Bermuda: A Domicile of Choice for Shariah Compliant Structures Using Aircraft as an Asset Base

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1 BERMUDA BRITISH VIRGIN ISLANDS CAYMAN ISLANDS CYPRUS DUBAI HONG KONG LONDON MAURITIUS MOSCOW SÃO PAULO SINGAPORE conyersdill.com September 2010 Bermuda: A Domicile of Choice for Shariah Compliant Structures Using Aircraft as an Asset Base Bermuda is globally recognised as a centre of excellence in a broad range of aviation matters, including aviation financing and aircraft registrations. Its history, reputation and profile in the business community offer a high level of comfort to investors and onshore regulators. As highlighted in Q by the GE sukuk, the first ever sukuk to be issued by a Fortune 500 company, Islamic finance practitioners are increasingly choosing Bermuda as the jurisdiction for Islamic finance transactions involving the financing of aircraft, including sukuk issuances backed by aircraft. This article explores some of the reasons why Bermuda is a compelling choice for Islamic finance transactions using aircraft as an asset base. Bermuda SPV and Regulatory Environment At the heart of each offshore structure is the special purpose vehicle ( SPV ) which typically takes the form of an exempted company in Bermuda. Bermuda SPVs are critical in the creation of asset holding entities and the structuring of individual or portfolio securitisations and similar asset backed structures. Aircraft portfolios yield themselves very easily to securitisation, which can be done by way of sukuk. In a typical financing structure, a Bermuda SPV is formed to act as owner and lessor or as lessee and sub lessor of the aircraft. There are numerous benefits in establishing an SPV in Bermuda. Bermuda is a tax neutral jurisdiction (meaning there are no additional taxes in Bermuda that would impact negatively on the transaction) with appropriate, but not overly burdensome regulation. The legal framework in Bermuda is based on common law principles with English common law having a persuasive role. In addition, Bermuda is a British Overseas Territory and offers a stable political environment, which provides

2 consistency and certainty. It is on the Organisation for Economic Co operation and Development s ( OECD ) White List. The involvement of a Bermuda SPV can act as a counterbalance to operator jurisdictions where such stability might be less evident. In addition, the location of the SPV in a tax neutral and flexible jurisdiction may offer certain protections against the bankruptcy of other involved parties and facilitates innovative and cost effective methods of asset finance, often utilising cross back tax benefits. While Bermudaʹs corporate law is largely based upon the corporate law of the United Kingdom, it also includes provisions that are derived from other commonwealth jurisdictions or that are unique to Bermuda. The key corporate legislation, the Companies Act 1981, is amended regularly to keep pace with international commercial developments. The rationale for introducing a Bermuda SPV into an aircraft financing structure is linked to financing and leasing regulations in the jurisdictions of the participant airlines, lessors or sub lessors. Bermuda meets, and in most cases surpasses, the risk threshold for financing these parties, who, in today s environment, want to hold assets in internationally well respected tax neutral jurisdictions that clearly recognise their ownership rights based on common law principles. Financiers involved in asset based finance transactions also want the possession rights of a borrower and security rights of a lender clearly and consistently applied. Financiers want to register their rights in moveable equipment in a manner that is universally understood and recognized and deal with a jurisdiction familiar with and prepared for sophisticated finance and leasing structures. Bermuda meets all of these criteria. Moreover, experience drawn from securitisation transactions and recent sukuk indicates that rating agencies are satisfied with the corporate laws of Bermuda when assigning ratings to their transactions involving issuers in this jurisdiction. Bermuda Trust Advantage Where a Bermuda SPV is used in an Islamic finance transaction, such as in an ijara sukuk, an ijara sale and leaseback or a musharaka structure, it is often the case that none of the parties to the transaction will wish to own the SPV directly or to include the SPV as an asset on their balance sheet. In such cases, and also for those parties who are looking for a neutral party in a network of commercial transactions, the solution is typically to establish an offshore trust in the same jurisdiction as the SPV to hold the shares of the SPV. The combination of a company wholly owned by a trust provides the means by which bankruptcy remoteness can be achieved, while enabling the transaction to be effected off balance sheet or as an orphan Page 2 of 6

3 structure in relation to its originator. Neutrality is achieved by appointing an independent locally licensed trust company as trustee of the offshore trust. In Bermuda a variety of trusts can be established, including discretionary trusts, charitable trusts and non charitable purpose trusts. Moreover, in many typical sukuk, musharaka and wakala structures, the SPV will declare itself as trustee of the aircraft assets it owns in favour of the investors. When this happens care must be taken to ensure that the SPV does not require licensing for carrying on trust business as this will inevitably lead to increased regulation, administration and costs. One way to avoid any licensing requirements is to ensure that the SPV can benefit from an exemption from the trustee licensing rules, usually by qualifying as a private trust company on the basis that it acts as trustee of a limited number of connected trusts or some other specific exemption. Bermuda private trust company legislation is particularly attractive to Islamic finance practitioners because of the simplicity of its provisions with regards to the trustee licensing exemption. Provided that the SPV s capacity as trustee is limited to the trusteeship of a trust or group of trusts specified in its memorandum of association, it will be exempt from licensing. There is no requirement to demonstrate that the SPV is issuing any type of financial instrument (such as sukuk) as is required, for example, by the Alternative Financial Instrument Regulations in the Cayman Islands. A Globally Accepted Registration The registration of aircraft in Bermuda is sought for a number of purposes and Bermuda registered aircraft are based and operated throughout the world. One of the key factors which distinguishes Bermuda from other offshore jurisdictions is the fact that its aircraft register is available in the private and commercial category. Increasingly, the majority of registered aircraft are leased to airlines where the state of the operator has agreed to accept a formal delegation of a substantial portion of their operational oversight. Bermuda retains airworthiness oversight; an attractive position for lessors as they receive the asset on return with a complete maintenance history to a very high standard. There are presently in excess of 546 aircraft on the Bermuda Register (the Register ) (which has been in existence since 1931) and the majority of these are low age assets with significant value. Aircraft are registered in the private or commercial categories; the former numbering approximately 200 and the latter 346 (as at July 2010). Many of the private registrations relate to large executive jets such as the Boeing 747 SP, Boeing Business Jet, Gulfstream GV, Falcon 900B, Bombardier Global Page 3 of 6

4 Express and Airbus Corporate Jetliner or commercial type aircraft such as the Boeing 777, Boeing 757 and Boeing 737 registered for private use. Commercial aircraft operated by international airlines and presently registered in Bermuda include the full range of Airbus, Bombardier and Boeing aircraft. There has been a growing use of the Register for commercially operated aircraft and this category has become the fastest growing for the Bermuda Department of Civil Aviation (the BDCA ) in recent years. The commercial operators of Bermuda registered aircraft must maintain high levels of operational safety. If a commercial operator is not as yet operating a Bermuda registered aircraft, there is an operator linked application and approval procedure in place to ensure that only aircraft operated by accepted operators will be considered for registration. Benefits of Registration in Bermuda Owners and operators enjoy a Bermudian administration which is rated as a Category 1 Aviation Regulatory Authority by the US Federal Aviation Administration and which is prepared to accept more than one internationally recognised set of airworthiness requirements, various flight crew licences for validation, and provides a low profile registration mark that is valuable when operating in areas of the world subject to security risks or political instability. The Bermuda registration mark VP B with two subsequent letters is seen as a neutral mark of high standard which is internationally accepted and its registered aircraft are accepted for operations world wide. Due to the success of the mark, an additional designation, VQ B, was introduced for the first time in May Owners and operators have expressed satisfaction with the high level of responsiveness of the BDCA when dealing with enquiries and requirements. This is made possible by the absence of the degree of administrative bureaucracy often encountered when dealing with other key aviation jurisdictions. Bermuda does, however, offer the full range of professional and administrative services necessary to ensure that all legal and other requirements are properly met and to ensure the BDCA and the Register retain a high level of international respect and confidence. Registration in Bermuda is not subject to any requirements that demand the aircraft be based in or operate through Bermuda, and Bermuda registered aircraft may be operated anywhere in the world, excluding war zones and the like or, practically, areas restricted by its insurances. Other jurisdictions impose requirements that an aircraft registered in that jurisdiction must be based and primarily used in that Page 4 of 6

5 jurisdiction, calculated upon the total number of flight hours during a designated measurement period. Aircraft that meet the standards of the BDCA may be registered by a Bermuda exempted company which either owns the aircraft or has a valid charter by demise via a lease arrangement. More Security In Bermuda, the Mortgaging of Aircraft and Aircraft Engines Act 1999 and related regulations have been in place since 1 July Under this legislation, a Register of Aircraft Mortgages and a Register of Aircraft Engine Mortgages is maintained to assist in the registration of security interests in both aircraft and aircraft engines (with certain minimum thrust or horsepower levels matching those set in the Protocol) and owned by or otherwise in the lawful possession of a company incorporated in Bermuda. In both instances, the priority of a mortgage can be fixed by acceptance of a priority notice by the BDCA pursuant to which the priority of a yet to be executed mortgage can be fixed for a 14 day renewable period. Fees are reasonable and presently set on a sliding scale up to a maximum of US$800. In addition, the shares of the SPV may be pledged in favour of the financiers and such charge can be registered with the Bermuda Registrar of Companies. Islamic Aircraft Funds Bermuda is ranked amongst one of the world s leading investment fund domiciles. Islamic financial institutions and Islamic asset managers are keen to diversify their portfolio of investments, which includes the acquisition of aircraft. Shariah compliant aircraft funds may have the objective of investing in income generating aircraft leased to and operated by commercial airlines. A Shariah compliant aircraft fund can be structured using the same underlying structure as a conventional fund with a Bermuda corporate or limited partnership structure as the fund level. Below the fund level, the practitioner will ensure the acquisition of the aircraft is undertaken in a Shariah compliant fashion and will also ensure that the income streams are Shariah compliant. Page 5 of 6

6 Meeting Market Challenges Bermuda has been, and continues to be, a leader among offshore financial centers, with modern corporate law statutes making it a jurisdiction of choice for international businesses and their advisors. Bermuda has been the jurisdiction of choice of major aircraft lessors in connection with the structuring of aircraft portfolio securitizations, IPOs, acquisition financing and warehouse financing facilities, including Genesis Lease Limited, Aircastle Limited, AerCap B.V. and Babcock & Brown Air Limited, in addition to the financing and registration of a diverse number of commercial operator aircraft fleets. Bermudaʹs clear, consistent and flexible corporate, trust and aircraft registration laws and proven track record make it a premier choice for conventional and Shariah compliant aircraft financing. Fawaz Elmalki Associate fawaz.elmalki@conyersdill.com This article is not intended to be a substitute for legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and give general information. About Conyers Dill & Pearman Conyers Dill & Pearman advises on the laws of Bermuda, British Virgin Islands, Cayman Islands, Cyprus and Mauritius. Conyers lawyers specialise in company and commercial law, commercial litigation and private client matters. Conyers structure, culture and expertise enable responsive, timely and thorough service. Conyers provides clients with the highest quality legal advice from strategic global locations including offices in the world s leading financial centres in Europe, Asia, the Middle East and South America. Founded in 1928, Conyers comprises 600 staff including more than 150 lawyers. Affiliated companies (Codan) provide a range of trust, corporate secretarial, accounting and management services. For more information please contact: Naomi Little +1 (441) naomi.little@conyersdill.com Page 6 of 6