When buying an aircraft from a seller under financial stress, and there are many stressed-out sellers these days, the first thing a potential buyer usually thinks is—"Great, I've got the leverage and I'm going to get an amazing deal." This may be true, and the buyer may fly away with a bargain, but there are some unusual risks involved when buying an aircraft from a distressed seller that can easily trap a wayward buyer. If a buyer is not careful, a distressed seller can back out of a deal without cost, put the deal into limbo or undo an otherwise completed aircraft sale. In order to secure a good deal from a distressed seller, but avoid the distressed seller's traps, here are some protective measures that a buyer can take.
The Problem with Financially Shaky Sellers
The main problem with financially shaky aircraft sellers is that they may declare bankruptcy, which can affect the buyer in a number of ways. Bankruptcy gives the distressed seller three critical weapons that can adversely impact the buyer: (1) the ability to hold the buyer to the contract terms while delaying a transaction beyond contractual deadlines, (2) the ability to reject an otherwise binding contract and (3) the ability to treat funds on hand (including deposits) as assets of the bankruptcy estate. These weapons have different impacts depending upon the stage of the transaction.
If the seller files for bankruptcy protection at any time before closing on the aircraft sale, the seller/debtor can use the bankruptcy process to reject the Purchase Agreement to enhance its position (e.g., it finds another buyer willing to pay more money). Of course, the ability to reject the contract is tantamount to the ability to renegotiate it with you.
The debtor/seller can reject a contract weeks or months into the bankruptcy, since the debtor/seller has time to make this decision before "plan confirmation" under the Bankruptcy Court proceedings. The buyer might need to absorb the prepurchase inspection costs, or at best pursue those costs as unsecured claims against the debtor. In the meantime, the buyer could be forced to wait—which means it will not have the aircraft it contracted to buy, and cannot commit to buying a different aircraft without the risk of ending up owning two aircraft. This could be very difficult for a buyer that intended to use the aircraft as replacement property in a 1031 exchange. If a seller files for bankruptcy after the aircraft was delivered, and the deal was "too good," a Bankruptcy Court could set aside the transaction as a "preference" item or fraudulent transfer if a judge decided that the seller received less than "reasonably equivalent value" for the aircraft. The possibility of this happening goes up if there are other buyers willing to pay more than what the aircraft sold for.
The Boxer's Mantra: Protect Yourself At All Times
The buyer of an aircraft from a distressed seller has different defensive tactics available at different stages of the aircraft-buying process. In a typical used aircraft sale, the deal structure is as follows: The buyer makes a good faith, refundable deposit, visually inspects the aircraft, and then the buyer and seller sign a Letter of Intent—a generally nonbinding letter that establishes the purchase price, timeframe and structure of the deal. The parties then negotiate and sign a Purchase Agreement that fills in all of the details for the aircraft sale—i.e., closing date, delivery location, escrow terms, closing conditions and inspection rights. After that, you have the aircraft inspection, repair the squawks, test flight, delivery and closing.
Pre Letter of Intent Phase: Before signing a Letter of Intent, a buyer should do some research into the aircraft seller for signs of economic hardship—SEC filings, lien searches (including tax liens), news reports—and— determine whether the aircraft purchase price is "too good." If, at this early stage, it looks like the seller is in a tight spot, the buyer has several options. The buyer can find another aircraft and let this deal go, or move forward with the transaction, in which case the buyer will want to complete the aircraft purchase as quickly as possible, since the longer the transaction takes, the greater the risk that the seller pulls out of the deal or files bankruptcy (dragging the buyer along into that morass). Also, a buyer should make sure that it is dealing with a person from the seller that has actual authority to do the deal and that the aircraft-owning company really wants to sell. The third option is to wait for the seller to file for bankruptcy. The benefits of doing that are discussed at the end of this article.
If the buyer decides to go forward, but is concerned about the seller's demise, the buyer can do several things. One option is to have an aggressively priced deal with a minimal pre buy inspection that closes very quickly. This works very well if the aircraft is relatively new, and still under manufacturer's warranty, and so the risk of airworthiness discrepancies would be low. But there is always risk (for example, an internal corrosion problem), and therefore the price can and should reflect this risk. A buyer could also consider purchasing the aircraft without a pre-buy inspection for 70 percent cash and a 30 percent promissory note. After the closing, the buyer would retain the right to inspect the aircraft and repair airworthiness discrepancies, and any problems found could reduce the amount owed the seller under the promissory note. The benefit of this deal structure is that it reduces the buyer's risk of getting trapped by the seller's filing for bankruptcy after the Purchase Agreement is signed, but before the aircraft is delivered to the buyer. The risk, however, is that airworthiness discrepancies on aircraft exceed the holdback under the promissory note. Ultimately, the seller probably will not like this structure, but might be willing to avoid it with an even further reduced purchase price.
Post Letter of Intent Phase: After the Letter of Intent is signed, but before the Purchase Agreement is executed, do not sign the Purchase Agreement if the seller is showing new, substantial levels of financial difficulties. Will the seller's cash "burn rate" get you through to the closing date? The buyer's due diligence on the seller should be to determine whether the seller is current on its aircraft direct operating costs, pilot salaries, maintenance costs, fuel, insurance premiums and engine maintenance programs. Has there been any unusual deferral of maintenance? Is the aircraft current on airworthiness directives? Has the seller defaulted on any financing? These questions can help give the buyer some insight into the seller's economic condition.
Purchase Agreement Phase: In drafting and negotiating the Purchase Agreement with a distressed seller, the buyer can build in some protections against the seller's default or bankruptcy. The main goal of the buyer is to be able to get out of the Purchase Agreement fast with no or low costs.
Typically, the buyer will make a good-faith deposit in anticipation of purchasing the aircraft, which sellers normally require as evidence of the buyer's ability to buy and seriousness, and to possibly cover costs incurred by the seller when engaging in the process of selling the aircraft. The buyer should deposit as little money as possible, and none with the seller, since this money can become the seller's property in bankruptcy. Instead, the deposit should be held in escrow by a third party. There is, however, no guarantee that a bankruptcy judge will treat this as the buyer's money; and in most cases if there is any dispute as to the money's proper home, the funds will sit frozen in the escrow account pending resolution. Part of the court's consideration will be the status of the deposit under the Purchase Agreement based upon the stage of the deal. Typically, the deposit remains refundable to the buyer prior to completion of the pre buy inspection. After the pre buy, if the buyer still wants to purchase the aircraft, the deposit often "goes hard" and becomes nonrefundable to the buyer. A Bankruptcy Court judge will look at these matters to decide whether the deposit belongs to the buyer or the bankruptcy estate. Therefore, a Purchase Agreement should be clear as to when title to the deposit transfers to the seller. Also, the buyer should try to "stagger" when and how much of the deposit goes hard in order to mitigate the harm of the buyer both losing its full deposit and having the Bankruptcy Court cancel the Purchase Agreement and deny the buyer from taking delivery of the aircraft.
In addition, a buyer in this situation will want the seller to represent that it is paid-up with its vendors and maintenance providers, so as to reduce the risk that liens might be filed that interfere with the closing on the aircraft. Unfortunately, there are a number of contract provisions that can be thrown into a Purchase Agreement that a Bankruptcy Court will not respect. For example, a Purchase Agreement cannot (on its own) terminate if there is a seller's bankruptcy, since this would violate the "automatic stay" under the Bankruptcy Code. Also, the contract cannot require that the seller pay the buyer for "incidental damages" if the seller declares bankruptcy.
If it looks like things are going bad for the seller, but the seller has not yet declared bankruptcy, there are several things that a buyer can do. The best option is to quickly complete the contract and take delivery of the aircraft before the bankruptcy filing. In the alternative, a buyer could breach the Purchase Agreement by failing to perform its obligations prior to the bankruptcy filing, which, in conjunction with a small liquidated damages provision in the contract, would allow the buyer to get out of the contract at a relatively low cost. Keep in mind that the event of bankruptcy generally cannot be used as a default, triggering the buyer's right to take funds and walk away. The so-called "stay" in bankruptcy prevents creditors and counterparties from taking commercially typical steps to protect themselves based on a bankruptcy filing. So, you should not expect to be able to cancel the deal and take your deposit back based solely on the seller's bankruptcy filing.
Buyer's Rights in Bankruptcy
If a buyer still finds itself in the middle of an aircraft purchase when the seller declares bankruptcy, all is not lost. If the deal was almost done, the Bankruptcy Court can give early and fast approval to allow the buyer to complete the purchase. There are legitimate incentives for this, since the aircraft is probably costing the debtor/seller money to maintain, and cash is being offered to the bankruptcy estate for an illiquid asset. The buyer can also claim that the aircraft does not properly belong to the bankruptcy estate since it is separately identifiable property. You should work closely with the seller to make certain that your transaction is put on the court's docket for immediate consideration and approval. Also, if a buyer performed a due diligence on the seller, but the seller concealed information, the buyer may have some additional rights in Bankruptcy Court if the seller's misrepresentations were a material inducement to the buyer's signing of the Purchase Agreement, and which allow the buyer to ask the court to either compel the delivery of the aircraft or terminate the Purchase Agreement and refund the buyer's deposit.
A Post Bankruptcy Transaction Is Easier
If you do not foresee being able to close a transaction prior to a bankruptcy filing (and you certainly do not want to be bound by a Purchase Agreement when that filing takes place), you should not be afraid to wait for the bankruptcy filing, and then pursue the purchase. In most cases, the bankrupt seller/debtor remains in control of the company, and the transaction (as a post petition event) is actually more orderly and clean. An aircraft purchased from an entity in bankruptcy will be supported by a judicial order that offers protection from creditors.
With a little planning and foresight, a buyer can get a good deal buying an aircraft from a distressed seller, and at the same time minimize the buyer's risks from the problems that can flow from such deals.
Originally published in World Aircraft Sales magazine.