Holland + Knight

Assignment and Assumption or Novation?:

Cape Town Convention Implications for the Unwary Drafter

AIRCRAFT FINANCING SUBCOMMITTEE

2008 ANNUAL MEETING – NEW YORK, NY

Presented By: Phillip L. Durham

Base ScenarioBase Scenario

Prior Lessor

New Lessor

Lessee

(2)

(1)

(1) Lease Transaction: Operating Lease between Prior Lessor and Lessee

(2) Sale Transaction: Prior Lessor transfers title in Aircraft to New Lessor

(3) Assignment/Novation Transaction: (a) Operating Lease assigned to New Lessor, (b) Operating Lease novated in favor of New Lessor

(3)

(1) Original Lease Transaction

Connecting Factor Analysis

• relates to Treaty/Protocol covered objects: Airframe (8+ passengers; 2750 k+ goods) and Aircraft Engines (1750 + thrust or 550 + HP), CTC Art 2 and PTTC Art I(b) and (e)

• constitutes a Treaty/Protocol covered form of transaction: Leasing Agreement form of International Interest, CTC Art 1(q), CTC Art 2, and CTC Art 7

• Treaty/Protocol covered party: Lessee is relevant party, CTC Art 3; and Lessee is "situated" in a CT state, CTC Art 4

• if aircraft registry is CT state, Lease Agreement in relation to the airframe (but not the engines) is covered due to the Protocol even if Lessee is not a covered party: PTTC Art IV

Additional Notes and Comments

• registration requires action by Lessor and Lessee: CTC Art 20(1)

• registration is valid until discharged (or expiry if there is a specified duration): CTC Art 21

• registration is held by and may be discharged by sole action of Lessor: CTC Art 20(3)

• registration establishes priority on a strict time of registration basis: CTC Art 29(1)

(3)(a) Assignment Transaction

• Assignment of associated rights transfers existing Lease international interest to New Lessor: register assignment of existing Lease international interest. CTC Art 31.

• Note priority of assigned Lease international interest runs from original date of registration of Lease international interest.

• Registration requires action by Prior Lessor and Prior Lessee.

• Registration is held by and may be discharged by sole action of New Lessor: CTC Art 20(3)

• Under current International Registry system, Lease international interest reverts back to Prior Lessor upon discharge by New Lessor (system treats outright assignments in same fashion as security assignments).

(3)(b) Novation Transaction

• novation terminates the existing Lease international interest and constitutes a new international interest: discharge existing Lease international interest; register new Lease international interest

• See base scenario item (1) as to Lease international interest discharge and registration steps, and note need for Lessee participation in the new registration

• Note priority of new Lease international interest runs from date of registration and does not "relate back" to registration of original Lease international interest

RESTATEMENT (SECOND) OF CONTRACTS NOVATION TESTRESTATEMENT (SECOND) OF CONTRACTS NOVATION TEST

(1) The addition of a new party to the agreement

(2) The creation of a new contractual duty by the substitute party

(3) agreement to discharge the original duty of the substituted party

• Assignment and Assumption clearly satisfies items #1 and #2 above.

• Determinative Question is whether release provision of standard Assignment and Assumption satisfies item #3 above.

• Sample release:

the prior lessor and the lessee each releases the other from such party's obligations, duties and liabilities under the aircraft operating lease agreement arising out of or pertaining to the period after the agreed effective time of the agreement.

THE GOLD CLAUSE CASES: THE CALIFORNIA AND WASHINGTON APPROACHTHE GOLD CLAUSE CASES: THE CALIFORNIA AND WASHINGTON APPROACH

Wells Fargo Bank, N.A. v. Bank of America

• Lessee assigned its leasehold interest in a ground lease

• Court applying California law found that the release provision in the assignment that stated that the assignor was released from all “liability accruing under [the] lease from and after the date of the assignment” satisfied item #3 above.

• Court held that assignment constituted a novation thereby reviving the “gold clause”.

THE GOLD CLAUSE CASES: THE CALIFORNIA AND WASHINGTON APPROACHTHE GOLD CLAUSE CASES: THE CALIFORNIA AND WASHINGTON APPROACH

Fay Corporation vs. Bat Holdings, Inc.

• Lessee again assigned its leasehold interest in a ground lease

• Court applying Washington law found that the release provision in the assignment that stated that the assignor was released and discharged from all “any and all obligations arising or accruing under the covenants and agreements contained in this lease subsequent to the date of such sale, conveyance or assignment” satisfied item #3 above.

• Court held that assignment constituted a novation thereby reviving the “gold clause”.

THE GOLD CLAUSE CASES: THE CALIFORNIA AND WASHINGTON APPROACHTHE GOLD CLAUSE CASES: THE CALIFORNIA AND WASHINGTON APPROACH

Release Standards

• Wells: “any and all obligations arising or accruing under the covenants and agreements in this lease subsequent to the date of such sale, conveyance or assignment”

• Fay: “any and all obligations arising or accruing under the covenants and agreements in this lease subsequent to the date of such sale, conveyance or assignment”.

• Sample Assignment and Assumption: “all obligations, duties and liabilities under the aircraft operating lease agreement arising out of or pertaining to the period after the agreed effective time of the agreement.”

Fay and Wells establish baseline standards for release provisions in assignment and assumption agreements governed by California and Washington law.

Heightened Scrutiny: The New York ApproachHeightened Scrutiny: The New York Approach

• Novation Test under NY law

– 1. previously valid obligation;

– 2. agreement of parties to a new contract;

– 3. extinguishment of old contract; and

– 4. valid new contract.

• Item #3 above requires complete release.

• Novation is an absolute defense against liability

• Burden on party claiming defense that the parties intended novation.

• Note that intentional full release in assignment and assumption would likely qualify as a novation under NY law.

Cape Town Convention ImplicationsCape Town Convention Implications

Washington and California Law

• Release provisions in Washington and California law governed assignment and assumption agreements need to be drafted carefully

• Assignment and Assumption agreements under Washington and California law present a Pascal’s wager of perfection; advisable to register both assignment of lease International Interest (if applicable) and new International Interest under novated lease.

Cape Town Convention ImplicationsCape Town Convention Implications

New York Law

• If full release is intended, register International Interest arising under novated lease.

• Countervailing interests: slight risk that court changes course and finds a partial release sufficient for a novation vs. making a registration that could be used as evidence of an intent to novate.

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