It’s now clear that we’ve been wrong footed by President Trump’s tariff talk. What was once perceived as a threat to force concessions is now reality. Our shipping and trade clients are scrambling to come to terms with this new reality and how it might affect their operations.
Whilst it will likely take weeks to understand the impacts of these new tariffs and the legal issues arising, here are just some of the immediate issues.
Deals agreed on ships under construction
Most of the world’s commercial vessels are built in China, Japan and South Korea. These countries now face US tariffs so, potentially, any “US buyer” faces an immediate tariff exposure on vessels currently under construction.
The position is not helped by the fact that these contracts were agreed years ago. It takes several years to produce a vessel from contract negotiation to maiden voyage. Shipbuilding contracts are structured on the basis of advances made by the buyers to the builder during the construction process. This is often backed by third-party refund guarantees assigned to the buyers’ financiers. Legal title does not pass until the ship is in all respects ready to be delivered whereupon all instalments are released to the builder.
It follows that, unless there is some mechanism in the contract to the contrary, any US buyer and its financiers are exposed to US tariffs on the purchase of a foreign built vessel.
Over time, ship builders will react to the tariff situation by including tariff contingency clauses but what about existing contracts? It is customary to include a taxes and duties clause in these contracts where the builder bears the cost of tariffs affecting the building of the ship and the buyer bears the cost of tariffs relating to the performance of the contract by it i.e. taking delivery of the ship and any tariff that may be consequential upon that.
Of course, it’s rare to see vessels being purchased by US buyers (unless necessary to comply with US Jones Act provisions) because of the complex taxation structures surrounding newly acquired vessels. Most vessel acquisitions involve some form regulatory arbitrage in which ships are acquired by offshore companies who flag them in countries such as Panama, Liberia or Marshall Islands. The latter two flag registries are in fact administered from the US. These ships are commonly leased to US operators or bareboat or time chartered to US operators.
The critical question is how the US customs will deal with Chinese, Japanese or Korean built foreign flagged vessels delivered to US operators after the imposition of the new tariffs. Up to now this has not been an issue because US operators have largely kept such vessels off their balance sheets. However, there is an increasing concern that this may be perceived as a form of tariff evasion which may lead to fines being imposed. There have already been threats from the Trump administration to impose punitive port fees on Chinese vessels and so it seems likely that attention may turn to US operators who take delivery either directly or indirectly of Chinese built vessels.
These are questions now faced by many US operators and the financiers who back them.
Second hand ship market?
What about ships that are currently in the process of being purchased by a US buyer? Most of these vessels are owned via offshore corporate structures, for example corporations based in Panama or Liberia. Both of those countries are on the 10% tariff list such that, in theory, a US buyer would face an additional 10% levy.
However, what if the US Customs take the view that one should look at the beneficial owners of the vessel? What about a vessel beneficially owned by COSCO which is in the process of being acquired by a Panamanian corporation beneficially owned by a US entity? What about vessels needed for US trade under the Jones Act which must be 75% US owned? Such a vessel may well be exposed to a large tariff which could disrupt any sale and lead to legal complications if the sale contract has already been signed and the vessel is due to be delivered – which is probably the case with hundreds of vessels on the water given that there is usually a period of several months between contract signing/ payment of deposit and legal delivery.
Purchase Options?
Traditionally, US operators of vessels have preferred to avoid capital expenditure by using leasing structures. Leased ships remain under the ownership of a foreign entity and so any sale of the vessel would not trigger US tariffs. But often the US operator wants to have the benefit of residual value in the vessel via a contractual purchase option which it can exercise at a certain point in the life cycle of the ship. However, those purchase options are now under threat if, post tariffs, the US Customs take the view that they should be subject to a tariff in the same way as detailed above.
Market volatility?
In a world where the beneficial ownership of the vessel becomes relevant on the issue of tariffs, a vessel being sold to a “US buyer” will be more expensive than one sold to a non-US buyer. So, it makes sense that attention is likely to shift towards lower tariff buyers. What happens however if there are insufficient lower tariff buyers? That is likely to lead to significant market volatility which is highly disruptive to the sale and purchase market. Any transaction requires a relatively steady period of several months to complete the sale and purchase process. The likely effect therefore is a decline in market activity, cancellation of deals that can be cancelled and an increase in parties seeking to find a legal way out of deals that have suddenly become unprofitable.
Verdict
Although it is early days, our initial view is that tariffs are going to be bad for those invested in ships in the same way as they are bad for those dealing with US bound cargoes. We predict an uptick in shipbuilding and sale and purchase disputes as clients review their contractual exposures in the light of the new US tariffs. Most of these contracts are subject to English law and arbitration in London regardless of the fact that the buyers and builders are located outside the UK.
Nick Burgess
Partner
