Legal considerations for engine financiers

Transcription

1 Legal considerations for engine financiers Daniel French Thursday 27 March

2 Topics covered Commercial opportunities and legal challenges Tracing title Security Cape Town Convention Other issues to be covered in documentation

3 Commercial opportunities Aircraft engines are very attractive assets to finance Stable values/rentals (even in downturn) High demand financing opportunities: airlines need spare engines growing commercial fleet (see recent orders) Long useful life/no hard life Portable/interchangeable (subject to thrust increase/derate) Generic assets: unlike aircraft, no transition costs

4 Legal challenges Special Characteristics Moveable Generally unregistered (save for FAA and Cape Town) Interchangeable with other engines Maintenance condition significantly influences value Interchangeable and high value components/llps Legal challenges Lex situs issues Rights against third parties Aircraft Lessors Aircraft financiers Maintenance providers Highly technical provisions on maintenance and return condition with significant value consequences

5 Tracing title Title exchange (owner of airframe to which engine is attached acquires title and original owner receives title to substituted engine) Title preservation/title tracking (title remains vested in original owner irrespective of the airframe to which engine is attached) greater certainty/simplifies security issues Local law analysis, not contract, may determine (e.g. merger of title under Dutch law: engine becomes property of airframe owner upon attachment to airframe) Operating Lessors may have more appetite for risk than banks

6 Example Lessor leased spare engine (the Engine ) to Dutch airline. In keeping with Dutch law, lease provided for title exchange. Lessor accepted this position on the basis that: Dutch airline gave a further assurances undertaking to document the transfer of title to any engine which was replaced by the Engine upon request from Lessor; in practice, Dutch airline would put the replaced engine into overhaul immediately after taking it off-wing and complete overhaul within short period (minimise period when recovery value is diminished); and at the end of the lease Dutch airline is required to return the Engine in redelivery condition. Lessor willing to take Dutch airline performance/credit risk

7 In this case, financier not willing to finance spare Engine because of: Different attitude to unsecured credit risk: what happens to further assurances re title and maintenance covenants if Dutch airline is insolvent? Uncertainty over day one fixed security over a fluctuating pool of engines. Will security need to be re-granted (with new hardening periods) each time title is exchanged? No RORA or other third party acknowledgements available Asset security would not meet Basel II requirements

8 Security How is priority established and perfected against third parties? No separate register of engine ownership or engine mortgages (except for FAA and Cape Town see below) documentation with specific third parties (e.g. RORA) may not cover all possible third parties Local law issues (e.g. statutory liens with priority) Conflict of laws: e.g. could third party interest validly created under lex situs displace otherwise validly created security interest?

9 Practical ways to minimise risk Local law due diligence in jurisdictions where enforcement and/or insolvency proceedings are likely to take place Documentation: Information covenants/consent requirements regarding movement of engine Identification plates re title/security interests Limit movement/use and enter into RORA or third party waivers/acknowledgements Obligation to substitute a replacement engine? Loss of title results in event of default (or Total Loss) Cross-collateralize security for engine portfolio

10 Cape Town Convention: When will it apply? Connecting factor : debtor in Contracting State (unlike Aircraft, not registration of asset in Contracting State) location of mortgagor/seller/lessee is key (does not depend on location of engines) Registrable interest : mortgage, sale, lease, finance lease/purchase option, subordination agreement Financiers should resist registrations in favour of debtor (e.g. purchase option, quiet enjoyment rights)

11 Cape Town Convention: What will it do? Title preservation applies (overrides local law in Contracting State) Priority against third parties (in order of registration or as agreed in registered subordination agreement) Subject to declarations in relevant Contracting State Enforcement remedies (e.g. self-help without need for leave of court) Special bankruptcy regime ( Alternative A preferred and most commonly implemented)

12 Alternative A (mimics US Bankruptcy Code s.1110) Within specified waiting period (or any earlier date when creditor would be entitled to possession under applicable law) insolvency administrator/ debtor must: give possession of asset to creditor; or cure all defaults and agree to perform all future contractual obligations enhance prospect of full/timely recovery: improves credit rating for securitisation assists Basel II analysis (hence greater lender appetite) Alternative B Upon request of creditor insolvency administrator/debtor must notify creditor within prescribed period whether it will: cure all defaults and agree to perform all future contractual obligations; or give possession of asset to creditor subject to any condition court may impose (e.g. moratorium) greater uncertainty increases repossession risk and requires additional liquidity support to achieve same credit rating

13 Cape Town Convention: Other benefits Prospective registrations (simplify closing) Due diligence: search against engine for pre-existing registered interests search against Contracting State for optional declarations (e.g. remedies, priority of statutory liens, insolvency regime) in jurisdiction where enforcement/insolvency proceedings are likely to take place

14 Cape Town Convention: Limitations Currently only 20 Contracting States, including USA and Ireland Will judgment in Contracting State be recognised in non-contracting State where asset is located? Remains subject to different declarations of each Contracting State Local law remains relevant (e.g. to determine if mortgagor had title)

15 Cape Town Convention: Other considerations If an engine is replaced, a new registration will be required under the Cape Town Convention Transaction documents should: require debtor to cooperate in making registrations if a relevant country becomes a Contracting State specify that following an event of default the creditor should be able to exercise the special remedies available under the Cape Town Convention (n.b. refer to specific provisions)

16 Other issues to be covered in documentation Insurance: Require airline to gross-up insurance cover (i.e. airline must insure Agreed Value of Aircraft plus 110% of the Agreed Value of the engine); obtain separate insurance certificate naming engine lessor/financier as a contract party (e.g. to receive payment of the Agreed Value of the engine on Total Loss); and airline to maintain off-wing insurance. OEM or PMA Parts? Tension between airline and financier due to significant impact (c. 33%) on maintenance costs/value of engine. Agreement with airline to be reflected in documentation

17 Other issues (continued) Engine maintenance reserves: Should Engine maintenance reserves be payable to Lessor or replaced by direct payments from lessee to maintenance provider under maintenance contract? What additional comfort will lessor/financier require to agree to these arrangements? Need to square the circle. For example, in the context of aircraft financing, products such as RR s operating and finance lease engine restoration agreements ( OPERA and AFERA, respectively) entitle Lessor to receive a credit against the next engine refurbishment in case of airline default or (in the case of OPERA) lease expiry. In theory the same arrangements could apply to engine financing transactions.

18 Freshfields Bruckhaus Deringer 2005 The information and opinions contained in this presentation are not intended to be a comprehensive study, nor to provide legal advice, and should not be relied on or treated as a substitute for specific advice concerning individual situations. This presentation speaks as of its date and does not reflect any changes in law or practice after that date. LON