In a nutshell: The demand for "quiet enjoyment" of a vessel by a charterer and a mortgagee's interest in the ship as collateral often clash in respect of expectations of the parties where there is no quiet enjoyment agreement in place. In February 2024, BIMCO published two draft quiet enjoyment letters ("QELs") to be used for time charters, bareboat charters and vessel leasing structures. In this newsletter we take a look at the right of quiet enjoyment in general and the draft QELs in particular.

A.    Understanding quiet enjoyment

Quiet enjoyment as a maritime legal concept can be summarised as the legal right of a charterer to the use and enjoyment of a ship free from interference. The right of quiet enjoyment can exist as a matter of English common law or as agreed contractually between the parties.

1)    English law quiet enjoyment: 

In the absence of a contractual agreement between a charterer and a mortgagee (e.g. letter of quiet enjoyment), English law provides some general principles governing the relationship between the charterer and the mortgagee. As a result, a charterer does benefit from a certain level of quiet enjoyment even where no letter of quiet enjoyment has been agreed (always assuming the charterer is duly performing under the charter). Although the area is relatively complex and each case will be determined on its own facts, the general principles are as follows:

(a)    If a charterparty has been entered into before the mortgage has been created and the mortgagee has knowledge of the existence of such charter, the charterer could obtain an injunction to prevent the mortgagee from interfering with the performance of the charter. This applies even if the charter impairs the mortgage. The only exception is where the shipowner is unable to perform the charter. If the shipowner is unable to pay his debts as they fall due he is 'unable to perform' the charter. An owner's failure to pay instalments under the loan agreement is commonly the reason why a mortgagee wishes to enforce its mortgage, so in most cases the exception will apply. Ultimately, whether the shipowner is 'unable to perform' the charter is a question of fact.

(b)    Under a pre-existing bareboat charter the situation is different. Possession of the ship is given to the charterer and owner's ability to perform the charter is of no relevance. As a consequence, a mortgagee's position is weaker than under a time charter. Unless the charterer is in breach of the charter, the mortgagee's rights will always be subordinated to those of the charterer and a mortgagee would not be entitled to arrest the ship.

(c)    Where the mortgage existed prior to the charter, following the decision in Myrto (1977) the general rule is that the mortgagee is not entitled to interfere with the performance of such charter by exercising its rights under the mortgage if the charter does not prejudice the mortgage and the shipowner is willing and able to perform the charter.

A court may regard a charter as prejudicial to the mortgagee's security for example if the shipowner is insolvent or likely to become insolvent and unable to meet its debts at the ports at which the ship is to call (resulting in maritime liens) or if the ship is uninsured or not adequately insured.

As stated above, an 'inability to perform' regularly means that the shipowner is unable to pay its debts, be it repairs of the ships or the instalments under the loan agreement. If the shipowner is unable or unwilling to perform under the charter, the mortgagee is entitled to enforce its rights.

It is important to note that the English court in Myrto held that it is ultimately a question of fact whether these conditions are satisfied. It also follows from Myrto that the breach must be the actual consequence of the mortgagee's actions. If the shipowner could only have performed the charter by obtaining credit which was not available to him, then the owner's inability to perform is not the result of any wrongful interference by the mortgagee.

There may of course be comparable rights in the jurisdiction in which a mortgagee is seeking to enforce a mortgage. Consequently, it is advisable to seek out local legal advice to determine what, if any, rights of quiet enjoyment a charterer may have before enforcing a mortgage.

2)    Contractual quiet enjoyment: 

A letter of quiet enjoyment creates a direct contractual relationship between the mortgagee and the charterer. It usually grants the charterer the right to use and enjoy the ship without mortgagee's interference so long as the charterer is not in default under the charter, regardless of whether the owner as borrower is in default under the loan agreement.

It is open to the parties to restrict or extend the English law position, but the English law position is often the starting point, modified to reflect the bargaining power of each party and to take account other legal and commercial considerations.

Before agreeing on contractual quiet enjoyment the following should be considered:

• governing law and jurisdiction: ships often operate internationally and English common law may not apply depending on the jurisdiction in which the ship is at any given time;

• balancing: it allows the parties to document a structure that better reflects their respective negotiation positions and commercial objectives;

• enforcement of common law rigohts of quiet enjoyment: the burden of proof to enforce the common law right of quiet enjoyment or to prove tortious interference by the mortgagee can be difficult; 

• step-in: English common law does not offer any step-in rights for mortgagees; and

• "It depends…": under English law the right of quiet enjoyment is substantially fact dependent and each case will be treated on its own merits.

B.    BIMCO's QEL forms

There is no standard form letter of quiet enjoyment. However, BIMCO has now published two standard Quiet Enjoyment Letters (QELs) for use in ship financing transactions, a short form by the mortgagee only and a standard form which is agreed by all three parties involved which provides for mutual undertakings. The QELs are intended for bareboat and time charter parties as well as ship leasing structures.

As stated by BIMCO, their objective has been to develop a "balanced standard which generally reflects market practice and fairly represents the rights and obligations of the parties." 

Two features of the QEL forms are particularly noteworthy.

1)    Compliance with CRR?

The first, and perhaps most interesting, feature from the perspective of a mortgagee that is a financial institution and subject to EU legislation such as Regulation (EU) No. 575/2013 (the Capital Requirements Regulation, CRR), is that BIMCO aimed to include language that makes the QEL compliant with CRR.

In its explanatory notes BIMCO states that the use of "in any manner" in paragraph 2 of the QEL ("… the mortgagee shall not […] exercise its rights as mortgagee in relation to the Vessel in any manner that would affect or disturb the Charterer's free and uninterrupted use…") would make it "clear that the mortgagee can enforce the mortgage but not in a way that conflicts with the quiet enjoyment." The QEL should "not operate as a bar on the lenders exercising their rights and enforce the mortgage, but rather only as a qualification on the manner in which such rights may be exercised." This intention is underlined by paragraph 5 of the QEL, stating that the mortgagee shall not be restricted from enforcing its rights in respect of the ship provided the charter party remains in place.

Whether this is sufficient to comply with the requirements of the CRR, Art. 194 para. 4 CRR in particular, is not only a matter for assessment by the individual financial institution but ultimately also by the European Banking Authority and the relevant national banking supervisory authorities.

2)    Good faith cooperation vs step-in right

The second feature is the lack of a clearly drafted contractual step-in right for the mortgagee with a hard obligation to the charterer, which would give the mortgagee or its nominee the right to step into the shoes of the shipowner under the charter and receive hire directly from the charterer by way of novation. The charterer's only obligation is to co-operate in good faith and in a timely manner to facilitate the transfer of the ship or the novation of the charter. From the mortgagee's perspective, where the charter is at the heart of the underlying financing, it would be preferable to have a clear pre-agreed contractual framework which includes provisions for the novation of all rights and obligations under the charter without the involvement of the shipowner and clearly defined grounds for a charterer to object to a substitute owner. Any ambiguity in such contractual arrangements creates uncertainty. This could be used as a pretext to prevent an effective step-in.

3)    Other features

The BIMCO QEL standard form requires the charterer to give certain undertakings to the mortgagee in exchange for the quiet enjoyment of the ship. For example, in the standard BIMCO QEL the charterer undertakes not to terminate the charter without notice, not to vary or assign the charter without the mortgagee's consent and to permit the mortgagee to inspect the ship. 

BIMCO's short form QEL focuses on the charterer's rights of quiet enjoyment. It does not offer any undertakings to the mortgagee.

C.    Conclusion

In the ever-evolving landscape of maritime law, letters of quiet enjoyment assist in providing clarity to all parties on their rights where there is a long-term charter on a ship. This clarity becomes especially important when dealing with international voyages and navigating through multiple legal jurisdictions. BIMCO have taken the step of providing standard form QEL documents to offer a balanced starting point for lenders and charterers. It remains to be seen as to the extent these will become used in the shipping market and how they will work in relation to the Capital Requirements Regulation. 
 

If you have any questions, please get in touch with your contact person at EHLERMANN RINDFLEISCH GADOW or with Rebecca Oliver or Hendrik Brauns.