Theo V. Sioufas & Co.Law Offices

In this issue we discuss a

recent Judgment (No.

3839/2014) of the Court of

First Instance of Piraeus on

a case relating to claims for

compensation in

consequence of: (i) the

diversion of assigned moneys

under an assignment of

ship’s earnings from the

designated Operating

Account and the ensuing

appropriation of such

assigned moneys by the

Defendants, and (ii) (in

relation to one of the

Defendants) a letter of

comfort signed by the said

Defendant in security of the

loan.

1. EQUITABLE1 ASSIGNMENT. THE ASSIGNED EARNINGS(PRESENT OR FUTURE) OF A SHIP BELONG TO THEASSIGNEE. DIVERSION OF THE ASSIGNED EARNINGSMAY CONSTITUTE MIS-APPROPRIATION(EMBEZZLEMENT). LEGAL CONSEQUENCES.

2. A LETTER OF COMFORT GIVEN AS SECURITY MAY,DEPENDING ON ITS WORDING, CREATE LEGALLIABILITY FOR ITS ISSUER.

NNeewwsslleetttteerr

Issue 15 – October, 2014

1 The assignment is complete when it is notified to the third party holding the assigned property (legal assignment), the effect of which is thatthe assigned property is transferred to the assignee. If the assignment is not notified to the third party (which is invariably the case in theassignment of future earnings), the assignment does not affect the third party holding the assigned property, but as between the assignor andthe assignee the assignment is complete (equitable assignment).2 This term is not the only one used in anglo-saxon law documents. Similar terms like “letter of interest”, “declaration of comfort”, “letter ofintent” are also used. In Continental legal systems, the terms used are: in Germany “Patronatserklarung”, in France “lettre d’ intention” or“lettre de patronage” or “lettre de confort”, in Italy “lettera di patronage” or “lettera di conforto”, in Spain “Carta de patrocinio” and inGreece “Epistoli or Dilosi patronias” or “Dilosi prostasias”.

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1. The assignment of the ship’spresent and/or future earnings ina shipping loan transaction is animportant credit support securitydocument and along with themortgage deed on the ship, theyconstitute the core of the loansecurity documents.

2. Another security documentfrequently used in shipping loantransactions is the pledge of theshares of the borrower (and,sometimes, of other corporatesecurity parties) and, lessfrequently, the “letter ofcomfort” (“LoC”, in Greekεπιστολή πατρωνίας2) which issigned by the person (physicalor legal) behind, or associatedwith, the borrower and isaddressed to the lender,whereby the signatory (issuer)of the LoC agrees to provide“comfort” to the lender, usuallyin the form of an expressundertaking of the signatory toassist the borrower to performits financial obligations towardsthe lender under the terms of theloan agreement.

3. Judgment no. 3839/2014 of thePiraeus Court considers thenature and the legal effect of:(a) the assignment of earnings,and (b) the LoC, in the contextof two actions filed by a lenderbank, the one in relation to theassigned earnings against bothDefendants and the other inrelation to the LoC against oneof them. Under the first actionthe Claimant claimedcompensation for the fullamount of the assignedmoneys which weremisappropriated by theDefendants and under thesecond action the Claimantclaimed compensation for thefull amount of the loan whichremained outstanding, on thestrength of the LoC.

4. The facts of the case are asfollows:

4.1 The 1st Defendant acting onbehalf of a company whichhad agreed to purchase a shipunder a MoA, applied to theClaimant for a bridge loan tothe purchaser.

Claimant agreed to provide theloan for a period of six months.The loan was secured by thefollowing instruments: (i) afirst preferred mortgage on thevessel; (ii) assignment ofearnings, (iii) assignment of theinsurances and requisitioncompensation, (iv) pledge onthe shares of the borrower, and(v) a LoC with a specifiedwording, given by the 1st

Defendant.

(legal assignment), the effect of which is thatird party (which is invariably the case in the

ClClaiaimamantnt aagrgrgreeeeeeddd toto pprororovivividedede tttheheheloan for a period of six months.The loan was secured by thefollowing instruments: (i) afirst preferred mortgage on thevessel; (ii) assignment ofearnings, (iii) assignment of theinsurances and requisitioncompensation, (iv) pledge onthe shares of the borrower, and(v) a LoC with a specifiedwording, given by the 1st

Defendant.

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The loan was to be repaid by oneinstallment. All securitydocuments (other than themortgage) were governed byEnglish law.

4.2 The borrower failed to repay theloan as agreed. Claimant agreedto restructure the loan, but theborrower failed again to complywith its obligations and theClaimant, pursuant to powergranted to it under the mortgage,sold the vessel by private treatyfor a sum which fell well belowof the outstanding loan amount.

4.3 During the loan period theborrower diverted thehires/freights of the vessel to anaccount of the borrower withanother bank in Piraeus, otherthan the account agreed underthe assignment (the so-called“operating account”). Theaccount into which funds werediverted was beneficially ownedby individuals (the Defendantsin the first action). These twoDefendants proceeded to remitout of the borrower’s accountsubstantial amounts (in theregion of several millions ofdollars) which they routed toaccounts of their own. All thesemovements of the borrower’saccount were later on revealed,following the exercise byClaimant of its rights under thepledge, as a result of whichClaimant became the “owner”(sole shareholder) of theborrower, whereupon itappointed new directors, etc. Inthis way, Claimant was able toobtain full evidence of theamounts of the assigned moneysand track their movements,whereby it identified theremittances made to theaccounts of the Defendants.Claimant then protested to theDefendants of misappropriationof the assigned moneys anddemanded full refund, yet theDefendents ignored the demand.

Claimant filed the subject actionin tort.

4.4 As aforesaid, the proceeds of saleof the vessel by Claimant –mortgagee left a substantialbalance on the outstandingamount of the loan. Claimant bynotice to the issuer of the LoCdemanded payment of thebalance, yet he did not respond.Claimant sued him in the secondaction and demandedcompensation equal to thisamount.

5. Both cases were heard together.The Piraeus Court issued itsjudgment under no. 3839/2014covering both actions. Theactions were upheld, on thefollowing grounds.

to accounts other than thedesignated operating orearnings account (invariablyprovided for in shipping loanagreements), and the ensuingappropriation of such moneysby those controlling therecipient account(s),constitutes an act (delict) ofmis-appropriation(embezzlement) which (interalia) gives rise to a right of theassignee to claimcompensation from theperson(s) responsible for suchillegal act.

6.3 Under the judgment, suchpersons (the Defendants in thiscase) were held to be liable topay the Claimant the fullamount of the assigned moneysso misappropriated, plusinterest, as compensation for thelosses suffered by thelender/assignee, plus costs.

7. Action under the LoC.

7.1 It was held that the LoC is asecurity document, which isgiven by its issuer for thepurpose of strengthening theborrower’s credit and enticingthe lender to making the loan orother credit facility to theborrower. The Court noted thatthe LoC is invariably given byeither the parental (holding)company of the borrower or byits principal or sole shareholder.

7.2 According to the Court, the LoCis not a legal instrumentregulated by the law as such,e.g. it is not a guarantee, but it ismerely the product of theapplication of the well knownprinciple of freedom to contract(in Greek «ελευθερία τωνσυµβάσεων») available to theparties under contract law,be it English or Greek.

7.3 Depending on the wording of aLoC, it may contain declarationsof support with or withoutbinding effect3 on the personmaking such declaration.

6. Action for themisappropriated assignedearnings.

6.1 The Court determined first thatthe assigned moneys belongedto the Claimant (lender –assignee), although theassignment was not notified tothe charterer (equitableassignment). This was so,because the equitableassignment of the present orfuture earnings (freights/hires)of the vessel, as between theparties thereto, was completeand had the effect of the legalassignment. The assignedmoneys were moneys of thelender. Hence, the siphoningof assigned moneys to privateaccounts of the Defendantsconstituted illicit appropriationof the assigned earnings whichcaused corresponding damageto the Claimant. (The Courtreferred to legal opinions onEnglish law and cited Section136 of the Property Law 1925,and Chitty on Contracts § 19-012).

6.2 Further, it was held that thechanneling of the ship’searnings assigned to the lender,

3 The first category refers to the so called “tough” or “strong” LoC.s, the other (which isof “ethical”, not “legal”, character) to the so called “soft” LoC.s.

Lawyers involved inthe handling of thecase on behalf of theClaimant:Theo V. SioufasHelen J. SioufasPanagos G.AnagnostopoulosGeorge P. Zouros

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7.4 In the case of the so called“tough” letter of comfort, theissuer undertakes the legallybinding obligation to providefinancial support to theborrower in order that the lattermay properly and timelyperform its obligations towardsthe lender.

7.5 No specific legal form isrequired to be observed in theexecution of the so called“contract of comfort” whichmay be concluded in the usualform of a proposal/offer andacceptance. The extent ofbinding commitment of theperson signing the LoC and thelegal consequences thereofdepend mainly on the wordingof such LoC as well as thesurrounding circumstances andfacts of the particular case.

7.6 Under the LoC, the issuer doesnot undertake a direct obligationtowards the lender to pay to thelender the indebtedness of theborrower (as would have beenthe case of a guarantee), butonly the obligation to provide tosuch borrower/obligor thefinancial means for theborrower to perform itsobligations vis-à-vis thelender.

7.7 In case of default of theborrower and the subsequentrefusal of the issuer of the LoCto perform his/its obligationsthereunder, the lender, mayhave a claim against the issuerof the LoC for damagessuffered. The liability of theissuer as well as the quantumof the damages to be claimeddepend on the exact wordingof the LoC.

7.8 Thus, in respect of the secondaction, it was held that:

(i) the LoC (which was subjectto English Law) satisfied all therequirements for such LoC to bevested with legally bindingeffect, namely the requirementsfor the conclusion of a valid

contract, i.e. the proposal (bythe issuer) and acceptance (bythe lender) and, hence, theagreement between them, theconsideration, the intention tocreate legal relations or theanimus contrahendi, certaintyof the terms contained in theLoC and the obligationsundertaken thereunder.

(ii) the Defendant/issuer of theLoC had executed a valid andbinding letter of comfort,whereby he undertook theobligation vis-à-vis the lenderto cover with his own financialmeans and on the lender’s firstdemand the financial needs ofthe borrower in order for thelatter to properly perform allits financial obligationstowards the Claimant under theloan agreement, and, since hehad failed to do so, the lenderwas entitled to compensationfor the full amount claimed,plus interest and costs.

8. Comments.

8.1 The judgment apparentlyconstitutes a milestone in thedevelopment of Greek caselaw, on matters of criticalimportance for the ship financeand for the construction ofcertain of the securitydocuments relating thereto.

8.2 In particular, the effect of thejudgment is significant forlending banks in that theassignment of earnings, asecurity invariably provided inship finance transactions,acquires special weight. Theassigned moneys belong to theassignee as of the moment theybecome due and payable by thethird party, usually a charterer.Hence, their mis-appropriationby the assignor (or the personsbehind it) give rise not only tocivil (and, probably also,criminal) liability of thoseinvolved in the scheme, but,most importantly, the

mis-appropriation can now befully unearthed. The assignoris obliged to give completeaccount as to what was the useof the assigned moneys,diverted to account(s) otherthan the earnings account atthe lending bank. As a result,the assignment of earningsbecomes a much stronger andmore useful security than itwas deemed to be before thisjudgment.

8.3 Under the judgment, thediversion of assigned moneys,a practice applied bydefaulting borrowers inshipping finance transactions,may prove very risky, if thelender/assignee has the will toprosecute the offenders.Those tempted to channelassigned moneys away fromthe designated earningsaccounts must now think twicebefore they do it.

8.4 The additional weight of thejudgment is that theindividuals liable for the mis-appropriation may also faceserious criminal charges (forembezzlement, moneylaundering et al).

8.5 This judgment uncovers alsothe value of another security,that of the pledge. It is nowcrystal clear that if theassignment of the ship’searnings is combined with anEnglish law pledge on theshares of the assignor, theposition of the assigneebecomes stronger and theverification of possibleviolations of the assignor’sobligations under theassignment (and the mis-appropriation of assignedmoneys) becomes easier.

8.6 The judgment breaks also newground in the matter of theimportance of the LoC as asecurity document, which untilnow was an unexploredground, for the reason that not

many cases involving LoCsbecame the subject of legalactions worldwide. Theprecedents in this field arerare. The judgementexplains in an elaborateway the legal nature andbinding effect of the LoC.

8.7 The careful drafting of theLoC acquires paramountimportance in that it canmake the differencebetween a valid andbinding security documentand one which is merely astatement of intent,probably not worth thevalue of the paper it iswritten on.

The judgment is subject toappeal.

Edited by:Michael G. RapsomanikisPartner