“Single Ship” Companies: Some Remedies for Creditors under US Law. Part 1. Alter ego Arrest under Rule B

This article is split into two parts. In Part 1, the author analyzes the problem of “single ship” companies for maritime lenders and explains why US maritime law gives lenders more tools to deal with such companies. The author then examines the main characteristics of the so-called alter-ego Rule B attachment – a type of arrest involving the piercing of the defendant’s corporate veil.

Part 2 provides a concise overview of several other instruments available under US law to creditors of one-ship companies. This includes in rem arrest under Rule C, equitable subordination of ship mortgages and liens, setting aside of fraudulent conveyances or transfers, and obtaining of evidence in the US in support of foreign proceedings under 28 U. S. C. §1782.

Introduction to the problem

Single-ship, or one-ship, companies have for several decades been the standard way for shipowners to organize their businesses. This model of organization has largely replaced the system in which one entity legally owns the entire fleet. In the most schematic form, a structure involving one-ship companies may be pictured as shown in the Figure at p. 97¹.

KEY OWNER[S]

100% IN TOTAL

HOLDING COMPANY

100% 100% 100% 100% 100%

ONE-SHIP COMPANY ONE-SHIP COMPANY ONE-SHIP COMPANY ONE-SHIP COMPANY ONE-SHIP COMPANY

Naturally, real-life business structures of most modern shipowning operations are more complicated. A number of other entities are typically added to above-mentioned scheme, e.g. to finance and manage ships and operations with them, as well as to optimize taxation².

However, several features remain the same in any shipowning structure. First, the registered owner of a ship is almost never the entity which makes actual management decisions concerning that ship. Secondly, shipowning businesses are still very close – in a sense that a fleet controlled by one group is operated day-to-day by a limited number of individuals through close, non-publicly traded corporations and limited liability companies. Participation in these companies is usually not available to third-party investors (as opposed to publicly traded corporations)³. This means that in the end all one-ship companies within the group are in one way or another controlled by the same beneficiaries.

It would be fair to say that maritime laws in many jurisdictions do not keep up with – or even recognize – this economic reality of the shipping business. As an example, suffice it to mention the still existing restrictions on the arrest of so-called “sister ships”.

Under both international conventions on arrest of ships, the claimant may arrest⁴ either (1) the specific ship in respect of which the maritime claim arose, or (2) any other ship owned by the defendant at the time maritime claim arose⁵. At the same time, “ownership” is usually understood to mean only registered ownership, and not beneficial or other de facto control⁶.

However, in a “one company, one ship” system, the arrest of sister ships will be quite rare in practice. Each defendant is a registered owner of only one ship, whereas holding companies, ship managing entities and/or bareboat charterers⁷ do not own vessels at all.

The same flaw afflicts the rules for arrest of ships belonging to time and voyage charterers⁸. Voyage charterers (e.g., major oil producers or commodity traders) rarely own vessels as registered owners. Meanwhile, if a shipowning operation time-charters additional tonnage for its fleet, then the charter is fixed through a separate company, which acts as the shipowner’s chartering department and does not own any vessels.

As a result, creditors dealing with one-ship companies are often unable to obtain sufficient security for their claims. Such creditors usually have three main options at their disposal:

(1) arrest the vessel in respect of which their maritime claim arose (which in practice may not be possible for a host of reasons beyond the scope of this article);

(2) obtain an arbitral award/judgment without security and then try to enforce that award/judgment (which in practice may likewise be difficult given the nominal nature of one-ship companies and the fact that they rarely hold assets other than the ship);

(3) bring a direct action against the one-ship company’s P&I club or other liability insurer (which is not permitted in many jurisdictions as matter of law and may be quite difficult in practice).

Compared to many jurisdictions, US maritime law gives lenders a set of tools that provide a higher degree of protection in dealing with one-ship companies. This is partly because the US is not a party to many international conventions (including on arrest of ships, limitation of liability, collisions, and marine pollution). In the absence of internationally mandated rules, US courts and Congress have furnished rules of their own, which are often quite different from those contained in the conventions. Another reason is the generally more pro-creditor approach in US law, in particular, in bankruptcy and corporate law. Finally, American courts are willing to analyze the realities of the shipping business and are more inclined to ignore the corporate form in favor of a result that more accurately reflects the actual economic situation.

At the same time, the US is one of the largest economies in the world. Almost every significant company in the maritime market has contacts with the US. This prompts creditors of these companies to increasingly turn their attention to American legal instruments in dealing with debtors – whether the aim is to obtain security or evidence or to launch full-fledged litigation/arbitration in the US. However, quite often neither the underlying dispute nor substantive proceedings may have any connection with the US at all.

The arrest of ships and other property by the rules: general rules

Unlike in most countries, in the US creditors have at least three types of ship arrest at their disposal (and often other non-ship related assets may be attached as well). The most commonly used is the so-called Rule B attachment. Its peculiar name due to the fact that the Federal Rules of Civil Procedure dealing with maritime claims are identified by letters A to E⁹.

Rule B attachment is governed by federal (not state) law, and therefore the applicable rules are broadly the same in all federal courts. This type of attachment may be used as an interim security measure in support of ongoing litigation or arbitration (including foreign proceedings), as well as at the enforcement stage (which also includes foreign judgments and awards)¹⁰. Compared with attachment under state law, a creditor seeking a Rule B attachment is not automatically required to provide counter-security (e.g. bond), to prove the risk of dissipation of assets, or the likelihood of prevailing on the merits.

Under Rule B, any ship owned by the debtor may be attached¹¹. However, any other “property” of the debtor in the broadest sense may be subject of the attachment as well¹². This includes tangible property (e.g. cargo), any intangibles (e.g. bank accounts, intellectual property), as well as debts owed to the debtor by third parties (e.g. freight, hire, or payments under a letter of credit).

In general, for an attachment under Rule B to be granted, a creditor needs to prove three main elements¹³:

(i) a prima facie valid maritime claim¹⁴ (low standard of proof);

(ii) the debtor’s property may be found in the judicial district where the relevant court sits (in practice, the fact that the ship itself is present in the district is sufficient)¹⁵;

(iii) the debtor “may not be found”, i.e. not subject to personal jurisdiction in the relevant judicial district (in practice, plaintiff’s attorneys would file a declaration confirming that the defendant is not registered in the district, does not transact business and has no registered agents there, etc.).

In practice, Rule B attachment is granted in the overwhelming majority of cases because the standard of proof for creditors is quite low. Depending on the complexity of the underlying facts, the attachment papers may be electronically filed with the court in 1–2 days. Due to the relative ease and speed, a creditor often only needs to notify the debtor of the intention to attach the vessel in order to obtain security (usually in the form of a P&I club letter of undertaking).

Difficulties for the creditor may arise if the ship is attached, but the defendant refuses to provide security and fights the attachment. Under US law, anyone who claims an interest in the attached ship is entitled to a post-seizure hearing¹⁶. Typically, the defendant files a motion to vacate the attachment, accompanied by evidence that seeks to refute any of the three elements described above. The court then assesses whether the plaintiff has proved that taking into account all of the evidence, “reasonable grounds” for attachment exist.

“Reasonable grounds” is still a fairly low standard of proof for the plaintiff, and defendants rarely succeed in presenting sufficient evidence to vacate the attachment. However, if the plaintiff is trying to pierce the defendant’s corporate veil for attachment purposes (see below), US courts analyze more factors than just three elements outline above, and it is in this category of cases that the defendants’ attempts to lift the attachment are often successful.

Rule B attachment and piercing the corporate veil

Rule B attachment may serve as an effective weapon against one-ship companies. When considering Rule B complaints, US courts may pierce the defendant’s corporate veil¹⁷ and establish that the actual owner of the vessel (or other asset) is not its registered owner, but an affiliated company or individual¹⁸. To do this, the plaintiff needs to show that there is an alter ego relationship between the two defendants.

Such alter ego attachment may be of assistance to creditors in a number of scenarios. For example, a Singaporean time charterer fails to pay hire to owners under a time charter. The charterer itself does not own any vessels, since it is merely a chartering department of a large Chinese shipowning entity. However, both the Singaporean charterer and the Chinese entity are both controlled by the same individuals. In this situation, the creditor may try to attach the ship legally owned by the Chinese entity, even though his claim is technically arises against the Singaporean charterer.

This alter ego type of attachment may be available in other situations as well. For example, companies A and B from Liberia and Panama are the registered owners of ships A and B, respectively. The ship manager / bareboat charterer of both ships is company C from Switzerland. All three companies are controlled by the same individuals from Russia. Ship A damages ship D in a collision. Ship D’s insurer may attempt to attach ship A (because it was involved in the collision). However, the insurer may try to arrest vessel B in the United States (although vessel B did not participate in the collision and does not belong to the defendant) – on the basis that companies A and B are only alter egos of the Swiss company C.

Unfortunately, there is no uniform approach to the definition of alter ego in US federal courts. What the plaintiff must prove depends on the US federal circuit where attachment is sought. In addition, the alter ego standard itself is not defined in the statute – US court evaluate a number of common law factors when deciding whether to pierce the defendant’s corporate veil.

For example, courts in the Second Circuit (New York, Connecticut, and Vermont) will pierce the corporate veil upon attachment if (1) the controlling persons used the company perpetrate a fraud or (2) the controlling persons so dominated and disregarded the corporate entity’s corporate form that the entity primarily transacted the beneficiaries’ personal business rather than its own corporate business¹⁹. In other words, the plaintiff needs to show either abuse of the corporate form, or domination and disregard of the corporate form. A similar alternative (disjunctive) standard has applied for several decades in the Ninth District (which includes California, Oregon, Washington, Alaska, and Hawaii)²⁰. As a result, it may be easier to obtain alter ego attachment in these states.

Most other states in the US use a higher standard for piercing the corporate veil in maritime disputes. In the Fifth Circuit (Louisiana, Texas and Mississippi), the plaintiff must prove both the abuse of the corporate form that caused it loss and that the owner exercised complete control over the corporation with respect to the transaction at issue²¹. Thus, in order to attach a ship owned by an affiliate of the defendant, the plaintiff would have to demonstrate both elements²². The similar cumulative (conjunctive) standard applies in several other “maritime” circuits of the US – in the Seventh²³ (Illinois, Indiana, Wisconsin) and Eleventh (Florida, Alabama, Georgia)²⁴.

Proving alter ego claims

“Complete control and domination” and “abuse of the corporate form” are not strictly defined legal terms. What exactly are the US courts looking at to determine whether to pierce the corporate veil?

Regarding the element of domination and control²⁵, the courts in the Fifth Circuit (Louisiana, Mississippi, and Texas) provide an instructive example. At least since 1985, federal courts in this circuit use a laundry list of 12 factors to determine whether a company is an independent entity separate from its members. Thus, the courts of the Fifth Circuit assess the following indicators²⁶:

(1) common shareholders / members;

(2) common directors and officers;

(3) common business departments (for example, one company states that the other is merely its department);

(4) consolidated financial statements and tax returns;

(5) whether the member finances the company;

(6) whether the subsidiary’s incorporation was caused by the parent;

(7) whether the subsidiary is grossly under capitalized;

(8) members / parent company pay salaries and other expenses of the subsidiary;

(9) the subsidiary receives no business except that given to it by the parent and serves the clients of the parent company / members;

(10) the members or the parent company use the property of the subsidiary as their own;

(11) the day-to-day operations of the two companies are not kept separate from each other;

(12) the subsidiary does not observe “corporate formalities” (e.g. keeping separate books, holding meetings).

This is not an exhaustive list of factors considered by US courts. Other factors which are not specifically listed include common registration / business addresses, common contact details and employees, common websites, common bank accounts and commingling of funds, as well as the existence of nominal directors and officers. In addition, not all factors will necessarily be of equal importance, even in similar cases²⁷.

As an example, in many maritime disputes it may be important whether the parent company claimed ownership of vessels that are actually registered in the subsidiary (such statements may sometimes be found on the shipowners’ websites or be made in the course of negotiations or contained in a recap²⁸). It may matter on whose behalf correspondence was conducted during negotiations of the charter and on whose behalf freight/hire was paid.

Very often, fleets and one-ship companies are managed by technical or commercial management companies. If the managing entity actually manages the fleet as its own in favor of common beneficiaries, then the court may find that both the manager and the one-ship companies are each other’s alter egos (since they are all controlled by the common beneficiaries). In turn, this may give grounds for attachment of any vessel controlled by the group.

If the plaintiff can prove that the one-ship company was deliberately set up to purchase a particular vessel and avoid future arrests, this may also support piercing the corporate veil. Quite often, the very name of the one ship company may be a potential indicator of this – it will coincide with the name of the ship itself.

Since most vessels are subject to ship mortgages, information about the collateral issued to the bank by the owners may be very useful. If a number of vessels legally owned by different companies serve as collateral for a single loan, then so-called “cross-collateralization” exists and is a strong indicator that both registered owners are alter egos of the controlling person. The same applies to situations where one company or member acts as a guarantor of loans to several one-ship companies (or guarantor under a time charter or a contract for the sale of a vessel). Another possible indicator could be the fact that a shareholder has issued a loan to the one ship company secured by a mortgage on that ship.

As regards abuse of the corporate form, US courts take a similarly broad approach to this element. To show abuse, the plaintiff is not required to prove that a crime or a tort has been committed – it is enough to show that the actions of the defendants could lead to fraud, injustice or fundamental unfairness in relation to creditors.

For example, US courts found abuse of the corporate form, sufficient to pierce the veil and grant an alter ego attachment, in the following situations:

(1) the controlling shareholder of the company, in the course of negotiations, claims that he or a company affiliated with him own the vessels (in reality, the vessels are legally owned by one-ship companies) – on the basis that the controlling shareholder may have misrepresented the financial and asset position of the entity under his control (since vessels are valuable targets for arrest/attachment)²⁹;

(2) sale of a vessel after a claim arose against it or proceedings began (especially if the vessel is sold to an affiliated company and retains the same attributes – the same manager, P&I club, flag, voyage routes, and also if the vessel is not offered for sale in the open market, was the only asset of the company and/or is sold soon after the company’s insolvency – since insolvency may have extinguished the ship mortgage/liens on the vessel)³⁰;

(3) transfer of assets and funds within a group of companies, often without reasonable business justification and documentation – on the basis that this may have been done to hide assets from creditors³¹;

(4) incorporation of several undercapitalized companies exclusively in order to register ships in their names, considering the fact that the directors ere nominal, lacked management experience in the shipowning business, and regularly consulted with shareholders, while the assets of the companies were being commingled³².

What do court statistics say?

Despite the more favorable approach in US law to piercing the corporate veil, most reported and published decisions in fact show courts vacating alter ego attachments. Such data naturally raises questions about the effectiveness of Rule B as a security measure (especially considering the cost of legal services in the US). However, there are several reasons for this.

First, the original court orders authorizing attachment are not published in US legal databases like Westlaw and Lexis³³. In general, only orders issued after post-seizure hearings are published. Suh hearings, though, only take place if the defendant fights the attachment. However, after attachment is granted (or even after a Rule B complaint is filed and the plaintiff threatens to attach the vessel), the majority of defendants prefer not to challenge the attachment. They usually provide security in the form of a P&I letter of undertaking to secure prompt release of the vessel. As a result, the number of published decisions vacating attachment noticeably exceeds the number of published decisions declining to vacate. Given that the purpose of attachment is most often to obtain security, such statistics do not correctly reflect the effectiveness of alter ego attachment in the US.

Second, many states (e.g. New York) apply a lower standard of alter ego attachemnt – the plaintiff must show either full control and domination or abuse of the corporate form, but not both. Coincidentally, it is in the Southern District of New York that the number of alter ego attachments being vacated is the highest. It may be that laxer rules increase the number of opportunistic attachments attempts. For example, if the plaintiff can only demonstrate the commonality of members, directors, and addresses of the defendant companies, he might still try to attach the ship in the hope of obtaining security without a fight. It may also be that when the defendant’s P&I club is faced with an opportunistic attachment, it has more incentive to challenge it.

In contrast, the standard for alter ego attachment is higher in other states (e.g. Texas). Here the plaintiff must show both complete control and domination and abuse of the corporate form. Probably, stricter rules force plaintiff’s lawyers to research the corporate structure of defendant companies more carefully and attempt to attach only if sufficient evidence of all elements exists. Accordingly, the number of published decisions vacating Rule B attachments in Texas appears to be generally smaller.

Overall, alter-ego Rule B attachment remains a highly effective instrument of protecting creditors of one ship companies in the US. However, using it together with other instruments which US maritime law affords may further strengthen the creditor’s position. It is these additional tools that will be discussed in Part 2 of this article. ■