1. Overview
Cyprus enjoys a prominent position in global shipping. As an EU member state, it adheres to high international standards set by the International Maritime Organisation and EU directives, ensuring compliance and safety. The Cyprus flag is consistently among the highest-ranking in the world, currently ranking 11th globally and 3rd in the European Union, in terms of tonnage. Cyprus is also an important ship management hub, from which hundreds of shipping companies manage thousands of vessels worldwide. Shipping is thus a major pillar of the Cypriot economy and the mechanisms by which the acquisition, construction or refit of ships is financed constitute an important parameter for the Cyprus shipping industry. The traditional lending from commercial banks and other financing institutions, both in Cyprus and abroad, remains the main source of funding; however, in recent years new financing structures have also been developed for the financing of ships, such as finance leases and other sources like bonds or private equity.
2. Domestic legislation
The registration of a ship in the Cyprus Register of Ships (as primary register) in the ownership of a qualifying entity is a fundamental step in any ship finance transaction in Cyprus, as it establishes legal ownership and allows mortgage creation. Mortgages are the primary security in ship financing transactions.
The key pieces of Cyprus legislation applicable to ship registration and ship finance are:
(a) the Merchant Shipping (Registration of Ships, Sales and Mortgages) Law of 1963, as amended (the “MS Law”), and
(b) the Merchant Shipping (Fees and Taxing Provisions) Law of 2010, as amended (the “MS Tax Law”).
3. Ship mortgages in Cyprus
3.1 Types of ship mortgage
Pursuant to the MS Law, a statutory mortgage over a Cyprus-registered ship can either secure (a) principal sum and interest, or (b) account current.
A mortgage securing principal sum and interest secures only the principal amount of the loan and interest thereon, whereas a mortgage securing account current can, in addition, secure any other sums that may become payable by the shipowner to the mortgagee, including costs and expenses incurred in the maintenance or enforcement of the security or contingent liabilities, such as liabilities under master swap agreements.
3.2 Secured indebtedness
There are no restrictions on the kind of indebtedness that may be secured by a Cyprus mortgage. The MS Law provides that a registered ship may be made a security for a loan or other valuable consideration. The mortgage may be given as security for the obligations of the shipowner or any third party.
Given that a Cyprus mortgage can secure account current (which is a notional account between the mortgagor and the mortgagee, and to which all amounts due to the mortgagee are debited and all amounts paid by or on behalf of the mortgagor are credited), it is also possible for a shipowner to grant a mortgage over a ship as security for future debts or obligations. For example, a Cyprus mortgage can secure
obligations under an overdraft facility, where before any amount is drawn under the facility, the amount secured under the account current mortgage will be zero, or it may also secure swaps or other derivative transactions that have not yet been entered into.
A mortgage securing account current may thus be executed before the debt or obligation arises, but in such case, the instrument from which the future debt or obligation will arise must have already been entered into and must be named in the mortgage deed.
3.3 Form of mortgage
The mortgage deed must be in the form prescribed by section 31 of the MS Law or as near thereto as circumstances permit and must be accompanied by a deed of covenants between the parties, which is attached to the mortgage deed and forms part and parcel of the mortgage security.
Although there is no prescribed form for the deed of covenants, the MS Law requires that the deed of covenants deals with any matter relating to the mortgage, including the mode of payment of interest and the repayment of principal, the insurances and the renewals thereof and the application of policy money, the limitations on employment of the ship, the events of default and the powers exercisable by the mortgagee in the event of default.
3.4 Mortgage registration and effect thereof
A ship mortgage, comprised of the mortgage deed and the deed of covenants, must be registered in the Register of Cyprus Ships, as an encumbrance on the vessel. The registration will provide the mortgagee with a right in rem against the ship, allowing the mortgagee to enforce the mortgage by an action against the ship itself, as opposed to merely exercising its contractual rights against the shipowner by an action in personam.
Upon registration of the mortgage in the Register of Ships, the Registrar will enter therein the date and time of registration and the mortgage will thus gain priority over any subsequently registered mortgages and over other unregistered and equitable mortgages.
In addition, if the mortgagor is a Cypriot company, or if the mortgagor is a foreign company that has established a place of business in Cyprus pursuant to the provisions of the Cyprus Companies’ Law, Cap.113, as amended (“the Companies Law”), the mortgage must also be filed for registration in the Register of Charges of the company kept by the Cyprus Registrar of Companies (see also 4.2 below).
Failure to file the mortgage with the Registrar of Companies will render the mortgage void against the liquidator and any creditor of the company in the event of the latter’s liquidation.
3.5 Agency and trusts
Trusts and agency relationships are recognised under Cyprus law and a mortgage may thus be held by a security agent and trustee on trust for and for the benefit of a syndicate of lenders.
3.6 Transfer and transmission of mortgages
3.6.1 It is quite common for shipping loans to be traded. If a loan is sold by a mortgagee to a new lender, the provisions of section 37 of the MS Law will apply and the mortgage will be transferred to the new lender by an instrument of transfer in the statutory form provided by the MS Law or as near thereto as possible. Upon production of the said instrument, the Registrar of Ships will enter in the Register the name of the transferee as mortgagee of the vessel. If the mortgagor is a Cypriot company or a foreign company that has established a place of business in Cyprus, the instrument must also be filed for registration at the Cyprus Companies’ Registry.
An instrument of transfer will only be required if the actual mortgagee will change. If the loan is syndicated and the mortgage is held by a security trustee or collateral agent who will not be changing, no actions will need to be taken in Cyprus if one of the syndicate lenders sells its participation in the loan.
3.6.2 Where the change of mortgagee occurs because of the merger of the mortgagee into another institution (or through universal succession), the provisions of section 38 of the MS Law will apply.
Pursuant to the said section, where the interest of a mortgage in a ship is transmitted by any lawful means, other than by a transfer under the MS Law, the transmission must be authenticated by a declaration of the person to whom the interest is transmitted, containing a statement of the manner in which and the person to whom it has been transmitted and accompanied by appropriate evidence.
Upon receipt of the said declaration and evidence, the Registrar of Ships enters in the Register the name of the person entitled under the transmission as mortgagee of the ship. The declaration of transmission must also be filed at the Companies’ Registry in the situations mentioned in 3.6.1 above, in relation to a transfer of mortgage.
3.7 Mortgage enforcement
3.7.1 Upon default, a ship mortgage may be enforced by the mortgagee through the following alternative methods:
(a) entry into possession;
(b) sale by the mortgagee (including private sale); and
(c) arrest of the vessel and judicial sale through the Admiralty Court.
3.7.2 Entry into possession
Where the entire ship is mortgaged, the mortgagee may take possession of the ship without recourse to the court, but notification of the assumption of management of the ship must be given to the Registrar of Ships, in accordance with section 31 of the MS Law. Upon taking possession, the mortgagee assumes the rights and liabilities of the owner, including responsibility for the operation and maintenance of the vessel and potential liability to third parties. In practice, entry into possession is rarely exercised as a long-term solution due to the associated financial and operational risks and is typically a step towards a sale of the vessel.
3.7.3 Sale by the mortgagee
Pursuant to section 35 of the MS Law, the mortgagee has a statutory power of sale, which may be exercised without court intervention, subject to the terms of the mortgage and the deed of covenants. Where there is more than one registered mortgage, a subsequent mortgagee may not sell the vessel without the consent of prior mortgagees or an order of the court.
A sale by the mortgagee transfers title free from the mortgage and any subordinate mortgages but remains subject to prior-ranking claims. In particular, maritime liens and other encumbrances ranking in priority to the mortgage may continue to attach to the vessel. It should be noted that maritime liens and other non-mortgage liens cannot be registered in the Register of Ships as encumbrances on a vessel and cannot therefore be revealed by a search against the vessel at the Shipping Registry.
In exercising the power of sale, the mortgagee must act in good faith and take reasonable care to obtain a proper price.
3.7.4 Arrest and judicial sale
Alternatively, the mortgagee may commence an action in rem before the Admiralty Court and seek the arrest and judicial sale of the vessel, provided the vessel is within the territorial waters of Cyprus.
The in rem action is commenced by a writ of summons and the application for arrest must be supported by an affidavit establishing that the claim remains unsatisfied and that there is a serious question to be tried. If the arrest is granted, the applicant will be required to provide a deposit for the Admiralty Marshal’s expenses and counter-security, typically by way of a Cyprus bank guarantee.
Following arrest, the mortgagee may apply for the valuation and sale of the vessel either before or after judgment. A judicial sale transfers the vessel to the purchaser free from all encumbrances, with all claims attaching instead to the proceeds of sale.
3.7.5 Priority of claims
The proceeds of sale of a vessel are distributed in accordance with the applicable order of priorities under Cyprus admiralty law. In the absence of special circumstances, the order is: (i) Marshal’s expenses; (ii) costs of the producer of the fund; (iii) maritime liens (including claims for damage, salvage, crew wages, master’s disbursements and bottomry); (iv) mortgages; and (v) statutory liens and other contractual claims.
Maritime liens rank ahead of mortgages irrespective of when they arise. Claims of the Republic of Cyprus for fees, dues or tonnage taxes enjoy statutory priority.
4. Other collateral
4.1 Typical security
The collateral obtained by lenders in ship financing transactions would, in addition to the mortgage, typically include one or more of: an assignment of insurances, an assignment of earnings and charterparties (where applicable), a floating charge over the borrower’s undertaking and assets, account charges and a pledge of shares in the ship owning company.
The assignment of insurances is important, since, in the absence of it and in the event of the ship’s loss, the mortgage will be of little practical significance to the mortgagee.
The security documents in finance transactions will contain detailed provisions on enforcement, commonly also including provisions for the appointment of a receiver.
4.2 Registration of charges
Any assignment or charge created by a Cypriot company or by a foreign company that has established a place of business in Cyprus pursuant to the provisions of the Companies’ Law over a vessel’s earnings and insurances or other property to which section 90 of the Companies’ Law applies (other than a pledge of shares in a Cypriot company) must be filed for registration at the Cyprus Companies’ Registry as a charge against the company, within 21 days from execution, if the document is executed in Cyprus, and within 42 days from execution, if the document is executed abroad.
Registration is effected by the submission of an original or certified copy of the instrument creating the charge with the Registrar of Companies, together with the prescribed form (setting out the particulars of the charge, including the secured obligations and assets charged) duly completed and signed, either on behalf of the chargor or the chargee and upon payment of the relevant government registration fees.
The effect of non-registration of a registrable charge will be that the charge will be void against the liquidator and any creditor of the company in the event of the latter’s liquidation.
All charges (including ship mortgages) created by a Cyprus company (whether registrable at the Companies’ Registry or not) must also be registered in the Register of Charges and Book of Mortgages kept by the company at its registered office in Cyprus.
Securities relating to cash, financial instruments or loan obligations (or a combination of these) that fall under the Financial Collateral Arrangements Law of 2004, which brings Cyprus law into line with the EU Directive no 2002/47 EC, may not require any registration in any Registry in Cyprus (except in the chargor’s register) despite any provisions of any other law in Cyprus. In practice, however, the above-mentioned statutory registration requirements are still being followed.
4.3 The Cyprus shares pledge
A statutory pledge of the shares in a Cyprus company is created under section 138 of the Cyprus Contract Law, Cap. 149, as amended, pursuant to which the pledge must be expressed in writing, must be signed by both the pledgor and the pledgee and the pledgor must sign in the presence of at least two witnesses. Notice of the pledge must be given by the pledgee to the company, which should make a memorandum of the pledge in its Register of Members and issue a Certificate to that effect.
The subject matter of the security under a pledge of shares is the “share certificates” as goods. The delivery of the shares certificates is therefore essential for the creation of a statutory pledge of shares. In the absence of delivery of the share certificates, the pledge of shares can only create an equitable charge over the shares and over any rights derived from such shares.
In addition to the share certificates, it is customary for a number of ancillary documents to be delivered to the pledgee pursuant to the pledge document, including instruments of transfer of shares signed in blank, directors’ resolutions approving the transfer, undated letters of resignation of the directors and secretary, irrevocable proxy and power of attorney of the pledgor and letters of undertaking of the directors and secretary.
Enforcement under a statutory pledge of registered shares (subject to the giving of reasonable notice) can thus also be effected extra-judicially, through the implementation of the above-mentioned documents delivered by the pledgor to the pledgee under the provisions of the pledge document. Such enforcement can take place without the need for a court order and without reference to a third party (except the company itself, to which the documents relating to the completion of the transfer of shares must be submitted).
The holder of a security over shares in a Cyprus ship owning company will not be deemed to have any form of ownership interest in the company prior to enforcing the pledge and becoming the registered owner of
the shares. There is therefore no risk that the pledgee might be deemed to be an owner of the relevant ship for regulatory purposes.
5. Finance leases and sale and leaseback
As an alternative to traditional lending from commercial banks, finance leases and sale and leaseback transactions are now a well-established means of financing in the shipping sector and are increasingly used in Cyprus related shipping structures.
A financial institution or leasing house will typically buy the ship using a single purpose vehicle (SPV) and lease it to the shipping company, giving the latter the option (or the obligation) to purchase the ship at the end of the term. The lessor will hold the legal title in the ship, whilst the lessee will maintain operational control of the vessel through a bareboat charter.
Cyprus related leasing and sale and leaseback structures might involve:
(a) a Cyprus or a foreign SPV (lessor) acquiring and registering the ship under the Cyprus flag in the ownership of the SPV and then leasing the ship to the lessee, or
(b) a Cyprus or a foreign SPV (lessor) acquiring and registering the ship under a foreign flag and then leasing the ship to a Cypriot or foreign (qualifying) lessee, with the lessee registering the ship in parallel in the Special Book of Parallel Registration of the Cyprus Register, pursuant to the provisions of the MS Law.
Except as mentioned below, finance leases and other charters relating to ships are not registrable in the Register of Ships or any other register in Cyprus. The lessee will not therefore appear anywhere as the “actual” owner of a ship, unless the ship is registered by the lessor in a foreign registry and the lessee registers the ship in parallel in the Special Book of Parallel Registration. In such case, a copy of the relevant bareboat charter must be filed with the Cyprus Shipping Registry and the lessee will appear as the ship’s disponent owner.
By using a Cyprus related leasing structure, the parties can benefit from the Cyprus tax regime. Under the MS Tax Law, qualifying owners of qualifying ships registered under Cyprus flag are automatically taxed on net tonnage rather than corporate profit, resulting in lower tax liability. The same applies where a ship is registered in parallel in the Special Book of Parallel Registration in Cyprus, in which case the bareboat charterer (lessee) will automatically be taxed under the tonnage tax system. Furthermore, under the MS Tax Law, if the lessee is a Cyprus tax resident, it may opt to be taxed under the tonnage tax system as the charterer of an EU vessel, provided other conditions are satisfied.
The use of a Cyprus related structure may also have other advantages, such as the non-imposition of stamp duty on documents and no capital gains tax on the sale or transfer of Cyprus vessels.