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Shandong Shipyard’s Lesson: Don’t Rock the Bank

A Shipbuilder Stung by European Clients Spends Years Fighting a Major Bank, So Far In Vain

What was initially billed as a lucrative order from a European customer has pushed a Shandong Province shipbuilding company to the brink of bankruptcy and ruined its relationship with one of China’s biggest banks.

Rushan City Shipbuilding Co. is fighting for survival after filing a lawsuit recently against the Rushan branch of the Agricultural Bank of China (ABC)—the latest in a series of ugly legal battles involving the bank and shipping companies that began in 2010.

The province’s highest judicial authority, the Shandong High Court, agreed early August to review Rushan’s case but gave no timetable for a decision.

The shipbuilder, a local government-backed company with 500 million yuan in total assets and 500 employees, wants the court to invalidate financing agreements with ABC tied to a 2007 contract for two ships ordered by an Italian client.

Rushan asked the court for permission to wash its hands of an ABC-backed repayment guarantee and a letter of credit, as well as all debts, obligations and responsibilities related to the defunct contract worth more than 80 million euros.

The contract was not only flawed, the shipbuilder claims, but figured into a conspiracy by European ship owners to undermine its business—a conspiracy that ABC, at least indirectly, supported and still supports by holding the shipbuilder to nearly 97 million euros tied to the guarantee plus interest and taxes.

Rushan, whose shipyard has been idle since late 2011, says it can’t pay the bank without going out of business.

Rushan’s court filing charged that “the [Italian] ship buyer, with the help and cooperation of a [ship] design company, duped Rushan Shipbuilding into signing a production contract and obtained a repayment guarantee from ABC by providing fraudulent information.”

The shipyard also slammed ABC for “from beginning to end, not reflecting the sincerity it should,” as well as “obstructing the shipbuilder’s efforts to protect its legal rights,” “helping foreign ship owners squeeze out shipbuilding companies,” and “signing irresponsible letters of guarantee contracts with foreign banks.”

ABC, one of China’s four largest state banks, has flatly rejected all of the charges leveled by its troubled customer Rushan. And it’s holding the shipbuilder to not only the European contract but the rest of its debts, estimated at about 1 billion yuan.

Contract Games

Rushan dates its ongoing travails to a March 2007 order for two 13,600 deadweight ton stainless steel tanker ships placed by the Italian shipping company Marnavi S.P.A.

Two months later the buyer, apparently as per its contract rights, radically adjusted the specifications. According to a contract addendum signed by the two sides, the shipyard was to enlarge the vessels to 15,900 dwt for the so-called Ship 510 and 17,000 dwt for Ship 511.

Meanwhile, Marnavi shifted legal responsibility for the purchase contract to a shipping subsidiary called Hambleton Gesto Enavegacao.

A Rushan source said the shipyard was almost finished building Ship 510 in April 2010 when the ship’s designer and Marnavi received a certification from an Italian ship classification society RINA for the vessels Rushan was building. But the certificates were for 19,000 dwt and 21,000 dwt vessels—ships far larger than the revised contract’s specifications.

Rushan officials were stunned: vessels with these new specs could not be delivered under the contract terms unless the shipbuilder swallowed a significant loss. But the client said that adjusting the tonnage requirements was “an unavoidable technical consequence of the shipbuilding contract revision work.”

Shipyard industry experts in China said Rushan was apparently trapped as a consequence of its own inexperience.

A Jiangsu Province shipbuilder’s legal affairs manager said that a smart shipbuilder “should sign a supplemental agreement with a buyer, agreeing that if the buyer makes any changes to a ship, resulting in changes to deadweight tonnage, the buyer cannot hold the shipbuilder accountable.” This is something Rushan apparently failed to do.

“Without experience,” a bank source familiar with Rushan’s dilemma said, “you have to accept possible risks.”

Rushan and Marnavi initially agreed in the contract to arbitrate any main contract dispute in Britain and any ship design disputes in France. So in August 2010, after Rushan concluded that it might be unable to deliver the ships on time, the Italian client filed for contract settlement arbitration with the London International Arbitration Commission.

In its claim, Rushan said the global financial crisis of 2008 and subsequent European debt crisis had pushed Marnavi to seek a way out of its purchase agreement. Indeed, the Chinese company said, many ship owners had used contract loopholes to break shipyard contracts between 2008 and 2010, leaving companies across the Chinese shipbuilding landscape in the lurch.

Results of the arbitration commission were released two months later: If Rushan failed to deliver the vessels according to the contract’s schedule, it ruled, the ship buyer would have the legal right to refuse delivery and deny payment.

The commission refused to hear Rushan’s claim that the buyer and ship designer had collaborated to defraud the Chinese company, saying the charges were beyond the scope of arbitration. The shipbuilder replied that the arbitrator should have looked into possible contract fraud before its final ruling.

Meanwhile, also in August 2010, Rushan filed claims against Marnavi and the designer in China with the Qingdao Maritime Court in Shandong. The claim accused the Europeans of “collusive fraud.”

The ship buyer, with help and cooperation from the design company, had “duped Rushan Shipbuilding into signing a production contract and obtained ABC’s repayment guarantee ABC by providing fraudulent information,” according to the maritime court claim.

The court accepted the case and had the ship buyer’s advance payment seized. But Rushan, acting on advice from its banker ABC, later dropped the lawsuit and launched negotiations the following December with Marnavi in Italy.

The talks went nowhere. The ships had to be built according to the modified specifications and delivered on time, Marnavi said, or Rushan would have to return its down payment. The shipbuilder called those demands impossible to meet.

The following April, the impasse broke when officials from the two sides met in Hong Kong. Under the settlement, Rushan agreed to cut prices 3.5 million euros for each ship in exchange for a delivery date extension.

Financial Crunch

Rushan’s business dimmed again in early 2012, however, amid a dispute with two clients from Denmark whose orders for four ships could not be met on time. ABC then lowered the shipbuilder’s credit rating, making it more difficult to obtain financing, which in turn affected the Danish deals and prompted these clients to sue Rushan.

As Rushan’s financial woes deepened, the company decided to re-open its case against Marnavi and the designer of ships 510 and 511. It went to the Shandong court, claiming fraud, and won permission for a freeze on assets tied to letters of guarantee issued by ABC.

The guarantees issued to Rushan by the bank were worth a combined 80.2 million euros. The arrangement obligated ABC to hand the money plus interest and taxes to the customer if the shipyard broke its agreement.

The freeze prompted ABC to cut Rushan’s credit rating again, making fund-raising even more difficult. Moreover, the bank retaliated by calling in the shipyard’s loans and bank acceptance bills worth some 120 million yuan.

Rushan argued that ABC in effect helped the Italians and hurt a domestic company. But ABC argued it was merely fulfilling its contractual obligations and that did not want the dispute with the shipyard’s Italian clients to damage the bank’s international credibility.

The guarantees issued by ABC included payment-on-demand clauses that obligated the bank to financially protect the ship buyer against any breach of contract by the shipyard. In turn, ABC covered this obligation against Rushan’s line of credit.

The bank source said the guarantees were subject to the decisions of any arbitration settlement that followed a shipyard-customer clash. Thus, because the London arbitration decision favored the customer despite Rushan’s claims, ABC had to pay the Italians.

Rushan decided to return to the maritime court in May 2012, but its claims were dismissed on grounds that any contract disputes with Marvina had been resolved through arbitration. Rushan appealed that ruling the following June, and the maritime court froze the guarantees again, prompting ABC to apply for administrative reconsideration.

The final blow from the maritime court came in July 2012, when Rushan’s follow-up request for legal support was rejected. That same day, ABC remitted the full, 80.2 million euros advance held on behalf of the Italian company, along with about 16.5 million euros worth of interest and tax payments.

Failed Rescue

The provincial government in Shandong has been closely watching Rushan’s case while trying to keep the shipyard in business.

In March 2012, for example, Shandong started coordinating with the state-owned investment firm Shandong Ocean Investment Co. to bail out the sinking shipbuilder.

While negotiations were underway, ABC encouraged Shandong Ocean as well as the Weihai city and Rushan governments to help pay down the shipyard’s debt. The bank also encouraged a partnership between Shandong Ocean and Rushan.

But the bank also wanted the shipbuilder to withdraw its lawsuit against the Italians to free up the cash tied to the frozen guarantees.

After the Shandong government’s National Defense Science Technology and Industry Office got involved in the restructuring, the agency’s officials held talks with ABC. Bank executives promised to “gradually reduce the company’s debt throughout the overall restructuring process,” according to minutes from the meetings.

Rushan Chairman Gao Mingyong later signed an agreement that said ABC would “commit to the government to reduce debt, and the shipbuilder would no longer accuse the foreign ship owner” of fraud.

But the following September, the restructuring stalled, and ABC decided it could not honor the commitments hammered out during the talks with government and Rushan leaders.

Officials from the Rushan branch of ABC told the city government that the restructuring plan was flawed because it called for forgiving 500 million yuan worth of debt. A bank source said that the branch “simply cannot” forgive debt “by ourselves.”

“The power to forgive debt lies with those above,” the source said. “Moreover, ABC is a listed company. We cannot simply do it by ourselves.”

So the shipbuilder decided to return to the courts. The case now before the high court began when Rushan, down but not out, sued the Rushan branch of ABC in a city court. The case then went to the Weihai City Intermediate Court, which in July transferred the case to the high court because it involved more than 100 million yuan.

A banking source said the local governments, for the sake of the economy, still hope to salvage the shipyard and its hundreds of jobs by facilitating a debt restructuring. The company is saddled with 1.42 billion yuan in liabilities—including about 1 billion yuan owed ABC—and a debt-asset ratio of 177 percent.

The ships built for the Italian and Danish companies but never delivered are now controlled by ABC. Rushan has asked the bank for permission to auction the ships to help pay off its debt, but at last word the shipyard was still waiting for an answer.

Bankers haven’t forgotten Rushan. “We are also thinking of ways to resolve this problem," an ABC source said.

But the bank is not letting shipyard off the hook. The Weihai branch of ABC, for example, has accused angry Rushan executives of disrupting business operations at its offices.