Ship Registry, Mortgages and Liens in Electronic Form

September 2005

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SHIP REGISTRY, MORTGAGES AND LIENS

IN ELECTRONIC FORM

September 2005


The potential benefits of a digital registry, how it might work, and some of the obstacles to going digital are reviewed in this note.

An electronic registry would make the ship registry process faster, more convenient and reliable. It would reduce expenses for the owners both directly by reducing transaction costs, and indirectly by reducing risk to lenders. In addition, since more deals are done when deals are easier to do, it could provide increased liquidity in the purchase and sale and finance markets for ships. Registries will not become fully digital, however, until rules and standards for certification authorities are established and digital signatures become more widely used. The drive to eliminate paper records, as reflected in adoption by the courts of electronic filing systems, is likely to spur use of digital signatures.

A. A Digital Ship Registry

Electronic Case Filing System (or “ECF”) in use in the federal courts provides a good model for structuring a digital ship registry. The ECF is web based. All the users of the system, those in the courthouse — judges, magistrates and clerks; and those on the outside — counsel, the parties and the general public, all work from the same set of documents on the web. Its central organizing feature is the docket sheet of a case, which lists every document filed in an action. Users can click on the document title in the docket sheet and view and download the entire document in Adobe PDF, a format that is easily accessible and retains the appearance of the original document.

Creation of the docket sheet is automated. When counsel for a party files a motion, for example, he logs on to the ECF website, selects the appropriate case, then selects from a menu the type of filing he wishes to make, e.g., file a motion. A form then opens online, in which counsel inserts the information required to generate the docket sheet entry. Each type of filing will call up a different form because the information provided in the docket sheet for different types of filings may vary. The form contains error correction features so that clearly erroneous data will not be accepted (for example, a hearing date that is earlier than the date of filing of the motion).

The ECF security system is in two parts. The first part consists of a password system under which anyone who wishes to file documents in any case must apply for a username and password. The court rules provide that filing a document under a password constitutes the signature of the password holder on the document. The password is likely to be replaced by a digital signature once they become widely used.

The second part of the security system is an automated email notification system that first sends an email to the filer confirming the filing, and secondly sends an email to every other party in the case notifying them of the filing. The court has very thoughtfully included in the email notification the direct URL of the document filed, so the recipient may simply click on the URL to view the document. All of the documents in the ECF are available for viewing by the public, except in those rare cases in which documents are sealed.

Adapting the ECF for a ship registry would seem to be very straightforward, at least conceptually. The docket sheet would become a vessel’s index in which every document submitted to or issued by the registry would be listed with a link to the document. Some modification of the court system would be required. For ships, the general public typically has access only to bills of sale, mortgages and other recorded documents, as well as the ability to request a certificate as to the current ownership and recorded liens on a particular vessel. Limiting access could be continued in an electronic system, while giving the registry staff, the shipowner and the mortgagee access to all documents.

The issuance of up-to-date electronic certificates of ownership for a vessel could be fully automated in a digital system. The software would examine the vessel’s index and issue a report as to the ownership and the instruments recorded against the vessel. The system would then affix a digital signature of the deputy commissioner and attach a digital signature certificate (these are discussed below). Thus, using an internet connection one could obtain a current certificate of ownership at any time from any location. Once obtained, the certificate of ownership could be emailed to others.

Some other changes to the ECF would have to be made. It would be useful to display on a vessel’s index a status indicator of documents filed that would reflect the state of various registry processes. For example, applications would be marked either submitted, which would be their status immediately upon filing, or accepted, which would indicate acceptance by registry staff of the particular application. A vessel’s registry status could include:
 
Like the ECF, the registry system should have an optional email notification feature for shipowners and mortgagees, which would provide them with immediate automatic notice of the filing of any document on a particular vessel’s index.

It would be useful if a ship registry system would provide, when a particular process is commenced, a list of all items outstanding in order to complete that process. For example, to register a vessel and record a mortgage, the system would list all the application forms and other documents that would have to be filed in the vessel’s index. The list should be dynamic so that as items are completed they will be either checked off or removed from the list of open items. Then everyone involved in a transaction on both the borrower’s and lender’s side may view its progress.

The registry would benefit from the applicant’s completion of forms on-line because after review, this data could be automatically transferred to the registry’s database without re-keying.

There are certain issues that are unique to shipping, at least compared with other lien recordation systems such as the Uniform Commercial Code (“UCC”) in the United States. The most significant difference is that shipowners have the ability to elect under which flag they will register their vessels. Since there is no unified worldwide title registry for vessels, there must be some protection against multiple fraudulent registrations and multiple fraudulent mortgages, although the number of attempted frauds of this sort is probably not high.² In the absence of a title registry, the Unidroit Convention provides only marginal improvement over the present lien recording arrangements for ships. Even if the Convention included this feature, it might be difficult to convince the popular flag states to give up the revenues they receive from their recording offices.

The integrity of the existing system depends on the existence of a limited number of original signed paper documents. For example, if one requests a permission to transfer from one registry to another, the existing registry will issue a signed permission in paper form, specifying the new flag. If the shipowner later changes its mind as to the desired flag, it must return the original written permission for transfer before a new one for the revised new flag will be issued. A similar practice is followed with respect to bills of sale. Normally, a limited number of original bills of sale are signed, and the new registry requires an original signed paper bill of sale. With electronic documents, there is no way to distinguish between an original and a copy. For all practical purposes, there is no discernible original, and multiple electronic copies may be made with the press of a button. The transparency of a digital ship registry, however, may more than compensate for this potential security deficiency. If all the major registries go to digital form, and each of them were to require in their regulations permission to transfer prior to the transfer of a vessel from that registry to another, the permission to transfer would be on the ship registry website available for everyone to see. The regulations could provide that a permission to transfer would be cancelled only after notice by email was given by the existing registry to the proposed new registry. Also, if the registries are digital and they reflect pending registrations, one could check to see whether the same vessel had registrations pending in more than one registry.

B. Helpful Legislative Changes

Under an electronic system, all of the documents in a transaction that are available before funds are disbursed would be filed on the vessel’s index, reviewed by the registry staff and be given a status of “accepted.” Although a legislative change would be required in most jurisdictions, there is no good reason that a mortgage could not be among the documents filed and marked “accepted” in advance of the closing. If the vessel is not yet registered in the flag, the statute would provide that the mortgage becomes effective on the completion of registration of the vessel. For a transfer of a vessel within the flag of registry, the statute would provide that it becomes effective upon the earlier of: (i) the time funds are advanced by the mortgagee or (ii) when a satisfaction of the old mortgage is recorded (if there is an existing mortgage being refinanced and the new mortgage covers only future advances).

These changes would remove some of the risks to lenders in a ship financing transaction by reducing the time between the lender’s advance of funds and the mortgaging of the vessel.

In the case of a change of flag, there is not a great deal of improvement to be made since the lender cannot have a mortgage until the vessel is registered (although at least one country has legislatively extended the tacking doctrine to a mortgage previously recorded under a different flag). In the case of a transfer within the flag, making the mortgage effective upon advancing funds would give the new lender a second mortgage position during the time it takes to transmit the funds, obtain confirmation of their receipt and obtain and record a satisfaction of the old mortgage. If, in the exceptional case in which funds advanced are not received by the outgoing lender on the intended day, the new lender would at least have a second mortgage position in the vessel and presumably its funds would be somewhere in the banking system. These would be either repaid to the new lender or eventually applied against the first mortgage, after which new lender’s position would automatically rise to the first position. Admittedly, if the new borrower’s funds are fraudulently misdirected or stolen (which infrequently occurs, if ever), the new lender’s second mortgage on the vessel may be of little value.

The current practice under United States and similar flags (i.e., Liberia, Marshall Islands and Vanuatu) is to record the loan agreement, the promissory note (if any) and any other document that evidences the indebtedness secured by the mortgage or contains a debt-related event of default as an exhibit to the mortgage. The theory behind filing these voluminous documents is that prospective creditors who are about to deal with the vessel will have the opportunity to become informed about the senior mortgage debt on the ship before extending credit. In practice, the only parties that contact the registries for copies of recorded documents are competitors of the shipowner against whom the mortgage has been recorded. The shipowner’s cost of capital often may be ascertained from the documents recorded with a mortgage. This is valuable competitive information that the shipowner usually prefers that its competitors not obtain. None of the statutes of the flags mentioned requires that these documents be attached to recorded mortgages, and it is questionable whether the attachments are actually required. Nevertheless, the practice is so ingrained that it would be helpful to have a statutory change providing for mere notice filing similar to the UCC system in the United States and the English statutory mortgage system.

C. Digital Signatures and Certificates

In the ECF, a lawyer’s use of his username and password constitutes his signature on documents filed in the system. Signatures of other persons, such as a client’s signature on an affidavit filed with a motion, is filed as a scanned image. The court rules require the submitting attorney to retain the signed paper original in his office available for inspection by the court or any other party in the case. This is probably an interim practical solution in the ECF. When digital signatures become widely available, this procedure will be replaced by the attorneys filing a court pleading bearing the attorney’s digital signature and attached to it will be the client affidavit that will also be digitally signed by the client.

The interim solution employed by the ECF system is obviously not suitable for a ship registry. Bills of sale, mortgages and applications for registry must be signed. The most likely solution at this time appears to be the use of digital signatures based upon Public Key Infrastructure (or “PKI”) technology. PKI is based upon pairs of keys, each consisting of a very large number, and PKI software. One key in each related pair is designated the private key, and the other, the public key. Electronic files encrypted by one of the keys may be decrypted only by the other key of that pair. This relationship is used to generate a signature when the encryption is done using the private key. In that case, a successful de-encryption using the public key establishes that the holder of the private key could be the only person who encrypted the message.

When the process is used in reverse, in other words when the file is encrypted using the public key, the file can be de-encrypted only by using the private key. This is a means of sending an encrypted electronic message that only the intended recipient is able to read, as he is the only holder of the private key.

The second part of a digital signature confirms that the digitally signed document has not been altered. The PKI software analyzes the document being signed and creates its hash (or digital fingerprint) based upon the distribution of the ones and zeroes in the binary expression of the document. It is not possible to recreate a document from its hash, which is a desirable security feature. On the other hand, the hash is sufficiently sensitive that the deletion of a single space in an electronic document will change the hash of the document. The PKI digital signature consists of an encryption, using the signer’s private key, of the hash of a document. Upon receipt of a signed document, the recipient uses the signer’s public key and the PKI software to decrypt the hash, indicating that only the holder of the private key could have encrypted or signed the document. The software then recalculates the hash of the received document and compares it to the decrypted hash. If they match, the document was not altered between the time the two hashes were generated.

At this point, the recipient of the message knows that the holder of the private key corresponding to the public key held by the recipient applied his digital signature to an electronic document and that the document has not been modified since it was signed. The recipient does not know, however, the identity of the holder of the private key (unless he happens to have independent knowledge of that person and his or her public key).

Verifying the identity of the holder of a pair of keys (disclosing only the public key) is the third element of the PKI digital signature — the digital certificate. This is an electronic certificate issued by a trusted third party such as a private company like Verisign or Entrust or a government agency such as the United States Postal Service, which is now issuing digital certificates confirming the signatures of government employees. Certificates might also be issued by law firms and a new type of e-notary. The certificate is a separate electronic document to which a PKI digital signature has been affixed. Typically, the certificate will contain the public key of the signatory. The certificate will say in effect that John Smith is the holder of public key XYZ. The public key contained in the certificate can then be used to verify the signature of Mr. Smith. The signature on the certificate itself can be verified by visiting the website of the issuer and obtaining its public key to apply to the certificate (using PKI software). In addition, because it is recommended that digital signatures and their corresponding certificates be updated not less than every 12 months for security purposes, one would also check the issuer’s website to ensure that the certificate has not been revoked. This process is similar to the checking done on a credit card consumer purchase and can be automated through the internet.³

There have been substantial developments in legislation approving the use of digital signatures and electronic records as satisfying the legal requirements of signatures and writings under state, federal and international law. There are very few rules, however, governing the liability of the entities issuing the digital certificate (the “certification authorities”) or the allocation of loss when fraud occurs.

The typical example of the possibility for loss is the theft or unauthorized access to a person’s private key. Even if the owner exercises reasonable care in protecting his key, if it is maintained on a computer connected to a network, a skilled hacker may be able to obtain it. The hacker could then use the private key to forge the owner’s signature to empty the owner’s bank account or incur a large debt for goods shipped to the hacker. In such cases, there are no adequate provisions as to who will bear the loss or the expense of tracking down the hacker.

There are, however, some feasible ways to increase the security of the private key. One method is to put the key on a smart card (resembling a credit card) so that the key does not reside on a computer, then combine access to the key with not only possession of the smart card but some biometric measure such as a fingerprint or retina scanning device and perhaps a password before the private key could be used.

Another (and not exclusive) possibility is some form of insurance among the certification authorities under which the liability of a signatory for fraudulent use would be limited to a manageable amount. Liability of the certification authorities could also be limited, and the balance of the loss could be covered by insurance.

Digital certificates can include not only verification of the identity of the signatory and his public key, but also a description of the limits of authority of the signatory for the specified entity. The postal service program for government employees, for example, provides digital certificates to government employees that certifies their public key and their authority to enter into purchase contracts on behalf of government entities up to a specified amount. Thus, when such a certificate is used, the digital signature will contain independent confirmation of the signer’s authority to act on behalf of an entity. This part of the certification could potentially eliminate the need for the attorneys’ formal legal opinions as to due authorization and execution by an entity.

One possibility for implementing such an arrangement would be to expand the role of the corporate registry such that in addition to filing articles of incorporation, corporations could file certificates in electronic form stating that:

John Smith is the president of ABC Company. His corporate public key is attached. He has authority to commit the corporation to transactions of unlimited size.

Alternatively, certificates could be filed in the corporate registry evidencing an individual’s authority to act in a particular transaction. The corporate registry could then issue its own certificate stating that the attached certificate has been filed with respect to ABC Corporation and has not been revoked. The law of the corporate jurisdiction would then provide that the third parties may rely on such a certificate, and the corporation will be bound by the document signed by Mr. Smith using the private key corresponding to the public key specified in the certificate.

A factor that must be considered by any party using digital signatures is the new burden of managing keys and certificates within an organization. Security over the key management operation must be maintained, keys and certificates for individuals must be regenerated periodically for security purposes, and changes, additions and departures of various individuals must be accommodated.

D. Liens for Necessaries

In the digital world, the law of maritime liens for necessaries is an anachronism. In the days of sailing ships, the maritime lien laws made sense. The vessel would frequently find itself in a port far from its owners and its home port (although often the master was an owner), communication with the home port was very slow and often unreliable. There was no feasible method for a supplier in a foreign port to conduct any due diligence as to the creditworthiness of the owner of a vessel that sought to purchase supplies on credit. With the communications facilities available now, none of these factors remain valid. Indeed, the only reasons for continuing to have a maritime lien for necessaries at all is that it is a convenient source of credit for the shipowner or operator, and the theory that the supplier should not be relegated to pursuing the shipowner or the vessel abroad for payment of his claim.

If a registry is using a digital system (or even prior to a full digital registry system, a registry could implement a digital system exclusively for recording lien claims), it would be a simple matter to enable the shipowner to file the equivalent of a UCC-1 Financing Statement to record a notice of a maritime lien for necessaries. The ability of creditors in some jurisdictions to file a notice of lien unilaterally would have to be eliminated. To implement such a system, the flag state would have to adopt legislation establishing rules for such filings. The UCC provides an excellent model, although the maritime filings should expire in the six to twelve months instead of the five years provided in the UCC. Discharges would be filed only by the holder of the lien. The rules would also have to provide for enforcement of prompt discharge of filings by lien holders upon payment. These filings would be accessible to the general public on the registry’s website.

Since the maritime lien for necessaries is created by the jurisdiction of the port in which the necessaries are provided, those laws would have to be amended to provide that if the laws of the flag state required a digital filing in order to perfect a maritime lien for necessaries, such law would govern the perfection of these liens.

Once a digital lien registry is in place, a shipowner desiring to purchase necessaries on credit would be able to file a notice of lien on its vessel’s index in a matter of minutes. The supplier could confirm that the notice had been filed by a quick visit to the registry’s website.

Under such a system, if the owner declines to file the lien, it will either have to pay cash for the necessaries or go without them. Such a system would provide financiers and owners of bareboat chartered vessels with an effective means of enforcing their no-lien clauses with respect to contractual liens. Since most non-contractual liens are covered by insurance, the contractual liens are often of greatest concern. Buyers of vessels and their lenders would also welcome a reduction in the number of the potential secret liens under such a system.

E. Putting It All Together

To purchase a vessel, register it and record a mortgage in the digital age, the shipowner’s representative would have to have a digital signature with a certificate evidencing either his general authority to bind the company for amounts in excess of the amounts involved in the transaction, or his specific authority to complete the intended transaction. The shipowner would digitally sign all of its applications for registry and file them through the internet. These will all have been reviewed and marked “accepted” on the vessel’s digital index. Prior to the closing, the shipowner would have filed with the new registry the permission to transfer, digitally signed by the outgoing registry. The shipowner also will have filed its mortgage on the ship through the registry’s website, which also will have been reviewed by the registry staff and marked “accepted.” The lender would review the status of the new registration on the registry website and would be able to see very easily that the only items remaining to be submitted before the vessel would be registered and mortgaged are the bill of sale and an up-to-date certificate of ownership and encumbrances reflecting that the seller is the owner of the vessel free of recorded liens – the documents that are obtained when payment is made. The lender and buyer could also check the index of the old registry for notices of liens (although this would be reflected in the certificate of ownership from the old registry).

The new registry would view the vessel’s index in the old registry to confirm that the permission to transfer the vessel (naming the new registry) has not been revoked or amended.

At the agreed time, the new lender would advance funds to the seller. The seller would then email the bill of sale and the certificate of ownership, both digitally signed, to the buyer, who would then file them through the registry’s website. The confirmation of signatures and the verification that certificates had not been revoked would all be done automatically.

Geography becomes irrelevant in a digital world because a digitally signed document may be delivered electronically anywhere in minutes. Thus, it would no longer be necessary to issue powers of attorney in order to accomplish simultaneous vessel closings when the parties are located long distances from each other. In addition, the lead time to accomplish a registry and financing could conceivably be reduced to a few hours if the parties have all the relevant information and the registry is willing.

Conclusion

While there are obstacles to be overcome, the potential of digital ship registries seems great and the benefits they can provide are compelling.

² A convention providing for the universal registry of title, mortgages and liens for vessels would solve these problems. Such a registry in digital form would be very useful. The flag states could retain control of issuance of nationality certificates. This type of bifurcation would operate in a manner similar to the bareboat registry provisions available in some countries. The Unidroit Convention on International Interests in Mobile Equipment (www.unidroit.org) comes close to this, but provides only for registration of security interests.

³ The reason for suggesting frequent changes to keys and certificates is that as computing power increases with passage of time, it becomes more feasible to apply computers to crack the encryption used in the PKI system. As keys are replaced, the newer ones consist of even longer numbers which will hold more powerful computers at bay.