The importance of having a guarantee

It is very important for buyers to obtain adequate guarantees from the shipyard in yacht construction contracts

by Federico Santini*

YACHT CONSTRUCTION CONTRACTS NORMALLY INCLUDE THE BUYER’S UNDERTAKING TO PAY a series of instalments as particular stages of the construction process are completed. These instalments are treated as advances on the final purchase price and allow the builder to finance the construction of the yacht, with ownership normally passing from builder to buyer on delivery and receipt of the boat, and upon payment of the outstanding balance.

So, if the contract is terminated because of non-compliance by the shipyard, or it goes into insolvency before delivery, the buyer has the right to be repaid the instalments.

To protect that right in this kind of scenario, buyers should obtain adequate guarantees from the yard. That need increases the greater the amount paid in instalments, and the longer it takes to build the boat, and in inverse proportion to the yard’s financial solidity.

Failure to secure sufficient guarantees during the negotiation stage may lead, if the shipyard were to become insolvent, to the total loss of any payments made, and only in the most fortunate cases can some of the investment be recovered.

The recent, and to an extent unexpected, bankruptcy of Perini Navi, which is unquestionably one of the world’s most famous shipyards, is further proof that people who want to have a boat built should get suitable protection from the risk of the yard becoming insolvent. Failure to secure sufficient guarantees during the negotiation stage may lead, if the shipyard becomes insolvent, to the total loss of any payments made, and only in the most fortunate cases can part of the investment be recovered.

These claims will be admitted as unsecured credits in the bankruptcy proceedings, which means that they can only be paid after the assets are liquidated and the following have been completely paid off: the costs of the proceedings and pre-deduction credits (including the fees of the receiver, lawyers and professionals employed by the receiver), preferential claims (including from employees, tax and social security contributions, professionals and consultants, and artisan companies), together with creditors who have recognised collateral on the goods of the debtor (mortgage credits and pledges). In practice it is very unlikely that at the end of all this there will be enough left to pay out unsecured creditors and, even when a minimal amount can be paid, that would take place several years after the declaration of bankruptcy.

It was important to make this clear from the start, but it is just as vital to stress that in practice the buyer’s legitimate need for protection should be balanced by the yard’s equally legitimate need to have enough funds to carry through and complete the construction of the yacht. The lawyers for the parties must thus find a reasonable balance in their respective positions and create a form of guarantee which both adequately protects the buyer and is also financially sustainable by the yard.

Owners can get a comprehensive guarantee from a bank refund guarantee issued by the shipyard’s bank. This ensures the repayment of each of the advances made during the construction process.

We should now move on to considering the guarantees normally used in yacht construction agreements, the main characteristics of which will be looked at in forthcoming issues. The strongest kind of guarantee for a buyer is unquestionably a bank refund guarantee, which is issued by the shipyard’s bank and ensures repayment of all of the instalments.

This type of guarantee can be structured in various ways and is widely used in the sector, although many yacht builders are reluctant or unable to provide one because of the cost of providing it, and the fact that banks normally require a fairly significant part of the instalment as security.

Another type of guarantee that is often used in practice, although it is unusual from a technical point of view, is the transfer of ownership of the yacht to the buyer during construction. The use of this type of “transfer of title” guarantee is made easier for Italian shipyards by the recognition in our legal system (article 238 of the Code of Navigation and article 411 of the Navigation Regulations) of the Registry of Ships under Construction (“RNC”) which includes all events relating to the construction contract. This guarantee can also be structured in various ways and is often used when the build reaches the stage at which the structure is complete (with the hull, deck and superstructure assembled) to replace the bank refund guarantees provided by the yard upon receipt of the first instalments.

The third type of guarantee used in the Italian yachting industry creates a mortgage on the yacht under construction in favour of the buyer, which is then registered in the RNC. This type of guarantee is regulated in Italian law by article 566 of the Code of Navigation, and has specific characteristics. The characteristics, advantages, and disadvantages of each of the types of guarantees mentioned above will be described in more detail in the coming issues.

(L’importanza delle garanzie – – Giugno 2021)