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Court rules on aircraft lessor's liability for unairworthy aircraft - International Law Office

International Law Office

Aviation - United Kingdom

Court rules on aircraft lessor's liability for unairworthy aircraft

June 16 2010

Summary
Facts
Decision
Comment



Summary

ACG Acquisition XX LLC v Olympic Airlines SA(1) related to the liability of a lessor for leasing an unairworthy aircraft.

The case concerned an application by ACG Acquisition XX LLC against Olympic Airlines SA for summary judgment for the payment of rent under an aircraft lease agreement. The aircraft was seriously defective and Olympic resisted the claim on the grounds of the total failure of consideration. Although the facts were extreme, the case is significant for the aviation industry and aviation finance lawyers, and is generating interest in the aircraft leasing industry. The case considered the concept of total failure of consideration and the ability of a lessor to rely on a 'no set-off' clause; more generally, it raises the issue of sound drafting of aircraft lease agreements.

Facts

By an aircraft lease agreement dated May 30 2008 the claimant, ACG, leased a Boeing 737 aircraft to the defendant, Olympic, for five years. ACG delivered the aircraft to Olympic on August 19 2008. Olympic signed a certificate of acceptance which, under the lease, was formally deemed to constitute delivery. The Hellenic Civil Aviation Authority granted a certificate of airworthiness. The aircraft went into revenue service on August 23 2008. Fifteen days later, it was grounded when broken control cables were found on one wing. Olympic discovered 14 separate categories of defect. The civil aviation authority subsequently withdrew the certificate of airworthiness.

Before the lease was signed, Olympic carried out certain limited external inspections, but was unable to open parts of the aircraft, inspect or test internal parts or run diagnostics, except in relation to the engines. Olympic asked ACG for permission to inspect the airframe more closely, but ACG refused. Before the lease was signed, Olympic reported to ACG that the spoiler cables were corroded, but by the delivery date they had been certified as having been repaired, although the judge noted that this appeared to be incorrect.

The lease required ACG to meet various delivery conditions, including the completion of a major overhaul, allowing the aircraft to fly 4,000 flight hours in 15 months before the next major overhaul.

In October 2008 Boeing inspected the aircraft at Olympic's request. Despite the fact that the aircraft was supposed to have completed a check - known as a C-check - before delivery, Boeing recommended that the aircraft undergo another C-check and recommended a review of its compliance with airworthiness directives.

In January 2009 a third-party European maintenance organization undertook an inspection of the aircraft and its records. This revealed that a number of airworthiness directives and corrosion prevention and control programme tasks had been either performed inadequately or omitted entirely. The civil aviation authority issued a permit to fly, enabling the aircraft to return to Athens. Having inspected the aircraft and its records, the civil aviation authority required extensive further checks to be carried out before the certificate of airworthiness could be revalidated.

In September 2009 ACG issued proceedings against Olympic, claiming outstanding payment of rent and maintenance reserves under the lease, plus damages. Olympic counterclaimed for damages for breach of the lease, in particular regarding the delivery condition of the aircraft. Olympic claimed damages representing the cost of wet leasing replacement aircraft between September 2008 and October 2009 of approximately €32 million, minus moneys that it would have had to pay to ACG had the lease been performed. Accordingly, Olympic's counterclaim was valued at around €5 million.

In October 2009 Olympic ceased trading and entered into liquidation.

On Olympic's unchallenged evidence, the aircraft was in such an unairworthy condition on delivery that it would have cost more than the aircraft was worth to make it airworthy, with the consequences that (i) Olympic had only 14 days' use of the aircraft under the five-year lease, and (ii) use was possible only because Olympic and the authorities were unaware of the aircraft's seriously defective condition at the time.

The case before the judge concerned ACG's application for summary judgment or, alternatively, security for costs. The issues before the court included:

  • whether Olympic had a real prospect of establishing that it was entitled to make a claim founded on ACG's failure to deliver the aircraft in the condition required by the lease;
  • if so, whether Olympic had a real prospect of establishing that its claim could be relied on to defeat ACG's claim for rent or whether there should be a stay of execution of any judgment in ACG's favour; and
  • whether an order for security of costs was appropriate.

Decision

The judge dismissed ACG's applications.

On the first issue, the judge was satisfied that Olympic had a real prospect that it was entitled to make a claim founded on ACG's failure to deliver the aircraft in the condition required by the lease.

One of the significant points argued by Olympic was that in view of the multiple defects discovered, which must have been present when the aircraft was delivered, ACG had fundamentally failed to perform its obligations in respect of the delivery condition of the aircraft, and had delivered an aircraft in a seriously unairworthy state. Accordingly, Olympic argued that it was not obliged to pay rent and that there had been a total failure of consideration; alternatively, it was entitled to counterclaim substantial damages. The judge noted that if - as the evidence suggested - the aircraft was beyond economic repair, it seemed unlikely that it would ever be granted a certificate of airworthiness and it would never be operated again.

The judge accepted that Olympic had at least a real prospect of making out its case that the conclusive effect of the acceptance of the aircraft was limited to the right of rejection and did not extend to the right to claim damages, still less to a claim for total failure of consideration. The judge stated that it would be both surprising and uncommercial if ACG could rely on the certificate of acceptance as a complete answer to a claim for breach of contract, no matter how serious its breach of its fundamental obligations under the lease; clear wording would be required in order for it to have this effect.

On the second issue, the judge accepted that Olympic had a sufficiently arguable case of total failure of consideration. He went on to say that if this was wrong and Olympic was confined to a claim for damages, it was a claim that went to the root of ACG's entitlement to claim rent. The judge said that it would be difficult to conceive of a clearer case of the defence of equitable set-off which impeaches the right to a legal demand - if ever there was a case which, on Olympic's evidence, a claim for rent should be capable of being resisted, this was it. ACG sought to rely on the 'no set-off' wording of the lease, but the judge stated that:

"if a case of total failure of consideration is made out, there is at least a real prospect of showing that there was no obligation at all to pay rent under what would then be an ineffective agreement."

Regarding the issue of security for costs, the judge stated that in light of Olympic's liquidation, there was sufficient evidence that Olympic would be unable to pay ACG's costs of the counterclaim should ACG succeed, and there was jurisdiction to order security for costs. However, he was not satisfied that this was an appropriate case to exercise his discretion and he did not consider it appropriate to order security for costs.

Comment

As this case concerned an application by ACG for summary judgment, the judge had to decide whether Olympic had an arguable case. Accordingly, there was not a full trial of the issues.

The lease contained various clauses that are common in the aviation industry. The judge considered the relevant clauses and made various observations on them and on their interaction. From its perspective as the lessor, ACG sought to rely on clauses that are regarded as relatively standard in the industry, whereby the aircraft was leased 'as is, where is' and where the lease sought to pass on the risk of defects to the lessee (as is invariably the case in the aircraft operating lease industry). As is common in the industry, the lease contained delivery conditions with which ACG was required to comply. Other provisions sought to obtain from Olympic irrevocable confirmation that the condition of the aircraft had been accepted and that, from the time of delivery, the aircraft was leased 'as is, where is'.

Although the case hinged on the question of total failure of consideration, aircraft lessors will wish to review and strengthen their lease terms, especially regarding the allocation of the risk of latent defects. However, generally speaking, this case shows that establishing a total failure of consideration will trump contractual terms. In a similar case of an aircraft beyond economic repair, even stronger contractual terms may not ultimately assist a lessor.

The crucial wording of the lease was that the lessor:

"shall deliver the [aircraft] 'as is, where is' and in the [delivery condition], except for any item set forth on... the certificate of acceptance and any other items agreed in writing by the lessor and the lessee."(2)

Prudent lessors will redraft this type of wording so that there is no ongoing liability for defects.

For further information on this topic please contact Austen Hall at Hogan Lovells by telephone (+44 20 7296 2000), fax (+44 20 7296 2001) or email (austen.hall@hoganlovells.com).

Endnotes

(1) Judgment was given on April 21 2010 (Hamblen J).

(2) Emphasis added.


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