Legal pitfalls amid economic distress: How to preserve financial stability in the shipping industry?

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The shipping industry is the backbone of international trade, moving over 90% of goods around the world. Yet, for all its importance, it faces unique financial crises and legal complications. High-value transactions, cross-border operations, and dependence on multi-million-dollar vessels contribute to its economic downfalls and complex legal disputes.

The industry’s vulnerability to financial distress

Shipping is a highly capital-intensive sector and involves huge investments in ships, facilities, and machinery. Since the vessels operate in international waters, shipping business revenues are frequently determined by a turbulent global trade environment that often gets caught up in the throes of economic cycles and geopolitics. As such, shipping companies remain particularly vulnerable to financial stress that arise during economic downturns. Key global events, such as the financial crisis in 2008 and Covid-19, were linked to a rapid decline in demand for shipping services and subsequent extreme cash flow difficulties, which caused major financial distress.

A specific example is the General Maritime Corporation, one of the largest tanker fleets in the world. The company could not pay its debt during the 2008 crisis and later filed for protection from bankruptcy under Chapter 11 in 2011. General Maritime, having more than $1.4 billion in debt, outlines how shipping companies can fall prey to a changed global market.

Legal issues and how they are affecting shipping businesses

Shipping companies very often operate in several jurisdictions and are thus exposed to multi-jurisdictional and complex legal cases. The challenges on the legal front are also beclouded by the nature of the shipping business that crosses borders since laws and regulations differ from country to country.

Among legal complexities is the freezing order, which is considered one of the very extreme judicial tools applied within the shipping industry. A freezing order prevents companies from dissipating their assets before the resolution of a legal claim. While such orders are in place to protect creditors, for shipping companies, the consequences could be detrimental considering the type of assets they rely on for day-to-day operations.

For example, in the case of SCF Tankers Ltd, a Worldwide Freezing Order was granted by the English High Court against Standard Maritime Parties over allegations of bribery, allowing transactions in the ordinary course of business, excluding vessel sales. The substantive underlying claims were ultimately struck out, and the England and Wales Court of Appeal ordered SCF Tankers to pay substantial damages to Standard Maritime Parties in order to cover all losses sustained as a result of the freezing order.

Another example is the case of Lakatamia Shipping Company Limited v. Morimoto, whereby Lakatamia Shipping sought a world freezing order against Mr Su in the English High Court to prohibit him from dealing with or dissipating his assets during the trial. However, Mr. Su had found ways to work around it by diverting these assets through his mother. This act of circumvention underlines the limitations of these complex legal orders. While the freezing order initially curbed Mr Su’s business activities, the case also illustrated that individuals can still successfully operate around these legal mechanisms. However, it was his attempt at being clever with the order that resulted in a protracted litigation that added operational constraints and financial disruption to the business.

Safeguarding shipping industry

While these legal remedies are crucial for protecting creditors, they must be applied with caution to avoid unnecessarily crippling businesses. Freezing critical assets, such as ships, can prevent a company from executing its contractual commitments, and thus, render it operationally paralyzed. In some instances, such aggressive legal actions can bring a company into liquidation, leaving creditors with fewer assets to recover.

Instead, the industry needs a more delicate balance that would allow companies to continue to operate while the process of claims is being legally pursued. This is particularly significant for the shipping industry, where even minor disruptions can affect global supply chains. Legal measures must be undertaken with due caution to ensure that processes protect the interests of the creditors without causing undue harm on the business and its operations.

By undertaking proper risk management, proactive practices, and cautious balancing acts in the application of legal remedies, to a certain extent, it can alleviate the legal and financial risks that the shipping industry is facing, further strengthening its position as a key player in international trade.