The “No Increased Obligations” Condition in the Assignment Section

Absent unusual circumstances it is standard for the Lessee to take “day one” structure risk and “change in law/circumstance” structure risk throughout the lease term. As a practical matter, what this means is that if (1) tax withholding is imposed on rent payments (and the lessee must therefore gross up), (2) foreign exchange controls make payments more difficult or expensive or (3) any other requirement (legal or otherwise) is imposed on the lessee in connection with its performance of the lease agreement or its use of the aircraft, then the risk and burden of that requirement is on the lessee.

Aircraft lessors are fond of using the real estate leasing term “triple net lease.” In real estate a triple net lease is one in which the real estate lessee agrees to pay the following three (hence “triple”) costs (1) real estate taxes, (2) insurance costs and (3) maintenance costs related to the property; but in both real estate and aircraft leasing “triple net lease” is also used generically to mean that, as between the lessor and the lessee, the lessor bears no asset, operational or performance risks under the lease agreement.

Aircraft leases being “triple net leases” is a core concept of the aircraft leasing business and any deviation from that concept should be allowed only for compelling reasons.

That said, one exception to the “triple net lease” concept is often made in connection with the assignment of the lease by the lessor (usually accompanying the sale of the aircraft by the lessor or an affiliate). The assignment section of most lease agreements will contain a provision saying something like (paraphrasing):

“As a condition precedent to the lessor’s assignment of the lease, the lessee’s obligations under the lease will not, as determined at the time of the completion of such transfer, increase as a consequence of such transfer.”

That’s fair. The lessee should not be required to bear increased obligations as the result of a transfer to, say, a lessor based in another jurisdiction.

But now let’s look at a couple ways that lessors screw up this provision.

1. In the paraphrase above, note the clause “as determined at the time of the completion of such transfer.” This clause is key for at least a couple reasons.

First, if it is omitted a large part of the risk of change in law (post transfer) is shifted to the lessor if the new lessor is in a different jurisdiction from the transferring lessor. For example, if, post-transfer, tax withholding is imposed on lessee payments to the new lessor’s jurisdiction (and not to the old lessor’s jurisdiction), then the lessee will not be obligated to gross up. (I suspect some lessees would see not grossing up as the fair result, but it is contrary the concept of an aircraft lease being a triple net lease; that is, change in law is not a risk that aircraft lessors should take–either in a de novo lease or an assigned leases.)

Second, by not tying the “no increased obligation” condition to the time of transfer, the new lessor leaves itself open to spurious and not so spurious defenses for the rest of the lease term.

2. The “no increased obligation” condition should be just that–a condition, not a covenant. Once the lease transfer is accomplished, the condition should fall away and no longer be an operative provision (at least until the next transfer). I’ve seen some lessors fail spectacularly on this issue, not only making the “no increased obligation” provision a covenant but going on to give the lessee an explicit defense to performance, setoff rights, an express indemnity and lease termination rights if the lessee does have increased obligations.

Maybe I shouldn’t be so critical. Aircraft leases are commercial transactions and an outsider will never know about all the tradeoffs involved in a negotiation, but I suspect that a lessor which agrees to an on-going “no increased obligations” covenant in a transferred lease would never agree to take change in law/circumstance risk in a lease it originates.