An Aircraft Lessor’s Delivery Commitment: Some Drafting Fundamentals (Part 2)

Picking up from the end of Part 1.

2. Don’t Make Vague, Un-Qualified or Open-Ended Delivery Commitments

Common Examples:

“The Aircraft will be in good condition.”

“All damage to the Aircraft will have been repaired.”

“The Aircraft will be ready for immediate operation by Lessee in Lessee’s normal operations.”

Let’s talk about each of the above.

“The Aircraft will be in good condition.”  What is “good condition”?  Does it mean “satisfactory to Lessee”?  Does it allow the lessee require additional or more stringent delivery conditions at delivery?  The goal for the lessor in the delivery conditions is agreeing a set of requirements that are achievable (don’t overpromise) and, just as important, objective.  If a lessee were to ask me to add this delivery condition, my response would be “Let’s agree a detailed set of delivery conditions that will make you comfortable that you are getting a satisfactory aircraft, but I can’t promise you the aircraft will be in ‘good condition’ because I don’t know what that means or requires.”

“All damage to the Aircraft will have been repaired.”  Really?  All damage?  Even the scratch on the underside of the armrest in row 23?  The requirement should be re-drafted as follows:  ” All damage to the Aircraft outside of maintenance manual limits will have been repaired in accordance with the SRM or as approved by the Airframe Manufacturer.”

“The Aircraft will be ready for immediate operation by Lessee in Lessee’s normal operations.”  This one is scary.  Does it mean that the lessor has to make the aircraft comply with all operational requirements of the lessee’s regulatory authority (even though the lessor promised only an FAA- or EASA- compliant aircraft)?  Does it mean that the lessor has to outfit the aircraft with lessee’s standard safety and galley equipment?  Does it mean that other parts (avionics, wheels and brakes, etc.) need to be swapped to the lessee’s standard to allow use “in Lessee’s normal operations”?  My response to this request would be the same as above:  “Let’s agree a detailed set of delivery conditions that will make you comfortable that you are getting a satisfactory aircraft, but I can’t promise you that you will be getting an aircraft that is ready for immediate operation in your ‘normal’ operations because I don’t know what that requires.”

3. Don’t Commit to Perfect Tender

It’s rare that an aircraft, even a new aircraft delivered from the manufacturer, meets all of the agreed delivery conditions.  In a transition between lessees it’s almost certain that there will be delivery condition discrepancies.  Different lessors address this issue in different ways, but the basic point is that the lease agreement should provide that the lessee cannot refuse acceptance of the aircraft when tendered by the lessor other than because of “material” delivery condition discrepancies.  The definition of “material” is going to be a discussion item with the lessee and it should be addressed in the lease agreement–and not left for delivery.  My standard approach is to say that the lessee may not refuse acceptance so long as the lessor has complied with its obligations regarding an export certificate of airworthiness (or certificate of airworthiness) and the aircraft is capable of being used by the lessee in its commercial operations–note not “normal commercial operations,” just “commercial operations.”  (The lease will also need a mechanism for the correction of the discrepancies post-delivery, the preferred mechanism (from my POV) being that lessee rectifies the discrepancies after delivery with the lessor to reimburse the lessee for the lessee’s out-of-pocket costs (or for an amount agreed in the acceptance certificate).)

Often during these negotiations the lessee will point out that the lease agreement requires “perfect tender” at redelivery, but not at delivery.  Why is that?  Well, my usual response is that “the lessee has control of the aircraft during the lease term, is responsible for arranging the return maintenance and part of its business is managing aircraft maintenance; on the other hand, the lessor is primarily a financier of aircraft and, in a transition, is relying on the previous lessee to perform its obligations–consequently the lessor should not be held to the same perfect tender standard.”  While I think that this argument is a good one, I do have some sympathy for the lessee’s point of view on this issue–and have agreed from time to time to apply a “materiality” standard at return, but only so long as the new lessee is willing to accept the aircraft with the return discrepancies without the lessor incurring any incremental costs.

4. Give the Lessor Adequate Time to Perform

As I discussed in Part 1 of this post, in a transition of an aircraft between lessees so much of the work required to make the transition successful is outside the control of the lessor–and so the lessor should have an extended grace period during which the lessor can satisfy the delivery conditions.  In addition, a short grace period for the lessor’s delivery obligations may encourage the lessee to “run out the clock” by delaying inspections, delaying comments on the condition of the aircraft, providing serial (daily) comments, nitpicking the condition of the aircraft, etc. until the grace period has expired and the lessee is able to terminate (or renegotiate) its obligations.  Keep in mind that a failed transition really is a disaster for a lessor because in most cases it will result in the aircraft being on the ground (and not earning rent) for a significant period of time–and so an extended grace period is a necessity for a lessor.

What’s the right grace period for a delivery?  From three to six months (possibly longer).  From the lessor’s perspective the minimum amount of time will depend on a lot of factors, including the reputation of each of the returning lessee and the new lessee for competence and fair dealing and the type and amount of work to be performed at return and for the new lessee.  Any factors that add to the uncertainty should result in the lessor pushing harder for a longer grace period.

Like with the perfect tender issue, the lessee will likely point out during these delivery grace period  negotiations that the lessee has no (or a very short) grace period in its obligation to return the aircraft in the required return condition at the end of the scheduled lease term.  The issues here are the same as the perfect tender issues discussed above, and like the above I do have some sympathy for the lessee’s “mutuality” argument so long as the delay in return does not adversely affect the next lessee’s obligation to lease the aircraft.

5. Don’t Give Away Money

During the delivery delay negotiations the lessee will often ask for a per diem “delay penalty” payment–for example, if the delivery if delayed for more than 30 days from the scheduled delivery date, then the lessor will pay the lessee an agreed amount for each day of delay in excess of 30 days.  If you get this request from a lessee, first, you should highlight to the lessee that a delay will likely have negative economic consequences for the lessor as well.  Second, keep in mind that a delay in delivery may be, at least in part, caused by the new lessee’s delay in accepting the aircraft–and the lessor’s agreement to pay a delay penalty to the lessee may only encourage further delay.  Third, also keep in mind that if the returning lessee believes the delay in return is being caused by the lessor (e.g., because of additional return work requested by the lessor) or by the new lessee (e.g., by the new lessee’s unreasonable demands) then the returning lessee may, rightly or wrongly, stop paying rent before return, in which case the loss of rent together with the penalty to the new lessee will be a double financial blow to the lessor.

What do I suggest?  If the returning lessee is obligated to pay a penalty in connection with a delay in the return of the aircraft, offer to share that amount with the lessee if and when actually received from the returning lessee.  Otherwise each party should bear its own costs of delay.

And of course under no circumstance should the lessor be obligated to pay the lessee for the lessee’s “losses” in connection with a delayed delivery.  The lease agreement should in fact expressly provide that under no circumstances will the lessor be liable for any such losses.  The foregoing should go without saying, but you should be careful about the interplay between the lessee’s delivery condition condition precedent and the language of the delivery procedures–for example, I have recently seen in a signed lease agreement (paraphrasing) “Lessor will not be liable for any losses of lessee incurred in connection with a delay in delivery (other than caused by a failure of Lessee’s conditions precedent to be met).”  Since one of the lessee’s conditions precedent was that the aircraft be in the required delivery condition, the lessor is this deal indirectly (and I’m pretty sure unknowingly) agreed to pay for the lessee’s losses in connection with any delay in delivery caused by the failure of the aircraft to meet the required delivery condition.

To sum up, as lessor’s counsel you should make sure the lease agreement’s delivery procedures and conditions are drafted so that your client (1) knows exactly what is required, (2) has the capability to meet the requirements, (3) has sufficient time to meet the requirements and (4) is not penalized for delay.

That’s it for now.