The ever-growing importance of sale and leaseback transactions as an alternative to financing ships by way of loan, makes it both timely and welcome that BIMCO has produced a standardised term sheet. There was strong Asian representation on the drafting committee. Reflecting the position of Chinese leasing companies in the market, the committee included representatives from four of them. The term sheet is accompanied by explanatory notes, following the structure of the earlier BIMCO loan term sheets (SHIPTERM and SHIPTERM S).
“The ever-growing importance of sale and leaseback transactions as an alternative to financing ships by way of loan, makes it both timely and welcome that BIMCO has produced a standardised term sheet.”
Any attempt to produce a standard or indicative term sheet for leasing transactions is challenging. All loan transactions are essentially the same, with differences between the terms of one loan from another being ultimately detail, albeit important detail. The borrower is obliged to repay the loan and once it has done so the lender is obliged to release any security. In contrast, what happens at the end of a lease varies as between one type of lease and another. The broad distinction is between finance leases, where the lessee rather than the lessor takes residual risk and upside benefit, and operating leases, where the reverse is the case to a greater or lesser extent and return conditions at expiry have greater significance. It should be noted, however, that the terms ‘finance lease’ and ‘operating lease’ are not terms of art and mean different things to different people, and in different contexts.
There are also important differences as regards the rights and remedies of a lessor following lessee default, compared with the rights and remedies of a secured lender as against a defaulting borrower. The lessor’s remedies as owner can in certain circumstances be more flexible and favourable than the remedies of a mortgagee. However, English law, at least, requires the lessor to navigate around the risk that a liquidated termination sum is potentially vulnerable to being struck down as an unenforceable penalty, which will be the subject of a briefing note shortly. The English law doctrine of relief from forfeiture can apply to both leases and secured loans but is likely to be more relevant to the former than the latter.
For a lessee, there are two main areas of risk compared with the position of a borrower under a secured loan. First, English law has for a long-time aided mortgagors by protecting their right to get the asset back free of mortgage on repayment (the ‘equity of redemption’) and by imposing duties on mortgagees in relation to the realisation of their security. These protections do not apply to a lessor, at least not to the same extent. Secondly, the fact that the lessor holds legal title to the asset means that a lessee is exposed to greater risks around lessor solvency, ownership and control of the lessor, disposal and lien-creating than is a borrower vis-à-vis a mortgagee.
Some of these differences between a lease and a loan are touched upon in our article from September 2019. Issues for lessees were addressed in our article from April 2020.
Since a term sheet for a sale and leaseback transaction will generally originate from the lessor’s side rather than the lessee’s, it is perhaps not surprising that the issues for a lessee briefly referred to above are for the most part not flagged either in the term sheet or in the explanatory notes. Reflecting both the legal complexities of leasing transactions as compared with loans, and also the variety of different structures and types of leasing deal, the term sheet and especially the drafting notes, refer to a number of features and issues, including the following:
• The term sheet generally assumes English law as the governing law of the lease;
• The emphasis is on sale and leaseback of second-hand tonnage rather than newbuildings. Deals involving newbuildings can include additional structural and documentation complexities which are not addressed;
• The intention is that the term sheet can be used for both finance leases and operating leases and even, possibly optimistically or ambitiously, as a basis for specialised transactions such as JOLCOs;
• It is aimed at a single ship deal and expressly does not attempt to address, in any detail, the complexities which can arise from multi-ship deals, especially when the lessors and/or the lessees involved are special purpose companies; and
• The possibility of lessor financing is referred to but not expressly that this can take place at inception rather than by way of ‘back financing’ once a sale and leaseback is completed.
“All-important financial matters such as the calculation of hire, the calculation of the termination sum and financial covenants are left to be completed in annexes.”
Any attempt to provide more detailed explanation or alternative drafting would have resulted in the term sheet itself and/or the explanatory notes become much longer and more cumbersome. One can sympathise with the drafting committee’s tendency towards conciseness. All-important financial matters such as the calculation of hire, the calculation of the termination sum and financial covenants are left to be completed in annexes. The drafting process included wider industry and professional consultation. A close-to-final draft of the term sheet was released for comment a few months before publication took place at the end of September. WFW was among the law firms submitting comments. The explanatory notes were not released in draft during the consultation process.
There are two issues to note, of a mainly stylistic nature. First, as the explanatory notes point out, there are no defined terms as such. The use of defined terms in term sheets is customary and would be familiar to, and possibly expected by, most users. Secondly, the BIMCO style of boxes at the front sits oddly in a term sheet, albeit that it is the format already used in the SHIPTERM term sheets. One example of an area where these features might be more than just one of form and have an effect on substantive issues are the treatment of Purchase Option and Purchase Obligation. If included, these are significant and potentially complex features where clarity is required. The combination of lack of detailed defined terms and the use of boxes imposes a constraint in this and other areas.
This BIMCO project has presented a welcome template for parties and their lawyers to work on. That said, it is unlikely – or at least it would be ill-advised – for non-expert parties to use it without assistance in any but the simplest of transactions. It is a starting point and a foundation rather than a fully-refined product – but that is inevitable having regard to the subject-matter and is the intention, as the explanatory notes make clear. Having now taken this step, it will be interesting to see if BIMCO turns its attention to a full-form lease. BARECON 2017 is used in many sale and leaseback transactions with detailed and extensive additional clauses. Although many lessors prefer to use a fully bespoke form of lease, a variant of the BARECON form addressed specifically at sale and leasebacks might be welcomed by those who prefer to use it as a starting point.