The Cape Town convention briefing

25 August 2005

Aircraft being loaded

Summary

The Aircraft Equipment Protocol, which will apply the Cape Town Convention to aircraft objects, is expected to come into force in the second half of 2005. The Convention and the Aircraft Equipment Protocol centre on the concept of an “international interest” in aircraft objects and associated rights in countries that are signatories to the Convention and provide a system of registration and priority of those rights in an International Registry.

Background

On 16 November 2001, a diplomatic conference was held in Cape Town for the purpose of adopting a Convention on International Interests in Mobile equipment (the Convention) and a supporting Protocol on Matters specific to Aircraft Equipment (the Protocol). The Convention provides a framework covering all types of mobile equipment. Different protocols will be added to the Convention, each of which will modify and supplement the Convention to make its terms relevant to specialised treatment of different forms of equipment financing. The only protocol adopted so far is the Protocol, which applies to airframes, aircraft engines, and helicopters above a minimum size or power threshold.

The Convention, which came into force on 1 April 2004, has no practical effect without the Protocol insofar as aircraft objects are concerned. The Protocol requires eight ratifications before it can come into effect. Although as of 31 July 2005 only six countries have ratified the Protocol, it is hoped that the Protocol will come into force in the second half of 2005.

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Primary purpose

The Convention and the associated Protocol are designed to facilitate asset-based financing and leasing of high value mobile equipment. Investment in aircraft has in the past been hindered by the application of different national regimes to security rights in aircraft objects. Legal systems either do not protect the creditor in an event of default or bankruptcy, or are simply unpredictable. The Convention and the Protocol aim to reduce the risks inherent in lending on high value mobile equipment by providing a method for the creation, recognition and enforcement of certain interests in aircraft objects and their registration and priority in an International Registry.

“Aircraft objects” includes the following:

  • Airframes that would carry at least eight persons or goods in excess of 2750 kilograms;

  • Engines having at least 1750 lbs. of thrust if jet propelled and at least 550 rated take-off shaft horse-power if turbine-powered or piston powered; and

  • Helicopters.

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Interests in aircraft objects

There are five categories of interests which may be the subject of protection:

International interest
  • An interest of a chargee granted under a security agreement; or
  • An interest vested in or held by a person who is the conditional seller under a title reservation agreement; or
  • An interest vested in or held by a lessor under a leasing agreement.

An international interest also extends to “proceeds” of an object but this only includes proceeds arising out of an object's total or partial loss, destruction, confiscation, condemnation, or requisition. Proceeds do not include sale proceeds or lease rentals.

Prospective international interest
  • An international interest intended to be created or provided in the future upon the occurrence of a certain event.
National interest
  • An interest held by a creditor in an aircraft object which is created by an internal transaction between a debtor and a creditor each in the same Contracting State and which relates to an aircraft object located in the same Contracting State at the time that the interest is created where the Contracting State has made a declaration that the Convention shall not apply to internal transactions.
Registrable non-consensual rights
  • A right or interest conferred under the law of a Contracting State (eg, a mechanic's lien or a judgment debt lien in either case conferred by statute) to secure the performance of an obligation where the Contracting State has made a declaration listing such right or interest as being one that is registrable under the Convention.
Non-consensual right or interest which is given priority without registration
  • A right or interest conferred under the law of a Contracting State on the provider of a public service (eg, Eurocontrol) to secure the performance of an obligation where the Contracting State has made a declaration that such rights or interest should have priority over any international interest registered after deposit of the relevant declaration even though the right or interest may not itself be registered.

In respect of each of the interests, a “creditor” is the person who has the benefit of the interest (eg, a lessor, seller under a conditional sale, chargee under a security agreement or the beneficiary of a lien).

A “debtor” is the person who either created the interest (eg, chargor under a security agreement) or the person who takes the aircraft object subject to the interest of the creditor (eg, a purchaser under a conditional sale or a lessee) or the person with the primary responsibility for payment of the debt secured by a lien.

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Creation

The following conditions must be fulfilled in order to create an international interest:

Agreement

There must be:

  • a security agreement (such as a mortgage or charge); or
  • a conditional sale agreement (seller of aircraft sells on basis of payment of purchase price by instalments with buyer getting possession and use before purchase price fully paid but seller retaining legal title until full purchase price paid); or
  • a leasing agreement (which can be a lease or sub-lease etc) (Article 2)2 or a contract for sale of an aircraft object (Article 6).

Location in a Contracting State

  • The debtor (or seller in a sale or prospective sale) must be located in a Contracting State. The location can include the registered office or principal place of business at the time of conclusion of the agreement creating the international interest (or the contract for sale) (Articles 3 and 4).
  • In the case of an airframe or helicopter only (i.e., not an aircraft engine on its own), the airframe/helicopter is registered or is agreed to be registered (eg, under the relevant lease agreement) in a Contracting State (Article 3(3)) – in this case the debtor need not be located in the state of registration which is the Contracting State.

Defined Aircraft Object

  • The aircraft object must fall within the definition of airframe, helicopter or aircraft engine (see Articles 1(c), (f) and (v)). For most aircraft, helicopters or engines used in commercial operations this will be the case.

Ratification by Contracting State

  • The state in question must be a Contracting State, ie, it must have ratified the Convention and the Protocol.

Requirements for agreement

Under the Convention, the agreement that is needed to constitute an international interest must comply with the following requirements. It must:

  • be expressed in writing;
  • relate to an aircraft object which can be identified by reference to the manufacturer (eg, Boeing/Airbus), generic type (eg, 747-400 or A340-500) and the manufacturer’s serial number;
  • relate to an object over which the chargor, conditional seller, lessor or seller has power of disposal (this also includes eg, the transfer of use or possession in the case of a lessor which is a sub-lessor);
  • in the case of a security agreement, enable the secured obligations to be determined but without the need to state a sum or maximum sum secured.

The creditor does not need to be located in a Contracting State and the debtor need only be located in a Contracting State at the time of the conclusion of the relevant agreement. It is unlikely that the Convention and Protocol will apply retrospectively, that is to say to transactions which occur prior to the Convention and Protocol coming into force insofar as the relevant Contracting State is concerned.

If the above conditions are met then an international interest over an aircraft object will be created. This will be the case even though conditions to the creation of a valid interest under other laws (e.g., the domestic law of the state of the debtor) may not have been fulfilled.

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Registration

The Convention provides for the creation of a central computer based International Registry (IR)4 for the registration, amendment, extension or discharge of registrable interests. The registration will be complete upon entry of the required information into the database so as to be searchable. Because it is a computer-based system, registration will be simple, inexpensive and will not require lodging of the documents evidencing the relevant international interest being registered. The Convention allows creditors to file directly with the IR, by computer, from anywhere in the world.

Each registration requires the consent of both the applicable debtor and creditor and will not be effective until consent is given to the IR (again by electronic means). It will also be possible to register subordination/priority agreements (ie, agreements which alter the order of priority of international interests) and assignments (see below).

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Priority

In order for an international interest to obtain priority it must be registered in the IR.

  • Priority is generally based on the order of registration, which is strictly time-based so that an international interest will rank for priority as from the time of registration over a subsequently registered interest.
  • A registered international interest will also have priority over one that is not registered, even if the registered international interest was registered with actual knowledge of the unregistered interest or a national interest where priority has not been protected by registration.
  • A buyer under a registered sale agreement takes its interest free of any interest subsequently registered or any unregistered interest (even if buyer knows of them) but the buyer will take subject to any interest registered prior to its acquisition.
  • A conditional buyer or lessee (effectively a debtor) takes its interest subject to an interest registered prior to registration of the international interest held by its conditional seller or lessor, but otherwise free from any unregistered interest (even if known about).
  • Priority may be varied by agreement between holders of respective interests but it is advisable to register the relevant priority/subordination agreement.
  • Priority does extend to proceeds, but as these are very strictly defined this will in most cases simply be insurance proceeds.
  • Where a prospective international interest is registered which subsequently becomes an actual international interest, then the time of registration (and hence the ordering of priority) is effectively back-dated to the time of registration of the prospective international interest.
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Recognition

The Convention and the Protocol are intended to provide for recognition of international interests in aircraft objects. This recognition is intended to override domestic law. A particular example of this is the effect of the creation of an international interest in an aircraft engine. In a number of countries throughout the world the attachment of an aircraft engine to an airframe results, under domestic law, in that aircraft engine automatically becoming owned by the owner of the airframe. If however an international interest has been registered in that aircraft engine then that interest, whether it be an ownership interest or a security interest or lease interest, will prevail even if it is inconsistent with the transfer of ownership under domestic law. This is not however the case where an item that does not itself constitute an aircraft object (thus excluding qualifying aircraft engines) is installed on an aircraft object. In that case, any rights of a person in such item (eg, leased in flight entertainment video equipment or a borrowed auxiliary power unit), provided that they are not affected by a law other than the Convention by installation on the aircraft object, will not be affected by the Convention and the Protocol.

The Convention and the Protocol also provide for recognition of certain rights such as the quiet enjoyment rights of debtors in the absence of default.

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Assignment

The Convention and the Protocol also deal with the “assignment” of international interests.

In principle, associated rights may be assigned, whether by way of security or otherwise, and this confers on the assignee associated rights with or without the transfer of an international interest. Associated rights means all rights to payment or other performance by a debtor that are secured by or associated with the aircraft object.

The most common form of assignment in an aircraft finance transaction is an assignment of a lease and examples include (i) an assignment by an aircraft owner to its financiers of the benefit of a lease out by the aircraft owner of the financed aircraft to its operator or (ii) an assignment by a lessee of an aircraft to the owner of the aircraft of the benefit of a sub-lease of the aircraft. Each such assignment constitutes a contract which, by way of security, gives to the assignee the relevant “associated rights”.

In brief:

  • the assignment can be partial (e.g., it is possible to assign part only of the rent under a lease - as is frequently the case with assignments of leveraged leases);
  • the assignment can take the form of a transfer or charge or pledge;
  • the assignment need not be by way of security (i.e., it can be absolute); and
  • the assignment should comply with the formal requirements of Article 45 (which are equivalent with the formal requirements for creating an international interest).

Effect of Assignment

Unless otherwise agreed, an assignment of associated rights will also transfer to the assignee the related international interest and all the interests and priorities of the assignor under the Convention and the Protocol (Article 44). This means that it is not necessary for the assignment to be expressed to transfer the related international interest as such transfer will be automatic unless agreed otherwise.

The parties to an assignment are free to agree that it does not transfer the related international interest and, if they do so, then the Convention will not apply to the assignment.

Priority of competing assignments

Articles 48 and 49 deal with priority as between competing assignments and with certain qualifications related to assignment of associated rights.

  • Where there are two assignments and one (at least) is an assignment to which the Convention applies (ie, it includes an assignment of the related international interest) the same rules apply as for international interests (see above).
  • Where there is an assignee of associated rights and the related international interest has a registered assignment, such assignee will only have priority under the Convention over another assignee of the same associated rights where the contract under which the relevant associated rights arise states that they are secured by or associated with the relevant aircraft object and such associated rights are “related” to an aircraft object.

Associated rights are only “related” to an aircraft object if they are rights to payment or performance related to:

  • a loan provided for purchase of that aircraft object or another aircraft object (if the assignor transferred its international interest in that other aircraft object to the assignee and that assignment has been registered); or
  • the price payable for, or rentals payable in respect of, the aircraft object; or
  • other obligations (eg, default interest, broken funding costs etc) arising from a transaction referred to above.
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Enforcement and remedies

The Convention and Protocol entitle the creditor holding an international interest to exercise certain agreed remedies (Articles 12 to 15).

Default

The remedies are usually triggered by the occurrence of a “default” which is vaguely defined in Article 17 as a default that substantially deprives the creditor of what it is entitled to expect under the agreement constituting the international interest. Article 17 works as a fall back provision if the debtor and the creditor have not agreed what constitutes a default. The relevant agreements should therefore contain a specific clause specifying that the occurrence of any of the stipulated events of default/termination events will constitute a default for the purposes of Article 17. The parties to a transaction can further agree whether or not remedies which are available can be exercised (to the extent that they do not specifically require application to a court) extra-judicially (i.e., without application to a court and the granting of a court order and referred to as “self-help”). There is however an overriding principle governing the use of self-help remedies, which is that a Contracting State may at the time of ratification of the Protocol declare that the applicable remedy can be exercised only with court approval (see Article 70 (2)).

Remedies for chargees under security agreement

A chargee has, in the event of a default, the right:

  • to take possession or control of the charged aircraft object;
  • to sell or lease the charged aircraft object; or
  • to collect or receive income derived from management or use of the charged aircraft object.

The chargee has to give written notice to “interested persons” regarding any proposed sale or lease of the charged aircraft object within a reasonable time prior to the sale or lease. Interested persons are the debtor, any guarantor and any other person having rights in or over the charged aircraft object who has given notice to the chargee of such rights. In addition to the above there is a right for the chargee and all interested persons to agree that the ownership or other interest of the chargor in the charged aircraft object shall vest in the chargee and the chargee may also apply to the court for a vesting order (Article 13). Vesting, whether voluntary or by a court order, may be useful in a case where recourse of the chargee to the chargor of the charged aircraft object is limited to the value of security provided by the chargor.

Remedies for lessors/conditional sellers

A lessor/conditional seller has, in the event of a default, the right:

  • to terminate the relevant agreement; and
  • to retake possession of the relevant aircraft object. Possession is only a self-help right, unless the Contracting State has made a declaration at the time of ratifying the Protocol that leave of the court is required.

Remedy for assignee

The remedies available to an assignee where an assignment by way of security has been granted and the assignor is in default are broadly the same as the remedies given to the holder of an international interest on a debtor's default.

Remedy of deregistration

On enforcement by a creditor, the relevant aircraft object will usually need to be deregistered from the aircraft nationality register on which it has been registered. The Chicago Convention 1944 forbids an aircraft to be registered on two different nationality registers at the same time. The Convention and Protocol provide the creditor with the right to deregister, export, and transfer an aircraft object from where it is located (Article 15). These rights are conditional on the agreement of the debtor (usually contained in the relevant agreement) and with the consent of the holders of any registered interest ranking in priority to the creditor. If the creditor seeks to exercise its rights to deregister etc without leave of the court then it must give written notice to interested persons within a reasonable time.

Interim relief

The Convention and Protocol specify five categories for interim relief for the creditor subject to (i) the agreement of the debtor (which can be given in advance eg, in the relevant lease, security agreement or title retention agreement), and (ii) to the creditor providing satisfactory evidence of default to the court. These categories relate to:

  • preservation of the aircraft object and its value (e.g., storage);
  • granting of possession/custody of the aircraft object to the creditor;
  • immobilisation of the aircraft object;
  • leasing out of the aircraft object or sale of the aircraft object; and
  • application of its proceeds.

Relief, in the form of an order, is granted by the court which is required to grant “speedy” relief. The relevant Contracting State must specify a period of working days within which relief should be granted following an application by a creditor. Before making its order the relevant court may require that notice of the request for interim relief be given to interested persons.

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Insolvency

Insolvency laws throughout the world are inconsistent in their approach to the rights of creditors, particularly with regard to the protection of their interests in aircraft objects in the event of a debtor airline’s insolvency. The Convention and the Protocol contain alternative procedures arising on insolvency of a debtor which are intended to speed up enforcement of a creditor’s rights and provide greater certainty as to the time within which a creditor may recover aircraft equipment from the debtor.

Article 23 introduces the possibility for a Contracting State to adopt a measure of protection for the creditor (Alternative A or the “hard” alternative) which is analogous to Section 1110 of the US Bankruptcy Code or an alternative measure of protection (Alternative B or the “soft” alternative) which may provide a creditor with a greater degree of certainty as to enforcement of its rights.

The provisions for remedies on insolvency under the Convention only apply where a Contracting State has made a declaration under Article 71 (3) that it will apply either the whole of the Alternative A or the whole of Alternative B. It is possible for a Contracting State to declare that it will apply the whole of Alternative A in the case of some insolvency proceedings and the whole of Alternative B in the case of others.

Alternative A requires, subject to cure rights, that the insolvency administrator of the debtor or the debtor itself gives possession of the aircraft object (in accordance with applicable law) to the creditor within a specified period.

There is an obligation on the insolvency administrator or debtor to preserve the aircraft object and maintain it and its value in accordance with the agreement (i.e., relevant lease, security agreement or title retention agreement from which the creditor derives its international interest). Under Alternative A, the creditor is also entitled to apply for interim relief available under applicable law.

If the insolvency administrator or debtor have, no later than the end of the specified period, cured all defaults (other than the default which resulted from the commencement of the relevant insolvency proceedings) and agreed to perform all future obligations under the agreement, the insolvency administrator or debtor may retain possession of the aircraft object.

Alternative B requires the insolvency administrator or the debtor to give notice to the creditor (within a time specified by the Contracting State) whether it will cure all defaults and agree to perform all future obligations under the agreement.

If the insolvency administrator or debtor does not give such notice, the court may (note permission is not obligatory) permit the creditor to take possession of the aircraft object upon such terms as the court may order.

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