Preparing for the Next Unthinkable Sinking
Hanjin was the world’s seventh largest container line. OW was one of the world’s largest bunker traders and providers. Both spectacularly collapsed in the largest insolvencies of their kind in history.
Each has caused the many bunker traders and suppliers dealing with them to suffer significant losses. They traded with Hanjin and OW vigorously right up until each filed insolvency proceedings.
Some saw the problems that were coming and got out, but others seemed to think that their collapse was unthinkable. How could Hanjin, with a world-wide fleet of 90 vessels moving hundreds of thousands of containers with billions of dollars of cargo, ever fail? How could the Korean government and Korean Development Bank ever allow Hanjin’s thousands of employees to lose their jobs?
For that matter, how could OW – with the largest public stock offering in Danish history – fail within months of its IPO? How was it possible that a trader with its talent, financial backing and world-wide presence would suddenly cease trading, after it had increased its purchases from suppliers and dominated in many bunker sale markets?
For Hanjin, the idea that it was “unsinkable” persisted many weeks after the Hanjin Paradip was arrested it in Durban in May 2016. The arrest was widely reported and described to be a charter party dispute. That was true, and the dispute was over unpaid charter hire. Not long afterwards, though, Hanjin stopped paying most charter hire and stopped paying an increasing number of its creditors. By the time of Hanjin’s Korea insolvency filing on September 1, 2016, Hanjin was several billion dollars in debt and unable to pay even for the port calls and the discharge of its vessels.
Many ignored the Hanjin Paradip arrest, the world economic downturn, Hanjin’s increasing dependence on its creditors, the overcapacity in the container shipping markets, the aging of Hanjin’s fleet and the relatively high price it was paying for its chartered vessels. Hanjin simply had to be too big to fail, and so that failure was unthinkable.
OW’s “sinking” to some was even more sudden and unthinkable. In hindsight, now that court cases and former insiders at OW have revealed the way that OW operated, it seems remarkable that OW should have floated at all. OW had been buying large amounts of marine fuel and then taking the dual risks of acting as a physical supplier and as a trader. OW’s risk management function became a profit center as OW worked to improve its paper financial performance to support its initial public offering. OW took on greater and greater amounts of unsecured credit, and ultimately, its bank consortium creditors found themselves significantly undersecured. They suspended the OW credit line and the OW entity – thought by many to be unsinkable – quickly sank, taking many other suppliers and downstream traders with it.
Hanjin’s and OW’s failures are examples of what some management writers have called the “Titanic Effect.” The“Titanic Effect” is the observation that “[t]he severity with which a system fails is directly proportional to the intensity of the designer's belief that it cannot.” (1) The observation underlying the “Titanic Effect” is the basic human tendency to ignore warnings about possible enormous disasters as unthinkable.
Considering OW, Hanjin, the Titanic, and other “unthinkable unsinkables,” one thing is certain: the unthinkable will occur. Without accepting and planning for that – with the lessons of the sinkings of Hanjin and OW in mind – one will go down with the next “unthinkable” insolvency as surely as the many went down with the Titanic.
To state it another way, “[t]o sum up the Titanic Effect would be to state the magnitude of disasters decreases to the extent that people believe that they are possible and that they plan to prevent them, or to minimize their potential impact. Ignoring the warnings regarding the red flags can lead to the unthinkable.” (2)
As an example, despite the warning signs for Hanjin, shippers contracted to continue to ship minimum volumes with Hanjin to obtain favorable rates. If they did not ship the contracted volumes, they owed money to Hanjin for breach of their volume shipping contracts. In effect they were compelled to continue putting their cargo on Hanjin, almost as if they had been Titanic passengers compelled to board as the Titanic sunk. With so many shipper contracts and committed freights, how could Hanjin fail? The direct problem was a revenue stream of freights committed at less than operating cost.
Shipper contracts operated the same way for Hanjin. Hanjin had committed to providing a certain amount of volume and was liable to pay great damages if it did not. Hanjin had to keep operating notwithstanding its negative margins, because the damages it would face it it did not, would bring a much greater loss than its already significant loss.
OW also operated differently from its competitors, with its significant positions in both bunker supply and trading. OW had to rely on extraordinary amounts of credit, not only from its banks but also from its suppliers. The cash from its IPO dwindled as bunker prices and thus profits fell. OW simply could not make back in profit what was necessary to pay back its loans.
Shippers should have “taken the clue” from Hanjin’s increasing debt levels. “Since 2013, Drewry Financial Research Services [had] warned that Hanjin was dangerously leveraged and living on borrowed time.” (3) Thus the announcement of the Hanjin Korea insolvency court at the end of September 2016 was entirely predictable: any rehabilitation plan was “realistically impossible.”
The same was true for those trading with OW. Some industry observers well before the November 2014 OW collapse cited the problems with OW’s significant positions as both a bunker supplier and trader, combined with the low prices of bunkers. They observed that OW’s model was not likely to be sustainable. Some result withdrew their positions with OW and no longer engaged as OW counterparties. Others still considered OW to be unsinkable because, after all, OW was still paying them as suppliers and downstream traders, even though their credit lines with OW were constantly increasing.
With OW’s November 2014 collapse, those who had been paid found themselves with significant open receivables, with OW having pledged all of its receivables (margins plus what suppliers had sold OW on credit) to the ING consortium.
So what should creditors of OW and Hanjin do now that the unthinkable has happened?
Particularly if you or your company provided bunkers or other maritime goods or services to Hanjin, you may wish to (subject to the increasing numbers of cross-border insolvency injunctions issued):
- Accelerate accounts immediately (if restraining / insolvency order allows).
- Apply any funds received from Hanjin to non-arrestable amounts (depends on whether in rem arrest is available).
- Track to favorable arrest jurisdictions the vessels you are owed on, and arrest vessels you’ve provided fuel, goods or services to if possible and before entry of restraining orders.
- Don’t give up on Korea as a place to arrest a vessel; it still may be possible to arrest even a Hanjin Group-owned vessel for a limited number of types of claims.
- Attach receivables otherwise due Hanjin. Don’t look only in your own jurisdiction for this – there are many localities where cross-border injunctions preventing attachment will never be issued.
- Put owners of ex-Hanjin vessels and their P&I clubs on notice of your claims. If the vessels are sold, the new owners will either be informed of your claims or have a claim against the former owners who failed to disclose them at sale.
- If you are a bunker provider, make sure you have full documentation and fuel samples of your sales; this is a situation inviting quality claims by owners with unpaid charters, stuck with paying for fuel Hanjin ordered but didn’t pay for.
- Determine the mortgage holders on the vessels you’re owed on, and also put them on notice of claims. It may be that the mortgage holder has been unpaid for awhile and you may have grounds, even if they arrest in a jurisdiction where the mortgage is generally prior, to have the ship mortgage subordinated to your claims.
- Collaborate with others owed on Hanjin and ex-Hanjin vessels to share costs of recovery and intelligence.
- Keep updated on developments.
- Assess possible insolvency voidable preference claims and defenses. Have you received payments from Hanjin within 90 days before its insolvency filings? If so, without defenses (in the U.S., in rem maritime lien discharge, simultaneous exchange for value; new value, ordinary course of business payment) you may have to return the payment, years after you received it.
- Check with your credit insurer. Has it changed policies because of the Hanjin insolvency? Should you add more accounts to be credit insured?
All of the above, though, is “unthinkable management.” That is, the Titanic has gone down and it is a matter of picking up survivors. A little over 30% of the Titanic passengers survived the sinking. That is far more than the percentage of OW or Hanjin assets creditors (that is, after secured creditors are paid) ever will pick up, even those effectively pursing the strategies above.
The question comes up, should claims be filed in Hanjin’s Korean proceedings? Should they have been filed in the OW Danish or other proceedings? In the Hanjin Korea proceeding, claims “deadlines” will be coming up soon and there were be a series of “deadlines” which may seem irresistible not to meet. But there will be no recovery for unsecured Hanjin creditors from claims filed in the Korean proceedings. None is likely from the Danish OW proceedings either, unless the OW Danish Receiver can win its suit against ING, et al, contending that the money collected by Price Waterhouse/ING actually belongs to other creditors. This suit is in progress and its success seems a challenge.
Instead, filing the claims submits the creditor not only to the expense of preparing the claim and submitting it, but also to Korea court jurisdiction. The impossibility of recovery and the likelihood of restraint of the Korean court of a creditor pursuing Hanjin assets outside of Korea, are good reasons not to file claims in the Korean proceedings, just as they were reasons not to file in the OW Denmark proceedings.
In this way the present Korean insolvency proceedings for Hanjin, and Danish ones for OW, are like the Titanic’s remains at the bottom of the North Atlantic. One could try to dive to the Titanic for some kind of recovery, but it is quite a long way down and back for any success.
What is needed from “Titanic Effect” events like Hanjin and OW is not management of the unthinkable after it happens, but leadership which knows that the unthinkable is certain to happen.
A strong contemporary example is Maersk. Maersk management sees the market trends and is making hard decisions now to anticipate the unthinkable – that its structure might not survive as negative trends continue – by transforming its organization.
The lesson that all in the marine fuel, supplier, service and related maritime industries need to learn from OW and Hanjin is that leaders need to do all possible to stop “unthinkable” failures before they occur, instead of waiting to pick up the survivors afterwards. “[T]he ability to deal with a crisis situation is largely dependent on the structures that have been developed before chaos arrives. The event can in some ways be considered as an abrupt and brutal audit: at a moment’s notice, everything that was left unprepared becomes a complex problem, and every weakness comes rushing to the forefront.” (4)
After “Titanic Effect” losses like OW and Hanjin, the tendency of any business is to focus on how to reduce being vulnerable again to that kind of loss. But this approach is inadequate to prepare for the next “unthinkable loss”: the first step is to know that there is much that you do not know, and to seek the answers from those who do.
So, how could OW’s, and Hanjin’s “unthinkable” collapses been forseen and their effects avoided? And how can bunker suppliers and others better position themselves to recover from such a loss?
Marine fuel traders and suppliers, marine service providers and others may want to ask:
- Which customers’ credit lines are lines drawing out?
- Which customers have a profile like Hanjin’s or OW’s, of increasing debt, under-priced contracts, healthier competitors, and in the case of a vessel charter or operator like Hanjin, older or smaller vessels?
- Where do the vessels of your customers – or that your customers sell to, if you are a supplier – call? Can you arrest the vessels there? Do you have the right to arrest vessels if you are not paid?
- If you are selling to vessel charterers, what are your customers paying for charter hire? Is it above market rate?
- How drawn out are your customer’s credit lines with others in the market? What is the size of the customer’s credit lines throughout the market? Basically, is your customer carrying too many “credit cards” and essentially paying one off with another?
- Do you have a policy in place to look out for “no lien” notices in BDRS or other communications?
- Are you receiving payments from entities other than your actual customer?
- Do you regularly seek out information from the maritime press and sources other than your direct contacts, from sources throughout the maritime industry – even your competitors – about how they do business?
Overall, how intensely do you believe that your business and the way that you do it cannot fail? The more intense your belief, says the “Titanic Effect,” the less likely your business will be able to survive or revive after an “unthinkable event.”
The press and industry analysts agree that there may be an “unthinkable event” to follow Hanjin’s – perhaps the collapse of another significant container line, and with it, perhaps traders with exposure to that line.
OW’s and Hanjin’s “unthinkable” sinkings certainly give reason to believe that some marine fuel traders, suppliers and marine services providers can fail – as much as their managers want to believe otherwise. Hanjin and OW provide the reason now not to ignore the industry warnings, to take clues from them, and to avoid damage from the marine industry’s next “unthinkable” but certain-to-occur event.
About the Author
J. Stephen ("Steve") Simms is a principal of Simms Showers LLP. With offices in Baltimore and metropolitan Washington, D.C. Simms Showers is one of the most active United States firms working in the area of vessel arrest, maritime attachment, and related maritime remedies for creditors. Mr. Simms can be reached by email at firstname.lastname@example.org or by mobile at (U.S.) 410-365-6131.
Much of this article is drawn from an editorial originally published in the Winter 2016-17 edition of Platt’s Bunker Bulletin. The author...
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.
The opinions expressed herein are the author's and not necessarily those of The Maritime Executive.