The Government of the United Kingdom has published its response to the consultation paper in relation to its proposed ratification of the Convention on International Interests in Mobile Equipment (the Convention) and the Protocol thereto on matters specific to Aircraft Equipment (the Protocol). The Convention and the Protocol (together the Cape Town Convention) have been regarded by the Government of the United Kingdom as an EU Treaty in accordance with the European Communities Act 1972 and existing EU law. The Cape Town Convention will be implemented into domestic law throughout the United Kingdom under secondary legislation, The International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 (the Cape Town Regulations).

The Cape Town Regulations will be made when they are signed by the relevant Minister, which we assume will be very shortly following the expiry of the consultation period. At that point they will become law. They will then be “laid before Parliament”, a procedure which allows Parliament to review the law and accept it or reject it (but not amend it). It is thought to be highly unlikely that any problem will arise at this stage. During this stage, the United Kingdom will formally ratify the Convention and the Protocol and deposit of the appropriate ratification papers with Unidroit. Three clear months then need to pass before they then come into effect, which means that this will happen on 1st July or 1st August, 2015.

We understand that the Cape Town Regulations will be signed into law substantially in the form attached to the latest consultation.

We have prepared this briefing summarising the main declarations which the Government has recommended the United Kingdom should make when ratifying the Convention.

The Regulations will signify a major change in the laws of the United Kingdom as they affect aircraft finance and leasing. Although their primary impact will be on United Kingdom airlines, there will be important consequences for banks and lessors operating within the sphere of English law and one of those consequences – how to take legally effective and enforceable English law security over aircraft, airframes or engines (aircraft objects) – is the subject of this briefing.

Currently, a financier wishing to take English law security over an aircraft object will have to do so in accordance with the principles set out in the Blue Sky decision1. In that case, the court held that:

  1. aircraft should not be treated differently to other tangible assets: it is the laws of the physical location of an aircraft at the relevant time (the lex situs) which determine whether a property interest, such as a mortgage, is effectively created over it;
  2. if the aircraft is registered in a different jurisdiction to that of the lex situs, a mortgage which is valid under the laws of the state of registration but which is invalid under the domestic laws of the lex situs jurisdiction will be ineffective in England; and
  3. English law will look only to the domestic laws of the lex situs jurisdiction without reference to its conflict of laws rules in deciding the issue of validity of the mortgage.

The result of the Blue Sky case is that lenders wishing to take security over aircraft objects under English law have been requiring the asset to be flown into English airspace, a process that has negative operational, economic and environmental consequences. As an alternative, some lenders have been requiring security over the aircraft to be taken under New York law: this is procedurally easier (there being no requirement for a lex situs connection) but there are questions as to how many jurisdictions outside New York would recognise that security.

The importance of obtaining appropriate security over the aircraft can be seen in the context of the Basel Accords and, in particular (in Europe), the provisions of Article 210 of the Capital Requirements Regulations. This provides that banks wishing to claim capital relief by virtue of security over a physical asset have to be able to establish (amongst other things) that:

  1. the relevant security arrangement is legally effective and enforceable in all relevant jurisdictions and enables that bank to realise the value of the collateral within a reasonable timeframe; and
  2. with the exception of legally preferred claims, only first liens on, or charges over, the asset qualify as eligible collateral and a bank needs to have priority over all other lenders to the realised proceeds of the collateral.

If the Regulations become law, will they enable a lender to take English law security over an aircraft object in a manner which satisfies its regulatory requirements but without requiring it to be flown into English airspace? The English law on mortgages and charges will remain unchanged: but will the Regulations provide for a new, autonomous security to which the lex situs rule in Blue Sky does not apply?

There had been considerable debate about this question during the consultation process leading to the publication of the Regulations. Although there can be little doubt, when reading the Official Commentary, that it was the intention of the draftsmen to provide for the creation of a new autonomous form of security, some lawyers interpreted the definition of “security agreement” in the Convention as extending only to arrangements which created security under pre-existing domestic law (in effect, in England, mortgages and charges).

The response to the consultation very helpfully dispels any doubt on this question: it states: “The application of lex situs to the creation of international interests would seem to conflict with [the objectives of the Convention] and would make the treaty less effective in the UK. An international interest is an autonomous class of interest, recognised between Contracting States. Therefore, the Government does not consider that domestic conflict of laws principles should be imported into the conditions for recognising an international interest.”.

To achieve this, Article 6(3) of the draft Regulations provides: “the international interest has effect where the conditions of the Cape Town Convention and the Aircraft Protocol are satisfied (with no requirement to determine whether a proprietary right has been validly created or transferred pursuant to the common law lex situs rule).”

Consequently, if the Regulations become law in their current form, it will be possible, to the extent that the Convention applies, to create security over aircraft objects under English law irrespective of the physical location of the relevant asset. The rights afforded to a lender by virtue of this security will be broadly equivalent to those under an English law mortgage: including the right to take possession or control of the aircraft object and to sell or grant a lease of it without the need for a court order authorising it to do so. These can validly be considered to be rights in rem or proprietary rights.  The principle of the Convention is that those rights should be recognised in every ratifying jurisdiction.

Security under the Convention can only be created either (in respect of airframes and engines) where the debtor is situated in a contracting state or (in respect of airframes only) if the aircraft is registered in such a jurisdiction. Where this is not the case, any English law security will need to be constituted under the existing law on aircraft mortgages and, in particular, in accordance with the decision in Blue Sky.

The expectation is that the United Kingdom Crown Dependencies and Overseas Territories (including the Cayman Islands, Bermuda and many other off-shore jurisdictions in which aircraft-owning vehicles are commonly incorporated) will ratify the Convention shortly after the United Kingdom. If that occurs, it is only where aircraft are owned by entities in jurisdictions that have not ratified the Convention (for example, in the context of Japanese, French or German leases) that parties will still need to consider the effect of the Blue Sky decision on how they obtain security over the aircraft under English law.

It will be a great relief to all those involved in the financing and leasing of aircraft – not to mention to airline pilots previously forced to take long detours over English airspace during delivery flights - that the ratification of the Convention by the United Kingdom will considerably mitigate the problems that had been caused by the Blue Sky decision.