Who Bears the Risk of Loss in Value After an Aircraft is Damaged?

Every lessor has horrifying examples of heavy damage to one or more of its aircraft—the tail strike on takeoff, the hard landing, the landing with the landing gear retracted, the exploding grenade perforating the fuselage, the aircraft leaving the runway and sinking in the mud, etc. Whether the damage constitutes a “total loss” of the aircraft for insurance purposes is often clear, and where not clear the lessor, the operator and the underwriters will negotiate to determine whether to attempt repair or declare a total loss. In these negotiations, the underwriters will generally favor repair (because it is cheaper than paying out the aircraft agreed value) and the lessor will favor declaring total loss (because it wants to receive the agreed value, which is usually in excess of the lessor’s book value). The oft quoted full of thumb is that if the expected cost of repair will exceed 75% of agreed value, then the underwriters will declare a total loss.

In those cases where the aircraft is repaired after heavy damage the airframe manufacturer will be involved in the repair planning and often will perform or manage the repair, and the airframe manufacturer will, at least as a practical matter, be the final arbiter of whether the repair was successful—that is, that the aircraft is airworthy and can be returned to service. But even after a successful repair, the aircraft re-sale value and re-lease value will be less than if the aircraft had not suffered the damage in the first place. Whether the values should be less will depend on the damage and the repair, but in the real world aircraft market an aircraft that has had substantial damage will always suffer a loss in re-sale and re-lease values.

Who should bear this loss in value?

The insurers will, correctly, point out that their only obligation is to pay for the repair.

The lessee will, maybe correctly, point out that its only obligations are to repair the aircraft in accordance with the terms of the lease (which usually provide that all repairs will be performed in accordance with the structural repair manual or otherwise as approved by the airframe manufacturer) and return the aircraft in the required return condition.

It’s at this point that the lessor’s lawyers will be closely reviewing the lease documents for a provision putting the burden of the loss in value on the lessee–which in all fairness is where it belongs. The first stops will be the damage repair provisions and return conditions. Maybe the lawyers will find something–it’ll vary lease to lease.

The next stop will be the general indemnity, which in almost all leases will provide that the lessee will indemnify the lessor for “losses” incurred in connection with the “operation” of the aircraft. The lawyers should also carefully review the exceptions to the general indemnity–an exception for “loss in market value” is a not uncommon exception. Even if the general indemnity looks like it applies, the lessee is certain to argue that its only obligation is to repair the damage in accordance with the lease documents’ damage and repair provisions, and these provisions trump the general indemnity–in other words, the lessor shouldn’t be able to make a claim under the general indemnity where the lessee has fully performed under the specific provisions of the lease documents.

The safest approach is to deal with the issue clearly and expressly in the damage and repair provisions, but you can expect some push back from the lessee during the lease negotiations.