Australia: Cape Town Convention (aircraft financing and leasing) – Developments in China and Indonesia

Last Updated: 8 November 2016

Introduction

The ratification of the Cape Town Convention (the Convention) continues apace. Widely acknowledged as promoting legal certainty and so improving the availability and terms of aircraft finance and leasing in contracting states, the degree of benefit it actually brings largely depends on the way it is actually legislated for and implemented in the relevant jurisdiction. One key issue is the Irrevocable Deregistration and Export Request Authorisation (IDERA) and Certified Designee Certificates (CDCs) under which a creditor of an airline (or its designee) can procure the deregistration of the aircraft following a default. In this article we consider current practice and regulation in East Asia's two most populous jurisdictions.

People's Republic of China

Financing aircraft in the People's Republic of China (the PRC) requires lenders to assess the availability of protections under the Convention for transactions involving onshore PRC lessors leasing aircraft to PRC airlines.

The Convention came into force in the PRC in 2009 except for the Special Administrative Regions of Hong Kong and Macau. The PRC utilised the Convention's flexibility to apply or disapply certain provisions through making declarations.

Under Article 50(1), the PRC made an opt-out declaration that the Convention shall not apply to national interests created by 'internal transactions' between a PRC debtor and a PRC creditor which relate to Aircraft Objects located in the PRC when the interest is created.

The PRC is one of only a handful of Contracting States to make the internal transaction declaration. The result is that the Civil Aviation Authority of China (the CAAC) treats any lease between a PRC lessor and a PRC airline as a separate and independent transaction from that PRC lessor's financing arrangements with an offshore lender - whether such financing is entered into with the lease or subsequently.

The significance of the declaration becomes apparent in this scenario. Notwithstanding that the lessor (probably an SPC) acquires the aircraft to be leased to the PRC airline with the benefit of the offshore funding, the CAAC will deem the leasing aspect of the transaction independent to the financing.

This has consequences for lenders. The leasing arrangement is excluded from Convention protections including most default remedies under Chapter III. Because aircraft are registered and operated in the PRC by airlines, the IDERA is granted by the airline not the lessor. The current CAAC practice is not to accept submission of any IDERA from the airline as the Convention is deemed not to apply. Access to an IDERA usually forms an important part of a lender's credit risk mitigation when financing aircraft in Cape Town jurisdictions because it should allow the aircraft to be swiftly deregistered and immobilised in a default situation.

Nevertheless, offshore lenders can still take comfort that the priority rules under the Convention will apply to an internal transaction. Hence, notice of the internal transaction can and should be registered under the Convention to secure the same priority treatment as a registered international interest. Article 30 of the Convention covering insolvency proceedings also remains applicable to the national interest and the PRC has adopted Alternative A.

Therefore, an offshore lender can in theory assert priority of its security interest against third parties and in any insolvency proceedings which provides some comfort under the Convention rather than relying solely on domestic PRC law.

Indonesia

Indonesia's Directorate General of Civil Aviation (DGCA) is currently drafting a regulation on IDERAs that is expected to favor aircraft financiers.

Current situation

The existing regulations on IDERAs do not specifically cover IDERAs in favor of financiers or certified designees. As a result, DGCA policy has lacked consistency. While lease agreements previously had to stipulate that the IDERA would be in favor of the financiers, the DGCA now requires consent from all parties (owners, lessors, operators and financiers) before an IDERA can be filed in favor of financiers, particularly when the financier or security trustee is not named in the lease agreement.

The DGCA does not maintain an official registry or records of CDCs. While a simple receipt of the submission of the CDC used to be provided by the DGCA, now the DGCA no longer accepts CDCs.

New regulation

In response to market developments, the DGCA is considering a regulation that expressly permits an IDERA to be granted in favor of financiers and the recording of CDCs.

Under the draft, financiers would be required to provide a summary of the relevant agreements (aircraft finance documents, headlease and sublease agreements) to record an IDERA in their favor. The DGCA plans to use this summary to understand the linkage between Indonesian operator (as the issuer of the IDERA) and the financier (as the party authorized under the IDERA).

The DGCA wants to allow aircraft deregistration to be processed by exercise of an IDERA, without investigating external facts related to the occurrence of default. While not the intention of the Cape Town Convention, the Indonesia's Aviation Law suggests that the DGCA should check if an event of default has occurred before deregistering aircraft. To avoid any involvement in determining the occurrence of an event of default, the DGCA expects all necessary information related to the event of default and the default mechanism to be submitted before the IDERA is recorded.

CDC registry

The DGCA plans to establish an official CDC registry. This should benefit financiers, especially if aircraft financing occurs at a later stage of aircraft leasing. Using CDC arrangements, it will not be necessary to revoke the existing IDERA and issue an IDERA in favor of the financiers – a process that can take some time.

Note: This discussion on the draft IDERA regulation is based on meetings held with the DGCA in August 2016. Since the DGCA is still discussing the draft regulation with various stakeholders, the regulation remains subject to change, with the final version expected to be issued by the end of 2016.

In summary

This article illustrates the importance, when relying on the Convention, of obtaining advice on actual practice and procedure in the relevant jurisdiction rather than on a high level interpretation of the Convention.

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