Shipyard insolvency risk raised by Covid-19: Here’s what to do
Vulnerable shipyards are at increased risk of insolvency due to the Covid-19 global pandemic and investors and owners should be vigilant to protect the value of their assets, according to the latest Superyacht Investor Town Hall online meeting.
While Covid-19 has restricted the movement of yachts around the world, its greatest risk is to already vulnerable shipyards, warned Robb Maass, shareholder, Alley, Maass, Rogers & Lindsay. “Covid-19 has a greater effect on yard profitability and the probability or possibility that a yard would get into financial difficulties,” Maass told Town Hall delegates.
“Covid-19 has driven up costs as yards scramble for ways to make up for lost labour and the inability of sub-contractors outside the country to enter the country together with general yard disruptions.” But Maass went on to add that the market over the past year had proved surprisingly robust. “Everything from existing yachts to new builds were booming. Even if cost factors have been driven up, at least a lot of the better yards have made that up with new orders.”
Before placing a new order, Jay Tooker, partner and co-head of Yachts, HFW advises clients to plan for the possibility of yard insolvency when negotiating the construction contract. “It’s negative cash flow that leads to insolvency and there are various ways of planning for it within construction contracts,” said Tooker. All contracts will include one of three security arrangements for the buyer. Those are: refund guarantees, ownership of the vessel during construction or a combination of the two.
Refund guarantees cover all the pre-delivery payments made by the buyer. This means if the buyer needs to terminate the contract, due to the builder’s insolvency, there is a third party, ideally a bank, from which to reclaim the money.
The alternative, if the shipyard can’t provide shipyard guarantees, is to give the buyer ownership of the vessel during the build. “This is a common one in shipyard construction because most shipyards can’t afford to make all bank guarantees for all the pre-delivery instalments,” said Tooker. “This always has to be done in accordance with local law – wherever that may be. Sometimes you need to register that title to perfect it.” Securing title to the yacht under construction means that if you have to terminate the contract due to the shipyard’s default or insolvency, you can take possession of the yacht and remove it for completion elsewhere.
But buyers should remember that during the early stages of a two- or three-year construction project “there won’t be much to show for your money”. So, in the early stages, even when the owner has title during construction, there will usually be provision for bank guarantees covering those early payments.
“Often the bank guarantees will continue throughout the construction to cover the peaks and troughs in the value of the components used in the build,” said Tooker. They also cover the inevitable extra costs of transporting the yacht for completion at another shipyard, which will always result in a higher price than the one agreed in the contract.
“The third option is a combination of the two [refund guarantees and ownership of the vessel during construction],” said Tooker. “This gives the buyer title to the vessel but also the cushion of extra guarantees.”
Refund guarantees are the preferred protection, if they are available, according to Alex Sayegh, legal director, HFW. “The one thing refund guarantees are not going to give you is the yacht that you have contracted for,” said Sayegh. “But they offer a neat and efficient solution to the problem of shipyard insolvency, if it arises.”
Where buyers decide to take title during construction, there are some extra measures that can be built into the contract. “You need to register your title locally in many jurisdictions in order to gain protection from other creditors of the shipyard,” said Sayegh.
Also, buyers are recommended to take a far keener interest in the shipyard’s insurance. “Buyers will want to be named as co-insured on the yard’s insurance policy,” he said. “And there are practical steps you need to take to police the project. Those include insuring that your yacht’s components are segregated from other goods at the shipyard and marked with the hull number. So, it’s a bit more labour intensive policing a project when you have title in construction.”
Turning to danger signs that a yard may be in difficulty, Maass, of Alley, Maass, Rogers & Lindsay, advised buyers to listen to vendors’ complaints about late or withheld payments. “One of the problems with dealing with a yard under stress is that it will do anything to avoid making that evident,” said Maass. “As soon as the word is out that a yard is in trouble, nobody wants to sign up for what could prove a problematic project. It can be a death knell.”
Requests for premature payments are another warning sign, said Tooker, from HFW. Between eight to 12 payments are normally due at key stages in the construction, such as keel laying, installing the engines, electrical systems or interiors. “When you have a yard in difficulty, you can start to see premature requests for payment,” he said. Examples include payment requests for the installation of electrical switch boards but without the fitting of supporting cables or engines that are installed and then quickly removed.
“A shipyard relies on the working capital provided by the owner’s payments during construction,” said Tooker. “As that money comes in, it also goes out to pay for engines, steel and other materials. It can become a fine balance between positive and negative cash flow. And if you complicate the process by having several yachts under construction at the same time, the risk of cash flow becoming negative is greater.”
In the event of a yard bankruptcy, if owners decide to intervene in the building process to direct payments to suppliers, the extent of their liability needs to be considered carefully. “If the shipyard does end up in insolvency, there’s a risk that you have somehow become a shadow director of the business,” said Tooker. “If you are directing where the cash goes, you could be personally liable for the consequences if it results in some creditors being preferred over others. That’s generally against the rules in any kind of insolvency.”
Another point to beware when buyers take title of their yacht under construction at an insolvent yard is the point at which VAT is liable to be paid. Most contracts, particularly at EU shipyards, specify that for VAT purposes the point of delivery will be when the yacht is delivered to the buyer on its completion as a sea-going vessel. Most yachts are built for export so new owners will typically have 90 days from the EU.
“But if an event happens earlier than that to terminate the contract or a buyer enters into the possession of the yacht, you are changing the point of supply,” explained Sayegh. “That can trigger an immediate VAT charge on payment instalments you have paid to date.”
Tooker acknowledges that shipyard insolvency can be terrifying at first glance. “It’s something you need to contemplate when negotiating a construction contract. But if you have a plan for managing it, shipyard insolvency is not necessarily a disaster.”
The Town Hall, ‘Managing yard insolvency’, was sponsored by HFW and took place on Thursday March 25th, 2021. You can watch the meeting here or listen to the podcast here. Next month’s Town Hall, ‘Is finance available?’, takes place on Thursday April 29th.