Recognition and Satisfaction of Newly Arising Claims During Ship Arrest

—On the Amendment of Article 111 of the Special Maritime Procedure Law of the People's Republic of China

Abstract: Article 111 of the Special Maritime Procedure Law of the People's Republic of China (the "Special Maritime Procedure Law") stipulates that announcement of the maritime court's order for forced auction of a ship, creditors may participate in the distribution of the proceeds from the judicial sale by registering their claims. It also explicitly prescribes the legal consequences for failing to register within the time limit announced. The claims eligible for registration under this provision must have arisen before the publication of the auction announcement. However, in maritime enforcement proceedings, new claims related to the ship often arise after the ship has been arrested or even during the auction announcement period. The Special Maritime Procedure Law does not provide any specific provisions regarding the recognition and satisfaction of such newly arising claims. This article examines a maritime enforcement case in which an arrested ship went adrift during the auction period, leading to a series of new maritime disputes. Based on this case study, the article proposes feasible approaches to the recognition and satisfaction of claims that arise during the period of ship arrest.

Keywords: Ship Auction, Claim Registration, Newly Arising Claims, Maritime Claims, Satisfaction Procedure

I. A Typical Case of Newly Arising Claims During Ship Arrest

In a series of financial loan contract disputes [1] between Company A, an asset management firm, and Company B, a shipping company, enforcement proceedings were initiated before the Guangzhou Maritime Court (GZMC). Upon the application of Company A, GZMC arrested the vessels DI XIANG and DI JIAN, both owned by Company B, on May 15, 2018, while they were anchored in a sea area of Shandong Province, and the vessels subsequently entered the judicial auction process. During the announcement period, the applicant for enforcement and 137 crew members applied for claim registration (the claims for crew wages registered by the 137 crew members were satisfied from the proceeds of the judicial sale of another vessel, DI KUN, owned by the judgment debtor. As a result, Company A became the sole applicant for enforcement in this case). During the online court auction, the two vessels ran aground at the arrest location due to Typhoon Rumbia, colliding with breakwaters and aquaculture facilities. Less than three hours before the auction was set to conclude, GZMC decisively suspended the judicial auction proceedings for both vessels. The court then convened a meeting with the applicant for enforcement and the judgment debtor at the local maritime administrative organs to coordinate follow-up actions with the maritime regulatory agency. The local salvage bureau carried out pollution cleanup operations following the grounding of the two vessels. As the hulls of both vessels remained undamaged, GZMC resumed the judicial auction process, resulting in the successful sale of DI XIANG. However, after the DI JIAN was successfully auctioned but before delivery, Typhoon Lekima struck, causing the vessel to sink before the transfer of ownership. The successful bidder applied to set aside the judicial sale on the grounds that the actual condition of the vessel was inconsistent with the description in the auction announcement. Following negotiations between the applicant for enforcement and the judgment debtor, both parties and the vendee reached an agreement under which DI JIAN was sold to the vendee in its as-is condition for RMB 1.5 million. Meanwhile, after completing the towing and pollution cleanup operations for the DI XIANG and DI JIAN, the local salvage bureau submitted a claim registration application to GZMC, asserting priority rights over the two vessels in the amount of RMB 8.26 million. Additionally, Company C, an aquaculture enterprise, filed claims for breakwater and aquaculture damages. At that time, DI XIANG and DI JIAN had already been listed for online auction, and the claim registration period had expired. The claims for towing and pollution cleanup costs, breakwater repairs, and aquaculture damages were substantial, and the salvage operation for DI JIAN could not proceed due to legal and financial constraints. As a result, the enforcement proceedings reached an impasse, with legal and financial issues intertwining. Under the coordination of GZMC, and after extensive negotiations among all parties, Company C agreed to accept a lump-sum settlement of RMB 1 million for its claims relating to breakwater and aquaculture damages. Meanwhile, the applicant for enforcement, the judgment debtor, and the local salvage bureau reached a consensus regarding the post-grounding salvage operations of DI XIANG and DI JIAN. With these agreements in place, the enforcement proceedings were successfully concluded.

II. Claims Related to Ships

As high-value movable property, ships give rise to various claims in the course of their operation [2]. These claims arise from or relate to the ownership, possession, management, operation, construction, sale, salvage, mortgage, pledge, and other maritime disputes involving maritime liens [3]. In maritime law, such claims (or rights to compensation) are also referred to as maritime claims. Some of these claims are secured by ship mortgages and enjoy priority satisfaction, such as claims arising from ship mortgage loans. Some are secured by possessory liens, which are also entitled to priority satisfaction, such as claims for ship repair costs. Some are secured by maritime liens, which take precedence over other claims, including crew wages, tonnage dues, and salvage remuneration. Others do not benefit from priority satisfaction, such as financial loans extended for ship operations that are not secured by a ship mortgage. These claims share a common characteristic: they are all related to the ship itself or its operation, and their satisfaction is governed by specific legal procedures.

III. Satisfaction Procedures

1) Arresting a Ship to Obtain Security

The Special Maritime Procedure Law prescribes 22 types of maritime claims for which a ship may be arrested. When a creditor holding a claim related to a ship fails to reach an agreement with the debtor, the creditor often requires the debtor to provide security or to perform or refrain from certain acts. In such cases, the creditor may apply to a maritime court for maritime claim preservation by requesting the court to take compulsory measures. Ship arrest is a commonly used method of maritime claim preservation aimed at securing the satisfaction of maritime claims. The purpose of ship arrest is not an end in itself but rather a means to compel the debtor to provide security in exchange for the maritime court lifting the arrest. The security thus provided serves as a guarantee for the creditor's claim satisfaction. The creditor then initiates legal proceedings before the maritime court concerning the maritime dispute, and the final recoverable amount is determined and enforced within the security provided by the debtor.

2) Satisfaction Through Ship Auction

In maritime judicial practice, the "arrest-security-release" mechanism of maritime claim preservation often fails when the debtor lacks sufficient creditworthiness to provide security. In such cases, the arrested ship may be subject to judicial sale. According to Article 29 of the Special Maritime Procedure Law, where on the expiry of the time limit for ship arrest, a person against whom a claim is made fails to provide security and it is not appropriate to keep the ship under arrest, the maritime claimant, having brought an action or applied for arbitration, may apply to the maritime court ordering the ship arrest for auction of the ship. If the maritime court orders a compulsory judicial sale, it must publish an auction announcement. During the announcement period, creditors must register their claims related to the ship. The maritime court will review the registered claims and supporting evidence. Once a claim is verified, the maritime court will confirm it by issuing a ruling, or the creditor may initiate a separate action for confirmation of the claim. Finally, the maritime court will convene a creditors' meeting to either negotiate a settlement agreement on the distribution of the auction proceeds or issue a ruling on the distribution plan for the proceeds of the judicial sale.

IV. Newly Arising Claims During Ship Arrest

1) Risks During the Period of Ship Arrest

From the moment a maritime court arrests a ship and publishes an auction announcement, through the process of creditors registering their claims, initiating actions for confirmation of claims, the judicial sale of the vessel, the distribution of proceeds, and the final transfer of the ship, the entire procedure is wide-ranging in scope, legally complex, and lengthy in duration. Although a custodian is appointed to oversee the vessel during the arrest period, it remains difficult to ensure absolute security. The primary risks faced by an arrested ship arise from natural disasters and unforeseen incidents, such as typhoons or collisions with other vessels. After ordering the arrest of a ship, a maritime court may take preventive measures to mitigate these risks, including relocating the place of arrest or requiring the vessel to be insured.

2) Potential Newly Arising Claims During Ship Arrest

If an arrested ship is affected by a typhoon or other natural disasters, new claims may arise, yet there are no clear legal provisions on how such claims should be satisfied. For example, in the previously discussed case, after the vessel was arrested by the maritime court, it encountered a typhoon while moored at the place of arrest, broke loose from its moorings, and collided with aquaculture facilities and breakwaters, also posing a risk of an oil spill. In response, the local maritime authority engaged a pollution cleanup company to extract oil from the vessel, generating new claims, including damage to aquaculture facilities, breakwater repair costs, and oil extraction expenses incurred by the cleanup company. Under such circumstances, two key legal questions arise: How should the original judicial sale process proceed? How should the newly arising claims be satisfied? At present, the Special Maritime Procedure Law does not expressly address the issue of claims arising after the arrest of a ship but before the completion of its judicial sale. The absence of specific legal provisions has resulted in uncertainties in judicial practice regarding the handling of such claims.

V. Satisfaction of Newly Arising Claims

1) Compensation by Insurers

After a maritime court orders the arrest of a ship, it shall conduct a review. If it is found that the ship is not insured, the court shall require the relevant parties to obtain ship insurance that includes third-party liability coverage. Newly arising claims resulting from natural disasters or unforeseen incidents may then be satisfied through insurance claims, which constitutes a relatively secure and feasible method for the satisfaction of such claims.

2) Allowing Creditors to Seek Recovery from the Vessel Owner or Custodian Outside the Proceeds of the Judicial Sale

If the arrested ship is not insured, compensation cannot be obtained from the insurer. Additionally, newly arising claims during the period between the arrest of the ship and the conclusion of its judicial sale have not been registered as claims against the ship, making it difficult for them to be satisfied through the distribution of the proceeds of the judicial sale at a creditors' meeting. Therefore, creditors should be allowed to seek compensation from the vessel owner or the custodian, using assets outside the proceeds of the judicial sale of the ship.

3) Allowing Creditors to Participate in the Distribution of Auction Proceeds

In maritime enforcement proceedings, where the judgment debtor's only asset is the vessel being auctioned, allowing creditors to participate in the distribution of the auction proceeds becomes particularly necessary. As this matter concerns the registered creditors, the vendee of the auctioned vessel, and other lawful rights holders, it warrants careful consideration.

The satisfaction of newly arising claims during the period between ship arrest and the conclusion of its judicial sale is directly related to the lawful rights and interests of the ship's vendee after the auction is finalized. If these newly arising claims are not taken into account during the auction process, their holders still retain the right to apply for the arrest of the ship, meaning that the judicial sale fails to achieve the intended effect of extinguishing prior rights (purging of encumbrances). In this scenario, the ship vendee is entitled to raise an objection to enforcement, further complicating the proceedings. Therefore, the auction of a ship must take into account the issue of satisfying newly arising claims during the period between arrest and judicial sale.

The risks during ship arrest primarily stem from natural disasters and unforeseen incidents, such as typhoons or collisions with other vessels. These events often lead to hull damage and depreciation of the vessel's value, which may render the valuation and appraisal reports on which the auction is based unreliable. Notably, if the actual condition of the vessel has undergone substantial changes compared to the appraisal report, the originally determined reserve price loses its basis. Consequently, it would be impractical to deliver the vessel to the purchaser in accordance with the condition stated in the appraisal report, and bidders may challenge the reserve price or the validity of the auction process at any time. Whether hull damage has occurred determines not only whether the original auction process can proceed smoothly, but also how newly arising claims should be satisfied. Therefore, the author suggests that the satisfaction of newly arising claims during the period between ship arrest and judicial sale should be addressed differently depending on whether the vessel has sustained damage.

1. Hull Damage

If the hull is damaged, the valuation report and appraisal report on which the judicial sale is based will no longer reflect the vessel's actual condition and cannot serve as the basis for delivering the vessel to the vendee upon completion of the sale. In such cases, the maritime court should terminate the original auction process and engage a valuation agency and an appraisal agency to issue a new valuation report and appraisal report. The court should then render a new ruling on the judicial sale of the vessel, publish a new auction announcement, and designate a new claim registration period. Creditors with newly arising claims must complete claim registration within this newly designated period and subsequently initiate confirmation of claims proceedings. The claim registrations already completed under the original auction process remain valid, and creditors who have previously registered their claims are not required to re-register. Finally, in accordance with Article 117 of the Special Maritime Procedure Law, the maritime court shall convene a creditors' meeting to negotiate a distribution plan. If no agreement is reached, the maritime court shall issue a ruling on the distribution of proceeds.

2. No Hull Damage

If the hull remains undamaged, the valuation report and appraisal report on which the judicial sale is based remain valid, and the original auction process should not be terminated. In this case, newly arising creditors should be notified to complete claim registration within the designated registration period, and their claims should be distributed together with previously registered claims from the proceeds of the ship's sale. However, this raises another issue: if a new claim arises after the original claim registration period has expired or is about to expire, the newly arising creditor may be unable to complete claim registration within the original registration period. For instance, if a new claim arises on the day before the registration period expires, the new creditor would not have sufficient time to register the claim. To address this issue, a statutory period should be designated, allowing newly arising creditors a reasonable timeframe to complete claim registration from the date the claim arises. A period of two months would be an appropriate timeframe for this purpose.

VI. Proposed Amendments to Legal Provisions

To protect the rights of newly arising creditors who seek satisfaction from the proceeds of the judicial sale of the ship, it is necessary to amend the relevant legal provisions. The proposed amendment is as follows:

An additional paragraph may be inserted as Paragraph 2 of Article 111 of the Special Maritime Procedure Law: "For claims related to the auctioned ship that arise during the announcement period or after its expiration, creditors shall apply for claim registration within two months from the date the claim arises. Failure to register within this period shall be deemed a waiver of the right to participate in the distribution of the proceeds from the judicial sale of the vessel."

In summary, the Special Maritime Procedure Law does not currently provide for the satisfaction procedures for newly arising claims after a ship has been arrested, particularly those arising during the auction period. This omission presents a new challenge for maritime trial. To address this issue, solutions should remain within the framework of the Special Maritime Procedure Law and align with the legislative intent and objectives. The preferred approach is to resolve all claims within the proceeds of the judicial sale as far as possible in a single distribution process. This approach enhances the effectiveness of judicial auctions and strengthens the credibility of maritime judiciary, thereby preventing situations where creditors of newly arising claims seek to arrest the vessel after its sale and transfer, which would impair the vendee's rights and lead to additional disputes and litigation.

VII. Authors

Luo Chun, Li Chunyu, Xu Jiahui

VIII. References

[1] Luo Chun, Series of Enforcement Cases on Financial Loan Contract Disputes Between Hongjie Asset Management Co., Ltd. and Diyuan Holdings Co., Ltd., et al., in Ye Liudong (ed.), Judicial Insights from the South China Sea – Selected Cases of the Guangzhou Maritime Court, Sun Yat-sen University Press, 2021.

[2] For example, the maritime claims listed in Article 21 of the Special Maritime Procedure Law.

[3] Jin Zhengjia, Weng Ziming, Special Study on Maritime Claim Preservation, Dalian Maritime University Press, 1st Edition, August 1996, p.3.