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Vedder Thinking | Articles Another Hurdle Cleared on the Path to Ratification – The UK and the Cape Town Convention and Aircraft Protocol

Newsletter/Bulletin

"The Government has carefully considered the views of the respondents to the call for evidence and has decided to proceed with ratification of the treaty" – para. 1.4 - Convention on International Interests in Mobile Equipment (the Convention) and the Protocol thereto on Matters Specific to Aircraft Equipment (the Protocol), Government Response to the Call for Evidence (the Government Response).

As part of the UK Government's ongoing consultation on the ratification of the Convention and the Protocol, the Government Response was published on 6 December 2013 – it followed a call for evidence issued on 30 July 2010 and a summary of responses published in February 2011. The Government Response is cautiously optimistic about any benefits that may accompany ratification, noting that it:

  • may reduce financing costs for airlines in relation to their purchase and leasing needs, particularly through the capital markets;
  • would bring a benefit in terms of the ability to register interests against engines (currently interests may only be registered against airframes in the UK – common with many other jurisdictions);
  • could remove pressure from the closing of aircraft finance transactions because the International Registry is available online throughout the year (currently the registration section of the Civil Aviation Authority in the UK is only available between 10 a.m. and 4 p.m. London time);
  • could reduce problems arising out of conflict of laws on cross-border finance and leasing transactions; and
  • may resolve some of the concerns that arise on the application of the rules on lex situs in relation to English law aircraft mortgages and title transfers.

Points of Interest

The ASU Discount

The Government Response also suggests that, following ratification, UK airlines may be eligible for the OECD Aircraft Sector Understanding (the ASU) discount, which may be granted by an Export Credit Agency (an ECA) in relation to its support for the financing of aircraft. The discount for UK airlines is normally restricted due to the so-called "Home Country Rule" – an unwritten rule, which has traditionally prevented airlines in "producer nations" (i.e., the UK, France, Germany, Spain and the United States) from receiving export credit support from the ECAs for aircraft manufactured in those countries – predominantly Airbus and Boeing aircraft.

British Airways (BA) was, however, able to obtain Euler Hermes (the German ECA) support for its JOLCO transaction for an Airbus A380 in September 2013. It should also be noted that the Home Country Rule does not apply for, amongst others, Embraer or Bombardier aircraft.

Capital Markets Ratings

One advantage of ratifying the Convention and the Protocol by adopting the qualifying declarations set out in the ASU – the so-called "gold standard" – is the positive weighting attached to this standard by the ratings agencies when considering the ratings for capital markets transactions. If the UK adopts these "gold standard" qualifying declarations, even if no export credit-supported aircraft financing transaction is ever entered into by a UK airline, full implementation of the qualifying declarations may well result in the ratings agencies providing more favourable ratings for capital markets transactions than are available now.

One of the principal qualifying declarations is the adoption of "Alternative A", the insolvency regime set out in Article XI (Remedies on insolvency) that provides, arguably, the best legal protection for creditors in aircraft financing transactions. The Government has not yet determined whether to implement Alternative A, and the Government Response indicates this will be consulted upon. The UK's ability to adopt Alternative A is restricted by the declarations made by the EU (see "Next Steps", following), which require that implementation may only be made through amendment to national insolvency laws. In capital markets transactions utilising an Enhanced Equipment Trust Certificates vehicle (EETC) involving airlines located in countries that have ratified the Convention and the Protocol other than the United States1 (e.g. Canada and the UAE), the adoption of Alternative A has been a focus of the ratings agencies.

Repossession in the UK

In the UK, BA's "British Airways 2013-1" EETC launched in June 2013 (covering 6 Airbus A320s, 2 Boeing B777-300ERs and 6 Boeing B787-8s) without the benefit of the Convention and the Protocol's Alternative A.

When giving a rating for the EETC, Fitch noted "…[its] legal analysis for this transaction relied on the general insolvency regime in the UK, which [it] considers to be strong for creditors in general, but notes that there are no special carve-outs for aviation assets similar to 1110 or the CTC. However, the creditor-friendly nature and reliability of the UK legal regime, precedent under UK law, and several structural elements of the transaction provide significant credit protection, making possible the application of [its] EETC criteria to this transaction.2"

On the one hand, it might be argued that the repossession regime in the UK is sufficiently robust so as not to need Alternative A to be adopted. However, previously favourable statements by ratings agencies are no guarantee that the UK's repossession regime will continue to be regarded this way. Adoption of Alternative A should ensure that the UK's airlines are at least on a par, in this respect, with the airlines of other countries that have adopted Alternative A.

Lex Situs

Ratification of the Convention and the Protocol has, as some contributors to the Call for Evidence highlighted to the Government, raised the possibility of ridding English law of fundamental issues with respect to the creation of valid mortgage interests in aircraft and valid title transfer (if the aircraft is located outside the UK at the relevant time). The rule under English law is that the creation of a mortgage interest or title transfer under an agreement governed by English law must be valid in the jurisdiction in which the aircraft is located at the relevant time – the application of the rules on lex situs as confirmed in Blue Sky.3 Some commentators have (perhaps hopefully) suggested that, because the Convention and the Protocol do not look to lex situs for the purposes of considering when an international interest has been created, lex situs would have no relevance for the creation of valid mortgage interests (or for valid title transfers) under English law following ratification of the Convention and the Protocol.

The UK Government correctly confirms, in the Government Response, that ratification of the Convention and the Protocol will not solve the Blue Sky issue. Ratification allows registration of interests against UK "debtors" (as defined in the Convention and the Protocol) and in relation to UK-registered aircraft, but this does not resolve general issues of lex situs – creditors must still look to English law (which applies lex situs rules) to determine whether an interest has been validly created or transferred.

Ratification of the Convention and the Protocol may represent an opportunity to make an additional amendment to English law to address the lex situs issues but the Government Response does not indicate that this is a matter the Government is considering.

Next Steps

The Government Response does not set out a timetable for the ratification of the Convention and the Protocol, but notes that there will now be a consultation on the declarations to be made in relation to the treaty.

The UK's choices in relation to the declarations are limited, in certain circumstances, by its membership in the European Union. The EU acceded to the Convention as a "regional economic integration organization" (pursuant to Article 48 of the Convention) and made certain declarations that bind the Member States and have the effect that:

  • no Member State may make a declaration in relation to Article XXI of the Protocol, which relates to the jurisdiction that has competency in relation to an aircraft object – Member States' rules governing jurisdiction are determined pursuant to Council Regulation (EC) No. 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgment in civil and commercial matters – nor will Member States be able to amend their national law so that the same substantive outcomes are produced as if a declaration had been made;
  • no Member State may make a declaration in relation to Article VIII of the Protocol, which relates to the "choice of law" provisions for agreements – Member States' rules governing choice of law are determined pursuant to the Rome I Regulation4 – nor will Member States be able to amend their national law so as to achieve the same result; and
  • no Member State may make a declaration in relation to Articles XI or XII of the Protocol, which relate to (a) in the case of Article XI, the insolvency remedies that will apply (i.e., selection of Alternative A or Alternative B) and (b) in the case of Article XII, the required co-operation by national courts in the jurisdiction where the aircraft is located with the applicable foreign courts and foreign insolvency administrators. Member States' rules governing insolvency are subject to Council Regulation (EC) No. 1346/2000 of 20 May 2000 on insolvency proceedings – Member States will, however, be able to amend their national law so as to produce the same substantive result.

Conclusion

Whilst no timetable for implementation was set out in the Government Response, the outlook for implementation in the UK appears to be good. The Government Response clearly and precisely sets out reasons why implementation makes sense for the UK, even if the benefits are not guaranteed, and dismisses the notion that implementation will solve the Blue Sky issue.

If you have questions about this update, please contact John Pearson at +44 (0) 20 3667 2915.

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1 While the United States did not adopt Alternative A in its ratification of the Convention, Section 1110 of the United States Bankruptcy Code is widely viewed as providing substantially equivalent protections to Alternative A, and was the model that Alternative A was based on.
2 Fitch Ratings, British Airways 2013-1.
3 Blue Sky & Others v. Mahan Air [2009] EWHC (Comm), [2010] EWHC 631 (Comm).
4 Regulation (EC) No. 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations.



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John Pearson

Solicitor