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We often receive questions related to seller financing, the documents required, and whether it is a legitimate option in a transaction. There are often scenarios where banks and other traditional financial institutions are unable to provide a loan to a vessel purchaser, whether it be due to the type, age or usage of a boat, or perhaps the creditworthiness of a borrower. For example, it is more difficult to obtain a traditional marine loan for a 40-year-old wooden charter boat than a new production sport-fisher to be used purely as a recreational vessel. As a result, we are regularly engaged by clients involved in unique scenarios who wish to draft a customized seller-finance package.
The Same Process
The reality is that a buyer and seller can arrange financing in the same manner as if a traditional lender is involved, with the seller having the same basic rights and the buyer with the same legal obligations. Of course, the difference is that a seller is fully funded at closing by a lending institution but only partially funded through a seller-financing transaction, the amount of which depends on the terms of the parties’ agreement.
The Documents
A typical marine finance package for a Coast Guard-documented vessel includes a promissory note, loan agreement, personal guarantee, and a preferred ship’s mortgage. A promissory note, often informally referred to as an IOU, is essentially a written promise by the borrower to repay a lender a specific sum of money within a specified period of time in accordance with certain repayment terms, including the frequency of payments and the agreed-upon interest rate. A loan agreement is similar to a promissory note, but it also contains more details about the loan, including specific representations and covenants made by the borrower.
A personal guarantee is typically required when the borrower is an entity. Under such an agreement, the individual beneficial owners of the company promise to repay the balance of a loan in the event the borrowing business entity defaults. I have yet to see a marine-finance package provided by a bank or other form of financial institution that did not require the execution of a personal guarantee when the borrower is a business entity.
A preferred ship’s mortgage is the security for the loan, and the vessel itself is the lender’s collateral in the event of a borrower default. Such a mortgage is available only to Coast Guard-documented vessels, and the mortgage is perfected by filing it with the National Vessel Documentation Center. A preferred ship’s mortgage takes priority over all claims against a vessel other than preferred maritime liens. The terms of the mortgage typically give the lender the right to repossess and sell the vessel without a court order and without notice to the borrower in the event of a default.
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Not Holding Paper
A lender generally retains the original Certificate of Title when providing a loan against a motor vehicle or vessel that is state-titled, which prevents the borrower from being able to sell the asset. This process is known as “holding paper” because the lender will not release the lien or the physical title itself until the loan has been fully repaid. However, a preferred ship’s mortgage is simply recorded with the National Vessel Documentation Center, and ownership of the vessel cannot be transferred until the mortgage on record has been satisfied or cleared. Thus, the original Certificate of Documentation remains on board the vessel even though there is a mortgage recorded against it.
State-Titled Vessels: Security Agreements
The loan documents for a state-titled vessel are similar to one that is Coast Guard-documented, but rather than a preferred ship’s mortgage, the loan is secured by a security agreement and the lien holder is identified on the face of the title. A basic security agreement provides many of the same rights to a lender under state law as a preferred ship’s mortgage, and in most cases, the lender’s security interest can also be perfected by filing a UCC-1 financing statement. However, such a lien is not protected under the Ship’s Mortgage Act or the lender-friendly rules of federal judicial foreclosure.
Seller financing certainly carries its own set of risks, but there are situations where it can be a valuable tool for all parties to a transaction. If drafted and filed properly, the documents used through a seller-financing package can provide the same rights and obligations as if handled through a traditional financial institution. However, legal counsel should always be involved in the process to ensure that the seller is fully protected in the event of a default.
Raleigh P. Watson is a contributing author, and a Partner at Miller Watson Maritime Attorneys.
