Aviation Finance – Part 3: Aviation Financing Structures Overview
Aircraft Finance Loan Structure
In a loan structure:
• The bank advances a loan to the airline to be used to purchase the aircraft.
• The airline purchases the aircraft from the manufacturer (if the aircraft is new) or the seller (if the aircraft is second-hand).
• The airline grants a mortgage, or security under the Cape Town Convention, (over the aircraft to the bank to secure the loan.
The airline then repays the loan (plus interest) to the bank over a pre-agreed period and, once the loan has been repaid in full, the bank releases the mortgage. If the airline does not repay the loan in full (or defaults under the loan agreement), the bank becomes entitled to enforce the mortgage and sell the aircraft.
The key security taken in a loan structure is the mortgage. However, a mortgage which is acceptable to the lending bank may not always be available because:
• It may be very expensive for the airline to grant a mortgage, for example, because of high stamp duty or similar charges.
• It may not be possible for the airline to grant a mortgage that is recognised and enforceable in all relevant jurisdictions.
• In many jurisdictions, a mortgage can only be enforced by a public auction conducted by the courts. This restricts the lending bank’s flexibility and may be slow or expensive.
If a mortgage (or security under the Cape Town Convention) is not available, a finance lease structure may be used instead if the bank is prepared to rely on a charge or pledge over the shares of the owner, and an assignment of the lease to the airline.
Aircraft Finance Lease Structure
Under English law, a finance lease is usually drafted as a hire purchase agreement. Under this type of agreement, the owner of an aircraft leases it to an airline for a fixed period on terms which provide that once the airline has paid the final instalment of rent, the airline has the option (but not the obligation) to purchase the aircraft for a nominal sum. Until the airline has exercised its purchase option, it is not a “buyer in possession” and, therefore, the provisions of the Sale of Goods Act 1979 do not apply.
If a finance lease instead imposes an obligation on the airline to purchase the aircraft (rather than giving the airline the option to purchase the aircraft), the lease may be construed as a conditional sale agreement under English law. The lessee or buyer under a conditional sale agreement is a “buyer in possession” under the Sale of Goods Act 1979, and so the airline would have the right to transfer good legal title to the aircraft to an innocent third party even though the airline itself did not have good legal title. This is the main exception to the nemo dat quod non habet rule. This is less attractive from a bank’s perspective.
A simple finance lease structure involves the same commercial parties and has a similar commercial effect as a loan structure, but from a legal and structural perspective involves the introduction of an additional tier.
In a simple finance lease structure:
• A tax neutral, insolvency remote single purpose vehicle (SPV) is created and is often incorporated in a tax neutral jurisdiction. Generally the SPV involves an independent trust as shareholder and is not owned by the airline or the bank. The SPV purchases and owns the aircraft.
• The bank advances a loan to the SPV which the SPV uses to purchase the aircraft.
• The SPV purchases the aircraft from the manufacturer (if the aircraft is new), or the seller (if the aircraft is second-hand).
• If possible, the SPV grants a mortgage (or security under the Cape Town Convention (see Cape Town Convention)) over the aircraft to the bank to secure the loan.
• The SPV leases the aircraft to the airline under a finance lease.
• The SPV assigns its rights under the finance lease to the bank, again to secure the loan.
• The shares in the SPV are charged to the bank by the shareholder as security for the loan.
The airline pays rent to the SPV under the finance lease and, in broad terms, that rent is equal to the principal and interest the SPV must pay to the bank in respect of the loan. The term of the finance lease and the loan coincide and so, upon the expiry of the lease term, if the airline has paid all amounts due from it under the finance lease, the SPV will have repaid the loan in full. At that point, the bank releases the mortgage and its other security described above, and the airline is entitled to purchase the aircraft for a nominal sum.
If the airline fails to pay all amounts due from it under the finance lease, the SPV is entitled to terminate the lease to the airline and repossess and sell the aircraft. In practice, those rights will be exercised by the bank pursuant to the security granted to it by the SPV.
The advantages of a simple finance lease structure over a loan structure include the following:
• It is easier to create a lease that is recognised and enforceable in all relevant jurisdictions than it is to grant a mortgage which achieves this. Most jurisdictions recognise the concept of an aircraft lease and allow the parties to select its governing law.
• Leases are less likely than mortgages to attract stamp duty or similar charges.
• It is unusual for a court-supervised public auction to be required in order to enforce a lease (although in some jurisdictions the SPV may require a court order to repossess the aircraft).
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