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09 March 2016
On December 21 2015 the Court of Appeal delivered its judgment on the appeal by PK AirFinance and GECAS against the Commercial Court's decision in Alpstream v PK AirFinance.(1) The judgment provides a welcome clarification of duties owed by mortgagees to financiers and lessors.
Alpstream and Betastream leased seven Airbus A320s to Blue Wings, a German airline that filed for insolvency in 2010. The aircraft were financed by PK Airfinance Sarl. The financing for the aircraft was cross-collateralised to the financing of certain other aircraft ('the Caelus aircraft') leased to Olympic, a Greek airline. Alphastream, an affiliate of Alpstream, had an equity interest in the Caelus aircraft.
As a result of the Blue Wings insolvency, Alpstream defaulted on the financing of the Airbus A320 aircraft. PK repossessed and conducted a public auction of the aircraft. At the auction, PK bid on the aircraft and won (there were no other bidders), and subsequently sold the aircraft to its affiliate GECAS, which leased the aircraft to JetBlue, a US airline. Alpstream alleged that PK breached its duties as a mortgagee in possession, in that it sold the aircraft to GECAS at less than the price that PK should have achieved as a mortgagee in possession. In addition, Alphastream alleged that because PK had failed to take reasonable steps to achieve the best value for the Airbus A320 aircraft, Alphastream's equity interest in the Caelus aircraft was eroded. Notably, no party wanted to void the sale from PK to (ultimately) GECAS. Both Alpstream's and Alphastream's claims against PK and GECAS were grounded in the economic tort of unlawful means conspiracy.(2)
The Commercial Court originally found in Alphastream's favour, finding that the elements of the tort had been made out:
The Court of Appeal's judgment wholeheartedly rejected this.(3)
No economic loss
To date, the Caelus aircraft continue to be owned in the original structure, operating on lease, and Alphastream's equity interest in the Caelus aircraft (even if eroded by sale of the aircraft at an undervalue, as Alphastream alleged) persists – any economic loss is contingent only on the Caelus aircraft being sold and the proceeds of sale being realised. The Court of Appeal noted that "such a loss is not actionable prior to the occurrence of the relevant contingency".(4) The Commercial Court's calculation of a loss based on the hypothesis of a notional sale of the Caelus aircraft in May 2010 was incorrect and should not have formed the basis for a damages award. The Court of Appeal further noted that even if the Commercial Court had been correct, the relevant amount should have been added to the mortgage account, payable through the waterfall, instead of being paid as damages.
No breach of duty
In the first-instance decision, the Commercial Court held that PK, as mortgagee, owed a duty to obtain the best price reasonably obtainable in the circumstances for the aircraft to Alphastream, as the party that held an interest in the residual of the cross-collateralised equity in the Caelus aircraft. The Commercial Court held that PK and GECAS eroded the value of this interest by agreeing to set a level for the purchase price that PK would bid at the auction of the aircraft. The Court of Appeal confirmed that this was incorrect.
The Court of Appeal ruled that while Alphastream might foreseeably suffer a loss if the aircraft were sold too cheaply, it had no interest in the aircraft. Alphastream was the creditor of the owner of the Caelus aircraft, in which it has no interest, being an unsecured, subordinated lender and a possible recipient of the residue at the end of the waterfall of any proceeds of any sale of the Caelus aircraft. Accordingly, PK owed no such duty to Alphastream:
"To extend the duty of PK as mortgagee of the [Aircraft] to Alphastream in its capacity as junior lender or possible recipient of the residue of the [waterfall for the Caelus Aircraft] would involve a departure from established authority which I do not believe to be justified."(5)
The Court of Appeal also confirmed that the duties owed as mortgagee are equitable (and that such duties have not been subsumed into the tort of negligence) and that such duties may be modified by agreement.(6) The terms of the transaction documents were such that Alphastream was not to receive any payment under the waterfall until PK had been fully repaid – and "equity should not recognise a duty in favour of Alphastream [which would] confound the arrangements as to priority which the parties, including Alphastream, agreed".(7)
The Commercial Court had held that the manner in which the auction was held was flawed and that PK had not taken reasonable precautions to obtain the best price reasonably obtainable at the time of sale, therefore breaching its duty as mortgagee. Again, the Court of Appeal decided that this was incorrect. Instead, it held that "an auction sale conducted perfectly would not have produced any more from a third party than $146.8m"(8) (the price that PK paid for the aircraft). The Commercial Court's decision appears to have indicated that the only way that PK could have satisfied its duty as mortgagee was to purchase the aircraft at the price indicated by an independent valuation on the basis that GECAS was a "special" or "uncommonly motivated" purchaser – the Court of Appeal confirmed that this was incorrect: "I do not regard PK, which was under no duty to purchase at all, as having been under any duty... to pay more than it was in fact prepared to pay."(9)
The decision confirms that on the basis of the evidence, GECAS was not a "special" or "uncommonly motivated" purchaser – the $146.8 million PK bid was the only amount that it was willing to pay for the aircraft. In addition, GECAS's dealings with PK and JetBlue indicated that it knew that a third party might outbid PK and that the aircraft might not be obtained for lease to JetBlue; the court had already found that "the undisputed evidence was that PK would not have paid any more than it did even though that might mean that others might acquire the [aircraft]".(10) Accordingly, the Commercial Court's special-purchaser analysis was unsound and the price PK bid was the best price reasonably obtainable at the time of the sale – no breach of duty as mortgagee could have occurred (even if such a duty had been owed to Alphastream).
No intention to cause harm
Finally, in determining that the intention element had not been met, the Court of Appeal found that:
"in circumstances where PK bid or pay more than the aircraft were worth at auction, it seems to me impossible to infer... (a) that PK knew that its failure to bid or pay more than it did was unlawful, or was reckless as to whether that was so, or (b) that it intended to cause the Borrowers or Alphastream loss or acted deliberately knowing that it would cause them loss."(11)
As a cross-appeal, Alpstream argued that the sale of the aircraft was void on the basis of it being a "sale to self", something both the Commercial Court and the Court of Appeal have rejected – the Court of Appeal held that the sale from Alpstream and Betastream (as owners of the aircraft) to Wells Fargo (to which title to the aircraft had been transferred as owner trustee before the auction) and then on to PK was not grounds for the transaction to be set aside.
However, the arrangement did:
"give rise to a conflict of interest and duty. That conflict is addressed by the imposition of the reverse burden of proof, which... was sufficient protection for the claimants... there is no good reason to apply or expand the self-dealing rule to the facts of a case such as the present, particularly in light of the common practice in the aircraft industry for a non-recourse secured lender to bid in order to protect the value of his security."(12)
PK relied on two further grounds as to why the 'sale to self' rule could not apply:
The Court of Appeal held that the first ground applied in the case at hand – given the sale from Alpstream and Betastream to Wells Fargo and on to PK – but that the second ground was inapplicable, as no such affirmation could validate a sale to self – a sale to self is no sale at all.
The Commercial Court placed significant weight on the fact that no independent valuation had been obtained for the aircraft ahead of the auction, and it awarded damages on the basis of a valuation that the judge believed would have resulted had an independent valuation been obtained.(14) The Court of Appeal decided that this valuation was irrelevant for the purposes of the purchase of the aircraft – "the only candidate as a purchaser in May 2010 prepared to pay anywhere near [the judge's valuation] i.e. PK would not have been prepared to pay that price for the Aircraft".(15) While an independent valuation may act as a guide to a mortgagee of the price that may be obtainable, in this context it was unnecessary and should not have formed the basis of the judge's calculation of damages.
The Commercial Court found that PK had exercised its duties as a mortgagee in a manner that constituted wilful misconduct because of its conduct in the repossession and sale process. Pursuant to the underlying finance documents, PK's liability was limited to situations in which its actions involved gross negligence or wilful misconduct. This limitation of liability extended to its liability not only to the borrowers, but also to Alphastream; the Commercial Court found that the scope of PK's liability to Alphastream could not be wider than the scope of PK's liability to the borrowers simply because Alphastream was not a party to the underlying finance documents.
The Court of Appeal found that the judge's analysis was incorrect – while PK and GECAS may have engaged in the conduct identified by the Commercial Court, what mattered was whether PK engaged in wilful misconduct in relation to its duty to obtain the best price reasonably obtainable at the time of sale. The failure to obtain such a price was the basis of Alphastream's claim for economic loss, and this was not proved – the Court of Appeal determined that PK paid considerably more than the aircraft were worth to a third party at a properly conducted auction.
The Court of Appeal confirmed that while a mortgagee which exercises its power of sale, in connection with enforcement of its mortgage interest, owes the mortgagor a duty to take reasonable care to obtain the best price reasonably obtainable at the date of sale, it is for the mortgagee "to decide whether and when to sell, by reference to [its] own interests, even if the timing is unpropitious [and] that the mortgagee does not owe the mortgagor any duty of care in his choice of time".(16)
The Court of Appeal also confirmed that, subject to anything to the contrary set out in the relevant mortgage deed, the mortgagee may decide whether a sale should be conducted by auction or private treaty and that the decision between the two involves "an exercise in informed judgment such that in exercising the power of sale a prudent mortgagee will take advice including, where appropriate, valuation advice".(17)
The first-instance judge was quite critical of the manner in which the auction was conducted by PK and opined that this amounted to a breach of PK's duty in the conduct of the auction. The Court of Appeal found that it was open to the judge to find that the duty had been breached in light of some of the conduct but that the judge had erred in stating that the auction was simply "no more than, a method of obtaining ownership [and that it was, rather,] also a method of obtaining value".(18) In any event, such conclusions were of no value to Alphastream as its losses stemmed from the purported failure to obtain an independent valuation of the aircraft and a purchase of the aircraft at the value determined pursuant to that independent valuation, something that the Court of Appeal determined that PK, as mortgagee, was under no duty to do.
Alphastream also sought to claim that GECAS had caused PK to breach its duties as mortgagee. The Court of Appeal considered whether the relevant elements of the "tort of procurement" had been made out, as follows:
For the reasons set out above, in relation to the tort of unlawful means conspiracy the Court of Appeal established that:
Thus, the first, second and last elements of the tort of procurement were not established.
The Court of Appeal also found that while GECAS knew that PK owed duties to the borrowers, this did not "show that it had actual or blind knowledge"(20) that PK might owe duties to Alphastream or a company in its position. Additionally, the judgment notes that several hours of contentious argument had been held into whether PK owed Alphastream a duty and that it did not seem "realistic to say that GECAS knew or was recklessly indifferent to whether PK owed such a duty".(21) Further, even if the judge was correct about the independent valuation, there was no evidence that GECAS knew that "PK should not have bought at auction at all save in accordance with an independent valuation (plus a bit because they were a special purchaser) and at a price greater than that to be obtained from any third party at any auction".(22)
Finally, as PK could have been liable to Alphastream (as a matter of primary liability) only if it had engaged in wilful misconduct in accordance with the terms of the mortgage deed, which the Court of Appeal had determined it had not, GECAS could not be secondarily liable, as PK was not primarily liable.(23)
The following conclusions hold true for prudent financiers and should be reviewed by financiers approaching any default scenario:(24)
In addition, the following four points are worth outlining as useful confirmations:
The determinations of the court that no duty as mortgagee was owed to Alphastream and that it had suffered no loss, and that the sale to PK was not a sale to self, are the primary determinations of the case. The rulings on independent valuations and wilful misconduct, the timing and conduct of the auction and the tort of procurement, as well as other matters not discussed here in full, may be viewed as obiter dicta that a future court is not bound to follow because the Court of Appeal did not need to give judgment on these matters. That said, the rulings provide a useful guide to mortgagees and may be persuasive in any future case relating to a mortgagee's duties.
For further information on this topic please contact John Pearson at Vedder Price by telephone (+44 20 3440 4680) or email (email@example.com). The Vedder Price website can be accessed at www.vedderprice.com.
(2) For further details please see "Alpstream v PK Airfinance: lessons for financiers and lessors".
(14) The judgment indicates that the value GECAS's Mr Beaubron calculated of $171.5 million pursuant to GECAS's SAFE system was a SAFE calculation of market price and suggests that GECAS may have conducted something akin to an independent valuation itself. Paras 191 to 194, PK AirFinance Sàrl v Alpstream AG  EWCA Civ 1318.
(19) Clerk & Lindsell on Torts, 21st Ed 24-03 – the so-called 'tort of procurement' is broken into separate torts, including the tort in Quinn v Leathem and torts involving the breach of a statutory duty owed to another, by some commentators.
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