The aviation industry is one of the most complex spaces that require continuous manoeuvring and shuffling between various stakeholders, regulatory bodies, and financial institutions. It is not unknown that since its inception, India’s aviation sector has been plagued with multifarious contractual disputes, particularly relating to lease agreements. This is because almost 80% of commercial aircraft are leased from foreign parties. It is also not unknown that the Indian aviation industry has been hobbled in the past by airline failures, weak infrastructure, and questions over lessors’ rights.[1] In this piece, we will discuss the need for specific clauses in a contract that aid the benefit of lessors during any dispute. We will also discuss why the benefit to the lessors is the need of the hour to uplift the aviation sector in India.
The apprehension of the lessors in entering the Indian market found its roots in the 2012 Kingfisher Airlines Saga when one of India’s major airlines ceased its operations. The request of lessors and financiers for deregistration and repossession of their aircrafts was met with delayed responses in the Indian Courts. The collapse of Kingfisher and subsequent events presented challenges to aircraft financiers and lessors[2], which ultimately proved detrimental to the interests of the aviation Industry in India. The case was highlighted more so in the pretext of India’s commitment to its international obligations to the Convention on International Interest in Mobile Equipment, 2001 (“Cape Town Treaty”), ratified by India in 2008. The lessors of Kingfisher, namely DVB Bank and International Lease Finance Corporation, faced hurdles in regaining possession of its leased aircrafts. The Cape Town Treaty failed to prove helpful for the lessors during the Kingfisher fiasco, as no legislation had been passed to give effect to the Treaty, thus, putting the lessors and financiers at the mercy of the local laws of India. 13 years on, even now no legislation came into place post the ratification of the Treaty in 2008.
Then came another significant development in the aviation lease sector in India, when Spice Jet was similarly placed as Kingfisher Airlines. The increasing financial pressure ultimately constrained the lessors to terminate their leases with the airlines whilst demanding the deregistration of their aircrafts. That the Delhi High Court majorly emphasized the broad framework of the Cape Town Treaty and the conflict with the local laws of the land. However, keeping in mind the relevant provisions of the Cape Town Treaty, the Delhi High Court ultimately directed the Directorate General of Civil Aviation (“DGCA”) to deregister the aircrafts. Spicejet was also faced with similar actions before the Madras High Court in 2015 itself; however, the airline entered into a settlement agreement with the concerned lessors on the ground that it was restructuring its business. Although there was a delayed response from the Delhi High Court in granting the deregistration, which was primarily because of the improved financial position of the airlines. It seems that the same was indicative of the seriousness of the Indian Courts towards its commitment to the Cape Town Treaty and its desire to protect the interest of the lessors.
While protection of the interest of the lessors and financiers was being talked about in the Indian markets, major complications began in the wake of the Covid-19 pandemic, which thwarted the operation of aviation business worldwide. Due to travel bans imposed worldwide, the aviation industry was massively impacted in terms of severe loss to all the stakeholders who were forced to come to a standstill in terms of the operation of the airlines, resulting in several premature terminations of aircraft lease agreements. While the lessees were able to get some relief in terms of the force majeure clauses available in the lease agreements, the lessors were left with no option but to succumb to the unprecedented situation brought up by the pandemic.
In light of the above-mentioned scenario, it becomes imperative for the lessors to review the terms and conditions of the lease agreement entered into with various airlines to ensure smooth operations throughout the term of the lease as well as the period thereafter. While this article enumerates all the relevant clauses in a lease agreement, an attempt has been made to throw light upon certain important clauses which are to be focused upon by the lessor in such lease agreements.
Before adverting to the clauses of the lease agreement, it is pertinent to mention the types of lease agreements that can be entered into between the lessors and the airlines. The aircraft leasing options available to the parties range from obtaining either a wet, dry, or damp lease. While in a wet lease, along with the aircraft, the airline is provided with the crew, maintenance, and insurance, the dry lease only involves the aircraft provided by the lessor. Finally, in a damp lease, only the maintenance and insurance are provided along the aircraft, but the aircraft crew is not leased.
While different categories of lease agreements can be executed, the basic structure of such contracts is always complex and risky, requiring careful planning and negotiation to avoid costly and lengthy disputes. Some of the clauses which require careful consideration are as follows:
- Delivery: Since the majority of the lessors in the aviation industry are placed outside India, it becomes imperative to pay attention to where the aircraft will ultimately be delivered to the airline.
- Term: The duration for which the lease agreement is to be executed ought to be clearly mentioned, which will depend upon the lease being either a wet lease which can be for a period of a maximum of six months, or a dry lease, which can be for 12 months and extendable thereafter.[3]
- Payment: This clause is one of the most important clauses in a lease agreement wherein the amount of consideration, i.e., the rent along with the payment schedule and the mode of payment, is to be mentioned. This clause should clearly mention the currency in which the consideration would be paid, which will depend upon the parties involved in the lease agreement.
- Taxes: Since the lessors in an aircraft lease agreement are foreign entities, due consideration should be given to the liability of taxes imposed on the import of an aircraft in the country.
- Maintenance: The maintenance clause specifies the liability of the party responsible for the maintenance of the aircraft, including its service, repair, and overhaul during the lease agreement. This clause also needs due consideration from the perspective of the lessors being the aircraft owner. While it specifies the liability imposed on one party depending upon the nature of the lease agreement, the lessor must also consider including a provision for maintenance reserves. Maintenance reserves are basically designed to protect the lessor by ensuring sufficient funds to cover major activities. In the event that an aircraft is forcibly repossessed due to a default by the airline, the aircraft may require expensive investment in outstanding maintenance work before it is in a condition to be re-leased or sold to another airline/investor. Therefore, a lessor’s primary risk in relation to maintenance is one where the lessee fails to pay, in whole or in part, for the maintenance utility they consumed.[4] This will also have an impact on the lease rentals that are decided by the parties. Where it has been agreed that maintenance reserves are payable during the lease term, these amounts are regarded as supplemental rent. It is critical that these amounts are calculated and paid on time to avoid payment default.
- Force Majeure: This clause was particularly highlighted during the Covid-19 pandemic, wherein the majority of the airlines were forced to ground a majority of their aircrafts and implement drastic measures such as implementing pay cuts, cancellation of flights, etc., which ultimately impacted their ability to fulfil the rental payment obligations. In this background, it is important to understand the importance of a force majeure clause in a lease agreement. A force majeure clause is a contractual provision wherein both parties are free to seek exemption from the performance of their contractual obligations in light of certain events beyond the control of either of the parties. This clause, if included, might directly impact the termination and therefore, the very existence of the lease agreement by the lessee. Therefore, the import of words pertaining to all the events deemed as force majeure events should be done carefully. For example, an event that might impact the resources of the lessee but could be mitigated with time should not be considered a force majeure event.
- Hell or highwater: The escape from a force majeure clause is provided in the form of a “hell or highwater” clause (“HOHW”). It is a well-confirmed postulation of common law that HOWH places an absolute, irrevocable, and unconditional obligation on the lessee to make the necessary lease payments, notwithstanding the happening of any circumstance of any nature whatsoever. On the face of it, this clause puts a lot of pressure on the lessee to adhere to its obligations under the lease agreement, come what may. This clause was further strengthened in the case of Olympics Airlines vs. ACG, wherein it was held that the risks inherent in the aircraft lease would have to be borne by the lessee, and the clause shall forbid him to claim force majeure or frustration of the contract.
Impact of the HOHW clause, even though it seems to be in favour of the lessor, however, the same might have a major impact on the aviation industry, which depends on the agreement for their survival, like travel and tourism. The HOHW may also lead to the liquidation of the airlines, which might create a ripple effect in the aviation industry. Therefore, while drafting such a clause, the lessor may also like to consider the inclusion of certain options which might be available in the occasion of default by the lessee. For example, the lease agreement can also include the provision of return of the aircraft, i.e., repossession on an ‘as is, where is’ basis, or may even consider renegotiating the payment obligations, which will have a bearing on the future income of the lessors arising from the lease agreement.
- Aviation insurance: This clause pertains to the liability imposed on one party liable to cover the damage, if any, caused to the aircraft. This is again a significant clause wherein the lessor must require the lessee to maintain an agreed insurance policy in place during the term of the lease agreement. The clause must further contain a stipulation wherein, if no insurance policy is in place, the same may constitute a default on the part of the lessee.
- Termination: This clause gives rights to the parties to terminate the contract if the terms and conditions of the agreement are breached by the other party. The authors are of the opinion that the lessor might also consider incorporating a clause relating to “Events of Default” that may further strengthen the grounds which may entitle the lessor to terminate the Aviation lease.
- Repossession of the aircraft: Crucial part of a lease agreement that needs to be considered by the lessor is how quickly an aircraft can be recovered in the event of default or termination of the lease. The above-enumerated events have raised the apprehension of the aircraft lessors regarding their rights to take possession of their aircrafts. While India has ratified the Cape Town treaty, no legislation has come into place to implement the convention. There is, however, a bill, i.e., Protection and Enforcement of Interests in Aircraft Objects Bill, 2022 (“Bill”) that has been proposed by the Ministry of Civil Aviation on 16th April 2022 to duly address the issues involved in repossession and other disputes related to the aviation industry. However, the same is still at the implementation stage. Therefore, until the said bill is implemented, the latter will prevail in case of any conflict between the Cape Town Treaty and the domestic laws of the country.
The repossession clause is essential in cases where the lessors are looking to have the first right over creditors to repossess the aircraft. However, without proper avenues for remarketing an aircraft, repossession of an aircraft may not always be feasible economically. In such a situation, the lessor should also be prepared to negotiate the payment obligations, waivers, or deferrals which may be worked out.[5]
- Dispute resolution: This clause is crucial since it talks about the mode of resolving disputes between the parties. The parties may agree to resolve the disputes by going to the courts. However, it is advisable that the lessor should consider incorporating an arbitration clause in the aviation lease, thereby enabling a more effective and efficient path for the lessor. Further, Article 8 of the Cape Town Treaty and Article 8 of the Bill specifically gives rights to the lessor to approach the courts to exercise the remedies available. The courts, in this instance, also include the arbitral tribunal by virtue of Article 1(h) of the Bill and Article 1(h) of the Cape Town Treaty. Before adverting to the dispute mechanisms available to the lessor, one should see the remedies that may be resorted to by the lessor, i.e., taking possession of the aircraft, selling or granting a lease of the aircraft, collecting or receiving income from or profits arising out of the management or use of the aircraft. Any additional remedy may also be incorporated in the aviation lease as the parties decide. Further, the lessor is free to approach the courts for interim relief pending the final determination of the disputes. The said interim relief can be like preservation of the object, possession, control of the object, and even immobilisation of the object.
One thing to be kept in mind while obtaining the remedies in India is that any such procedure followed by the lessor should be preceded by a notice to the Directorate General of Civil Aviation (“DGCA”) specifying the remedies being availed. Further, even in the case of a foreign award, the order to execute such remedies must be preceded by a written notice to DGCA.
While the mode of availing the remedies is clear, the parties must also be careful in specifying the governing law and the chosen forum that is best suitable for the lessor. That clause must be in writing, and the parties must ensure that the aviation lease is in consonance with the governing law provided.
- Redelivery of aircraft: Although occurring at the end of the term of the lease agreement, this clause should be prepared well in advance at the start of the term itself. While drafting this clause, the redelivery date and the other protection mechanisms in case of late redelivery of the aircraft should be clearly included. Further, due consideration should be given to the redelivery conditions to be imposed on the lessee. Such conditions might specify the condition of the aircraft to be close to the delivery condition at the start of the lease agreement. Further, in case of any non-compliance with redelivery conditions, the lessee must be obliged to remedy the defects at its own costs. Here the lessee might argue normal wear and tear during the use of the aircraft, which might result in adverse financial consequences to the lessor. Therefore, it is advisable that the term ‘wear and tear’ should be clearly defined in the lease agreement.
While an attempt has been made to provide detailed analysis regarding the clauses which are to be duly considered by the lessor while preparing a lease agreement, one should always consider the long-term goals of a lease agreement, i.e., benefit to both the parties, i.e., lessee as well as the lessor. Therefore, a lease agreement must be particular vis-a-vis the nature, rights, risks involved, and obligations of both parties, which might ultimately reduce the burden of being involved in any dispute. The legal complications involved in aviation transactions can have lasting effects on the operations and business of both parties, which, therefore, demand proper attention to the language of the terms being included in an aviation lease agreement.
References:
[1] Tim Hepher, Aditi Shah Analysis: Lessors lead rush to finance huge Air India jet Order (February 15, 2023 11:32 PM) https://www.reuters.com/business/aerospace-defense/lessors-lead-rush-finance-huge-air-india-jet-order-2023-02-15/
[2] Narayanan, Nithya and Ramanathan, Ashwin, Aviation Disputes in India: Flying Uncharted Skies (June 1, 2014). Acquisition International, June 2014, at 86, Available at SSRN: https://ssrn.com/abstract=2509006
[3] Office of the Director General of Civil Aviation, Civil Aviation Requirement Section 3- Air Transport Series ‘C’ Part I, Issue IV, March 24th 2017
[4] Shannon Ackert A Lessor’s Perspective of Maintenance Reserve Theory and Best Practices AIRCRAFT MONITOR August 2012, at 2
[5] Henry Kiyoko, Liability Management for Airlines Following Complete Shut Down of Operations or Aircraft Groundings in The Wake of Coronavirus (COVID-19), Brown Rudnick, http://www.brownrudnick.com/alert/liability-management-for-airlines-following-complete-shut-down-of-operations-or-aircraft-groundings-in-the-wake-of-coronavirus-covid-19/ (last visited August 10, 2020, 10:05 AM).
