LEGAL ISSUES - Airfinance Journal Validity z Blue Sky v Mahan Air (2010) z Validity of mortgage /...

CFM / AirFinance Journal

Financing and Investing in Engines

31 March 2011

Financing and Investing in EnginesGavin Hill

LEGAL ISSUES

CONTENTS 1. Sample Structure

2. Title: Overview, Validity and Priorities

3. Title: Risk and Protection

4. Jurisdictional Review: Legal Families

5. Jurisdictional Review: Security Issues

US Owner Trust StructureSampleStructure

Seller Purchaser

Owner Trustee

Lessee

LendersSale of Engine Assets

(Trust Interest)

Loan

Trust

Lease

SampleStructure

BenefitsNo lease transfer - limited lease / lessee interference

No title transfer

Strong perfection of interests - US owner permits CTC, FAA and UCC filings

Tax transparency

Title Overview

Good title is essential for equipment leasing and financing Establishing title Protecting title Risk of title loss / subject to third party priority interest

Insolvency officialsThird party purchasers / creditorsHost aircraft ownersEurocontrol / national air traffic agenciesEmissions Trading Scheme agenciesNational aviation authoritiesAirport operatorsCustoms authoritiesTax authorities

TitleValidity

Blue Sky v Mahan Air (2010)

Validity of mortgage / title transferValidity of mortgage / title transfer determined by reference to the lex situs

Dicey, Morris and Collins ("The Conflict of Laws" -14th edition / 2006) states at Rule 120 that "chattels are situate in the country where they are at the relevant time"

One must apply the domestic laws of the country, and not its entire law (including its conflict of laws rules) – no renvoi

Local legal opinion cannot refer back to English law with respect to the validity of the mortgage (or bill of sale) to create (or transfer) an interest in an aircraft / engine (cf – contractual obligations and execution requirements)

TitleValidity

Aircraft / engine located in international airspaceException to Rule 120 stated in Dicey, Morris and Collins with respect to aircraft: "A civil aircraft may at some times be deemed to be situate in its country of registration“The reasoning for this exception is stated to be that “such an ascription would avoid difficulties which could arise in the case of an aircraft in flight over the high seas or a territorium nullius“Blue Sky referred to this exception but did not need to consider itPosition is unclear:- if English conflict rules follows DMC:

- situs would be state of registration- following Blue Sky, one would apply the domestic laws of the

state of registration, and not its entire law (including its conflict of laws rules) – noting that this was not specifically considered in Blue Sky

- English conflict rules might favour the “proper law of the transfer” (i.e. English law if that is chosen under the sale agreement / mortgage) – this is logical in that:- engines invariably have no state of registration- where location is not known, Blue Sky says that English law

applies (and what is the difference between no location and location in international airspace?)

TitleValidity

Aircraft / engine location cannot be determined

An English law mortgage / bill of sale would be valid

Blue Sky states "In the absence of proof of any other law, English law applies and the mortgage is valid"

New York mortgagesNo reference to lex situs

Requirement for connection to the jurisdiction

All relevant perfection requirements remain

TitlePriorities

PurposeEnsure best title

Ensure best title protection against rest of world

- priority over any third parties

- insolvency official, creditor, purchaser, lessee, etc

Priority normally established by further action that “perfects” interest against third parties

- to fullest extent possible

- also possible by contract / structure (as between transaction parties)

- CTC subordination agreement

TitlePriorities

Fundamental insolvency principlePari passu / pro rata / equal payment of creditors

Each creditor is paid from the insolvency estate proportionately to his debt

Always varied

Insolvency ladder (generalised)Super-priority creditors

Priority creditors

Pari passu creditors

Subordinated creditors

Equity shareholders

Expropriated creditors

Title Priorities

Super-priority creditorsSecured creditors

Title finance creditors

Creditors with a set-off

Beneficiaries under trusts

Other “special” categories

Priority creditorsAdministrative claims (i.e. insolvency-related)

Taxes

Employees

Others

Priority creditors can rank ahead of secured creditors – jurisdictions vary

TitlePriorities

Pari passu creditorsSelf-explanatory

“true” / “pure” unsecured pari passu creditors

Subordinated creditorsEquity creditors – creditors whose debt is regarded as equity shares

Equity shareholders

Expropriated creditorsLate claimants

Foreign currency creditors (claim must be proved and converted)

Tort claimants

- Including jurisdictions that follow pre-1986 English insolvency model

TitlePriorities

UK priority rights / title risk

Statutory detention / sale rights

- Eurocontrol / UK CAA for unpaid air navigation charges

- Environment Agency for unpaid penalties under Emissions Trading Scheme legislation

- Airport operator for unpaid airport charges

- HMRC for unpaid taxes

- Priority based on first to exercise detention right

TitlePriorities Contractual liens

Supersedes the terms of a lien that arises by operation of lawCan be more extensive than a possessory lienMay not be effective in all circumstances (e.g. if it extends common law lien to entire fleet or is stated to be effective regardless of possession)

Salvage liensThe Gustaf (1862)

Possessory liensCommon law lienLawful continuous possessionWork on equipment must improve it (not mere maintenance)Work must be authorised

Registered mortgagesin order of registration

Unregistered mortgages

Title RiskHost Aircraft Owners

Host aircraft ownersTitle annexation

Most common in Roman-Germanic civil law systems (e.g. Scandinavia, The Netherlands and Russia)

Engine is considered an integral part of aircraft

Need for protective agreement between relevant parties

Agreed value / total loss coverage for relevant loss event

Increase in agreed value of host aircraft during installation

Title RiskEurocontrol

Eurocontrol / air navigation chargesUK CAA has detention and sale right for Eurocontrol, NATS and Danish / Icelandic navigation charges

detention and sale if charges not paid within 56 days of detention

lien for liability of prior operator

fleet-wide lien

- seized aircraft need not have incurred charges

- engines included in risk

Eurocontrol zone operators / Eurocontrol “abuse”

Title RiskETS

ETS

Emissions Trading Scheme legislation

UK Environment Agency

- detention and sale right for unpaid civil penalties under ETS legislation (failure to comply with regulations / reporting requirements / failure to surrender allowances)

- detention and sale if charges not paid within 56 days of detention

- fleet-wide lien

- UK operators only

- engines included in risk

Title RiskCustoms

Customs authorityRussia (as recent example / Krasair)

- Confiscation risk for breach of customs regulations

- Risk applies even if lessee is not the engine owner

- Engine can be treated as integral part of the aircraft

- Risk logically applies if the engine is not the “offending object”

Title RiskTax

VAT (change in UK rules from 1 January 2011)Applies to sale, import into EU and lease

“Qualifying Aircraft” / zero-rating- Historic – 8,000 kg test- Current – international test

- zero-rating applies to aircraft “used by an airline operating for reward chiefly on international routes” – matches general position across EU

- international routes- any route that is not a domestic route within UK airspace- “chiefly” – more than 50% non-UK - Cimber case (C-382/02 – 2005) – test is assessed by

reference to the airline and not the individual aircraftEngines- VAT treatment follows status of aircraft- If engines are supplied in relation to a qualifying aircraft, VAT

will be zero rated“the supply of parts and equipment, of a kind ordinarily installed or incorporated in, and to be installed, or incorporated in, the propulsion, navigation or communications systems or the general structure of qualifying aircraft” - Value Added Tax Act 1994 / Schedule 8 Group 8 / Note 2A

Detention / forfeiture right for non-payment

Title RiskTransaction Parties

Servicing agent / lease managerFees

- security

- proceeds entitlement / waterfall position

- subordination

ManufacturerMaintenance service agreements

- Contractual / fleet lien over subject engines

Buy-back rights / sale consent

- Under original manufacturer purchase agreement

- Due diligence / consent

Title RiskInsurances

Possible challenges by insurers in relation to insurance proceeds entitlement

Blue Sky case

Insurable interestPrinciple- Insured must have some relationship with the subject matter of

the insurance- English law definition

“a right in the property, or a right derivable out of some contract about the property, which in either case may be lost upon some contingency affecting the possession or enjoyment of the party” (Lucena v Crauford (1806))

Examples include equipment owners and mortgagees

Interest need not be vested or proprietary

For liability insurance, this includes anyone with a potential liability

Can insurers claim that a failure to properly create and perfect a mortgage means that the mortgagee has no insurable interest?


Duty of Good FaithUtmost good faith / uberrima fides

Duty arises by operation of law

Disclosure- insured’s duty to disclose all material facts (1) that

are within the actual knowledge of the insured or (2) that, in the ordinary course of business, ought to be known by the insured and are reasonably ascertainable

- provisions of the Marine Insurance Act 1906 (ss.17-19) state the common law position and apply equally to aviation insurance

- possible breach of duty of good faith for failure to disclose non-perfected mortgage interest


Duty of Good Faith

Misrepresentation- a representation as to a material fact that is false or

inaccurate

- again derived from Marine Insurance Act 1906 (s.20)

Continuing duty- not just at policy inception- applies at renewal / extension and at other “key” points

(e.g. if the policy is varied mid-term)- “..continues throughout the contractual relationship at a

level appropriate to the moment” (Manifest Shipping Co Ltd v Uni-Polaris Ins Co Ltd (The Star Sea) (1997))

Consequence of breach of duty of good faith- insurers can avoid insurance contract


Duty of Good Faith

AVN 67 (s.3.2)- coverage for Contract Parties not invalidated by

act or omission (including misrepresentation and non-disclosure) of any other person

Duty of Contract Parties- duty applies equally to Contract Parties (subject

to AVN 67 protection above)

Title ProtectionPractical Methods

Variety of practical methodsHost aircraft owners

Protective agreement (RoRA)Agreed value payment obligation on title loss / increase in agreed value of host aircraft

MonitoringEurocontrol letter (current approach / all operated aircraft)ETS letterAirport letter

InsuranceNon-repossession insurance- Physical re-possession risk- De-registration / export risk- Government / third party lien risk- Technical records

Title ProtectionPractical Methods

Insurance (cont.)Contingent insurance

- Airline’s policy fails to respond

- Termination for non-payment of premium

- Operations outside geographical limits

- Failure of cut-through clause

- Insurer payment illegality / impossibility (e.g. caused by sanctions or exchange control restrictions)

- Limits exceeded

- Errors and omissions by insurance broker

Title ProtectionLegal Methods

Basic legal requirementsSpecific documentary provisions to be included- see “Jurisdictional Review: Security Issues” Specific documentary formalities to be observed- notarisation / other documentary formality- stamping / other payment- as condition to effectiveness of document / filing /

perfection / admissibility in court

PerfectionAssuming due transfer / creation of original interest - effective as between the partiesPerfection - how does the interest become effective against third parties?- third party creditor / purchaser / lessee / other- insolvency officials

Title ProtectionLegal Methods

Methods of perfectionFiling in public register- debtor registers (companies / commercial register)- asset registers (national aircraft register / CTC

International Registry)- “UCC” style registers - other registers (title / deeds register)NoticePossession / control

Title ProtectionCape Town Convention

Application to enginesAircraft engines are “aircraft objects”- 1,750+ lbs thrust / 555+ horsepowerHelicopter engines are not “aircraft objects”- if installed- ability to register prospective international interestEngines in context of aircraft financing- if the only CTC connection is the state of

registration of the aircraft, international interest in engine is not registrable (c.f. – actual practice)

Where is the debtor situated?- Place of incorporation- Place of registered office- Centre of administration- Place of business- Cayman / Irish entities


PrioritiesA registered interest has priority over an unregistered interest and a subsequently registered interest – Art 29

A Contracting State can declare that CTC applies to pre-existing interests (3 year limit) – Art 60

A Contracting State can declare priority for certain non-consensual interests – Art 39

A Contracting State can declare certain non-consensual interests to be registrable – Art 40


Interaction with domestic law

Good international interest / bad national interest

Why do you need a good national interest?

Practice on engine transactionsValid international interest / remedies should be recognised by Contracting States – that is the purpose of CTC

Ensure effective national interest in non-Contracting States

Example – financing of engine owned by US owner trust and leased to Brazilian airline

Title ProtectionNational Registers

Lack of engine-specific registers / registers that permit recording of engine interests

US / FAANotable exception

Register for leases / mortgages in relation to engine interests that have US connection (owner / operator)

FAA counsel

Pre-positioning of original documents

Other countriesTitle / deed register – Napoleonic jurisdictions (e.g. Brazil)

Company / commercial registers

Title ProtectionUCC Article 9

Uniform Commercial Code OverviewUnified code of rules for creation and public registration of security interests in personal propertyState law- model law that can be adopted by each state (level of

overall harmony is high since 1998 revisions)Personal property – all assets other than landSecurity interests- broad- any transaction that creates a security interest in

personal property by contractSecurity created by all persons (including individuals) Coverage- Creation / attachment- Publicity / perfection - Priorities- Enforcement (excluding on insolvency)

Title Protection UCC Article 9

Uniform Commercial Code Overview (cont.)Simple filing system

- “notice” filing system

- Name of parties / simple description of collateral

- No filing of security agreement

- “Tender rule” – filing is at the time of communication (not time of entry on record)

- Debtor need only authorise (not sign)

- Third parties make enquiries of debtor (secured party has no obligation to give information)

- Electronic filing

- No filing time limit

- Filing renewal requirements - continuation statement filed within 6 months of each 5 year period


“Unique” featuresTitle finance = secured financeCoverage- Reservation of title- Conditional sale- Finance leaseLease tests – when is a lease a security interest?- Lessee obligation to acquire title or use asset for

projected useful life- Lessee option to acquire title (or extend lease

term beyond projected useful life) for no / nominal consideration

Substance over form - c.f. English common lawSubject to Federal law- e.g. separate FAA rules for aircraft mortgagesCodifies priority rules


Perfection MethodsFiling- The basic method of perfectionOther required methods for different collateral (examples)- Federal action

- Aircraft / engines (FAA rules)- Possession

- “chattel paper” – a record that evidences a monetary obligation and a security interest in specific goods (e.g. – finance lease or operating lease with security deposit)

- Control- deposit accounts – automatic if secured party is

depositary bank; otherwise control agreement under which depositary bank agrees to comply with secured party’s instructions without debtor consent

Jurisdictional ReviewLegal Families

Anglo-American Common Lawc.47% (by number of jurisdictions) / c.35% (by population)

England, Australia, Canada (excl. Québec), much of Caribbean, Cyprus, Hong Kong, India, Ireland, Israel, Malaysia, New Zealand, Nigeria, Pakistan, Singapore, USA

Napoleonic (Civil Law)c.26% (by number of jurisdictions) / c.23% (by population)

France, Belgium, Greece, Italy, Luxembourg, Portugal, Spain, Francophone Africa, most of Latin America and North Africa, much of Middle East

Roman-Germanic (Civil Law)c.10% (by number of jurisdictions) / c.11% (by population)

Germany, Austria, Baltic States, Czech Republic, Korea, The Netherlands, Poland, Russia, Scandinavia, Switzerland


English common lawMost comprehensive and liberal system with respect to corporate entitiesGenerally creditor friendlyFew formalitiesGreat scope for security (including “universal” security)- present and future assets- present and future liabilitiesSimple enforcement procedures- usually without court assistance- usually without grace periods / limitationsSimple / centralised debtor filing systems for security interests Relatively low avoidance riskRecognition of trusts


American common law Largely protective of security interests

Similar to English common law

UCC – simple “perfection” system

Differences

- Separate state regimes for real property

- Self-help enforcement more restricted

- Chapter 11 corporate reorganisation restricts security interest

- Title finance recharacterisation as secured finance


Roman-Germanic Arguably less favourable than Anglo-American group; more favourable than Napoleonic group

Scope of security can be quite wide

Corporate rescue principles limited

Limiting features

- Restrictions on security over future assets

- Restrictions on security over “all” assets (cf English floating charges)

- Requirement for possession in certain jurisdictions (such as Austria / Switzerland)

- “Special” requirements for security (such as a statement as to the secured amount)

- Lack of recognition of trusts (subject to Hague Trusts Convention 1985)


Roman-Germanic (cont.)- Accessory nature of security

- Requirement for “parallel debt” provisions

- Notarial formalities

- “over-security” principles (Germany)

- limited security renewal requirements (Finland –10 years)


Napoleonic Less favourable than Anglo-American and Roman-Germanic groups

Limiting features

- Restrictions on security over future assets

- Problematic to secure future debt

- “Special” requirements for security (such as maximum secured amount / specified interest rate)

- Enforcement regime tends to be debtor-protective

- Emphasis on judicial processes (auctions / court orders)

- Restrictions on self-help


Napoleonic (cont.)- Security registrations subject to renewal

requirements- Argentina – 7 years- France – 10 years- Italy – 20 years

- Greater formalities - notarial requirements- formalised notification procedures for

assignments of contracts and rights- Centralised debtor filing systems for security

interests less common (e.g. at a companies / commercial registry)

- Possessory requirements- Historic non-recognition of trusts (except in much

of Latin America and (more recently) France / subject to Hague Trusts Convention 1985)

Jurisdictional ReviewSecurity Issues

Accessory securityUsually in civil code jurisdictions

Security is accessory to secured debt (i.e. it follows and depends upon it)

Assignment of debt carries assignment of security

Discharge of debt (or invalidity of secured obligation) terminates the security

- “classic” English law / LMA loan transfers

Role of security trustees

Parallel debt provisions


Third party security Security granted for the obligations of a third party

Unusual to find prohibitions

Some exceptions

- France – assignment of business receivables under the Monetary and Financial Code (arts. 313-322)

- Belgium – general enterprise pledge

Possible solution

- Security granted to secure debtor’s obligations under a guarantee given by it in relation to the third party liabilities


Security over derivative assets and rights

Ideal – security over an asset includes:Asset in another form

- such as proceeds / insurance proceeds

Derivative / related assets and rights

- such as rights in relation to shares (e.g. dividends / voting rights) in the case of share security

- such as guarantee rights


Security over derivative assets and rights (cont.) Proceeds

English law – no automatic entitlementUCC includes proceeds – any property arising in respect of the collateral (can include proceeds of proceeds)

InsurancesEnglish-based systems do not cover insurances- A security interest over an asset does not (per se)

include an assignment of the related insurancesCivil law / US jurisdictions cover insurances- Insurances automatically follow the mortgaged

asset- Austria, Denmark, France, Germany, The

Netherlands, Norway, Switzerland, USA (personal property covered by UCC 9-102)


Supporting guarantees and securityGeneral rule - an assignment of a debt includes any supporting guarantees or security

Examples

- England - if a debt is assigned without reference to any supporting mortgage, the transferor holds as trustee and must enforce in accordance with the instructions of the transferee as beneficial owner

- USA – creation of security over debt / contract carries with it supporting guarantees and security interests (UCC 9-203)

Perfection – registration of assignment might be required at any relevant registry

Prudent practice – formal assignment / transfer


Description of secured debtEnglish and American common law systems allow cross-reference to other documents (e.g. loan agreement)

Many Napoleonic (and some Roman-Germanic) jurisdictions require full details of secured debt in the security agreement


Future debt English and American common law systems freely allow security for all present and future debts –expressed as a “continuing security”

- unless (for example) the future debts are outside the originally intended scope of the security (in which case new security must be granted)

UCC Article 9 is more permissive than English law

Roman-Germanic and Napoleonic systems are less permissive and often require that the debt is “determinable” (future debt can be determinable)

- new security might have to be created for new debt

- in traditional Napoleonic jurisdictions, there are real limitations (so that even a revolving credit facility might not be covered)


Maximum secured amount / maturity date English common law jurisdictions - no objection in most jurisdictions to security for an unspecified amount

Napoleonic / Roman-Germanic jurisdictions – most jurisdictions require stated maximum amount

Amounts to be stated might include principal, interest and other amounts

- possible limitations / calculations required in relation to interest (e.g. 3 years interest in France and Belgium)

- creditors will look to have highest amounts

- debtor might not wish to have inflated amounts recorded on a public register

- stated amount may drive costs (notarial or registry fees; which might be affected by inflated figures)

- if stated amount is exceeded, new security will be required (which might be subject to intervening security)


Maximum secured amount / maturity date (cont.)

Maturity date statement more common in Napoleonic jurisdictions (but generally not usual –instead there might be a requirement to state that the security is granted for an undetermined period)


Interest Some jurisdictions limit:

- the rate of interest that can be charged

- the period of back interest

- the capitalisation of interest or the charging of interest on interest

Basis in usury laws

No usury laws in England since 1854

Back interest

- Napoleonic jurisdictions often limit

- Argentina, Italy – 2 years

- Belgium, France, Greece – 3 years

- Most English-based jurisdictions do not have limits (just usual limitation periods for claims)


Interest (cont.)Capitalisation of interest

- Problematic in some jurisdictions (Germany, Argentina, Brazil)

- Permitted in most English-based jurisdictions

Penalty interest

- Reasonable penalty interest is valid in many countries

Foreign currency debtA number of countries have restrictions on mortgage debts being expressed in a foreign currency

- often due to exchange control rules or a lack of up-dating in the law

- land mortgages may have to state the local currency amount for registration purposes –Germany, The Netherlands, Switzerland and Sweden

LEGAL ISSUES - Airfinance Journal Validity z Blue Sky v Mahan Air (2010) z Validity of mortgage /...

Documents

Transcript of LEGAL ISSUES - Airfinance Journal Validity z Blue Sky v Mahan Air (2010) z Validity of mortgage /...