5 Things to Know Before Buying a Boat

September 28th, 2015

Many boaters have years of experience on the water. But just like the language of boats and boating is different from that of the land and landsmen, so is the legal landscape of buying a boat different from the practical realities of being a boatman. There is no doubt that being an excellent boater should be of primary consideration for boat owners. But no matter how skilled a boater is, he or she must understand the technicalities of buying a pleasure craft in order to fully appreciate boat ownership.

Use A Yacht Broker

When buying a boat, the right broker can reduce stress and make the transaction go smoothly and painlessly. Yacht brokers play a major role in facilitating the transactions between seller and purchaser in a yacht transaction. Brokers obtain the listings for the vessel or represent the manufacturer, advertise the listing, solicit the buyers, assist in the financing of the yacht and guide the parties through the closing. Often the broker’s services go beyond these charges and he or she may aid the buyer in repair or maintenance or adding equipment and may locate berthing or other services. Brokers are usually the most knowledgeable in a given geographical area for understanding yachting activities and practices.
California law requires the licensing of brokers selling yachts 16 feet or more in length and under 300 gross tons. However, licensing does not insure that the person with whom you are dealing is either honest or well qualified. Before engaging the services of a yacht broker and salesperson, a seller or prospective purchaser should contact the California Division of Boating and Waterways, Yacht and Ship Broker Licensing to determine whether the particular broker or salesperson has been the subject of any complaints or discipline proceedings. Information regarding licensing can be found here: http://dbw.ca.gov/Yns/Yacht.aspx.

Brokers are compensated by commissions. That is, a percentage of the sale price is paid to the broker after the successful completion of the sale transaction. Brokerage commissions vary somewhat among the major boating regions in the U.S. For the most part, commissions tend to range from 6 percent to 10 percent of the selling price depending on the size of the vessel.
A broker has a duty to disclose known conditions of the vessel. A yacht broker who willfully fails to disclose a known defect or condition of a vessel to a prospective purchaser may be just as liable as the owner of the vessel for restitution or repair.
Check The Title and Get Seller’s Assurance Regarding Liens and Encumbrances

There are many issues that a purchaser should be aware of regarding the title to a vessel. Specifically, that a purchaser of a vessel takes that vessel with all maritime liens and encumbrances whether known or unknown. A lien is a cloud on title and may restrict the free transferability of a recreational vessel. Liens are generally burdens on the vessel. That is, they represent amounts owed to others which may arise out of contract or tort such as the repairs of vessels, provisioning of vessels, salvaging of vessels or maritime collision or maritime personal injury. A lien can arise by operation of law without any formal writing and some maritime liens are secret in that there is no recording required. In some cases, the vessel owner may not know of their existence.

An encumbrance, on the other hand, generally refers to mortgages or security interests created by written agreements. For example, a preferred maritime mortgage may be an encumbrance on a documented vessel. A security interest may be an encumbrance on a state registered vessel.

Before purchasing a vessel, the prospective purchaser should obtain an Abstract of Title from the U.S. Coast Guard National Vessel Documentation Center. The Abstract of Title should identify any mortgages or claims of lien recorded with the Coast Guard. However, because some liens are secret, the Abstract of Title may not accurately represent all existing liens on the vessel. A purchaser should require, and almost all boat transactions include, a representation from the seller that the vessel is free and clear of all liens and encumbrances.

For the most part, there is no way to assure the purchaser that the vessel is being purchased lien free. Unlike real property there are no title insurance companies nor are there mandatory requirements for recording maritime liens. Therefore, the only means by which a purchaser is assured of a lien free vessel is by the representation of the seller that the vessel is free and clear of all known liens and encumbrances. A purchaser should, to the extent possible, check with those who may have performed work or provided services to the vessel or with whom the vessel’s owner was dealing in the months preceding the sale. Additionally, the purchase should demand written assurance that the seller will indemnify the buyer against all claims that may be brought against the purchaser for liens that attached prior to the sale.

You May Not Have to Pay Sales Tax

“Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.” Judge Learned Hand, Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934).

California imposes two types of taxes on the sale and purchase of property, including vessels – sales and use tax. The distinction between the two is often confusing. Sales tax is imposed on the sale of property, whereas use tax is imposed on the use or storage of property in California. Generally, California will not impose both taxes on the same transaction. For example, purchasing a vessel in California may require the imposition of a sales tax, but the purchaser’s continued use of the vessel in California does not require a use tax.

Property purchased for use outside of California is not considered purchased in California. California imposes a presumption that property purchased outside of California, which is first functionally used outside of California, and then remains outside of California for the first 12 months, is purchased with the intent not to use the property in California. Stated differently, if the vessel is purchased out of California and is brought into California within 12 months from the date of its purchase, it is rebuttably presumed that the vessel was acquired for use in California and thus subject to use tax. The 12 months excludes any period the vessel is in California exclusively for warranty or repair service and is in California for that purpose for 30 days or less.

In order to take advantage of the tax exemption, the buyer must follow very specific rules and not appear to intend to bring the vessel back to California, or appear to be keeping it out of California specifically to avoid the sales tax. A crucial first step is to perform an offshore delivery. A yacht broker should be able to assist with this and the offshore delivery should be specifically provided for in the purchase agreement. Generally, the vessel will be taken at least three miles off shore into international waters. The location of the vessel at the time of delivery will be documented by taking pictures of the GPS location, the day’s newspaper to verify the date and execution of the closing documents. The vessel will then be brought back into California for provisioning before it is taken outside of California shortly thereafter. The owner should keep all records of usage out of state to verify the vessel was used out of state and not simply stored.

If a boat purchaser can follow these guideline he or she may be able to successfully avoid use tax in California. We strongly recommend using an attorney to insure compliance with California and federal tax laws.

Insuring Your Purchase

There are many forms of insurance applicable to the marine industry. Hull insurance is written with the expectation of insuring the hull of the vessel. One provision of a hull insurance policy, dealing with “constructive total loss”, is of particular interest. In the event of a total loss of the vessel, the hull insurance will pay off either the “stipulated value” if it is an agreed or stipulated value policy, or the “fair market value” of the vessel as determined according to proof. However, if the vessel is not totally destroyed but the cost of repair or restoration would exceed some specified percentage of the agreed or stipulated value of the vessel at the time of loss, then it is deemed a constructive total loss and the entire proceeds of the policy are payable. Some policies provide that payoff in the event of constructive total loss is an option at the discretion of the underwriter and that the underwriter may elect to repair. That provision can create a conflict between the insured and the underwriter particularly if there is major damage which will require substantial time to repair.

The protection and indemnity insurance form, or “P & I” as it is more commonly called, is equivalent to the general liability form of policy on automobiles. Like the hull policy, the P & I policy should be read carefully and any question about its contents or the meaning of its paragraphs should be addressed to competent insurance brokers. Like the hull policy form, the P & I form is interpreted through a great deal of history and therefore should be carefully read and understood since some of its clauses do not necessarily mean what they appear to say on their face. If the yacht owner employs crew or is engaged in passenger carrying operations, the yacht owner must be careful to ensure that there are adequate liability insurance coverages for passengers and crew members. Because of the high cost of seaman injury claims, employing crew members will undoubtedly adjust premiums rates considerably. Passenger carrying activity will also adjust insurance rates. The vessel owner should be certain that all conditions of the policy are met. Any unsatisfied condition may give rise to a policy which is not of any force and effect or may be voidable at the election of the underwriter. Insurance forms and terminology can be confusing so it is important that a yacht owner consult with a broker and/or attorney to ensure a clear understanding of the risks that are covered by the particular policy.

Making It Official

Recreational boat owners in the U.S. are required to either register their vessels with their respective state governments or document their vessels with the U.S. Coast Guard.

Under current federal law any vessel over five tons net is eligible to be documented as a pleasure vessel with the United States Coast Guard. These same vessels, and vessels under five tons net, may be registered in accordance with the laws of the state in which the owner resides.

Assuming a vessel is eligible for federal documentation, there are several reasons why an owner may choose federal documentation over state registration. If an owner travels to foreign waters, the Coast Guard issued Certificate of Documentation facilitates clearance with foreign governments and provides certain protection by the U.S. flag. It may be easier to obtain a bank loan to finance a vessel if it is documented. The lender will generally want to record a preferred ship mortgage with the Coast Guard to perfect its lien. The mortgage is enforceable throughout the U.S., its territories and some foreign countries. Once documented, the vessel stays documented for the life of the vessel. Thus, if the vessel is sold the new owner needs simply to update the documentation information by filling out paperwork for the Coast Guard and paying a fee. The vessel’s documentation number will remain the same. There is an annual documentation update form required by the Coast Guard, but this is automatically sent to the owner 45 days in advance of annual expiration and there are no further fees involved.

Generally, the Coast Guard standard Bill of Sale is sufficient to pass title of a federally documented vessel if properly completed and executed. The Bill of Sale is not effective until filed with the Coast Guard National Vessel Documentation Center (“NVDC”). A standard Bill of Sale and other forms related to documentation are available from the NVDC here: http://www.uscg.mil/nvdc/nvdcforms.asp.

This is a very general discussion of purchasing a vessel and vessel ownership. Each aspect of purchasing and owning a vessel has a multitude of variations, specific requirements and hidden pitfalls. We always suggest that anyone interested in purchasing a vessel seeks the advice of counsel to help navigate through this complex, yet rewarding, process.

For any questions about this article or the purchase of yachts in general, please contact Alex Gruft at agruft@cwlfirm.com.