It cannot have escaped the attention of anyone involved in the aviation finance industry that the UK is currently in the process of ratifying the Cape Town Convention (being the Convention on International Interests in Mobile Equipment and related Protocol on Matters Specific to Aircraft Equipment). Here, we will look at that ratification process and consider the principal legal and practical implications for our clients.
The International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 (the Regulations) were made by the UK Government on 23 March 2015 and laid before Parliament on 26 March 2015.
The UK acceded to the Convention by depositing the formal instruments for ratification with Unidroit on 27 July 2015 (the Deposit Date). The Convention itself will enter into force on the first day of the month following the expiration of three months after the Deposit Date (the Effective Date). The Effective Date for the UK will be 1 November 2015. The Regulations will also come into force on the Effective Date.
As well as applying to England and Wales, Scotland and Northern Ireland, the UK's ratification extends to the Island of Guernsey, the Cayman Islands and Gibraltar.
The Benefits of Ratifying the Cape Town Convention
The principal benefit is an anticipated reduction in the cost of raising finance by providing for:
(a) an internationally recognised system of "international interests" to be created and registered; and
(b) standard remedies in a default scenario giving creditors certainty as to the likelihood of being able to recover the aircraft.
These remedies include the ability to take possession, deregister and export the aircraft, sell or grant a lease of an aircraft object, collect or receive any income or profits in connection with the management or use of that aircraft object and obtain interim relief pending final determination of any claim.
The Regulations also permit either (i) a chargee and all "interested persons" to agree that ownership (or any other interest of the chargor) in a secured aircraft object is to vest in the chargee in or towards satisfaction of the secured obligations following a default or (ii) the chargee to apply to the court for an order to that effect.
Remedies must be exercised in a "commercially reasonable manner".
In providing for a standard set of remedies, the aim is that aircraft financiers benefit from greater certainty and confidence in their ability to recover their assets should an airline default. This should reduce risks and, in theory, result in lower financing costs.
What Declarations has the UK made?
There are various optional provisions which Contracting States can decide whether or not to adopt during the ratification process which form an integral part of the treaty system if adopted. Different Contracting States have made different declarations but certain declarations are key if Contracting States wish to enable their national airlines to have access to the greatest economic benefits of ratification (such as being in a position to satisfy the criteria set out in the OECD's Aircraft Sector Understanding (the ASU) to be eligible for a discount to the premium charged by export credit agencies in export credit backed financings of aircraft.
The UK Government lodged a number of declarations with Unidroit on the Deposit Date. In summary:
Article 39 of the Convention (Rights having priority without registration)
Certain non-consensual rights and interests will continue to have priority over a registered international interest post-ratification. The two relevant rights and interests set out in the Regulations are:
(a) possessory liens for maintenance or repair work carried out on the aircraft object and
(b) any arrest and detention rights in effect under domestic UK law including for the non-payment of amounts due in respect of public services relating to that aircraft object (such as the Eurocontrol fleet lien which has been a controversial feature of UK domestic law for a number of years) .
These non-consensual rights and interests will not need to be registered with the International Registry in order for their priority status to be protected. It is also irrelevant whether these rights and interests arose before or after ratification of the Cape Town Convention and/or creation of the relevant international interests.
Article 54 of the Convention (Declarations regarding remedies)
The use of "self-help"/extra-judicial remedies (i.e. enabling the creditor to take action against the debtor without leave of the court) is already permitted under UK law provided the debtor has previously agreed to the use of those remedies. This will continue to be the case post-ratification as the UK has made the relevant declaration under Article 54(2) providing that any remedy available to a creditor under any provision of the Convention which is not there expressed to require application to the court may be exercised without the leave of the court.
Other Key Points of Note
The Regulations will apply to purely national transactions (i.e. where the relevant parties and the aircraft object(s) are all UK-based) as well as those with an international element.
Sales and Prospective Sales
The Regulations provide that certain provisions of the Cape Town Convention will be extended to cover sales and prospective sales of aircraft objects as if they were international interests or prospective international interests in accordance with the Aircraft Protocol. Contracts of sale can be registered with the International Registry with the seller treated as if it were the debtor and the buyer treated as if it were the creditor.
Pre-Existing Rights and Interests – Transitional Provisions
The Regulations will not apply to any pre-existing right or interest which will remain outside the scope of the treaty and parties will not be required to separately register these with the International Registry. Therefore, any interests registered with the UK Civil Aviation Authority (the CAA) prior to the Effective Date will retain their priority as against any subsequently registered international interest.
However, any interests registered with the International Registry post the Effective Date will take priority over interests subsequently registered with the CAA.
Insolvency Remedies - "Alternative A" (Article XI of the Protocol)
The UK has adopted the US Chapter II-style Alternative A with a specified waiting period of 60 days.
Alternative A requires that, upon the occurrence of an insolvency-related event, the insolvency practitioner or debtor either:
(a) gives up possession of the asset to the creditor or
(b) cures all defaults and agrees to perform all future obligations under the relevant transaction documents,
in each case, by the earlier of the end of the specified waiting period or the date on which the creditor would otherwise be entitled to possession of the aircraft object if the Cape Town Convention did not apply.
In the meantime, the insolvency practitioner or debtor is required to preserve the aircraft object and maintain its value in accordance with the transaction documents until possession is given to the creditor.
No court permission is required at the end of the waiting period by the creditor in order to obtain possession. Prior to obtaining possession, the creditor is also entitled to apply for other forms of interim relief available under national law.
Once possession has been obtained, the creditor has the right to deregister and export the aircraft. The CAA must make these remedies available to the creditor within 5 working days of notification from the creditor that they have a right to those remedies.
IDERA (Article XIII of the Protocol)
IDERAs will be permitted for use in the UK and must, if submitted, be recorded by the CAA.
Aircraft Sector Understanding
The UK Government has ratified the Cape Town Convention in a manner intended to meet the eligibility requirements of the ASU in order to qualify for a discretionary discount of up to 10% on the premium rate of export credit support. One of the key declarations required to achieve this is the adoption of Alternative A.
What will be the Principal Effect of Ratification on UK Domestic Law as a Consequence?
In cases where the Cape Town Convention applies, the UK's insolvency regime in respect of aircraft objects will change. The adoption of Alternative A means that the moratorium that is currently available under UK national insolvency laws in the case of an administration will no longer be available in circumstances where the Cape Town Convention applies and interests have been validly registered with the International Registry. The insolvency regime for all other types of assets will, however, remain unchanged.
The Cape Town Convention was originally intended to allow for the creation and registration of interests independently of national laws. A security interest can arise under the Cape Town Convention which, provided it qualifies as a valid interest under the rules of the Convention, is an autonomous class of interest creating a right in rem in the asset and recognised amongst Contracting States regardless of whether or not it complies with individual domestic conflict of rules principles.
Following clarification in the Blue Sky case, English law currently provides that a mortgage can only be effectively created under English law if it is validly created under the domestic laws of the country where the asset was located at the time of creation of that security interest (without regard to that country's conflict of laws principles).
In contrast, the Regulations provide that an 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)". This will make it easier to take security over aircraft objects in cases where the Cape Town Convention applies.
It should be noted, however, that this will only apply where international interests are validly created under the treaty. If the Cape Town Convention does not apply to a transaction, the validity of a security interest which is not also an international interest will continue to be determined in accordance with existing English law principles – ie. lex situs and the Blue Sky rules will continue to apply.
Ratification in Practice
It is likely that in most cases where an interest is created under domestic UK law, it will also constitute an international interest under the Cape Town Convention with the two interests existing in parallel.
There is no obligation to register interests with the International Registry following ratification – that is left to individual parties to decide. However, we would always advise clients to register all interests as soon as possible if the Cape Town Convention rules are applicable in order to ensure that priority is preserved and protected.
Under the Regulations, any additional remedies available in accordance with applicable law, including any remedies agreed upon by the parties, may be exercised to the extent that they are not inconsistent with provisions which may not be waived by agreement under the Regulations or the Cape Town Convention.
Therefore, if creditors wish to have access to remedies which are available under domestic UK law for domestic interests (which may or may not also be international interests under the Cape Town Convention), domestic law requirements in connection with those interests (including perfection and/or registration requirements) need to continue to be satisfied.
The UK national aircraft register maintained by the CAA will remain open following ratification and parties can and should continue to register interests with the CAA as usual if a valid English law mortgage has been created.
The Regulations also make it clear that section 859A of the Companies Act 2006 (which governs the registration of charges created by English companies) will not apply to international interests. However, if the security agreement creates a charge which would usually have been registrable under section 859A in any case, that charge should continue to be registered with Companies House in the usual way irrespective of whether or not it is also an international interest. This is important for two reasons:
(a) failure to register a registrable charge with Companies House means not only that the charge is void as against an insolvency officer as a matter of domestic English law but it also means that the underlying debt secured by that charge becomes immediately repayable and
(b) dual registration enables the chargee to have access to both Cape Town Convention remedies and any applicable domestic UK law remedies.
UK airlines will need to become accustomed to requests to provide IDERAs to their lessors and financiers. These may be in connection with both new and pre-existing transactions because it seems possible to be the holder of an IDERA under the Cape Town Convention without necessarily having an international interest.
We are expecting the CAA to issue detailed guidance on these matters in the coming weeks.
English Law Mortgages
If an English law mortgage gives rise to a valid security interest under, and in accordance with, the Cape Town Convention, there will be no need for the aircraft to be located in England, or flown into English airspace in order to create a valid international interest over that aircraft (which is the current practice following the Blue Sky case).
However, a valid English law mortgage may be required, or considered to be advantageous, for other reasons in which case compliance with the English lex situs rules will continue to be necessary in order to ensure that a valid English law mortgage is constituted. These "other reasons" can include, amongst other things, because the Cape Town Convention does not apply to the transaction, if there is a likelihood that the aircraft may need to repossessed in a non-Cape Town Contracting State (which may not recognise the concept of an "international interest" but will recognise the concept of a mortgage) or if the creditor wishes to avail itself of additional remedies which may be available under a mortgage but not under the Cape Town Convention. In particular, the concept of "proceeds" secured under a typical mortgage document usually extends beyond the limited definition of "proceeds" under the Cape Town Convention which only encompasses "money or non-money proceeds of an object arising from the total or partial loss of physical destruction of the object or its total or partial confiscation, condemnation or requisition".
With 68 Contracting States including the UK (as of the date of writing), the Cape Town Convention is fast becoming the international norm in aviation financing transactions and the potential benefits it brings are to be welcomed. There will, however, be an inevitable period of adjustment to the new regime over the coming months. If you have any questions or require any further information or assistance in connection with this, please contact any of Justin Benson, Adrian Beasley, Louise Mor or Alison Weal.