Preferred Ships Mortgages


Anyone who has ever stood on the shore's edge to feed ducks knows that the competition for your offerings can become fierce.  Aside from the squabbling ducks, seagulls may be competing from above.  Various fish may be competing from below.  In the end, only the most viable competitors will leave with a full stomach.   When the creditor of a vessel wishes to foreclose on its debt, a similar scene ensues.  There may be various liens on a vessel and each lien holder hopes to collect its claim in full.  However, maritime law assigns preference to the various liens, which means that some claimants in the distribution process will not be paid. 


Historically, under the laws of maritime, a mortgage was not considered a maritime contract.  Thus, it could not be foreclosed under maritime law and it was given low preference among creditors that sought to reclaim debts owed by a vessel.  Congress saw that this loophole in the common law gave little incentive to finance a vessel.  For that reason, among others, it enacted the Ship Mortgage Act, which created the Preferred Ship Mortgage. 


The Preferred Ship Mortgage provides the finance of a vessel competitive status among competing claims that might arise against a vessel.  The lender of an ocean vessel, if eligible, should always secure its loan with a Preferred Ship Mortgage.  Otherwise, in that unfortunate event where the lender must foreclose, it will rank almost last among the various maritime creditors that may be competing to collect on a vessel's proceeds.  Historically, the only other viable option for the lender was to secure its loan with a bottomry bond.  However, under maritime law, a debt that is secured by a bottomry bond will be discharged if the ship itself is lost.  Thus, the bottomry bond today remains an option for only the daredevil or thrill seeking lender.    


A lender, under the Ship Mortgage Act, may also take advantage of the statute's provision that bars any limit on interest rate which may be charged.  A high interest rate may still be attacked under state usury laws.  Recent cases, however, tend to uphold mortgage interest rates that are attacked on this basis.   While ship mortgages, under the Ship Mortgage Act, are termed "preferred", it is important to note that other liens on a vessel will still be given higher priority.  Those include certain claims by employees of the vessel, salvage claims, tort liens, and general average liens.   Because the Preferred Ship Mortgage is a statutory creation, it is vital to a ship mortgagee that it strictly adheres to the statutory requirements.  Otherwise, it will lose its distribution priority and its attempts to foreclose on debts owed will be futile.  A mortgage holder's failure to adhere to federal procedures for mortgage creation and enforcement could even result in its total inability to collect on a debt.   


The creation of a Preferred Ship Mortgage requires both eligibility requirements and documentation requirements.  Among the eligibility requirements, the vessel owner must be a United States citizen and the vessel must be constructed in the United States.  Proper and effective documentation requires close adherence to time, place, and manner procedures.  Foremost, the financer must be sure that it is securing the "whole" vessel, including its appurtenances to be given "preferred" status.  A mortgage can cover more than one vessel.  


What are the consequences if a borrower defaults?  The Ship Mortgage Act provides two primary enforcement remedies against a deficient borrower.  The lender may enforce its lien against the vessel itself in a federal court.  The lender may also bring an action against the vessel�s owner in either federal or state court.  The Preferred Ship Mortgage itself will often contain a provision that empowers the mortgage holder to utilize self help methods for repossessing the vessel upon default.   The typical bank is probably not going to foreclose on a vessel after a single missed payment or contractual infraction.  The vessel owner will probably receive a letter from its lender that identifies the default and how that default should be cured.  It may also inform the borrower of its intent to foreclose on the vessel if the borrower is unable to cure its default.  Then, if the borrower remains in default, he or she should expect that the vessel will be arrested and repossessed.  The repossessed vessel will then be sold in either a private or public auction/sale.  The Ship Mortgage Act and Federal Judicial Sales Act provide procedures for the judicial sale of a foreclosed vessel.  If the lender followed proper federal procedures, the borrower should also expect that further action will be taken against her personally to collect any deficiency between the debt owed and amount received from the vessel's sale.  If federal procedures were not properly followed, courts are inconsistent in whether they will apply state law to allow for a deficiency judgment.  


A Federal Circuit Court summarized the Ship Mortgage Act as fulfilling three important purposes:  "it set forth the requirements for recording preferred mortgages, established that only maritime liens would have priority over ship mortgages, and provided for a means of enforcing preferred mortgage liens in admiralty."  Dietrich v. Key Bank, 72 F.3d 1509 (11th Cir. 1996).  The peculiar nature of Admiralty law requires that both lender and borrower consider applicability of the Act when analyzing their lending/borrowing options.  We recommend that out banking clients always use Preferred Ships Mortgages where the requirements can be met.  If you are a borrower under a Preferred Ships Mortgage, it is important to read the agreement so you know your rights and responsibilities.  In the event of a dispute, it is imperative that one obtain representation that is familiar with this interesting, but complex, area of the law.