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Representative Mortgagees in Preferred Ship Mortgages

May 29, 2019 | Benedict's Maritime Bulletin, 2d Quarter 2019
 
RERESENTATIVE MORTGAGEES
IN PREFERRED SHIP MORTGAGES
By Glen T. Oxton

Ship mortgage law in the United States (and in the Marshall Islands, Liberia and Vanuatu, which have adopted the general maritime law of the United States) is often difficult to ascertain.  The relevant statutes lack detail, leaving many questions unanswered.  As courts often say, there is no federal law of mortgages. Instead, courts look to analogous state laws to interpret the federal mortgage statute.  As a consequence, change in the practice of ship finance occurs slowly. Rules are followed and forms are used because things have always been done that way, and outdated theories enjoy an unjustifiably long lifespan.  Two notions that ought to be retired are the fiction that a ship mortgage transfers title in the vessel to the mortgagee and its corollary that only a trustee and not a mere agent may be a representative mortgagee for multiple lenders.

The corollary is said to result from the fictional transfer of title in the vessel to the mortgagee, and that an agent, may not hold title to property.[1]  The first proposition reflects obsolete chattel mortgage law, and the second is simply wrong.  Ship mortgages have evolved from a chattel mortgage title theory to a more modern and realistic lien theory[2] under which an agent may serve as a representative mortgagee.[3]  As Professor Lloyd noted in 1923:
[T]he mortgage of to-day does not mean the same thing to the parties that it did to their ancestors when borrowing money to go to the Crusades. The creditor's security is no longer physical but legal.  William H. Lloyd, Mortgages-The Genesis of the Lien Theory, 32 Yale L.J. 233, 246 (1923)

 
A. Background
The law of mortgages has been shaped by two competing theories: the title theory and the lien theory. Under the title theory, the mortgage is viewed as a conveyance of title to the mortgagee with the owner having a right of possession until an event of default occurs.  Upon default, the owner may redeem the mortgage by paying the indebtedness or lose all rights to the vessel.  Under the lien theory the mortgage is seen as creating a statutory lien in favor of the mortgagee that is enforceable if a default occurs.
In the late 19th century security interests in personal property were governed by chattel mortgage law.  Chattel mortgages on ships existed at that time but they were considered non-maritime obligations that were not enforceable in admiralty even though they had to be recorded in the office of the collector of customs. The Law of Chattel Mortgages and Conditional Sales, Griffin and Curtis, 2d Ed. 1916 (Cornell University Library Digital Collection) at 189-95 (“Chattel Mortgages”).

Chattel mortgages were based on the title theory:  
A chattel mortgage is an instrument by which the title to personal chattels is transferred to a mortgagee as security for the payment of a debt … with a condition that upon payment… the title shall revest in the mortgagor; but if the debt is not paid …the title becomes absolute in law in the mortgagee.”  Chattel Mortgages at 2.
 
In distinguishing mortgages in real property, the authors said:
There is a manifest difference between a mortgage of real and a mortgage of personal property.  The former is merely a security for the debt; the mortgagee has only a chattel interest, and the freehold remains in the mortgagor.  A chattel mortgage, however, is more than a mere lien or security.  By the latter the legal title to the property is transferred, subject to be defeated by the payment of the mortgage debt.  Id.
 
The mortgagee’s title in the chattel was acknowledged to be only theoretical:
Before default in the condition of the mortgage, the legal title to the mortgaged chattels is in the mortgagee. … But while this is so technically and theoretically, yet practically, the substantial title remains in the mortgagor with all the incidents of legal title.  He retains the use, control and benefit of the property subject to the mortgage.  When entitled to possession before default, he can exercise many powers which ordinarily accompany the legal title to property.  He may maintain an action for conversion against any wrongdoer taking the property even against the mortgagee; he may sell the mortgaged property and convey good title subject to the mortgage; and, in many cases, the property may be seized and sold by virtue of an execution against him. Chattel Mortgages at 4.
 
In any case, the transfer of title to the mortgagee cannot be taken literally:
But while the Anglo-American lawyer is familiar with a form of chattel mortgage which contains words indicating a transfer of title to the mortgagee, such as “bargain, sell and convey,” there is a risk that under the laws of some foreign countries such words might be taken literally and result in the exposure of the mortgagee to liability for contracts or torts of the ship, or, where the foreign law requires the ship to be majority-owned by nationals, to the loss of registry of the ship under the laws of her foreign flag.  George deF. Lord and Garrard W. Glenn, The Foreign Ship Mortgage, 56 Yale L.J. 923 (1947).
 
The Ship Mortgage Act of 1920, 66 P.L. 261, 41 Stat. 1000 (the “SMA) brought ship mortgages within admiralty jurisdiction and provided mortgagees with a priority in rem lien on the vessel.  Notably, Congress did not provide the mortgagee with a right in admiralty to enforce its purported title.  Had it done so, the mortgagee’s priority would be that of an owner: subordinate to all maritime liens; and on payment of the debt the vessel would have to be re-conveyed to the mortgagor.  Instead, Congress created the ship mortgage lien.  The SMA states that “a preferred mortgage shall constitute a lien upon the mortgaged vessel” 46 U.S.C.A. §951 (now 46 U.S.C. §13325).

There is an anomaly in the SMA’s requiring a “mortgage” to obtain the lien.  In 1920 and for the next several decades a mortgage meant a chattel mortgage.  Thus, one had to engage in the fiction of conveying title to the mortgagee in order to create a chattel mortgage in order to obtain the lien.  
Practitioners persisted in using the fiction of title conveyance to the mortgagee.  In Chemical Bank New York Trust Co. v. S.S. Westhampton, 358 F. 2d 574 (4th Cir. 1965) (rehearing en banc denied 1966)[4], the Court held that the mortgagee “holds legal title to the mortgaged property, the SS. WESTHAMPTON.” But the Court did not expressly acknowledge the fiction or discuss the fact that title to the vessel also appeared to be in the registered owner. The Court’s conclusion was based solely on the granting clause of the mortgage, which stated in part:
“By these presents does hereby grant, bargain, sell, remise, release, convey, assign, transfer, mortgage, deliver and pledge, or cause to be granted” the SS. WESTHAMPTON. 358 F. 2d at 584.
 
The Court noted that for a mortgage to have preferred status, it must first be a “valid” mortgage, citing 46 U.S.C.A. §922(a) (“A valid mortgage…shall have preferred status.”).  However, the Court did not cite any source of law or other guidance as to the standards for determining validity.  The sole factor examined by the Court was the lack of validity of the debt based on a violation of federal law requirements as to citizenship.  This principle has been followed by other courts.[5]

As all of the States adopted the Uniform Commercial Code (the “UCC”), the last being Louisiana in 1990, chattel mortgages became obsolete.[6]  What then does “mortgage” mean in the SMA and the CIMLA?  According to the NOONIE G (discussed below), it means an instrument that complies with 46 U.S.C. §§ 13321 and 13322, regardless of its form. 

Section 9-104 of the original version of the UCC (now 9-109) excluded transactions from Article 9 to the extent that a federal statute governed the rights of parties and third parties in particular types of property.  The official comment indicated that the SMA was one of the statutes contemplated and further noted:
[T]he Ship Mortgage Act is far from a comprehensive regulation of all aspects of ship mortgage financing. … If problems arise under a ship mortgage which are not covered by the Act, the federal admiralty court must decide whether to improvise an answer under “federal law” or follow the law of some state with which the mortgage transaction has appropriate contacts.  … Thus, if the federal statute contained no relevant provision, this Article could be looked to for an answer.
 
On many occasions the courts have referred to state law, including the UCC, to resolve ship mortgage issues.  In their analyses, the courts do not look to state law as it existed in 1920 but instead review current state law.[7]  The NOONIE G indicates that this principle remains valid following recodification of the SMA to the CIMLA (defined below).

However, until the NOONIE G decision, the issue of whether a ship mortgage must be a chattel mortgage did not reach the courts. As a result, many practitioners continued to use forms of mortgage that contain a granting clause similar to the one in the Westhampton (quoted above) which purports to transfer title to the mortgagee.[8]

Coincidently, at about the time Louisiana adopted the UCC, the US maritime laws were re-codified and the provisions of the SMA were incorporated in the Commercial Instruments and Maritime Lien Act of 1989 (Public Law 100-710) (“CIMLA”).  The CIMLA made modest substantive changes but retained the basic structure of the SMA.  The CIMLA eliminated requirements for endorsement of mortgages on registry certificates, affidavits of good faith and separate discharge amounts for multiple vessels and non-vessel property.  It eased citizenship requirements for mortgagees, and clarified security for revolving credit loans.  Richard B. Barnett, US Ship Mortgage Law Relaunched, 8 Int’l Fin. L. Rev. 27 (1989).

B. A Ship Mortgage Conveys no Property
Both the SMA and its successor provide a mortgagee with a statutory mortgage lien enforceable in admiralty in rem.[9]  Enforcement of the lien is by a court sale of the vessel.  Nothing in the act or in the process of foreclosure inevitably results in a transfer of title to the mortgagee.  A typical mortgage provision authorizes the mortgagee to sell the vessel in a private sale by granting a power of attorney in favor of the mortgagee which would not be required if the mortgagee already held title. In addition, if the mortgagee is the owner, the remedy on default would be a possessory action under Rule D, not foreclosure. The archaic conveyance language in a ship mortgage today is, accordingly, meaningless.  In Hozie v. Vessel Highland Light, 1998 U.S. Dist. LEXIS 23076 (C.D. CA), the Court said:
The Ship Mortgage Act expressly states that a “preferred mortgage is a lien . . . .” 46 U.S.C. § 31325(a). Thus, the Bank had a lien and not a title interest in the Vessel. See 3 Witkin, Summary of California Law, § 13, at 438 (“[A] mortgagee obtains only a lien, notwithstanding an apparent transfer of the legal title; i.e., the transfer, if intended merely as security, is treated as a mortgage.”).
 
In the recent case of the NOONIE G,[10] a ship mortgage was challenged on the ground that it was not a valid mortgage under state law and therefore could not be a preferred mortgage under the CIMLA.  Ironically, the alleged defect was that the mortgage was in the form of a Louisiana chattel mortgage and this had been rendered obsolete by the adoption of the UCC.  Rejecting this argument, the Court held:
The Defendants in effect contend that, even if all six [statutory] requirements are met, the Ship Mortgage Act imposes an additional requirement for the mortgage to be valid—that the underlying mortgage be valid under the law of the state in which it was executed. After conducting a thorough review of the language of the Ship Mortgage Act, applicable case law, and numerous secondary sources, the Court finds no such requirement.  2017 U.S. Dist. LEXIS 93748 at 15.

The Court identified six requirements as to the form of a mortgage, citing 46 U.S.C. §13321.   The mortgage must:
(1) identify the vessel;
(2) state the name and address of each party to the instrument;
(3) state, if a mortgage, the amount of the direct or contingent obligations . . . that is or may become secured by the mortgage, excluding interest, expenses, and fees;
(4) state the interest of the grantor, mortgagor, or assignor to the vessel;
(5) state the interest sold, conveyed[11], mortgaged, or assigned; and
(6) be signed and acknowledged.
2017 U.S. Dist. LEXIS 93748 at 13.
 
Thus, any requirement that a ship mortgage include a transfer of title to the mortgagee would have to be contained in the CIMLA or in the mortgage cases included in the general maritime law. No such requirement exists.

Not only does a mortgage not require transfer of title to the mortgagee, any such transfer would cause serious problems under other laws.  To document a vessel, a statement must be made under the penalty of perjury as to the identity of the owner and its citizenship.  46 C.F.R. §17.141; CG-1258.  In practice, the mortgagee is not named as the owner.  In addition, under 46 C.F.R. §67.167(b):
A Certificate of Documentation together with any endorsement(s) thereon becomes invalid immediately, except as provided in § 67.161, when:
(1) The ownership of the vessel changes in whole or in part.
 
Clearly, there is no transfer of title in a mortgage or the documentation of all mortgaged vessels would be invalid.  As Lord Mansfield said in 1781, “It is an affront to common sense to say the mortgagor is not the real owner.” Quoted in William H. Lloyd, Mortgages-The Genesis of the Lien Theory, 32 Yale L.J. at 237 (1923).

Maritime liens, like mortgage liens, are enforceable in admiralty in rem.[12]  For both types of liens the enforcement procedure consists of arrest of the vessel and a public auction under court supervision.  The lien is then satisfied out of the proceeds of the vessel (after paying the expenses of the court’s possession).

Maritime liens are often characterized as a “special property interest” in the vessel.  Admiralty and Maritime Law §9:1, Schoenbaum (6th Ed. 2018).  It is “special” because unlike common law liens, it does not depend on possession of the vessel.  The China, 74 U.S. 53 (1868) at 68.  It is a “property interest” because it is a right in rem.  The lien attaches to the vessel itself and is not defeated by a subsequent sale or the insolvency of the owner. The Young Mechanic, 30 Fed. Cas. 873 (D. ME. 1855). But this is to say nothing more than it is an in rem lien.  The lien is not property; it is a statutory right.  It is nonsensical to refer to title to a statutory lien.  Nor is there any registry for such purported titles.  The requirement to record a mortgage is for the purpose of providing notice of the lien to other potential creditors.  As stated in House Report 100-918, p. 19 (September 15, 1988) discussing the recodification of the SMA:
However, the mortgage is not valid as to notice to third parties for purposes such as establishing priorities until it is filed, since third parties will not have had the opportunity to know of its existence until then.

C. Agent as a Representative Mortgagee
Even if contrary to the law, a ship mortgage were viewed as a conveyance of property, there is no reason an agent may not be a mortgagee (leaving aside US citizenship requirements).
The nature of an agency relationship does not preclude an agent from holding mortgage rights for another, whether those rights are viewed as a jus in re, an interest in property, a quasi-interest in property or merely the right to a statutory lien. Section 14B of the Restatement 2d of Agency (1958) reads:
One who has title to property which he agrees to hold for the benefit and subject to the control of another is an agent-trustee and is subject to the rules of agency.
Comment (a) states in part:
Agents and trustees are both fiduciaries, and there is no antithesis between the relations. An agent may or may not hold a title for the principal, but he is always subject to the principal’s directions. A trustee always holds a legal or equitable title for the beneficiary, but he may or may not be subject to the beneficiary’s control. … [Emphasis added].
 
There is nothing in the SMA, the CIMLA or any federal case involving preferred mortgages that prohibits an agent acting for one or more lenders from being a mortgagee.  Moreover, two courts have upheld mortgages in which an agent was the mortgagee.  In re Dixie Pellets, LLC, 2010 Bankr. LEXIS 5624 (Bankr. N.D. AL); In Re Muma Services, Inc., 322 B.R. 541, 2005 Bankr. LEXIS 494 (Bankr. DE).
In Muma Services, Wachovia Bank was the mortgagee in several US ship mortgages “as agent for itself” and other lenders.  The case was a Chapter 7 liquidation in which a trustee was appointed.  The trustee stipulated to the validity of the ship mortgages, indicating that there was no reasonable basis for challenging them.  Under Section 704(5) of the Bankruptcy Code[13], the trustee has a duty to “object to the allowance of any claim that is improper.”

Dixie Pellets was a chapter 11 bankruptcy case in which the debtor commenced an adversary proceeding (Case 10-00038, Doc 1, 04/09/10) challenging certain maritime lien claims and other claims but stipulated to the validity of a US ship mortgage in favor of Bank of New York Mellon Trust Company as “collateral agent for the lenders.”  If there were any grounds to challenge the ship mortgage, the debtor would have included such a claim in its adversary proceeding.
 
A representative mortgagee is the real party in interest in the enforcement of a preferred mortgage lien.  The real party in interest under the federal rules is the mortgagee named in the mortgage notwithstanding that all of the benefit may go to another.   In Avondale Shipyards v. Tank Barge ets 2303, 1987 U.S. Dist. LEXIS 4253 at 13 (E.D. LA), the Court said:
The effect of Rule 17(a) is that the action must be brought by the party who, according to the governing substantive law, is entitled to enforce the right.
* * *
It is clear in this case that ITT [the named mortgagee], not GECO, is the actual mortgagee on the preferred mortgage giving rise to the lien from which ITT seeks priority. Thus, ITT is entitled to enforce the rights conferred by Section 951. Under Rule 17(a), ITT therefore also is the real party in interest, although it may ultimately gain nothing, and GECO and/or Ocean Capital stand to benefit from the judgment.
 
If a court sitting in admiralty were presented with the issue of whether an agent may be a mortgagee, the analogous state law to which it would refer is the UCC.Under the UCC:
“Secured party” means: (A) a person in whose favor a security interest is created or provided for under a security agreement, whether or not any obligation to be secured is outstanding; (B) a person that holds an agricultural lien; (C) a consignor; (D) a person to which accounts, chattel paper, payment intangibles, or promissory notes have been sold; (E) a trustee, indenture trustee, agent, collateral agent, or other representative in whose favor a security interest … is created or provided for; or (F) a person that holds a security interest arising under [specified sections of the UCC].  [Emphasis added]. NY UCC 9-102(73).
 
Under NY UCC 9-502(a):
A financing statement is sufficient only if it:
  1. Provides the name of the debtor
  2. “provides the name of the secured party or a representative of the secured party;” and
  3. Indicates the collateral covered. [Emphasis added].
A failure to indicate the representative capacity of a secured party does not affect the sufficiency of the financing statement. NY UCC 9-503(d).

The relationship between a representative mortgagee and its lenders is a matter entirely between themselves.  None of the other creditors, a bankruptcy trustee or the borrower has any legitimate interest in the nature of the relationship or whether it is a trust or an agency.  As the court noted in First State Bank v. Towboat Chippewa, 402 F. Supp. 27, 34 (N.D. IL 1997), in rejecting the contention that a loan participant should have been named as the mortgagee:
 [The owner] quite properly points out that neither [creditor] acted to its detriment or was misled by the non-appearance of American Bank as a mortgagee, that the $130,000 mortgage was a matter of public record, and that the appearance of American Bank as mortgagee in Coast Guard documentation would have made no difference in the actions of either of the intervenors.
 
The preference for using a trustee and not an agent may have grown out of citizenship restrictions for mortgagees of vessels under US flag (later eased by the CIMLA).  In his article, Some Problems in Vessel Financing – a Lender’s Lawyer’s View, 47 Tul. L. Rev. 629, 640 (1972-73), Edward H. Mahla discusses issues involving multiple lenders, and implies, without citing any authority, that if a trustee was not used each lender would have to be recorded as a mortgagee. He focuses on the requirement of citizenship affidavits for each mortgagee and the endorsement of the certificate of registry, both of which have eliminated.

D. Liberia, the Marshall Islands and Vanuatu
In 1948, Liberia, with the help of American attorneys, adopted maritime and corporate laws that were modelled on US statutes, including the SMA, in which many sections were verbatim copies of the US versions.  In addition, the Liberian law incorporated by reference the general maritime law of the United States to the extent that it did not conflict with any Liberian statutes. 

In 1990, while Liberia was suffering a disastrous civil war, both the Marshall Islands and Vanuatu adopted maritime laws following the Liberian model, including the incorporation by reference of United States general maritime law.  The US recodification in 1989 was not followed by the other countries but Liberia and the Marshall Islands both eliminated endorsements and good faith affidavits and made certain other updates, while the law in Vanuatu has remained fairly static.  The main aspects of these laws, however, remain sufficiently similar to the CIMLA that the American ship mortgage cases referred to above are relevant in these other jurisdictions.

E. Conclusion
The purported conveyance of title in a ship mortgage is an archaic fiction that should be abandoned.  Even when the mortgage contains conveyance language, an agent may be a representative mortgagee for lenders.
 
[1] The latter might be based on the concept that an agent cannot be the record owner of a vessel because the statute requires the owner’s name to be recorded.  A mortgage lien, however, does not convey title to the mortgagee, as discussed below.
[2] This is illustrated by South Lafourche Bank & Trust Co. v. M/V Noonie G, 2017 U.S. Dist. LEXIS 93748 (E.D. LA) (the “NOONIE G”) discussed below.
[3] An agent as a representative ship mortgagee has been upheld in two bankruptcy decisions: In Re Muma Services, Inc., 322 B.R. 541, 2005 Bankr. LEXIS 494 (Bankr. DE); In re Dixie Pellets, LLC, 2010 Bankr. LEXIS 5624 (Bankr. N.D. AL), discussed below.
[4] A bond issued to a German bank was secured by a ship mortgage in favor of a citizen trustee.  The Court held that the bond was void because it constituted a transfer of an interest in the vessel to a non-citizen under Section 37 of the Shipping Act of 1918 (then 46 U.S.C.A. § 835(b), and now 46 U.S.C. § 56102) for which consent of the Maritime Administration was required but was not obtained, and that, consequently, the mortgage was void. 
[5] Merchants Nat’l Bank of Mobile v. Ward Rig No. 7, 634 F.2d 952, 958 (5th Cir. 1981) (“We are examining the validity of the ship mortgage which does not require a promissory note, only a debt which is being secured.”); Tropicana Shipping, S.A. v. Epresa Nacional ‘Elcano’ de la Marina Mercante, 366 F.2d 729 (5th Cir. 1966) (“… it is well established that the validity of a mortgage is dependent only on the existence of a debt actually secured by the mortgage and not on the description of the debt contained in the instrument. The actual existence of a subsisting debt at the time of foreclosure may be established by parol testimony, and where it is established that the notes or bonds, or other evidence of indebtedness described in the mortgage did not exist, the mortgage may, nevertheless, be foreclosed.”)
[6] As noted by Professor Gant Gilmore in Security Interests in Personal Property (1965), § 10.2, as a “propaganda” measure, the Code did not expressly abolish the pre-Code chattel mortgage, but the statutory and decisional chattel mortgage law was abolished, and a chattel mortgage does not provide security unless it complies with Article 9.
[7] E.g. Custom Fuel Services, Inc. v. Lombas Industries, Inc., 805 F.2d 561 (5th Cir. 1986); J. Ray McDermott & Co. v. The Vessel Morning Star, 431 F.2d 714 (5th Cir. 1970); Morgan Guaranty Trust Co. v. Hellenic Lines, Ltd., 621 F. Supp. 198 (S.D.N.Y. 1985); First Federal Sav. & Loan Asso. v. Zequeira, 288 F. Supp. 384 (Dist. P.R. 1968); United States v. Caprice, 427 F. Supp. 1035 (D. NJ 1976); Bergren v. Davis, 287 F. Supp. 52 (D. CT 1968); Oil Screw Mary Evelyn, 248 F. Supp. 520 (1965); In re McLean Industries, Inc., 76 B.R. 328 (Bankr. S.D.N.Y. 1987).
[8] E.g. Simpson v. Lady Nell, 2013 U.S. Dist. LEXIS 136091 (W.D.WA.) (the “ship mortgage conveys to Plaintiffs the whole of the vessel Lady Nell”).
[9] 46 U.S.C.A. §951, now 46 U.S.C. §31325
[10] Fn 2 supra.
[11] Section 13321 covers all types of instruments that are to be filed, including a “bill of sale, conveyance, mortgage, assignment or related instrument.”   The terms “sold” and “conveyed” in paragraph 5 of the quoted section refer to bills of sale and conveyances, not mortgages.
[12] Notwithstanding this similarity, mortgage liens are not maritime liens because they must be recorded, priority is based on first in time and they are not subject to laches. 
[13] 11 U.S.C. § 704(5).