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 One in three ships ordered from Chinese builders was behind schedule
in 2013, according to data from Clarksons Research, a UK-based
shipping intelligence firm. Although that was an improvement from 36
percent a year earlier, it was well behind rival South Korea, where
shipyards routinely delivered ahead of schedule the same year.
That means Chinese banks may be on the hook to pay large sums to
buyers if the yards can't come through per contract, with little
hope of recouping the cash from the yards. China is the world's
biggest shipbuilder, with $37 billion in new orders received last
year alone. Buyers pay as much as 80 percent of the purchase price
upfront.
Chinese bankers rushed to finance shipbuilding after the 2008 global
financial crisis as Beijing pushed easy credit and tax incentives to
lift the industry and sustain industrial employment levels in the
face of collapsing exports.
Fees generated by offering such guarantees looked like easy money
until massive oversupply and falling demand started taking a toll on
the yards around 2010. Shipyards fell behind schedule and buyers
demanded their money back. But behind or not, the builders, keen to
keep orders on the books and prepaid money in their pockets, have
submitted injunctions against banks in Chinese courts to prevent
them from paying out.
"China's ambitions to take over South Korea as the top major
shipbuilder meant that all the banks were encouraged to open up
their wallets and lend money to the shipbuilders without making
thorough due diligence," said AKM Ismail, former finance director
for Dongfang Shipyard, the first Chinese shipyard to be listed on
London's AIM Stock Exchange in 2011.
Since ships cost millions of dollars and can take years to deliver,
a shipbuilder generally asks for part of the purchase price upfront
to cover material and labor costs. Buyers normally obtain a refund
guarantee from a bank to assure their money is returned if the yard
defaults, and the yard pays the bank's fee for the service.
Lawyers say that in many cases, banks did not require shipyards to
pledge any specific collateral, partly because these guarantees are
like a form of insurance rather than a loan. That leaves banks stuck
with the default bill.
If banks obey local court injunctions and hold off from issuing
refunds, they risk being taken to court by ship buyers in foreign
jurisdictions. But if they pay out under the refund guarantee or
seek compensation from the shipyard for the loss, bankers say they
risk alienating local governments, which can damage the banks'
business interests in the region.
"The whole issue of refund guarantees has been a big headache," said
a finance executive at China Minsheng Bank.
"On the one hand, we know that our clients, the shipyards, will be
saddled with huge debt that they will struggle to repay to us, if
they can even pay back at all. But at the same time, our credibility
is at risk, so we have to pay them out."
He and other bankers interviewed for this article all spoke on
condition of anonymity because of the legal sensitivities of the
issue.
Minsheng Bank did not respond to a request for comment.
In one case, UK court records show that in November 2012,
subsidiaries of German ship owner First Class Ship Invest GmbH took
China Construction Bank Corp to court in London to enforce payment
of more than $10 million under a refund guarantee after Zhejiang
Zhenghe Shipbuilding Co Ltd allegedly failed to deliver on an order.
CCB lawyers argued that an injunction served on it by Zhejiang
Zhenghe in China would open up the bank to fines and the responsible
banker could be arrested in China were it to pay out, but the judge
rejected the argument.
None of the parties in the suit responded to requests for comment
from Reuters.
Reuters was unable to find a single public example of a Chinese bank
successfully fighting off a refund guarantee claimant in an overseas
court; nearly all refund guarantee contracts stipulate litigation
must be conducted in a foreign court.
Jim James, a partner at Norton Rose Fulbright in Hong Kong, said
that he has been involved in several cases in which yards repeatedly
obtained injunctions from different Chinese courts to drag out the
refund process.
James, who has represented buyers, shipyards and banks in different
cases, said the problem had become so serious that China's supreme
court planned to issue guidance to lower courts on the handling of
injunction applications.
LOBBYING WAR
Most customer suits are settled in arbitration and domestic court
records are usually not published, so there is little hard data on
the number or value of contracts under dispute.
But loan officers at China Export Import Bank, Bank of
Communications, Bank of China and Shanghai Pudong Development Bank
told Reuters that they had seen refund claims rising rapidly in 2012
and 2013.
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The problem was widespread enough for the China Behavior Law
Association Training Cooperative Center, an organization registered
with the Ministry of Civil Affairs, to hold a three-day conference
for Chinese banks last July on the risks of refund guarantees.
On the other side, the Shanghai Shipbrokers' Association published
advice for shipyards on how to keep banks from paying out refund
guarantees on its website, saying Chinese banks should be more
cooperative.
Shanghai Pudong Development Bank said it largely disbanded its
shipping finance team in 2012, due to the sudden rise in refund
guarantee claims and worsening market conditions.
An executive at another Chinese municipal bank told Reuters his
company was interested in getting into the refund guarantee business
"but we've been warned by regulators to be careful."
Jonathan Silver, shipping finance partner at Howse Williams Bowers,
said banks have been taking steps to reduce their exposure,
including asking shipyards to put up the partially built vessel as
collateral for the guarantee.
SHARING BLAME
But lawyers also said that the Chinese shipyards are not always to
blame, nor are their injunctions always frivolous.
Ismail of Dongfang Shipyard said his experience at the yard showed
many foreign investors had exploited the weakness of Chinese
shipyards — and inexperience of Chinese banks — to drive very hard
bargains vis a vis refund guarantees.
Some buyers would gamble that prices would rise by the time the ship
was completed and they could sell for an immediate profit. If prices
didn't rise, they would reject the ship and cash in the guarantee.
In one instance, he said Dongfang had an agreement to deliver two or
three ships that were behind schedule but 90 percent completed. The
buyers pulled the plug and sought a refund, even though Dongfang was
willing to renegotiate and sell the ship at a lower price, he said.
BIG FISH
Clarkson Research data shows that the Chinese shipbuilding industry
won $37 billion in new ship orders in 2013, up 92 percent
year-on-year.
But this rising tide is not lifting all boats: Chinese state media
reported that 80 percent of new ship orders went to just 20 yards.
Investors are concerned that the debt-sodden Chinese shipping
industry is set for a wave of defaults if Beijing doesn't bail it
out.
China Rongsheng, the country's largest private shipyard, reported a
$1.4 billion loss for 2013 and some customers are worried about
Rongsheng's $4.6 billion worth outstanding orders.
Greek ship operator Dryships Inc has already put down a $11.56
million downpayment, 8.5 percent of the total cost, toward four
cargo ships scheduled to be delivered in 2014, but Dryships
executives said they aren't sure Rongsheng has even started cutting
steel.
"We don't want to make any more payments to Rongsheng," Dryships CFO
Ziad Nakhleh told Reuters in February. "Things are getting worse not
better."
Rongsheng said in an emailed statement to Reuters that thanks to
recent refinancing, it is optimistic it can make delivery, but would
not otherwise comment on other refund guarantee cases.
Regardless, Dryships executives also said they expect Bank of China,
the guarantor, to refund their money plus 8 percent interest if
Rongsheng fails.
Bank of China did not respond to a request for comment.
By paying up, Chinese banks can reassure foreign customers doing
business in China, protect their overseas assets and preserve their
reputations. And the amounts, while large, are manageable, said
Silver of Howse Williams Bowers.
"If there is any collection of banks anywhere in the world able to
disperse those sums of money... it's going to be Chinese banks."
(Additional reporting by the Shanghai Newsroom, Fayen Wong, and
Keith Wallis in Singapore; editing by Emily Kaiser)
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