UK: Is the Pindell Case Manifestation of the Law of Unintended Consequences?

Last Updated: 5 April 2011
Article by Zohar Zik

Zohar Zik1 considers the decision of Pindell Limited v AirAsia Berhad2, in which the court rejected a claim made by an aircraft lessor against the lessee for damages relating to the loss of the sale of the aircraft due to late redelivery by the lessee. In particular, he examines the implications of the decision on the leasing industry and offers some practical steps that parties to leasing transactions might wish to consider when attempting to mitigate them.

Facts

This claim concerned an aircraft which was owned by Pindell Limited (Pindell) but operated by AirAsia Berhad (AirAsia) under a sublease agreement which was granted in June 2003 for a five-year term by Pindell's lessee, BBAM Aircraft holdings 98 (Labuan) Ltd (BBAM).

By 2007, the aircraft was 20 years old, an age described as a "watershed" in the life of a commercial jet aircraft. In February 2008, BBAM, acting on Pindell's behalf, agreed to sell the aircraft to an unconnected leasing company by 1 August 2008 for a very attractive price. The sale agreement allowed the purchaser to terminate if Pindell failed to perform its obligations thereunder.

Due to significant mechanical problems, AirAsia failed to redeliver the aircraft at lease expiry and, in fact, the aircraft was only returned in November 2008. By then, aircraft values had plummeted and, consequently, the purchaser had exercised its option to terminate the sale agreement and walked away from the deal.

Issues

There were two key questions of law in this case: firstly, was AirAsia contractually obliged to redeliver the aircraft by the contractual expiry date of 17 June 2008 and, if so, was BBAM estopped from asserting that AirAsia was, in that regard, in breach of contract? Secondly, if BBAM was not estopped, could it claim in respect of the loss of the follow-on sale?

Attending to the first issue, the judge considered the redelivery provisions in the sublease and concluded that AirAsia was obliged – and had failed – to deliver the aircraft for technical inspection before 17 June 2008 and that, notwithstanding the fact that BBAM had, in practice, extended the lease period and the termination date, AirAsia was therefore in breach of contract. The judge also found that BBAM was not estopped from asserting that AirAsia was in breach. This was because there had not been the requisite common assumption between the parties that redelivery after the original expiry date would not be regarded as a breach of contract by AirAsia or that BBAM would not seek to insist on its legal rights.

Having established that AirAsia's breach was actionable, the judge then considered whether BBAM could succeed in a claim for damages in respect of the loss of the follow-on sale, and found that it could not. The judge also concluded that, as a matter of construction, BBAM could not claim under the contractual indemnities.

Comment

Reading through the Pindell judgment, one cannot avoid asking whether the "new" approach promulgated by The Achilleas3 and then applied in Pindell is a manifestation of the law of unintended consequences. Sadly, it appears that, as far as it applies to adjudicating disputes over aircraft operating leases, the answer would probably be "yes".

In The Achilleas, the dispute revolved around the late redelivery of a vessel with the consequence for the owner that a new charterer accepted the vessel, but following a fall in freight rates in the meantime, did so at a reduced rate. The owner sought to recover the difference between the original and the reduced rate of hire from the original charterer, but failed.

In the House of Lords, when considering the question of recovery of consequential losses, Lord Hoffmann and Lord Hope accepted that the Hadley v Baxendale test of reasonable contemplation would continue to be the norm but advocated a refinement of the test in "unusual" cases (unusual by reference to the circumstances of a case or by reason of the relevant market) by requiring consideration of whether the defendant had assumed contractual responsibility for a given type of loss. In contrast, two other law lords reached the same decision, but on the basis of the traditional Hadley v Baxendale test of reasonable contemplation. Although there has been some doubt as to what was the underlying ratio of this judgment, the decisions in Pindell and in a number of other cases4 seem to suggest that Lord Hoffmann and Lord Hope's "new" approach is the prevailing ratio.

On its face, this trend is good news for businesses as it gives courts presiding over disputes greater flexibility in formulating what they consider to be the most commercially sensible outcome. But this may not necessarily be the case. In Pindell, for example, the judge accepted the view that lessees enter into operating leases primarily because they do not wish to be exposed to residual value fluctuations, and deduced that, if a lessee knew it was going to be exposed to the risk of lessor's loss of follow-on sale or lease, it would be easier for that lessee to buy rather than lease an aircraft. This conclusion is, however, somewhat simplistic, to say the least.

Ignoring the fact that many lessees use operating leases because they simply cannot afford to buy an aircraft, the basic premise of operating leasing is as follows: the lessor's interest in the aircraft is purely financial with a view to making a return on the asset through leasing it during its useful lifetime and eventually disposing of it in one form or another. The lessee's interest in the aircraft, on the other hand, is purely operational with a view to making a return through utilisation over the term of the lease. However, for the lease term the lessee's position vis-ŕ-vis the aircraft is tantamount to ownership in all material respects. This dichotomy translates itself into rigid lease conditions for maintenance, operation and redelivery of the aircraft, aimed at maintaining aircraft value (barring extrinsic factors) and optimising follow-on transferability. The lessor is totally dependent on the lessee to comply with those obligations and, if the lessee fails to do so, the lessor's long term investment in the aircraft could be in jeopardy – at no fault of its own – and this exposure is particularly acute at redelivery. In these circumstances, it's not only just, but also sensible that the lessee and not the lessor should be liable for the loss of a follow-on lease or sale.

In Pindell, once the judge concluded that the risk of a loss of follow-on sale was the lessor's as a matter of principle, it was easy for him to conclude that the real reason for the loss was, in fact, the volatility of the market, echoing the views expressed by Lord Rodger in The Achilleas5.

Leaving other factors aside (such as the fact that the age of the leased aircraft should not have been given such prominence by the judge, as both parties knew from the outset that it would be 20 years old at lease expiry), the fact that the market was, at the relevant time, particularly volatile should have been neither here nor there in terms of allocating responsibility for the loss in this case. Taken to the extreme, this judgment means that lessors, such as BBAM, with more than 250 aircraft on its books, might need to consider whether they need to report the possibility of losing follow-on sales as a result of lessees defaulting on redelivery obligations as a new, contingent and substantial portfolio-based liability.

As such, this decision could present lessors with significant, undue exposures, leaving them with seemingly very little in terms of mitigation. Whilst lessors could, in theory, seek to pass the financial burden of the new risks back onto lessees by way of increased rentals, such a broad-brushed approach could be counterproductive and detrimental to all concerned, but to lessees in particular. Some other, less draconian options that lessors might wish to explore could be:

  1. To agree with the lessee from the outset who should be responsible for this type of loss and make sure this is clearly documented in the lease.
  2. To ensure that any follow-on sale agreement contains:

    1. Delivery conditions that match, as much as possible, the lease redelivery conditions.
    2. A longstop period which reflects the transactions at hand, taking account of the age or type of the aircraft and any projected complexities surrounding redelivery, including any bridging works that may be required.

  3. To inform the lessee of any follow-on sale agreement as soon as it has been agreed.
  4. To tighten up the contractual indemnity provisions to ensure that they are wide enough to cover the lessor in these instances. In Pindell, the judge concluded that BBAM could not claim under the contractual indemnity as a matter of construction. It remains unclear whether a more widely drafted clause would have given BBAM the contractual right it needed to pass the actual risk of loss to AirAsia; having reviewed the relevant provisions in the sublease, as recited in the judgment, it is possible a more tightly worded clause may have achieved this.
  5. To agree a liquidated damages provision that will be case specific and truly reflect the parties' attempt to pre-estimate the likely losses that could arise in the event of late redelivery. By contrast, in Pindell (as is the case with most aircraft leases), the lease provided for a payment of rent at 150 per cent of the basic rent in the event of late redelivery in excess of 21 days. This holdover rent was not an exclusive remedy and was payable in addition to any other damages the lessor might have sustained as a result of the delay; such "other damages" were then found to be unrecoverable.

The decision in Pindell presents the industry with a number of new exposures that lessors and lessees need to be addressing during lease negotiations and throughout the life of the lease to make sure that their respective obligations are clearly defined, complied with and, to the extent necessary, appropriately priced.

Footnotes

1. Zohar is the former General Counsel – Aviation of TUI Travel PLC

2. [2010] EWHC 2516 (Comm)

3. The Achilleas [2008] UKHL 48

4. See Supershield Ltd v Siemens Building Technologies FE Ltd [2010] EWCA Civ 7 and Sylvia Shipping Co Ltd v Progress Bulk Carriers Ltd [2010] EWHC 542 (Comm)

5. And to some extent Lord Walker as well, but his Lordship also agreed with Lord Hoffmann and Lord Hope

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.

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