This article is written by Abhijith Christopher.
Table of Contents
Abstract
Just like various other industries in the world, the aviation industry has suffered a major disruption in its functioning as a result of the ensuing pandemic. Considering the fact that surviving in the aviation industry is an economically unviable affair, many aviation companies and entities around the globe resort to leasing aircraft rather than purchasing them. One very reliable, but a conditional measure that these airline companies can possibly resort to in case of an unavoidable, unforeseen, and a major financial emergency situation where they are unable to repay their debt to the lessor is the ‘Force Majeure’ clause.
But, on the contrary, according to modern day aircraft lease agreement drafting practices, the agreement comprises of two principal features, the first being the delivery of the aircraft at an ‘as is where is’ basis, and the second being the ‘Hell or High Water Clause’, which eventually leaves the lessee helpless and without remedy in an unforeseeable situation such as the present pandemic despite the existence of the doctrine of Force Majeure and Frustration. In the light of the aforementioned, the article will delve upon why the above doctrines have been rendered inoperable in the light of the ACG v. Olympic case, and the Williams Pipeline Co. case, and possible precautions and alternatives that can be undertaken for a remedy with regard to the same.
Introduction
Presently, there are over 13,300 aircraft, which are valued at around 331 billion dollars that are being owned by various operating lessors, who lease their aircraft on this basis to various airline companies around the globe, thus representing more than 49% of the aircraft fleet operating all over the world. Apart from the aircraft being leased, the term ‘leasing’ is also applicable to the different parts of an aircraft and the different upgradation processes that are involved therein, .etc. For this very reason, there exist various financing companies that provide loans with regard to all the features pertaining to that of an aircraft. Ever since the culmination of the pandemic all over the world, people began refraining from aircraft travel as a precautionary measure, which eventually led to aircraft suffering losses.
Apart from suffering losses due to a sudden major drop in global operations, aircraft companies began struggling to meet ends with respect to paying off their leases. Furthermore, after being faced some very challenging business conditions, quite a few domestic airlines have resorted to layoff and leave expat pilots without pay. One very reliable, but a conditional measure that these airline companies pervasively resort to is the ‘Force Majeure’ clause. But, on the contrary, according to modern day aircraft lease agreement drafting practices, the agreement comprises of two principal features, the first being the delivery of the aircraft at an ‘as is where is’ basis, and the second being the ‘Hell or High Water Clause’, which eventually leaves the lessee helpless and without remedy in an unforeseeable situation such as the present pandemic. There are also certain other hindrances that are faced by airline companies and entities around the globe while invoking it, which will be elucidated upon by the author along with possible remedies that can be undertaken with regard to the same.
Defining the thresholds of the Force Majeure Clause: a contemporary view
In the month of August 2014, when the Ebola epidemic hit West Africa, the mining and steel company ArcelorMittal announced that it was suspending its expansion project to triple the production of the iron ore situated in Liberia. In July 2014, the gas and oil company Royal Dutch Shell suspended a shale gas exploration project in Ukraine due to the fact that the crash site of the Malaysian Airlines Flight 17 was situated in close proximity. What do the aforementioned instance have in common?
Each of them resulted in the invocation of the force majeure clause, which means an Act of God or a Superior Force, a clause which is common in international contracts of a long-term nature that frees both parties from obligation or liability when an event which is beyond the scope of control of the parties occurs and prevents either one or both of the parties from fulfilling their obligation entrusted to them under the contract. Even though the Force Majeure clause is pleaded at the phase where the contract breaks down, it is frequently not given the emphasis that is so deserves during the negotiation of the contract, owing to reasons such as certain contradictory clauses that hamper its invocation, such as the ones that will subsequently by delved into by the author in the subsequent sections.
The Exigency for a Reform in Modern day aircraft lease agreement drafting practices: explained with reference to the Landmark Case of ACG v. Olympic
As stated earlier, according to modern day aircraft lease agreement drafting practices, the agreement comprises of two principal features, the first being the delivery of the aircraft at an ‘as is where is’ basis, and the second being the ‘Hell or High Water Clause’, which eventually leaves the lessee helpless and without remedy in an unforeseeable situation such as the present pandemic. This fact was affirmed by the England and Wales Court of Appeal (Civil Division) in the case of ACG Acquisition XXLLC (ACG) v. Olympic Airlines SA (Olympic), where the two aforementioned essential elements of a standard commercial operating lease which set forth the process for delivering a used aircraft was emphasized upon.
The ‘As-is-where-is’ basis: The Acceptance Certificate v. The Air-worthiness Certificate
According to the facts of this case, in August 2008, Olympics Airlines took delivery of a Boeing B737-300 aircraft from the lessor, ACG on an operating lease for the term of 5 years. Before being delivered to Olympic, the aircraft had been leased out to Air Asia, and was subsequently redelivered to Olympic. Upon delivery to Olympic Airlines, the Hellenic Civil Aviation Authority had issued a Certificate of Airworthiness with regard to the aircraft. Soon afterwards, a defective cable was found in the aircraft, after which the former was withdrawn from commercial service. The Olympic Airline Company conducted further investigations, after which more defects were revealed. The aircraft was sent for maintenance and repair subsequently, despite which the Civil Aviation Authority (CAA) did not reinstate and revalidate the Certificate of Airworthiness. Post the delivery, and considering the above circumstances, Olympic was unable to pay maintenance reserved or rent after the delivery. After this, in the month of September’09, ACG sued the Olympic Airline Company in the High Court of England and Wales for maintenance reserves and unpaid rent, after which Olympic went on to counter-claims for the damages sustained by it during the term of lease. ACG made a few claims which are as follows:
- The Aircraft was in conformity with the terms of the lease agreement and was in fact, airworthy.
- There was an estoppel on the Olympic Airline Company to assert that the aircraft had not been delivered according to the terms mentioned in the lease agreement since it had signed the acceptance certificate.
- The failure to repay the amount towards maintenance reserves and rent amounted to a breach of the lease agreement by Olympic.
From a brief perusal of the aforementioned, it can be seen that, even though the air-worthiness certificate had been revoked by the CAA, the lessor could still raise a claim owing to the fact that the lessee, i.e., the Olympic Airline Company had signed and accepted the Acceptance Certificate on an ‘as-is-where-is’ basis. According to the acceptance certificate which was assented to and signed by Olympic on delivery, the airline had represented that:
- it “irrevocably and unconditionally accepts and leases from the lessor” the Aircraft, and
- the aircraft “complied in all respects with the conditions which were required at delivery”.
The acceptance certificate is the last and final in the delivery process and triggers the formal commencement of the lease. It was subsequently held in the case that the residual risk of an undetected effect rested with the lessee, Olympic Airlines.
“Irrevocably and Unconditionally”: The Hell-or-High Water Clause
It is general practice to incorporate the “hell or high water” clause in aircraft lease agreements. This clause eventually renders the lessee entirely and unconditionally responsible for the payment of the lease, while not taking into consideration the unforeseen circumstances which may have led to the operations of the airline company getting affected.
The meaning of the clause explained
The meaning of this clause was well explained by the US Federal Energy Regulatory Commission, in the case of Williams Pipe Line Co.. Discussing the aforementioned clause in the light of the facts prevailing in the aforementioned case, there were certain ‘deficiency agreements’ that had been entered into by the parent company (of the subsidiary company) with the creditor, as a form of an ordinary guarantee to be answerable for its subsidiary’s debt. These agreements “are instruments whereby each shipper-owner binds itself to ship, or cause to be shipped, through the pipeline its pro rata share of enough oil so that the pipeline will generate sufficient gross cash revenue…to service the interest and principle repay of the debt and service all operating expenses and other costs of the operation during the entire period of the loan”.
Deficiency agreements, such as the above, contained clauses which were referred to as ‘hell or high water’ clauses. The court, with regard to these clauses, observed that, “if for any reason whatsoever, even if the pipeline is inoperable, or the inability to ship is due to causes which under normal commercial dealings would provide a force majeure escape, the pipeline does not have sufficient cash to pay the principal and interest on the debt and discharge all its other obligations, the shipper-owners are required to make up the difference by a ‘cash-deficiency payment’.”. So as to relate the significance of the clause to the contracts being entered into between the lessor and the lessee in the aviation sector, there can be ‘hell-or-high-water’ clauses in a contract which may deprive the lessee to escape from its financial liability in the event of a force-majeure situation, such as the pandemic prevailing all over the world at present.
The Clause explained in the light of the ACG v. Olympic Case
According to what was observed in ACG v. Olympic, the lease is considered to be a ‘net lease’ in accordance with the “hell or high water” clause, whereby, once the lessee makes the acceptance of the delivery of the aircraft, the lessee must fulfil rental obligations on an unconditional and absolute basis. The rigidity of this clause was further fortified in this case by stating that, the risks which may be present in the aircraft lease agreement have to be taken up by the lessee and the clause will disbar and forbid him from invoking the doctrine of frustration of contract or force majeure. The intent behind the propounding of this clause is that, if properly conducted, the clause protects the lessor from liability, and obligates the lessee to pay the rent, irrespective of any unforeseen event which may arise.
Applicability of the Force-Majeure clause to the present COVID-19 pandemic scenario
As could be seen from the aforementioned case-study of ACG v. Olympic and the Williams Pipeline Co. case, the invocation of the Force Majeure Clause is not possible considering the ‘as-is-where-is’ basis clause, and the ‘hell-or-high-water clause’. Virtually, almost all kinds of equipment leases contain a hell or high water clause which mandates that that lessee must take up the risk of payment in all events, even if the equipment does not function properly. As stated earlier, the risks which may be present in the aircraft lease agreement have to be taken up by the lessee and the aforementioned clauses would disbar and forbid them from invoking the doctrine of frustration of contract or force majeure.
Possible Alternative Remedies and Precautions that can be resorted to by the operational/financial lessee in case of an unforeseeable event such as the Pandemic
Ever since the culmination of the pandemic all over the world, people began refraining from aircraft travel as a precautionary measure, which eventually led to aircraft suffering losses. Apart from suffering losses due to a sudden major drop in global operations, aircraft companies began struggling to meet ends with respect to paying off their leases. Furthermore, considering the general modern-day practices of drafting an aircraft lease agreement, the problem got exacerbated further due to the presence of the ‘as-is-where-is’ basis clause, and the ‘hell-or-high-water clause’. One must keep it in mind that there are various other industries that depend on the aviation industry such as the tourism and the travel industries. This might as well give rise to a ripple effect that may affect other industries at large.
Company Voluntary Arrangements
A possible remedy that airline companies can resort to is that they can negotiate the drafting of the agreement with the lessor in such a way so as to ensure that the implementation of a consensual restructuring is possible in times of distress. The negotiation can further involve postponing and rescheduling the payment of the debt by means of a Company Voluntary Agreement or a Scheme of Arrangement. It is a common fact that if an event constituting force majeure has serious consequences on the other party, and it is possible and foreseeable the circumstances arising out of the event may exceed a certain period of time, the parties shall agree and negotiate upon adjusting the terms of the contract to suit their requirements.
Incorporation of Price Negotiation Clauses in the agreement
The incorporation of a Price Negotiation Clause in the agreement is quite a prudent and feasible option an express duty can be levied upon the lessor (in lease agreements) to allow an opportunity to renegotiate certain terms of the contract in case an unforeseeable situation were to arise. The London High Court case of Associated British Ports v. Tata Steel UK Ltd., sets an important precedent when it comes to providing useful guidance on the same. Back in 1995, the parties had entered into a twenty-five-year-old licence to allow Tata Steel UK to use Associated British Ports’ deep-water harbour facilities situated at Port Talbot to receive the goods which were required at two steelworks belonging to Tata, situated nearby.
The licence had required that the Port must properly maintain its facilities and undertake dredging of berths that were used by Tata to accommodate the entry of a bulk carrier type vessel. The license fee comprised of a fixed sum to be paid each year by Tata and other similar, variable components. The parties incorporated a renegotiation clause in the agreement which stated that, “…in the event of a financial or a physical change in operations affecting Tata or ABP’s operation on or at any time after 15th September, 2007, either of the parties may serve a notice on the other stating the required terms of the licence to be re-negotiated…”, and in case such a renegotiation were not to occur, the matter must be referred to arbitration. So similarly, in the present discussion pertaining to aircraft lease agreements, the lessee can resort to invoking and incorporating the Price Negotiation Clause in agreements. These price negotiation clauses further enable the parties to set certain temporary standards of transactions whereby a situation involving a party having the lesser hand does not arise.
Conclusion: The Path Ahead
This contractual anomaly that exists in aircraft lease agreements may across as very unusual to many considering the extreme ways in which it may debilitate the lessee in an aircraft lease agreement from invoking the Force Majeure clause. But there are always remedies such as company voluntary agreements, as elucidated upon earlier, which serve as an effective reprieve from this anomaly that has arisen out of general contract drafting practices. Another possible reason for this asymmetric allocation of risk disadvantaging the lessee might be due to the fact that lessors comparatively bear obligations of a limited nature as compared to the lessee. The remedies and alternatives suggested in this paper, is hence suggestive of a reprieve with regard to the present issue being discussed. The results of the research can be made out from a bare perusal of the aforementioned paragraph, where the author hopes that the reader comes to a logical and an effective conclusion on the present topic.
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