Laws governing security interests and leases around the world are a hotch-potch. Countries making the transition to market economies, such as the former Soviet bloc, China, and Vietnam are still trying to grasp the concept of private property. The countries with the biggest aircraft appetites also tend to be the biggest financing nightmares. In India, for instance, a creditor cannot legally repossess property without the debtor's cooperation unless there is a court order. According to David Smith, a London-based solicitor at Wilde Sapte who regularly represents aircraft lenders, that means you file your case 'and go to the back of an eight-year queue.'
Unidroit's proposal comes at a critical time. In the past, most of the world's airlines were flag carriers that enjoyed at least de facto sovereign support. Privatisation is ending that and inevitably putting more pressure on asset-based finance.
To anyone still in doubt, Klaus Heinemann, joint general manager with the Long Term Credit Bank of Japan, warns: 'The assumption that things aren't broke is just an assumption. In many cases we've been spared the necessity to test enforcement of sometimes very complex contractual rights. When we have had to test it, the sight was not pretty.' Citing cases in Brazil and Mexico where lenders were forced into compromises to avoid long delays, Heinemann adds, 'Even where things have been fixed, as is the case with Varig, they were fixed at the expense of the lending institutions.'
Political risk insurance is not the answer, Heinemann says. The policies are too conditional, and even if they were not, he doubts there is sufficient insurance capacity to cover the problem. In his view, 'You simply cannot replace the asset as the answer.'
Foreseeing this need for more asset-based financing, Unidroit began work in 1988 on a proposed uniform law for international interests in mobile equipment. The institute had drafted related laws before, including its Convention on International Financial Leasing. The proposed law aimed to cover equipment ranging from oil rigs and ships to satellites and aircraft.
A year ago Unidroit's study group, comprised of law professors and security specialists, released its first draft of a proposed convention. It asked Airbus and Boeing to organise a joint proposal relating specifically to aircraft. Both companies agreed it would be best to form a small but diverse group of experienced aircraft finance and leasing experts.
The resulting aviation working group consists of Boeing, Airbus, McDonnell Douglas, the three largest engine makers, International Lease Finance Corporation, and three banking representatives - Banque Indosuez, Germany's KfW bank, and the Long Term Credit Bank of Japan. The group's main aim has been to reduce the uncertainties facing aircraft financiers and lessors and thereby cut the cost of credit to airlines.
Last May this group submitted its recommendations to Unidroit. Based on comments received since from the broader air finance community, the aviation group recently amended two of its recommendations with the hope of 'enhancing the political acceptability and practicability' of its proposal. Now Unidroit wants the aviation group to convert its recommendations into draft supplemental aircraft rules. Those will be ready for review by Unidroit at its April meeting.
The aviation proposals fall into two categories - core and optional. The core provisions would apply in any country adopting the Unidroit convention. These are the bare essentials needed everywhere for a system to work. Optional provisions would be elective in two ways. They would only apply if a country chose to adopt them and, at another level, they would apply in a specific transaction only if the parties had incorporated them into their contract.
Two reasons have been advanced for this separation between the core and optional clauses. First, optional provisions would offer countries with newly developing legal systems but large aircraft appetites an instant set of laws conducive to asset-based finance. Second, this approach would reduce political sensitivities by giving the adopting country a choice.
The aviation group suggests three optional provisions. The first would allow parties to choose what law would control their contractual rights and remedies. Closely related, the second would set a timetable for court enforcement of remedies. The third would offer a US Section 1110 look-alike for insolvency proceedings.
The choice of law option would be very broad, allowing the parties to pick the law of any country to control their rights and remedies. The law chosen need not be from a country linked to their deal in any way. The aviation group felt this could give financiers and lessors 'the benefit of certainty and predictability' by choosing 'well-developed and commercially recognised laws.' Thus, a US lender and an Indian airline could agree to use the law of Iceland. If Icelandic law allowed a creditor to use self help in repossession, there would be no more waiting in queues for Indian court orders.
Courts are often sceptical of choice of law clauses because large companies have been known to impose unfavourable choices on weaker parties. The aviation group felt such concerns were unjustified 'in the context of multimillion dollar international financings of aircraft, between sophisticated parties, represented by expert counsel.'
The second optional provision offers a mandatory timetable in which courts would be required to determine issues relating to remedies. If the parties agreed to put this schedule in their agreement, a court would be required to rule within five days on the grounding of an aircraft pending litigation, and within 30 days on a creditor/lessor's right to repossess or sell that aircraft.
Under the final optional provision, in the event of insolvency or a debt moratorium, the parties would be allowed to agree that the debtor or lessee be required to cure all defaults within a specified time or return the aircraft without prejudice to the creditor or lessor's other rights. This concept is borrowed from Section 1110 of the US bankruptcy code.
The gamble with all these optional provisions is that the countries that need them most will actually adopt them. Without these options the practical benefit of Unidroit in countries that lack well-developed commercial laws could be limited. The tradeoff for those countries that need these laws will be between national pride in retaining their own laws or customs and the higher credit risk ratings their local airlines could face.
The core provisions that would apply in every country adopting Unidroit's convention relate to the creation, filing, and priority of security interests and leases for aircraft and engines.
These proposals centre on the notion of one international asset register for filing all such interests. Recording would be by manufacturer's serial number. The party filing first would take priority. Existing national filing offices, such as the US Federal Aviation Administration, might serve as 'satellite' offices for the international register so that parties could file notices locally and have them forwarded to the central register. Local registers would continue to accept filings for nationality purposes, but the international register would become the sole depository for filings involving finance. It would apply even to a purely domestic deal.
But what if an airport authority is claiming a lien for unpaid landing fees or a local tax authority is claiming for delinquent taxes? In most countries these creditors even prevail over a recorded interest. Unidroit would not change that but would simply require each country when adopting this convention to disclose those types of creditors entitled to such preference. A country could change that list later, but only prospectively.
The creation and validity of security interests and leases would depend on the law chosen by the parties. This is a separate choice of law from the optional choice relating to contract rights and remedies. The proposal would also draw a mechanical distinction between security interests and leases for classification purposes.
Other core provisions would cover what type of documents should be filed, how to handle transfers, conveyances, and assignments, a separate or sub-register for aircraft engines, expedited de-registration, and rules banning subordination based on knowledge of prior, unrecorded interests.
'A lot of this looks pretty ho-hum for those of us who have been involved in international aircraft financing,' says David Lloyd Jr, senior counsel with GE Aircraft Engines. The concepts of filing, priority, choice of law, subordination, and so forth are not new. The new part is putting them in a uniform international code and convincing the world to adopt it.
Lawyers do not spare Unidroit from their scepticism regarding anything new and untried. How will a central filing system overcome language differences? How can you ensure that a local 'satellite' office forwards a notice promptly to the international register? And what makes you think a judge in Abu Dhabi will pay much attention to any of this? David Smith says 'simplicity must be the key' so that developing country jurisdictions understand the proposal and feel comfortable adopting it.
Lawyers are not the only ones concerned about local acceptance. Scott Scherer, Boeing's assistant treasurer, sees the Unidroit proposal as entering 'the consensus building stage.' The aviation group has been briefing individual airlines as well as the major airline associations. Jeffrey Wool, the Perkins Coie attorney who spearheaded the aviation group, is now acting as a consultant to all the Unidroit study group delegates. Boeing is informing the Bank of China which has a superior understanding of the need for China's airlines to accelerate their transition from bank guaranteed to asset-based financing.
Ultimately airline enthusiasm for Unidroit may depend on the likely reduction in their financing costs but opinions on that vary. Heinemann sees too many variables to quantify the savings. Financing costs change dramatically with the structure, he notes. Boeing's Scherer predicts 75 to 100 basis point savings, which would translate into 5 or 10 per cent of an aircraft's capital cost. Others may find that too bold, but everyone seems to agree that Unidroit will cut credit costs.
The question now is when Unidroit will finish its convention. The manufacturers are trying to impress the commercial urgency on Unidroit's study group. Boeing's Scherer believes there are opportunities in countries such as Russia that currently lack commercial laws and, for that reason, find financiers reticent. However the longer the Unidroit convention is delayed the less willing a country like Russia could be to set aside its own law in its favour.
At the aviation group's urging, Unidroit has made 'a soft commitment' to the end of 1998. The group wants to accelerate that, but some observers think even 1998 is optimistic. 'It could be another 15 years,' says one US finance lawyer. The view from nations that crave aircraft is one of urgency. As the chairman of one Russian carrier says, 'We need this yesterday.'
Core provisions
* Single international registry for aircraft; separate or sub-registry for engines
* Registry to handle all filings regarding finance: security interests, leases, transfers, conveyances, and assignments
* International registry would apply to all such transactions, whether domestic or international
* Creation and validity of security interests and leases determined under law chosen by parties in their agreement
* Characterisation of security interests and leases for tax or liability purposes determined by local law
* Priority based on first to file, except for preferred creditors recognised under local law
* Each country required to disclose at time of adopting convention what type of preferred creditors would take priority without filing. Subsequent changes prospective only.
* No subordination based on alleged prior knowledge of unrecorded interest
* Expedited deregistration
Optional provisions
* Parties' choice of law would govern contract rights and remedies
* Mandatory timetable for court action on remedies
* In bankruptcy or debt moratorium proceedings, debtor or lessee required to cure all defaults within specified time or return aircraft without prejudice to creditor or lessor's other rights.
Source: Airline Business
