How mortgagees' rights of enforcement are affected by charter and b/l committments

1. Introduction

A ship mortgage is a document entered into between the owner of a vessel and the mortgagee which gives rise to rights and obligations between them. It also, of course, creates a security interest in the ship itself. A mortgage of a British ship is subject to the Merchant Shipping Act 1894 which provides that "except as far as may be necessary for making a mortgaged ship ... available as a security for the mortgage debt, the mortgagee shall not ... be deemed the owner of the ship ... nor shall the mortgagor be deemed to have ceased to be owner thereof".

A charterparty is, by contrast, a contract between the owner and the charterer and, save in the most exceptional cases, the bank will not be a party to it. The doctrine of privity of contract therefore dictates that the charterer will be unable to enforce his charterparty rights against the mortgagee directly. Any right or remedy which the charterer may have against the mortgagee must therefore, subject to what is said below, be based on a cause of action in tort. There is a nebulous category of actionable wrongs in English law known as the "economic torts". It is beyond the scope of this article to consider these in detail but in essence they comprise various causes of action which are aimed at imposing liability on a person for the harm that he causes to the contractual or business interests of another. For present purposes (and by way of gross over-simplification), "A" commits a tort if, without lawful justification, he intentionally interferes with a contract between "B" and "C" either by persuading "B" to break his contract with "C", or if, by some unlawful means, he directly or indirectly prevents "B" from performing his contract. In the present context, these torts can be broken down into three main categories.

(a) Wrongfully inducing a breach of contract

This could arise where the bank, without lawful justification, induced the owner to breach the charter (e.g. by diverting to a non-contractual port). It is possible that, for the bank to be liable, it must have intended to bring about the breach or, perhaps, have been reckless as to whether such a breach will occur or not. This tort will seldom, however, be relevant to the normal enforcement situation where the bank merely arrests the vessel, since there is in this case no "inducement" on the owner to breach the contract. The breach is simply a natural consequence of the bank's actions.

(b) Unlawfully interfering with a contract

This tort is perhaps more relevant but, again, it is probable that some degree of intention to harm the charterer must be present (which will usually not be the case). Further, the interference must be without lawful justification or by unlawful means. It must be arguable that the exercise of rights which, as between owner and mortgageee are fully justified, could not be categorised as unlawful for this purpose, particularly if what is complained of is simply the arrest of the vessel in legitimate court proceedings.

There are examples of other such torts, including conspiracy and intimidation, the precise requirements of which vary, but which all derive from a general category of causing loss by unlawful means.

There is no reason in principle why a charterer cannot invoke these torts against a bank which is seeking to enforce its mortgage, if the requirements of the tort in question are satisfied on the facts of a given case. But, for the reasons indicated above, in the majority of cases the charterers will be unable to make good such a claim because, assuming the bank is acting in accordance with the mortgage and is not actuated by malice, they will be unable to establish the requisite degree of "intent", "wrongfulness" or "unlawfulness". As will be seen, therefore, the cases in which charterers have sought redress from banks in these circumstances have not in fact proceeded on the basis of the traditional "economic torts" at all, but on the basis of special rules which appear to have been developed specifically in the area of ship mortgage enforcement. It seems clear that the position will differ, depending upon whether the charter was entered into before or after the mortgage was concluded.

2. Charters entered into before the mortgage

The relationship between a charterer and a mortgagee who takes his mortgage over the vessel after the date of the charterparty will often be specifically regulated by the terms of the financing documents themselves. If it is not, the situation will depend to a large extent upon whether the mortgagee has notice of the charter when he acquires his interest. If he does not, he is probably not bound by it. Where, however, he does have notice, the position may well be different. In the case of De Mattos -v- Gibson (1858) 4 De G & J 276, the mortgagee was fully aware at all times of the terms of the charterparty. He sought to enforce his security by taking possession of the ship and diverting it to another port where it could be sold, and the charterer applied for an injunction to restrain him from doing so. An interlocutory injunction was granted by the court. Knight-Bruce LJ summarised the position as follows:-

"Where a man has acquired property, with full knowledge of a previous existing contract, legally entered into, that that property should be used in a particular manner, the acquirer should not be allowed to apply or use the property otherwise than under the contract, or to the damage of the person with whom that earlier contract had been made."

The action failed at the full hearing, but only because it was found that the owner was unable to proceed with the charterparty anyway, since he was unable to pay for the repairs necessary to enable the ship to continue its voyage. It is quite clear from Lord Chelmsford's judgment that, had the owner been in a position to perform the charterparty, the charterer would have been entitled to his injunction even if, as against the owner, the mortgagee was fully entitled to enforce the security.

It has been suggested as a possible exception to this rule that, if the mortgagee's security was or became impaired by the existence of the charter, the mortgagee might then be justified in enforcing his rights even if he had had notice of its existence; but the authorities by no means make this clear. (The whole question of "impairment of security" is considered in greater detail below). Subject to this point, the extent of the rule in De Mattos -v- Gibson was fully considered in Issue 7 of the Review which discussed the similar position of the purchaser of a ship who acquired it with notice of a pre-existing charter. This situation is not therefore considered further here.

3. Charters entered into after the mortgage

(a) The early cases

More commonly, the charter will post-date the mortgage. Here, the situation will have arisen because the owner has been left in possession of the ship by the mortgagee specifically in order to enable it to be traded, and the owner will have entered into chartering commitments pursuant to that arrangement and with the bank's knowledge that this is being done. The courts have therefore held that there must be some restriction on the bank's ability to ignore the charter when seeking to enforce its rights.

In Collins -v- Lamport (1864) 11 L.T. 497, it was held that a mortgagee was not entitled to interfere with the performance of a charterparty entered into after the date of the mortgage unless there was a threat to the mortgagee's security, and the charterer was therefore held to be entitled to an injunction to ensure that the breach of charter did not take place. It is clear that this decision was based on a construction of the predecessor to the provision in the Merchant Shipping Act which is quoted in paragraph 1 above. At the time, the nature of a mortgagee's interest in a mortgaged ship under English law was still in the course of formulation and the Act had therefore sought to make it clear that the mortgagee, while not being regarded as the owner, retained an interest "as far as may be necessary for making [the] mortgaged ship ... available as a security for the mortgage debt". The basis of the decision in Collins -v- Lamport was that, if it was not so necessary (because the security was not in fact impaired by performance of the charter), the mortgagee could not interfere. A similar line of reasoning can be found in many of the early cases. However, at least some of these were concerned with non-British flag vessels which were not therefore expressly subject to the Merchant Shipping Acts. This extension of the principle to non-British ships appears to have been adopted without any specific acknowledgment that this was being done.

(b) The "MYRTO" [1977] 2 Lloyds Rep. 243

Whatever the origin of the rule, the modern formulation of this principle is now embodied in the judgment of Brandon J. in the "MYRTO", a case which involved a vessel registered initially in Liberia and subsequently in Greece.

On 7 January 1977 the "MYRTO" was arrested in Sunderland by a mortgagee bank pursuant to a claim for sums due under mortgages registered against the vessel in Liberia/Greece. Other defaults were also alleged. The mortgagees applied to the court for the vessel to be sold, and the charterers applied for an order that she should be released on the basis that the arrest was wrongful or was inconsistent with their rights under the charterparty. The charterparty in question had been entered into in September 1976 (after the date of the mortgage), for a voyage from several ports in north-west Europe to the Persian Gulf. The vessel had loaded a part cargo in Antwerp in November 1976 and had then proceeded to North Shields and to Sunderland where the arrest took place.

Brandon J., having reviewed a number of cases from the late 19th and early 20th Century (including Collins -v- Lamport), summarised the owner's rights to deal with the ship and the bank's right to arrest under English law as follows:-

(1) The owner is entitled, subject to one exception, to deal with the ship (and that includes employing her under a contract with a third party) in the same way as he would be entitled to do if the ship were not mortgaged.

(2) The one exception is that the owner is not entitled to deal with the ship in such a way as to impair the security of the mortgagee (which is a question of fact).

(3) Where the owner makes a contract with a third party for the employment of the ship, of such a kind and made or performable in such circumstances, that the security of the mortgagee is not impaired, and the owner is both willing and able to perform such contract, the mortgagee is not entitled, by exercising his rights under the mortgage, whether by taking possession, or selling, or arresting the ship in a mortgage action in rem, to interfere with the performance of such contract.

(4) The mortgagee is, however, entitled to exercise his rights under the mortgage without regard to any such contract made by the owner with a third party for the employment of the ship in two cases:-

(a) where the contract is of such a kind and/or is made or performable in such circumstances, that the security of the mortgagee is impaired;

(b) where, whether this is so or not, the owner is unwilling and/or unable to perform the contract.

(5) Where the mortgagee, by exercising his rights under the mortgage, interferes with a contract made by the owner with a third party for the employment of the ship in circumstances where he is not, in accordance with (3) and (4) above, entitled to do so, he commits a tort ( or actionable wrong in the nature of a tort) against the third party.

(6) The remedies available to the third party against the mortgagee in respect of such tort or actionable wrong are as follows:-

(a) where the mortgagee interferes by taking possession or seeking to sell, an injunction restraining him from doing so;

(b) where the mortgagee interferes by arresting the ship in a mortgage action in rem, an order for the release of the ship from arrest in such action;

In summary, on the basis of this judgment, where the owner of a ship has entered into a charterparty or other contract for the employment of the ship, the mortgagee will be restricted from taking possession, selling or arresting the ship unless the contract is such that the security of the mortgagee would be impaired, or the owner is unwilling and/or unable to perform the contract. This is so even though the mortgagee may be entitled, on the strict terms of the mortgage, to take any of those steps he chooses. His freedom of action is limited by the effect it would have on the charterer.

As stated above, it will be a question of fact whether the charterparty is such as to impair the mortgagee's security. For example, neither the exposure of the vessel to the ordinary perils of the sea (The "MAXIMA" (1878) 39 LT 112), nor the fact that the voyage will involve her removal from the jurisdiction of the English courts (The "FANCHON" (1880) 5 PD 173), will necessarily be regarded as inconsistent with the sufficiency of the mortgagee's security. However, the mortgagee's security was held to be impaired where a vessel was sent on a hazardous voyage for which it was impossible to insure (Law Guarantee Society -v- Russian Bank [1905] 1 KB 815). The same view was taken in The "MANOR" [1907] P 339, where the vessel was being sailed by an impecunious mortgagor with the risk that she might become liable to maritime liens for necessary disbursements.

On the facts of the "MYRTO" itself, Brandon J. concluded that the banks security was impaired and that they were therefore entitled to maintain the arrest:-

(1) the charterparty contained a number of unusual provisions such that there was a serious risk that the expenses to be borne by the owners would exceed the freights. For this reason the contract was "speculative and improvident";

(2) the owners were impecunious and might have required further credit in order to perform the voyage;

(3) the vessel had already been arrested by another creditor;

(4) the evidence indicated that there were numerous other debts and liabilities to other creditors which were enforceable against the ship and which might have priority over the mortgagee's claims in other jurisdictions.

The judge further explained that the right to order the release of the vessel was, in any case, discretionary. Even if he had concluded that the bank's security was not impaired and that the owners were able to perform the contract, he could therefore have ordered that the vessel remain under arrest and that the charterers be left to their alternative remedy in damages.

One final issue was raised by the charterers which should, perhaps, be mentioned. They had accepted that the bank had not known of, or approved, the specific charter in advance. Had that not been the case, questions of estoppel might have arisen. They did, however, contend that the bank had served a notice of assignment of charter earnings on them, and that this amounted to a form of affirmation of the charter which precluded the bank from interfering with its performance. The judge rejected this contention on two grounds:-

(a) Firstly, the bank had two independent forms of security (the mortgage and the earnings assignment); and there was no reason why they should have to elect or choose between them.

(b) In any event, the bank had arrested the ship before giving notice of the assignment. If there had been any question of election, therefore, they had elected for the enforcement remedy first.

In conclusion, although Brandon J. referred in his judgment to "interference with contract", the principles he set out appear to differ significantly from the requirements laid down for the "economic torts" described above. What is wholly unclear, therefore, is how, if at all, this decision (and the 19th Century cases on which it is based) are intended to interrelate with the substantive requirements of the law of torts generally, and whether this line of cases is now to be regarded as a form of special rule applicable solely (i) to the exercise of the arrest jurisdiction in Admiralty Court proceedings or (ii) to the enforcement of mortgages over ships. No subsequent case in the English Courts casts any light on this question (and it is interesting to note that the "MYRTO" is not even referred to in Clerk and Lindsell, one of the leading textbooks on the law of tort). However, the problem has recently been addressed in the courts of Canada.

In this case, the ship was subject to a Greek ship mortgage on which the owners had defaulted in November, 1984. No sums were paid under the mortgage after that date. From April, 1986 to January, 1987 the vessel had been laid up in Greece without the mortgagee bank making any attempt to enforce its security. On 23 January, 1987 the owners chartered the vessel for a time charter trip from Europe to the west coast of North America. The bank learned of the charterparty on 26 January, 1987. Shortly thereafter it arrested a sister ship over which it also held a mortgage and advised the owners of the "Alexandros G. Tsavliris" that it intended to arrest that vessel also. Certain threats were said to have been made by the owners to divert the vessel to Taiwan and to sell her there for scrap. The bank's solicitors therefore instructed lawyers in Panama to prepare arrest papers. On the same day the owners instructed the vessel to stop in international waters. The following day the bank gave instructions to the Panamanian lawyers to arrest the vessel if she entered the Panama Canal. The charterers learned of this and various discussions ensued between the parties' solicitors in London as to the terms on which the bank would permit the voyage to continue. No agreement was reached and, rather than risk the arrest of the vessel, the charterers diverted her around Cape Horn.

The vessel was eventually arrested by the bank in New Westminster, British Columbia. The charterers issued proceedings against the bank in which they claimed to be entitled to recover the additional expenses incurred by avoiding passage through the Panama Canal, and an indemnity in respect of various claims they had settled with several bill of lading holders whose cargo had been delayed.

None of the acts complained of had occurred in Canada and, in order for the bank to be liable for a foreign tort under Canadian law, it was necessary for the charterers to establish:-

(a) that the conduct of the bank would have been actionable if it had been committed in Canada; and

(b) that that conduct must not be justifiable in the place where it occured.

At first instance, Strayer J, (Federal Court of Canada, Trial Div, 27.4.1990) assumed that, as there were no decided Canadian cases on the subject, the Canadian courts would follow the maritime common law as it had developed in England. He considered that the "MYRTO" was the relevant English authority on this area of law although he conceded that it was not directly applicable since it was concerned with arrest in the Action which was then before the court, and not merely with the threat of arrest elsewhere. He was, however prepared to extend the Myrto principle to threats of arrest. His view was that it was clear from the "MYRTO" that a mortgagee was not entitled to interfere with the performance of a charter party by arresting a vessel (unless the security was impaired), and it therefore followed that the mortgagee could not be in a better position in respect of a threat to do so. On the facts of the case, Strayer J found that the bank's security was not impaired. There was nothing unusual about the charterparty which was on normal rates of hire, the charterers had offered to fund the voyage and the bank was not justified in taking seriously the threats made by the owner. The owner was both willing and able to perform. The conduct of the bank would therefore have been actionable in Canada.

Regarding the second part of the test, Strayer J concluded that the acts complained of were unlawful where they occurred, which he considered to be London by reason of the fact that discussions between the parties almost exclusively took place there. In coming to this conclusion, he was expressing his opinion that English law, like Canadian law, would recognise a mere threat of arrest as an unlawful interference with the charterparty. As a result, he held the bank liable to the charterers for the damage they had sustained. It did not matter, for this purpose, that the threatened arrest would not have been wrongful under the laws of Panama, which is where the arrest would have taken place.

The bank appealed against this decision to the Federal Court of Appeal of Canada. In a judgment given by the Chief Justice of Canada (14th August 1992), the decision of Strayer, J. was overturned and the appeal allowed on the simple ground that the bank's conduct would not have been actionable as a tort in Canada had the acts complained of been committed there. Accordingly the first part of the two-pronged test for suing on a foreign tort was not fulfilled.

In reaching this conclusion, the Chief Justice made some interesting observations. Firstly, he pointed out, quite rightly, that the facts of the "MYRTO" were very different from the case under consideration. The "MYRTO" involved an actual arrest, not a threat to effect an arrest. Secondly, he found nothing in the "MYRTO" to support the conclusion that there was a special maritime tort of interference which differed from the general law relating to economic torts. The acts complained of would either have to amount to the tort of intimidation, or to the tort of inducing breach of contract. It was the Chief Justice's view that the acts of the bank, in that they involved a threat, were more akin to intimidation. Under Canadian law, however, (as in English law) the tort of intimidation depends upon there being an intent to injure. The bank had no intention to injure the charterers in the present case. Further, even if the bank's acts could be said to resemble inducing a breach of contract (which was how Strayer, J. characterised them) its conduct would not be tortious if it was 'justified'. The Chief Justice concluded that, as the bank's right to arrest the vessel had crystallised, it was entirely justified in taking the steps it did.

4. Conclusion

Since the Canadian decision was based on a conclusion that the "MYRTO" did not, taken on its own, form part of the laws of Canada, the case has done nothing to clarify what was already a difficult area of English law. It does, however, highlight a number of potential uncertainties in relation to the application of the "MYRTO" rule generally.

Firstly, despite the view expressed by the Court of Appeal in Canada, it does appear that the "MYRTO" (whether rightly or wrongly) purports to represent a distinct tort under English law which is not constrained by the traditional limitations imposed on the torts of intimidation or unlawful interference. Certainly, the suggestion that arrest would be justified merely so long as the mortgagee's right had crystallised is directly at odds with the "MYRTO". The real problem with the "MYRTO" decision, therefore, is the difficulty of establishing (i) how it is intended to interrelate with the "economic torts", and (ii) what are the limits to its applicability. The Canadian decision does not, of course, clarify these questions.

Secondly, the view of Strayer, J. that a mere threat to arrest can constitute unlawful interference with the charterparty would represent a dramatic extension of the existing English position. In the "MYRTO", the vessel had actually been arrested and the court was concerned with the propriety of the arrest in the context of the Admiralty Action in which judgment was being given. There was no suggestion by Brandon J. (who appeared to be attempting an exhaustive definition of English law on this subject) that anything short of actual arrest or the entering into of physical possession would suffice.

Thirdly, as stated above, the act which Strayer, J. found to have been threatened in the "ALEXANDROS G. TSAVLIRIS" was an arrest of the vessel in Panama. The "MYRTO" was concerned only with an arrest in England. Although this is not entirely clear from the judgment, an arrest in Panama would have been lawful under Panamanian law. Presumably, therefore, if the vessel had simply been arrested, with no threat having been made, the bank could not have been held liable. Regrettably, this issue was not addressed by the Court of Appeal in Canada.

Finally, Strayer J.'s decision may have extended the right to claim damages. Although it did not arise for direct consideration in the "MYRTO", Brandon, J. does not appear to have contemplated that damages should be recoverable unless and until there had been an actual arrest or wrongful taking of possession of the vessel by the mortgagee. Strayer, J. felt that it would be a curious result if a charterers' remedies in the case of a threatened arrest were confined to an injunction prohibiting the mortgagee from arresting or otherwise taking possession.

Despite these difficulties, until a case similar to the

"ALEXANDROS G. TSAVLIRIS"

arises in the courts in England, Brandon J's guidelines in the

"MYRTO"

must be regarded as the definitive statement of English law on this subject. Plainly, therefore, unless overwhelming factors dictate otherwise, a mortgagee would be well advised (both from a legal and commercial point of view) to seek to enforce his mortgage at a time when the ship is free of charterparty commitments.