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Anthony J Cordato
Cordato Partners Lawyers, Sydney
ajc@businesslawyer.com.au

 

Monday 23 September 2019

 

 

Session Chair

Brenda Nichols  ELFC London, London, England; Secretary, Aviation Law Committee

Moderator

Gerard Melling  M&T Aviation, Long Beach, California, USA; Publications Officer, Aviation Law Committee

Speakers

Kathleen Oliver Avolon, Hong Kong SAR

H K Helen Sohn  Lee & Ko, Seoul, South Korea

Bob Gilbert  Kim & Chang, Seoul, South Korea                                   

Donald Gray  Blake Cassels & Graydon, Toronto, Ontario, Canada

 

Topic: Avolon and Jet Airways: A Case Study

(Brenda Nichols introduced the topic and the panel.)

Kathleen Oliver, Head of Transaction Legal – Asia Pacific, Avolon, Hong Kong SAR

Kathleen provided an overview of how commercial aviation lessors enforce their rights against aircraft and gave a case study on Avolon’s experience of repossessing seven aircraft from Jet Airways in 2019.

Kathleen made these comments regarding aircraft leases:

The enforcement process described in most aircraft finance leases includes a definition of default; seizure; control; sale in a commercially reasonable fashion; and accounting for the proceeds.

The procedure for repossessing and enforcing lease and security rights depends on local law and registrations. Generally, one must enforce in the jurisdiction of the asset’s location, rather than issuing the courts and law provided in the lease, though this could be possible.

If the Cape Town Convention applies, it applies to both the airframe and to the engines. The ownership and security interests constitute ‘international interests’ which must be filed in the International Registry to give it priority.

Enforcement/remedies may be a form of self-help (if permitted) and may include a temporary restraining order from a court to preserve the asset and a waiting period to allow the debtor to cure the defaults. If the default is not cured, the financier’s rights must be exercised in a commercially reasonable manner. In the case of a mortgagee sale, a private sale is most efficient as it will achieve the best price.

For repossession preparations, original irrevocable deregistration and export request authorisations (IDERAs) and leases need locating; fleet liens at maintenance, repair and operations (MROs) and otherwise-researched, potential follow-on registries must be identified; the location of the engines and major components must be identified with export requirements; and the requirements for applicable financings must be met.

Avolon began watching Jet Airways closely in mid-2018 due to the airline’s overdue rentals, operating losses and weak liquidity. In December 2018, Jet defaulted on its bank debt and pro-active follow up discussions were held in preparation for the airline’s insolvency. Avolon’s internal airline monitoring processes triggered action items across the business in late 2018 and early 2019, including review of the lease security position, taking updated insolvency and repossession advice, locating engines and components and assessing remarketing opportunities.

India acceded to the Cape Town Convention in 2008. However, no implementing legislation was passed, so local law continued to govern the repossession of aircraft. In an effort to remedy the problems encountered by the Kingfisher insolvency, the Indian aviation authority produced a Standard Operating Procedure (SOP) to set forth the steps for repossession of aircraft using an IDERA and the Jet insolvency was the first test of the SOP. Under the SOP:

• an IDERA holder may submit a deregistration application in a prescribed format;

• the Directorate General of Civil Aviation (DGCA) must ‘immediately’ post public notice of all deregistration applications;

• airport operators and ‘private entities supplying public services’ have five business days from date of public notice to submit invoices for any dues related to aircraft incurred in the prior three-month period;

• upon payment of invoices by the IDERA holder, a ‘no dues certificate’ shall be issued;

• the IDERA holder shall submit all no dues certificates, apply for export permit and pay any customs fees; and

• immediately before export, the IDERA holder must pay any further fees incurred by the airport where the aircraft is grounded since the date of IDERA submission.

In Avolon’s experience, the aviation authority’s application of the SOP’s requirements was uneven. However, in most lessors’ cases the repossession actions against Jet were much smoother than prior Indian airline insolvency actions. The most contested parts of the SOP were primarily around demands for payment from private companies not included in the SOP guidelines. The Indian government took a hands-off approach to these disputes and each lessor was required to decide for itself if it would prefer to pay certain invoices not required by law in order to release its aircraft quickly, or engage in dispute resolution that may delay the return of its aircraft.

Avolon managed to repossess and re-home all seven of its aircraft within 45 days of the Jet Airways lease terminations. Avolon’s takeaways from the Jet repossessions are that the existence of robust internal airline watch processes allowed Avolon to be well prepared in the early days of Jet’s descent; and a willingness to act quickly in distressed airline environments is a key factor in a lessor’s success in extracting aircraft efficiently.

Part 1: How to protect the interests of aircraft owners, lessors and finance parties under Korean law?

H K Helen Sohn specialises in aircraft financing and leases

Korea is a non-Cape Town Convention country. Aircraft ownership and lease/finance interests are registrable with the Aircraft Registry at the Ministry of Land, Infrastructure and Transport (MOLIT). Registration costs are nominal: registration tax is KRW 14,000 (which is approximately USD 13) and the registration fee is KRW 8,200 (which is approximately US 7). Registration gives priority over third party rights.

An Aircraft Mortgage is the most common form for registration of security interests under Korean Law. It is called Kun-Mortgage Agreement, under the Act on Mortgages over Specific Movable Properties including Automobiles. All finance parties, together with the security agent/trustee must be parties and it is effective upon registration with the MOLIT. Evidence of registration is available within seven to ten business days. The agreement provides security for up to 150 per cent of the debt. The mortgage is often entered into in conjunction with an international mortgage in aircraft financing transactions for Korean airlines.

Part 2: Korean law aircraft mortgage v Cape Town Convention international interests

Under Korean law, only mortgage interest is available while there may be a charge, pledge, conditional sale or mortgage under the Cape Town Convention (CTC).

The security is effective immediately upon registration, both under Korean law and under the CTC.

In Korea, the mortgage covers the ‘aircraft’ (airframe, engines and parts) as one unit; the CTC covers the airframe and engine as independent, separate property.

In Korea the mortgage is physically filed during business hours, while under the CTC an international interest can be filed electronically at any time. The Korean mortgage has priority over both unregistered and subsequently registered claims in Korea: under the CTC there is priority over all competing interests, whether or not registered with the IR.

For enforcement in Korea there is mandatory enforcement or an ‘agreement’ to take title back, or to have a privately arranged sale. Under the CTC, there is the exercise of ownership or security interests; sale or leasing; receipt of profits; and repossession.

Part 3: Growing concerns over lessor’s beneficial ownership under the Ireland-Korea tax treaty

Bob Gilbert, Kim & Chang, Seoul. Bob acts principally for lessors and lenders in aircraft financing and leases.

Withholding tax is payable in Korea on the domestically sourced income of Foreign Corporations. However, the Korea-Ireland Tax Treaty provides for an exemption from withholding tax on rents from leasing aircraft to a Korean lessee, provided that the lessor is the ‘beneficial owner’ of the rental income.

If based in Ireland, the lessor must prove to the Korean Tax authority that it is the beneficial owner, as opposed to a ‘pass through entity’.  There are seven principal elements required to do this: officers and employees residing in Ireland; Irish corporate documents with clear business objectives; board meetings and minutes; office space with ownership/lease records; a certificate of incorporation and tax residence in Ireland; payment of Irish tax by the entity or shareholder; and payment of Irish tax by the officers and employees.

Generally, the principle of substance over form will apply as part of the global trend on enforcement.

Voluntary and involuntary return of aircraft:

• Korea is an operator register. There is no CTC; and

• the security is deregistered and the aircraft is redelivered.

Involuntary return (non-judicial):

• return takes place through direct negotiation. In Korea, if an airline has no aircraft, it cannot have an Air Operator Certificate (AOC), which could be the only thing of value, so airlines will tend to cling on to the aircraft or they will lose their investment;

• failing airlines will see a departure of the maintenance staff needed for sign-off, so lessors would need to pay them to do this work;

• only possessory liens are recognised, typically for maintenance and suppliers: there is no Air Traffic lien;

• the Korean authorities (MOLIT) take a hands-off approach to repossession. Where there is a deregistration Production Organisations Approval (POA), but absent precedent and policy, it is not clear that this would be accepted by MOLIT. In addition, MOLIT staff typically rotate within the government every three years so, in case of repossession, it may well be difficult to retain experienced staff; and

• personal guarantees are only as good as the assets of the guarantor and it can be difficult to trace assets.

Involuntary Return (judicial):

• Korean law is based on the German civil code (Bürgerliches Gesetzbuch – BGB) and local orders can be obtained;

• foreign judgments may be recognised on the basis of reciprocity. There are precedents for the recognition of judgments rendered in the United States and England and a precedent for the rejection of a judgment rendered in Australia;

• arbitration awards can be enforced under the New York Convention; and

• based on the above or on local proceedings, the Korean Courts will make orders for the repossession of aircraft and decide contractual claims. 

Insolvency:

• under the Debtor Rehabilitation and Bankruptcy Act, rehabilitation is available on a similar basis to Chapter 11; and

• termination before rehabilitation is preferable, but it is not certain that the Court would recognise termination based on lessee’s insolvency in order to preserve the ability of receiver to exercise authority to rescind or perform lease.

Topic: Aircraft and engine repossessions under Cape Town Convention and Aircraft Protocol

Donald Gray, Blake Cassels & Graydon, Toronto (Gerard Melling made the presentation in Donald Gray’s absence)

Don started with a comedy video on aircraft failures, which provided some light relief.

Recent repossessions in Canada include the hostile repossession of two WOW A321-200s at Toronto Pearson (Ontario Common Law) and Montréal Trudeau (Quebec Civil Law), 27 April 2019, for a single lessor; and the 2015 repossession of SkyGreece 767-31AER at Toronto Pearson.

General observations

Taking control of an aircraft’s documents is the core indicator of possession of an aircraft.

In other cases, taking control of an aircraft by placing a tow bar on that aircraft and moving it to another section of the airport where you have responsibility for parking fees has been found to be an effective means of repossession.

The default remedies under the CTC are for: preservation of value; possession/control/custody of the object; immobilisation of the object; sale/lease of the object; and collection of income from object management. The CTC provides for a country declaration as to whether self-help is permitted or a court order is required.

IDERA, under the Cape Town Convention, requires an opt-in declaration (ie, an Organisation for Economic Co-operation and Development-qualifying declaration). This is to be recorded in the national registry and provides ‘Authorised Party’ rights:  for deregistration and assistance with export within five working days, upon presentation of IDERA and certification of discharge (or consent) of prior ranking registered interests.

In Canada, there are priority liens/detention rights for Airports and NAVCanada for unpaid fees and a requirement for reasonable prior notice to the debtor and any known guarantors.

CTC Alternative ‘A’ applies in Canada: upon insolvency, creditors may repossess on the earlier of: the expiry of the applicable waiting period; or the date on which the creditor would be entitled to repossess, pre-CTC.

Engines may be CTC registered. In this case, the rights and remedies are the same for aircraft and the main issues are the seizure of documents, the tracking of modules and cooperation with airframe owners.

Repossession options

Gary suggested two repossession options:

• ‘Smash and grab’, which involves using own-flight crews to remove the aircraft out as quickly as possible, avoiding liens and cannibalisation; and

• Maintaining existing registration: contacting the debtor to keep licences in place; having maintenance and records updated and delivered under the insolvent airline’s Approved Maintenance Organisation (AMO); ferrying aircraft/engines under the insolvent airline’s AOC and insurance; maximising the chances for recovery of records, manuals, missing parts and loose equipment.

Race to Registry

If a lessor/lender terminates the right to operate aircraft or gets effective repossession prior to the Canadian authorities obtaining a court order for their rights (similar to lien), the lessor/lender wins and the aircraft is seizure proof. This also functions in reverse.

Super Liens

Look out for potential ‘Super Liens’, which include those of air navigation authorities/airports; tax repairers; mechanics; landlords; storers.

Conclusions

Use pre-signed termination/repossession consents if available; use seizure order if necessary; take control of the aircraft/engines/documents immediately; serve lease termination; use consensual repossession if there is no risk of air authority seizure or if those claims are already bonded.

Panel Discussion

Anna Masutti suggested that the commercial reality favours quick sale, while the value of the aircraft is still greater than any debt. In Europe, the status of the Convention is that it has mostly been ratified, but not yet implemented. Aircraft lessors are registering their charges in the international registry from a country in the European Union, such as Ireland, which has implemented the Convention. The charge can be enforced abroad, in the airport where the aircraft is located.

Comments

• Serap Zuvin: Turkey has ratified the Convention. This has been implemented to overcome local law restrictions. As a result, it provides cheaper finance for aircraft from the export/import bank.

• Ravi Nath: Even ‘fast track’ in India can take several months.

• Anna Masutti: Aircraft cannot fly unless outstanding taxes are paid. Can aircraft taxes become a lien? This varies around the world.

• Regina Lynch: In Brazil, the issue of a bond by the lessor can delay repossession.

• Carlos Sierra: In Mexico, a court order for repossession has been enforced.

• Ravi: In India, the Supreme Court has applied the Cape Town Convention.

• Sierra: The definition of ‘aircraft’ needs to be comprehensive in the lease, in order to include the airframe, records, parts (see Article 13).

• John Toriello: Records are the number one priority in the United States. On a practical level, you need to be able to obtain records from the cloud. Self-help is not practical. Most commercial jets are located at airports where access requires a court order.

 

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