I am a boat mechanic and I have been working on a project to re-power a 70-foot motor yacht. The job is almost complete, but I just received notice that Federal Marshals have seized the boat on behalf of a bank to foreclose on a preferred ship mortgage. The owner of the boat still owes me a lot of money, but he won’t return my phone calls. I spoke with the bank’s attorney, and he advised that I should hire an attorney to file my own claim in the bank’s Federal lawsuit. Then I received notice that the owner filed for “Chapter 7″ bankruptcy protection and all legal proceedings are frozen while the Bankruptcy Court sorts through all the claims. I believe that this project should qualify for a maritime lien, but I never recorded a lien with the Coast Guard. At this point I am completely lost. Can he walk away from my claim? Should I hire a bankruptcy attorney or a maritime attorney? Or both? Please help.
Bankruptcy law and maritime law don’t intersect very often, but when they do, things get very complicated in a hurry. The short answer for our reader is similar to the advice that we provide most often in this column: “It depends.” Here, it depends on the type of bankruptcy protection the boat owner is seeking, and it depends on whether there will be any equity left in the boat after the bank is paid.
I won’t use this column to stray into an extensive lecture on bankruptcy law and procedure, other than to say that a personal bankruptcy may be broken into two main categories: A reorganization of debt under Chapter 13 of the Bankruptcy Code, or a liquidation of debt under Chapter 7 of the Code. Under Chapter 13, the Bankruptcy Court works with the debtor and all of the creditors to come up with a plan that will eventually pay off as much debt as possible. Under Chapter 7, the debtor walks away, and the Bankruptcy Court administers the sale of most of the debtor’s assets to pay the creditors. Our reader is dealing with a Chapter 7 case filed by the boat owner so we will focus on that proceeding. A Chapter 13 case will be more complicated, since the Bankruptcy Court must first answer the question of whether the boat will be sold.
Under both forms of bankruptcy, secured creditors (creditors whose claims are secured by one or more assets as collateral) will be paid first through the sale of their collateral, while “unsecured” creditors (claims that are not secured by collateral) fight over what is left after the secured creditors are paid.
Secured creditors must usually record their claim against the collateral at the time credit is granted. For example, a car loan will be secured when the lender records its interest with the DMV. Similarly, a home loan or payment due to a home contractor will be secured when the lender or contractor records a First Trust Deed or Notice of Claim of Lien with the County Recorder’s office.
This is where maritime law starts throwing curve balls into the Bankruptcy process. A loan that is secured by a boat will require the recording of a “Preferred Ship Mortgage” with the Coast Guard’s National Vessel Documentation Center (NVDC). But, as we have discussed often in this column, other types of maritime liens may create a valid security interest against a vessel without recording anything anywhere. So, in our reader’s case, he will have a valid security interest against the boat for his engine re-powering project even though he never recorded his claim with the NVDC.
In any bankruptcy, proceedings against the debtor will be stayed until the Bankruptcy Court orders otherwise. Creditors must request “relief from stay” from the Bankruptcy Court to move forward with their claims against the debtor, including relief to move forward with the sale of the boat, which brings us to another maritime law curve ball.
As noted by our reader, parties involved with a maritime bankruptcy are dealing with two separate courts – the Bankruptcy Court and the Federal District Court. Both courts are empowered to order the sale of the boat to satisfy the creditors’ claims. But it is well established that only the Federal District Court is empowered to sell a boat free and clear of all liens and encumbrances where clear title will be recognized internationally. Therefore, under most circumstances, the creditors with claims against the boat will seek leave from stay to allow the District Court to administer the sale of the boat.
With the Bankruptcy Court out of the picture, the creditors with claims against the boat may now proceed with the sale. But first they need a seat at the table. In our reader’s case, the bank initiated the case against the boat by filing a lawsuit in Federal Court and having the boat seized, or “arrested,” by U.S. Marshals. Other claimants may enter the case to assert their claims, but this is not automatic. They must request permission from the Court to “intervene” as additional plaintiffs, or “Plaintiffs in Intervention.” This procedure will require our reader to draft his own complaint against the boat owner and the boat, as if he were initiating the case rather than the bank. If he fails to intervene, his claim against the boat will be lost forever when the boat is sold pursuant to the order of the District Court.
All of this can be very expensive, which brings us to the other issue we presented at the beginning of this article. Does the boat owner have any equity in the boat after accounting for the amount owed to the bank?
Any judicial proceeding for the foreclosure of claims against an asset must deal with this mathematical question. What is the asset worth, and do the claims against the asset exceed the value of the asset? If so, the Court must prioritize the claims and distribute the proceeds from the sale of the asset accordingly. In our reader’s case, and in most maritime foreclosure cases, the holder of the preferred ship mortgage has priority over everyone else. There are exceptions to this rule but that’s for another day. Here, our reader must do the math and determine whether there will be anything left from the proceeds of the sale after the bank is paid. If not, the cost of joining the lawsuit as a Plaintiff in Intervention will be a waste of money.
We should note that our reader may not be completely out of luck if he does not intervene in the District Court case against the boat or if the bank’s claim consumes all of the sale proceeds. If he loses his claim against the boat, he will still have a claim for breach of contract against the owner personally. Unfortunately, in a bankruptcy case like this, his breach of contract claim against the owner would be characterized as an unsecured claim, and he would need to line up with the rest of the unsecured claims for a portion of the remaining funds available in the bankruptcy.
Finally, our reader asked whether he will need to hire both a bankruptcy attorney and a maritime attorney. The sad reality is that he will, at a minimum, need to consult with both attorneys. His decision will depend on the facts of the case.
David Weil is licensed to practice law in the state of California and as such, some of the information provided in this column may not be applicable in a jurisdiction outside of California. Please note also that no two legal situations are alike, and it is impossible to provide accurate legal advice without knowing all the facts of a particular situation. Therefore, the information provided in this column should not be regarded as individual legal advice, and readers should not act upon this information without seeking the opinion of an attorney in their home state.
David Weil is the managing attorney at Weil & Associates (www.weilmaritime.com) in Seal Beach. He is certified as a Specialist in Admiralty and Maritime Law by the State Bar of California Board of Legal Specialization and a “Proctor in Admiralty” Member of the Maritime Law Association of the United States, an adjunct professor of Admiralty Law, and former legal counsel to the California Yacht Brokers Association. If you have a maritime law question for Weil, he can be contacted at 562-799-5508, through his website at www.weilmaritime.com, or via email at firstname.lastname@example.org.