The collapse of Hanjin Shipping (117930.KS) will boost the cost to U.S. businesses and consumers of a wide range of imported goods, from furniture and clothing to fresh fruit and frozen meat, according to federal agencies, shippers and retailers. With Hanjin’s future in doubt, carriers have announced they will hike container freight rates by as much as 50 percent beginning next month as retailers scramble to secure shipping ahead of the peak year-end holiday season, industry sources said.

United Parcel Service Inc (UPS.N) said on Thursday it is seeing a bump in demand for its freight services and is working with customers in Asia to shift goods from Hanjin containers to other ocean freight operators or air freight services. About $14 billion worth of cargo was stranded by the collapse of the seventh largest container carrier in the world. “Right now, there is much more (freight) demand than there is supply. People are scrambling to find a carrier with space,” said Peter Friedmann, executive director of the Agriculture Transportation Coalition shipping industry group. “But the biggest challenge right now is for people with cargo on Hanjin ships,” he said.

Cargo shippers have been forced to pay thousands of dollars in fees to terminal owners and truckers to reclaim their goods from Hanjin ships to prevent perishable foods from spoiling and to avoid losing sales because goods are not available when customers want them. Hanjin would normally pay the fees for port usage and container handling as part of its freight services. With the South Korean shipper in receivership, it is unclear if shippers would recoup any added costs they pay out of pocket to retrieve their goods. Singapore-based crop shipper Agrocorp International said that DP World, terminal operator at Port Metro Vancouver, last week held 24 containers, or 600 tonnes, of its Canadian lentils that were bound for India and Bangladesh, demanding a release fee of $450 per container.

Industry analysts expect the freight increases to be short-lived as more shipping capacity comes on line. “The Hanjin ships are going to be off the market for the holiday seasons. It will take several months to sort through the legalities, but any rate increase will be temporary,” said David St. Amand, president of Navigistics Consulting.

In the short term, retailers are likely to take hits to their profit margins as they try to shield customers from any more price rises in a hyper-competitive retail market. “We believe that (the Hanjin collapse) will likely increase our short to medium term ocean freight costs which will minimally impact product cost in all of our operating segments to varying degrees. However, inventory availability is good,” Paul Toms, CEO of Hooker Furniture (HOFT.O), said on an earnings conference call on Thursday.

Joe Parsons, CFO for Michael Kors (KORS.K), said from the Goldman Sachs retail conference on Wednesday that the company does not expect a significant long-term impact on its business. But “there is going to be some pricing pressure. At this point, we are continuing to evaluate it,” he said. The American Apparel and Footwear Association said it expects gross margins to be pressured in the near term by the higher shipping prices and additional unloading fees.

Hanjin’s collapse could wreak havoc on port operations and shipping lines over the next two to three months and could impact trade between the United States and South Korea, the U.S. Department of Agriculture said in a report published on Thursday. Container freight charges have more than doubled since May and could appreciate further, the agency said. The average cost to move goods in 40-foot containers from the U.S. West Coast to Asia was quoted at $1,700 this month, up from $788 in May.

Reuters (Aditional reporting by Nandita Bose in Chicago, Rod Nickel in Winnipeg and Liz Hampton in Houston; Editing by Bernard Orr)

Hanjin Shipping’s New Jersey bankruptcy filing has yet to calm chaos across the US, as a swathe of creditors from all walks of the maritime industry urged a judge not to rush to recognise fully the operator’s South Korean court proceedings without greater measures to sort out the tangle. Detractors of the company’s restructuring filing included shippers, bunker suppliers, terminal operators, container lessors, tug owners, rail companies and chassis lessors expressing doubts about how their rights to collect on past debts will be protected and how to ensure they will be paid for services provided as Hanjin ships float out of limbo.

And before US Bankruptcy Judge John Sherwood entered an order on Tuesday night putting a freeze on litigation, as is standard procedure in Chapter 15 petitions to recognise foreign bankruptcies, the litigation against Hanjin grew. At least nine lawsuits by six plaintiffs are on public dockets in US courts and at least two arrest orders have been issued against Hanjin vessels. But the allegations in those cases pale in comparison to the potential claims that some creditors disclosed in a hearing this week in the US Bankruptcy Court in Newark, New Jersey.

An estimated 15 ships are waiting in limbo off the US coast, either to avoid arrest or because ports will not let them enter as long as there are doubts about Hanjin’s ability to pay its bills. In the bankruptcy case, terminal operators have complained that they are saddled with Hanjin containers that they cannot move, and they asked Sherwood for protections to ensure suppliers will be paid once the idled vessels move to a berth to unload. Even lawyers for Total Terminals International (TTI), a joint venture that has Hanjin as its largest shareholder, complained that there are no provisions in the ship operator’s Chapter 15 bankruptcy filing that deal with the process for discharging these vessels. “This lack of a short-term plan for these vessels will lead to mayhem,” wrote the company’s lawyers, led by Douglas Deutsch of Clifford Chance. In the packed courtroom, he said Hanjin is $50m behind on its payments to the terminal operator, which is no longer accepting the Korean shipping giant’s cargoes.

Hanjin’s lawyer, Ilana Volkov of New Jersey firm Cole Schotz, said Hanjin is aware that service providers will need confidence that they will be paid but added that the company is seeking the litigation freeze as a first step in the process. “Everybody is working around the clock to secure the funds for this international operation to continue,” said the lawyer.
Shippers, meanwhile, complained that hundreds of millions of dollars-worth of cargo is stuck on Hanjin vessels.

Lawyers for computer maker HP proposed establishing protocol in the bankruptcy to turn over containers to cargo owners and said the company would be willing to put money into a trust fund to pay for the effort. Other cargo interests expressed approval of the protocol. “HP faces the prospect of loss of customers, business reputation, market share and other irreparable harm,” wrote the company’s lawyers at Pachulski, Stang, Ziehl & Jones. “This is especially the case because the potential for any recovery of damages from the foreign debtor, who is currently insolvent, may be remote at best.” Other cargo interests complained that in some cases Hanjin has refused to turn over containers.

Simms Showers lawyer Stephen Simms, who is representing several bunker suppliers, tug owners and container lessors, urged Sherwood to safeguard his clients’ maritime liens against Hanjin ships by ensuring that his ultimate order does not allow the ship operator to take vessels to jurisdictions where the US protections would not apply. “That wipes out our security entirely,” he said. Simms told the judge that one client, bunker supplier OceanConnect, has secured an arrest order against the Hanjin-chartered, 4,590-teu Seaspan Efficiency (built 2003) over $837,000 in unpaid bills and it has filed papers to intervene in World Fuel Services’ arrest of the 4,250-teu Hanjin Montevideo (built 2010). Sherwood responded by ordering Hanjin not to take its ships away from US waters until he can consider the maritime lien arguments.

Shipowners, meanwhile, have been without charter hire from Hanjin for months, legal and security filings reveal. As TradeWinds has reported, an affiliate of Idan Ofer’s Eastern Pacific Shipping, for example, has filed lawsuits in California and Illinois over $1.38m in unpaid charter hire for the 3,670-teu Hanjin New Jersey (built 2013). And brother Eyal Ofer’s Zodiac Maritime has filed three lawsuits in California and Baltimore over $1.69m allegedly owed on the 3,670-teu Hanjin Louisiana (built 2013) after charter payments stopped at the end of June. New York-listed Danaos has told the US Securities & Exchange Commission (SEC) that Hanjin was behind on $16.9m as of the end of June, while rival Seaspan had $18.6m in unpaid Hanjin charter hire as of 18 August.

As TradeWinds has reported, Hanjin filed for court-supervised restructuring in Seoul last week with some KRW 6.03 trillion ($5.04bn) in total liabilities and KRW 6.62 trillion in assets. The three-judge panel, which approved commencement of the company’s rehabilitation proceedings, noted that Hanjin faces some KRW 3.14 trillion in loans maturing within one year but no possible way to pay it off.

Scrapping of dry bulk tonnage slowed dramatically between July and August, partly due to India’s monsoon season. Analysts say increasing owner optimism, particularly for capesizes, may keep even more of those ships off breaking beaches until the end of the year.

Speaking on condition of anonymity, a research director for a commodity trading firm says the capesize market remains “structurally oversupplied”. He estimates that between 100 and 120 capesizes would need to be scrapped for balance to be restored. “If we get to 100 [capesizes scrapped this year], that’s going to be an achievement,” he said. The number of capesizes scrapped is running below last year’s levels. Some 67 capesizes were recycled from January to 22 August this year, according to cash buyer GMS Dubai.

Deutsche Bank analyst Amit Mehrotra says 69 capesizes were scrapped between January and July 2015. Arctic Securities analyst Erik Nikolai Stavseth also notes that “scrapping in the capesize segment has disappointed”, with only two such vessels going to the breakers over the past two months. The slowdown in scrapping will result in net fleet growth of up to 3% for the year, Stavseth estimates.

The first half of the year showed better tonne-mile demand than had been originally forecast, which helped push freight rates off earlier lows. But further gains are in doubt as capesize owners face what Stavseth calls “their own ‘prisoners dilemma’ as the lack of scrapping holds the entire market hostage”. Capesize rates showed one of the strongest rebounds of the year, dipping below $2,000 per day in late March before rising to just over $9,000 per day a month later. Spot rates have averaged about $6,500 per day since May. The outlook is for more rate improvements. Freight futures markets are pricing capesizes to earn $9,000 to $10,000 per day during the fourth quarter.

With those rates more than covering operating expenses, it is more likely “owners are holding on to their ships in order not to miss out on the next rally”, says Seaport Global Securities analyst Magnus Fyhr. The next rally hinges on the always uncertain outlook for China’s coal and iron ore demand. Fyhr says low coal inventories at Chinese ports and strengthening prices could support rates into the fourth quarter. Cutbacks in China’s domestic coal output fuelled more cargo activity during much of the year. But with import prices on the rise, China’s government signalled that it would allow greater domestic production once again.

Likewise, Stifel says iron ore inventories at Chinese ports remain elevated, which may dampen further imports. But China is pushing steel producers to be cleaner – a step that would require higher-quality overseas iron ore in place of domestic iron ore. Deutsche Bank’s Mehrotra says seasonal patterns – if they hold true this year – also point to a slowdown in scrapping activity. Over the past five years, his research shows that roughly two-thirds of all scrapping activity takes place in the first half of the year, with those levels tapering in the second half. The fourth quarter of last year was unusual with 15 capesizes scrapped. But, on average, the final three months have only seen nine capesizes being scrapped over the past five years. Seasonal strengthening in capesize rates will further dissuade shipowners from scrapping. Mehrotra’s research shows that fourth-quarter capesize rates have risen 35% from August over 13 of the past 16 years.

If anyone were to scrap, Mehrotra says it is more likely to be smaller owners with five or fewer ships, especially older ones. The cost of special surveys on ships of 15 years or older may be the tipping point for some owners. “They don’t have deep pockets of larger owners,” Mehrotra said. “All the big guys, they hope the market stays weak to force more of the smaller players out.” But a slowdown in scrapping in the fourth quarter will likely take a toll on freight rates in the first quarter of next year. That period is typically weakest for cargo activity and, still, high vessel supply could make rates even worse. “The market could be really crappy in the first quarter because of the lack of scrapping,” Mehrotra said.

HONG Kong Shippers’ Council has criticised local port terminals for their imposing deposits on Hanjin boxes, adding it might file litigation against such “unacceptable” moves.

The organisation has received hundreds of calls from its members and some outside importers, complaining that one of the city’s terminal operators has forced them to pledge a considerable amount of cash before they can take their Hanjin Shipping containers out of the port.

“This is really like highway ransom,” HKSC chairman Willy Lin told Lloyd’s List.

“The financial dispute is between Hanjin Shipping and the terminals. Cargo receivers should not be used as a pawn.”

Mr Lin declined to disclose the name of the operator. However, Lloyd’s List has learned separately that it is HPH Trust-owned Hong Kong International Terminals, a main receiver of Hanjin’s boxships.  The deposit is said to be HK$10,000 ($1,290) for a 40 ft box and HK$6,000 for a 20 ft box. HIT refused to comment, only saying it “endeavours to help affected parties to minimise the impact of the disruption to their supply chain”.

Mr Lin said most of the complainants are small and medium-sized local firms, which could suffer huge losses from damage to their cargoes, especially food and wines, due to delay in deliveries.

At the same time, the deposit has also caused huge financial burden for these SMEs.

“I know some forwarders have put down HK$10m-HK$15m to get their boxes,” said Mr Lin.

He added that a small sum in extra handling fees — such as a surcharge of €25 ($28.11) per container ruled by the court in Rotterdam over Europe Container Terminals — was acceptable, but “nothing more”.

The council has consulted its lawyers, while taking legal action against the terminals is under consideration, according to Mr Lin.

“We’ve expressed our concerns to the Hong Kong Terminal Operators Association,” he said, adding that the terminal operators, with a global business scope, should not want to see their brand name stained.

“Nobody wants to go to litigation, but if they want, surely we’ll win.”

Ince & Co partner Su Yin Anand, who has also received similar complaints about terminal deposits, tended to support Mr Lin’s argument.

“Terminals are unlikely to have any legal basis to impose such deposits on cargo owners or freight forwarders as they are not the terminal’s contractual parties,” she said.

Hong Kong is not the only port in China to have made such moves. Lloyd’s List reported that Shanghai and Tianjin have also demanded similar deposits from local shippers, as part of the efforts to seize Hanjin containers.  

A source from the port of Shanghai told Lloyd’s List that the deposit was an emergency measure to make sure the empty boxes would be returned to ports, as security for Hanjin’s port fee arrears.

To add more pressure to the terminals, the HKSC has also informed the Hong Kong government of the problem, while it will issue an official complaint to Beijing shortly, said Mr Lin.

“I think this time terminals are jumping the gun a bit too fast and too greedy,” he said.

“They could’ve asked the court for a lien on those containers.”

That said, the Hong Kong cargo owners and freight forwarders might still have to pay the “ransom” first to the terminals, as suggested by Mr Lin, as litigation can take time and greater cargo damage or defaults on downstream clients should be avoided.

Splash has been given exclusive access by BigOceanData to its proprietary system allowing readers to see where all Hanjin Shipping vessels are around the world. The access shows that most previously stranded ships in international waters are now moving again, with many heading towards South Korea. Readers can find full details of all the ships by clicking here.

“Vessels that are within the region without fear of being arrested – such as Korea, the US, Japan and the UK, cargoes are to be discharged at ports,” a source at Hanjin Shipping toldSplash today.

Separately, Splash can reveal that Hanjin Shipping’s China network has come to a complete halt. All China offices of the Korean line are not working at the moment withSplash redirected to Seoul headquarters. There have been earlier reports of knife wielding angry customers and contractors trying to attack workers at Hanjin’s Tianjin office. Other violence has been aimed at Hanjin workers around the world, with one report suggesting a number of employees in India sought protection at a consulate.

In another hammer blow to the beleaguered line, which sought court protection eight days ago its main creditor, Korea Development Bank (KDB) has refused a court request to hand over further financial support. KDB has shied away from the request fearful it would not be able to recoup the money.

Earlier this week, parent Hanjin Group promised to pump KRW100bn ($91m) to the line to help it offload cargo around the world, a figure that was originally going to be matched by the state, something authorities have since decided against.

More Hanjin ships have been seized around the world. Two fuel suppliers teamed up to lay a claim on the 4,253 teu Hanjin Montevideo which has been arrested at Long Beach.

Meanwhile, irate shippers around the world have slammed ports for trying to cash in on Hanjin’s demise. Ports in the US, for instance, are trying to squeeze shippers for as much as $4,200 per container, while terminal operators in Hong Kong are charging shippers an additional fee of $1,260 to release each Hanjin container. Other ports in Europe and Asia are also demanding four-digit dollar figures if shippers want to get their boxes released. In Shanghai, the world’s largest container port, authorities are refusing to unload Hanjin boxes, shippers tell Splash, until the Korean line pays all its existing debts owed to the port, causing major supply chain headaches for many shippers.

Trying desperately to solve the crisis, with an estimated $14bn of cargoes on Hanjin ships around the world, the South Korean government has announced plans to deploy more than 20 containerships from next week as substitutes for Hanjin Shipping vessels.

In one of the longest running sagas in shipping regulation the IMO’s Ballast Water Management (BWM) has finally met its ratification criteria, meaning it will come into force in 2017.

Having been very close to ratification for several years Finland has finally pushed the scales past the 35% of the world fleet by gross tonnage one of two key metrics for the convention to come into force 12 months later.

Finland ratified the convention today meaning it will come into force on 8 September 2017, which is now set to be a key date for shipowners, managers and equipment manufacturers around the world.

“This is a truly significant milestone for the health of our planet,” said IMO secretary-general Kitack Lim.

“The spread of invasive species has been recognized as one of the greatest threats to the ecological and the economic well-being of the planet. These species are causing enormous damage to biodiversity and the valuable natural riches of the earth upon which we depend. Invasive species also cause direct and indirect health effects and the damage to the environment is often irreversible,” he said.

The accession by Finland brings the total tonnage of contracting states to 35.14% passing the 35% threshold which had seemed so hard to reach, including in November last year when Indonesia ratified but it later turned out its fleet was smaller than documented. It brings to and 12 years of uncertainty as to when the regulation would come into forrce but deep concern will remain from shipowners over the approval of systems.

It will, however, be a major boost for equipment manufacturers who have developing systems for many years.

“The entry into force of the Ballast Water Management Convention will not only minimize the risk of invasions by alien species via ballast water, it will also provide a global level playing field for international shipping, providing clear and robust standards for the management of ballast water on ships,” Lim added.

The filing for court receivership by Hanjin Shipping on 31 August was the biggest bankruptcy ever seen in container shipping and has sent shockwaves through industry and the global supply chain.

The scale and complexity of the fallout from the receivership filing means that the Hanjin Shipping story will continue to develop for many months, if not years. Seatrade Maritime News is launching a timeline of the Hanjin Shipping collapse which is featured below, and will be kept updated as an easy reference for our readers as the story continues to unfold.

7 September– Hanjin is granted interim bankruptcy protection in the US, has to return to the courts on Friday.

6 September– Hanjin to get $90m in emergency funding from parent to unload vessels stranded around the world.

5 September– Hanjin moves to stop it vessels being arrested if they berth in the US.

2 September– Alliance and service partners move quickly to suspend or terminate joint services.

1 September– In the wake of the receivership filing chaos ensues in the global supply chain as Hanjin vessels are stranded around the globe.

31 August– One day after creditors pulls support Hanjin files for court receivership sending shockwaves through the industry.

30 August– The knell sounds as the Korean Development Bank pulls its funding support.

16 August– Hanjin’s losses continue to mount in the second quarter.

11 August– More bad news for Hanjin as the state aid is not forthcoming.

27 July– Signs that all is not going well with Hanjin restructuring as shipowner Seaspan makes clear it won’t agree to cut charter rates.

16 May– Hanjin revealed a hefty first quarter loss.

4 May– Things were looking promising with Hanjin receiving creditor approval for a voluntary restructuring.

The sudden collapse of South Korea’s largest carrier, Hanjin Shipping, and its entry into court rehabilitation has brought the precarious financial situation of the shipping industry into sharp relief. Most of the carriers are not even covering their operating expenses. It is a very uncomfortable predicament for shipowners to be in, and while the business will recover, it will take time, which is not a commodity on a cash-strapped carrier’s side. 

As Hanjin found out, even state-owned banks with deep pockets can run out of patience when the debts hit stratospheric levels. Hanjin’s total debt had gone past USD5 billion when Korea Development Bank pulled the plug.

How long until the shipping industry turns around will depend on the global economy and the supply and demand balance, and that uncertain timeline has left struggling shipowners with only two options:

They can try to ride it out, deferring the problem with one eye closed and wait to see what happens in a couple of years, or they can look at the sustainable liability of their company and try to restructure it.

The shipping market has been bad for the last five years. When people ask me about the market turnaround, or when I ask others in the business when it will pick up, the answer I give and hear from others most often is “not this year but maybe next year.” This year has been particularly poor and I don’t see the market recovering anytime soon, so for many companies restructuring is the only option. Three or four years ago a lot of private equity came into the sector but they lost heavily and there is nothing coming in now. No investor wants to talk about shipping at the moment.

The fact is that every year since 2011 the industry has been getting worse. Shipowners have been hoping for the best for the past five years and expecting the market to turn around, instead of sitting down and looking for a proper way to address the inadequate capital structure of their companies.

Today, there are multiple shipping companies struggling for cash flow. First tier container shipping companies such as Maersk Line, MSC, OOCL and some others should be okay, but several tier two and three carriers are already going through the restructuring process. Hanjin lost the support of its banks and was forced into receivership, while Hyundai Merchant Marine is being restructured, as are the Japanese shipping lines. It really depends on how strong the shareholders are. Some shareholders are prepared to support companies through the rough patches and wait for the operating environment to improve, while other shareholders are saying enough is enough.

However, if a shipowner decides to walk through the restructuring door, he must understand that although it will be an expensive and painful process, it will also be a crucial one that will have a positive impact in the medium to long term. He will be resolving a problem that is threatening the very survival of his company. For instance, as part of a restructuring deal a few years ago, Korea Lines agreed to pay 20% interest on an USD80 million loan and everyone was shocked. But even with the heavy interest, the loan allowed the company to restructure its entire capital structure and the carrier repaid the loan within a year. The company is now worth at least USD450 million.

Dry bulk has been in bad shape for the last four years and a lot of bulk operators have been restructuring their capital debt or, if they have been unable to cut a deal with creditors, filing for bankruptcy. What we have seen in the past six months is container lines looking for a similar restructuring process. Before the Korean lines it was ZIM. Container lines are trying to reduce their capital cost and have some breathing room to amortise their loans or interest to survive this difficult time. Once the cycle turns they will be able to normalise their finances.  But as mentioned earlier, there is no clear indication of when the cycle will turn. So in the face of that uncertainty, the only real option is to restructure and take the pain rather than deferring the decision and holding thumbs that a market recovery will arrive before bankruptcy.

That is easy to say in hindsight, but some shipping companies have done it and those that restructured three years ago are still making a positive cash flow. It wasn’t their choice, but they were flirting with collapse and were forced to make some hard decisions, and they did it. It is expensive to restructure, yes, but if a company can get it done and well prepared for working capital throughout restructuring process, the value creation it will generate from this process is huge.

You don’t normally get advance warning of an attempt to put a company over a barrel and call in bankruptcy lawyers. Using forced bankruptcy as a means to oust bad business owners or managers is a risky undertaking and plotters usually keep their schemes very secret. Is it surprising then, that the Korea Development Bank, who for months kept telegraphing how supportive it was of Hanjin’s efforts to right itself, suddenly says “Pardon me, but the parent is not pitching in their own money, so we are packing up and see you in court”.

South Korea is hardly a perfect setting for a tale of shipping intrigue, having the bank long stand by its two major carriers, Hanjin and Hyundai Merchant Marine (HMM), and by the shipbuilding and ship servicing industries behind them. But it is intriguing, that the bank stood by, while the teams representing both carriers were pitching to them identical sets of strategies aimed at reducing the debt obligations and battening the hatches to preserve cash in light of rapidly falling trade volumes and the vicious downward spiral of container rates. It is intriguing that the bank group stood by when the carriers were chaotically shedding their more profitable bits to preserve the cash-draining business of container shipping. And it is intriguing that, confusingly to everybody in the market, the bank kept fuelling the hope by rescheduling its own loans to the carriers and appearing to be ready to step in with more financial support.

The market could have been told much earlier that all of this was just about getting the owner to throw more of their own cash in. It would have spared a lot of management expenses to the charterers who went through a slow capitulation process on charter rates, and to all debtor institutions who spent time and money negotiating Hanjin’s debt obligations.

Would the owner throwing their own money into the business work? I doubt it. Earlier on, in a very similar situation, the owner of HMM threw in KRW30bn ($24m at that time) of her own fortune, only to be ousted from the chair’s post shortly after. That move only demonstrated the futility of throwing more fuel on a fire burning out of control.

Could it have been that all the debt’s owner wanted was a different management team, thus a different management strategy? If it was, the market could have been told much earlier that this was about perceived lack of management prowess. Kind of doubtful, as the management teams did not consist of people living only in the good times of the container shipping business. Amongst the managers in both companies, there are plenty of long timers, who had experience of good times and bad times, thus enough expertise to act in either set of economic circumstances. If the tactical and strategic decisions were not entirely made by their seasoned teams, it would be great to let the market know where all important management decisions regarding Hanjin and HMM were made. That way, everybody could have had an equal chance in assessing the probability of recovery versus probability of default.

What would be the consequences to the global trade of pushing Hanjin into bankruptcy? Hanjin’s fleet consists of about 37 own vessels and about 51 charters, all of them carrying containers of allied carriers and non-alliance partners under the slot sharing agreements that have to be kept as not to jeopardize anybody’s standing with their own customers. The bankruptcy dramatically increases the possibility of detention of vessels in ports around the world, thus throwing into doubt recovery and delivery of cargo stored on those vessels. It will make everyone wary of selecting Hanjin as a carrier, no matter how attractive their rates could be. On the other hand, capacity of about 90 vessels becoming unavailable to the market is not something that can be easily ignored by the companies depending on shipping their containerized goods overseas. It will affect their routes to markets, their efficiency, and their financial and business plans.

Needless to say, this bankruptcy is in nobody’s best interest, even though some competitors may be already rubbing their hands in Schadenfreude-like satisfaction.

Low freight rates have been a concern for a great number of reasons and a wide range of market participants. Shipowners faced with weak cash flows cannot perform on their loans, causing problems for lenders. Investors faced with poor returns turn to asset sales, driving values even lower. Shipbuilders faced with a great deal of slippage and defaults on existing orders have seen demand for additional newbuilds vaporize.

All the concerns mentioned above – and they are only a sampling – emanate from a single cause: a depressed freight market that radiates and affects every aspect of shipping. And despite the recent bounce in the dry bulk market, freight rates are still very low and at barely operating breakeven levels. Markets have been too low for too long, and those shipowners still in business have had to dig deeply into their cash reserves or seen their equity overly diluted. There is little left in terms of available cash, funding from investors or, for that matter, patience.

Now another concern has to be added to the long list of consequences springing from a weak freight market: moral hazard. Moral hazard in this case can be defined as the behavior of an owner who is so disengaged from reality as to act carelessly in reference to an asset and the parties with an interest in the asset. The most obvious example is when the owner’s economic interest in the asset is so miniscule that there is little reason to care about it. That leads to all kinds of disrespectful and harmful behavior.

Moral Hazard in Financing

When the principal amount of the ship mortgage is materially higher than the present value of the vessel (and any hope of market recovery thereof), owners have little incentive to make any effort to fulfill their loan obligations. There is very little hope that they will ever see their money again and thus little incentive to behave.

Several owners we know had been making good, more or less, on their loans for the last couple of years in the hope of a market recovery. Two years later, having thrown good money after bad and reaching the bottom of their cash reserve piles, they are barely inclined to keep performing.

There have been cases of shipowners who have stopped paying interest and principal on their loans despite having the financial capacity to do so, believing they are better off with shipping loans in default than with performing loans. First, they preserve capital, which they can deploy to new, clean-slate shipping investments and let the legacy transactions sink. Second, for loans in default, banks seem inclined to grant concessions to shipowners with nonperforming loans while holding “good” shipowners to a much higher standard. Thus, it pays to be bad. Third, there had traditionally been an unspoken law in shipping that for a borrower defaulting to a shipping bank, effectively they were ostracized for life by the ship banking community. This was a very high incentive to behave, not to borrow more than one could afford and, even when things turned sour, to make every effort to see that the lender recovered as much as possible of the outstanding principal.

Now with several executives at shipping banks being corporate officers with little knowledge of or affection for shipping, and with a great number of shipping banks actively exiting the business, there is no longer the self-watching ship banking community to ensure proper borrower behavior and thus plenty of room for moral hazard. “You don’t have to be nice to the bank anymore” is the attitude. “What can they do to me?”

Moral Hazard in Vessel Maintenance

There has been moral hazard in reference to the maintenance of vessels as well. When the freight market is low, economizing by cutting down on expenses is required to make do with less and ensure survival in a challenging market. First goes the “fat.” Next comes “discretionary spending” (spare parts onboard the vessel is the classic case), followed by laying off people ashore, and then keeping vessel maintenance only to the extent that the classification society requires in order to renew the certificates.

Talking to inspectors boarding vessels on behalf of charterers, the technical quality of the vessels has become a concern, and this concern is highly troubling for tankers and oil companies given the level of liability in the event of an accident involving pollution. Talking to inspectors boarding vessels on behalf of port state control (such as the U.S. Coast Guard), there is real concern about vessels that have been under-maintained. Talking to inspectors boarding vessels on behalf of buyers of ships in the secondary market, there is lots of concern about vessels that have been neglected for too long.

With the freight market too low for too long and with many vessels afloat effectively “depending on the kindness of strangers,” there is little incentive to do anything beyond the absolute minimum required in terms of maintenance.

Moral Hazard in Personnel and the Environment

There has been moral hazard in reference to seafarers and the environment as well. There have been several stories recently in the trade press about seafarers being abandoned, unpaid for months and malnourished, and even stories of vessels arrested due to outstanding crew wages. Unfortunately, in a market where owners do not care much about the asset or the lender or the crew, it’s hard to envision how or why they would care much about anything else, such as the environment or adhering to sound navigational practices. Such is the risk of moral hazard.

There is no doubt we are living through unique times in shipping. The present crisis has been much more monstrous than others in the past. Examples of moral hazard are a known consequence of rapidly shifting economic structures and defaults (think of moral hazard in the subprime real estate market in the U.S. a few years ago).

However, given low expectations of a market recovery in the near future, issues arising from moral hazard will only get more complicated and perilous. After all, moral hazard in shipping can affect trade, human lives and the environment. When contemplating actions in shipping at present, one has to be cognizant of addressing alignment of interests and dissipation of moral hazard.

There is an anecdote of Shipowner A confiding to his friend, Shipowner B, that Shipping Bank X arrested four of his vessels. “Oh dear,” replies Shipowner B, “I am so sorry to hear that. And now who is your best banking relationship?” To which Shipowner A dryly replies: “I think I already told you. Bank X!”

As funny as the joke may be, a market cannot function on such a basis.