Norton Rose’s Carol Aitken looks at the key
concerns of financing and leasing aircraft engines and how they can
be minimised
The question is often asked: why has the financing of aircraft
engines not developed and diversified to the same extent as the
financing of aircraft? This can, in part, be explained by the
fact that an aircraft operator’s primary objective – to keep the
fleet flying – is served by a combination of leasing and financing
of entire aircraft and by the well developed range of spare engine
leasing solutions offered by engine lessors and
manufacturers.
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This article examines another possible explanation: that the
financing of aircraft engines creates unique challenges for a
financier seeking to obtain a perfected security interest, or
security interest in an asset protected by claims from other
parties, over an aircraft engine.
Capital adequacy requirements
Obtaining a perfected security interest, while always a crucial
factor in financing decisions, has gained even greater importance
as a result of the capital adequacy requirements imposed on
financiers in the wake of the recent financial crisis. In
order for security to be taken into account in Basel II risk
weighting calculations, the security must be effective and
enforceable in every relevant jurisdiction.
Where is the engine?
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By GlobalDataWith an asset with such international movement as an aircraft
engine, the likelihood is that many jurisdictions will be involved
and complex conflict of law issues will arise. Lessors and
financiers will want to know on whose airframe the engine is
installed, where the engine is operating, and where the engine will
be at the time of any operator default.
A major concern for lessors and financiers is that in certain
jurisdictions, such as The Netherlands, domestic law provides that
title to an engine, including an engine which is subject to a
mortgage, is transferred automatically to the owner of the airframe
on which the engine is installed.
This principle is commonly referred to as accession, though the
impact of such domestic law varies greatly in its effect between
jurisdictions. Does it mean, for example, that none of the
rights of the lessor under the lease or the financier under the
mortgage would be recognised, or “only” that priority and
ring-fencing of the asset is lost?
Alternatively, the engine may, at the time of enforcement of the
lease or mortgage, be located in a 
jurisdiction whose domestic law does not recognise
mortgages or which does not provide for the same remedies as
English law. Due diligence can be performed in the relevant
jurisdictions at the outset of a transaction but what about those
jurisdictions which become relevant over the lifetime of the lease
or the financing?
The documentation should contain covenants requiring the
operator to provide timely information about the whereabouts of the
engine and to advise, for example, of monthly utilisation,
forthcoming shop visits, on ground events and any change of
habitual base. The provisions governing engine interchange
and pooling (including pooling of modules and parts) will be of
paramount importance to the lessor and the financier. Whilst
the lessor and the financier will usually want to impose a
restrictive regime, the objective of the operator is to keep the
fleet flying and some flexibility will be required.
Common restrictions imposed in respect of pooling arrangements
include pooling only with solvent carriers, there being no transfer
of title to the pooled engine, the imposition of a time limit, and
a requirement to obtain from the parties on whose airframe the
engine will be installed an acknowledgement of the lessor’s and the
financier’s interest in the engine, as well as a confirmation that
they will not assert rights over the engine.
The last of these restrictions is particularly important as the
lease or mortgage of the airframe on which the engine is to be
installed will often provide that title to the engine will transfer
to the lessor or mortgagee of the airframe when it is installed
thereon. Whilst such a provision is unlikely to be binding on
the lessor or financier of the engine, it could lead to a dispute
at a practical level, and a written recognition by the airframe
owner of the lessor’s or the financier’s interest in the engine
will assist.
Without tracking the whereabouts of the engine it will be
impossible to monitor and inspect the condition of the engine and
to protect the value in the engine, 30 to 60 % of which can depend
on its condition.
Current challenges under English law: lack of an engine
register
The lessor and the financier will want to ensure that third
parties such as MROs, a liquidator, any proposed purchaser of the
engine and the owner of the airframe on which the engine is
installed are aware of the lessor’s and the financier’s interests
in the engine.
Typically, inclusion of a right on a public register would
fulfil any notice requirement. One challenge under English
law is the absence of a register of aircraft engines or rights in
aircraft engines, other than a registration in the mortgagor’s
domestic corporate charges registry. The same is true of many
other jurisdictions – notably not the USA – as the 1944 Chicago
Convention does not contemplate the registration of engines and the
1948 Geneva Convention does not provide for the separate
recognition of rights in engines.
Inclusion on a public register could also provide protection to
the lessor and the financier by requiring the consent of the lessor
and the financier to any de-registration of the engine or any
security interests in such engine. Aircraft engines are
readily interchangeable between airframes, operators and countries,
generally free from any de-registration or registration
requirements and a public register could assist the lessor and the
financier in tracking the whereabouts of the engine.
A practical way of giving notice to third parties in the absence
of a public register is by installing nameplates on the engine
detailing the lessor’s and the financier’s interests in the
engine. Whilst nameplates can, in practice, be removed or
covered, it is one basic protection which should be availed of in
every leasing and financing transaction.
Current challenges under English law: Blue Sky One
Limited & O’rs v Mahan Air & Ano’r [2010] EWHC 631
(Comm).
The English courts recently clarified that an English court will
only give effect to a mortgage which is valid under the domestic
laws of the jurisdiction where the engine is situated at the time
of the granting of the mortgage. As far as engines are
concerned, the prudent approach in relation to an English law
mortgage is to ensure the relevant engine is located in England at
the time of the grant of the mortgage, though a number of other
jurisdictions – such as Hong Kong – might also be viable.
The option to take a valid English law mortgage over an aircraft
located in international airspace at the time of the granting of
mortgage, provided that the aircraft is registered in a qualifying
jurisdiction, such as England, may not be available with respect to
engines individually.
Is help on its way?
The Cape Town Convention and the Aircraft Protocol (the
Convention) should offer real benefits to lessors and financiers in
addressing some of the concerns set out above, at least for engines
with at least 1750lb of thrust for jet engines or 550 rated
take-off shaft horsepower or its equivalent for turbine or piston
powered engines. The aim of the Convention is to provide
international recognition of the relevant ‘international interest’
and to provide a set of remedies applicable in every jurisdiction
in which the Convention is ratified for the enforcement of lease
rights and security over assets with international application.
Provided that the engine fulfils the power ratings set out above
and the lessee under the lease or the mortgagor under the mortgage
is located in a country which has ratified the Convention, the
‘international interests’ of the engine lessor under the lease or
the financier under the mortgage will be registrable on the
electronic register of the International Registry.
Registration is available for engines separate from airframes, even
if the engines are on-wing. The priority of the registration
will be based on the time of registration. However, this can be
varied with the consent of the parties.
The Convention, when implemented in a given jurisdiction, also
creates rights independent from domestic law. This means that
the issue of accession of engines may be avoided and extra-judicial
(self-help) remedies may be available in countries where a court
order was previously necessary under the domestic law.
Nevertheless, the practical implementation of the Convention
into a country’s domestic law must be considered. Some
countries have reserved certain rights under their domestic law, in
others there remain inconsistencies between the domestic law and
the Convention, and in others the Convention has been implemented
without the extra-judicial remedies. Finally, the attitude of
the local courts on the enforcement of a lessor’s and a financier’s
rights and remedies should not be underestimated.
Whilst the European Union has ratified the Convention, the
domestic legislation required to give effect to the Convention in
the UK has not yet been implemented. The hope is that the
implementation of the Convention in the UK will address the issues
arising as a result of the lack of a separate engine register and
might also overcome the difficulties associated with the Blue Sky
case.
Carol Aitken is a senior associate at Norton Rose
