UK: What Happens When It Goes Wrong? Default Situations In Aircraft Finance

Last Updated: 25 June 1998
It is impossible to deal comprehensively with that simple question; when dealing with default situations, aircraft repossession, lessee insolvency or any combination of the above (plus all the other unexpected things which may happen) flexibility and adaptability are crucial.

Events surrounding a default will create problems that even the most prudent financier had never imagined. You may have to deal with parties claiming a lien that you never even knew existed. You may find yourself negotiating with Eurocontrol in relation to its charges which it cannot readily quantify. You may find your aircraft involved in a fleet detention. No matter how good your documentation is, you may have to deal with some other party, possibly in a different jurisdiction, whose interpretation of it is different to yours.

The message is, be flexible and be ready to act.

Given these opening remarks, it may not be surprising that what follows may seem to be more or less a series of checklists. I make no apology for this; it should serve to highlight the various and differing problems you may face in a default situation.

Review of Relevant Default Provisions

An aircraft is usually defined in contractual documentation as "the airframe" together with "engines" (whether or not any of the engines may from time to time be installed on the airframe). Any reference to the aircraft in the documents should also be expressed to include the Manuals and Technical Records. The airframe, the engines and the Manuals and Technical Records are usually defined in great detail. The important point here is that the asset can only function commercially as an aircraft if it comprises engines and records as well. For aircraft repossession in particular you need to be certain you repossess everything - airframe, engines and records.

Lease documentation will contain a comprehensive series of events of default of various descriptions, from straightforward non-payment of lease rentals to technical matters concerning the condition of the aircraft to insolvency provisions and material adverse change clauses.

Some default events are extremely specific. Lease payments are to be made by a certain date. Time will be expressed to be of the essence and whether or not payment has been made on time is a fact. Other typical events of default are also factual eg. whether fleet insurances have been obtained and maintained, whether the lessee has maintained all its licences, authorisations, and registrations to enable it to operate, whether the maintenance obligations have been complied with, whether or not insolvency proceedings have been commenced or whether the registration of the aircraft has been cancelled.

These are specific events/facts which are easily recognised and are capable of being proved with some certainty.

Material adverse change.

Such clauses are also properly included amongst events of default but are, as the name implies, more subjective. A typical such clause would be (normally at the end of the litany of events of default)

"any other event occurs (other than a Total Loss) or circumstance arises which in the reasonable opinion of the Lessor has, or may reasonably be expected to have, a prejudicial effect on the Lessor's rights, title and interest to the aircraft or its rights under any Lessee Document or a material adverse effect on the ability of the Lessee to perform all of its obligations under, or otherwise to comply with the terms of, any of the Lessee Documents".

Such a clause is deliberately wide and great care must be taken when attempting to terminate a lease on this basis. Various questions arise. How is the "reasonable opinion of the Lessor" to be judged? Is it reasonable to assume that an event will have "or may reasonably be expected to have" a prejudicial effect on the Lessor's rights? These questions can lead to disputes and possible litigation.

Available Remedies (Practicalities of Enforcement)

Assuming that there is a default, one or more of the events of default carefully set out in the lease having occurred, the next step is to ensure that a properly worded notice is served strictly in accordance with the notice provisions with copies to other interested parties (the Lessee's lawyers for example).

The relevant events of default should be specifically set out so that it is clear to the Lessee (or to any other party which may subsequently look at the notice, such as an insolvency practitioner or a Court) what that notice means and on what basis it is being served. In the standard form of lease the Lessor and the Lessee will have agreed that it is a fundamental term and condition of the lease agreement that none of the events of default occur during the Lease Period and the occurrence of any of them shall constitute a repudiatory breach of the agreement. At any time after the occurrence of such an event the Lessor may by notice to the Lessee terminate the lease period whereupon, as the Lessee agreed and acknowledged at the outset, the Lessee's rights, title and interest in and to the aircraft and to possess and operate the aircraft shall terminate. The Lessor is contractually entitled to retake possession of the aircraft and the Lessee has agreed that the Lessor may enter upon any premises where the aircraft or any part of it is located in order to do so. The Lessee is normally obligated then to pay to the Lessor:

a)all amounts outstanding;

b)all losses incurred by the Lessor in connection with the termination (including costs and expenses (including legal fees) in recovering possession of the aircraft and in carrying out any work or modifications required to bring the aircraft up to the return condition); and

c)any loss suffered by the Lessor because of the Lessor's inability to place the aircraft on lease with another Lessee on terms that are as favourable to the Lessor as the previous lease.

Leases also typically contain provisions that on termination of the lease period the Lessee is obliged to deliver the aircraft to an airport of the Lessor's choosing (although this invariably does not happen), in a specific condition with the relevant engines and documents.

It often happens that the aircraft is returned voluntarily after possibly some negotiation. The engines and technical records normally follow (sometimes reluctantly) but thereafter there may be litigation to collect the outstanding monetary sums due. If, however, the aircraft is not returned voluntarily there are various remedies available to the Lessor. Immediate action may be required if, for example, the aircraft is likely to be flown to a jurisdiction where repossession is likely to be difficult. It may be that the aircraft is about to be flown to a jurisdiction where detention for Eurocontrol and other charges is likely. Another example is where there are ongoing disputes with the Lessee - immediate repossession is required to avoid a long running dispute about recovery.

In relation to the repossession of an aircraft, the requirements in the UK are relatively few. You do not need a Court Order - you can employ self help; nor do you need a sheriff, nor a bond nor any other official process. Gaining possession of the aircraft is not normally the problem - the trickiest part of the exercise, normally, is ensuring that the aircraft is in a satisfactory jurisdiction when the lease is terminated and action is required. This is perhaps not so difficult when repossessing a single aircraft (although it does depend on the scope of that aircraft's operation), but can be problematical when two or more aircraft, or indeed an entire fleet, are involved.

English law treats such disputes as basically a matter of contract; in relation to mortgages, a mortgagee whose mortgage has become enforceable may obtain possession of the aircraft by using self help. The mortgage, if properly drafted, will give the mortgagee a power of sale and the Courts do not need to be involved, although there are often good reasons for seeking the protection of a Court Order.

To summarise, it is possible to enforce strictly the provisions of your contract and to exercise self help. If it is evident that this will not work because of the Lessee's attitude, or for some other reason, it is possible to apply to the Court for an injunction to reinforce your contractual position.

Through the Court

Assuming, for present purposes, that the aircraft is in the UK when you terminate and you do experience difficulty in possessing it, it is normally possible to apply quickly to the Courts for an injunction to enforce or reinforce your rights. Sometimes there may be doubts that the Lessee will co-operate. Although the contract is clearly drafted the Lessor may feel that the operator will ignore the termination notice or will attempt to move the aircraft which is, on any view, a relatively transportable asset. In those circumstances it is possible to apply to the Court for an injunction preventing the aircraft leaving the jurisdiction (commonly called a Mareva injunction). Alternatively, having terminated the lease, the Lessor can apply to the Court for an order for "delivery up" of the asset, claiming that the aircraft is no longer in the Lessee's possession with the consent of the Lessor and that it should be returned to the Lessor in accordance with the lease provisions.

If you apply for an injunction, you must issue a writ, usually in the Commercial Court. It is not possible to obtain an injunction in a vacuum; it must be part of wider proceedings.

In English law there is no general right to attach the aircraft prior to the hearing of that application. An injunction restricts the continued use or movement of the aircraft by the Lessee, but one will only be granted if there is a risk that the aircraft will be moved from the jurisdiction of the Court and will not return (something of a hurdle if the aircraft is operating on regular schedules to and from the UK) or will otherwise be disposed of or will deteriorate so as to prejudice the rights of the Lessor.

The conditions for obtaining injunctive relief are quite strict. It will be necessary for a Lessor to satisfy the Court (by affidavit evidence) that it has a good arguable case against the Lessee, that damages would not be an adequate remedy and that on the balance of convenience, an injunction should be granted. The applicant will be required to make full and frank disclosure of all material facts and most importantly to give a cross undertaking as to damages, ie a guarantee to the Court and to your opponents that you will be responsible for any damages caused by your injunction should your injunction subsequently be found to be unjustified.

It might be appropriate not to apply for an injunction but simply to sue for damages. This may well have an impact on the ongoing commercial relationship between the parties.

Practicalities of Enforcement

In contrast to the procedural position, the practical position can be extremely complicated and it is impossible to set out a list of the different matters you may need to consider urgently. Is there a possibility that the Lessee may apply to the Court for the protection of an Administration Order? I list below some other matters in no particular order:

1 Where is the aircraft at the time of termination?

2 Is it in a jurisdiction which will recognise your contractual rights; some jurisdictions, notwithstanding the clear terms of the contract, may well require a Court order or some form of legal process?

3 Have you arranged local advice (both legal and technical)? You must consider carefully the jurisdictional questions before acting.

4 Where will your aircraft be moved to immediately after you have taken possession of it? If it is in the Lessee's "home" jurisdiction, and the Lessee is in financial difficulties, your aircraft may be a "target" for other creditors. Your termination will almost certainly trigger cross default clauses.

5 Are there any liens?

6 Will the aircraft be subject to detention by the airport authorities?

7 Have you considered the position of Eurocontrol? In the UK the Civil Aviation Authority monitors Eurocontrol charges on behalf of Eurocontrol and has the power to detain aircraft on its behalf. It should be borne in mind that the CAA has the power to detain and ultimately to sell aircraft for unpaid navigational charges including Eurocontrol charges on UK and non-UK registered aircraft. The aircraft may be detained in the UK for substantial unpaid charges which relate not only to the aircraft which has been detained but also to other aircraft in the relevant operator's fleet at the time when the detention began. If the Eurocontrol position has not been carefully monitored throughout the contractual relationship, this can be a major and unwelcome shock to a repossessing lessor.

8 Are there any regulatory requirements? Have you considered these in advance and opened up the necessary lines of communication?

9 Will your deregistration power of attorney work?

10 What happens next? Have you thought about remarketing the asset? You have a duty to mitigate your losses.

Constraints in different jurisdictions

As you will appreciate, these remarks are written mainly from an English law point of view. Other jurisdictions are not so favourable, or indeed so flexible, for a repossessing lessor. It is of course good practice to obtain advance advice from lawyers in appropriate jurisdictions; otherwise this advice may have to be sought and obtained at very short notice. Again, it is impossible to predict what might happen, but some general remarks may highlight the problem:

* Notwithstanding your extremely well drafted choice of law and jurisdiction clause, you may find that that is not recognised by the foreign court. Indeed, in some jurisdictions it is not lawful for, say, an airline incorporated in that jurisdiction, to agree to be governed by a "foreign" law. This is something that your legal opinion should have dealt with at the outset of the transaction but the legal, political and social position may change during the lease period and can do so fairly rapidly. You might ultimately have the benefit of political risk insurance in extreme cases but you may have difficulties bringing your claim within a tightly worded policy. It will also not help if you suffer from the vagaries of the operation of a perfectly valid, but strange legal system. You may find yourself therefore in a Court applying foreign legal concepts to your lease and not always to your advantage.

* Some jurisdictions do not allow self help and will be very sceptical about your claim that you are entitled to enforce your rights without the need for a formal order. Other jurisdictions have more fundamental problems with your position - for example in the former Yugoslavia, a mortgage could only be enforced by way of a Court auction of the aircraft. "Yugoslavian law" in general does not recognise the right of a creditor to take possession of assets - it is simply a concept alien to them. There are other examples from all over the world.

* Liens - many jurisdictions may not maintain a central register which can be searched to ascertain whether any party holds liens. Liens can cause distinct problems. Certain liens can rank in priority to the interest of a first mortgagee. They will need to be discharged (or compromised in some other way) before a mortgagee can attempt to realise the value of its security. Airport authorities (for landing and parking fees), the domestic aviation authorities, Eurocontrol, repairers and maintenance organisations may all claim liens and normally at a very inconvenient time. In some jurisdictions you will find that the local labour legislation gives, say, the flight crew rights of detention over the aircraft in respect of their unpaid salaries.

* There are certain international conventions which may impact upon your efficient repossession - the Geneva Convention (the Convention on the International Recognition of Rights in Aircraft signed in Geneva in 1948) or the Rome Convention (on Precautionary Arrest, 1933) may apply in certain jurisdictions.

* Some jurisdictions will require you to post a bond or appoint a special officer of the Court to assist you in repossessing the aircraft and any engines or records. Such an officer will require payment.

* Some jurisdictions have considerable difficulties with claims for interest, or for "balloon payments" on termination of a lease. You may find your termination charges under attack, particularly if you have relied on a material adverse charge clause.

* There are different interpretations of "reasonable opinion". I have many examples of surprising decisions from foreign courts on clauses which an English lawyer/financier would regard as uncontroversial and clear cut.

* Foreign insolvency systems can be problematical, time consuming, and bureaucratic. Advice from experts in the appropriate jurisdictions is essential.

As is inevitable in a talk such as this, I have highlighted problems. It is by realising that these problems exist that you can best prepare for them. However, as indicated at the outset, flexibility and ability to react to them will assist, together with help from professional advisers.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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