre-approval of the wording of the notice and acknowledgement is often the most time consuming process in the financing of PRC newbuildings.
B. Assignment of Supervision Agreement
If the buyer’s financing bank would like to continue with the construction of following the buyer’s default under the loan, one of the biggest hurdles is that the bank may not have the expertise to supervise the constructions.  Depending on the stage of construction, it may not be a good idea to appoint new supervisors as well.   Therefore, the solution is that lenders would take a security assignment of the buyer’s rights under the supervision contract made between the buyer and its on site supervisors, so that in case of the buyer’s default under the loan, the buyer’s bank could enforce their rights under such assignment and "step into the shoes" of the buyers so that the supervisors would then be under the instructions of the bank.  Again, a notice of assignment to the supervisor is required under English laws for perfection and an acknowledgement from the supervisor is advisable.
C. Assignment of Refund Guarantee
During the construction period, it could well be possible that it is the shipyard who may run into financial or operational difficulties rather than the buyers.  In addition, it is sometimes difficult (if not impossible) for the buyer’s financing bank to conduct due diligence or obtain information regarding the financial and the technical capacity of the relevant shipyard or to assess such risk.  Therefore, in almost every cases, the buyer’s financing bank would require an assignment of refund guarantee, so that the buyer’s financing bank will be entitled to claim under the refund guarantee directly from the refund guarantor following a default by the shipyard or cancellation of the shipbuilding contract.  The buyer’s financing bank usually requires the refund guarantor to be a state owned company or a first class international bank, and prefers to have direct involvement in negotiating the wording of the refund guarantee in order to make sure that it is assignable and the scope and duration of the refund guarantee would match and cover the financing terms.  Again, a notice of assignment to the refund guarantor is required under English laws for "perfection" and an acknowledgement from the refund guarantor is advisable.  However, as in the case of the assignment of shipbuilding contract, obtaining the PRC refund guarantor’s pre-approval of the wording of such notice and acknowledgement is often the most time consuming process in the financing of PRC newbuildings.
D. Mortgage of Shares
As in other financing transactions, it is a fairly standard practice for the a lender to take mortgage over all the shares in the buyer as security.  This is especially important if the buyer is a single-purpose company.  If a default occurs, it will give the bank the option to transfer the shares in the buyer to itself or its nominee and in effect “step into the shoes” of the buyer.  This is particularly helpful in case the shipyard, the buyer’s supervisor or the refund guarantee does not cooperate with the lender following a default by the buyer or the shipyard.  
The Mortgage of Shares also gives the bank the option, in an enforcement scenario during the pre-delivery period, to sell the shares in the buyer rather than selling the shipbuilding contract.  However, care should be taken regarding the possible stamp duty which might be payable on a transfer of shares in certain jurisdictions which could be quite substantial.  There is also the risk that the buyer has other unknown debts which the buyer will continue to be subject to after a transfer of shares.
On the other hand, it is more and more common that shipbuilding contract would contain a buyer’s undertaking or warranty that the buyer shall remain wholly owned by its holding company before the delivery of the vessel.  If so, any change of shares in the buyer may results in a breach of the shipbuilding contract.
E. Guarantee
Since it is often the case that the buyer has no assets at all during the pre-delivery period, the buyers’ financing bank will usually require other sources of credit support and this would quite often include a guarantee from the parent company of the buyer.
3. Post-delivery Security Documents
The usual post-delivery security documents for ship financing transactions includes, the ship mortgage, deed of covenants, assignment of earnings, assignment of insurance and assignment of charter.  While theoretically it is not logical for the buyer to execute the any of these documents when the buyer does not have title to the vessel, it is often the case that the final form of the post-delivery security documents would be negotiated and finalised before the execution of the pre-delivery loan agreement, pending to be executed immediately upon the delivery of the vessel.
Furthermore, in the case of charter assignment, it is often the case that, during the pre-delivery period, the buyer’s parent company would agree to time charter the newbuilding (commencing from her delivery from the shipyard for a period no less than the maturity period of the loan) from the buyer, execute the time charter and deposit it with the buyer’s bank.  The buyer would also execute a security assignment of time charter in favour of the buyer’s bank.  By doing so, provided that the buyer’s parent company is financially strong, the lender’s concern regarding the source of income of the vessel after delivery could be sufficiently addressed.

PART III. NEWBUILDING VESSEL FINANCING WITHOUT GUARANTEE
INTRODUCTION
Whether or not we have an international financial crisis, credit line is, as always, a precious item safely guarded and treasured by enterprises and business ventures all around the world, may it be a multi-billion retail business or a newly start-up.  Shipyards and shipping companies are no exception to this rule.
However, as indicated above, given the time gap between payment and delivery and the substantial sums involved, one of the very crucial elements in shipbuilding transaction and its relevant financing is the various bank refund guarantees and bank payment guarantees that need to be arranged by the buyer and the shipyard for other parties’ comfort and financial security.  If the buyer fails to secure a credit line for a bank payment guarantee, or if the shipyard fails to secure a credit line for refund guarantee, most shipbuilding transaction cannot proceed.
On the other hand, if the buyer and the shipyard are closely related, or if both the buyer and the shipyard could demonstrate to each other that they have and will continue to have substantial financial strength before the ship is delivered, in some cases we have seen, it is not uncommon for the buyer and the shipyard to agree that no bank payment guarantees and bank refund guarantees are required.
Having said so, even if it is commercially acceptable between the buyer and the shipyard that no bank payment guarantees and bank refund guarantees are required, in most cases, buyer’s financing banks would nevertheless, following the results of their risks analysis, request for refund guarantees by the shipyard’s bank be issued and be subsequently assigned by the buyer in favour of them as security.
The following example (as simplified) is an exceptional case where the buyer’s financing bank, the buyer and the shipyard managed to design and agree upon a structure where no bank refund guarantee and no bank payment guarantee were required for the shipbuilding project and its financing.  However, please note that the buyer’s group and the shipyard mentioned below are closely related and both of them are of substantial financial strength.  Similar structure has been adopted by some of our clients in shipbuilding transactions for a couple of times over the last few years.  The advantage is that both the shipyard and the buyer could, as a result, save their credit lines for bank guarantees for some other transactions.
Step 1

Step 2
By a Standby Novation Agreement ("SNA"), the Buyer will sell and transfer all their rights and obligations in the Shipbuilding Contract to the Buyer’s Parent Company. However, this will not take immediate effect but will ONLY take effect upon the following conditions:-
• after the Buyer has rejected the vessel as per the Shipbuilding Contract by giving notice to the Shipyard; and
• after the Buyer has given a notice to the Buyer’s Parent ("Operative Notice")
• In the SNA, the Parent agree that the Parent shall be bound by the terms of the Shipbuilding Contract, including (i) the rejection of the Vessel made by the Buyer as per the Shipbuilding Contract and (ii) the terms in the Shipbuilding Contract regarding refund.

Step 3
The Buyer then assigns all their rights in the Shipbuilding Contract and the SNA to the Buyer’s Bank as security.

In the event of a default…
In the event of a default by the Buyer under the loan agreement or by the Shipyard under the Shipbuilding Contract, the Buyer shall be obliged to tender the Operative Notice to the Parent, upon which the SNA will become effective and the Parent will:-
• pay the purchase price for to the Buyer as per certain formula in the SNA
• assume all rights under obligations of the Buyer under the Shipbuilding Contract, including the right to demand refund from the Shipyard,
while the Buyer will use the proceeds of sale of the Shipbuilding Contract to prepay the Buyer’s bank.  Following such events, the Parent, as the new buyer under the Shipbuilding Contract, shall claim refund from the Shipyard.

Conclusion
As long as construction of vessel remains a complicated engineering process, and as long as there remains a substantial time gap between payment and delivery, in order to sufficiently protect the interests of various parties involved in a shipbuilding project and its financing, the logical consequence is that the terms of shipbuilding contracts would have to be detailed enough to make sure that the numerous major practical issues that are bound to arise during the construction state are not left unanswered, while the terms of the loan and security documents would have to address and match those relevant issues in the shipbuilding contract, as well as to address the numerous practical and legal issues which may arise when the lender enforces its securities against the buyer, the shipyard, the buyer’s supervisor and/or the refund guarantor.