Much has and will continue to be written about the April decision in ACG Acquisition XX LLC vs. Olympic Airlines which will impact aircraft finance transactions for the foreseeable future. The judgment is one of first impression under English law concerning delivery conditions and their effect following an industry standard aircraft lease delivery.
The U.S. is generally recognized as the birthplace of aircraft leasing being the home to International Air Leases and ILFC. Because of this, together with the majority of early aircraft finance lawyers having been located in New York, New York law became the preferred choice to govern aircraft leases. Favorable tax law changes around the year 2000 strengthened Ireland’s position in aircraft leasing. With onward growth in Asia and elsewhere outside the U.S., English law became a favored alternative to New York. During the transition, New York law documents were often converted for English law transactions by simply amending the choice of law provision and having the documents confirmed by an English lawyer. But how would documents drafted using New York law and legal concepts actually play in London? After all, the boilerplate “AS-IS, WHERE-IS” disclaimer so familiar to transacting parties worldwide is lifted straight from the Uniform Commercial Code, a U.S. body of law. The ACG case illustrates a loss in translation.
The case involves the lease of a used 737 to the now defunct Olympic Airways. The aircraft was returned to ACG off lease from AirAsia for onward lease to Olympic. A contemporaneous return and delivery were conducted with Olympic inspecting the aircraft during the course of AirAsia’s return C-Check. ACG accepted return of the aircraft from AirAsia only after Olympic accepted the aircraft condition under its lease with ACG. All went according to plan until, less than 20 days after delivery to Olympic, a spoiler cable broke. Subsequent inspections revealed corroded control cables which, with other issues, prompted the Greek aviation authority to pull the aircraft’s airworthiness certificate. Subsequent work and follow-on inspections over a period of months revealed what Olympic contended were necessary repairs so extensive that, a year after delivery, they considered the aircraft beyond economic repair.1 Less than 2 months later, Olympic ceased operations. ACG sued Olympic for past due rent under the “hell or high water clause” and Olympic counterclaimed for breach of lease.
The facts in evidence show this as a plain vanilla transaction for the lease of a used aircraft. Delivery conditions to Olympic were harmonized with return conditions from AirAsia. Inspections, while limited, were permitted with Olympic having the right to reject the aircraft if it failed to meet condition. Technical representatives of both ACG and Olympic participated in the process. At delivery, Olympic confirmed its acceptance of the aircraft and condition, with some discrepancies to be remedied after delivery. So what went wrong?
Boiled down, the lease required that at delivery the aircraft be “airworthy” and “in a condition for safe operation”. Notwithstanding Olympic’s acceptance of the aircraft, they argued that given its grounding so shortly after delivery and the extent of technical issues discovered following post-delivery inspection that it could not have been “airworthy” or “in a condition for safe operation” when delivered. Olympic contended ACG was therefore in breach. Because ACG breached, Olympic argued, their obligations under the lease ended, including the obligation to pay rent. Having no knowledge of the defects, ACG argued that except for those items they agreed to address post-delivery, technical risk passed to Olympic at acceptance. Olympic was therefore obligated to pay rent with their sole remedy being a suit for damages.
After exhaustively reviewing the delivery process, technical reports and lease delivery conditions, the court concluded that the aircraft was neither airworthy nor in a condition for safe operation at delivery. The court found ACG in breach for its failure to deliver the aircraft in the agreed condition. Nevertheless, because Olympic executed an acceptance certificate whereby they “irrevocably and unconditionally accepted” the aircraft, and ACG relied on this acceptance in accepting return of the aircraft from AirAsia, Olympic was estopped (legally prevented) from alleging a failure to comply with delivery conditions and found for ACG.
While aircraft lessors breathed a collective sigh of relief, the court’s ruling is nevertheless troubling. The court applied a self-made test in finding the aircraft unairworthy and in the process rewrote aviation regulations. The court stated, “…the ordinary and natural meaning of airworthy is, in my judgment, fit or safe for the carriage of passengers by air…An aircraft with a defective part which renders the aircraft unfit or unsafe for flight is not rendered fit or safe for flight on account of the operator of the aircraft being unaware of the defect.” The court continued, “I do not consider that any prudent lessor or lessee…would regard an aircraft as airworthy if the aircraft carried a hidden defect which, if the lessor or lessee had known about it, would have to be corrected before the next flight.” According to this court, an aircraft is unairworthy if any out of limits defect exists, whether known or unknown. Troubling indeed.
The court acknowledged that it was unlikely ACG knew of these defects. AirAsia had certified the aircraft as airworthy and the return C-Check was performed in accordance with applicable requirements. Nevertheless, the court determined that ACG was in breach of the lease because the delivery conditions were not met — due to the existence of defects ACG neither knew nor had reason to know existed. In other words, ACG prevailed for no other reason than Olympic, by its own actions, was legally barred from alleging a breach.
The English court treats delivery conditions as a warranty of condition and confirmation by the lessor that the aircraft is, in fact, free from defects. This is a standard no lessor could meet, one that regulations do not require and one that the industry should universally reject. New York law and the New York courts interpreting them would treat these facts differently. In an industry-standard aircraft lease, delivery conditions are an agreement by the lessor to make the aircraft available for lease in an agreed condition. It is nevertheless up to the lessee to confirm that the aircraft meets those conditions. If it doesn’t, the lessee’s remedy is to reject it. If the lessee accepts the aircraft, the conditions expire and the lease begins with the lessee taking the risk of condition thereafter. Permitting otherwise would give the lessee a second bite at the apple.
Precise drafting remains a best practice. As noted in last issue’s article, avoid using the terms “airworthy” and “serviceable”. Specify that delivery conditions expire at delivery and that compliance be verified by the lessee to the exclusion of the lessor. Choice of law must be considered carefully in light of this decision. For now, New York and other U.S. state’s laws, with the U.C.C., provide greater certainty.
- Once ACG regained possession of the aircraft from Olympic, a further C-Check was performed, the aircraft was certified as airworthy by the U.S. FAA and the aircraft was leased to AeroSur of Bolivia in 2011. ↩