So much has been written about the International Safety Management Code (or ISM Code as it is universally known) that almost every angle on its implications and introduction seems to have been covered. One area that has been rather under-represented, however, is how much interest shipping lenders should be taking in the Code.

Compliance with the ISM Code by an operator of a vessel is important to a mortgagee of that vessel. The vessel can be detained or denied access to ports if the operator and/or the vessel are in breach of the Code’s requirements or do not possess valid certificates or, where certificates have been applied for but not yet issued, where the company has not demonstrated that it has a safety management system meeting the objectives of the Code. Once the Code has come into effect in a vessel’s flag state, that vessel should not be permitted to trade to any jurisdiction where the Code is also in force, unless the vessel is operated by a party which holds a document of compliance and unless the vessel itself has a safety management certificate.

It is not yet known how rigorously the Code will be enforced by individual flag states and, more importantly, port states, but, theoretically, vessels should be prevented from trading to most countries unless the appropriate certificates have been issued. Furthermore, most jurisdictions will reserve the right to carry out spot checks and, if conditions aboard the vessel do not conform to the required standard, the vessel can be detained.

Fundamentally, from a mortgagee’s point of view, failure to comply with the Code could have an adverse effect upon the vessel’s insurances. A number of P&I clubs propose to make compliance with the Code a condition of insurance cover.

If other P&I clubs (and hull insurers) follow this example then non-compliance with the Code would probably in practice result in non-compliance with normal insurance covenants. If failure to comply with the Code does affect the shipowner’s right to claim under his insurance, the introduction of the Code will make it more important for mortgagee banks to have mortgagees’ interest insurance. However, an interesting debate is in progress regarding the effect of the Code on mortgagees’ interest insurance. It concerns the extent to which a mortgagee will need to verify for itself an operator’s compliance with the Code to prevent its own protection being lost if it could be shown that it either knew or should have known that the underlying insurances were ineffective because of non-compliance with the Code.

So how should the requirement that an operator comply with the Code be reflected in financing documentation? Mortgage documentation normally includes a covenant for the borrower to ensure that the vessel at all times complies with the regulations applicable to vessels registered at its port of registry or otherwise applicable to it. Breach of the covenant should result in an event of default unless remedied within an agreed grace period. So should arrest and detention of the vessel for more than a stated period. Compliance with the ISM Code in accordance with the regulations of the vessel’s flag state should therefore be required under that general covenant.

However, it must be recognised that some banks will wish to spell out specific requirements when documenting new facilities. The nature of additional provisions that may be required will vary according to the lender, the borrower and the ships and from transaction to transaction. They could range from a simple undertaking that the borrower will ensure that it and any other operator of the vessel or vessels is at all times in compliance with the Code to specific representations and warranties, undertakings, conditions precedent (including providing copies of the relevant certificates) and events of default. Banks and borrowers should discuss the appropriate level of control and monitoring with their legal advisers on a case-by-case basis. In particular, they should perhaps discuss the approach to be adopted regarding applications for certification by new companies and/or in respect of newly acquired vessels (including time periods by the end of which permanent rather than interim certification has been obtained).

Another topic for discussion is grace periods for events of default (although if non-compliance has the expected effect on insurance cover, it seems likely that in most cases it will, indirectly, cause an immediate event of default anyway).

In summary, although Banks cannot afford to ignore the Code and non-compliance with it will be a matter for serious concern, it is likely that in most mainstream English law financing documentation, the compliance of borrowers, other operators and vessels with the Code will be covered by existing broadly-drafted provisions. If it is felt helpful to focus a borrower’s attention upon the way in which its compliance (or lack of it) will affect its obligations under a loan agreement, lawyers can easily draft additional provisions in appropriate detail to suit their clients’ expectations,

Fiona Evans,
Solicitor Norton Rose,
London
evansfes@nortonrose.com