Cape Town Convention gives hope to China aviation

This international treaty offers secured financiers for the acquisition of (and lessors of) aircraft objects unrivalled rights and remedies when compared to other mobile assets such as ships and rolling stock. In most cases it also provides a certainty of enforcement within a time-scale which should significantly decrease the risk to such lending or leasing. Reduction in risk should deliver to the airline access to more readily available liquidity and also improved and reduced cost of borrowing.

What the Convention seeks to do, and how
From the perspective of both aircraft financiers/lessors and airlines, the financing of mobile high-value assets such as aircraft gives rise to unique risks and uncertainties. Aircraft can easily move across borders and different countries often have materially different laws. Financiers/lessors are concerned that laws in certain countries may not afford adequate recognition of their rights, or adequate protection in terms of remedies in the event of airline default or insolvency while the aircraft is in that country. Uncertainties over the ability of a financier/lessor to, for instance, repossess an aircraft mortgaged to it as security in such countries are a serious concern and have a material impact on the risk profile of any loan or lease offered to airlines. Uncertainty affects the financeability of aircraft as an asset class.

The Cape Town Convention:

(a) establishes one international register for recording so-called international interests in aircraft objects (airframes, aircraft engines and helicopters of a certain size and performance);

(b) creates a clear set of priority rules where there are competing international interests for the same aircraft objects; and

(c) provides for default remedies to enforce such international interests.

The operation of the Convention only applies to interests arising in certain types of agreements and is triggered (amongst other things) if the debtor (normally the airline) is located in a Contracting State or if the aircraft is registered in a Contracting State (see box: What can be registered under the Cape Town Convention?).

International interests

An international interest is a proprietary interest in a suitable aircraft object which has been granted under a security agreement, vested in a seller under a conditional sale agreement, or vested in a party under a leasing agreement (Cape Town Contract).

Where an international interest arises under the Convention, the holder of the interest may optionally register it on the International Registry of Mobile Assets. Registration provides significant benefits as it provides public notice that such international interests exist over the relevant aircraft object. It also determines priority of rights when more than one creditor has a competing right over the same aircraft object. The registry is computer-based and can be accessed at any time; searches can be conducted by anyone, for a fee.

Priority of interests

Priority is determined on the basis of the order in which international interests are entered onto the registry. In addition, someone who has registered his international interest in the register will have priority over someone who has not registered his international interest over the same aircraft object, regardless of when the interest arose.

It is also possible to register future, intended international interests. For the purposes of deciding priority, an international interest which later arises under such prospective registration will be taken to have been registered at the time the prospective international interest was entered/registered onto the Registry.

Default remedies

The Convention provides for certain default remedies to enforce international interests; these include the right to take possession or control of the charged aircraft, to sell or grant a lease of such an aircraft and/or to collect proceeds in respect of the aircraft. With leave of the court, the Convention also permits relief pending final determination of a claim. Relief includes preservation of the aircraft object and its value, and immobilisation of and/or possession, control or custody of the aircraft object. In the event of insolvency of the debtor or airline, remedies may be exerciseable by creditors within certain defined time limits and local courts may not stay proceedings beyond those time periods.

Implementation in mainland China
Given the size and potential of the Chinese aviation market, the coming into effect of the Convention in China is being watched very closely by the aviation industry.

(a) A key declaration adopted by China states that all non-consensual rights or interests under Chinese law will have priority over international interests. Such non-consensual rights include those arising following insolvency of an airline, such as:

· bankruptcy expenses and community debts;

· employee wages;

· taxes arising before the mortgage, pledge or lien of the aircraft;

· remuneration for rescuing the aircraft; and

· fees for the custody and maintenance of the aircraft.

(b) Many of the Convention remedies (e.g. repossession, power of sale) are in the nature of self-help remedies and should not customarily require the intervention or assistance of local courts. China has adopted the Convention subject to the reservation, however, that all remedies require leave or permission of the relevant court to enforce. It remains to be seen whether the court, as an administrative act, will merely sanction the enforcement of remedies once a default by the borrower has been established, or whether the court will exercise other discretionary powers to assess the merits of the case before permitting the exercise of remedies under the Convention.

(d) China has adopted the creditor-friendly Alternative A insolvency option under the Convention. Following a default by a debtor airline, if the debtor airline becomes insolvent and a court exercises its prerogative to stay proceedings against the defaulting debtor airline, such stay of proceedings can not exceed the waiting period of 60 calendar days. After that, the creditor will be free to exercise its remedies (including taking possession of the aircraft object) if the relevant default has not been cured, regardless of whether the debtor airline is at that time solvent. Insolvency of airlines is rare in China, but in the present unprecedented financial climate it can not be said to be improbable. Financiers/lessors will welcome this new development: previously the relevant courts in China had great discretionary powers in staying the taking of any proceedings (preventing repossession, for example) against any insolvent entity in China for unspecified periods of time. This left creditors uncertain as to how long they would have to wait before they can enforce their rights under defaulted contracts.

(e) As to interim relief under the Convention (which refers to relief granted to a creditor before final determination of a claim, as discussed above), China has declared that the relevant people's court will deliver its decision whether to grant such relief within 10 calendar days of receiving the relevant application, with orders to be enforced “immediately”. For other interim relief involving the leasing or management of the aircraft object and the income therefrom, the people's court will deliver its decision on applications within 30 calendar days, and will similarly enforce such orders immediately. Creditors will welcome this measure as it provides much needed certainty as to the speedy action from local courts.

(f) China has declared that the Convention will only apply to cross-border transactions and will not apply to any so-called internal transactions within the PRC. This means that if all the parties to the relevant Cape Town Contract are based in China (that is, if the centre of the main interests of that party is in China) and the aircraft object is located in China at the time of the conclusion of the contract, the rules and principles of the Convention will not apply to such Cape Town Contract. In other words, either (i) at least one party to the relevant Cape Town Contract must be based outside China or (ii) the aircraft object should be located outside China at the time of the conclusion of the relevant Cape Town Contract (presumably the time of due execution by all the parties) in order for the Convention to apply.

(g) China has designated the Aircraft Rights Registry operated by the Civil Aviation Administration of China (CAAC) as the entry point for China. At press time, there is little published information as to the entry point. It remains to be seen what measures China will take to ensure that the international registry and the aviation administration's Aircraft Rights Registry are able to operate side-by-side in harmony. Potential issues that would need to be addressed here include:

· ensuring the two registries are effectively integrated, from an administrative perspective, to provide parties with a single streamlined process and access point for making registrations on both registries; and

· avoiding potential conflicts between filings on the two registries (that is, to avoid the circumstance of an interest being recorded on one but not the other registry, or interests being recorded in different orders in the two registries).

In the United States, the implementation of the Convention has already necessitated amendments to the Transportation Code and Federal Aviation Administration (FAA) Regulations to deal with such issues. Depending on how the CAAC is planning to operate the entry point, legislation clarifying the concerns raised above may be necessary. None have been publicly announced as yet, although it is understood that the CAAC is holding consultations with industry members on this and other related issues.

Conclusion
Many view the ratification and the implementation of the Convention in China as an important step forward in the modernisation and the further growth in the Chinese aviation industry. The actions of the aviation authorities, regulatory bodies and judiciary will greatly determine the impact and success of the Convention in China and thus whether the intent, aspirations and benefits of the Convention manifest themselves fully. Everything depends on exactly how they apply the principles of the Convention.

Paul Ng Wei Han, partner and global head of aviation, Stephenson Harwood