Credit bidding is the process whereby a lender, with a secured charge over a borrower’s asset, bids on that asset using the very debt that is owed by the borrower to the lender. The circumstances are usually foreclosure of a lending position against a borrower.
In the maritime sector, this process often takes place in the context of forced judicial sales of vessels pendente lite (i.e., during the course of litigation) and frequently before judgment is obtained against the borrower shipowner.
However, why would or should the secured lenders be bidding on a distressed asset in the first place? How does the process work, where can it be done, and who might object?
This article seeks to explore some of these questions in the context of judicial sales of ocean-going vessels and looks at some of the differing jurisdictional approaches to credit bidding.
A typical credit bid scenario in the maritime industry may occur where a borrower defaults on a loan secured by a mortgage over a vessel. That vessel is then arrested and ultimately sold under the supervision of the courts in the arrest jurisdiction.
Often, the borrower’s default is a payment default; however, it might equally be a breach of covenants in the facility, such as the obligation to maintain a minimum value of collateral to the loan amount.
In these circumstances, the lender usually serves a notice of the default. Sometimes, the borrower will cure the breach, and sometimes the parties might otherwise renegotiate or restructure the facility. Sometimes, however, the parties are unable to find a mutually acceptable path forward. This latter scenario becomes more likely where the lender has lost confidence in the borrower’s long-term ability to service the loan or where the lender has concerns relating to the integrity of the vessel (which, of course, serves as the main collateral for the facility).
Where a default scenario cannot be resolved to the mutual satisfaction of the parties, a lender may arrest the subject vessel to put further pressure on a borrower to cure the default (i.e., to make the missing payments or to prepay the loan to re-balance the loan-to-value obligations) or to re-negotiate commercial terms.
Where consensual agreement cannot be reached, a lender may apply for judicial sale of the vessel in the jurisdiction in which it was arrested. In terms of timing, each jurisdiction differs; however, it would not be unusual for a lender to obtain a sale order within two to three months of arrest.
Why would a lender bid at all?
Why, you may ask, would a secured lender be inclined to bid in a judicial auction for a vessel that secured its loan? There are a number of reasons why this would seem unlikely. The lender may be unlikely to count ship owning or operating amongst its core activities or commercial ambitions. Further, vessel ownership or operation comes with commercial and technical challenges that the lender is unlikely to be able to service in-house. Finally, it may be difficult to square the risk profile of vessel ownership (including significant exposure to third-party risks, such as pollution), with the usual risks with which the lender is associated, the most obvious being credit risk. Of course, where a lender is determined, none of these reasons are insurmountable, particularly with the assistance of third-party commercial or technical managers, insurers, and good legal advice…