On 27 July 2015 the United Kingdom’s instruments of ratification to the Convention on International Interests in Mobile Equipment 2001 and the Protocol thereto on Matters Specific to Aircraft Equipment 2001 (together for the purposes of this article the “Cape Town Convention”) were deposited with UNIDROIT. The Convention and the Aircraft Protocol will enter into force in the United Kingdom on 1 November 2015. The ratification by the United Kingdom of the Cape Town Convention serves as an interesting example of how a contracting state faces the legal and policy issues arising from the implementation of the Convention.
The Cape Town Convention is the result of a remarkable effort by states to establish a commercially-oriented international legal framework that governs the creation, registration, priority, search and enforcement of security and leasing interests in aircraft. It has been ratified to date by 58 states (now 59 following UK ratification; in addition the EU has ratified in respect of its areas of competence) including major aviation jurisdictions such as the United States, China, India, Ireland, Russia and the UAE. There are important economic benefits from becoming a contracting state to the Cape Town Convention; aircraft operators increase their ability to obtain additional – and less costly – sources of financing in the market due to a reduction of legal risks, and not surprisingly, many have encouraged their states to become parties to it.
One fundamental aspect of the Cape Town Convention is that it is a tailor-made instrument that allows contracting states to make declarations on several key provisions (i.e. non-consensual liens, relationship with the 1933 Rome Convention, internal transactions, territorial units, remedies, pre-existing interests or rights and certain other provisions). The declarations that a contracting state makes can greatly enhance or diminish the Cape Town Convention’s economic impact. For example, an aircraft operator (and, if different, the borrower/buyer or lessor) may qualify for a reduction of export credit costs provided that the corresponding contracting state has made the recommended “qualifying declarations” set out by the Organisation for Economic Co-operation and Development’s Aircraft Sector Understanding (ASU).
As part of the UK’s ratification and implementation effort the Government invited stakeholders in the UK to be part of a consultation process and its results were published in March 2015 together with an impact assessment and a draft of regulations to implement the Cape Town Convention. Parties that submitted responses included manufacturers, lessors, airlines, legal practitioners and non-governmental organisations.
The Government analysed each of the responses and then explained the legal and policy considerations that it took into account in adopting a particular implementation option. One key consideration was to comply with the ASU export credit discount criteria by making the appropriate declarations in the Cape Town Convention so that eligible operators in the UK may be able to benefit from the discount.
Although the Cape Town Convention reflects basic concepts of English law, partly because of the central role that the UK played in its negotiations and at the diplomatic conference in which the instrument was concluded, its ratification and implementation by the UK involves addressing a number of issues. The UK signed the Cape Town Convention in 2001 so the ratification process has taken over a decade, partly because certain elements of the Convention which touch on the EU’s jurisdiction were required to be addressed by the EU first (such as insolvency provisions). By EU Council Decision 2009/370/EC the EU ratified the Convention in April 2009 in so far as it has competency over the relevant subject of the Convention / Aircraft Protocol. The United Kingdom made declarations under Articles 39(1)(a)-(b), 39(4), 52, 53 and 54(2) of the Convention, and under Articles XXIX, XXX(1), XXX(2) and XXX(3) of the Aircraft Protocol.
As a result of ratification by the UK the Convention will become effective in certain offshore jurisdictions which are of significance in aviation: for example, the Convention is now due to come into force in the Cayman Islands on 1 November 2015 at the same time as the Convention takes effect in the UK.
Retention of non-consensual liens
Under English law, aircraft may be detained (and sold) to cover unpaid airport charges and air navigation charges incurred by an operator. These debts take priority over any security that a creditor may have over the aircraft and, most worryingly for parties holding an interest over them, the rules allow an aircraft to be detained to cover unpaid charges of an entire fleet (the “fleet lien” under Section 88 of the Civil Aviation Act 1982).
One of the main purposes of the Cape Town Convention is to establish a first-to-file priority based registration system for interests over an aircraft that is readily viewable by interested parties. Therefore, the fact that a set of third parties can detain an aircraft without registering their interests, and regardless as to whether there are other parties with prior interests registered with the international registry set up by the Convention, diminishes the very legal certainty that the Cape Town Convention hopes to provide. However, Article 39 of the Convention allows contracting states to make a declaration whereby non-consensual liens have priority over a registered international interest created under the terms of the Cape Town Convention. Therefore, by making the appropriate declaration, a contracting state that already has such provision in its laws is able to retain it under the Cape Town Convention.
The “fleet lien” has been strongly criticised by legal practitioners and academics, and many saw the ratification of the Cape Town Convention as an opportunity to repeal it. Indeed, respondents to the consultation raised their concerns by stating that the “fleet lien” is a draconian compliance mechanism that unjustly affects aircraft lessors and financiers. However, while noting the concerns regarding the potential impact of the fleet lien on third parties, the Government decided to grant all existing and future non-consensual rights that have priority under English law over a mortgage or lease the same priority over an international interest, including the fleet lien, and will, therefore, make the appropriate declaration. This is reflected in the implementing Regulations (the International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015).
The Cape Town Convention contains alternative provisions in respect of insolvency remedies available to creditors. Article XI enables the contracting state which is the “primary insolvency jurisdiction” to specify a “waiting period” at the end of which the insolvency administrator or the debtor must give up possession of the relevant aircraft or engine to the creditor, unless the insolvency administrator or the debtor has cured all defaults and agreed to perform all future obligations under the relevant agreement. The main advantage of adopting Alternative A is that by stipulating a waiting period, together with the availability of remedies to de-register and export aircraft from the state where it is situated, creditors may be assured that in an event of default scenario the aircraft or engine can be recovered within a fixed period.
Alternative A essentially permits creditors to exercise selfhelp remedies and is much more flexible than Alternative B which is a more restrictive, court-based approach. This alternative allows for greater involvement of courts in line with civil law tradition. Finally, in the absence of a declaration of a contracting state as to which alternative it chooses, the remedies on insolvency are governed by applicable law.
Alternative A is, not surprisingly, favoured by lessors and financiers and is also required by the ASU discount criteria. The majority of stakeholders in their responses called for the Government to adopt Alternative A in the implementation of the Cape Town Convention. However, insolvency practitioners stated that English law insolvency rules are robust and well understood by parties and therefore there was no need to implement Alternative A; national insolvency rules should then be retained.
In the end, and in a departure from its initial position, the Government decided to adopt Alternative A based on the fact that (i) there are potential economic benefits for aircraft finance associated with the adoption of such alternative (i.e. it complies with the ASU discount criteria) and (ii) aircraft are a sufficiently unique type of asset that warrants a separate administration regime. Therefore, Alternative A is reflected in the Regulations and a 60-day “waiting period” was adopted as well, all in line with the ASU discount criteria.
Lex situs and the international interest
Under English law, the lex situs principle, as clarified by the (in)famous 2010 Blue Sky case, is used to determine whether a security interest has been validly constituted over an aircraft. This means in practice that in order for an English law security interest to be validly constituted over an aircraft, the aircraft needs to be physically located in England (or airspace over England) at the time of taking the mortgage. This has substantial practical implications when choosing English law as applicable law and can potentially increase the parties’ transaction costs.
The Cape Town Convention seeks to exclude the application of conflict of laws when creating interests over aircraft. Therefore, the fact that the lex situs is applied under English law conflicts with this very goal because under the Cape Town Convention an international interest is constituted over an aircraft once the Convention’s (straightforward) validity conditions are satisfied without taking into account national laws. Therefore, the UK had to address this crucial matter in the implementation of the Cape Town Convention. The Government, in line with the provisions of the Cape Town Convention, declared that an international interest is a proprietary right that takes effect in law once the conditions for the creation and registration of an international interest are satisfied, effectively distinguishing an interest created under the Cape Town Convention from other interests created outside it. As a result, the validity of a security interest under English law which is not an international interest would still be determined by the application of lex situs. This interpretation is included in the Regulations, regulation 6 of which provides: “an international interest has effect where the conditions of the [Cape Town] Convention 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)”.
Irrevocable de-registration and export request authorisation
The Cape Town Convention sets out provisions in relation to an irrevocable de-registration and export request authorisation (IDERA) which allows the person in whose favour the authorisation has been issued to exercise the remedies available to it. Contracting States are able to make a declaration as to whether this provision applies and such a declaration is mandatory in order to obtain the benefit of the ASU discount qualifying criteria.
The Government acknowledged that under English law a power of attorney can be issued by the debtor and that therefore making a declaration to apply the IDERA provision was not altogether necessary. Nevertheless, the Government decided to apply the IDERA provisions. Under the Regulations, the UK’s Civil Aviation Authority must honour a request for de-registration filed with it but subject to any applicable safety laws and regulations. The CAA will provide further guidance on this matter.
The UK is ratifying and implementing the Cape Town Convention in such a way that it achieves its maximum effect i.e. reducing legal risk by having an international framework under which aircraft financiers can better predict outcomes, and thus allowing operators in the UK to obtain financing on more favourable terms. In depositing the instruments of ratification at UNIDROIT Mr Jonathan Marshall, the Justice and Home Affairs Counsellor at the British Embassy in Rome, stated: “The United Kingdom’s approach to the ratification of treaties on private law matters is known for being highly prudent and pragmatic”. The Secretary-General said at the occasion: “We see in the United Kingdom ratification of the Cape Town Convention and the Aircraft protocol another demonstration of both the high quality of this Convention as well as the tangible economic benefits it generates.”
Moreover, by the UK’s having made all the ASU “qualifying declarations”, operators in the UK should be able to benefit from the export credit discount. This is, however, provided that the “home country” rule is not applicable. This rule, which dates back to 1992, is an unwritten, informal understanding among the four principal ECAs supporting the manufacturers of large commercial jet aircraft: ExportImport Bank of the United States (Ex-Im Bank); Export Credits Guarantee Department (UK); Compagnie Française d’Assurance pour le Commerce Extérieur, also known as COFACE (France); and Euler Hermes (Germany). These agencies agreed not to provide financing for competing aircraft that will be principally located in their own or in each other’s countries (including, for this purpose, Spain).
Although the Government stated that it evaluated the impact of each of the implementation options separately and on their own merit, it seems that the rationale behind the Government’s choices was to effectively comply with the ASU criteria, as other contracting states to the Cape Town Convention have done. Unfortunately, however, because of the “home country” rule, it is unlikely that most UK airlines will be able to benefit from the export credit discount that follows from compliance with the ASU criteria.