From the Editor: Keeping up with the aviation finance world in 2020

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Gerard Melling
M&T Aviation USA Inc (a Mitsui & Co Ltd subsidiary), California
g_melling@tombo.com

I am in the second year of a two-year stint as Publications Officer and I have been heartened by the response for publications from our Committee Members. The IBA is discussing the release of publications to a wider audience than the Committee, though articles may be republished. I have reflected on the value of our publications: our committee is unique because the IBA is multinational and, as we all know, every transaction reins in the different jurisdictions of lessors, banks, operators and governing law. This is a unique forum for connecting with those counterparties whom we meet daily on calls and on email , but neither in person nor outside transactions. It is also valuable to be able to keep eyes on our ever changing world at our conferences, as well as in our publications. I’d therefore like to mention some of the developments we are dealing with in 2020.

As aviation finance lawyers, we need to be adaptable and understand many fields: contracts, insurance, litigation, bankruptcy, tax. We must also have the skills to manage different challenges and issues that will emerge unexpectedly. It is important to know who to contact to help you; our association is helpful here.

Technical matters

Lawyers leave technical matters to the experts, but nevertheless need to appreciate and understand the issues that arise. These include the following:

MAX grounding

Boeing is now saying it will take ‘several quarters’ to return the B737 MAX (‘MAX’) to service. Some 700 planes are grounded as the result of the issues with Maneuvring Characteristics Augmentation System (MCAS, in our conference report as updated by Gene Kaskiw) and following two huge, fatal crashes. We have to consider the following:

Continuing rent payments

Typical rents are over $300,000 per month. Boeing has undisclosed arrangements with the purchasers for support, which must involve huge amounts (and losses). The next party in the contract line (such as sale and lease back purchasers/lessors from and to airlines, or lessees from leasing companies who purchased from Boeing) relies indirectly on that support and some operators have asked to reduce rent or exit leases. Lessors/financiers of course want to be paid and do not want to repossess grounded aircraft with no Boeing support. That support also means operators can lease replacement aircraft and keep their business going, which is what lessors and financiers want.

Preservation of aircraft

Boeing has requirements but, the longer the storage, the deeper the preservation and the greater the concerns and costs on return to service. 

Aircraft value

As a type, there had been discussion of a replacement new midsize airplane (NMA).  Owners are nervous that the MAX will continue to be a good asset with strong residual value, much like its predecessor (the ‘New Gen’ 737-800s).  Boeing’s losses exceed $18.4bn and the catastrophe will have some long term effects on this issue.

Engines

The new generation aircraft (MAX, neos) have engines that are more efficient through use of higher pressure, new materials, gearing and larger fans. At the same time, these present issues.

Teething troubles occur particularly in the first two years, with engines needing to come off wing. These troubles are largely overcome, but have been significant. With R&R, the fan blade replacements have had a massive impact for Boeing 787 operators.

Parts like the Pratt & Whitney-geared turbofan (GTF) have shorter lives and must be swapped out much sooner than on the previous generation. This can be covered by manufacturer support, but also affects the maintenance expense provision for end-of-lease payments or reserves, which must be carefully drafted to avoid owners being locked into unrealistically low rates that don’t reflect the new maintenance costs, which could, in turn, lead to huge exposures.    

Transactional Developments

There are two developments guided by the Aircraft Working Group (AWG), an association of manufacturers, major lessors and banks. (See www.awg.aero/project/gats and www.awg.aero/project/cape-town-convention for more details.)

Global Aircraft Trading System (GATS)

Discussed at our Rome convention, this is a platform for electronic trading, targeted for launch on 1 April 2020. There will be an electronic ledger and aircraft will be put into compatible trusts with electronic signatures and transfers. The aim is to make sales of aircraft with leases attached easier and more efficient. Some transactions have already taken place and the lessors and lessees need to be willing and set up to go: it remains to be seen how quickly or widely it is adopted.

Cape Town Convention Compliance Index (also discussed at the Rome Conference): 

This convention should make repossession of aircraft from defaulting airlines more straightforward and automatic: the International Registry in Ireland registers title, lessor and security rights and many countries are a party to the convention, which should mean the Organisation for Economic Co-operation and Development (OECD) financing a ‘Cape Town Discount’. An irrevocable de-registration and export-request authorisation (IDERA) registered with the authority of registration of the aircraft should ease the deregistration process. 

The implementation of this convention has been very uneven, with some repossession and export disputes occurring (such as that of Avianca Brazil in 2019). The AWG, which assists countries in implementation procedures, has researched and established a compliance index, which grades each country on its compliance with the treaty and which is scheduled to be launched on 29 February 2020. This will be updated semi-annually and for major developments. There will be a public and a proprietary (available for purchase) index. 

Tax

As a result of the European Union Anti-Tax Avoidance Directive, there will be specific requirements of substance in Ireland from 2021 in terms of employees, offices and assets: aircraft-leasing companies in Ireland have the benefit of tax treaties which reduce withholding taxes on rent paid to Irish entities to either nil or a lower amount. As a result, entities without required substance are renting offices and recruiting/transferring staff.

External events

Global events have an unsettling effect on aviation. The Coronavirus has resulted in a lot of cancellations, which has put pressure on affected airlines globally, with staff being furloughed and planes grounded. This rebounds to lessors and financiers, as airlines need income to pay their rent and pay back their loans. Airbus has suspended its China production and other manufacturing consequences may arise. A lawyer must be prepared, as always, for negotiations with lessees for support, and for redeliveries, which involves dealing with maintenance claims and redelivery obligations, arranging for storage and insurance and possibly taking court proceedings. 9/11 had a very dramatic impact on aviation, which included states taking over insurance obligations.  

Accidents and incidents occur mainly in individual cases, so their effect is not as widespread, though repetitive issues may lead to insurance problems. This year we have already seen Ukraine Air International flight 752 shot down over Iran and two incidents with Pegasus Airlines in Istanbul (in one of these, the plane skidded off the runway and broke into three: three people were killed). In the MAX cases, the MCARS issue led to a fleet grounding, but for individual accidents, insurers will take care of liability and hull claims: this underlines the central importance of insurance for lessors and financiers, who can seek insurance opinions on documentation. The bigger institutions may also have insurance specialists.

Lastly, environmental issues will have an evolving effect on this sector: flight shaming is gaining some momentum and there are pressures to develop alternative fuels and propulsion, as well as ensure greater efficiencies with less emissions.

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