With the latest wave of bankruptcies sweeping the aviation and airline industries, you will find bankers and lawyers sweating over the priority and perfection of their aircraft liens. These bankruptcies seem to have a different character when contrasted with the bankruptcies of 2002 through 2004. Many of the 2008 bankruptcies are operational shut-downs and liquidations rather than restructurings. That means that the status of creditors (as secured or unsecured) is going to become acutely relevant and will determine how much the bankruptcy affects the creditor's financial outcome.
Just File in OKC
By federal law, ownership (title) and encumbrances (mortgages, leases, etc.) on U.S. registered aircraft are evidenced by filings with the Civil Aviation Registry in Oklahoma City (the "Registry"). Encumbrances (not title) on larger engines are also evidenced by such a filing. This process became a bit more complex when the U.S. signed on to the Cape Town Convention (Convention on International Interests in Mobile Equipment, 2001) requiring a parallel filing with the International Registry (IR). The combined FAA/IR filing gives high comfort to any aircraft lessor or financier that its interest in the aircraft is protected. Recent changes to the Uniform Commercial Code have simplified filing requirements for non-aircraft assets, but nothing could be simpler than a single registry for encumbrances. However, the FAA/IR protection is not bulletproof.
Liens that do not require filing can beat you.
The Registry was established to simplify financings on aircraft. Central filing in Oklahoma City was a substitute for the state filing requirement that you would otherwise use to perfect a lien on any other tangible asset. A lien has three basic elements—attachment, perfection and priority. The Registry deals solely with perfection and priority but only when the applicable state law provides that perfection is accomplished by filing. State law continues to govern:
- Perfection by means other than filing,
- The steps required to establish the lien (a.k.a. "attachment"), and
- The priority of that lien in relation to others.
So, stated another way, a lien recorded with the Registry/IR may not be effective (and/or may be trumped by other liens) if:
- The collateral is subject to a conflicting lien that attaches by some means other than filing, and that is given superior status under state law, or
- The lien was not properly established in the first place, for example, by a binding security agreement.
Mechanics' Liens
Most states establish a special lien to protect the rights of service providers like mechanics or warehousing companies. These liens (often called "mechanic's" or "warehouseman's" liens") are established (i.e., they attach) when the mechanic/warehouse is owed money, and they are perfected by physical possession of the asset (e.g., the aircraft), and in most states, a lien perfected by possession takes priority over other perfected liens. As a result, if an airline goes bankrupt while an aircraft is in the possession of a maintenance provider, a lien on an aircraft perfected by a filing with the Registry may well be in a secondary position behind a maintenance provider's lien. As a result, the maintenance provider is entitled to be paid before the aircraft can be released to or liquidated by the filed lienholder.
Tax Liens
As discussed above, the federal government has a convenient system for centrally recording liens on aircraft. This system inexplicably does not apply when the federal government (specifically the Internal Revenue Service) files liens on aircraft. Rather, federal law (26 U.S.C. § 6323) specifies that tax liens on personal property are filed where relevant state law requires filings be made. In most cases, that requires filing where the aircraft is located. Of course, given the mobile nature of aircraft, and the possibility that an aircraft has had several owners and several home bases, it can be difficult to determine where a lien filing might be located. As a result, despite best efforts and a filing with the Registry/IR, you could find your lien subordinate to an IRS tax lien.
Non-Aircraft Assets
A lessor or financier may need to repossess more than the aircraft. There may be tangible assets associated with the aircraft (maintenance records and programs, manuals and associated equipment), and perfection/priority of these liens may not be determined by use of the Registry/IR. These are often assets perfected in the conventional way (state-level filings). Similarly, intangible rights like warranties or claims against third parties (for example, for faulty repairs) are not going to be perfected by filing with the Registry/IR.
It is not clear at this point if the upswing in bankruptcies will continue, or if it will instead evolve into a wave of mergers and consolidation. Secured creditors would be wise to confirm their filing status and to consider interim moves to keep their liens at their intended priority. This could be the first legal test of the IR and U.S. implementation of the Cape Town Convention. Despite the best efforts of legislators, there will always be ambiguities in how the IR affects priority, especially with respect to those transactions effected at or near the date the IR became applicable to U.S. transactions (January 2005).