Designing and building a yacht may be the ultimate dream for those with the required resources but, as with many exhilarating projects, comes with its fair share of risk. The potential owner commits to paying a vast amount of money over a long period of time. Therefore, protecting yourself financially is imperative. Article by James Clayton, Amy Lindemann and Francesca Norman.

This article seeks to explore the main financial pitfalls involved in yacht construction and offer ways to mitigate the risk.

Builder Bankruptcy

Builder bankruptcy should be a consideration right from the start of the yacht construction process. Given that the construction of a yacht can take years to complete, a buyer cannot be certain that the builder’s financial position at contract signing, will remain on an even keel. Even at the price negotiation stage, the buyer must think about the future. Strangling the yard in order to get a deal most would regard as “too good to be true” can leave the builder cash-strapped and struggling to perform the contract further down the line, unable to absorb any unforeseen extra costs.

However, price negotiation is only one part of the new build process. Usually, the full price of the yacht will be paid in instalments throughout the construction of the vessel, with such milestone payments becoming due as specific stages in the construction are achieved. This, of course, carries with it an inherent risk that a builder which subsequently becomes insolvent, is unable to complete the vessel, and has no means to refund the instalments already paid.

One way to mitigate this risk is to provide in the contract for a progressive transfer of title in the yacht from the builder to the buyer. It is important that such progressive transfer of title includes the vessel’s systems and components at the time of their construction and integration. The contract should have a built-in right for the buyer to remove the incomplete yacht from the yard in the event of builder’s default (including both bankruptcy and breach of contract as explored further below). A well-drafted contract will also protect the buyer’s costs and expenses in doing so.

It is also worth noting that progressive ownership rights can be publicly registered in certain jurisdictions. Although not strictly necessary, such registration can be helpful in demonstrating title should it be required.

Another useful protection in mitigating the risks associated with instalment payments is obtaining a refund guarantee. Refund guarantees are essentially what their name suggests– a guarantee of the builder’s contractual obligation to refund to the buyer any instalments already paid, in the event of the builder failing both to complete the yacht, and refund those instalments.

Such a guarantee would usually be in force until title to the yacht transfers to the buyer upon delivery and is typically granted by banks or financial institutions in favour of the buyer.

If no bank guarantee is available then this can be substituted by a corporate guarantee provided by another commercial entity, such as the parent company of the builder in question. However, this is a poor substitute for a bank guarantee as it relies on a connected commercial entity being in a financially viable state when the builder is not. Thorough due diligence will need to be carried out in relation to any corporate guarantor and the buyer should be aware of the risks involved.

A final option to mitigate the risk of builder bankruptcy is the use of escrow arrangements. This would involve the builder paying a previously agreed upon portion of the purchase price of the yacht into an escrow account to be held by a third party. These funds would then be released on the occurrence of pre-agreed trigger events, such as the commencement of insolvency proceedings in respect of the builder. If no trigger event occurs then the funds would be released to the builder on the conclusion of the project.

Breach of contract

The buyer should always ensure that the building contract includes a right to terminate the contract in the event of breach (and failure to remedy that breach) by the builder. Builder bankruptcy should be one such breach. The contract should clearly specify the process for serving a valid notice of termination, setting out the builder’s obligations towards the buyer upon termination. Ideally the buyer should seek to recover all sums paid to the builder pursuant to the contract and any additional losses caused by such breach.

Loss of the vessel during construction

It is not beyond the realms of possibility for a yacht to become a partial or total loss during the course of its construction. In the event of such a disaster it is important that appropriate insurances are in place. The safest way for a buyer to ensure this is to have provisions built into the shipbuilding contract which oblige the builder to take comprehensive insurance coverage out in respect of the yacht and over any supplies of the buyer which are delivered to the yard. It is very important to review the contract to ensure that the buyer has adequate protections in place so that their exposure to risk in this regard is limited if not entirely eliminated.

Delivery delay

With any long lead projects there is scope for delay in delivery. This holds true in the construction of new build yachts. With this in mind, the buyer should ensure that the building contract sets out the legal consequences for the parties in the event of delay. These consequences could range from liquidated damages at a fixed daily rate to a right of cancellation for extended delays. It will be important for the contract to spell out any ‘permissible delays’ with a high degree of clarity to avoid any scope for ambiguity in the event of delay. It is advisable to include a grace period in any clauses, setting out the consequences of delay. It is also worth noting that these clauses can be hard to enforce if it can be argued that the buyer is partly responsible for the delay for example, delivering equipment which buyer is supplying, later than scheduled.

Performance inconsistencies

Unfortunately, the risks do not end once the yacht has been built and launched. There may be issues with the construction which only become evident once the Buyer has taken delivery of the yacht. In order for the builder to have any recourse against the builder it is vital that robust warranties are incorporated into the shipbuilding contract. These should be sufficiently wide and last for long enough to protect the new yacht owner against latent defects, which may only become apparent some time after taking delivery from the builder.

Another useful protection for performance failings is the use of a performance guarantee. This could be tied into the refund guarantee discussed above or could be a stand-alone document. Performance guarantees are often used to underwrite any potential failure of the builder to carry out their warranty obligations discussed in the paragraph above.

Conclusion

As with any big project, the process of designing and constructing yachts varies from case to case. Not all of the protections listed above will apply to every situation and there are many other issues which may need to be considered including intellectual property rights, confidentiality clauses and regulatory compliance to name but a few. However, a well drafted shipbuilding contract which includes the necessary insurance, default and warranty provisions will go a long way to mitigating some of the risk involved in a new build yacht project.