The Cape Town Convention And Its Effects on Aircraft Financing and Leasing

01 July 2006

BENEFITS OF THE CAPE TOWN CONVENTION 

The convention is designed to facilitate and standardise the sale, financing and leasing of transport category (certified to transport at least eight passengers) aircraft and aircraft engines of more than 1,750 pounds of thrust. The convention is designed to provide financial assurance to lessors that the assets that they have leased or financed will not be jeopardised by security interests filed in jurisdictions which are not party to the Cape Town Convention. Lessees may enjoy lower financing costs because adoption of the convention reduces the security risk for lenders who do not have to worry that the assets they have leased or financed are subject to competing security interests. 

The convention offers benefits for both lessors and lessees. Lessors will benefit by avoiding local conflicts over priority in security interests and ownership interests in aircraft, whereas lessees will benefit from lower financing costs. Several banks have indicated that purchasers of aircraft will be eligible for a discount on asset backed aircraft financing in countries that sign, ratify and implement the Cape Town Convention and its protocol. For example, the United States Export Import Bank announced that it had reduced the risk premium it charges on financing for large commercial aircraft and engines from 3 per cent to 2 per cent for airlines based in countries that have ratified the convention. It has been estimated that, in certain cases, aircraft operators could save as much as a million dollars per aircraft on lease finance costs if the Cape Town Convention is applicable to the transaction. 

Commentators have hailed the convention as an instrument that has resulted from the ability of all aviation interests to put aside their private concerns to bring about a convention, which is expected to benefit everyone in aviation, from manufacturers to financiers to aircraft lessees. 

APPLICATION OF THE CAPE TOWN CONVENTION 

The convention applies to the sale, financing and leasing of an aircraft to an operator if either the aircraft is registered in a contracting state or the purchaser or lessee of the aircraft is located in a contracting state. In the case of engines, the convention applies to the transaction only if the purchaser or the lessee of the engine is located in a contracting state. 

If the home country of the lessee airline is not party to the convention, it may still apply to certain financial structures, and lenders almost certainly will try to create a structure in which the convention will apply. 

If the convention is applicable, the transaction needs to be registered with the Cape Town International Registry (CTIR) located in Dublin, Ireland. Registration can be effected only by authorised individuals. In the United States, an individual may obtain authorisation by completing and filing the appropriate form with the FAA Aircraft Registry. See 14 CFR section 49.63, which allows the International Registry to be searched electronically (article 22, Cape Town Convention) by the requester. The present US aircraft registration system requires parties having recordable security interests to protect these interests by filing with the FAA in Oklahoma City, Oklahoma. This is in contrast to the CTIR, where registrations will be done only in electronic format. 

MAJOR FEATURES OF THE CAPE TOWN CONVENTION 

Manufacturers, banks, financiers and airlines should be aware of the following principal provisions of the Cape Town Convention: 

• in addition to customary aircraft liens, aircraft leases and engine leases are treated as security interests and are referred to as ‘international interests’; 

• an operator’s interest in an aircraft leased to another (an international interest) can be protected by registration in the International Registry in Ireland, which will protect that interest from third-party claims; 

• aircraft engines of at least 1750 pounds of thrust are covered and interests in engines can be registered in the registry; 

• in engine interchanges, the convention will ultimately mandate a ‘title tracking’ system; 

• leases and security interests (eg, mortgages on personal property) can be registered with priorities based upon time of filing in the International Registry; and 

• the international interest in an aircraft, if registered, will under most circumstances have priority over a bankruptcy trustee’s and other creditor’s interests. 

If certain declarations are made at the time of ratification, lenders will also receive a number of specific protections (such as the right of repossession and deregistration), should the debtor default and go into bankruptcy. The convention also offers ‘quiet enjoyment’ protection to a lessee airline against a lender’s repossession if the lessee airline has registered its international interest. This is an important protection for the operator-lessee of an aircraft in the event the lessor goes into bankruptcy. 

THE CAPE TOWN CONVENTION'S EFFECT ON EXISTING TRANSACTIONS  

The Cape Town Convention has no effect on existing security interests and financial transactions. Nothing more needs to be done at the present time. Whatever interests in the United States are protected at the present time under the FAA filing system will continue to be protected. For transactions effected after the convention’s enforcement, however, two registrations are required; one with the FAA and one with the CTIR. 

For the convention to govern, a new ‘international interest’ must be created after 1 March 2006 by the ‘refinancing’ or an amendment to the transaction documents. Transactions closed prior to 1 March 2006 are not affected by the convention. Whatever protections obtained in prior transactions are secure. 

Since 2001, aircraft financiers have anticipated the likelihood that the convention would enter into force imminently, and in many transactions after 2001, lenders have inserted in documents the right to ask debtors for ‘further assurances’ in anticipation of seeking to rely on the convention. If the convention can be made to apply to an existing transaction (by creating a new international interest in the refinancing documents in the jurisdiction where the debtor (ie, airline operator) is located, or where the aircraft is registered, in a contracting state), the lender will probably want to refinance or amend the documents. For its own part, an airline or leasing company, many want to redo any leases and register them in the International Registry to obtain the protection of the convention. 

An important benefit obtained through registering an international interest is the priority conferred on the interest holder. Thus, the first party to have registered a recordable interest with the CTIR has priority over any other interest subsequently registered and over any unregistered interest, even if the holder of the registered interest has knowledge of such prior unregistered interest (article 29 (1, 2a) Cape Town Convention). 

CONCLUSION 

Although only a few countries have ratified the Cape Town Convention to date, during the next few years the convention is likely to be ratified by many more nations. Accordingly, aircraft and engine manufacturers, as well as financing institutions, regardless of where they are located, need to be aware of the convention and its looming importance. US domestic financed sales or leases of aircraft or engines are now governed by the convention, and filings with the International Registry through the FAA portal will be necessary to protect any lender- or any manufacturer- financed interest in a transport category aircraft or large engine. Rod Margo and Michael Holland are Partners of Condon & Forsyth LLP, based in the firm’s Los Angeles and New York offices, respectively. Condon & Forsyth is the largest law firm in the United States devoted primarily to the field of aviation law. 

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