SNR Denton - Drafting Aircraft Leases and Managing Deliveries ...

May 24, 2012

There has been concern in the aircraft finance and leasing community about which way the decision in ACG v. Olympic [2012] EWHC 1070 would go. Now that we have the ruling from a full trial of the dispute, it may be helpful to emphasise:

• the lease in ACG was unusual, in that ACG promised Olympic the leased aircraft would be airworthy and fit for immediate commercial service at delivery;
• the judge?s ruling at the full trial does not cast doubt on the efficacy of the hell or high water payment provisions found in aircraft leases;
• instead it reinforces the means for making those provisions ? and the agreement that the lessee takes the aircraft as is, where is ? enforceable;
• the case contains a useful ruling on acceptance certificates and some useful drafting guidance on conclusive evidence clauses in aircraft leases;
• the guidance on conclusive evidence clauses is more likely to be useful in practice than the acceptance certificate ruling;
• the case is most relevant to an operating lessor of pre-leased aircraft ? particularly in those rare cases where the lessor (under pressure to lease a pre-leased aircraft to a hard bargaining next lessee) agrees to some positive term or representation as to the condition of the aircraft at delivery; and
• for a finance lessor, the case is less likely to be relevant in practice. However, it does hightlight two devices (the acceptance certificate and conclusive evidence clause) for reinforcing the as is, where is and hell or high water payment nature of the lease.

As well as reviewing the decision in ACG, this note looks at how lessors can document leases and manage deliveries so as to rely on the pro-lessor aspects of this decision. It also notes that a lessee that has won a rare concession from a hard pressed lessor as to the condition of the aircraft at delivery should check that the devices discussed below do not take back that concession.

Summary of Facts and Ruling

In ACG, the lessor undertook in an operating lease of a pre-leased aircraft that the aircraft would be airworthy and fit for immediate commercial service at delivery. Soon after delivery to Olympic, the aircraft turned out to have met neither condition at delivery. When the resulting dispute reached a full trial, the judge:

• ruled the acceptance certificate the lessee had signed before delivery stopped it from relying on pre-delivery defects in the aircraft (discovered post-delivery) as defences to ACG?s claim for sums due under the lease; and
• commented on the drafting of a conclusive evidence clause in the lease.

Acceptance Certificate (Estoppel by Representation) and Conclusive Evidence Clause (Contractual Estoppel)

ACG?s two main arguments in this case were:

• Acceptance Certificate: when, before delivery, Olympic signed an acceptance certificate which ACG relied on in accepting re-delivery of the aircraft under a previous lease, this created an estoppel by representation that also prevented Olympic from relying on the pre-existing defects in the aircraft that emerged after delivery; and
• Conclusive Evidence Clause: once Olympic took delivery of the aircraft, a conclusive evidence clause in the lease created a contractual estoppel that prevented Olympic from relying, in any dispute between ACG and Olympic, on those same pre-existing defects in the aircraft that emerged after delivery.

ACG won on the acceptance certificate/estoppel by representation argument, but lost on the contractual estoppel/conclusive evidence argument. But in other cases, the contractual estoppel/conclusive evidence argument may well have a better chance of success and more predictable results than the acceptance certificate/estoppel by representation argument.

Establishing Estoppel by Representation via an Acceptance Certificate

To win on this issue, ACG had to convince the judge:

• Reliance: ACG had relied on Olympic?s clear and unequivocal statement in the acceptance certificate that the aircraft was in the condition required by the lease; and
• Detriment: in reliance on that statement, ACG gave up its rights to require the previous lessee to make the aircraft airworthy before re-delivery.

Remedies for Estoppel by Representation

Unlike contractual estoppel, estoppel by representation is an equitable doctrine. Whether an equitable doctrine applies is in the judge?s discretion given the facts of each case. And the remedy the judge grants may vary from case to case.

In ACG, the judge said the estoppel by representation completely blocked Olympic from raising any defects in the aircraft not mentioned in its acceptance certificate. Another judge on another day with the same or slightly different facts might (for example) have ruled the estoppel prevented Olympic from terminating the lease, but not from claiming damages for defects in the aircraft not mentioned in the acceptance certificate or not discoverable by Olympic when it signed the certificate.

Estoppel by Representation in Finance Leases and in Sale and Leaseback Transactions

In a finance lease and in a sale and leaseback transaction the likely position is that the lessor will not have agreed to any express term or representation that the aircraft is in any particular condition at delivery. So the need to argue the acceptance certificate prevents the lessee from claiming the aircraft was not in the required condition at delivery should not arise. The acceptance certificate will merely be part of the evidence that the lessee inspected and accepted delivery of the aircraft.

However, should a lessor in these circumstances wish to rely on the acceptance certificate to prevent the lessee from claiming the aircraft did not comply with the lease at delivery it would need to show that:

• the lessor relied on a representation from the lessee in the acceptance certificate that the aircraft was in such condition (if any) as the lease required ? which the lessor should be able to demonstrate in most cases; and
• the lessee acted to its detriment in relying on that statement.

In ACG, the lessor was able to show the necessary detriment by showing that it gave up its rights against the previous lessee to have the aircraft put in the re-delivery condition before the next lease began. In a finance lease or a sale and leaseback transaction the lessor should be able to show in most cases that its detriment was giving up its right:

• in a finance lease, not to accept the aircraft from the manufacturer; and
• in a sale and leaseback transaction, not to accept the aircraft from the lessee.

Estoppel by Representation in Leases of Pre-leased Aircraft

At the other end of the spectrum, in an operating lease of an aircraft recently repossessed by the lessor on a default termination, for example, the lessor may or may not know whether the aircraft complies with the new lease at delivery. If the judge finds the lessor:

• knew the aircraft was defective; or
• was aware it knew no more nor less about this than the lessee,

it is unlikely the lessor will be able to establish estoppel by representation on the basis of an acceptance certificate.

Similarly, where an operating lessor has physical possession of the aircraft before the new lease begins, it may be hard to show the lessor acted to its detriment on any representation from the new lessee in the acceptance certificate if the lessor merely performs its contractual obligation to deliver the aircraft.

Where the acceptance certificate will not create an estoppel by representation, the lessor may be better off relying on a conclusive evidence clause in the lease to create a contractual estoppel.

Establishing Contractual Estoppel via a Conclusive Evidence Clause in an Aircraft Lease

Contractual estoppel is a recent and developing area of English contract law. Broadly, it allows parties to an agreement to agree certain things are to be treated as true between them under that contract. In JP Morgan v. Springwell [2010] EWCA Civ 1221, the Court of Appeal ruled that a contract can validly provide that something shall be treated as true between the parties even if they know it is false ? unless some rule of public policy provides otherwise.

It will be very rare that a rule of public policy will prevent well-advised, sophisticated commercial parties to a cross-border aircraft lease from validly agreeing that once it has accepted the aircraft and taken delivery, the lessee cannot later claim the aircraft did not comply with the lease at delivery. Among other things, this will be because:

• the parties are perfectly aware that (even after pre-delivery inspections of the aircraft by experts) neither party will be completely certain the aircraft is in any particular condition at delivery; and
• the lease will contain many other terms demonstrating that the parties have freely decided for good commercial reasons that, once it has accepted the aircraft, all risks of the aircraft not being in any particular condition should rest with the lessee.

In ACG itself, the judge accepted the parties could have agreed this in the lease?s conclusive evidence clause. However, he thought the clause they had agreed on was too general to prevent Olympic from claiming the aircraft had been defective at delivery. To achieve that, clearer and more specific drafting was needed. The conclusive evidence clause in the ACG lease (clause 7.9) provided:

?Delivery by 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 Lessee and that Lessee has irrevocably and unconditionally accepted the Aircraft for lease hereunder without any reservations whatsoever (except for any discrepancies which may be noted in the Certificate of Acceptance).?

The judge concluded the effect of this (with bold emphasis added by SNR Denton) was:

?? to waive any right the lessee might otherwise have had under clause 3.4 to refuse to accept the aircraft under lease. It does not purport to waive any right the lessee might have to claim damages for breach of the lessor's obligation to deliver the aircraft in the requisite condition. Those rights are separate and distinct rights. Clause 7.9 waives the one but not the other.?

Acceptance Certificate or Conclusive Evidence Clause or Both?

Both. Under the current law, a well-drafted conclusive evidence clause is likely to be effective as a contractual estoppel in most cross-border aircraft leases. However, this is a developing area of the law. Exceptions may emerge as the courts test this new estoppel against different facts. If an exception applies, it may be that the lessor will be able to rely on its acceptance certificate as creating an estoppel by representation instead.

Drafting Leases and Managing Deliveries after ACG

Outside those rare cases of an operating lease of a pre-leased aircraft to a hard bargaining lessee who wins an agreement from the lessor that the aircraft will be in a given condition at delivery, it will usually be possible for the lease validly:

• to provide that the aircraft is to be delivered as is, where is and in no particular condition; and or
• to include the other traditional elements of the hell or high water payment provisions (e.g. unconditional payment obligation, no-set-off clause, tax gross-up, very full and detailed exclusions and disclaimers and the aircraft being at the lessee?s risk).

In these respective situations, lessors can use the devices discussed in the ACG case:

• to manage their exposure to a lessee to whom they have undertaken the aircraft will be in a given condition; and or
• to reinforce the as is, where is nature of more usual leases containing no such undertaking.

Acceptance Certificate and Managing Deliveries

If the acceptance certificate is to have the potential to create an estoppel by representation in favour of the lessor:

• the lessor?s position should be that it has not designed, chosen, manufactured, selected, possessed or inspected the aircraft;
• the lessor must not suggest to the lessee that the aircraft is in any particular condition at delivery;
• the lessee should agree that it is up to the lessee, not the lessor, to check whether the aircraft complies with the lease;
• the lessee needs to be given the full contractual opportunity for its experts to inspect the aircraft;
• this contractual opportunity should in fact allow the lessee to know more about the condition of the aircraft on delivery than the lessor;
• where appropriate, the parties should agree that any defects the lessee discovers in the aircraft should be remedied or compensated for in a particular way, but should not give rise to any right to terminate the lease or withhold rent on the basis of set-off, abatement, etc; and
• the lessee should clearly and unequivocally represent to the lessor in the acceptance certificate that the aircraft is in the condition required by the lease at delivery. Further, the lessor should consider, following ACG, whether this representation should also refer to all circumstances in which the lessee waives all rights it might otherwise have to claim anything to the contrary, including in relation to any claim for breach of the lease and any claim that the lessee may terminate the lease, withhold rent and or sue for damages for breach of the lease.

Conclusive Evidence Clause in the Lease

This needs clearly and specifically to state:

• what facts are to be treated as prevailing between the parties after acceptance;
• that the lessee cannot argue those facts are otherwise; and
• all of the key circumstances in which the lessee cannot argue that the facts are otherwise ? in particular, following the ruling in ACG, which causes of action and remedies for those causes of action cannot be claimed by contradicting the agreed facts.

If the leasing and delivery are not to be documented and managed as suggested above, the lessor may also wish to consider:

• what remedies the lessor has against any previous lessee for breach of re-delivery conditions;
• what security the lessor has from the previous lessee for those remedies; and
• whether the exclusions in the new lease will protect the lessor against claims for (for example) loss of profits flowing from being unable to use the leased aircraft.

From the lessee?s point of view, it needs to ensure any acceptance certificate it signs or conclusive evidence clause it agrees to does not cut across any rare concession it has won from the lessor as to the condition of the aircraft at delivery.

For further information on the issues covered by this article, please contact Nick Chandler, Sarah Dyke, Bill Gibson, Brett Hailey, Matthew Harvey, Paul Holland, Paul Jarvis, Greg Kahn, Serge Sergiou or your usual SNR Denton contact.

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