On May 22, 2019, the U.S. District Court for the Central District of California decided Air Lease Corporation; ALC B378 41345, LLC; and ALC B378 37772 v. Far Eastern Air Transport Corp. The case was based on an allegation that Far Eastern, a Taiwanese airline, was in breach of contract for refusing to accept delivery of two Boeing 737-800 aircraft that it contracted to lease from ALC. The court ordered Far Eastern to pay ALC more than $23 million in damages plus prejudgment interest for refusing to honor the leases. In its findings, the court addressed two interesting issues related to the aircraft leasing market: (1) the materiality of an aircraft being placed into storage prior to delivery under a lease as it relates to the lessee’s obligation to accept delivery of the aircraft and (2) the obligation of a nonbreaching lessor to remarket an aircraft to mitigate damages in the event that a lessee refuses to accept delivery.

Background 

The parties began to discuss a two aircraft leasing deal in February 2015 when Far Eastern contacted ALC to inquire about the availability of its Boeing 737-800 fleet. The negotiation process lasted for a six-month period from June through December 2015 and was ordinary by each party’s account at trial. ALC and Far Eastern traded comments and met in person from time to time to discuss terms, and by December they had executed leases for both aircraft. One of the aircraft that would be leased to Far Eastern, MSN 37772, was on lease to Air Berlin during the negotiations, a fact known by Far Eastern. As part of its corporate strategy to switch to Airbus aircraft, Air Berlin opted to exercise an early termination option under its lease and return the aircraft to ALC in July 2016, at which time it would be delivered to Far Eastern under the new lease.

The deal between Far Eastern and ALC started to unravel in May 2016 when Far Eastern notified ALC that it was rescinding the lease of MSN 37772 because it learned that the aircraft was grounded by Air Berlin since November 2015 and placed in storage. Prior to sending the notice, Far Eastern had only once asked ALC about the operational status of the aircraft. At the time, the aircraft was still being flown by Air Berlin and ALC responded in the affirmative. Throughout the remainder of the six-month negotiation period, Far Eastern never again raised any question as to the flight status of the aircraft.

Notwithstanding ALC’s contention that Far Eastern had no legal right to rescind or terminate the lease, ALC agreed to mutually terminate it on the condition that (1) the parties enter into a termination agreement for the MSN 37772 lease and agree to release one another from any claims or liabilities relating to the lease and (2) Far Eastern fully perform its obligations under the lease of the second aircraft, MSN 41345. Far Eastern rejected ALC’s offer and refused to enter into a lease termination, claiming that it had suffered millions of dollars’ worth of damage as a result of the collapse of the MSN 37772 Lease. Far Eastern then refused delivery of MSN 41345, and ALC was forced to remarket the aircraft. Two months later, the aircraft were both leased to SpiceJet. ALC brought this case against Far Eastern for breach of contract for refusing to perform under both leases.

The Materiality of Storing an Aircraft Prior to Lease Delivery 

At trial, Far Eastern offered four excuses for its nonperformance of the MSN 37772 lease, three of which were dismissed on summary judgment. The only argument that survived was Far Eastern’s claim that it was excused from performing its obligations under the lease due to ALC’s negligent misrepresentation of the operational status of the aircraft. Far Eastern argued that ALC misrepresented the status of the aircraft when, in August 2015, ALC confirmed that it was flying but then subsequently failed to notify Far Eastern when the aircraft was placed into storage. In order for Far Eastern to prevail on its claim, the court required proof of the following three elements: (1) misrepresentation of a past or existing material fact, without reasonable ground for believing it to be true, and with the intent to induce another’s reliance on the fact misrepresented; (2) ignorance of the truth and justifiable reliance on the misrepresentation by the party to whom it was directed; and (3) resulting damage.

The court held that Far Eastern’s claim for negligent misrepresentation failed to satisfy a number of requisite elements. The parties did not dispute that aircraft was in fact flying in August 2015 when ALC made the representation as its operational status, and so the court found that ALC did not misrepresent a past or existing fact. In addition, the lease with Air Berlin did not require that notice be sent to ALC when the aircraft was placed into storage, and so the court found that ALC did not know, nor should it have known, that Air Berlin stored the aircraft.

The most interesting reason the court gave for dismissing the negligent misrepresentation claim, however, was the finding that ALC’s representation as to the operational status of the aircraft did not concern a material fact. According to the court, “[a] misrepresentation is judged to be” material “if a reasonable man would attach importance to its existence or nonexistence in determining his choice of action in the transaction in question.”1 Further, a matter is material if “the maker of the representation knows or has reason to know that its recipient regards or is likely to regard the matter as important in determining his choice of action, although a reasonable man would not so regard it.”2

In order to determine whether ALC’s alleged misrepresentation would be material to a “reasonable man” under the Engalla test set out above, the court considered the testimony of the expert witnesses called to testify to the effects of storage on an aircraft. After weighing the testimony of the experts, the court sided with ALC and its expert writing that “air carriers around the world routinely store aircraft” and “storage under an approved program does not impact airworthiness, maintenance condition, or value of an aircraft.” Based on the court’s finding that “ALC’s representation did not concern a material fact,” it appears that the court’s position is that, absent a contractual obligation with regard to storage or operation, a reasonable lessee will not attach importance to the fact that an aircraft is properly stored prior to taking delivery under a lease.

While the Engalla test is objective and based on a “reasonable man” standard, the rule in Kwikset required that the court determine if ALC knew or had reason to know that Far Eastern would regard the storage of the aircraft as important in determining whether or not to lease the aircraft. The undisputed testimony at trial was that not only did Far Eastern only inquire once as to the operational status of the aircraft during the negotiation period, but it was also pursuing leases for six other aircraft that it knew to be off lease and in storage. Considering Far Eastern’s actions, the court determined that ALC did not know, nor did it have reason to know, that Far Eastern would consider storage a material fact.

The subjectivity of the Kwikset test makes it difficult to apply the court’s findings in this case to a different set of facts. However, the court’s position with respect to the objective Engalla test, and its statements regarding aircraft storage generally, imply that, absent a contractual obligation regarding storage and operation, the court does not consider the fact that an aircraft is stored prior to delivery under a lease to be an acceptable reason for a lessee to refuse delivery. Of course the facts of each individual case, including whether or not the aircraft was properly stored and how active the lessee was in monitoring the operational status of the aircraft during lease negotiations, will be taken into consideration by the court. However, the court was clear in its position that storage of an aircraft should not be material to a reasonable lessee given that storage is commonplace in the airline industry and proper storage does not negatively affect aircraft values, conditions or airworthiness.

Lessor ReMarketing Obligations

After Far Eastern refused delivery of the second aircraft on May 24, 2016, ALC immediately began its remarketing efforts and reached out to 12 to 15 airlines within a short period of time. By mid-July, ALC entered into leases with SpiceJet for the aircraft, each of which were for lower rent rates and shorter lease terms than the Far Eastern leases.

Under California law, when one party breaches a contract, the other party is entitled to damages sufficient to make that party “whole” so that it is in the same position as if the breach had not occurred. The court, therefore, determined the amount of ALC’s damages by calculating the difference in value between the Far Eastern leases and the SpiceJet leases.

California law also requires, however, that the prevailing party mitigate damages or the award to the prevailing party will be discounted. Far Eastern raised this issue with the court and argued that ALC failed to properly mitigate because it rushed into the SpiceJet leases and did not consider a number of alternative leasing scenarios. Therefore, Far Eastern claimed, ALC received a below-market deal and the damages should have been mitigated to reflect the fact that ALC could have made a better deal.

The court disagreed with Far Eastern and awarded ALC the full amount of the difference in values between the Far Eastern leases and the SpiceJet leases, equal to $14.6 million for the MSN 41345 leases and $6.6 million for the MSN 37772 leases. Despite the considerable discrepancy in the values of the leases, the court was unconvinced that ALC did not reasonably mitigate damages. The court relied on testimony from ALC stating that SpiceJet was able to secure lower lease rates in part because the aircraft were already customized to Far Eastern’s specifications, and SpiceJet was acquiring the aircraft towards the end of the peak summer season in India. ALC further testified that there was a sense of urgency to place the aircraft on lease, and SpiceJet was interested in the aircraft as a package deal. Finally, as noted above, ALC testified to the fact that it approached up to 15 different airlines in order to find a new lessee.

Based on ALC’s testimony, the court held that ALC reasonably mitigated its damages. The court found that ALC moved to re-lease the aircraft as soon as possible after Far Eastern’s breach; that ALC sought to re-lease the aircraft on the best terms it could obtain; that ALC re-leased the aircraft in an amount of time that was as good as or better than industry standard for re-leasing; and that ALC obtained the best possible lease terms it was able to obtain.

In determining whether a lessor has properly mitigated damages when remarketing an aircraft as a result of a contract breach, it seems that the court will not place much importance on the terms of the deal that the lessor is able to obtain, even if the deal is at a substantial discount from the one that was breached. As long as the lessor moves quickly to remarket and accepts the best deal it’s offered considering the circumstances, the obligation to mitigate damages will be satisfied.