Re-delivery generally

The matter of re-delivering an aircraft to its owner at the expiry or earlier termination of an operating lease is necessarily a complex one. A well-organised process involving the commercial, technical and often legal resources available to the operator (and similarly both the owner and any third party maintenance provider contracted to work on the aircraft through the redelivery phase) is essential in order to avoid not only difficulties with the phasing-out of the aircraft from revenue service but also circumstances in which the owner of the aircraft might take advantage to the ultimate detriment, usually cost, of the relevant lessee.

Market trends

The flight in recent times of traditional aircraft finance lenders from the aviation finance market has created,  in certain segments of the market, a significant shortfall in available capital which is required for the extensive fleet orders that have been placed at this time. Part of that shortfall is being addressed by motivated equity sources, part by the export credit agencies and a portion by the aircraft manufacturers themselves. None is more hungry however than the range of existing and new entrant operating leasing companies, who see huge growth potential in offering sale/leaseback financing for the ‘right’ equipment and jurisdiction and are prepared in order to beat off the significant competition to provide elements of financing also for the pre-delivery payments required to be made by the airlines. Combined with the continually robust levels of operating leasing of used aircraft of the full range of types, this means leasing know-how and leverage will assume even more importance in this next phase of the aviation cycle. Matters relating to the re-delivery of the aircraft to its owner and relevant to the period around the expiry of the contractual term or any earlier termination  of the relevant lease are clearly a hugely important aspect of any leasing transaction and therefore should be given priority as regards items to be addressed comprehensively in any lease negotiation.

Preparation and risk management

As mentioned above, organisation and therefore preparation is key to dealing usefully with the range  of issues associated with re-delivering an aircraft. That preparation starts ideally with the necessary efforts being made to negotiate a well-balanced and ultimately fair lease agreement which is also clear and unambiguous in respect of its terms and conditions and contains the necessary mechanisms to ensure the interests of the lessee operator are properly protected. The precursor to that is usually a partially-binding ‘Letter of Intent’ or ‘Heads of Terms’ which will seek to contain some of the relevant provisions even at that stage and therefore the same concerns apply to any negotiation of that document also in terms of what it contains.

Techniques

On any level, the ability to secure a fair position for the operator lessee will ultimately depend on the respective bargaining positions and therefore ‘leverage’ of the parties concerned. There are therefore many good reasons to avoid, for example, the scenario which sees a prospective lessee which is desperate to obtain additional capacity by way of a leased aircraft but is severely time-constrained in terms of the aircraft’s required entry into service.

In the event of the opportunity to properly work through a lease negotiation, there are a number of mechanisms and concepts which, if properly addressed in the drafting and clearly understood and disseminated among their teams by the respective parties, can go a long way to addressing the inherent imbalance and potential unfairness between the positions of a lessor and a lessee. Several of those are connected from a lessee’s perspective, whether directly  or indirectly, with the matter of aircraft re-delivery and the period at the end of the leasing relationship between the parties.

Redelivery conditions themselves

Market practice has moved on considerably from when an aircraft was required to be returned to its owner in substantially the same condition as at delivery, “fair wear and tear excepted”. The potential for disagreement when applying such a general concept to specific component conditions is fairly clear. Specific and detailed redelivery conditions should be drafted by those with legal or commercial expertise with continued input from technical post-holders to form part of the lease agreement.

Compliance with redelivery conditions

It is still not uncommon that a bona fide dispute occurs between the parties in the course of a re-delivery process for an aircraft, where a lessee maintains that it has complied with the terms of the lease agreement and a lessor or owner disagrees. In some cases the ability of either party to refer the matter to an independent third party with the appropriate know-how (for example, a qualified engineer licensed to cover the relevant aircraft or component type and nominated by the Royal Institute of Aeronautical Engineers) before litigious steps are considered is a genuinely helpful option, particularly in the context of a delayed redelivery which might give rise to certain imbalanced rights as referred to elsewhere in this article. This should hold little fear for a party which intends to act reasonably and with integrity in this regard.

Lessor rights

Typically, a lease agreement (which will in almost all cases be provided by the aircraft owner or lessor) will seek to contain provisions whose intention is to maximise any and all leverage possible over an operator in conjunction with the return of its asset. While it is accepted that an aircraft owner is entitled to deal with its property in this way, it is important to balance any attempt to exploit that premise. For example, the lease agreement will typically require enhanced rent (possibly even double the contracted rent amount) to be paid from the time when the aircraft was expected to be delivered until it is actually delivered to the owner, in each case with the aircraft in the required redelivery condition. Where there is a genuine breach by the lessee it is reasonable to ‘incentivise’ the party to complete the redelivery work and avoid paying what is in effect a penalty charge. However, where there is a genuine dispute about the aircraft condition or where a lessor is having difficulty securing a follow-on lessee for its aircraft, then the regime applicable needs to change – for example, an initial grace period from rent, a ‘freeze’ of payment obligations until any dispute is resolved using a technical adjudicator or similar, or a ‘stepped’ approach to increasing rental payment.

General terms

While not necessarily connected with the aircraft redelivery at lease expiry or earlier termination per se, a number of other issues dealt with in the lease agreement between the parties will do well to be given similar focus at the outset of discussions, including:

  • Return of security deposits

Usually representing a significant cash amount (typically equal to three rental payments) whether held as such by the owner or lessor or by a third party provider of documentary credits as collateral, these need to be returned to the lessee as quickly as possible and independent of any dispute between the parties regarding redelivery conditions (unless the lessee has breached its payment of rent obligations)

  • Maintenance reserves

The accumulated reserve amounts should be made available to pay for the costs of redelivery of the aircraft to the owner or the lessor, save for those reserves which genuinely compensate loss of utilisation of aircraft components and consumed life on limited parts. This would have the effect of mitigating any unfair windfall on the part of the aircraft owner or lessor, which is not the purpose of entering into a long term operating lease agreement. In addition, it is worth considering structuring maintenance reserve obligations and rights so that cross-drawing between different reserve accounts is allowed in order to manage cash flows at the relevant times (subject to a certain limited “topping-up” obligation on the part of the airline), particularly across engine components, for which reserves are accrued separately

  • Lessor solvency

Usually for withholding tax management reasons but often (in the case of new aircraft financing in particular) for risk allocation purposes in the context of a particular financing structure, the lessor or aircraft owner is simply a special purpose company with no assets other than the aircraft or the receivables from the relevant specific lease transaction itself. In this situation, there is a genuine risk of it not being able to perform (admittedly few in number) material obligations to a lessee under a typical operating lease, such as the reimbursement of maintenance reserves to cover the costs of scheduled maintenance during the lease, the return to the lessee of cash security deposits and indeed the ongoing availability of the aircraft itself for the lessee. Mechanisms to consider when looking to mitigate the effects of this risk might include a third party holding cash payments made by the lessee, documentary credits instead of cash to secure the obligations of the lessee generally and a guarantee from a sufficiently creditworthy entity of good standing of the obligations of the aircraft owner or the lessor to the operator under the relevant lease agreement

Conclusion

These are just a few of the issues we see regularly in the context of aircraft leasing transactions insofar as they relate directly or indirectly to the circumstances of redelivery of the aircraft to its owner. It is difficult to always quantify the value in dealt terms as regards time, management attention and ultimately the costs of external professionals required to solve problems arising. However there is clear and demonstrable evidence from the market, both historically and currently, that an open and organised approach to contemplating the issues in play and implementing mechanisms to deal with them will avoid a difficult situation and turning a strained relationship between the parties into a full-blown crisis.