Background
Mechanics of the Convention
Comment


Background

In Autumn 2001, at the conclusion of the Cape Town Diplomatic Conference, the International Institute for the Unification of Private Law and the International Civil Aviation Organization adopted the Convention on International Interests in Mobile Equipment and the Protocol on Matters Specific to Aircraft Equipment. The Cape Town Convention and Aircraft Protocol constitute an effort to provide substantive treatment to international secured lending practices, and to facilitate efficient asset-based financing and leasing of high-value mobile equipment.

Traditionally, international secured financing and leasing presented a widely variable regime for establishing rights and interests in mobile equipment. Lex situs, the law of the location of the equipment, customarily determined the security rights and interests therein. However, for high-value mobile equipment, constant location changes create a greater adverse risk to creditors' security rights and interests. The drafters of the Cape Town Convention identified the need to preserve certain basic commercial rights regardless of the location of the equipment, and approved a set of instruments influenced by US and European financing regimes, designed to provide financiers and debtors with a uniform body of substantive law for high-value mobile equipment.

Although the convention has been signed by 25 nations, it has not yet been ratified by the requisite number of member nations to become enforceable. However, it is generally expected that in the future, the Cape Town Convention and Aircraft Protocol will be ratified, and will become the basis for perfection and recordation of security interests in mobile equipment in cross-border financing. The United States has not yet signed the treaty. However, a source at the State Department is confident that the Private International Law Department of the US State Department will recommend authorization to sign the treaty and then request clearance for presentation to the Senate for ratification.

Mechanics of the Convention

Together, the Cape Town Convention and the Aircraft Protocol parallel the structure and underlying principles of Article 9 of the Uniform Commercial Code, effective in all 50 states of the United States. The similarity of the treaty to the US regime should provide creditors, investors and debtors with a sense of familiarity. The convention functions as the foundational instrument, providing the structural framework that applies to specific classes of high-value mobile equipment. The industry-specific protocols detail the rules by which the convention ultimately affects an individual equipment category. As adopted, the convention permits protocols for aircraft and railway equipment and space assets. However, to date protocols for railway equipment and space assets have not been adopted, and the only existing protocol is the Aircraft Protocol. The convention and the relevant industry protocols are to be interpreted as a single instrument. Together, the instruments create a body of international substantive law that would supersede applicable national law. A consolidated text of the convention and Aircraft Protocol is available, and will provide users with helpful guidelines.

The Cape Town Convention:

  • establishes an international security interest in specified objects distinct from traditional security interests;

  • creates a priority system for competing international security interests;

  • provides an international registry through which to perfect international security interests and provide notice of the security interest to third parties; and

  • establishes a variety of remedies following insolvency or default.

Under the convention various interests, depending on the type of agreement that creates them, are protected. The convention allows for the creation of international security interests in uniquely identifiable objects in three classes of mobile equipment - airframes, aircraft engines and helicopters; railway rolling stock; and space assets - which are granted under a security agreement, vested in a conditional sale agreement under a title reservation or under a leasing agreement. Should the need for new categories or classes of equipment arise, the convention contains a mechanism whereby any category of high-value mobile equipment may be included within the convention by the adoption of new protocols. In addition, the convention encompasses assignments of international interests and their associated rights.

To invoke the provisions of the Cape Town Convention and Aircraft Protocol, the debtor must be located in a contracting state, or the equipment must be on the aircraft registry of a contracting state, at the time of the agreement creating the international interest. Thus, in order to reap the benefits of the convention and Aircraft Protocol, the debtor's nation must have adopted the convention.

A critical element of the convention is the creation of an international registry which, similar to Article 9 of the Uniform Commercial Code, implements a first-to-file rule. Registered interests enjoy priority over unregistered and subsequently registered interests. The registry functions as a priority-determining and public notice mechanism. If a registered interest is effective and the convention applies, then a party's priority will be determined on a first-time basis.

The registry will operate as a public facility; anyone who follows the appropriate procedure may enjoy access. Searches will be available via automated services 24 hours a day from workstations in various locations. The establishment of the registry aims to clear up conflicts or ambiguities about rights and claims of registered equipment by providing public notice of international interests and assignment or subordination.

The registry is an administrative-like structure, composed of a registrar and supervisory authority. The Aircraft, Railway and Space Protocols will each have a supervisory authority assigned to it which will supervise the creation, operation and maintenance of the registry. With respect to the Aircraft Protocol, the drafters favoured the International Civil Aviation Organization as the most competent supervisory authority. In the event of errors, omissions or system malfunction, the supervisory authority, its officers and employees retain immunity from any legal or administrative process, although this immunity may be waived. Unlike the supervisory authority, the registrar's immunity is limited. The registrar remains liable in a suit for compensation in the event of loss suffered by a person directly resulting from system malfunction or an error or omission of the registrar and its officers and employees. However, the registrar is not liable for events which the best practices in current use in the field of electronic registry could not prevent. Registrants should be aware that they are responsible for the factual accuracy of the information provided. Accordingly, the registry is not responsible (and not liable) for errors in the forms it receives.

An important feature of the Cape Town Convention permits a holder of an international interest to exercise various remedies on default. Remedies on default consist of taking possession of the equipment, selling or leasing it, and collecting income or profits from the management or use of the object. These remedies are not exhaustive and additional remedies pursuant to applicable law are still available. In order to provide greater flexibility, contracting parties are free to create or limit available remedies. Such limitations include the ability not to grant a lease of the object in that jurisdiction or whether available remedies may only be exercised by leave of court.

One of the intended features of the treaty is to prevent the application of inconsistent national insolvency laws. The convention reflects the need for prompt enforcement of creditors' rights following default. In the Aircraft Protocol, the rules governing remedies after insolvency provide two options. The onus is on the contracting state to declare adoption of an option in its entirety, or to reject these options and simply apply its own insolvency rules.

The first option requires the insolvency administrator to surrender the equipment to the secured party within a short time after default, unless the insolvency administrator cures all defaults and agrees to perform all future obligations during the specified waiting period. The Aircraft Protocol also prohibits the prevention or delaying of remedies allowed by the Aircraft Protocol during the insolvency proceedings. In addition, the insolvency provision would prevent the modification of the debtor's obligations during the insolvency proceedings, in the absence of creditor consent. The effect of this option is to deny the power of a local bankruptcy court to modify a debtor's obligations in connection with a reorganization plan.

The second option requires that the insolvency administrator or debtor, as applicable will, upon the request of the creditor, issue notice to the creditor within the time specified by a contracting state as to whether it will cure all defaults (other than defaults related to the filing of the insolvency proceeding) or allow the creditor to take possession of the aircraft in accordance with applicable law. This alternative is the 'soft' option which does not require any action by the debtor or insolvency administrator until a request is made by a creditor; the first option requires the debtor to take action within a specific time and is more akin to the 60-day period found in Section 1110 of the US Bankruptcy Code.

The drafters of the convention opted for a narrow jurisdiction provision. The court of jurisdiction may be selected by the contracting parties. The court selected by the parties has exclusive jurisdiction unless otherwise agreed. If the contracting parties do not agree in writing or in accordance with the intended forum's requirements, private international law rules determine jurisdiction.

One of the anticipated issues was how the convention was going to affect pre-existing rights or interests in equipment. In essence, rights or interests established prior to the date on which the Aircraft, Railway or Space Protocols enter into force in the debtor's state will remain unaffected. However, a participating state has the option to require a transitional registration in order to determine priorities. Creditors are given a minimum of three years to file a transitional registration, which must also provide a method for protecting any existing priorities.

Comment

The Cape Town Convention and Aircraft Protocol provide a sound legal framework for and an international consensus on cross-border secured financing of aircraft equipment. The foremost intention of the convention is to subject mobile security interests, enforcement mechanisms and priority claims and rights to a uniform body of law. The drafters envisioned that such uniformity will reduce the costs of aviation credit, which will encourage asset-based financing and leasing by improving investor and creditor confidence. The drafters predicted an increased demand in aircraft financing over time. In an attempt to meet the international community's increasing needs, the drafters envisioned that the convention and Aircraft Protocol would facilitate aircraft funding at a time when investment in the aircraft industry is running dry. It is likely that a growing demand in financing and the rising need for security in property will prompt all nations to adopt the Cape Town Convention and Aircraft Protocol.


For further information on this topic please contact Timothy Lynes at KMZ Rosenman by telephone (+1 202 625 3500) or by fax (+1 202 298 7570) or by email ([email protected]).