—— Taizhou Hailing District Hengxing Shipyard vs. Mr. Huo, Mr. Guo, and Henan Changtai Container Shipping Co., Ltd. Shipbuilding Contract Dispute

Key Word：Advance-funded shipbuilding; Priority of payment; Ship lien; Quality dispute; Mortgage auction 

Case Summary:

In 2014, Mr. Huo entered into a shipbuilding contract with Hengxing Shipyard, stipulating the construction of a bulk cargo ship through the supplied material processing method.  After completion of the ship's construction, Mr. Huo and Mr. Guo mortgaged the ship to the Luohe Branch of China Post Savings Bank and obtained a loan of CNY 1.3 million. When settling the ship's payment in 2016, Mr. Huo and Mr. Guo issued promissory notes to Hengxing Shipyard. These notes outlined the agreement to pay the remaining CNY 150,000 for the ship's construction before the shipyard delivered the vessel. Additionally, the notes included an arrangement regarding the shipyard's advance payment of CNY 900,000, which was to be repaid over a three-year period with a monthly interest rate of 1.2%. After the promissory notes were issued, Mr. Huo only paid CNY 38,000. He subsequently lodged complaints with government authorities, citing quality issues with the ship as the basis. In response, Hengxing Shipyard retained possession of the ship. As Mr. Huo and Mr. Guo failed to repay the loan from the Luohe Branch of China Post Savings Bank, the bank applied for the detention and auction of the ship. Simultaneously, Hengxing Shipyard filed a lawsuit demanding Mr. Huo and Mr. Guo to return the shipbuilding payment of CNY 1.02 million and sought confirmation of their priority payment rights for the ship auction proceeds.

Judgment:

After deliberation, the court held that Hengxing Shipyard had completed the construction of the vessel in 2015 and had passed both the entry inspections conducted by the Anhui Maritime Safety Administration and the Henan Maritime Safety Administration, which declared the vessel met the standards. Mr. Huo, as the shipowner, had been actively involved throughout the ship's construction process. Despite raising quality concerns with multiple maritime authorities, investigations by these relevant departments concluded that the issues reported did not affect navigation safety or ship quality. Hengxing Shipyard's exercise of the right of retention was legitimate. Mr. Huo's claim that he did not need to pay the final ship construction installment due to alleged quality defects in the vessel was not justified. In the first-instance judgment, the court ruled that Mr. Huo and Mr. Guo must pay a total of CNY 1.01 million for ship construction and advances. It also confirmed Hengxing Shipyard's priority payment rights over the proceeds from the auction of the ship. The second-instance judgment upheld the original verdict.

Significance:

To secure orders, small and medium-sized shipbuilding companies often provide advance funding for ship construction on behalf of shipowners. These funds often come from private financing, and the shipyards agree to relatively high interest rates on these advances. Disputes arising from shipbuilding contracts can carry substantial risks when advance funding is involved. In this case, the court conducted a comprehensive assessment based on contract performance, agreed-upon interest rates, shipyard's advance funding, maritime department quality inspections, and other factors. The court confirmed that the shipyard had constructed the vessel as stipulated in the contract, and the vessel met the quality standards while the interest rate was in accordance with legal requirements. Consequently, the court supported the shipyard's request for the shipowners to pay for the ship construction and advances. Furthermore, it legally confirmed the shipyard's priority payment rights. This judgment sets a precedent for maintaining a proper balance between industry practices and financing security, thereby regulating the shipbuilding market.