Microsoft PowerPoint - GRKASS_-_AE_Korea_Presentation_022017

LEGAL ISSUES IN

AIRCRAFT

LEASING

February 20, 2017

Geoffrey R. Kass

PART I

Legal Due Diligence

 Why Do We Do Due Diligence?

• Portfolio analysis

• Purchase price confirmation

• Portfolio integration

• Financing

 Long Form, ABS-style (see Attachment 1)

 Short Form, Equity-style (see Attachment 2)

Lease Due Diligence

PART II

Purchase and Sale

Agreements

Who is the Buyer?

 What Is My Ownership Structure?

 What Jurisdiction Am I Based In?

 Do I Meet the Transfer Restrictions?

 Do I Need Financing?

Issues Related to the Buyer Entity

LUXCO

UKCO

LUXCO

IRISHCO

BAHAMASCO

LUXCO

IRISHCO

SINGCO

FRENCHSARL

IRISHCO

Aircraft

Aircraft

Aircraft

Aircraft

Aircraft

LUXCO

Bermuda (PT)

HOLDCO1

Delaware (PT)

HOLDCO2

Delaware (PT)

HOLDCO3

DELLLC

DELTRUST

DEL LLC

DELLLC

Aircraft

DELLLC

Aircraft

LEASING COMPANY

Sr. A&BNotes &Upstream

Guarantee

Sr. A&BNotes &Upstream

Guarantee

Sr. A&BNotes &Upstream

Guarantee

BERMUDACO

Aircraft

IRISHCO

LUXCO

LUXCO

IRISHCo

CANADACO

Aircraft

IRISHCO

Aircraft

Aircraft

DELTRUST

LUXCO

Aircraft

LUXCO

Aircraft

UKCO

Aircraft

Who is the Seller?

 Who Owns the Aircraft?

 Is the Seller Creditworthy?

 What Is the Leasing Structure?

 Is There Financing?

Issues Related to the Selling Entity

LUXCO

UKCO

LUXCO

IRISHCO

BAHAMASCO

LUXCO

IRISHCO

SINGCO

FRENCHSARL

IRISHCO

Aircraft

Aircraft

Aircraft

Aircraft

Aircraft

LUXCO

Bermuda (PT)

HOLDCO1

Delaware (PT)

HOLDCO2

Delaware (PT)

HOLDCO3

DELLLC

DELTRUST

DEL LLC

DELLLC

Aircraft

DELLLC

Aircraft

LEASING COMPANY

Sr. A&BNotes &

UpstreamGuarantee

Sr. A&BNotes &Upstream

Guarantee

Sr. A&BNotes &

UpstreamGuarantee

BERMUDACO

Aircraft

IRISHCO

LUXCO

LUXCO

IRISHCo

CANADACO

Aircraft

IRISHCO

Aircraft

Aircraft

DELTRUST

LUXCO

Aircraft

LUXCO

Aircraft

UKCO

Aircraft

What am I buying?

 Am I Buying an Aircraft or an Asset Owning Entity?

 Aircraft vs. Entity Purchases

• Due diligence issues

• Liability issues

• Tax issues

• Novation issues

Issues Related to the Asset

What does

“As Is, Where Is”

mean?

And how does my

inspection fit with an

“as-is, where-is” sale?

 “As-Is, Where-Is”

 Inspection

• Physical

• Records

• On-lease vs. Off-lease

Issues Related to Inspection

 What Are the Purposes of Representations and

Warranties?

• Due diligence – What does the Seller know?

• Risk allocation – What should the Seller be responsible

for?

̵ (see Attachments 3 and 4)

• Entity representations and warranties

̵ (see Attachment 5)

Representations and Warranties

continuedcontinued

• What is a “knowledge qualifier,” and when is it

appropriate?

• Conditions precedent vs. representations

Representations and Warranties

 Damages

• Threshold

• Repair?

 Other Customary Circumstances

• Drop dead dates/Lessee issues

• Defaults

Termination Events

 Who Holds the Deposit?

 When Is the Deposit Refundable?

Issues with Deposits

Insurance and

Indemnities (in

Purchase

Agreements)

PART III

Issues in Aircraft

Leases

 Maintenance Reserves

 Insurance

 Transferability

 Tax Structuring

Issues in Aircraft Leases

Maintenance

Reserves

 What Are Maintenance Reserves?

• Are they “reserves” or “rent”?

• Why does it matter?

̵ Tax/accounting

̵ Bankruptcy

 Reasons for Reserves

• Lessee vs. Lessor

• Preservation of Value

Maintenance Reserves

continuedcontinued

 Elements of Reserve Provisions

• Rates and terms of payment

• Criteria for reimbursements

• Annual adjustments

 Maintenance Events (see Attachment 6)

• Airframe heavy check(s)

̵ Annual (C) Check

̵ High-level Checks

Maintenance Reserves

continuedcontinued

• Landing gear overhaul

• APU overhaul

• Engine performance restorations

̵ Module breakdown

• Engine LLPs

 Calculation

• Rates based on event cost divided by interval (as dictated by

maintenance program and manufacturers)

Maintenance Reserves

continuedcontinued

• Event cost loosely based on industry standard (except for LLPs,

catalog cost)

• Paid monthly in arrears based on utilization (hours, cycles,

calendar) for previous month

• Adjustment for variation from specified flight hour/cycle ratio–

usually engines only (see Attachment 7)

 Reimbursing the Lessee

• Paid on proven completion (and payment) or Qualifying Event

• What is a Qualifying Event? (see Attachment 8)

Maintenance Reserves

continuedcontinued

• What is excluded from reimbursement?

• Lessee must provide full work package and invoices to support

request

 Negotiating Issues

• Lessor approval process

• Excess reserves and cost overruns

• Loss distributions

Maintenance Reserves

continuedcontinued

• Interest and where reserves are held

̵ Lender issues

• Betterment with non-reimbursable events

• Adjustments (see Attachment 7)

̵ Fixed annual percentage is preferred

̵ Mixture of consumer price indices acceptable

̵ Engine manufacturer’s catalog price for LLPs

Maintenance Reserves

continuedcontinued

 Other Considerations

• New vs. used Aircraft

• Use of letter of credit (see Attachment 7)

̵ Adjusting amounts

̵ Common mistakes

• Bankruptcy considerations (see Attachment 9)

Maintenance Reserves

continuedcontinued

 Additional Issues

• “Power by the hour” contracts

̵ What are they?

̵ How are the contracts priced?

̵ Early exits/terminations

̵ Assignments to Lessor

• Termination payments

• Transitions between operators

Maintenance Reserves

continuedcontinued

• Used aircraft

̵ “Upsy-downsy”

̵ Lessor cost contributions

• up front

• shared cost

• at redelivery

• caps

Maintenance Reserves

Aviation Insurance

 Why Is Insurance Important?

• Potential loss to aircraft – hull insurance

• Exposure to tort liability – liability insurance

Aviation Insurance

continuedcontinued

 Some Basics

• Insurable interest – the party receiving the monetary

benefits from insurance coverage must have an “insurable

interest” in the aircraft

̵ An insurable interest exists where the party will gain some

benefit through the existence of the aircraft or suffer some

loss from its destruction (includes “any lawful and substantial

economic interest in the safety or preservation of property

from loss, destruction or pecuniary damage”)

Aviation Insurance

continuedcontinued

̵ Not necessary for a party to have title to the aircraft being

insured in order to have an insurable interest

• Declarations – sets forth information including the identity

of the named insured, policy number, the insurers, the

effective dates, description of the named insured’s

business, the type of coverage purchased, amount of

coverage purchased, the premium charged and a list of

endorsements

Aviation Insurance

continuedcontinued

̵ Endorsements are specific changes or amendments to the

terms and conditions of the standard-form policy language

̵ Named insured is the person or organization to whom the

policy is sold

• Who Is Insured?

̵ “Named insureds” under the policy is usually the

airline/operator (automatic qualification)

Aviation Insurance

continuedcontinued

̵ An “additional insured” is a party who is not automatically an

insured under the policy, but to whom the named insured

wishes or is obligated to extend a measure of protection

under its policy

• Limits of insurance – set a ceiling on the amount of money

the insurer will pay, regardless of the number of insureds

covered by the policy, the number of losses, the number

of claims made or the number of persons or organizations

making claims

Aviation Insurance

continuedcontinued

• Deductibles – many policies contain deductible clauses

requiring payment by the named insured of a specified

portion of the loss before the insurer’s obligation is

triggered

̵ Lessors or financiers should ensure that the named insured

has adequate financial resources to pay the deductible

̵ Hull v. Liability

̵ Deductible = Self-insurance (credit risk)

Aviation Insurance

continuedcontinued

• Cancellation and changes – under standard insurance

policy, the insurer owes no duties to provide notice of

cancellation, non-renewal or changes to additional

insureds or loss payees; rather, it owes such duties only to

the named insured

̵ Lessors and financiers should insist that the insurance policy

contain a clause giving interested parties advance notice of

any cancellation, non-renewal or material changes in the

policy

Aviation Insurance

continuedcontinued

̵ Normal hull and liability policy may not contain any

cancellation clause at all (policy intended to be a fixed

contract for 12 months) – if it does contain a cancellation

clause the notice period will normally vary from 10 to 30

days

̵ For a “war and allied perils” policy the situation is different –

there are specific (short period) cancellation provisions

which can give rise to an aircraft or a specific geographical

area being excluded from cover at relatively short notice

Aviation Insurance

continuedcontinued

̵ For hull policies, the usual cancellation provisions may

include:

• Automatic termination in the event of the excluded perils

• Seven days at any time to review the rate of premium and/or

the geographical limits

Aviation Insurance

continuedcontinued

̵ For liability policies, the usual cancellation provision may

include:

• Automatic termination in the event of a war between the five

great powers

• Automatic termination of liability war coverage (not the allied

perils) in the event of the detonation of a nuclear weapon

• Seven days at any time to review the rate of premium and/or

the geographical limits

Aviation Insurance

continuedcontinued

• Subrogation – most insurance policies permit the insurer

the right to subrogation, or the right to “take over” the

rights of a party receiving an insurance payment

• Geographical limits – traditionally insurances have been

worldwide containing effectively no geographically limits (it

has always been understood that if the named insured

departs from its “normal” operations it will (i) act as if not

insured and (ii) notify his insurers)

̵ Exceptions

Aviation Insurance

continuedcontinued

• Premiums – lessors and financiers should not be liable for

any premiums (insurers will typically agree to this, but will

seek to deduct any premium due in respect of the aircraft

from any claim in respect of such aircraft)

 Loss Payee Clause

• A loss payee clause is an insurance policy provision that

names a person to whom the hull insurance proceeds are

to be paid if a loss occurs

Aviation Insurance

continuedcontinued

• Lessors and financiers can arrange to be named as loss

payees under the policy – such status does not entitle

them to any rights under the policy except to be paid the

proceeds after the loss

 Breach of Warranty

• Most airline policies contain warranties which provide

something like the following: the assured shall take all

reasonable precautions to ensure that: (i) at the

commencement of each flight, the aircraft shall have a

Aviation Insurance

continuedcontinued

• (cont.) current and valid Certificate of Airworthiness or

other permit to fly issued by a competent authority and

shall be airworthy and in every way fit to fly; (ii) all

government regulations and instructions for civil aviation

are complied with; (iii) the aircraft shall operate in

accordance with the weight restriction imposed by such

aircraft’s Certificate of Airworthiness

̵ Failure to comply with these warranties could invalidate the

insurance

Aviation Insurance

continuedcontinued

• Breach of warranty endorsement provides that the

insurance maintained by a lessee or a borrower shall not

be invalidated as to a lender or lessor by reason of any

act or neglect of the named insured

• Insurer will require that if it has a defense against the

insured, its payment obligation to the creditor shall not

exceed the indebtedness due the creditor and it shall be

subrogated to the rights of the creditor against the insured

Aviation Insurance

continuedcontinued

 Aircraft Hull Insurance

• Hull insurance protects against physical loss or damage to

the aircraft

• Generally the obligations under a hull policy expressly

cover “all risk” except those that are specifically excluded

• Generally a hull policy provides for a deductible –

deductibles should not apply in the case of a total loss

̵ Deductibles dependent on the type and size of the aircraft

Aviation Insurance

continuedcontinued

̵ Deductibles can be reduced by means of a separately

placed “deductible insurance” policy

• Generally lease documentation provides that an event of

loss with respect to the airframe constitutes an event of

loss with respect to the entire aircraft (including the

engines)

• For damaged property, insurance policies generally

provide the cost of repair/replacement

Aviation Insurance

continuedcontinued

• For destroyed property, insurance policy may obligate the

insurer to pay on the basis of actual cash value of the

property, replacement cost or agreed value (generally

require “agreed value”)

• Hull insurance will not cover loss of use, delay, grounding

or any other consequential loss nor will it pay for wear,

tear and gradual deterioration

• War and allied perils are excluded (AVN 48B)

Aviation Insurance

continuedcontinued

 Passenger and Third-Party Liability Insurance

• Liability insurance covers the legal liability of the named

insured and additional insureds for bodily injury to

passengers and damage to persons (other than

passengers) or property resulting from the operation of the

aircraft

̵ Liability can be divided into three categories: (i) liability in

respect of passengers, baggage, cargo and mail carried on

the aircraft (these liabilities result from the operations of the

Aviation Insurance

continuedcontinued

̵ (cont.) carrier), (ii) aircraft third party liability (liability for

damage done to property or person outside the aircraft itself)

and (iii) “general third party” (liability for damage done to

property or people arising other than from the use of the

aircraft (these are the “ground operations” risks comprising

premises, hangarkeepers and products liability))

• In certain jurisdictions, lessors and financiers may be held

responsible for injury or property damage stemming from

the use of an aircraft simply because of their interests in

the aircraft (“strict liability” concerns)

Aviation Insurance

continuedcontinued

̵ Overall concern is due to their perceived “deep pockets” –

target in any litigation resulting from the operation of aircraft

• Liability insurance is generally capped at a specified

amount for claims arising from a single “occurrence”

(however it is defined) – an “occurrence” is defined

generally to be an “accident” or a series of related

conditions collectively constituting an accident

Aviation Insurance

continuedcontinued

 War and Allied Perils Coverage

• Hull and liability insurers will usually exclude from their

respective coverages certain war and associated risks

including invasion, rebellion, insurrection, hostile

detonation of atomic weapons, strikes, riots, civil

commotion, acts of political and terrorist nature, sabotage,

confiscation, nationalization, and hijacking (AVN 48B) (see

Attachment 10)

Aviation Insurance

continuedcontinued

• Certain of these risks are often written back into the hull

and liability policies by virtue of supplemental

endorsements to the policies

̵ Hull coverage

• The hull “war risks” policy will cover those claims for physical

loss of, or damage to, the aircraft which have been excluded

from the named insured’s hull “all risks” policy either by (i) the

application of the AVN 48B or (ii) when the aircraft is outside

the control of the operator by reason of any of these “war”

perils

Aviation Insurance

continuedcontinued

• LSW 555B (see Attachment 11)

• AVN 51 (see Attachment 12)

• Most hull “war risk” policy are subject to an aggregate limit

̵ Liability coverage

• All of the risks excluded can be written back except for the

hostile detonation or explosion of a nuclear weapon

• AVN 52E (see Attachment 13)

Aviation Insurance

continuedcontinued

• A separate policy is not necessary – the risks excluded by AVN

48B can be reinstated by an endorsement known as Extended

Coverage Endorsement (AVN 52E) which, subject to its terms

and conditions, provides coverage in respect of liability war

and allied risk

• Normally no deductibles applied to hull “war and allied

perils” policy

Aviation Insurance

continuedcontinued

 AVN 67B / 67C (see Attachment 14)

• AVN 67 consists of two separate policy endorsements –

one for ‘all risks’ policy and one for the ‘hull war’ policy

(the two endorsements are almost identical)

• AVN 67 is not a policy, but rather evidence of the inclusion

of insurance coverage for the specific protection of the

identified contract parties, and it allows them to be

endorsed directly onto the operator’s policy as additional

insureds

Aviation Insurance

continuedcontinued

• Underwriters in the United States do not follow AVN 67B

unless they are participating in transactions involving

London-led underwritings

• Major Differences

̵ No Loss Payee

̵ Contracts and Contract Parties

Aviation Insurance

continuedcontinued

 50/50 Clause

• 50/50 clause is a devise intended to deal with those

claims where the circumstances of the loss are such that it

is not clear whether they will be covered by the “all risk”

policy or the “war and allied perils” policy (AVS 103A) (see

Attachment 15)

Aviation Insurance

continuedcontinued

 Reinsurance/Cut-Through Clause

• In many jurisdictions, local law may require that all insurances is

placed with a domestic insurer, who will often reinsure into the

international markets

• The ratings of such domestic insurer are often lower than would

normally be acceptable – lessors and financiers may require

reinsurances due to creditworthiness concerns of the domestic

insurer

Aviation Insurance

continuedcontinued

• “Cut through” clause is a devise by which it is required that the

reinsurers make direct payment of a claim to the loss payee

nominated in the original policy

• See Attachment 16

 Political Risk

• Political risk insurance (repossession insurance,

repatriation insurance and collateral deprivation

insurance) is utilized to protect financiers who are unable

to recover possession of their aircraft as a result of action

Aviation Insurance

continuedcontinued

• (cont.) or inaction of the government or governmental

authority of the state in which the lessee or operator of the

aircraft is located (LSW 147) (see Attachment 17)

 Tail Coverage

• Extension of liability coverage for lessor or lenders for an

agreed period (typically 2 years) after the earlier of a

transfer or the lease/loan expiry

Aviation Insurance

 See attachment 18

Transferability