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Acceptance Is The First (and Last) Step: New Case Impacts Aircraft Leasing Industry

Written by Paul Jebely and Mark Bisset. Reproduced with kind permission of Bloomberg

A recent decision by the English Commercial Court in ACG Acquisition XX LLC v. Olympic Airlines S.A. has been followed closely by aircraft lessors and airlines. The lessons are that aircraft lessors are entitled (and best advised) to ensure that all necessary legal and commercial protections are in place before entering into a lease and parting possession with their aircraft and that airline lessees, prior to accepting the aircraft, are entitled (and best advised) to avail themselves of their contractual rights to have their technical experts inspect the aircraft prior to and during the delivery process to ensure that the aircraft is airworthy and otherwise meets all delivery conditions.

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Commercial aircraft operating leasing is a multibillion-dollar industry, and the current percentage of the global commercial aircraft fleet under operating lease is approximately 40 percent - nearly double that of 1996. The average annual leased fleet growth is more than double that of the entire annual global aircraft fleet growth. Continued growth and penetration of the global aircraft leasing industry is expected, and aircraft lessors will continue to occupy a critical intermediary position between aircraft manufacturers and airlines going-forward.

It is in this commercial context that the English Commercial Court recently delivered its judgment in ACG Acquisition XX LLC v. Olympic Airlines S.A. (in special liquidation) SA [2012] EWHC 1070, a case that has been followed closely by aircraft lessors and airlines around the world. In precluding an airline that had accepted an aircraft from claiming against an aircraft lessor for breach of contract for faults later found in the aircraft, and in reaffirming an airline’s absolute and unconditional obligation to pay rent, the Court’s decision has attracted widespread attention and may lead to the adoption of new best practices across the aircraft leasing industry.

Background

 Airlines have increasingly turned to operating lease products for their aircraft fleet requirements as, among things, they typically allow for off-balance sheet treatment, low capital outlay, fleet planning flexibility and minimum investment in the aircraft—and, therefore, minimum exposure to the risk of depreciation in the aircraft’s residual value risk. At its most basic level, an aircraft operating lease features the lessor owner of an aircraft, who retains ownership of the aircraft, delivering the aircraft to the airline lessee in an agreed condition and configuration and, in exchange for periodic rent and other payments, granting the airline lessee the use of the aircraft until the end of the lease.

The case in question relates to a Boeing 737-300 aircraft that was delivered to Olympic Airlines (Olympic) in August 2008 under a five-year operating lease by an established U.S. aircraft lessor, Aviation Capital Group (ACG). Olympic signed a Certificate of Acceptance upon delivery of the aircraft. The aircraft was put into commercial service and completed 112 flights until a defect was discovered on a spoiler cable on the left wing of the aircraft in September 2008, at which time the aircraft was taken out of service for maintenance.

During the ensuing inspections of the aircraft, further defects were discovered to the aircraft’s spoiler cables and other areas. These were reported to the Hellenic Civil Aviation Authority (HCAA), which is responsible for flight safety in Greece. As a result of the defects, the HCAA suspended the aircraft’s airworthiness certificate, grounding the aircraft. In July 2009, the HCAA refused to restore the aircraft’s airworthiness certificate, despite maintenance work having been carried out at a cost of 1.5 million euros ($1.9 million). Olympic decided that the aircraft was ‘‘beyond economic repair’’ and put it into storage.

In September 2009, ACG commenced legal proceedings against Olympic for unpaid rent and maintenance reserves. Olympic subsequently entered into creditors’ special liquidation in October 2009. The aircraft was finally returned to ACG in November 2010. In September 2011, just over three years after the inception of the lease between ACG and Olympic, in which time the aircraft had been in commercial service for just two weeks, it was leased to a new lessee by ACG.

Legal Proceedings

In its September 2009 claim, ACG claimed for non-payment of rent and maintenance reserves from the inception of the lease until redelivery in November 2010, plus damages for loss of rent from November 2010 until the end of the originally intended five-year term of the lease, less monies received from the aircraft’s new lessee.
Olympic counterclaimed for damages resulting from breach of contract, claiming ACG failed to deliver the aircraft in the contractual condition stipulated in the lease. Olympic claimed the cost of leasing an alternative aircraft and the cost of returning the originally leased aircraft to an airworthy condition.

ACG submitted in reply that, even if the aircraft had not been delivered in the contractual condition stipulated in the lease, Olympic was estopped, either by the terms of the Certificate of Acceptance they had signed or by law, from asserting that the aircraft was not delivered in accordance with the lease.

Olympic submitted in response that the signing of the Certificate of Acceptance did not preclude Olympic from claiming damages because the aircraft had not been delivered in the required condition and had not been airworthy. Olympic submitted that it was therefore not required to pay rent or maintenance reserves to ACG and was entitled to damages for breach of lease.

Judgment

Mr. Justice Teare’s judgment contained a close analysis of the language of the lease, starting with the lessor’s obligation to deliver an airworthy aircraft in a condition for safe operation. The aircraft was found to have not been in an airworthy condition on delivery by ACG to Olympic, in breach of the terms of the lease. ACG contended that, notwithstanding this, Olympic should be precluded from any claim relating to breach of the delivery conditions in the lease by its signing of the Certificate of Acceptance. This was referred to as a ‘‘contractual estoppel’’ argument.

The Certificate of Acceptance contained confirmation by Olympic that ‘‘Lessee irrevocably and unconditionally accepts and leases from the Lessor. . .the Aircraft’’ and that the ‘‘Lease[d] Property complied in all respects with the condition required at delivery. . . .’’

In addition, clause 7.9 of the lease provided that:

‘‘Conclusive Proof
Delivery by the Lessee to Lessor of the Certificate of Acceptance will be conclusive proof as between Lessor and Lessee that Lessee has examined and investigated the aircraft, that the Aircraft and the Aircraft Documents are satisfactory to the Lessee and that Lessee has irrevocably and unconditionally accepted the Aircraft for lease hereunder without any reservation whatsoever (except for any discrepancies which may be noted in the certificate of acceptance).’’

The judge held that the effect of clause 7.9 of the lease was that those matters of which the delivery of the Certificate of Acceptance was said to be conclusive proof could not be questioned as between lessor and lessee. ACG submitted that one of these matters was the statement made by Olympic in the Certificate of Acceptance that the aircraft ‘‘complied in all respects with the condition required at delivery. . ..’’

The judge stated, however, that any reasonable observer would regard ACG’s obligation to deliver the aircraft in the condition required by the lease as an important provision of benefit to Olympic, and so, had the parties intended that clause 7.9 would prevent Olympic from making a claim for damages for breach by ACG of that obligation, the reasonable man would expect to find a clear reference in clause 7.9 to clause 4.2 and Schedule 2. Therefore, Olympic was not contractually estopped from claiming damages for breach of lease by its signing of the Certificate of Acceptance.

The judge then went on to consider whether Olympic was estopped from claiming damages for breach of lease due to its representation in the Certificate of Acceptance that the aircraft complied in all respects with the condition required at delivery under Section 4.2 and Schedule 2 of the lease. The judge considered that although the representation in the Certificate of Acceptance was not - in conjunction with clause 7.9 of the lease - conclusive proof of the truth of that situation, it was nevertheless still a representation that could give rise to an estoppel under English law. On the facts, the judge concluded that ACG had relied on the representation by Olympic through the signing of the Certificate of Acceptance that the leased property complied in all respects with the condition required at delivery. On the basis of the representation, an affiliated ACG entity accepted redelivery from Air Asia, thereby losing its right not to accept redelivery. Olympic were therefore estopped from claiming damages due to breach by ACG of the lease.

The court further dismissed a claim by Olympic that it had no obligation to pay rent and maintenance reserves under the lease based on its claim that delivery had not occurred in accordance with the lease in the first instance. The court held that, as per the lease terms, ACG could claim unpaid rent and maintenance reserves and damages for loss of rent and maintenance reserves.

It is also worth noting that, as part of its arguments, Olympic submitted that any rent and maintenance reserves it paid would immediately be recoverable because of the total failure of consideration, in that the aircraft was delivered in fundamentally non-airworthy condition. A previous interim judgment in this dispute (ACG Acquisition XX LLC v. Olympic Airlines S.A. [2010] EWHC 923 (Comm), which attracted much consternation and criticism in the aircraft leasing community, had decided that Olympic had an arguable case for total failure of consideration. The judge in the present case stated that as Olympic was estopped from stating that the aircraft was delivered in a non-airworthy condition, any claim for total failure of consideration would itself fail.

Appeal

The judgment is currently subject to an application by Olympic for permission to appeal to the U.K. Court of Appeal.

Conclusion

This latest English court decision, while ultimately in favor of the aircraft lessor in question, mandates careful attention to legal agreements that document commercial intentions and the evolution of best practices. Much like the greater airline industry, the dynamics of the aircraft leasing industry are constantly changing, and it is an industry with market participants adept at evolving.

Aircraft lessors are entitled (and best advised) to ensure that all necessary legal and commercial protections are in place before entering into a lease and parting possession with their aircraft. Prior to accepting the aircraft, airlines are entitled (and best advised) to avail themselves of their contractual rights to have their technical experts inspect the aircraft prior to and during the delivery process to ensure that the aircraft is airworthy and otherwise meets all delivery conditions.

Aircraft lessors expect a Certificate of Acceptance and a ‘‘conclusive proof’’ clause to insulate themselves effectively from potential claims in relation to airworthiness in the event that a leased aircraft does not satisfy the delivery conditions. This case shows that an English court will rightfully support the lessor’s expectation in this regard, provided that there is sufficient clarity in the relevant drafting. Ultimately, in the words of the judge in this case: ‘‘Having that clear and certain interpretation of leases facilitates the efficient and cost-effective finance of aircraft, which benefits all operating airlines as well as lessors.’’