Securing trade loans for goods carried by sea: should banks be a party to a bill of lading?

Security for trade loans in general

Banks and other financial institutions (lenders) involved in the financing of international trade deals face challenges additional to those who are financing domestic trade operations.  This is principally because the goods that are purchased using the trade finance have to be paid for well before they are delivered to the buyer and well before they are within the lender’s territory.  Lenders can seek comfort in the usual arrangements for trade debt such as pledges, cessions, suretyships and general or special notarial bonds.  All of these mechanisms require a contract, some of those contracts have to be registered, and some of the mechanisms require the goods to be within South Africa.

Security for international trade loans

On international deals, all of these options provide security once the goods arrive and pledges.  Cessions and suretyships also provide comfort from the time the loan is effected, but some lenders require additional security whilst the goods are at sea.  This has resulted in these lenders attempting to secure their position during that period.  This can be done by insuring their interest in the goods or by exercising control over the bill of lading issued by the ocean carrier for the transport of the goods by sea or for the entire delivery chain.

Insurance of the goods in the lender’s name is an option which does not attract any real risk, but does require the lender to have a valid insurable interest reflected in the underlying sales agreement.  The simpler alternative may be to require the borrower’s insurers to undertake to pay any indemnity under the marine cargo policy directly to the lender.

Security over bills of lading

Insofar as bills of lading are concerned, their use as a form of security can be valuable, but depends on when payment is due in terms of the underlying loan and depends on the lender understanding the risks it accepts when dealing with the bill of lading.

This is because the bill of lading has a number of functions.  In the first instance, it is a receipt by the carrier for the goods named on the bill of lading.   Secondly, it is evidence of the contract of carriage and it determines who the cargo has to be delivered to.  Thirdly, in certain circumstances, it is a document of title which accordingly represents security for the value of the goods described in the bill of lading.

It is the second of these issues which creates the biggest risks for lenders. 

If the repayment of the underlying loan is due after the goods have already been discharged at a South African port and delivered to the borrower, then the lender should restrict its additional security during the ocean passage to insurance over the goods should they be lost or damaged.  There is no merit in holding security in any form over the bill of lading if payment by the borrower is only due after delivery is effected under the bill of lading.

Some lenders provide that one of the terms of the loan is that the lender has to be reflected as the named consignee in the bill of lading or the negotiable bill of lading must be endorsed in blank to them and physically held by them.  This means that from a security perspective, the only party who can present the bill of lading at the discharge port or delivery place in order to obtain delivery of the cargo is the lender.  The lender accordingly has complete control over where the cargo is delivered to after discharge or delivery.  This is obviously a very positive issue from a lender-security perspective. 

Liability under bills of lading for general average, salvage, customs and other charges and claims

What many lenders overlook however is that the named consignee, in addition to being entitled to delivery of the goods, attracts numerous obligations under the bill of lading. 

In the first instance, the lender is only entitled to take delivery of the cargo against payment of any charges due on the cargo.  Those charges may include the freight payable to the carrier for the carriage of the goods from the load port to the discharge port or the delivery place along with any storage, detention and demurrage charges that may be incurred by the carrier should the lender not immediately take delivery of the cargo at the discharge port.

Secondly, as the named consignee, the lender will be reflected as the importer on the customs clearance documents and will be exposed to liability under the Customs and Excise Act for all duties, levies and penalties levied on the goods by SARS.

Thirdly, being the named consignee also exposes the lender to a number of claims from various parties. The three main ones are general average, salvage and third party liability claims from the carrier and any other cargo owners.

In the event that the vessel suffers a casualty and the carrier declares general average to recover port of refuge costs and/or concludes a salvage contract, the named consignee is obliged to secure those general average and salvage claims in order to take delivery of the cargo.  The named consignee is then obliged to pay any general average contribution and/or salvage award once those have been determined.

The adjustment of GA typically takes several years, and may take as long as ten years.  During that period, the security has to remain in place.  GA contributions can vary widely.  On a smaller casualty, they may only be 5% of the value of the cargo, but we have been involved in a number of cases where the contribution approached 20% and one where the GA contribution was 100% of the value of the cargo.

In the numerous cases we have been involved in, salvage awards varied widely between a low of 5% and a high of 65% of the value of the cargo. 

GA and salvage charges are covered by all risks insurance, but lenders must then make sure that they have the appropriate all risks marine insurance in place and have an insurable interest in the cargo that entitles them to claim under the policy even though they do not own the cargo or bear risk in it.  Insurers may be reluctant to offer this cover because their subrogated right to recover any losses against the party responsible for it is a hollow one in most cases.  The insured lender neither owns the cargo nor bears risk in and to it.

Liability for damage caused by cargo

In addition to fairly regular GA and salvage claims, the consignee may face claims from the carrier and any other cargo on board the vessel in the event that the cargo in the lender’s bill of lading causes any damage to the ship and/or to other cargo.  These claims, particularly on hazardous cargo or cargo dangerous to the environment, can be extensive if, for example, a container is lost over the side of the ship and the carrier is faced with cleanup costs from the relevant environmental and maritime authorities in the coastal state. In an admittedly extreme case, the consignee of a bulk shipment of phosphoric acid faced claims of several million dollars from the ocean carrier when the acid caused damage to the ship’s tanks.  It was alleged that the acid was a different specification to that declared by the shipper.   

Lenders need to assess the benefits and liabilities carefully

The effect of the above is that in our view, being the named consignee under a bill of lading is only worth that risk if holding the right to control delivery of the cargo brings any real comfort to the lender.  If the borrower is not obliged to pay the lender on or before discharge then that comfort is nugatory.

If a lender decides that it is worth its while from a timing perspective to exercise control over delivery of the cargo then it must make sure that it has appropriate insurance in place to cover the GA, salvage and cargo liability claims that may arise.  It must also accept that it cannot insure its liability to pay freight and any other carrier’s costs or duties, levies or penalties to SARS in the event that the borrower does not do so. 

Before embarking on demanding security via a bill of lading, lenders must make sure that they properly understand their potential obligations if they are either the named consignee in a bill of lading or the holder of a negotiable bill of lading.