Financing an Aircraft? Did You Check the Small Print?

We’re told to read the small print all the time. Yet we don’t. With the burgeoning of small print explanations and disclaimers online, and the simplicity of an ‘I agree’ button to click, it’s quite possible we are doing it even less. Here's why you can't afford to skip the small print with aircraft financing...

Not that long ago, Londoners were promised free Wi-Fi connectivity if they met conditions in the small print of a contract they had to agree to. Those conditions clearly stated that the recipient “agreed to assign their first-born child to us for the duration of eternity”. Quite a few people signed up.

One might hope that those signing a multimillion-dollar contract for a loan to buy an aircraft might take a bit more care than someone looking for a free Wi-Fi signal to continue watching football on their phone. Not all do, however, and Gary Crichlow, director, Aviation Finance at London-based finance brokerage and advisory firm Arc & Co, explains why buyers need to beware. 

“Without putting too fine a point on it, aircraft are potentially lethal pieces of kit, and everything about them comes with a price tag with a lot of zeros attached,” he says. “With the stakes that high, it's perfectly reasonable to expect financiers to do everything they can to protect their interests and mitigate risk by baking provisions into the financing contract.”

So it’s important for borrowers to read the small print, says Paul Jebely, who leads the private wealth and asset finance practice of law firm Pillsbury Winthrop, because for them “it often contains landmines”.

All Responsibility With the Owner/Lessee

Aoife O’Sullivan, partner and co-founder of the Air Law Firm, says it’s important to understand that, while with a lease the lessor owns the aircraft and with a loan the borrower owns the asset, “in reality, all responsibility for the aircraft rests with the lessee or owner.

“Whoever signs the loan or lease is duty-bound to comply with regulation, and is duty bound to make sure the aircraft is operated properly.”

Even with a tripartite agreement, where an operator is the third party, if the operating company fails to honour the terms “the owner/lessee still is responsible,” she says.

“The buck will always stop with the owner.”

All is not lost, though. Crichlow notes, “financiers who specialize in aviation, in my experience, by-and-large stick to broadly reasonable requirements that are based both on expertise gained by hard experience in the sector, and by pragmatic commercial nous.

“This is why it's key to have equally specialist expertise on your side when negotiating a contract, so that you have a clear understanding as to why certain small-print provisions are there, and can take a fully educated view on the practical ramifications of accepting (or rejecting) them.”

How Stringent are the Requirements?

Lenders are keen to protect the value of their asset. That’s one reason many require aircraft to be under maintenance contracts. It’s important to understand how stringent such requirements are, though – and whether allowing a maintenance contract to expire, for example, could require the lender to insist on early repayment of the loan.

There may be limitations on use, too. An owner who starts out intending to use the aircraft for his or her own use but then wants to defray some of the costs by offering it out to charter might find that is against the provisions of the loan.

Crichlow says it is vital to “keep an eye on the section of the contract setting out default provisions - what events would trigger an event of default, what the financier's obligations are leading up to the declaration of an event, and what powers the financier can exercise if an event is declared.”

The most obvious trigger for a default is if the borrower or lessee stops paying, says O’Sullivan. “But a default could also arise if the aircraft isn’t maintained properly,” she says, “or if it’s flown into a jurisdiction it isn’t allowed to fly into.”

Be Clear About Your Obligations

It is important also to be clear about your obligations at maturity, says Crichlow. “Particularly for operating leases,” he says. “Poorly drafted or ambiguous return conditions can strongly tip the balance of favor from one party to another.”

Tax is another issue. Usually, indemnities written into contracts mean that any tax liabilities become the owner’s responsibility.

Brexit has retreated from the front of people’s minds, but where there’s potential that it could impact your aircraft, checking the small print with a Brexit focus is a good idea until all the issues are resolved. Even apart from the UK’s relationship with the EU, keeping an eye on cross-border and jurisdictional issues would be wise.

And it’s worth bearing in mind that some jurisdictions do not recognize mortgages over aircraft, and several require substantial stamp duty payments for mortgages. Enforcement is also key – under some local laws a court-ordered auction is the way mortgages are enforced.

The COVID Effect

There are a few specific issues that have surfaced in the wake of the shock of the coronavirus global pandemic. Just a few weeks ago many experts were confident about the trajectory of aircraft values.

“Aircraft are considered to maintain their future value relatively well compared to other assets, and they have a predictable likely market value during the term of any financing,” were the words of one finance specialist, adding, “Many aircraft models are easily re-marketable.”

Now, however, aircraft values could be in free-fall. While it’s hard to be clear on prices and values because relatively few deals are going through, assumed slides in value have tripped loan-to-value ratios. 

Thus borrowers are finding that they could be in for an uncomfortable margin call by their lender.

Fortunately, most lenders have not yet done so. Another effect of the COVID-19 crisis has been an awful lot of borrowers finding that their contracts with lenders did not include a force majeure clause, or any other way of dealing with an extraordinary event. In the future contracts might have a clause to deal with the unexpected, but it would be wise to check – and to make sure any such wording is not weighted in the wrong direction.

The All Important Small Print Aid

The crucial thing is to get good advice from an expert in the field – preferably the specific field. “When it comes down to it, financiers operate in both the legal and the pragmatic spheres, and they tend to prefer to operate in the latter if they can,” Crichlow points out. In other words, the more you can anticipate their concerns, the more you will understand their small print.

Some lenders, especially in the US (and particularly non-bank lenders) can be very aggressive, says Jebely, “and occasionally obnoxious” in asserting that their terms are not negotiable.

Nevertheless, he says, it is always worth focusing on “default triggers, related remedies and grace periods, affirmative and negative covenants as well as aircraft preservation requirements and restrictions.

“This is, of course, is in addition to the key commercial and economic terms, including loan-to-aircraft-value ratios and default interest.” 

As O’Sullivan says: “We try to help individuals or corporates delegate responsibilities that they cannot possibly know about.”

And as for the fate of those first-borns? Fortunately the provision of the Wi-Fi hotspot, with its rather onerous but legally cast-iron “Herod clause” in the small print, was a test carried out by a Finnish security company to see how alert Londoners would be. A significant proportion were not.

The Finns, however, were forgiving. “We have yet to enforce our rights under the terms and conditions,” the company said. “As this is an experiment, we will be returning the children to their parents.”

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