Tag Archives: Aircraft Purchase Agreement

The Definition of “Engine Basic Shop Visit”

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I used to joke with a friend that “I’ll be 70 years old and still negotiating the definition of ‘Engine Basic Shop Visit’ on a daily basis.”

That was at least 15 years ago and while “on a daily basis” was an exaggeration, that term (some lessors use “Engine Performance Restoration” or similar terms) is still the most important defined term in most aircraft lease agreements and it is (no doubt about it) the defined term that the lessor’s lawyers and tech officers will look at most often after delivery (and usually while under stress–“oh, please let it say what I need it to say”).

The term should be used sparingly in a lease agreement.  In a previous post I have noted that the term should not be used in return conditions–because the definition usually sets a high standard for the restoration workscope and the main point of the relevant return condition should be on-wing time remaining to the next performance restoration (of any sort)–not on-wing time remaining until the next full performance restoration.  The same logic applies to the delivery conditions, though using the defined term in the delivery conditions would benefit the lessor–unless the delivery conditions uses a “time since” standard for the engine delivery condition.

In lease agreements that I draft the term will usually appear only in the provisions related to maintenance reserves and/or return compensation.  In the maintenance reserve provisions the defined term will be the trigger for when the lessor reimburses reserves.  In the return compensation provisions it will be the trigger for when the hourly return compensation payment from the lessee starts to accrue.  In both cases the lessor will benefit from a high standard.

The definition of ” Engine Basic Shop Visit'” that I use has four components:

1. Workscope. The threshold question in drafting the definition is whether the maintenance reserve/return compensation trigger will be the overhaul of any listed engine module or an overhaul of a set (or all) of modules required.  This issue is usually addressed by the tech and financial officers of the lessor and the resolution will be driven by the expected condition of the engine at delivery and the performance restoration reserve balance for the engine.  (If the “modular approach” is used, then the reserve/return compensation/lessor contribution provisions will need to be drafted to allocate the relevant amounts (usually on a percentage basis) among the modules.)

2. Engine Manufacturer Manuals and Guidelines. The performance restoration should be performed in accordance with the relevant engine manufacturer manuals and guidelines.  The lessor’s tech officers should provide (or at least review) the description of the relevant engine manufacturer manuals and guidelines.

3. Performance Standard. Here is a requirement that I often do not see in lessor’s lease agreements.  The workscope has been agreed with the lessor and the performance restoration has been carried out in accordance with the agreed engine manufacturer manuals and guidelines, but the EGT margin from the test cell after the performance restoration is the same as before the performance restoration.  Should the completion of the performance restoration be a sufficient trigger for purposes of a maintenance reserve reimbursement or return compensation reset?  No, it shouldn’t.

So, I suggest adding a performance standard that requires the performance restoration :

fully restores [the Engine’s/such module’s] performance and service life using the workscope defined in the Engine Manufacturer’s [Engine Management Program and the Engine Manufacturer’s Engine Manual] and so that the EGT margin is (a) at least the average EGT margin that is expected in the industry for an engine of the same model as the Engine fresh from performance restoration (determined on the basis of the Engine Manufacturer prescribed test cell conditions and procedures prevailing at the time of such shop visit) and (b) such that such Engine can reasonably be expected (as determined by the Engine Manufacturer if Lessor and Lessee fail to agree) to run for the average meantime between performance restorations (based on Engine Manufacturer data) for engines of the same model as the Engine

4. LLP Build Standard. The definition should require a minimum LLP build standard, the minimum to be based on the expected run-time between overhauls.  In other words, you don’t want the run-time requirements discussed in 3 above to be undercut by the engine being driven off-wing for an LLP replacement before the next anticipated performance restoration.

Some lessors may argue that 3 and 4 above are unnecessary so long as the lessor has a consent right over the planned workscope.  I don’t think that is right.  A consent right give you no protection over a failed performance restoration and a consent right will likely lead to a negotiation where the lessee will ask for additional (outside of the contract) contributions for what the lessee’s will describe as enhancements to the workscope not required by the lease agreement.  (Nonetheless, somewhere in the lease agreement the lessor should be given consent rights over each performance restoration workscope.)

Random notes:

1. For references to performance restoration where a high standard is not required, I suggest just using “performance restoration” (not defined) or using “Performance Restoration” as a defined term and defining it as follows: “means the off-wing maintenance of an Engine where, as a result of an overhaul or performance restoration, useable life is restored to the engine.”  As always, when using defined terms the drafter and reviewer each needs to be cognizant of both the definition and how it is used–when in doubt, search for the defined term throughout the document and make sure it is being used consistently–and, in each case, to your client’s advantage.

2. In two-way return compensation provisions, you will also need to provide for the “time since” calculation at delivery. As mentioned in a previous post, my preference is (where possible) to specify the date of the last relevant maintenance visit–rather than rely on a definition or description of the prior visit.

Cross-Operational Indemnities in Aircraft Purchase Agreements

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Despite often referring to themselves as “aircraft suppliers,” aircraft lessors are more accurately described as aircraft financiers who also take residual aircraft value risk. In an aircraft lessor’s perfect world, the lessor would never take possession of an aircraft or become involved in the manufacture, configuration, maintenance, repair or operation of an aircraft–because all of those things open the lessor up to claims from a lessee and possibly from third parties in the case of an accident involving the aircraft. In general, aircraft lessors will go to great lengths to avoid taking any risks associated with the physical (as opposed to financial) aspects of an aircraft.

The Disclaimer and General Indemnity sections of the lease agreement reflect this distancing of the lessor from the aircraft. The Disclaimer and General Indemnity sections of an aircraft lease agreement provide that, respectively, (1) as between the lessor and the lessee, once the aircraft is delivered to the lessee, the lessor has no responsibility or liability with respect to the condition of the aircraft and (2) during the lease term the lessee will bear all risks and costs, and will indemnify the lessor for all claims, arising out of the operation, maintenance, etc. of the aircraft. Lessees understand this allocation of risk and responsibility, and it’s rarely questioned in any meaningful way during the negotiation of the lease documentation. “Lessors don’t take operational risk” is a fundamental tenet of the aircraft leasing business.

And so I’m always surprised when I’m working on an aircraft purchase agreement and the lawyer on the other side (representing another aircraft lessor) says “my client insists on cross-operational indemnities in the purchase agreement.” Cross-operational indemnities in this context mean that (simplifying) the seller indemnifies the buyer for claims arising out of the operation of the aircraft prior to the purchase and the buyer indemnifies the seller for claims arising out of the operation of the aircraft after the purchase.

Here’s the seller half of a cross-indemnity (redacted) from a draft agreement I reviewed (representing the buyer):

Without prejudice to the disclaimers in Clause 7 (Condition of Aircraft), the Seller shall indemnify the Purchaser in full on demand on a net after-Tax basis in respect of all Losses suffered or incurred by the Purchaser or any of its officers, directors, employees, servants, representatives or agents arising out of or connected in any way with . . . the purchase, manufacture, ownership, possession, registration, performance, transportation, management, sale, control, use, operation, design, condition, testing, delivery, leasing, maintenance, repair, service, modification, overhaul, replacement, removal or redelivery of such Aircraft, or any loss of or damage to the Aircraft, or otherwise in connection with the Aircraft or relating to loss or destruction of or damage to any property, or death or injury to any Person caused by, relating to or arising from or out of (in each case whether directly or indirectly) any of the foregoing matters and regardless of when the same arises or occurs, or whether it arises out of or is attributable to any act or omission, negligent or otherwise of the relevant Purchase . . . provided that such indemnities shall not extend to Losses . . . to the extent that such Losses arise out of any occurrence or event which occurs after Delivery in respect of such Aircraft.

There was a mirror indemnity given by the purchaser.

In this particular transaction, the aircraft was being sold subject to lease. So, my first question was “why do we need cross-indemnities given that, pursuant to the lease novation, both the purchaser and the seller will be covered by the lessee’s operational indemnity and by the lessee’s insurance?” I also pointed out that as aircraft lessors we usually strenuously try to avoid ANY operational risk on aircraft, but in the draft we are each expressly taking broad, unlimited operational risk for an aircraft operated by a third party. The actual response I received: cross-indemnities are “standard.”

A better response would have been something like “cross-indemnities just fairly allocate existing risk between the purchaser and the seller, they don’t create any risk that isn’t already there.” Well said, but (1) do the cross-indemnities really allocate the risk fairly and (2) would the parties be better off without the cross-indemnity? The same question another way: Does the before-after split really allocate the risk fairly?

One example: seller and buyer agree to cross-indemnities using the above wording and the sale/purchase of the leased aircraft closes. The aircraft crashes and there are lawsuits for injury/death and property loss. Neither the seller nor the purchaser was at fault (no negligence or other misconduct), but the jurisdiction where the aircraft crashed is a strict liability jurisdiction that imposes liability on the owner of the aircraft regardless of fault (e.g., Sweden last time I checked). The cause of the aircraft crash was faulty maintenance by the operator that occurred prior to the sale of the aircraft. Without the cross-indemnities, the purchaser, as owner at the time of the crash, would bear the full liability for the crash (as between the purchaser and the seller); with the cross-indemnities, the seller bears the full liability. Reasonable people could argue about which is the “fair” result, but for the seller the cross-indemnities definitely created an operational risk that it did not have before (once it sold the aircraft).

Another example: Same as the above except the lessee had a history of sloppy recordkeeping of which the seller was aware, but the seller did not tell the purchaser. The crash–in a non-owner strict liability jurisdiction–was the result of bad recordkeeping that occurred after the sale of the aircraft. The purchaser was wholly unaware of any recordkeeping problem. The seller is sued because it was aware of the sloppy recordkeeping, and the seller makes a claim under the cross-indemnity. The cross-indemnity would put at least some (and possibly all) of the seller’s liability on the purchaser–an unfair result in my opinion.

My preference in purchase agreements is to not include operational cross-indemnities and, by remaining silent, to make each party responsible for managing its own liability with respect to the aircraft–regardless of whether that liability could be characterized as arising before or after the sale.

What about naked aircraft (that is, aircraft not on lease at the time of sale)? I think it is the same answer. Parties should manage their own liability (through insurance, prior and future operator indemnities, due diligence, etc.) without assuming broad, uncapped liability under cross-indemnities in a purchase agreement.

P.S., bonus points to those of you who paused on clause “Without prejudice to the disclaimers in Clause 7 (Condition of Aircraft), . . .” in the quoted language above. Yes, I too wonder how that would undercut the seller’s indemnity. Even without that clause, I think you still have a possible conflict between the seller’s disclaimer and the seller’s cross-indemnity. The above clause would make more sense if it said “Notwithstanding the disclaimers in Clause 7 (Condition of Aircraft), . . . .”

The Description of Aircraft in Purchase Agreements

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Here is my nomination for the “most overlooked important issue in an aircraft purchase agreement”: What exactly is the seller selling and the buyer buying?

I often see purchase agreements that have a definition of “Aircraft” in the definition section that reads as follows (paraphrasing):

“Aircraft” means one Boeing 737-800 aircraft bearing manufacturer’s serial number xxxxx, together with two Engines [defined elsewhere] and all parts, accessories, etc. installed on the aircraft on the Delivery Date.

Sometimes the definition will go into more detail by referring to a schedule to the purchase agreement which will contain APU and landing gear model and serial numbers. Sometimes the definition will also have a reference to “all associated aircraft documents.”

Now, if the aircraft is off lease, parked and available for inspection by the buyer, maybe the above summary description will not lead to any material disagreements later (although I would add to the above definition “in the condition as inspected by buyer on [date]”).

But if the aircraft is on lease and is being sold subject to lease or being sold upon return from lease then I think it is very important for both the buyer and seller (especially the buyer) to insist on a detailed description of the aircraft in the purchase agreement.

Keep in mind that most purchase agreements do not have a delivery condition or delivery inspection section. At most the purchase agreement will have a provision saying the buyer is not obligated to buy the aircraft if the aircraft has suffered damage in excess of an agreed threshold since the buyer’s inspection signoff. So, if an issue arises at closing about what is included with the aircraft, the buyer will have no “out” from its obligation to buy the aircraft.

When the aircraft being purchased is subject to lease, an acceptable shortcut description for the aircraft may be as follows (paraphrasing):

“Aircraft” means one Boeing 737-800 aircraft bearing manufacturer’s serial number xxxxx, together with two Engines [defined elsewhere] and all parts, accessories, etc. installed on the aircraft on the Delivery Date, as more fully described in the Lease Agreement and Lease Acceptance Certificate.

But of course then you need to be satisfied with the description of the aircraft in the lease documents. Hopefully the acceptance certificate in the lease has a LOPA, loose equipment list, document list, etc.

A real life example: I was doing due diligence on an aircraft purchase where the aircraft was subject to a lease and was going to remain on lease after purchase. The aircraft had been purchased by the seller new from the manufacturer as part of a sale-leaseback with the lessee. The lease agreement had the generic return condition requiring the aircraft be in the same configuration at return as at delivery, but otherwise the lease had no description of the aircraft (not really surprising given the aircraft was ordered from the manufacturer by the lessee). The lack of information about the aircraft was making me nervous and then I looked at the lease acceptance certificate and saw that the aircraft was delivered from the manufacturer with no passenger seats. When I kicked this issue back to the commercial people it turned out that neither the buyer nor the seller had realized that the aircraft was going to be returned from the lessee with no seats (and the lessee was well aware of this fact).

If you conclude that a detailed description of the aircraft is needed in your transaction, the next questions are (1) who is going to prepare the description and (2) how detailed does it need to be. I think the description has to be a joint effort between legal and technical and in most cases it can consist of references to existing documents, with the level of detail to be determined on a case by case basis–the goal not being absolute precision, but to avoid surprises later on.

Finally, if the aircraft is being sold subject to lease, you should consider whether you need/want the lessee to confirm (in the novation agreement) the agreed description of the aircraft.