TRANSPORTATION (AVIATION - FINANCE)

Transportation (Aviation - Finance)

Drafting, negotiation or review of various types of aviation-related agreements, contracts, documents, forms and templates, such as for: aircraft engine lease (AEL); aircraft financing lease (AFL); aircraft maintenance and modification services (AMAMS); aircraft operating lease (AOL); aircraft wet lease (AWL); new aircraft purchase (NAPA); new aircraft sale (NASA); pre-owned aircraft lease (POAL); pre-owned aircraft purchase (POAPA); pre-owned aircraft sale (POASA); residual value (RV).

Representation for aircraft buyers, aircraft parts companies, aircraft sellers; family offices, financial institutions, fixed-base operators (FBOs), fleet operators, fuel supply entities, investment firms, leasing companies, and the like, for transactions such as: aircraft-related mergers and acquisitions (M&A); Bankruptcy Code Section 363 sales; commercial aircraft finance; commercial aircraft lease; commercial aircraft purchase; corporate aircraft finance; corporate aircraft lease; corporate aircraft purchase; fleet risk management; maintenance and repair organizations (MROs); private aircraft finance; private aircraft lease; private aircraft purchase; restructuring; workouts.

Compliance with Federal agencies, guidelines, laws, regulations, rules, statutes, treaties, such as the: 1944 Chicago Convention on International Civil Aviation (Chicago Convention); 1948 Convention on the International Recognition of Rights in Aircraft (Geneva Convention); 2001 Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment and the Protocol on the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment (collectively, Cape Town Convention); Federal Aviation Administration (FAA); Foreign Account Tax Compliance Act (FATCA); United States (US) Internal Revenue Service (IRS); National Transportation Safety Board (NTSB); Transportation Security Administration (TSA); US Customs and Border Protection (CBP); US Department of Transportation (DOT); World Trade Organization (WTO) Agreement on Trade in Civil Aircraft.

Aviation finance is a type of asset finance.

Due diligence should actually be the first task when considering financing an aircraft, such as: allowing a sufficient amount of time for the financing process, so that any written commitment to a third-party (to buy or lease) does not expire before the proposed financing has actually been approved by the prospective financing entity; verifying the value (as opposed to just accepting the proposed price or rental) of the chosen aircraft though the combination of an expert inspection and an expert appraisal, so that a financing entity may be more generous when establishing the loan to value ratio based on the collateral (the aircraft); determine the location and structure of the legal entity which will ultimately buy, lease or operate the chosen aircraft, based on factors such as the ability and credit worthiness of the individual buyer, lessee or operator or each business partner (if the aircraft is to be owned or operated by a legal entity composed of individuals or multiple legal entities), FAA ownership and operating rules, public company reporting requirements, risk allocation and management concerns, and tax considerations (depending on what country or even what state in the US will be used as the venue for the closing); consult with legal and tax subject matter experts (SMEs) to determine whether a purchase or a lease would be more advantageous to use for the legal structure to consummate the transaction; consult with legal and tax SMEs to determine whether an asset-based lender (which would focus more on the value of the chosen aircraft, rather than on the creditworthiness of the individual or legal entity lessee, operator or purchaser) or a credit-based lender (which would focus more on the creditworthiness of the individual or legal entity lessee, operator or purchaser, rather than on the value of the chosen aircraft); if non-recourse financing is the only option being considered by the lessee, operator or purchaser, it may be very difficult to find a willing institutional lender, so only relationship-based financing through private lenders may available, who might be willing to accept the risks of such an arrangement (but only at extremely-high financing rates); consult an aircraft acquisition SME to assist in generating financing proposals that may be acceptable to various lenders, based on how such lenders may generally accomplish such transactions, based on past transactions and customs within a particular venue; if possible, do preliminary negotiations with the potential lenders identified by the aircraft acquisition SME to get the most-favorable terms before making a final choice of lender; once the final selection of a lender has been accomplished, have a complete due diligence document package – perhaps including the appraisal, individual or entity financial statements, individual or entity tax returns, inspection report, logs (if a used aircraft), maintenance records (if a used aircraft), pre-transaction report, proposed lease, operation or purchase agreement – ready to present to the proposed lender, which such lender may use to jumpstart its own due diligence review.

When parties may be engaged in preliminary negotiations regarding a proposed aircraft transaction, many US jurisdictions (such as New York), allow the parties to enter into a letter of intent (LOI) prior to the actual consummation of a transaction, in which the parties outline in general the material terms of their proposed transaction, and in which some or all of such terms may or may not be legally-binding on the parties, but only if the LOI has specific language clearly expressing which such terms are legally-binding, and which are not.

Familiarity with aircraft financing structures such as: asset-backed security (ABS); bank loan; export credit agency (ECA) financing; japanese operating lease (JOL) (generally for purchasing used aircraft from an airline through a sale/leaseback or from a third-party lessor, with an associated operating lease); japanese operating lease with call option (JOLCO) (generally for financing new aircraft); leveraged leases; private placement; sale-leaseback; secured debt; special purpose vehicles (SPVs) – such as limited partnerships, orphan trusts and subsidiary companies; syndicated loan; tax leases; term loan; unsecured debt; warehouse financing.

A JOL is considered to be an operating lease for accounting and tax purposes, so the lessor is treated as the owner of the asset, and may take depreciation on the asset and include the asset on the lessor’s balance sheet, whereas a JOLCO is considered to be a capital lease (a financing lease) for accounting and tax purposes, so the lessee is treated as the owner of the asset (while the lessor is considered to be providing a secured loan to the lessee, and retaining title to the asset as collateral for such secured loan), and so the lessee is also considered to be the equity owner of the asset under both bankruptcy rules (since the capital lease is deemed to be a “financing”) and FAA registration rules.

Under Islamic law, Islamic finance structures are permissible for use in aviation financing.

Working knowledge of specialized commercial aviation and related insurance products, such as for: agricultural aircraft; aircraft maintenance; airline hull and liability; airport liability; airport service providers; aviation ground handlers liability; aviation manufacturer’s products liability; charter operations; contingent aircraft liability; corporate aircraft/industrial aid; corporate non-owned aircraft liability; fixed base operators (FBOs); flight training facilities; hull deductible buyback; legal liability for aviation products and provision of aviation services; pay-by-the-hour; property and hanger insurance; repossessed aircraft hull and liability; rotor wing operators (RWRs); tailored cross-class cover; war, terrorism and political risk; workers’ compensation.

Most of the aircraft flying today are operated under some type of lease.

One of the major difficulties in drafting an aircraft lease, is that the drafters must try to anticipate that it should be enforceable in every global jurisdiction, due to the mobility of the aircraft itself, and the impossibility of knowing when and where in the world a breach of the lease may occur.

Drafters of aircraft leases must also concentrate on the indemnity provisions of the lease, particularly in regard to required regulatory compliance with all the applicable laws of all global jurisdictions, for example, contending with the complex requirements imposed by diverse global regulators, such as the European Union (EU) emissions trading system (EU ETS) and the US Treasury Department Office of Foreign Assets Control (OFAC).

A distinguishing characteristic between typical aircraft lease types may be who derives the benefits and risks of ownership during the term of the lease, which is generally for a definite long-term time period (in general, 3 - 10 years);in a true aircraft operating lease, ownership (evidenced by title) of the aircraft and risk of loss (ROL) remain with the actual owner lessor of the aircraft, both during the lease term and after expiration of the lease, when the lessee must return the aircraft to the lessor (subject to certain conditions in the lease), and thus the lessor derives all the major tax benefits related to the aircraft, whereas the lessee is only allowed to claim the entire aggregate value of the yearly lease payments on its tax return; in an aircraft capital (finance) lease, the financing entity lessor is the legal owner of the aircraft only for the duration of the lease, while the lessee not only has operating control over the aircraft, with all the incumbent benefits for accounting and tax purposes, but also has some share of the economic risks from any loss or change in the valuation of the aircraft, and the lessor will transfer ownership and title of the aircraft to the lessee at the expiration of the lease.

It is a common practice in the aviation industry for lessors not to spend their own cash on purchasing an aircraft, but rather to obtain financing for the purchase of an aircraft from institutional or perhaps private lenders, granting a security interest (superior to the lessor’s own property rights in the aircraft and contractual rights in the subsequent lease to the lessee) to a security trustee in return, to be held in trust;under the lease, the lessor retains economic ownership risks of the aircraft, and the lessee assumes the operational risks of the aircraft; the lessor does assume any of the costs involved in the operation of the aircraft as those costs would erode the lessor’s profits from simply leasing the aircraft to the lessee, who must bear the burden for risk of loss (ROL) under the lease; thus, most aircraft operating leases will contain a detailed disclaimer that the lease must be considered a net lease (analogous to a triple net real estate lease) or hell-or-high-water provision, the purpose of which is to make crystal clear to the lessee that the lessee’s obligation to pay periodic rent to the lessor is inviolate, ironclad and immune to interruption for the entire term of the lease, for any cause whatsoever, including but not limited to force majeure, commercial frustration, commercial impracticability, or the like, that might excuse or release the lessee of its payment obligation to pay periodic rent to the lessor; thus, the lessee has the sole responsibility for ensuring that the aircraft is crewed, insured, maintained and operated at all times in accordance with all contractual and regulatory requirements (applicable to any global jurisdiction in which the aircraft operates); the aircraft operating lease will also specify that the aircraft must be returned to the lessor at the end of the lease in substantially the same condition as when the lessor gave possession of the aircraft to the lessee at the commencement of the lease, normal wear and tear excluded (much the same as in a residential rental agreement).

One of the key implications in the aircraft lease from the lessee’s perspective is the right of quiet enjoyment, under which the lessee is granted freedom from interference from the lessor for the term of the lease, providing that the lessee has not breached any of the terms of the lease (similar to such a covenant in a real estate lease); and, one of the rights most-useful to the lessee, flowing from the right of quiet enjoyment, is the right of the lessee to sublease the aircraft during the term of the lease during those times when the lessee may not need it; however, as in a real estate lease, the right to sublease cannot implied, but must be expressed clearly in writing in the lease, with all conditions specified (for example, the proposed sublessee must have a financial condition that is as good or better than that of the lessee).

Within the allowance for subleasing, the lessee may request latitude to engage in “wet leasing” or an ACMI (aircraft, crew, maintenance and insurance) lease, in which the lessee would provide the aircraft, crew, maintenance and insurance to facilitate lucrative short-term or charter flight situations requested perhaps by wealthy or influential clients, perhaps for a single round-trip day-flight to a particularly-interesting destination, or for a business purpose, or for an emergency situation.

Rather than include outright penalty provisions with specified penalty amounts for a schedule of defaults, which penalty provisions may not be enforceable in some global jurisdictions (thus subjecting the lease to the peril of partial invalidity with resulting severability, or even total invalidity), aircraft operating leases generally include provisions for default interest (interest on late or missed rental payments, not to exceed the maximum amount permitted by applicable law, to avoid usury challenges), rent step-ups (in the event the lessee fails to return the aircraft to the lessor in the condition specified in the lease at the end of the lease term, in which the lease will automatically be extended for an indefinite term, with the monthly rent increasing in increments every month, until the lessee makes whatever maintenance or repairs are necessary, to the sole satisfaction of the lessor, at which point, the extended lease terminates), or specified liquidated damages (a fixed sum negotiated by the parties and memorialized in the lease, intended to completely liquidate any specified types of damages for which the parties could not concoct a calculation formula).

Airlines are the predominant purchasers of new aircraft, generally in multi-plane orders that can extend for several years, with specified milestone delivery dates; in such cases, the aircraft manufacturer may demand progress payments – called pre-delivery payments (PDPs) – based either on a fixed schedule of calendar dates, or on milestones, such as the completion or substantial completion of a certain number of aircraft in a particular group; such payments generally relate to the term of the production agreement, and may be as high as thirty percent (30%) of the total value of the production agreement; airline lessors also generally purchase new aircraft, but generally as smaller orders or single-plane orders; because of such expensive payment obligations, airlines and lessors may actually seek financing to make such payments, rather than using their own cash-on-hand.

For orders involving aircraft of large size, the airline or lessor may purchase the engines directly from the engine manufacturer, and have them shipped to the facility where the aircraft for their order are being assembled, for final integration into the aircraft.

In the secondary aircraft market for pre-owned and pre-leased aircraft, the original aircraft owner or the original aircraft lessor (in the case of a true aircraft operating lease) or the original aircraft lessee-now-owner (in the case of an aircraft capital finance lease), will enter into sales agreements directly with the buyers, who may be other airlines, lessors or conversion enterprises (which specialize in converting one type of aircraft – such as a passenger aircraft – into another – such as perhaps a freighter aircraft or a tanker aircraft).

Under 49 U.S. Code Section 44102, an aircraft not already-registered in a foreign jurisdiction may be registered in the FAA Registry, if the aircraft is either based in the US or used primarily in the US – meaning that at least sixty percent (60%) of the flight hours during any six-month period must be between two US points, as verified and reported to the FAA, and, if the aircraft is owned by either: a US citizen; or, an individual citizen of a foreign jurisdiction (who has a US permanent residence); or, a foreign corporation or association (of which the president and at least two-thirds of the board or managers must be US citizens and at least three-quarters of the voting interests must also owned or controlled by US citizens – meaning that if the voting interests are in foreign jurisdictions, such voting interests may form a voting trust, control of which must be transferred to an independent trustee who is either an individual US citizen or an entity that may somehow otherwise satisfy the requirements for citizenship, and who is not related to any of the foreign parties) organized and doing business under Federal law or the law of any US state or district; or, a non-citizen trust – composed of non-US citizen beneficiaries, but only if the ownership entity qualifies as a US citizen or US resident alien, and either, the non-US citizen beneficiaries who qualify as US citizens hold at least seventy-five percent (75%) of the ability to direct, influence or remove the trustee, or, the trustee has the express and unlimited ability to take actions regarding the ownership and operation of the aircraft that in the sole discretion of such trustee are necessary to protect the interests of the US.

Familiarity with the FAA aircraft registration requirements of 49 U.S. Code Section 44103, which determine the ownership of the aircraft for limited FAA purposes only (notwithstanding the resulting Certificate of Registration, such Certificate is not conclusive evidence of ownership in Federal cases where the actual ownership of the aircraft is at issue), establish the nationality of the aircraft for international law purposes, and subject an aircraft to the FAA safety requirements.

The FAA also allows recording of conveyances such as leases, mortgages and security interests in aircraft, engines, propellers, spare parts and the like, which then become valid notices against any third-party claimants.

Under 49 U.S. Code Section 44102, an aircraft not already-registered in a foreign jurisdiction may be registered in the FAA Registry, if the aircraft is either based in the US or used primarily in the US – meaning that at least sixty percent (60%) of the flight hours during any six-month period must be between two US points, as verified and reported to the FAA, and, if the aircraft is owned by either: a US citizen; or, an individual citizen of a foreign jurisdiction (who has a US permanent residence); or, a foreign corporation or association (of which the president and at least two-thirds of the board or managers must be US citizens and at least three-quarters of the voting interests must also owned or controlled by US citizens – meaning that if the voting interests are in foreign jurisdictions, such voting interests may form a voting trust, control of which must be transferred to an independent trustee who is either an individual US citizen or an entity that may somehow otherwise satisfy the requirements for citizenship, and who is not related to any of the foreign parties) organized and doing business under Federal law or the law of any US state or district; or, a non-citizen trust – composed of non-US citizen beneficiaries, but only if the ownership entity qualifies as a US citizen or US resident alien, and either, the non-US citizen beneficiaries who qualify as US citizens hold at least seventy-five percent (75%) of the ability to direct, influence or remove the trustee, or, the trustee has the express and unlimited ability to take actions regarding the ownership and operation of the aircraft that in the sole discretion of such trustee are necessary to protect the interests of the US.

Familiarity with the FAA aircraft registration requirements of 49 U.S. Code Section 44103, which determine the ownership of the aircraft for limited FAA purposes only (notwithstanding the resulting Certificate of Registration, such Certificate is not conclusive evidence of ownership in Federal cases where the actual ownership of the aircraft is at issue), establish the nationality of the aircraft for international law purposes, and subject an aircraft to the FAA safety requirements.

The FAA also allows recording of conveyances such as leases, mortgages and security interests in aircraft, engines, propellers, spare parts and the like, which then become valid notices against any third-party claimants.

To deregister an aircraft, the owner (or such owner’s successor) named in the Certificate of Registration must initiate the deregistration procedure to remove the aircraft from the FAA Registry, using the protocol specified by the FAA (the owner must provide, to the sole satisfaction of the FAA, at a minimum: a signed FAA deregistration request, including a detailed description of the aircraft – with the existing FAA registration number, the manufacturer name, the model and manufacturer serial number of the aircraft; an explanation as to why the owner is requesting deregistration; the name of the country to which the aircraft will be exported; proof that all recorded interests senior to the owner’s have been discharged, or in the alternative, that the holders of such senior interests have consented to the proposed deregistration); once the FAA approves such deregistration, the aircraft owner must send notice thereof to the foreign country in which the owner wishes to register the aircraft, and must cease to use the aircraft (other than to export such aircraft to such foreign country for registration in such foreign country) until such registration in such foreign country has been approved by the appropriate agency in such foreign country.

If the aircraft is subject to the Cape Town Convention and an Irrevocable Deregistration and Export Request Authorisation (IDERA) has been filed with the FAA, then the FAA Registry will honor a cancellation request only from the person authorized under the IDERA or their designee or legal successor, and such IDERA-authorized person must also include in its request a copy of the International Registry Search Certificate (IRSC); an IDERA is often used by secured parties in the US as a bar to the deregistration of an aircraft from the FAA, although US airlines generally do not agree to provide IDERAs; if an IDERA has been issued, the operator of a leased aircraft should not be able to block the deregistration by the IDERA-authorized holder.

Following an event of default and assuming there is a successful repossession or foreclosure of the aircraft, an aircraft owner may file a Certificate of Repossession (COR) unilaterally with the FAA, certifying that it has validly repossessed the aircraft in accordance with applicable state law, which will then be honored by the FAA.

Aircraft generally do not depreciate in value by large and unpredictable percentages (absent extensive damage or degradation) over their initial lifecycle, and so many popular aircraft models are easily remarketable in the secondary market; residual value agreements are used in connection with the aircraft secondary market as a method of hedging against a precipitous loss in the value of an aircraft as a result of a variety of circumstances, allocating such potential loss of residual value among many parties, or transferring any such loss in value to some third-party, such as an insurer.

In the US, a mortgage on an aircraft or aircraft engine registered with the FAA, may be given under applicable US state law, with New York law generally being the most-prevalent for aviation finance transactions; security interests in aircraft and aircraft engines are generally governed by Article 9 of the Uniform Commercial Code (UCC); in order for the secured party to enforce a security interest against a debtor, such security interest must have “attached” – which means that the creditor gave some consideration for the security interest, and, the debtor has rights in the collateral, and, the debtor must execute (“authenticate”) a written security agreement that must provides a detailed description of the collateral (here, the aircraft or aircraft engine); the requirements for perfection of the security interest vary by state,

The security interest may be generally perfected in the US by filing a UCC-1 financing statement with the applicable filing office; however, if the aircraft or aircraft engine is registered with the FAA, then the applicable UCC provisions are technically pre-empted by Federal aviation requirements, which provide that security interests in US-registered aircraft or aircraft engines are perfected by recordation of a security agreement with the FAA; the US also follows the Cape Town Convention which requires that where a debtor is in the US, or an aircraft or aircraft engine is registered with the FAA, then any international interests in the applicable “aircraft objects” (as defined in the Cape Town Convention) must be registered with the International Registry.

Spare parts may be included in the collateral subject to an aircraft or engine mortgage, but under the Cape Town Convention security interests in spare parts cannot be recorded with the FAA; instead, security interests in spare parts are only perfected by filing a UCC-1 financing statement in the applicable filing office.

It is possible to take a security interest in the aircraft indirectly, by taking a security interest in the shares, membership interest or beneficial interest in the entity holding title to the aircraft or aircraft engine;since title to a US aircraft is generally held in an owner trust or a limited liability company, a security interest in the beneficial interest of such owner trust may be taken by entering into a beneficial interest pledge agreement between the holder of the beneficial interest and the secured party; a security interest in the membership interest of a limited liability company can be taken by entering into a membership interest pledge agreement between the holder of the membership interest and the secured party; such security interests may then be registered by filing a UCC-1 financing statement in the appropriate filing office.

Additionally, non-consensual security interests may be created on aircraft and aircraft engines under applicable state law through filing liens such as Federal tax liens, hanger operator’s liens, judgment liens, fuel provider’s liens mechanic’s liens, and the like; some such liens may be recorded with the FAA and the International Registry (subject to applicable state laws, including the UCC);some such liens may only be perfected by the lienholder maintaining possession of the aircraft or aircraft engine; such liens may not be recorded with the FAA or under the Cape Town Convention, but may be filed with the relevant state or county.

Possessory liens on goods that secure payment or performance of an obligation for services or materials furnished with respect to such goods in the ordinary course of business, whose effectiveness depends on the lienholder’s possession of the goods, have priority over other forms of perfected security interests, under USS Section 9-333; in general, possessory liens are governed by the laws of the state in which the relevant lienor is located or actually possess the aircraft or engine.

In general, a security interest in a lease agreement is perfected in the same manner as an aircraft mortgage, by filing a UCC-1 financing statement with the appropriate filing office; if the relevant aircraft or aircraft engine is registered in with the FAA, both the lease and the related security agreement should be filed with the FAA; an international interest in respect of the lease, together with a transfer of the right to discharge the lease in favor of the secured party, and an assignment of international interest in respect of the lease in favor of the secured party, should all be filed with the International Registry pursuant to the Cape Town Convention.

Some jurisdictions allow a mortgagee to repossess a mortgaged aircraft or aircraft engine without first obtaining a court order, and then to either sell it privately or operate it or lease it out following an event of default by the mortgagor.

The key disadvantages of secured lending structures are that: it can be difficult to predict whether a mortgage will be enforceable before local courts; some jurisdictions do not recognize mortgages on aircraft; some jurisdictions require significant stamp duty payments to perfect a mortgage; and, in some jurisdictions, mortgage enforcement takes place through a court-ordered public auction; however, provisions in capital finance leases may be employed as an alternative to secured lending structures, to mitigate such issues.

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