LEGAL ISSUES - Airfinance Journal Validity z Blue Sky v Mahan Air (2010) z Validity of mortgage /...
Transcript of LEGAL ISSUES - Airfinance Journal Validity z Blue Sky v Mahan Air (2010) z Validity of mortgage /...
CFM / AirFinance Journal
Financing and Investing in Engines
31 March 2011
Financing and Investing in EnginesGavin Hill
LEGAL ISSUES
CONTENTS 1. Sample Structure
2. Title: Overview, Validity and Priorities
3. Title: Risk and Protection
4. Jurisdictional Review: Legal Families
5. Jurisdictional Review: Security Issues
US Owner Trust StructureSampleStructure
Seller Purchaser
Owner Trustee
Lessee
LendersSale of Engine Assets
(Trust Interest)
Loan
Trust
Lease
SampleStructure
BenefitsNo lease transfer - limited lease / lessee interference
No title transfer
Strong perfection of interests - US owner permits CTC, FAA and UCC filings
Tax transparency
Title Overview
Good title is essential for equipment leasing and financing Establishing title Protecting title Risk of title loss / subject to third party priority interest
Insolvency officialsThird party purchasers / creditorsHost aircraft ownersEurocontrol / national air traffic agenciesEmissions Trading Scheme agenciesNational aviation authoritiesAirport operatorsCustoms authoritiesTax authorities
TitleValidity
Blue Sky v Mahan Air (2010)
Validity of mortgage / title transferValidity of mortgage / title transfer determined by reference to the lex situs
Dicey, Morris and Collins ("The Conflict of Laws" -14th edition / 2006) states at Rule 120 that "chattels are situate in the country where they are at the relevant time"
One must apply the domestic laws of the country, and not its entire law (including its conflict of laws rules) – no renvoi
Local legal opinion cannot refer back to English law with respect to the validity of the mortgage (or bill of sale) to create (or transfer) an interest in an aircraft / engine (cf – contractual obligations and execution requirements)
TitleValidity
Aircraft / engine located in international airspaceException to Rule 120 stated in Dicey, Morris and Collins with respect to aircraft: "A civil aircraft may at some times be deemed to be situate in its country of registration“The reasoning for this exception is stated to be that “such an ascription would avoid difficulties which could arise in the case of an aircraft in flight over the high seas or a territorium nullius“Blue Sky referred to this exception but did not need to consider itPosition is unclear:- if English conflict rules follows DMC:
- situs would be state of registration- following Blue Sky, one would apply the domestic laws of the
state of registration, and not its entire law (including its conflict of laws rules) – noting that this was not specifically considered in Blue Sky
- English conflict rules might favour the “proper law of the transfer” (i.e. English law if that is chosen under the sale agreement / mortgage) – this is logical in that:- engines invariably have no state of registration- where location is not known, Blue Sky says that English law
applies (and what is the difference between no location and location in international airspace?)
TitleValidity
Aircraft / engine location cannot be determined
An English law mortgage / bill of sale would be valid
Blue Sky states "In the absence of proof of any other law, English law applies and the mortgage is valid"
New York mortgagesNo reference to lex situs
Requirement for connection to the jurisdiction
All relevant perfection requirements remain
TitlePriorities
PurposeEnsure best title
Ensure best title protection against rest of world
- priority over any third parties
- insolvency official, creditor, purchaser, lessee, etc
Priority normally established by further action that “perfects” interest against third parties
- to fullest extent possible
- also possible by contract / structure (as between transaction parties)
- CTC subordination agreement
TitlePriorities
Fundamental insolvency principlePari passu / pro rata / equal payment of creditors
Each creditor is paid from the insolvency estate proportionately to his debt
Always varied
Insolvency ladder (generalised)Super-priority creditors
Priority creditors
Pari passu creditors
Subordinated creditors
Equity shareholders
Expropriated creditors
Title Priorities
Super-priority creditorsSecured creditors
Title finance creditors
Creditors with a set-off
Beneficiaries under trusts
Other “special” categories
Priority creditorsAdministrative claims (i.e. insolvency-related)
Taxes
Employees
Others
Priority creditors can rank ahead of secured creditors – jurisdictions vary
TitlePriorities
Pari passu creditorsSelf-explanatory
“true” / “pure” unsecured pari passu creditors
Subordinated creditorsEquity creditors – creditors whose debt is regarded as equity shares
Equity shareholders
Expropriated creditorsLate claimants
Foreign currency creditors (claim must be proved and converted)
Tort claimants
- Including jurisdictions that follow pre-1986 English insolvency model
TitlePriorities
UK priority rights / title risk
Statutory detention / sale rights
- Eurocontrol / UK CAA for unpaid air navigation charges
- Environment Agency for unpaid penalties under Emissions Trading Scheme legislation
- Airport operator for unpaid airport charges
- HMRC for unpaid taxes
- Priority based on first to exercise detention right
TitlePriorities Contractual liens
Supersedes the terms of a lien that arises by operation of lawCan be more extensive than a possessory lienMay not be effective in all circumstances (e.g. if it extends common law lien to entire fleet or is stated to be effective regardless of possession)
Salvage liensThe Gustaf (1862)
Possessory liensCommon law lienLawful continuous possessionWork on equipment must improve it (not mere maintenance)Work must be authorised
Registered mortgagesin order of registration
Unregistered mortgages
Title RiskHost Aircraft Owners
Host aircraft ownersTitle annexation
Most common in Roman-Germanic civil law systems (e.g. Scandinavia, The Netherlands and Russia)
Engine is considered an integral part of aircraft
Need for protective agreement between relevant parties
Agreed value / total loss coverage for relevant loss event
Increase in agreed value of host aircraft during installation
Title RiskEurocontrol
Eurocontrol / air navigation chargesUK CAA has detention and sale right for Eurocontrol, NATS and Danish / Icelandic navigation charges
detention and sale if charges not paid within 56 days of detention
lien for liability of prior operator
fleet-wide lien
- seized aircraft need not have incurred charges
- engines included in risk
Eurocontrol zone operators / Eurocontrol “abuse”
Title RiskETS
ETS
Emissions Trading Scheme legislation
UK Environment Agency
- detention and sale right for unpaid civil penalties under ETS legislation (failure to comply with regulations / reporting requirements / failure to surrender allowances)
- detention and sale if charges not paid within 56 days of detention
- fleet-wide lien
- UK operators only
- engines included in risk
Title RiskCustoms
Customs authorityRussia (as recent example / Krasair)
- Confiscation risk for breach of customs regulations
- Risk applies even if lessee is not the engine owner
- Engine can be treated as integral part of the aircraft
- Risk logically applies if the engine is not the “offending object”
Title RiskTax
VAT (change in UK rules from 1 January 2011)Applies to sale, import into EU and lease
“Qualifying Aircraft” / zero-rating- Historic – 8,000 kg test- Current – international test
- zero-rating applies to aircraft “used by an airline operating for reward chiefly on international routes” – matches general position across EU
- international routes- any route that is not a domestic route within UK airspace- “chiefly” – more than 50% non-UK - Cimber case (C-382/02 – 2005) – test is assessed by
reference to the airline and not the individual aircraftEngines- VAT treatment follows status of aircraft- If engines are supplied in relation to a qualifying aircraft, VAT
will be zero rated“the supply of parts and equipment, of a kind ordinarily installed or incorporated in, and to be installed, or incorporated in, the propulsion, navigation or communications systems or the general structure of qualifying aircraft” - Value Added Tax Act 1994 / Schedule 8 Group 8 / Note 2A
Detention / forfeiture right for non-payment
Title RiskTransaction Parties
Servicing agent / lease managerFees
- security
- proceeds entitlement / waterfall position
- subordination
ManufacturerMaintenance service agreements
- Contractual / fleet lien over subject engines
Buy-back rights / sale consent
- Under original manufacturer purchase agreement
- Due diligence / consent
Title RiskInsurances
Possible challenges by insurers in relation to insurance proceeds entitlement
Blue Sky case
Insurable interestPrinciple- Insured must have some relationship with the subject matter of
the insurance- English law definition
“a right in the property, or a right derivable out of some contract about the property, which in either case may be lost upon some contingency affecting the possession or enjoyment of the party” (Lucena v Crauford (1806))
Examples include equipment owners and mortgagees
Interest need not be vested or proprietary
For liability insurance, this includes anyone with a potential liability
Can insurers claim that a failure to properly create and perfect a mortgage means that the mortgagee has no insurable interest?
Title RiskInsurances
Duty of Good FaithUtmost good faith / uberrima fides
Duty arises by operation of law
Disclosure- insured’s duty to disclose all material facts (1) that
are within the actual knowledge of the insured or (2) that, in the ordinary course of business, ought to be known by the insured and are reasonably ascertainable
- provisions of the Marine Insurance Act 1906 (ss.17-19) state the common law position and apply equally to aviation insurance
- possible breach of duty of good faith for failure to disclose non-perfected mortgage interest
Title RiskInsurances
Duty of Good Faith
Misrepresentation- a representation as to a material fact that is false or
inaccurate
- again derived from Marine Insurance Act 1906 (s.20)
Continuing duty- not just at policy inception- applies at renewal / extension and at other “key” points
(e.g. if the policy is varied mid-term)- “..continues throughout the contractual relationship at a
level appropriate to the moment” (Manifest Shipping Co Ltd v Uni-Polaris Ins Co Ltd (The Star Sea) (1997))
Consequence of breach of duty of good faith- insurers can avoid insurance contract
Title RiskInsurances
Duty of Good Faith
AVN 67 (s.3.2)- coverage for Contract Parties not invalidated by
act or omission (including misrepresentation and non-disclosure) of any other person
Duty of Contract Parties- duty applies equally to Contract Parties (subject
to AVN 67 protection above)
Title ProtectionPractical Methods
Variety of practical methodsHost aircraft owners
Protective agreement (RoRA)Agreed value payment obligation on title loss / increase in agreed value of host aircraft
MonitoringEurocontrol letter (current approach / all operated aircraft)ETS letterAirport letter
InsuranceNon-repossession insurance- Physical re-possession risk- De-registration / export risk- Government / third party lien risk- Technical records
Title ProtectionPractical Methods
Insurance (cont.)Contingent insurance
- Airline’s policy fails to respond
- Termination for non-payment of premium
- Operations outside geographical limits
- Failure of cut-through clause
- Insurer payment illegality / impossibility (e.g. caused by sanctions or exchange control restrictions)
- Limits exceeded
- Errors and omissions by insurance broker
Title ProtectionLegal Methods
Basic legal requirementsSpecific documentary provisions to be included- see “Jurisdictional Review: Security Issues” Specific documentary formalities to be observed- notarisation / other documentary formality- stamping / other payment- as condition to effectiveness of document / filing /
perfection / admissibility in court
PerfectionAssuming due transfer / creation of original interest - effective as between the partiesPerfection - how does the interest become effective against third parties?- third party creditor / purchaser / lessee / other- insolvency officials
Title ProtectionLegal Methods
Methods of perfectionFiling in public register- debtor registers (companies / commercial register)- asset registers (national aircraft register / CTC
International Registry)- “UCC” style registers - other registers (title / deeds register)NoticePossession / control
Title ProtectionCape Town Convention
Application to enginesAircraft engines are “aircraft objects”- 1,750+ lbs thrust / 555+ horsepowerHelicopter engines are not “aircraft objects”- if installed- ability to register prospective international interestEngines in context of aircraft financing- if the only CTC connection is the state of
registration of the aircraft, international interest in engine is not registrable (c.f. – actual practice)
Where is the debtor situated?- Place of incorporation- Place of registered office- Centre of administration- Place of business- Cayman / Irish entities
Title ProtectionCape Town Convention
PrioritiesA registered interest has priority over an unregistered interest and a subsequently registered interest – Art 29
A Contracting State can declare that CTC applies to pre-existing interests (3 year limit) – Art 60
A Contracting State can declare priority for certain non-consensual interests – Art 39
A Contracting State can declare certain non-consensual interests to be registrable – Art 40
Title ProtectionCape Town Convention
Interaction with domestic law
Good international interest / bad national interest
Why do you need a good national interest?
Practice on engine transactionsValid international interest / remedies should be recognised by Contracting States – that is the purpose of CTC
Ensure effective national interest in non-Contracting States
Example – financing of engine owned by US owner trust and leased to Brazilian airline
Title ProtectionNational Registers
Lack of engine-specific registers / registers that permit recording of engine interests
US / FAANotable exception
Register for leases / mortgages in relation to engine interests that have US connection (owner / operator)
FAA counsel
Pre-positioning of original documents
Other countriesTitle / deed register – Napoleonic jurisdictions (e.g. Brazil)
Company / commercial registers
Title ProtectionUCC Article 9
Uniform Commercial Code OverviewUnified code of rules for creation and public registration of security interests in personal propertyState law- model law that can be adopted by each state (level of
overall harmony is high since 1998 revisions)Personal property – all assets other than landSecurity interests- broad- any transaction that creates a security interest in
personal property by contractSecurity created by all persons (including individuals) Coverage- Creation / attachment- Publicity / perfection - Priorities- Enforcement (excluding on insolvency)
Title Protection UCC Article 9
Uniform Commercial Code Overview (cont.)Simple filing system
- “notice” filing system
- Name of parties / simple description of collateral
- No filing of security agreement
- “Tender rule” – filing is at the time of communication (not time of entry on record)
- Debtor need only authorise (not sign)
- Third parties make enquiries of debtor (secured party has no obligation to give information)
- Electronic filing
- No filing time limit
- Filing renewal requirements - continuation statement filed within 6 months of each 5 year period
Title Protection UCC Article 9
“Unique” featuresTitle finance = secured financeCoverage- Reservation of title- Conditional sale- Finance leaseLease tests – when is a lease a security interest?- Lessee obligation to acquire title or use asset for
projected useful life- Lessee option to acquire title (or extend lease
term beyond projected useful life) for no / nominal consideration
Substance over form - c.f. English common lawSubject to Federal law- e.g. separate FAA rules for aircraft mortgagesCodifies priority rules
Title Protection UCC Article 9
Perfection MethodsFiling- The basic method of perfectionOther required methods for different collateral (examples)- Federal action
- Aircraft / engines (FAA rules)- Possession
- “chattel paper” – a record that evidences a monetary obligation and a security interest in specific goods (e.g. – finance lease or operating lease with security deposit)
- Control- deposit accounts – automatic if secured party is
depositary bank; otherwise control agreement under which depositary bank agrees to comply with secured party’s instructions without debtor consent
Jurisdictional ReviewLegal Families
Anglo-American Common Lawc.47% (by number of jurisdictions) / c.35% (by population)
England, Australia, Canada (excl. Québec), much of Caribbean, Cyprus, Hong Kong, India, Ireland, Israel, Malaysia, New Zealand, Nigeria, Pakistan, Singapore, USA
Napoleonic (Civil Law)c.26% (by number of jurisdictions) / c.23% (by population)
France, Belgium, Greece, Italy, Luxembourg, Portugal, Spain, Francophone Africa, most of Latin America and North Africa, much of Middle East
Roman-Germanic (Civil Law)c.10% (by number of jurisdictions) / c.11% (by population)
Germany, Austria, Baltic States, Czech Republic, Korea, The Netherlands, Poland, Russia, Scandinavia, Switzerland
Jurisdictional ReviewLegal Families
English common lawMost comprehensive and liberal system with respect to corporate entitiesGenerally creditor friendlyFew formalitiesGreat scope for security (including “universal” security)- present and future assets- present and future liabilitiesSimple enforcement procedures- usually without court assistance- usually without grace periods / limitationsSimple / centralised debtor filing systems for security interests Relatively low avoidance riskRecognition of trusts
Jurisdictional ReviewLegal Families
American common law Largely protective of security interests
Similar to English common law
UCC – simple “perfection” system
Differences
- Separate state regimes for real property
- Self-help enforcement more restricted
- Chapter 11 corporate reorganisation restricts security interest
- Title finance recharacterisation as secured finance
Jurisdictional ReviewLegal Families
Roman-Germanic Arguably less favourable than Anglo-American group; more favourable than Napoleonic group
Scope of security can be quite wide
Corporate rescue principles limited
Limiting features
- Restrictions on security over future assets
- Restrictions on security over “all” assets (cf English floating charges)
- Requirement for possession in certain jurisdictions (such as Austria / Switzerland)
- “Special” requirements for security (such as a statement as to the secured amount)
- Lack of recognition of trusts (subject to Hague Trusts Convention 1985)
Jurisdictional ReviewLegal Families
Roman-Germanic (cont.)- Accessory nature of security
- Requirement for “parallel debt” provisions
- Notarial formalities
- “over-security” principles (Germany)
- limited security renewal requirements (Finland –10 years)
Jurisdictional ReviewLegal Families
Napoleonic Less favourable than Anglo-American and Roman-Germanic groups
Limiting features
- Restrictions on security over future assets
- Problematic to secure future debt
- “Special” requirements for security (such as maximum secured amount / specified interest rate)
- Enforcement regime tends to be debtor-protective
- Emphasis on judicial processes (auctions / court orders)
- Restrictions on self-help
Jurisdictional ReviewLegal Families
Napoleonic (cont.)- Security registrations subject to renewal
requirements- Argentina – 7 years- France – 10 years- Italy – 20 years
- Greater formalities - notarial requirements- formalised notification procedures for
assignments of contracts and rights- Centralised debtor filing systems for security
interests less common (e.g. at a companies / commercial registry)
- Possessory requirements- Historic non-recognition of trusts (except in much
of Latin America and (more recently) France / subject to Hague Trusts Convention 1985)
Jurisdictional ReviewSecurity Issues
Accessory securityUsually in civil code jurisdictions
Security is accessory to secured debt (i.e. it follows and depends upon it)
Assignment of debt carries assignment of security
Discharge of debt (or invalidity of secured obligation) terminates the security
- “classic” English law / LMA loan transfers
Role of security trustees
Parallel debt provisions
Jurisdictional ReviewSecurity Issues
Third party security Security granted for the obligations of a third party
Unusual to find prohibitions
Some exceptions
- France – assignment of business receivables under the Monetary and Financial Code (arts. 313-322)
- Belgium – general enterprise pledge
Possible solution
- Security granted to secure debtor’s obligations under a guarantee given by it in relation to the third party liabilities
Jurisdictional ReviewSecurity Issues
Security over derivative assets and rights
Ideal – security over an asset includes:Asset in another form
- such as proceeds / insurance proceeds
Derivative / related assets and rights
- such as rights in relation to shares (e.g. dividends / voting rights) in the case of share security
- such as guarantee rights
Jurisdictional ReviewSecurity Issues
Security over derivative assets and rights (cont.) Proceeds
English law – no automatic entitlementUCC includes proceeds – any property arising in respect of the collateral (can include proceeds of proceeds)
InsurancesEnglish-based systems do not cover insurances- A security interest over an asset does not (per se)
include an assignment of the related insurancesCivil law / US jurisdictions cover insurances- Insurances automatically follow the mortgaged
asset- Austria, Denmark, France, Germany, The
Netherlands, Norway, Switzerland, USA (personal property covered by UCC 9-102)
Jurisdictional ReviewSecurity Issues
Supporting guarantees and securityGeneral rule - an assignment of a debt includes any supporting guarantees or security
Examples
- England - if a debt is assigned without reference to any supporting mortgage, the transferor holds as trustee and must enforce in accordance with the instructions of the transferee as beneficial owner
- USA – creation of security over debt / contract carries with it supporting guarantees and security interests (UCC 9-203)
Perfection – registration of assignment might be required at any relevant registry
Prudent practice – formal assignment / transfer
Jurisdictional ReviewSecurity Issues
Description of secured debtEnglish and American common law systems allow cross-reference to other documents (e.g. loan agreement)
Many Napoleonic (and some Roman-Germanic) jurisdictions require full details of secured debt in the security agreement
Jurisdictional ReviewSecurity Issues
Future debt English and American common law systems freely allow security for all present and future debts –expressed as a “continuing security”
- unless (for example) the future debts are outside the originally intended scope of the security (in which case new security must be granted)
UCC Article 9 is more permissive than English law
Roman-Germanic and Napoleonic systems are less permissive and often require that the debt is “determinable” (future debt can be determinable)
- new security might have to be created for new debt
- in traditional Napoleonic jurisdictions, there are real limitations (so that even a revolving credit facility might not be covered)
Jurisdictional ReviewSecurity Issues
Maximum secured amount / maturity date English common law jurisdictions - no objection in most jurisdictions to security for an unspecified amount
Napoleonic / Roman-Germanic jurisdictions – most jurisdictions require stated maximum amount
Amounts to be stated might include principal, interest and other amounts
- possible limitations / calculations required in relation to interest (e.g. 3 years interest in France and Belgium)
- creditors will look to have highest amounts
- debtor might not wish to have inflated amounts recorded on a public register
- stated amount may drive costs (notarial or registry fees; which might be affected by inflated figures)
- if stated amount is exceeded, new security will be required (which might be subject to intervening security)
Jurisdictional ReviewSecurity Issues
Maximum secured amount / maturity date (cont.)
Maturity date statement more common in Napoleonic jurisdictions (but generally not usual –instead there might be a requirement to state that the security is granted for an undetermined period)
Jurisdictional ReviewSecurity Issues
Interest Some jurisdictions limit:
- the rate of interest that can be charged
- the period of back interest
- the capitalisation of interest or the charging of interest on interest
Basis in usury laws
No usury laws in England since 1854
Back interest
- Napoleonic jurisdictions often limit
- Argentina, Italy – 2 years
- Belgium, France, Greece – 3 years
- Most English-based jurisdictions do not have limits (just usual limitation periods for claims)
Jurisdictional ReviewSecurity Issues
Interest (cont.)Capitalisation of interest
- Problematic in some jurisdictions (Germany, Argentina, Brazil)
- Permitted in most English-based jurisdictions
Penalty interest
- Reasonable penalty interest is valid in many countries
Foreign currency debtA number of countries have restrictions on mortgage debts being expressed in a foreign currency
- often due to exchange control rules or a lack of up-dating in the law
- land mortgages may have to state the local currency amount for registration purposes –Germany, The Netherlands, Switzerland and Sweden