An Examination of the Laws Guiding Aircraft Financing and Leasing

Chapter 1

Introduction

The airline industry became known in the 1920s but its full development started after the Second World War 11. During the 1950s, aircrafts began to be used for leisure trips as well as for business trips. Due to this expansion of global and domestic air transport system, the aviation industry has made the global economics and cultures cross-fertilized and caused markets to proliferate in number and to grow in size and wealth. Recently, the aviation industry is an important part of growth to the world economy and must be careful in other for failure not to occur. For this growth to remain in the economy, a considerable amount of capital is needed to support the growth of airlines ‘Fleet size’. Aircraft finance could mean ‘Financing an Aircraft’. An aircraft is moveable and tangible as defined by article 7 of the Chicago convention of 7th December 1944. Therefore, an aircraft is alleged to be asset gotten through finance, it has its value and earns good returns. According to Ronald Scheinberg in his book, it mentioned that the aircraft finance industry presently is in surplus of US$ 100 billion per year for financing new aircrafts. There are different things that have to do with purchasing an aircraft for an airline industry. Before any purchase can made, firstly the price of the aircraft must be put into consideration which will then be negotiated between the manufacturer and the purchaser especially when there is a consideration on buying a large number of airplanes. Another aspect to consider is the financial institution or bank for funds and a life insurance company.

Airlines hardly buy aircrafts with their own funds. Instead, they obtain financial assistance in the form of a loan from banks or financial institutions with a secured debenture like personal property or the use of the aircraft as collateral which will be called an equitable trust. In this recent time, it is common with airlines to lease their airlines either by rental or by a long term lease with the right to acquire. The book “An Introduction to Airline Economics” “stated that the legal instruments under which aircrafts are financed or leased varies in the range of secured debt and lease financing device signifies an almost continuous spectrum in the line between one and the other”. However, aircraft financing is a complex method which involves not only the final users of the aircraft but also the manufacturers, banks, private investors, trustees and institutional lenders. Moreover, aircrafts are expensive and moveable; even if the capital for purchase is available, a factor to consider is risk and flexibility which may affect the acquisition transaction. Aircraft leasing is an important part of financing and accounting of airline companies as regards size of capital as well as the difficulty of the classification. Because of its capital nature, majority of these airlines depend on other means of resources for the purchase of an aircraft. Leasing is a vital means used by airlines to take possession of aircrafts when they are facing financial difficulties. However, lease categorization and other related accounting treatments are critical to the airlines and the industry. An aircraft is not about its ownership but the use of it because an organization may wish to purchase an aircraft for use but finds it unnecessary to purchase its legal title. Leasing is a way of acquiring economic use of an aircraft for a specific period of time without getting ownership interest for the asset.

During this period, the lessor (owner) grants the lessee (borrower) to use the property for the stated period of time as agreed and payments will be made to the lessor. An agreement between the lessor and the lessee allows the right to use an asset for an agreed period of time in return of payment which is known as a lease. This is sometimes referred to as hire or hire-purchase contracts or referred to as lease term. As a rule, a lease cannot be cancelled by either of the parties unless there are certain terms and conditions stated in the agreement contract that could prompt its cancellation (bankruptcy, death or non-payment). These lease agreements can state an earlier cancellation on a reasonable ground on a particular date with or without penalty for different predestined grounds. At the end of the lease agreement term, the lessee is meant to return the asset to the lessor, except the lessor provides an alternative means for the lessee to purchase the asset. A purchase alternative price is normally in formula base and may be optional for market value or small amount depending on the type of lease. Nevertheless, the problem question of this study is that, it will critically examine the financial aspect relating to leasing, how leasing should be considered during the acquisition process as against the purchase choice with special reference around the world. It will also look carefully on the types of leasing involved, operation or financing an aircraft, its limits, challenges in the airline industry, effects and implications of aircraft financing.

Scope of study

Aircraft financing has a wild range of study because it looks at all the aspects of financing which are mostly used around the world purchasing an aircraft. It will give us an insight of the financial institutions which provides the leasing facilities to acquire an aircraft. This dissertation will show methods of how different countries carry on with financing/leasing and the laws that also abides to financing and leasing.

Aim of the Study

The main aim of this research is to carry out a critical examination on the laws guiding aircraft financing and leasing in the aviation industry and offer unique contributions from a legal point of view. This research is to find out the best typical method to purchase an aircraft from the state of transaction through to the execution and documentation processes, conferring on the issues that arises and decision. It is suggested that a complete examination of the interrelationship between the law and practices of the typical provisions on aircraft operating leases has been rather an understudied area of aircraft finance law to date. For the outline, this dissertation will look at Introduction which is largely descriptive; the Aircraft Operating Lease and Finance which will be analytical and based on research, and will constitute by far the greater body of this study and then conclusion. Lastly, realities, challenges and ambitions will be added at the end of this dissertation suggesting out a form of aircraft operating lease for a second hand aircraft which is used by a leading commercial aircraft leasing company. This will differentiate in details from the second hand by other leasing companies but will explain the contents in the current state of the market. This addition will be precise in showing many of the points made and cross-references will be made where appropriate

Research Methodology

In other to get good resources and knowledge on this study, it will be important to study all the laws and materials which relates to this dissertation using Articles, Journals, and books. Using all these materials will support and make this research a bit easy. This research will be based on critical thinking, reasonable, realistic, practical and full functional examination study using a wholly qualitative method. 1.4Data Collection All sources that will be used to carry out this research are secondary materials. As earlier mentioned the research is wholly a qualitative method. On the proposal, the literature review has shown that the secondary data are available in books, articles, journals and internet base using Westlaw, LexisNexis, Air and Space law journal and internet as a whole.

Chapter 2

Aircraft Financing In the Industry

The airline industry is a vital industry that has contributed greatly into the entire economy of the world. The industry receives important attention from policy makers and analysts. Aircraft finance is a special unit in the aircraft industry and its purpose consist of leasing, owning and sales of aircraft. This unit relies on a limited revenue sources. The cash flow gotten from this revenue will be used for the payment of operation and other relevant expenses of aircraft finance. Also, to service the interest of outstanding notes, related liquidity reserves and to issue any outstanding amounts to the owners of the beneficial interest certificates. Aircraft finance is the ability to generate enough cash from its aircraft assets to repay the notes which depends on the rental rates it can get from the lease which the lessee agreed on the terms and the price it can realize on any aircraft sale. But for aircraft finance to service this notes, will depend on the stage of an aircraft finance expenses which includes its maintenance and any unforeseen liabilities. The ability of aircraft finance to produce incomes depends larger on how much effort put by the independent third party service providers as part of their duties and responsibilities. The controlling bodies or trustees have failed in their duties for the property and concerns of aircraft finance due to the terms and conditions of the trust agreement and the indenture.

Controlling trustees depend on GE capital aviation services limited (GECAS), Phoenix American Financial Services Inc (Phoenix), the administrative agent, financial advisor and security trustee, Wilmington trust company and Deutsche bank trust company Americas (owner trustee) formerly known as Bankers trust company. In the past, Lehman Brothers Inc acted as an advisor to 3 different aircraft finance and became liquidated in September 2008. Afterwards, Credit Suisse securities (Credit Suisse) was appointed as a replacement to Lehman. The development of aircraft financing has been tested through different stages to get to its position. The banking sector support the initial stage followed by the equipment trust certificate (ETC), also the Enhanced Equipment Trust Certificate (EETC), then finally, the Asset Backed Security (ABS). Enhanced Equipment Trust Certificate (EETC) is a corporate bond that share features like credit trenching and liquidity facilities. But Asset Back Security is a different entirely because they are not corporate bonds but backed by leases and attached to a number of airlines instead of been attached to a single airline and this is based on the cash flow from the aircraft leases, loans and collaterals worth of an aircraft.

The Legal Aspect of Aircraft Financing

Generally, one of the major problems one may encounter when considering acquiring an aircraft is financing the transaction. Firstly, an airline will contact the manufacturer of an aircraft before purchasing in other to know the financial amount involved because they can be very expensive and this may lead to sourcing for funds to acquire one. Therefore, this will lead to borrowing of money to pay for the purchases then leads to the next stage which is the application process and the types of methods and documents that will be necessary before the acquisition is accepted.

Application Process

To purchase an airline, getting a loan is required; therefore the same information needed in purchasing a real estate might be needed to acquire loan to pay for the aircraft. Before this application is made, there might be need to find out if one is credit worthy, if not the possibility of getting the loan becomes void. One important thing that must be done before starting an application process is to assess the credit score. Over the years, prospective creditors had access to a credit score number allocated to the people who applied for credit until the current change in law because one could not access its own credit score but now they can. Most lenders also get to know about current and potential credit earnings by putting a telephone call through to the employer to confirm the statement presented income tax return in order to get a good employment background history to make sure one is capable to generate income or have enough assets to back up a good loan. This leads to the types of loan documents one would need to felicitate one. Loan documents There are usually document that will be required when applying for a loan for the purchase of an aircraft. These documents are security agreement, promissory note and personal guarantees.

Promissory Notes

The most important document that must be signed is a promissory note and signing this note, means you must agree to pay the holder of the note the sum owed in addition with any interest as mentioned in the promissory note. One must bear in mind that the notes may be kept by a different holder who may be receiving the payment. The reason for this is because; in most cases the notes might be a negotiable instrument (that is it can be transferred from one holder to another). A promissory note shows the amount that you owe the holder and the interest rates as discussed between the borrower and the lender and this can vary from different buyer and seller agreements. Failure to pay this loan can lead to bad financial risk transaction.

Security Agreement

On security agreement, a promissory note is a lender’s legal sign and evidence that one will pay a loan. However, this promissory note is not enough evidence for the lender that monies will be paid back. In other words, a show of assets (properties) must be added to make the promissory note valid. In considering this risk, the lender will want to get security interest over the aircraft. That is, failure to pay the loan back, the lender can make a claim on the aircraft. However, if the lender is a bank or a financial institution or funds are saved with either of them, the bank or the financial institution can have access to this money. But if the aircraft is repossessed by the lender, one can reclaim the aircraft back before it is sold. For this to be possible, it will amount to full amount paid to clear the debts of the loan and a substantial amount put down to run the loan. However, the attempt of getting back an aircraft might fail because someone else has purchased the aircraft. When this is done, the difference between what was paid and the loan balance is called “Deficiency”. This balance is the money paid to the lender to finish paying the loan. It is necessary to note that any change in title to an aircraft may prompt the need to make full payment of the loan. And this type of loan is known as ‘Due on Sale’ clause. This basically means that one cannot transfer title to any other person or entity as long as the loan balances exist without approval from the lender.

Guarantees

If you make a decision to form a separate entity to have an aircraft, the lender may need the borrower and/or fellow members or shareholders or partners to attest and guarantee making the borrower personally responsible for the payment of the promissory note. The lender accepts this because in some cases, the entity formed may have no assets, credit history or earnings other than the aircraft. The guarantee will mention that if the aircraft owing entity defaults on the agreement signed, the lender will take the payments. Therefore, a personal guarantee is meant to be taken seriously or else the law will impose them, personal credit and assets will be at risk when one fails to comply with the agreement.

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