Maritime mortgages in Brazil: a controversial ongoing court dispute

April 2017 | EXPERT BRIEFING | LITIGATION & DISPUTE RESOLUTION

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Financiers usually look for a security interest over the financed asset. For financing and acquisition transactions involving assets or companies in the oil and gas business, maritime transportation and other sectors involving shipping activities, the creation, validity and enforceability of a ship mortgage are of the essence.

Ownership registration of Brazilian vessels

In Brazil, rights over vessels are governed by the laws of the country of the flag that the vessel is flying. Registration of ownership (title) of a vessel in Brazil (registration of maritime property (RMP)) is made when the owner of the vessel is resident or domiciled in Brazil, except in the case of sports and recreational vessels.

Brazilian vessels are those entitled to fly a Brazilian flag. The following requirements must be observed for a vessel to fly a Brazilian flag: (i) the owner of the vessel must be either an individual resident and domiciled in Brazil or a Brazilian company; (ii) the vessel’s captain must be an individual with Brazilian nationality; (iii) the chief engineer of the vessel must be an individual with Brazilian nationality; and (iv) at least two-thirds of the vessel’s crew must be individuals with Brazilian nationality.

RMP grants the nationality, validity, assurance and publicity of the vessel’s ownership in Brazil. In order to be valid against third parties, the ownership rights and security interests over Brazilian vessels must be registered with the Maritime Court, an administrative body of the Navy Command, under the jurisdiction of the Ministry of Defense.

Special Brazilian registration: REB

Brazilian companies operating a foreign vessel may provisionally register her to fly a Brazilian flag (the Special Brazilian Registration (REB)) during the period of utilizing the vessel in Brazil, subject to specific requirements, to enjoy certain administrative and tax benefits. Brazilian vessels are also eligible for registration with the REB.

The REB is not a register of title and merely supplements the RMP; it cannot replace said document. Registration of title to a Brazilian vessel is made by the Maritime Court.

The following vessels may apply for the REB: (i) those flying a Brazilian flag at the discretion of their owner; and (ii) those flying a foreign flag under bareboat charters with the right to fly such foreign flag suspended, under certain circumstances.

In case of vessels registered with the REB, only the vessel’s captain and the chief engineer of the vessel must have Brazilian nationality.

Brazilian mortgages

Mortgages over Brazilian vessels must be made by public deed, be governed by Brazilian law and expressly contain certain information required by law. In order to be valid against third parties, title and security interests over Brazilian vessels must be registered with the Maritime Court.

Under Brazilian law, the enforcement of a mortgage must be made at court.

Brazil adhered to the Brussels Convention of 1926, which establishes certain uniform rules for maritime mortgages and privileges, enacted in Brazil by Decree No. 351 of 1 October 1935. Brazil is also party to the 1928 Convention on private international law made in Havana, issued in Brazil by Decree No. 18871 of 13 August 1929 (the Bustamante Code).

Jurisdiction of Brazilian courts

Under Brazilian law, Brazilian courts have jurisdiction whenever the defendant is domiciled in Brazil, the obligation has to be performed in Brazil or the fact under dispute has been originated in Brazil. Brazilian courts have exclusive jurisdiction in actions relating to real property situated in Brazil.

With respect to a foreign vessel mortgage, Brazilian courts have jurisdiction to decide on the mortgage in relation to provisional remedies, that is, protection measures related to the status of the mortgagee’s rights over the vessel and for protection of the vessel from depreciation or destruction. Brazilian courts have jurisdiction in case of any action seeking repossession of the vessel or in case of arrest, provided that the vessel is located within Brazilian territorial waters, the exclusive economic zone or the continental shelf of Brazil.

A recent court dispute

There is an ongoing controversy with respect to the validity of a foreign vessel mortgage in Brazil under dispute in Brazilian courts that should be carefully considered by mortgagees in a similar situation.

A Dutch Special Purpose Company (SPC), created as an offshore subsidiary of a Brazilian parent company, entered into a construction contract of a certain vessel with a non-Brazilian engineering company. The Cayman branch of a Brazilian bank issued a performance guarantee in favour of the engineering company. The Brazilian parent company was made joint obligor with the Dutch SPC.

Due to a default by the Dutch SPC, the Cayman bank was called to honour the performance guarantee and then filed an enforcement action to seize the vessel owned by the Dutch SPC, which was operating in Brazilian waters. The Dutch SPC, however, had issued certain bonds in the international market to finance the acquisition of the vessel and granted a mortgage over her. The vessel was Liberian flagged, with a mortgage registered with the New York Office of the Deputy Commissioner for Maritime Matters of the Liberian Republic.

The bondholders as mortgagees promptly requested priority over any proceeds from a potential sale of the mortgaged vessel under the enforcement action, on the grounds that the mortgage, although created and registered abroad, would be valid in Brazil because: (i) the Maritime Court in Brazil would not have the authority to register a mortgage over foreign vessels; (ii) the foreign mortgage was registered with the Registry of Titles and Documents (RTD) in Rio de Janeiro, to give publicity for the validity and admissibility in evidence of foreign documents in Brazil; (iii) as an internationally acknowledged practice, ownership over vessels shall be governed by the laws of the country of the flag the vessel is flying (that is, the place where the vessel is registered, which is Liberia in the case under dispute), rather than by the laws of the place where the vessel is located; (iv) Brazil ratified the Bustamante Code, which ensures the extraterritoriality effects of maritime mortgages; and (v) if Brazil does not acknowledge such foreign mortgage, the country’s international image could be adversely affected, as there would be more than 200 vessels in Brazilian waters flying a Liberian flag, out of which 141 would be mortgaged in favour of lenders which financed their construction.

The Cayman bank seeking the sale of the mortgaged vessel challenged the validity of said foreign mortgage in Brazil, alleging that: (i) the Liberian flag would be only a ‘convenience flag’ to offer advantages to the owner of the vessel, attempting to avoid the application of Brazilian law; (ii) Liberia would not be a signatory of the Bustamante Code nor the 1926 Brussels Convention, so the extraterritoriality effects of the foreign mortgage would not apply; (iii) registration of the mortgage with the RTD would not have been made in a timely manner; and (iv) the existence of a bareboat charter with a Brazilian shipping company would entitle registration of the vessel and her mortgage at the Brazilian Maritime Court.

An interlocutory decision granted by the lower court in charge of the enforcement action considered the foreign mortgage as invalid, in view of the absence of registration at the Maritime Court. This decision was maintained at the court of appeals based on the following: (i) the fact that registration of a foreign vessel mortgage at the Maritime Court would not be possible under Brazilian law would not result in the validity of such foreign mortgage registered with the competent maritime authority at the country of the vessels’ flag; (ii) the discussion regarding the Liberian flag serving as a ‘convenience flag’ would not be relevant to the dispute, as the extraterritoriality effects of the mortgage would depend on agreements for the validity of foreign security interests between the countries of the parties under dispute; (iii) Liberia is not a signatory of the international treaties on maritime mortgages to which Brazil is a party and, therefore, Brazil would not be required to acknowledge such Liberian mortgage; and (iv) the bondholders were aware of the risk related to the foreign mortgage not being acknowledged at the jurisdiction where the vessel would operate, as evidenced in certain contractual provisions.

The matter is still subject to appeal and it is difficult to predict whether this decision will be confirmed or not. Nevertheless, this is a leading case in Brazil in respect of maritime security practices and has raised concerns over ship financing transactions in Brazil, with migration of vessel ownership registration to countries that are party to the Bustamante Code and 1926 Brussels Convention.

While the bondholders are trying to protect their rights under a foreign mortgage in Brazil, it appears to be a matter of lack of jurisdiction of Brazilian courts to handle the enforcement action filed by the Cayman bank, as the vessel is owned by a foreign company, the mortgage is not registered in Brazil and the Dutch SPC as defendant is not located in Brazil.

Hopefully, the contents of the decision will be reviewed at the high court level.

The Maritime Court in Brazil only has authority to register ownership rights over Brazilian vessels. The Brazilian Maritime Court would not have authority to register ownership rights over a foreign vessel, even if that foreign vessel is provisionally registered under the REB.

Brazilian courts do not have jurisdiction to decide on the sale of a foreign vessel to secure a debt payable by the Dutch SPC outside of Brazil. This perhaps would be the reason why the lawsuit is causing so much confusion.

Ricardo Coelho is a partner and Caio Vianna is an associate at Pinheiro Neto Advogados. Mr Coelho can be contacted on +55 (21) 2506 1618 or by email: rcoelho@pn.com.br. Mr Vianna can be contacted on +55 (21) 2506 1677 or by email: cvianna@pn.com.br.

Ricardo Coelho and Caio Vianna

Pinheiro Neto Advogados