As China's population continues to surge and its foreign currency reserves swell, the aviation industry in China is expanding at an astonishing rate. Indeed, a Chinese aviation official recently confirmed that China's airlines are preparing to purchase hundreds of new airplanes,¹ and The Boeing Company has forecast that "China's airlines by 2031 will need 5,260 new airplanes valued at $670 billion."²

This epic expansion has created countless business opportunities in China for aviation-related industries, including manufacturers, banks, and lessors. It has also created numerous legal challenges for their counsel, including choosing the governing law of the aircraft sale agreement or lease.

Where a contract for a sale or lease with a Chinese entity and a foreign entity contains links to more than one legal order, it is crucial to designate at the outset and understand the provisions commonly referred to as "choice of law" or "governing law" provisions. These provisions determine the applicable law that will be used to resolve potential disputes. Many banks and other institutions choose New York or English law to govern their legal matters because New York City and London are major financial centers with a well-developed body of commercial law precedent and extensive experience with international trade and disputes.³ This article will discuss some of the advantages for aircraft companies doing business with Chinese⁴ entities in applying New York law to aviation leases and sale agreements.

Prior to 1979, there were few choice of law rules governing commercial trade in China because, for the most part, Chinese law governed all contracts. In the last few decades,  China has implemented major economic reforms aimed at moving the nation toward the mainstream of the world economy, which included adopting a more liberalized approach toward choice of law rules, including providing for party autonomy in aviation operating leases.⁵ For aircraft sale matters, however, Chinese law did not provide for party autonomy and required that the law of the State in which a civil aircraft was registered would "be applicable to the acquisition, transference and extinction of the ownership of the civil aircraft."⁶ This restriction ceased in 2009 when China ratified the Cape Town Convention⁷ and the related Cape Town Aircraft Protocol⁸ (the "Protocol" and, together with the Cape Town Convention, the "Cape Town Treaty") and made an opt-in declaration to the Protocol's choice of law provisions.⁹

Today, with China's ratification and declaration under the Protocol, "[t]he parties to an agreement, or a contract of sale, or a related guarantee contract or subordination agreement may agree on the law which is to govern their contractual rights and obligations, wholly or in part."¹⁰ Accordingly, Chinese law provides that, in an aircraft operating lease transaction or a transaction where the Cape Town Treaty is applicable, such as the case where an aircraft is registered in China or a Chinese entity is the lessee, seller, or conditional buyer of the aircraft, the contract parties may choose the governing law of the agreement.

Although both New York and English law provide for party autonomy in commercial transactions and allow the parties to an aircraft sale agreement or lease to designate New York or English law, respectively,¹¹ only the United States has ratified the Protocol and made the same opt-in choice of law declaration as China. While English law does provide for party autonomy even absent its ratification of the Cape Town Treaty, the UK's lack of adherence to a key aviation treaty is a prime example of where New York law shares more in common with Chinese law.

Besides this shared adherence to an important aviation treaty, New York contract law incorporates similar legal protections as those found in Chinese contract law, and this commonality can help satisfy the reasonable expectations of Chinese companies involved in complex aviation transactions. In particular, China's Contract Law ("CL") includes an obligation of good faith whereby "parties shall abide by the principle of good faith in exercising their rights and performing their obligations."¹² This obligation is similar to New York's Uniform Commercial Code ("UCC"),¹³ which states that "[e]very contract or duty within this Act imposes an obligation of good faith in its performance or enforcement."¹⁴ New York's covenant of good faith is also not limited to the UCC, and New York's highest court has held that "[e]very contract implies good faith and fair dealing between the parties."¹⁵ Good faith is so important under New York law that the UCC expressly prohibits agreements disclaiming the implied covenant of good faith and fair dealing.¹⁶

The good faith protection offered by both Chinese and New York contract law contrasts with English law because "[t]here is no general principle of good faith established in English law."¹⁷ This distinction is an important one that places English law outside the framework of the international contract principles that many parties, including Chinese, take for granted.

For instance, the United Nations Convention on Contracts for the International Sale of Goods ("CISG")¹⁹ requires "the observance of good faith in international trade."²⁰ While the CISG is inapplicable to the sale of aircraft, it is illustrative of the approach that China and the United States have applied to contract law. Both China and the United States have ratified the CISG and have generally accepted this good faith principle into their domestic contract law,²¹ but the UK has not. As such, English law has the potential to create unnecessary risk and uncertainty for contract parties that would otherwise be accustomed to the protection of an implied covenant of good faith in most other domestic and international contracts.

This risk and uncertainty is not just theoretical, and a lack of good faith in a complex contract can have critical ramifications. This risk can be illustrated in numerous ways. For example, a company acts contrary to good faith if it grants another entity the option to purchase an aircraft within a fixed time limit and then deliberately makes itself unavailable for such period so that the option cannot be exercised.²² Similarly, a contract's terms might provide that a party may accelerate payment or performance "at will" or when the party deems itself "insecure."²³ An aircraft financier's demand for payment, however, without justification and with no prior warning would be against good faith.²⁴

Furthermore, it is settled New York law that a failure to fulfill a condition precedent prior to closing relieves a contracting party from having to complete the transaction.²⁵ However, the implied covenant of good faith and fair dealing requires a promisor to reasonably facilitate the occurrence of a condition precedent by either refraining from the conduct that would prevent or hinder the occurrence of the condition, or by taking positive action to cause its occurrence.²⁶ Thus, a party cannot get out of its agreement by failing to take action to fulfill the conditions precedent of the agreement.

Finally, take as an illustration the New York UCC's provision on modification of a sales contract, which provides that "an agreement modifying a contract within this Article [Article 2] needs no consideration to be binding."²⁷ Suppose that an aircraft seller refuses to perform for no other reason other than that the price of the aircraft has gone up and the seller wants to extort a higher price from the buyer. Such a modification of price would be ineffective because the modification must meet the test of good faith.²⁸ As a seller or purchaser or lessor or lessee of aircraft, having to abide by a doctrine of good faith and knowing that your contracting partner must abide by the same doctrine is very appealing. The implied covenant of good faith found in both Chinese and New York law is intended to inject an element of fairness and protect the parties' expectations and interests because abuses of discretion, lack of clarity, and omission can arise in every contract.

In contrast to the adoption of an implied covenant of good faith, one British judge noted, "English law has, characteristically, committed itself to no such overriding principle but has developed piecemeal solutions in response to demonstrated problems of unfairness."²⁹ Although English "piecemeal solutions" may often reach the same result,³⁰ New York's and China's shared legal framework regarding the issue of good faith is more likely to be established, understood, and trusted by all concerned parties. This circumstance is important when deciding which law should govern a complex aviation agreement because cultural and legal misunderstandings can present obstacles and delay finalizing deals.

Chinese companies and foreign aircraft companies doing business in China will find that there are advantages to choosing New York law over English law based on common international standards and good faith principles found in both New York and Chinese law.

Footnotes

1 Joanne Chiu and Jeffrey Ng, " Aviation Industry Leaders Cautious On Near-Term Industry Growth Prospects," Wall St. J. (Jun. 11, 2012).

2 Boeing, Long-Term Market: China (accessed Nov. 14, 2012).

3 See N.Y. State Bar Ass'n, Choose New York for International Arbitration; The Law Soc'y of Eng. and Wales, England and Wales: The jurisdiction of choice.

4 This article does not address Hong Kong or Macau, which have their own legal systems.

5 Choice of law issues for aircraft operating leases and certain other transactions outside the aviation context are governed by the Law of the People's Republic of China on the Laws Applicable to Foreign-related Civil Relations (promulgated by the Standing Comm. Nat'l People's Cong., Oct. 28, 2010, effective Apr. 1, 2011), available here.

6 Civil Aviation Law of the People's Republic of China (promulgated by the Standing Comm. Nat'l People's Cong., Oct. 30, 1995, effective Mar. 1, 1996), art. 185, available here.

7 Convention on International Interests in Mobile Equipment (Cape Town, Nov. 16, 2001). (This significant treaty offers international standards for the registration of ownership, liens, leases, and conditional sales contracts, and it provides a shared legal framework that can help alleviate the insecurity related to financing complex aviation agreements).

8 Protocol to the Convention on Int'l Interests in Mobile Equip. on Matters specific to Aircraft Equip (Cape Town, Nov. 16, 2001).

9 Protocol, art. VIII.

10 Id.

11 See N.Y. Gen. Oblig. Law § 5-1401 (authorizing parties to choose N.Y. law to govern commercial contracts valued at $250,000 or more); see also Regulation (EC) No 593/2008 of the European Parliament and of the Council of June 17, 2008 on the law applicable to contractual obligations ("Rome I"), 2008 O.J. (L 177) 6 (governing choice of law matters in the UK). (Prior to Rome I, international contracts involving choice of law issues were governed by the Rome Convention on the Law Applicable to Contractual Obligations, 1980 O.J. (L 266) 1, reprinted in 19 I.L.M. 1492 (1980)).

12 Contract Law of the People's Republic of China, (promulgated by the Nat'l People's Cong., Mar. 15, 1999, effective Oct. 1, 1999), art. 6, available here.

13 See Patricia Pattison & Daniel Herron, "The Mountains Are High and the Emperor Is Far Away: Sanctity of Contract in China," 40 Am. Bus. L.J. 459, 471 (2003) ("the CL now holds parties to good faith performance standards....This parallels the UCC's requirement of good faith.").

14 N.Y. U.C.C. § 1-203.

15 M. O'Neil Supply Co. v Petroleum Heat & Power Co., Inc., 280 N.Y. 50, 19 N.E.2d 676 (1939). See also 511 W. 232nd Oivners Corp. v. Jennifer Realty Co., 98 N.Y.2d 144, 746 N.Y.S.2d 131, 773 N.E.2d 496, 500 (2002).

16 N.Y. U.C.C. § 1-102(3).

17 Nathalie Hofmann, "Interpretation Rules and Good Faith as Obstacles to the UK's Ratification of the CISG and to the Harmonization of Contract Law in Eur.," 22 Pace Int'l L. Rev. 145, 163 (2010).

18 Cf. UNIDROIT Principles of Int'l Commercial Contracts, 1994, art. 1.7(1), 34 I.L.M. 1067, 1069 (1995) ("Each party must act in accordance with good faith and fair dealing in international trade.").

19 U.N. Convention on Contracts for the Int'l Sale of Goods, art. 2(e), (Vienna, Apr. 11, 1980), 1489 UNTS 3.

20 Id. at art. 7(1).

21 See, e.g., Restatement (Second) of Contracts § 205 (1979) ("Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement.").

22 Cf. UNIDROIT Principles of Int'l Commercial Contracts, art. 1.7, cmt. 1.

23 N.Y. U.C.C. § 1-208.

24 Cf. UNIDROIT Principles of Int'l Commercial Contracts, art. 1.7, cmt. 4.

25 Perna v. Desai, 101 A.D.2d 857, 858, 475 N.Y.S.2d 883 (2d Dep't 1984), aff'd, 63 NY2d 898, 472 N.E.2d 1039, 483 N.Y.S.2d 211 (1984).

26 In re Roman Crest Fruit, Inc., 35 Bankr. 939 (Bankr. S.D.N.Y. 1983).

27 N.Y. U.C.C. § 2-209.

28 Id. cmt. 2.

29 Interfoto Picture Library Ltd v Stiletto Visual Programmes Ltd, [1989] 1 Q.B. 433.

30 See Mary E. Hiscock, "The Keeper of the Flame: Good Faith and Fair Dealing in Int'l Trade," 29 Loy. L.A. L. Rev. 1059, 1070 (1996); Nathalie Hofmann, "Interpretation Rules and Good Faith as Obstacles to the UK's Ratification of the CISG and to the Harmonization of Contract Law in Eur.," 22 Pace Int'l L. Rev. 145, 164 (2010).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.