What is it and what does it do?
An assignment of charter is a security agreement whereby a party (typically, a vessel owner) that has entered into a charter assigns its rights under such charter to a secured party (typically, the vessel’s mortgagee). Assignments of charters are typically given by a vessel owner for long term charters when the vessel subject to the charter is also subject to a mortgage in favor of the secured party. The intent of a charter assignment is to give the secured party the ability to step into the owner’s place under the charter following an event of default under the relevant debt agreement. If a mortgagee seeks to enforce its mortgage following such event of default by taking possession of the vessel or selling the vessel, the benefit of a charter assignment is that the mortgagee can step into the charter that the owner has with a counterparty, and continue to allow the vessel to earn under the charter, either under the mortgagee’s or new buyer’s ownership, without interruption. Essentially, the charter assignment allows the mortgagee to maximize the value of its collateral in the vessel that is mortgaged.
Sample Definition in a Credit Agreement
“Assignment of Charter” shall mean, with respect to a Vessel, an assignment of charter made by the relevant Vessel Owner in favor of the Security Trustee in respect of any Charter, in substantially the form of Exhibit X or such other form acceptable to the Administrative Agent and the Required Lenders.
“Charter” means, in respect of a Vessel, any charter or other contract for its employment, whether or not already in existence, having a term (including any optional extensions) in excess of twelve (12) months.
How does it affect a Borrower in practical terms?
Under the New York law, in order for a secured party to actually enforce all rights granted to it in an assignment of charter and step into the underlying charter, a consent of the counterparty (i.e., the charterer) is required1. Therefore, the borrower owner is typically required under the terms of the assignment of charter to (a) deliver a notice in the form attached the assignment of charter, informing the charterer of the assignment of its rights, and (b) use its best efforts or commercially reasonable efforts to obtain the charterer’s consent to such assignment in the form attached the assignment of charter. Approaching such charterer can have operational and relationship impacts for the borrower. In particular, when approaching a charterer for a consent to an assignment of the charter, it is not atypical for the charterer under the underlying charter agreement to condition their consent upon receiving a quiet enjoyment letter from the mortgagee. Additionally, owners who have entered into charter contracts with government agencies, such as Military Sealift Command (MSC), the U.S. Department of Defense’s transportation provider, under the U.S. Maritime Security Program (MSP) or Tanker Security Program (TSP), should be cautious when agreeing to grant charter assignments, as an assignment of such rights is prohibited under the U.S. Anti-Assignment Act2.
How is it negotiated?
The key negotiation points in granting a charter assignment include:
1. The length of the charters that a borrower is required to assign. This length is typically twelve (12) months, but can be as long as twenty-four (24) months. The length can also include (or exclude) optional extensions, and can exclude charters that, although being initially in excess of 12 months, have less than 12 months remaining.
2. The requirements to deliver the notice to the charterer and obtain the consent of the charterer. Depending on the bargaining power of the owner and the underlying contract terms, an owner and secured party may agree to a springing obligation to deliver the notice of assignment and obtain the consent of the charterer to the assignment, for instance, upon an event of default (or such other agreed event). In these situations, it is important for a secured party to understand that if the charterer does not consent, they will not be able to step into the actual charter, but they would have an assignment of the right to the proceeds (receivables) paid to the owner under such charter (provided the assignment itself includes language granting an assignment to the proceeds thereunder).
3. Governing law. For enforcement purposes, depending on the underlying governing law of a charter, a secured party under a charter assignment may require that the charter assignment is granted under the charter’s governing law. Secured parties should confirm with local counsel in the relevant jurisdiction of the charter’s governing law if the law governing the transaction documents would create an enforcement issue with regards to stepping into a charter.
4. Whether a charter assignment should be required where underlying charters expressly restrict assignments. In these situations, an earnings assignment without a charter assignment may be sufficient if the secured party is comfortable without having an assignment of the contract rights. Typically, an assignment of earnings relating to a vessel assigns an owner’s rights to proceeds under all charter contracts entered into by that owner in respect of the vessel. Under New York law, even if the underlying charter restricts assignments, a contractual restriction on assignment of general intangibles, such as payment rights, is ineffective3, so the assignment of the proceeds thereunder would be enforceable.
Questions?
Please contact the Maritime & Transportation group at Seward & Kissel (“S&K”) if you have any questions.
__________________________
1 In the U.S. generally, a contract that is silent on assignment is generally freely transferable unless either a statute or public policy provides otherwise, or there are material adverse consequences to the non-assigning Party. ‘Personal services’ contracts, such as a charterparties, are exceptions to the freely transferable rule.
2 41 U.S.C. § 6305. The Assignment of Claims Act (31 U.S.C. § 3727) however permits assignments of moneys due under such contracts subject to certain conditions.
3 NY UCC § 9-408 (2022).