In this article we discuss the mortgagee’s duty on the sale of mortgaged aircraft under English law (including the recent Alpstream AG and others v PK/GECAS case), and we comment briefly on some equivalent requirements in respect of New York law mortgages, which also are commonly used in aircraft finance.
English law mortgages and the Alpstream AG and others v PK/GECAS case
English law aircraft mortgages will usually allow the mortgagee/lender, in a default situation, to exercise ‘self-help’ and sell the aircraft without the need to involve the courts.
This can be by private or public sale or auction with or without notice to the mortgagor. However, the mortgagee must consider the mortgagor’s ‘equity of redemption’, ie, that there may be equity in the asset to be returned to the borrower/mortgagor from the sale proceeds after repayment of the loan. The law therefore requires the mortgagee to use its best endeavours to sell the distressed asset for the best price reasonably obtainable, and to act in good faith for proper purposes.
A recent Commercial Court case serves as an example of a breach of duty by a mortgagee when selling mortgaged aircraft to a connected company (Alpstream AG and others v (1) PK Airfinance Sarl (PK) and (2) GE Capital Aviation Services Limited (GECAS) ). The case is of particular interest in so far as it holds that the duty of the mortgagee owed to the mortgagor is also owed to the residual beneficiary of the sale proceeds within the same contractual structure (ie, a junior lender), and explores unlawful means conspiracy within the context of sale of distressed mortgaged assets by the mortgagee to a connected party.
It is worth stressing that the successful claimant in this case was not a mortgagor/borrower (all of which were too far in debt to have suffered any loss), but a junior lender which had provided finance for three of the seven aircraft and which was entitled, pursuant to a ‘waterfall’ security arrangement, to be repaid from any equity in those aircraft after repayment of the senior lenders, ie, any excess sale proceeds.
In very brief outline, the senior lender/mortgagee (PK) sold six of seven repossessed A320s to a connected third party (GECAS) for the purpose of leasing the aircraft to a US airline. A junior lender (Alphastream) which had provided a loan subordinated to the security of PK in respect of three of the seven A320s, and which was not a mortgagee but ultimately was entitled to repayment from surplus proceeds of sale of the aircraft (ie, a residual beneficiary of the sale proceeds within the same contractual structure), successfully claimed that PK and GECAS breached the duty to use best endeavours to sell the distressed asset for the best price reasonably obtainable, and were liable for the tort of unlawful means conspiracy.
Significantly, the fact that the sale by the mortgagee had been to a connected party had the effect of shifting the evidential burden from the mortgagor to the mortgagee which then had to prove that, on the balance of probabilities, it had in fact used its best endeavours to sell the aircraft for the best price reasonably obtainable.
In practice this means that, unless the mortgagee can establish that the “desire to obtain the best price was given absolute preference over any desire” (Tse Kwong Lam v Wong Kit Sen, a 1983 Privy Council case and one of the guiding authorities on sale by a mortgagee to a connected party), the only conclusion can be a breach of duty. Moreover, if it is clear that such onus is not satisfied then “the measure of damages must be the difference between the best price reasonably obtainable [at the relevant date] and the price… paid” (Tse Kwong Lam). This contrasts with the ordinary case where the mortgagor/borrower must prove the breach: “a mortgagee will not breach its duty to the mortgagor if, in the exercise of its power to sell the mortgaged property, it exercises its judgement reasonably and to the extent that that judgement involves assessing the market value of the mortgaged property the mortgagee will have acted reasonably if its assessment falls within an acceptable margin of error” (Michael v Miller ). In a sale to a connected party, there is no “acceptable margin of error”.
For PK and GECAS to be liable for the tort of unlawful means conspiracy, the following had to be proven: (i) actions in furtherance of a common design, (ii) by PK or GECAS, using means which were unlawful, and when they knew they were unlawful, or, with knowledge of the facts, were reckless as to whether they were harmful, (iii) with the intention to cause loss to another, or, deliberately, and knowing that they will cause loss to another as a result.
As regards breach of duty, in outline, the Judge held that PK acted with wilful misconduct (ie, unlawfully) and in breach of its aforementioned duty as mortgagee, and that such duty owed to the mortgagor is also owed to the residual beneficiary of the proceeds within the same contractual structure, being Alphastream (the junior lender in respect of 3 of the aircraft which was entitled to residual equity in respect of those aircraft once PK’s loan had been repaid).
The Judge found that the auction exercise carried out by PK was “(at best) half-hearted” and “somewhat of a charade”. For instance, PK did not take adequate steps to inform potential bidders of the substantial value-enhancing work that was carried out on the aircraft prior to the auction (which was “unprecedented but untrumpeted” and carried out for the purpose of leasing the aircraft to the US airline), to market the aircraft or follow up with interested bidders, or to obtain independent valuations. The Judge commented that “it was not necessary or impossible for GECAS to advance its determination to purchase the aircraft for the purpose of leasing to [the US airline]… provided that PK can show that the correct value was obtained”; as a result, “there was no point in an auction, certainly not a half- hearted auction, in order to arrive at a price at an auction at which there was no competition”; and “had they simply acted straightforwardly, it would have been upon the basis that they intended, by… March 2010, for PK to purchase, sell to GECAS, transfer to the N register and lease to [the US airline]. It would then have become apparent that GECAS was a ‘special’ or an ‘uncommonly motivated’ purchaser… [and] There would have been no call to have the impugned auction of ‘distressed aircraft’, devaluing the aircraft by 20% (in accordance with the views of the two experts)…”.
As a special purchaser, it was found that PK would have paid (just) more than the market price of USD 157.3 million, therefore USD 158 million. Accordingly, “USD 158 million would have been credited to the mortgage account in respect of the relevant aircraft, and not USD 146.8 million being the price which PK chose to ‘bid’ in the uncompetitive auction…”, ie, a difference of USD 11.2 million.
As regards conspiracy, the Judge found that PK and GECAS were liable for conspiracy, to the relevant standard of proof. The Judge commented that his conclusions as to there being a breach by PK of its duty (involving wilful misconduct) owed to the borrowers (and to Alphastream), and the procurement of such breach by GECAS, are sufficient to establish ingredients (i) and (ii) mentioned above. As to the third ingredient, the Judge found that there was “deliberate loss, which both PK and GECAS knew and intended to be caused by the unlawful acts, not only to the borrowers but… to the residual beneficiary Alphastream”.
In respect of the three aircraft in which Alphastream was residual beneficiary, the Judge assessed the equity as USD 42.18 million (value of USD 124.38 million less debt of USD 82.2 million). Before taking into account this equity, the deficit on the mortgage account (recoveries/credits less total debt and cost of maintenance etc. work) was assessed at USD 24.825 million. This deficit would then have been offset against the USD 42.18 million equity in respect of the three aircraft in which Alphastream was residual beneficiary. It was the diminution in value of that equity which was found to be Alphastream’s loss, and Alphastream was awarded damages of USD 10.175 million (being the aggregate of the USD 11.2 million sale price difference, adding additional swap break costs of USD 1.4 million and adjusted by USD 0.375 million for the use of new instead of reconditioned engine fan blades). We understand that PK/GECAS may be planning to appeal the decision.
New York law mortgages
Under the Uniform Commercial Code (UCC) Article 9, the secured party (mortgagee) disposing of collateral has a duty to act in good faith and proceed in a commercially reasonable manner as to all aspects of a disposition. Every aspect of the disposition must be commercially reasonable. UCC § 9-610(b). The duty exists irrespective of whether or not the borrower/mortgagor has surplus equity in the mortgaged asset.
A creditor that fails to proceed in a commercially reasonable manner in disposing of collateral may lose the ability to collect on a deficiency after a foreclosure. With respect to damages for noncompliance, UCC § 9-625(b) specifically provides that “Subject to subsections (c), (d), and (f), a person is liable for damages in the amount of any loss caused by a failure to comply with this article.” Therefore, the general rule is that the creditor may be liable for actual damages for noncompliance with Article 9 of the UCC.
Notably, subsection (d) of UCC § 9-625 provides:
Recovery when deficiency eliminated or reduced.
A debtor whose deficiency is eliminated under Section 9-626 [action in which deficiency or surplus is in issue. e.g., where the secured party has disposed of the collateral] may recover for the loss of any surplus. However, a debtor or secondary obligor whose deficiency is eliminated or reduced under Section 9-626 may not otherwise recover under subsection (b) for noncompliance with the provisions of this part relating to collection, enforcement, disposition, or acceptance.
The last sentence of subsection (d) eliminates the possibility of double recovery or other over-compensation arising out of reduction or elimination of a deficiency based on noncompliance with the UCC provisions relating to, inter alia, disposition of collateral. Accordingly, the creditor can be liable to the debtor for disposing of the collateral in a commercially unreasonable manner, but damages should be limited to recovery for the loss of any surplus.
As to who may recover actual damages for noncompliance with Article 9, the UCC provides that “A person who, at the time of the noncompliance was a debtor, an obligor, or held a security interest in or other lien on the collateral may recover damages.” UCC § 9-625(c))
New York law aircraft mortgages commonly contain a provision along the lines that upon the mortgagee giving the mortgagor 15 days’ prior notice, the mortgagee can, “without advertisement”, sell at public or private sale the whole or any part of the collateral. The UCC does not mention advertisement in this context, therefore we have seen borrowers argue that an express right to sell without advertisement runs contrary to the UCC requirement to proceed in a commercially reasonable manner (which on the facts may or may not require advertisement).
As regards private sales, we have seen borrowers object to clauses requiring them to waive any claims against the mortgagee arising by reason of the fact that the price at which the aircraft may have been sold at a private sale was less than the price that might have been obtained at a public sale (or was less than the aggregate amount of the secured obligations). Borrowers have argued that such a waiver is not acceptable on the basis that separating the price from the manner of the sale is artificial, and effectively renders the UCC obligation to proceed in a commercially reasonable manner unenforceable, as it will be precisely the price that would be in dispute.