The São Paulo Appellate Court recently decided that a Liberian ship mortgage was invalid in Brazil. Despite the potential negative effects on ship and offshore asset financing in Brazil, this is not yet an end-game for this security
The case involves a dispute between bondholders secured by a Liberian ship mortgage and an unsecured creditor. The latter moved to attach a debtor’s FPSO vessel operating in Brazil. The bondholders, in response, moved to assert their first priority in proceeds that could be obtained from a foreclosure.
The unsecured creditor claimed that the ship mortgage was not valid in Brazil because: (1) Liberia is a flag of convenience chosen for tax reasons; the lack of connection between the vessel and the flag state should be considered an illegal evasion of Brazilian law; (2) unlike Brazil, Liberia is not a party to the 1926 Brussels Convention on Maritime Liens and Mortgages, which makes ship mortgages registered in one country valid in another; and (3) ship mortgages must be registered with the Brazilian Maritime Tribunal to be valid.
The secured creditor responded that: (1) the Brazilian Maritime Tribunal only registers ship mortgages of Brazilian vessels, not foreign ones; (2) ship mortgages are governed by the law of the flag, and it is an international custom that they be deemed valid and enforceable in the country where the vessel is located; (3) the fact that Liberia is a flag of convenience does not mean per se that it is fraudulent; and (4) Brazil is party to the Brussels Convention and to the 1928 Bustamante Code; both grant effects to foreign ship mortgages in Brazil and the principle behind them should apply regardless of Liberia being a signatory.
The Court decided in favor of the unsecured creditor for three key reasons. First, the Court held the facts that Liberia is a flag of convenience or that it is impossible to register the mortgage with the Brazilian Maritime Tribunal irrelevant to assess the validity of the mortgage in Brazil. Second, there must be an international treaty between Brazil and the other country for foreign security interests to be valid in Brazil. This was not the case with Liberia.
Finally, the Court stated that, although the mortgage could be valid if an international customary law recognizing foreign ship mortgages was shown to exist, such a custom was not duly evidenced in the case files. In its view, the submitted foreign legal opinions only dealt with domestic laws, not with the international custom issue.
Before sailing vessels out of Brazil, one should be aware that the decision is not yet final, and even a final negative outcome would not bind other courts nor render other mortgages invalid. Particularly, the possibility of showing that an international custom exists allows different outcomes in other cases.
The decision is unaligned with international practice and fails to recognize vested rights acquired abroad – a principle of international law that even has constitutional basis in Brazil. Notwithstanding, until the decision is reverted, it will create tension and uncertainty. In the meantime, owners and lenders should examine their security packages and consider alternative collaterals.
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*Rafael Baptista Baleroni is patner at Souza Cescon Advogados.
*Vitor Nunes Falcone is associate at Souza Cescon Advogados.
