“Single Ship” Companies: Some Remedies for Creditors under US Law. Part 2. Rule C Arrest and Maritime Liens

This article is split into several parts. Part 1¹ addressed issues maritime creditors face when dealing with one-ship companies under US law and discussed the so-called alter ego Rule B attachment – a type of ship arrest which involves piercing the defendant’s corporate veil.

In turn, Part 2 deals with in rem arrests, known in the US as Rule C arrests. This type of proceeding means action is brought directly against the vessel as defendant in order to enforce a maritime lien. The author considers the peculiarities of maritime liens in general and the special features of these liens in the US, in particular. The article then goes on to discuss several scenarios where Rule C arrests are most effective against one-ship companies.

Subsequent parts of this article will address other, non-arrest tools which creditors of one-ship entities have at their disposal under US law. In particular, the author will briefly considers equitable subordination of claims secured by maritime liens and mortgages, the doctrine of fraudulent conveyances (transfers), as well as obtaining evidence in the US in support of foreign court and arbitral proceedings under 28 USC §1782.

In rem (Rule C) arrest

This type of ship arrest² is probably unique to US law and may no longer be encountered elsewhere³.

In essence, a Rule C action is a claim against the vessel as defendant which is brought to enforce (“execute”) a maritime lien on that vessel. Importantly, the identity of the shipowners is irrelevant in this kind of action, since the ship itself becomes liable on the claim. This is known as the ‘personification doctrine’. In the meantime, almost every “maritime” claim – broadly construed⁴ – in the US is secured by a maritime lien. The combination of these two factors (vessel personification and recognition of a large number of liens) may make Rule C arrest a powerful weapon against one-ship companies in an appropriate scenario – e.g. when the offending ship is sold within one group of companies.

Maritime liens – in general

In essence, a maritime lien is a strong security device which attaches to and follows the ship, giving the claimant a right to arrest it and have it sold. Maritime liens differ drastically from liens, mortgages, charges, and retention rights “on land”. In many jurisdictions (including Russia):

1) A maritime lien does not require a separate agreement to arise. Rather, it emerges automatically by operation of law and attaches to the vessel when the underlying cause of action arises⁵.

2) The lien may only be enforced by court proceedings (e.g. a judicial sale)⁶; however, a holder of a lien may lose it if it does not participate in the sale⁷.

3) Maritime liens are valid without registration⁸ and a lienholder is not required to retain possession of the vessel to maintain the lien.

4) This type of lien follows the vessel even into the hands of a bona fide purchaser (for value without notice) of that vessel⁹. In other words, maritime liens are “secret”.

5) Lastly, at least in relation to the value of the vessel to which it attaches, a maritime lien gives priority over most other types of security “on land” (mortgages, charges, rights of retention, etc.)¹⁰ – both in bankruptcy proceedings and in non-bankruptcy admiralty sales.

Maritime liens – in the US

Still, maritime liens as they exist under US law are an even more peculiar type of security and afford their holders even more protection against one-ship companies. This is so for several reasons.

First, US courts recognize that a lien arises against the vessel even if the shipowner may not be personally liable on the underlying claim. For instance, if a time charterer purchases bunkers supplied to the vessel and fails to pay for them, a lien would still attach to that ship (even though the owners are not liable under the sale contract)¹¹. Likewise, if a collision or an allision is caused by the fault of a bareboat charterer¹² or a compulsory pilot¹³, a lien would still arise (even though the owners would not be personally liable here).

Second, the number of claims secured by maritime liens is much larger in the US than in other jurisdictions. Ordinarily, a lien secures claims for personal injury and death, collision/allision damage, crew wages and related payments, as well as claims for salvage rewards¹⁴. However, US law recognizes that a maritime lien would also secure claims for:

• Breach of any type of charterparty¹⁵

• Supply of goods or services necessary for the exploitation of the vessel¹⁶ (known as necessaries – e.g. bunkers, containers, repairs, stevedoring services, towage, pilotage, port, canal and wharfage fees, etc.)

• Loss of or damage to cargo due to carrier’s fault¹⁷

• Unpaid freight or demurrage¹⁸

• Any maritime tort¹⁹ (which includes several causes of action for pollution and claims under several federal pollution statutes)

• Ship mortgages (both US²⁰ and foreign²¹)

• General average²²

• Unpaid insurance premiums in marine insurance contracts²³, etc.

The several notable exceptions which do not give rise to maritime liens are contract for the sale of vessels²⁴, shipbuilding contracts²⁵, and also seamen’s claims under the Jones Act²⁶ for personal injury and death²⁷. Nevertheless, even with these exceptions, the overall list of claims secured by a maritime lien in the US is significantly wider than in most other jurisdictions.

Third, US courts are much more willing to recognize and enforce foreign maritime liens. The position in most other countries is that creation and existence of liens is a procedural matter, which is therefore governed exclusively by the law of the forum (lex fori)²⁸. In such jurisdictions, a court may only enforce liens which are similar to those already recognized in the forum jurisdiction. For example, a Russian court would ordinarily²⁹ decline to recognize and enforce a lien for bunkers, for the simple reason that Art. 367 MSC does not list claims by bunker suppliers as giving rise to maritime liens.

For the US courts, however, the issue of creation and existence of liens is substantive, not procedural. It follows that it may be governed by a law other than the law of the forum (e.g. by the law applicable to the underlying claim)³⁰. As a result, if a maritime contract contains a US federal maritime choice of law clause, a US court would most likely recognize that a lien has arisen – even though neither the contract nor the parties may have no other connection to the US, except perhaps for the fact that the vessel is arrested there³¹.

This conflict of laws feature is actively used by bunker suppliers. For instance, a Singaporean supplier may, through an agent in Taiwan, sell fuel to a Taiwanese time charterer of a Malaysian-flagged vessel. The supplier’s standard terms would then be governed by US federal maritime law. If the time charterer fails to pay the invoice, the supplier may proceed to arrest the vessel under Rule C when it calls at a US port, since a lien has already arisen against that ship³².

Rule C arrest as a tool against one-ship companies

When it comes to one-ship entities, a Rule C arrest may be most effective in at least two scenarios, especially where the other type of arrest under US law (known as alter ego Rule B attachment – see Part 1 of this article) is not available.

The first scenario may occur when a claim arises against a ship (e.g. for cargo damage during carriage) and persons controlling the shipowning operation sell the vessel to a different entity within the same group of companies, in order to avoid arrest and subsequent enforcement proceedings. In some cases, the creditor may be able to prove that the purchasing entity is a mere alter ego of the seller (i.e. pierce the seller’s corporate veil). The creditor may then be able to attach the ship under Rule B, since the vessel will still be deemed to be owned by the selling entity or by the persons controlling both companies³³.

However, a creditor may find it difficult to collect sufficient evidence to prove an alter ego relationship in this intragroup sale scenario. If this is the case, what the creditor may try to do is arrest the vessel in rem under Rule C on the basis that damage to the cargo caused a maritime lien to arise against that ship. Since the lien follows the vessel into the hands of subsequent purchasers, the buying entity would be unable to escape liability, e.g., on the basis that it is not the “carrier” of the damaged cargo, since the relevant bill of lading was not signed on its behalf³⁴.

The second scenario where an in rem Rule C arrest may prove effective concerns situations where the defendant is a large shipowning company (or holding) and maintains branches and appointed agents in most large US ports. In this case, a Rule B attachment may not be readily available, since the creditor will find it difficult to show that the defendant may not be “found” (subject to the court’s jurisdiction) within the relevant judicial district³⁵.

Sometimes, large shipowning entities appoint agents in ports specifically to avoid a looming Rule B attachment.

By contrast, in a Rule C arrest a plaintiff is not required to demonstrate that the defendant may not be “found” in the jurisdiction. What needs to be shown is (1) that a prima facie valid maritime lien arose against the vessel sought to be arrested and (2) that the vessel is within the relevant judicial district or will be there while the action is pending³⁶.

If a court authorizes the arrest under Rule C, the defendant³⁷ may (1) refuse to provide security and refuse to appear; (2) provide security to release the vessel (usually in the form of a P&I Club letter of undertaking); (3) enter a so-called restricted appearance to try to vacate the arrest³⁸, or (4) enter a so-called general appearance and answer the complaint on the merits without seeking to vacate the arrest.

The defendant’s strategy at this stage may define the extent of his potential liability. If the defendant loses in situations (1) or (3) above, judgment against him may not exceed the value of the arrested vessel (since the action is brought and won against the vessel itself). In situation (2) the parties would usually agree on the amount of the letter of undertaking, which would be more than sufficient to cover any claims of the plaintiff, but the judgment then may not be entered for a greater sum (unless, perhaps, the defendant separately consents to personal jurisdiction of the arresting court). However, in situation (4) the defendant risks getting a judgment entered against him in an amount exceeding the vessel’s value, since by appearing generally and answering on the merits he consents to the court’s personal jurisdiction over him.

As a final comment, it should be mentioned that Rule B and Rule C actions may be filed simultaneously against the same vessel. This often happens when the plaintiff wishes to protect itself against an arrest/attachment being vacated (e.g. because no valid maritime lien turns out to exist). ■