This is the third and final article in our series on common issues faced in cross jurisdictional finance transactions.
In our first article of this series we looked at how some jurisdictions deal with the grant of security in syndicated finance transactions where the concept of security trustee is not recognised. In the second and in this final instalment in the series, we look at the options and remedies that may be available to lenders when enforcing security over moveable assets and the cross jurisdictional considerations that lenders should take into account before deciding the most appropriate route of action.
In the second article of the series, we looked at ship mortgage enforcement. In this final article, we look at enforcement of security in aviation finance transactions and, once again, focus on the mortgage document.
The importance of the aircraft mortgage
As is the case within the realm of ship finance, a financier's recourse in an aviation finance transaction will be to the asset which is the subject of the financing i.e. the aircraft. In contrast to ship finance where a relatively extensive portfolio of security is taken, the security package taken in aviation finance transactions is generally limited. However, in both types of finance the mortgage document provides the most comprehensive form of security to the lender.
Recourse to the aircraft (on a default) will provide financiers with comfort that should their borrower default, there will be adequate means of their loan being repaid. In non-COVID 19 times, aviation finance has often been viewed as "future proof"; typically, financiers are able to predict the market values of aircraft because aircraft, more so than ships, are generally easily re-marketable to other owners/lessors and lessees.
Practical issues on enforcement: jurisdiction issues
Aviation finance is subject to multiple jurisdictional elements; the state of registration of the aircraft (SOR), the state of incorporation of the parties involved in the transaction and the location of the aircraft and its likely operations, all of which cumulate to give a thoroughly international backdrop with multi-jurisdictional considerations.
One such practical multi-jurisdictional consideration which is key to the issue of enforcement of an aircraft mortgage is that (and again to state the obvious) as an aircraft is a moveable asset, how and if a financing party is able to enforce security constituted under a mortgage will depend on the validity and the enforceability of that security in the jurisdiction where the aircraft is located at the time any enforcement action is taken.
Whether or not a jurisdiction will recognise an aircraft mortgage can depend on one or a myriad of factors. Some jurisdictions will only recognise a mortgage if it is effective under the SOR, others may look instead to where the mortgage document itself was executed or where the mortgagor is incorporated or where the aircraft was situated at the time of the execution of the mortgage. Given these considerations, it is often the case that a "local law" mortgage is taken i.e. a mortgage that is governed by the SOR as it is thought that on a balance of probabilities this may be the most widely recognised by "foreign" jurisdictions.
Practical issues on enforcement: the benefits of self help remedies
On enforcement, however, further practical problems can arise where a local law mortgage document does not allow the financing party as mortgagee to seek to enforce its powers under the mortgage without the involvement of the courts. In the absence of self help remedies, a court enforcement processes can be lengthy, unpredictable, and costly. A local law mortgage can also necessitate the payment of inordinately high taxes on the registration of the mortgage with the aircraft registry in its SOR (typically in order for the security constituted under a mortgage to be "perfected" the mortgage will require to be registered on the SOR aircraft registry).
We should note of course that whilst the availability of self help remedies can be attractive, in the current climate these are unlikely to be utilised (at least as a first option) where the impact of COVID 19 has seen the grounding of many aircraft. In these circumstances the financier as mortgagee following enforcement of self help remedies will become liable for arguably a much longer period of time for (amongst other things) the insurance, maintenance and storage of an aircraft when trying to find a prospective buyer or lessee.
Predominance of English law governed aircraft mortgage
Against this often uncertain multi-jurisdictional backdrop, English law has (along with the laws of the state of New York) emerged as being one of the most common systems of laws that is chosen to govern the finance documents in aviation finance transactions. The reasons for this are manifold; generally, English law is deemed to provide a creditor with a strong element of certainty as it is well established and highly developed. Importantly, and similarly to the position for UK ship mortgages, English law also allows the financing party as mortgagee to seek self help remedies and enforce its powers under the mortgage without the involvement of the courts.
All this being said, and as referred to above, it does not automatically follow that other jurisdictions will recognise an English law governed mortgage and the powers granted to a mortgagee under it (including the right to take possession, de-register the aircraft from the aircraft register or the power of sale). Lenders cannot therefore rest on their laurels on the assumption that having an English law governed mortgage will mean that they can ignore the other international elements of an aircraft financing. Often, for example, it will be deemed appropriate to supplement the English law mortgage with the execution of a local law mortgage.
English law aircraft mortgages and conflict of laws
Under an English law mortgage, the title to the property/asset is transferred from the owner to the financier as mortgagee subject to the equity of redemption (that is to say, subject to the title of the asset being transferred back to the owner upon satisfaction of the debt) . The proprietary right given to a financier as mortgagee under an English law governed mortgage, governs that financier's rights in rem (rights in the asset itself) so that when a default occurs and following the relevant enforcement action, it gives the financier the right to obtain payment of its debt out of its appropriation of the property. Whilst this proprietary right provides the mortgagee with powerful remedies, it also gives rise to often complex conflict of laws considerations.
The general rule governing English conflict of laws is that the validity of the right of a party claiming under an instrument which governs a transfer of "a tangible moveable" (in this case, the aircraft) will be the law of the country where the "moveable" is at the time of the transfer (the lex situs) .
In aviation finance, however the "law of the country" has been interpreted narrowly by the English courts. An English court, for example, will not apply that other country's conflict of laws rules. This means that for an English law mortgage to be recognised by an English court as being enforceable, the English courts will look solely to whether it is effective under the domestic laws of the jurisdiction where the aircraft was located at the time of the mortgage's creation. This has resulted in the often costly and cumbersome practice of ensuring that at the time of creation of an English law mortgage, the aircraft which is the subject of the mortgage is either located in England, or is flown into English airspace or a jurisdiction that recognises the validity of the English law mortgage.
The Cape Town Convention and early considerations
While an exploration of the Cape Town Convention (CTC) is outwith the scope of this article, it is worth noting that the lex situs rule does not apply to the creation of security interests created under it. Where a CTC security interest has not been created or where there is a likelihood that the aircraft is operating (and therefore may be likely to be repossessed) in a jurisdiction which has not ratified the CTC, financiers would however be prudent to consider taking an English law mortgage which complies with the English lex situs rule as well as a local law mortgage (a mortgage under the law of the aircraft's state of registration) in that jurisdiction.
Given the interplay of such complex cross jurisdictional aspects in aviation finance, it is imperative that early legal advice (ideally at term sheet stage) is taken, particularly with regard to the financiers' security package.
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