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The Matter of the Secured Interests of the Operator-Lessees

For a very long time in the international legal aviation practice there is consensus that the rights of the lessors (owners) and financiers of aircraft and engines must be properly secured. However, also the proprietary interests of the commercial and private operator-lessees of aircraft need adequate protection in the event that the lessor is in default or becomes insolvent.[1] Therefore, for instance under the national aviation finance law of all the territorial units of the Kingdom of the Netherlands (Kingdom) and the property law of the United States under a (true[2]) lease agreement the lessor of the aircraft may grant the operator-lessee a secured interest (security interest in the United States) to ‘acquire’ or ‘possess’ the aircraft. Under the special aviation finance law of the Kingdom such a secured interest (zakelijk recht) can be created, provided that the aircraft is recorded in the national Aircraft Title Registry. The latter party is the ‘holder’ (houder) of the aircraft. The secured right to possess the aircraft finds its origin in an ‘operational lease agreement’ which must include a term of at least 6 months (art. 8:1309 Civil Code). The secured right of the operator-lessee to acquire and possess (to purchase) the aircraft can be included in a ‘financial lease agreement’ (art. 8:1308 Civil Code).[3] In practice, this interest is called an ‘option to purchase’ the aircraft.[4] In the European Netherlands, the large commercial airlines will generally insist on obtaining these interests. In the Kingdom,[5] the secured interests of the operator-lessee originate in the Convention on the International Recognition of Rights in Aircraft which requires their recognition in the other member States.[6] In turn, the Geneva Convention-covered rights are based on the property laws which existed in the United States before article 9 Uniform Commercial Code (UCC) was established. These former property laws existed in New York and Pennsylvania and they protected the conditional buyer and lessee respectively. Currently, they fall under the application of Article 9 UCC[7] which is implemented in all the Constituent States of the United States. Similar laws exist in other jurisdictions.[8] In the Kingdom, United States and other countries the security interest of the operator-lessee is a full right in rem, as opposed to a right in personam. Accordingly, this real right has third-party effect (erga omnes) as long as it is recorded in an aircraft title registry in the Kingdom or perfected in the United States. It is emphasised that this type of interest is legally not characterised as a lessee’s right of quiet possession. This is a personal right of the lessee which is frequently included in financial documents. Therefore, it only has effect against the contracting party (lessor). However, globally the problem arises that the local property laws of many jurisdictions are hostile to the secured rights of the operator- lessees. For example, the security interest of an airline that is validly established in

New York, cannot be enforced in a number of foreign countries. Only an international aviation finance and lease law related treaty can dictate the opposite.

While the regime of the Cape Town Convention is not explicit, extensive legal research has established that the secured interests of the operator-lessees can fall under the sphere of application of this treaty. However, provided that these interests are covered by the definition of an international interest. Article 2(2) of the Convention provides the following broad definition: ‘.. .an international interest in mobile equipment (aircraft) is an (national) interest.: (a) granted by the chargor under a security agreement; (b) vested in a person who is the conditional seller under a title reservation agreement; (c) vested in a person who is the lessor under a leasing agreement’. The above-addressed Kingdom, United States or other secured interests of the operator-lessees do not belong to categories (b) and (c). This is because they are not interests which are offered to the conditional seller or lessor. Nonetheless, they do fall within category (a). A specific Kingdom, United States or other secured interest of the operator-lessee must be characterized by the applicable national special aviation finance law or general substantive property law. The secured interests of the operator-lessees to acquire or possess an aircraft can be enforced as follows. The regime of the Cape Town Convention provides for extensive remedies which can be upheld against third-parties, provided that they have been recorded in the International Registry. The operator-lessee’s registered international interest has priority over any other interest subsequently registered and over an unregistered interest in the event that the lessor defaults. Furthermore, it is enforceable against a new and undesirable lessor in the event that the title to the leased aircraft is transferred. It can also be upheld against (non-secured) third-party creditors in the bankruptcy procedure of the lessor. Provided that it was registered in the International Registry before the beginning of the insolvency proceeding. It is emphasized that also under the Cape Town Convention the interest is not classified as a ‘right of quiet possession’ of the operator-lessee. This is just a personal right which cannot be registered as a separate international interest.[9] The operator-lessee has to rely on the lessor to register the latter’s international interest in the International Registry. Accordingly, the personal right to quiet enjoyment is not offering the operator-lessee the equivalent protection as is provided to the holder of an international interest. Consequently, it is important for a Kingdom, United States airline or other operator which has been granted a secured interest by the lessor under the applicable national law, to obtain a registered international interest under the Cape Town Convention. Otherwise its substantial financial interests will not be adequately protected internationally.

Obviously, whether in practice a lessor will indeed provide a secured interest to an operator-lessee depends, inter alia, upon the economic and financial leverage of the parties to a certain lease and financial transaction. In addition, cultural differ?ences that exist between one state and another play a significant role. For example, when an established airline is located in the European Netherlands, generally the United States and other lessors are willing to offer the operator-lessee a secured interest. On the other hand, this may not yet be so in a scenario which concerns a lessor and airline which are both situated in the United States. In such a case the lessor is often reluctant to provide a security interest to the operator-lessee. A reason for this concern could be that most United States trained aviation finance and lease lawyers have never heard of the possibility to create security interests of operator- lessees under article 9 UCC. Let alone that they have any idea that such a right can form the basis of a registrable international interest under the Cape Town Convention (article 2(2)(a) Convention). Due to their ignorance they do not feel at ease with advising their clients about these interests. This is true, despite the fact that historically the national secured rights of the lessees find their origin in United States (New York and Pennsylvania) substantive property laws. Furthermore, anecdotal evidence shows that some lawyers in the United States fear that offering the security interests to the operator-lessees will jeopardise the registered international interests of their clients which are financiers and lessors. However, in practice there is no threat. To create the desired priority ranking among the competing proprietary interests, the international interest of the financier will be registered at the International Registry first in time, the interest of the lessor afterwards and the one of the operator-lessee last. This procedure achieves that the international interests of the financier and lessor are properly protected. It is noted that under the Cape Town Convention by an agreement between the holders of these interests the priority may be varied.

It is concluded that the availability of national secured rights for the operator- lessees, which can form the basis of international interests under the Cape Town Convention, are critically important to any airline or other operator. Wherever the operator-lessee is situated, it may influence its decision to enter into an aircraft lease agreement. This policy has certainly been adopted by the leading local airlines in the European Netherlands. This is because these days also the lessor may default or become bankrupt and the lessee seeks to mitigate its damages. The Convention and Protocol supplement, or offer new remedies to, the rights that are locally available to the operator-lessees. However, first it is required that a Contracting State has already implemented the concept of secured rights of the operator-lessees in its national legal system. Otherwise, the airlines cannot obtain registrable international interests under the treaty. Therefore, in order to have the operator-lessees appreciate the needed predictability and consistency provided by the Cape Town Convention, the states are well-advised to create the local special substantive property laws. This is also true in a non-Cape Town Convention scenario as in every country the airlines require adequate protection.

  • [1] B.P. Honnebier, The Cape Town Convention and the Aircraft Equipment Protocol: Protecting theregistered secured interests of airline lessees, Air and Space Law (ASL), 2005-1, p. 27; The newinternational regimen proposed by UNIDROIT as a means of safeguarding rights in rem of theholder of an aircraft under Netherlands law, Uniform Law Review (ULR), 2001-1, p. 5.
  • [2] See article 2A Uniform Commercial Code (UCC) of the United States for the definition of a ‘truelease agreement’.
  • [3] It is noted that the legal systems of all the territorial units of the Kingdom of the Netherlands donot provide for special operational or financial lease law (lex specialis). B.P. Honnebier, De (international) leasing transactie als financieringsmethode van roerende kapitaalgoederen, in: Dossier,2007, p. 59; Een internationale uniforme materiele regeling voor het eigendomsvoorbehoud is totstand gekomen. De conventie van Kaapstad, in: Nederlands Tijdschrift Burgerlijk Recht (NTBR),2002-6, 233; De internationale financieringspraktijk heeft wederom behoefte aan de uitbreidingvan het bestaande pakket van Nederlandse zakelijke rechten, Weekblad voor Privaatrecht,Notariaat Registratie (WPNR), 2000, 914.
  • [4] B.P. Honnebier, The Cape Town Convention and the Aircraft Equipment Protocol: Protecting theregistered secured interests of airline lessees, in: ASL, 2005-1, 27; The Dutch real rights of airlinescan be the basis of international interests under the Convention of Cape Town, just like theirequivalent American security interest, ERPL, 2004-1,46;The new international regimen proposedby UNIDROIT as a means of safeguarding rights in rem of the holder of an aircraft underNetherlands law, in: ULR, 2001-1, 5.
  • [5] See articles 8:1308 and 8:1309 Civil Code of all the territorial units of the Kingdom of theNetherlands and article 9 Uniform Commercial Code (UCC) of the United States. SeeB.P. Honnebier, ERPL, 2004-1, p. 46.
  • [6] ‘ ‘The Contracting States undertake to recognise ...: (b) rights to acquire aircraft by purchasecoupled with possession of the aircraft; (c) rights of possession of aircraft under leases of sixmonths or more”. (article I (1)(b-c) Geneva Convention).
  • [7] For the situation in the United States see G. Gilmore, Security Interests in Personal Property (2volumes), 1965; G. Gilmore, Security law, formalism and Art. 9, 47 Nebraska Law Review, 1987,p. 21; Repossession of Collateral and Foreclosure of Security Interests in Leveraged Lease AircraftFinance Transactions, ASL-10, 1995, p. 9; O. Shrank, Commercial Concerns in Prepaid RentDeals, Leader’s Equipment Leasing Newsletter, June 1996, p. 6; J. Honnold, The Law of Sales andSales Financing, 4th edition 1976, p. 30; R.E. Speidel, Advance Payments in Contracts for Sale ofManufactured Goods: a Look at the Uniform Commercial Code, 52 California Law Review, 1964,p. 281; F.R. Kennedy, The Trustee in Bankruptcy under the Uniform Commercial Code: SomeProblems Suggested by Art. 2 and 9, 37 Rutgers Law Review, 1960, p. 518; W.E. Hogan, TheMarriage of Sales to Chattel Security in the UCC, Massachusetts Variety, Boston University LawReview, 1958, p. 571.
  • [8] For example, most of the Canadian Provinces and Territories, Australia, New Zealand, Serbiaand Surinam have similar laws. See for Canada’s applicable law M. Deschamps, Les regles depropriete de la Convention du Cap, ULR, 2002-1, pp. 22-24.
  • [9] R.M. Goode, The Official Commentary, 2013. See articles 29(1)(4)(5), 30 Convention andXVI(1) Protocol.
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