How to Build a Boat And Not Go Broke

by Nicholas Walsh, PA

You find a nice model boat, talk to the builder and come to terms, and plunk down five-figure money to get the process started. Two months later the builder has used your money to buy a hull and an engine, and he’s well along on the process of building your dream.

Then one day you open a scary envelope and learn the boatyard is filing for Chapter 7 bankruptcy.

But you’re ok, right? I mean, the yard used your money to buy the hull and engine. You can get those back, right?

Here’s a little Bankruptcy 101. When a person or company files bankruptcy their assets (often referred to as the “estate”) come under the control of the U.S. Bankruptcy Court, acting through an appointed trustee. There are fundamentally two types of bankruptcy. In a Chapter 11 “reorganization”, the debtor (usually a business, sometimes an individual with a lot of assets and a lot of debt) tries to keep the business going, using the trustee’s powers as leverage to negotiate better terms with lenders and other creditors. A Chapter 13 bankruptcy is a lot like a Chapter 11, except it’s for wage-earning individuals who want to try to pay their debts on a stretched-out schedule. A Chapter 12 bankruptcy is like a Chapter 13, except it’s for farmers and fisherman, and it offers a few advantages.

A Chapter 7 bankruptcy, in contrast, is a yard sale. In a business Chapter 7, everything must be sold to pay creditors. The vast majority of personal bankruptcies are Chapter 7, but so are many business bankruptcies.

In any bankruptcy creditors are paid according to their statutory priority. The first priority is administrative claims, which are the legal and other costs of getting the bankruptcy done. The IRS and the state generally come next, with their tax claims (depending on when the taxes become payable). Next are secured creditors, such as the bank that loaned money secured by a lien (mortgage) on the boatyard’s assets, assets which the bank will now seize and sell to pay its loan. Those seized assets will include your under-construction boat if you don’t follow the advice in this article. Last in line are the pitiful “unsecureds”, who in a Chapter 7 are lucky to get a few pennies on the dollar and who typically get nothing.

The truth is that in most business Chapter 7s the administrative expenses get paid, and the first priority lienholder (the bank) gets paid or mostly paid, and the other creditors – even secured lenders with liens which are junior to the bank – get little or nothing. And keep in mind that in terms of whether you’re going to get paid back it doesn’t matter whether you and the yard owner are best friends, and that he would never do you wrong. The bankruptcy trustee drives the process, and his or her charge is to treat creditors (of which you are now one) in accordance with the law. A bankruptcy trustee has a heart of brass.

The takeaway is this: Unless you have a “security interest” – a lien, which is basically a mortgage – in the hull and engine your money bought, if the yard goes under you will probably be deemed a mere unsecured creditor, standing in line with the guy that sold the yard its glue. There is an excellent chance you will lose all the money you paid the yard and get nothing back – not the hull, not the engine, and certainly not the cash.

A lawyer reading this might say, “but maybe the customer has a common law lien.” Sure, dusty old law might give you an argument that you are a secured creditor. The trustee and every creditor senior to you would fight you on that, of course. And do you really want to risk major money on a “maybe”?

There’s a better way. It involves small money for lawyers, but it is the way to go.

First, tell the yard that you will need a security interest in the components as the yard buys them and in the boat as it comes into being, to secure the money you pay to the yard as the project moves along. The creation of a security interest will require the yard to sign a simple lawyer-prepared document granting you the interest and identifying the components which will secure the yard’s obligation, by make, model, hull identification number and engine serial number. Any component which is expensive and bought for the project ought to be specifically identified: hull, engines and generators, but also electronics, steering gear, bow thruster, watermaker etc., adding the catch-all “And, other materials and components of said boat, wherever situated.”

Then the security agreement is “perfected” by recording it with the UCC Division of the Secretary of State. This is lawyer work, or possibly bank work, but it’s pretty cheap or should be.

Don’t be dissuaded by the yard’s protest that no one has ever asked for this before. It’s standard procedure at the bigger yards, and you will be bringing your builder’s business practices up to speed by your request. More importantly, without this step you are totally at risk if the yard goes bust.

But here’s a hitch. The yard’s ank probably already has a security interest in everything the yard has! Yet you certainly don’t want to be junior to or “behind” the bank if the yard goes under. The solution is simple and routine. The bank will sign a “partial release” of its security interest, releasing only the interest it has in the components your security agreement describes and in the boat as it comes along. In other words, as to your boat only, your security interest is senior even to the bank’s.

The bank will be happy to do this because it understands the need and because it knows that the request means its borrower is busy building boats. But if the bank is reluctant, watch out. If a borrower is in trouble, and already behind on its loan payments, its bank will be very leery of relinquishing any security. The bank will not tell you its borrower is having a hard time paying the bank, but if it refuses to give a partial release don’t give the yard another nickel until you sort out the situation. Don’t jump to conclusions, and please confirm that the bank officer understands the request before assuming the refusal has real significance, but beware. And please, don’t take a grant of security in your boat if the bank is ahead of you and won’t give you a partial release. Find another boatyard.

When you take delivery of the boat you will get a Coast Guard builder’s certificate and a bill of sale from the yard, and you’ll use that to either document the boat with the Coast Guard or register it with the state. There is no need for any action relating to the security agreement.

A final note: If the yard were to have a fire that burns up your project, the yard’s insurance may not cover the loss. You need course of construction insurance (commonly known as “Builder’s Risk”) to protect you from loss of or damage to the hull and the components of a vessel during construction. This insurance attaches from the time construction commences, and covers subsequent launching and sea trials, eventually merging seamlessly with the “hull insurance” you will use to cover the delivered boat. In the event of a catastrophe at the yard you would be indemnified. Talk to a marine insurance broker about such coverage.

Nicholas Walsh is an admiralty attorney with an office in Portland, Maine. He may be reached at 207-772-2191, or nwalsh@gwi.net.