Legal protection during yacht construction

We take a look at bank refund guarantees in yacht building agreements protecting the instalments paid during the construction process

by Federico Santini*

IN THE JUNE ISSUE OF BARCHE, WE SAW HOW IMPORTANT it is for the owner who commits to building a new yacht to obtain sufficient guarantees from the yard to ensure repayment of all advances made during construction if the contract is terminated because of default or insolvency.

We will now consider bank refund guarantees which are provided by boat builders against each down payment made by the owner. This type of guarantee is undoubtedly the one that best protects the owner, although it is also the most burdensome for the yard. Bank refund guarantees can be structured as a first demand guarantee by which the bank undertakes to pay the guaranteed amount to the beneficiary upon demand in writing, and regardless of any objections from the yard. So if the termination of the contract is disputed in court, the enforcement of tis kind of guarantee depends on the outcome of the case or arbitration between buyer and builder.

The bank will pay the guaranteed amount only if there is an enforceable judgment and will therefore be protected from the risk of builder claiming compensation.

First demand guarantees are normally straightforward and very concise but are now only rarely used because they create a significant imbalance in favour or owners – who are free to enforce them at first demand and, in theory, even in case of unlawful termination. The most commonly used form is therefore the second type, which is fairly complex and often the result of extensive negotiations between lawyers representing the owner, the builder and the bank. Payment by the bank is normally subject to the provision by the beneficiary of (i) an arbitration award or an enforceable court judgment declaring the builder to be in breach of contract and ordering the builder to repay the down payments made by the buyer, or (ii) a court judgment declaring the builder to be bankrupt or at least insolvent. In this way, the builder is protected from the risk of unlawful termination by the buyer and can dispute and present its case and objections in court or at arbitration. At the same time, the bank will pay the guaranteed amount only if faced with an enforceable judgment and will thus be protected from the risk of the builder claiming compensation.

The bank refund guarantee can be structured as a first demand guarantee by which the bank undertakes to pay the guaranteed amount to the beneficiary when asked to do so in writing and regardless of any objections raised by the boat builder.

An owner would normally require bank refund guarantee for each instalment of the price to be paid before delivery, meaning that builders have to provide as many banks guarantees as there are instalments, excluding the final instalment that is due upon acceptance and delivery of the yacht. With this method, the builder retains full ownership of the yacht until delivery and acceptance, at which time the builder transfers ownership to the owner against the return of the original bank refund guarantees and payment of the last instalment.

This guarantee mechanism allows builders to maintain legal possession of the yacht being constructed and thus register a mortgage against the yacht with a bank to finance construction.

In practice, the first demand guarantee is used increasingly rarely because it entails a significant imbalance in favour of the owner, who can execute it upon first demand and, in theory, even in case of unlawful termination.

However not all yacht builders are willing or able to provide bank guarantees for very high amounts, whether because of the costs involved in securing one or because issuing banks normally require pledges over a significant proportion of the advances that are to be guaranteed, which means that the builder does not have the entire amount of the down payment to finance the yacht’s construction.

For this reason, a hybrid guarantee mechanism is increasingly being used. This consists in the provision of bank refund guarantees to secure the first instalments until the stage where the yacht reaches a stage of construction where the yacht has a significant intrinsic value.

This usually occurs when the hull, deck, and superstructure are completed and assembled. Once that stage is reached, the owner returns all or part of the bank refund guarantees that had been issued and the builder transfers the ownership deeds to the owner, so that the construction continues on an asset that is already the client’s property. This hybrid guarantee mechanism can be structured in various ways depending on negotiation between the parties and the bargaining power each has during the drafting of the construction agreement. In the next issue we will look more closely at the ways in which ownership of the yacht can be transferred during construction.

(Legal protection during yacht construction – Barchemagazine.com – July 2021)