Stakes in leased asset sale transaction
How do payment-related mistakes still occur?
Cause of action
The trading of aircraft assets – be they whole aircraft or engines or other parts – between industry participants, such as institutionalised leasing companies, is as dynamic, legally complex and fraught with intense negotiation as ever.
Legal teams work hard to prepare tightly drafted documentation on behalf of clients, attempting to prescribe recourse for every likely and unlikely eventuality which may arise during the course or following the completion of a sale and purchase transaction.
However, despite the seemingly meticulously drafted documentation, unforeseeable events can occur and result in a potentially significant loss or cost accrual for an involved party. In the unlikely event that the documentation fails to provide a remedy or guidance for correcting the issue, in the absence of goodwill between the transaction participants, the aggrieved party may have no choice but to initiate litigation.
This update briefly explores:
- some of the stakes in an aircraft sale and lease novation transaction;
- the mistake of a lessee making a lease payment to the prior lessor after closing;
- the concept of unjust enrichment as the likely (but not necessarily exclusive) source for a cause of action; and
- the associated remedy of restitution.
Stakes in leased asset sale transaction
The purchase of an aircraft asset is normally concluded by the execution of a sale and purchase agreement (SPA) between the selling and purchasing entities. The example below illustrates the stakeholders in a common purchase and sale transaction and a mistake that could lead to unjust enrichment.
In this example, the selling entity under an SPA (ie, the existing lessor) is the full legal and beneficial owner of an aircraft asset and also the lessor of that asset under a lease agreement between itself and a third-party airline (ie, the lessee).
The purchasing entity under the SPA (ie, the new lessor) is purchasing not only the metal asset itself, but also the economic benefits – including the stream of rental payments – under the lease.
If the transaction is governed by English law and the asset sale is a straight 'metal sale' (as opposed to an assignment of a beneficial interest under a trust or the sale of an aircraft-owning company), the document that will govern the transfer of the lease will be a novation and amendment agreement. The execution of the novation by the existing lessor, the new lessor and the lessee will be a condition precedent to the sale of the asset under the SPA. The novation would contain provisions pursuant to which:
- the new lessor would promise to assume the role and rights of the existing lessor under the lease; and
- the lessee would promise to perform all of its obligations under the lease in favour of the new lessor.
Ordinarily, the novation will contain a provision called the 'effective time', which will govern when:
- the operative provisions of the novation become effective; and
- a new lease agreement is constituted between the new lessor and the lessee.
It will also typically contain carefully drafted provisions stating that:
- all payments made by the lessee under the lease that are attributable to the period before the effective time shall be made by the lessee to the existing lessor, even if they fall due or are paid after the effective time;(1) and
- all payments under the lease that fall due and are attributable to the period after the effective time will be paid by the lessee to the new lessor.
These provisions will be the subject of deliberate and intense scrutiny by the legal teams of both the existing and new lessors, each of which will want to ensure that its client does not fall victim to:
- a misinterpretation of the novation's provisions;
- an unintentional payment processing error; or
- a careless mistake or negligence on the part of the lessee.
Any of the above could have significant implications for the economic benefits of the transaction for the seller or purchaser (or both), such as a significant variation in the asset's purchase price.
How do payment-related mistakes still occur?
An example of a mistake in these circumstances occurred when an airline (the lessee in the above example) leasing an engine from an operating lessor (the existing lessor in the example) that was selling the engine to another operating lessor (the new lessor in the example), mistakenly paid maintenance reserve amounts (MRs) to the seller after the sale had concluded.
The engine was the subject of an SPA which provided that the total amount of the purchase price to be paid by the purchaser to the seller would be reduced by the total amount of MRs and security deposit held by the seller at the time of the sale. Both the seller and the purchaser had been of the understanding that the engine was off-wing and in storage during the three months preceding closing and that, therefore, MRs did not accrue during those months.
At closing, the total purchase price amount was reduced by an amount equal to the MRs for the engine held by the seller on the closing date.
Later that month, the lessee paid MRs to the seller for the three months preceding closing, as it realised that it had made a mistake regarding the engine which it had communicated to the seller and purchaser as being off-wing. The engine that was the subject of the sale was on-wing and MRs had accrued during those three months.
As the transaction had already closed, the seller stood to benefit from a significant windfall amount that, but for the lessee's mistake, would have been deducted from the purchase price on the closing date.
Crucially, there was nothing in either the SPA or the novation that governed to whom MRs that were attributable to the period before the effective time should be paid. As the rent, MRs and security deposit were built into the final purchase price calculation, it was considered satisfactory to include a generic provision in the novation stating that all amounts payable by the lessee under the lease would be paid to the new lessor, irrespective of whether such amounts accrued or were attributable to the period before or after the effective time.
Not only was the lessee mistaken in communicating that the engine was off-wing and therefore not accruing MRs, it paid the seller after the effective time, even though it had signed a novation stating that all amounts payable under the lease should be paid to the new lessor.
Because the seller in this case was a conscientious and reputable party, it paid the windfall to the purchaser even though it was not under a contractual obligation to do so. But what action could the purchaser have taken if, following closing, the seller looked to retain its windfall?
The precise structure, scope and nature of the law of unjust enrichment has been and remains the subject of contested academic thinking and debate and its rise is partially attributable to what in essence was an academic coup. There are a multitude of references to various legal academics throughout the relevant case law. However, all seem to agree that the decision that gave unjust enrichment unequivocal judicial approval as a distinct legal category in England is Lipkin Gorman v Karpnale Ltd,(2) in which Lord Goff pointed out that a plaintiff's claim "is founded simply on the fact that... the third party cannot in conscience retain the money – or, as we say nowadays, for the third party to retain the money would result in his unjust enrichment at the expense of the owner of the money".
Unjust enrichment now sits firmly in the spectrum of the law of obligations, alongside the laws of contract and torts.
For a claim of unjust enrichment to succeed, the plaintiff must prove that:
- the defendant has been enriched;
- the enrichment is at the claimant's expense;
- the enrichment at the claimant's expense is unjust; and
- there is no applicable bar or defence.
These requirements have been consistently expressed and referred to in case law since Lipkin Gorman, including in Banque Financière de la Citè v Parc (Battersea) Ltd(3) and, more recently, Bank of Cyprus UK Limited v Menelaou.(4)
The third requirement of an enrichment needing to be unjust has proven to be the most difficult to discern. The concrete list of unjust factors differs from textbook to textbook and from decision to decision. For example, Andrew Burrows includes the following in the range of viable factors:
- undue influence;
- legal compulsion;
- necessity; and
- failures of consideration.(5)
There is evidence to suggest that mistakes of fact are one of the more commonly provable causative factors for demonstrating the injustice of a particular enrichment.(6) Peter Birks has stated that where one person pays money to another while labouring under a causative mistake of fact or law, he or she may be entitled to restitution on the ground of a mistake.(7)
Reverting to the example set out above, the onus would be on the new lessor to prove that the lessee had made a mistake of fact in paying the MRs to the existing lesser after the effective time (which resulted in the unjust enrichment), notwithstanding the fact that this was contrary to what it had agreed to do under the novation. The standard of proof is quite low. In particular, it does not matter that the lessee was negligent or careless in making the mistake – the purchaser would still be entitled to restitution. The purchaser's case would be supported by the fact that it had suffered a loss because, had the lessee not miscommunicated the off-wing status of the engine, the purchase price which the purchaser paid to the seller at closing would have been reduced by the exact amount by which the seller was enriched after the effective time.
Although transacting parties go to great lengths to protect their pre and post-closing positions by attempting to account for all eventualities in the applicable transaction documentation, mistakes that fall outside the protective ambit of such documentation can still occur. However, in such cases, the law will attempt to step in to reverse the damage imposed on the aggrieved party – be it through a claim for unjust enrichment, the remedy of restitution or another ground entirely.
For further information on this topic please contact Lev Gantly at Vedder Price LLP by telephone (+44 20 3440 4680) or email ([email protected]). The Vedder Price website can be accessed at www.vedderprice.com.
(1) This will also be the exact time at which the sale of the asset under the SPA will conclude.
(5) Andrew Burrows, The Law of Restitution (third edition, OPU, 2011).
(6) Alastair Hudson, Equity & Trusts (third edition, 2003).