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25 July 2012
A delivery of a used aircraft under a standard commercial operating lease has two essential components.
First, the lessee is responsible for inspecting the aircraft, which is delivered on an 'as is, where is' basis. On completion of its inspection, the lessee issues an acceptance certificate, confirming that it has completed its inspection and accepted the condition of the aircraft.
Second, the lease is a net lease with a so-called 'hell or high water' clause. This provides that once the lessee has accepted delivery of the aircraft, it must pay rent on an absolute and unconditional basis.
In a closely watched case, the High Court has affirmed that this delivery process - if conducted properly - functions as intended, protecting the lessor from liability and placing the lessee under obligation to pay rent.
In August 2008 Olympic took delivery of a Boeing B737-300 aircraft from ACG under a five-year operating lease between the parties.
Before delivery to Olympic, the aircraft had been on lease to AirAsia and was redelivered immediately prior to delivery to Olympic. In court, it was shown that the redelivery from AirAsia was accepted by ACG only because Olympic agreed to accept the aircraft on lease following such redelivery.
The Hellenic Civil Aviation Authority issued a certificate of airworthiness on delivery to Olympic, but shortly afterwards a defective cable was discovered and the aircraft was withdrawn from commercial service. Investigations by Olympic revealed further defects and the certificate was suspended in September 2008.
The aircraft was sent for maintenance, repair and overhaul. However, on its return to Athens eight months later the Hellenic Civil Aviation Authority refused to reinstate the aircraft's certificate of airworthiness, determining that Olympic's compliance with airworthiness directives was unsatisfactory.
Olympic failed to pay rent or maintenance reserves following delivery. In September 2009 ACG sued Olympic in the High Court for unpaid rent and maintenance reserves; Olympic counterclaimed for its alleged damages. Olympic ceased trading in October 2009. ACG terminated the lease in March 2010 and sought the return of the aircraft, which was finally returned in November 2010 pursuant to a court order issued in August 2010.
ACG's principal claims were for:
Olympic claimed that the aircraft was not airworthy when delivered and that this breached the terms of the lease agreement; therefore, it was not obliged to pay rent or maintenance reserves. Furthermore, it claimed that even if this were not the case, there had been a total failure of consideration, or that performance under the lease agreement was frustrated by suspension of the certificate of airworthiness. As a consequence, the airline claimed that it was entitled to recover, as damages, its costs for repairing the aircraft and obtaining a replacement aircraft.
ACG claimed that:
The lease agreement required that the aircraft be delivered by ACG in an 'as is, where is' condition and in the required delivery condition, which included a requirement that the aircraft be "airworthy and in a condition for safe operation".
Under the acceptance certificate signed by Olympic on delivery, the airline represented that:
The lease agreement itself provided that Olympic's execution of the acceptance certificate was conclusive proof that it had "irrevocably accepted the Aircraft for lease", but did not also state that its execution was conclusive proof that the aircraft was in the required delivery condition. The court determined that the terms of the lease agreement itself did not preclude a claim by the airline for ACG's purported failure to deliver the aircraft in the required delivery condition; as a result, it considered whether the aircraft met this condition.
The court considered whether the aircraft was airworthy for the purposes of the required delivery condition. The court could not identify previous authority for the meaning of the term 'airworthiness' and looked to the world of shipping for assistance, adopting the following objective definition: "[W]ould a prudent operator of an aircraft have required that the defect should be made good before permitting the aircraft to fly, had he known of it? If he would, the aircraft was not airworthy."
The issue of whether an aircraft is airworthy does not depend on either party's knowledge of a particular defect. On the basis of the definition, the court found that the aircraft was not airworthy. As the court's ultimate decision in the case did not rest on its finding on this matter, the definition was obiter dictum (ie, made in passing) and other courts need not be bound by it.
The court turned to Olympic's specific representation in the acceptance certificate. It agreed with ACG that Olympic was prevented from alleging that the aircraft did not comply with the required delivery condition under the lease because of Olympic's representation in the acceptance certificate that:
Olympic asserted that ACG had not believed the representation, but the court found that it was improbable that ACG - as a major lessor, leasing to a national airline - would deliver an aircraft that it believed to be defective and not compliant with the required delivery condition. ACG had believed Olympic's representation and had relied on it to its detriment by agreeing to the redelivery from AirAsia. The court consequently denied Olympic's claim as a result of the action of estoppel by representation.
In the circumstances, two of Olympic's advisers had recommended a detailed inspection of the aircraft. A series of pre-delivery inspections had provided Olympic with the opportunity to determine the condition of the aircraft, with rectification work undertaken by AirAsia in relation to defects discovered during those inspections. Olympic must have appreciated, before signing the lease and agreeing to provide an acceptance certificate, that there might have been hidden defects which it could not have detected.
The court distinguished a case(2) relating to a consumer's acceptance, under a hire purchase contract, of a car which was not fit for use as a means of transport. It noted that:
The court's analysis leaves open the possibility that an unsophisticated lessee might have scope to argue that it did not intend a statement as to condition to be relied upon by another party; however, the strength of this argument is questionable at best.
The court rejected a claim by Olympic that ACG's failure to deliver an airworthy aircraft had been a breach of a fundamental obligation under the lease. The court clearly took into consideration that the agreed terms had been the subject of a free negotiation of the lease agreement between a leading participant in the aircraft leasing industry and a major airline.
As the court decided that delivery of the aircraft had taken place, and that Olympic was estopped from claiming that it had not, it followed that:
The court noted that the withdrawal of a certificate of airworthiness is an inherent risk in the leasing of an aircraft, and that such risk was borne by Olympic pursuant to the 'hell and high water' clause. The clause specifically identified "any prohibition or interruption of... [the] Lessee's use, operation or possession of the aircraft" and "any lack... of airworthiness" as matters which would not affect the lessee's obligation to pay rent and maintenance reserves.
Financiers and operating lessors should ensure that the delivery condition of an aircraft (including the airworthiness requirement) is an objective condition precedent in favour of the lessee. In this way, no positive obligation need be imposed on the lessor to ensure the delivery of an aircraft in any particular condition.
Lessees must take care to inspect the aircraft at delivery and be absolutely satisfied that it is in a condition which is acceptable to them. Lessees must be aware that any residual risk of an undetected defect rests with them.
The inclusion of clear wording in a lease acceptance certificate, which states that execution constitutes "conclusive proof that the aircraft is delivered in the delivery condition" (rather than merely irrevocable acceptance for lease), will make it difficult for an airline to bring a claim for failure to satisfy delivery condition.
In this case the 'hell and high water' clause helped to identify the risks inherent in leasing an aircraft that were to be borne by the lessee, thereby helping to prevent a claim for frustration of contract. Lessors should ensure that their clauses identify all the elements of operational risk that are to be borne by the lessee, so that it can be plainly shown that the parties intended such risk to be borne by the lessee.
For further information on this topic please contact Gavin Hill or John Pearson at Vedder Price LLP by telephone (+44 20 3440 4680), fax (+44 20 3440 4681) or email (email@example.com or firstname.lastname@example.org).
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