A new international convention has laid down new legal standards for aircraft financing arrangements. The aim is to end the uncertainty that has faced lessors and lenders in different jurisdictions around the world.
On 16 November 2001, after a three week inter-governmental conference in Cape Town, 53 countries adopted the text of a Convention and Protocol intended to have a profound effect on the financing of aircraft. The convention comes after nine long years of thought, debate, drafting and lobbying, strongly supported by the air transport industry. Its aim is finally to provide some standard legal rules on which lessors and lenders can rely as their aircraft move around the world. In the process it could even help to attract more badly needed finance to the air transport industry.
The basic problem has been that while aircraft may be highly mobile assets, the law relating to leases and the interests of lenders generally rests on domestic law. It is true that the rules governing the nature of a security interest or the rights of a lessor on termination of a lease are created under the law chosen by the parties when the transaction is entered into. At the time of default, however, the aircraft may be in another part of the world where the laws may be quite different. Some countries where the courts have little or no experience of international commercial transactions have recently become significant markets for new aircraft.
Experience shows that in some countries, repossession can be held up for long periods while judicial procedures are followed. If it takes place in the context of an airline insolvency, delays can be even worse. Many governments have given themselves a super-priority in relation to taxes, navigation and airport charges, and these amounts are sometimes kept secret from the secured creditor until the moment of repossession.
When airlines were largely government-owned, aircraft financing could almost be treated as sovereign borrowing. Where they are involved, state-backed export credit agencies may have taken on some of the repossession risks. But lower levels of state involvement are likely in future. Also, in order to meet the anticipated volume of demand in the future, the industry must access the widest possible range of funding sources, but this will not happen if the rights of creditors remain in their current state of uncertainty.
There have been previous attempts to solve this problem, but none of them has truly succeeded. In 1948, the Geneva Convention tried to address the problem by requiring contracting states to recognise rights in aircraft which were registered in another contracting state. Those rights were to have priority over local interests, including government liens. It did not achieve the worldwide coverage that was necessary to make it an effective international legal regime.
A Convention signed in Ottawa in 1988 on international financial leasing achieved even fewer ratifications. Previous attempts by the European Union and United Nations to deal with harmonisation of the treatment of security interests failed before they even got to the stage of a final convention text.
Financial evaluation
The Cape Town convention, jointly sponsored by ICAO and the International Institute for the Unification of Private Law (UNIDROIT) now represents a solution. It creates aircraft-specific enforcement rights and priority rules that apply to security interests, leases and conditional sales. This should enable a financial evaluation to be made of the risk of default, leading to more aircraft-financing transactions being rated for the purposes of raising funds in the capital markets.
The Convention sets out the remedies which contracting states must give effect to, crucially including interim remedies to allow the aircraft not to remain immobilised while the substance of a dispute is litigated. It provides for the release of an aircraft from insolvency proceedings in a manner inspired by the US Bankruptcy Code.
Electronic register
The rights and interests that have these protections would be entered on an international electronic register, from which a chain of ownership and the priority of leases and security interests could be conclusively established. The register would also contain information on subordination agreements and assignments.
Recognising that some countries may object to the radical changes made to their laws and practices, there are a number of declarations which contracting states are required to make that enable them to accept the basic provisions of the Convention without being obliged to accept every aspect of it. For example, a contracting state could declare that all liens for taxes, navigation and airport charges are themselves capable of registration and subject to the Convention's priority rules.
Alternatively, states can maintain the status quo of having super-priority without registration, although the fact that a declaration to that effect has been made by a contracting state will itself appear on the register. Other aspects that contracting states can opt out of include the availability of self-help remedies and the de-registration and export procedures. The time limits for repossession, for example on insolvency, must likewise be declared by contracting states.
The Convention is aimed only at improving the effectiveness and certainty of the enforcement of transactions. They do not affect the autonomy of the parties in writing their own contracts. The documentation of transactions is therefore likely to remain largely unchanged.
The closing of an aircraft transaction will involve an initial search of the international register and then a filing of the agreement, but the Convention's real impact is likely to be in the ability to carry out better analysis of financial transactions. If enough countries are persuaded to ratify the Convention so that the risk of non-recognition of creditors' rights or of lengthy repossession or insolvency proceedings is substantially reduced, there is a better chance that aircraft finance transactions will become attractive to more sources of finance than is presently the case. An economic impact assessment undertaken in 1998 estimated potential annual savings for the airline industry of $5 billion. That deserves everyone's attention.
Note: The full text of the Convention on International Interests in Mobile Equipment and the relevant Protocol can be found on www.unidroit.orgSource: Airline Business
