Shielding a Lessor In opposition to Re-characterization in Bankruptcy

Overview

Usually an aircraft financer will structure a secured plane mortgage as a comprehensive payout lease in buy to aid the exercising of therapies in the situation of a default by the borrower airline. Specifying that the lease is ruled by English law facilitates this construction mainly because English law recognizes the lessor as the complete proprietor of the aircraft. The authorized systems of lots of international airlines’ house nations may well nicely get the very same perspective. By distinction, in the United States, less than Uniform Industrial Code (UCC) concepts, courts could just take the place that because a entire payout lease is economically a secured financial loan regardless of the lease construction, the lessor must have the remedies of a secured lender relatively than that of a legitimate lessor.

In the case of a secured loan documented as a lease, the “lessee” pays periodic “hire” for the lease time period and is specified the ideal to order the plane from the “lessor” at the stop of the expression for a nominal acquire rate. Therefore the payment profile is the considerably similar to that for a completely amortizing financial loan. If the transaction is a lease and the lessee defaults around the conclusion of the expression, the lessor could repossess the aircraft and provide it or re-lease it and retain the full advantage of the residual benefit of the plane. If, on the other hand, the transaction is recharacterized by a court as a secured personal loan, the lessor would have to spend more than to the lessee the extra of the sale proceeds more than the stability of the implied bank loan, symbolizing the lessee’s imputed fairness in the plane.

A the latest US bankruptcy situation, King v. Bombardier Aerospace Corporation et al. (Case No.: 2:17-bk-21386-SK Adv. No. 2:19-ap-01147 SK (Oct 15, 2020), US Bankruptcy Court docket for the Central District of California, Los Angeles Division), displays the obstacle in surviving a lease recharacterization in a transaction with a US lessee, involving plane in the fleet of a charter airline.

The personal bankruptcy court docket dominated in excess of the vigorous objections of the personal bankruptcy trustee that the lease, which commercially was a disguised stability arrangement, was actually a lease for applications of the debtor’s personal bankruptcy, hence allowing the lessor to repossess and retain the total residual benefit of aircraft to the detriment to the unsecured collectors of the debtor. The court’s rationale was that this was the intent of the lessor and lessee, as expressed by their alternative of English law to govern the lease.

Nonetheless, this is at odds with the interpretation of disguised protection agreements less than the UCC and any lease terms that expressly deliver that the lessee is setting up equity in the plane, which may well assist the lessee’s using depreciation on the aircraft. It is also at odds with the Federal Aviation Administration’s interpretation of the lease that then supports a US registration of the aircraft in the identify of the lessee.

This advisory describes the court’s keeping in King v. Bombardier Aerospace Corporation and provides ideas for documenting the transaction to survive this kind of a recharacterization try.

The Situation

In 2017, Zetta Jet United states, Inc., a California company (“Zetta United states” or “Sublessee”) and its affiliate Zetta Jet PTE, Ltd. (“Zetta PTE”, alongside one another with Zetta United states of america, the “Debtors”) submitted for defense as debtors underneath Chapter 11 of the US Bankruptcy Code. CAVIC Aviation Leasing (Eire) 22 Co. Selected Action Firm (“CAVIC”) had supplied financing for the acquire and use by Zetta United states of 4 new Bombardier World wide 6000 Plane. The transactions for the four aircraft were being structured identically.

In a agent transaction, CAVIC extended a financial loan to a specific-objective have faith in called ZJ6000-3 Statutory Belief (“Head Lessor”) managed by CAVIC. The Head Lessor procured and held title to a single new Bombardier BD-700-1A10 plane bearing US registration no. N246ZJ (the “Plane”). The Head Lessor leased the Aircraft to TVPX ARS Inc. (“TVPX” or “Head Lessee” or “Sublessor”), performing as trustee for the benefit of Zetta PTE. In switch, the Sublessor subleased the Aircraft to Zetta United states pursuant to an Plane Sublease Agreement (the “Sublease”). Each of the Head Lease and the Sublease experienced an 84-thirty day period expression and recited that it was governed by English law.

The hire payable underneath the Head Lease consisted of an original payment in advance of commencement of the lease phrase calculated with regard to the obtain selling price payable to the manufacturer and the loan facility used to finance the acquire of the plane by the Head Lessor. The Head Lease recited that this quantity was payable by the Head Lessee directly to the manufacturer. The Head Lease hire also consisted of 28 consecutive quarterly installments setting up a few months just after shipping and delivery. A lease agenda involved in the Head Lease recited that the lease consisted of an “Fascination” ingredient and a “Principal” ingredient. The timetable also recited the “Exceptional Principal Harmony” remaining soon after each and every lease payment. The Head Lease even more recited that the quarterly lease was calculated to amortize the remarkable principal of the bank loan innovative under a secured mortgage arrangement in between Export Advancement Canada as loan company and the Head Lessor as borrower (the “Facility Arrangement”).

In several other locations, the Head Lease recited that alterations to the compensation terms of the Facility Settlement handed through as improvements to lease payable beneath the Head Lease.

At last, the Head Lease needed that on the final quarterly rent payment date, the Head Lessee also pay out an quantity equivalent to the equilibrium of the loan under the Facility Settlement. No Head Lease rent was out there for distribution to CAVIC, the beneficiary of the Head Lease believe in.

The Head Lease granted Head Lessee the option to invest in the Aircraft on the final working day of the Head Lease phrase for a selling price of US $100, in addition any costs then because of and payable less than the Facility Agreement these kinds of as make complete and crack charges, offered the Head Lessee experienced produced all other payments due in the course of the Head Lease term.

The Head Lease presented that if an occasion of default happened underneath the Head Lease, the Head Lessor was permitted to repossess the Aircraft and provide or in any other case dispose of it in the absolute discretion of the Head Lessor, free and very clear of any curiosity of the Head Lessee, as though the Head Lease had in no way been entered into.

The payments less than the Head Lease handed by way of to the Sublessee under the Sublease. The Sublease was in any other case considerably the exact same as the Head Lease, other than that only the Head Lease contained the order possibility. Mainly because the Head Lessee rely on was managed by Zetta PTE, Zetta PTE could immediate the Head Lessee to workout the acquire choice underneath the Head Lease and purchase title to the Aircraft. Zetta PTE could then keep or terminate the Sublease and either retain title to the Plane or convey title to the Sublessee.

The obligations of the Head Lessee underneath the Head Lease were secured by (1) a warranty issued by the Debtors and relevant guarantors in favor of the Head Lessor (which also integrated the obligations of the Sublessee less than the Sublease) and (2) a protection curiosity granted by the Head Lessee to the Head Lessor of the legal rights of the Head Lessee as Sublessor below the Sublease. After the Debtors were below individual bankruptcy defense, the Head Lessor as protection assignee of the sublease, repossessed the Aircraft.

The bankruptcy trustee asserted that one or the two Debtors ought to be viewed as the operator of the plane since US regulation would figure out that the Head Lease/Sublease arrangement as a disguised stability arrangement, and that the plane ought to be marketed so that any remaining equity could be used to fulfill the claims of the Debtors’ unsecured lenders when the principal portion of the remaining Head Lease payments was repaid. By distinction, CAVIC argued that underneath English legislation, which the get-togethers selected to govern the Head Lease and Sublease, the Head Lessor as titleholder was the absolute owner of the Plane. CAVIC argued that performing through its Head Lessor it had the proper to repossess the Plane and own it outright, without the need of any duty to return to the Debtors any excessive in value of the plane or proceeds of disposition of the aircraft.

The court docket wrestled with the query of whose law to use. In the end, the court upheld the decision of English legislation set forth in the Head Lease and Sublease. The courtroom held that though the regulation of the parties’ jurisdictions of formation governed irrespective of whether they validly entered into a agreement, at the time it was identified that they did validly enter into a deal, the parties have been absolutely free to select the conditions of that deal. Since the functions were being free of charge to pick out English law, all of the agreement interpretation rules that utilized beneath English legislation were to be applied as although the events experienced established forth all of people rules in the contract itself. The courtroom stated that English legislation acknowledges the lessor underneath an arrangement denominated a lease as the complete owner of the leased asset, as in between lessor and lessee. Therefore, until and until finally the lessee exercised and consummated the invest in selection, the lessor remained the absolute owner of the plane.  That meant that the lessor could repossess the plane from a defaulting lessee, terminate the lease, and have no obligation to provide the aircraft and remit any excessive more than the mortgage harmony to the lessee.

Examination

The court plainly upheld the principal of independence of agreement and the parties’ alternative of law. It upheld CAVIC’s ideal to complete possession of the aircraft unless and right up until the Head Lessee exercised the order possibility. The preference of English regulation, which dictated this end result, will have to as a result have been an expression of the parties’ intent for this to be the end result. If not, they would not have picked out English law.

This is ostensibly a harsh consequence. It suggests that a lessee could make most or even all payments beneath an English legislation lease with a discount order solution, default, have the plane repossessed, and not have any rights at all in the aircraft in spite of owning created considerable payments. The lessor could market the plane, repay its exceptional tiny or zero implicit loan balance, and keep the extra proceeds as a windfall. By distinction, if that identical lease have been ruled by the New York UCC, the lessee would be regarded to have built up substantial equity in the aircraft and the lessor would not be permitted to keep the windfall. Why would a lessee pick English regulation then? The most most likely motive is that the lessor demanded it to facilitate the repossession and disposition of the aircraft in the circumstance of a default, and would not have entered into the lease otherwise, or would have available fewer favorable conditions if the lease could be considered a secured financial loan. Possibly the Debtors assumed that if the Sublessee turned a debtor in a Chapter 11 individual bankruptcy, the Sublessee would be able to believe the lease under the Bankruptcy Code, make the remaining payments, allow the Head Lessee to physical exercise the buy option, and become the owner.

However, in relying on the selection of English legislation as the definitive expression of the parties’ intent, the court did not adequately contemplate other expressions of the parties’ intent. The 1 other expression of intent the court docket did think about was the actuality that that the plane was registered in the United States in the identify of the Sublessee. The Federal Aviation Polices permit an plane to be registered in the identify of a lessee under a lease that is a deal of conditional sale, which means a contract in which the lessee pays the worth of the aircraft and gets or has the choice to turn out to be the owner of the house upon performing the arrangement. This is mainly because in the United States, the civil aircraft registry is an owner registry, and the lessee beneath a disguised protection arrangement is economically the owner. But the court mistakenly seized on the phrase “lessee” in the laws to conclude that if Zetta Usa registered as a “lessee” that will have to indicate that its settlement was a genuine lease.

Furthermore, the court docket did not look at no matter whether Zetta Usa carried the plane on its publications for accounting and tax applications as an owned asset. In all chance it did. This also is an expression of the lessee’s intent, though outside the house of the four corners of the lease, that may well be stronger than the alternative of regulation, and would support the conclusion that the functions supposed a disguised safety arrangement rather than a accurate lease.

It also is considerable that even however the rent payment routine recites a personal debt stability, the remedies portion did not demand that right after repossession, the lessor sell the plane and pay the lessee any sale proceeds in extra of the scheduled personal debt stability. This is a popular aspect of a lease that is a disguised security agreement. The reality that the cures did not so offer supports the court’s conclusion. However, the court docket did not take into consideration this factor.

In the situation of a whole payout lease to a US lessee with a deal order option, to get over the presumption that this is not a genuine lease for individual bankruptcy functions, the parties must recite language indicating their intent, in addition to stating the preference of English legislation. The lessor and lessee should really take into consideration like a apparent statement that except if and right up until the order solution is exercised, the lessee (1) waives and relinquishes any right adhering to an event of default to the ownership of the plane or to any distribution of proceeds of the sale or other disposition of the plane by the lessor and (2) waives any appropriate to hull insurance plan proceeds paid in the case of an party of decline to the plane. A further courtroom could continue to quite effectively conclude, nonetheless, that the lessee’s accounting and tax treatment method, and the registration of the aircraft in the name of the lessee, are more powerful indications of the parties’ intent.