An Aircraft Lessor’s Delivery Commitment: Some Drafting Fundamentals (Part 1)

Delivering an aircraft to a lessee is difficult.  Delivering an aircraft to a lessee in a transition from a returning lessee is really difficult–easily an aircraft lessor’s most challenging task.  And a failed delivery is a disaster.  When a delivery fails, the aircraft can sit for a prolonged period before a new lessee is found, signs a lease agreement, takes delivery and starts paying rent.

In this post I will be discussing delivering an aircraft to a new lessee in a transition from a returning lessee, but most of the concepts I discuss apply equally well (with some tweaks) to a delivery of a new aircraft and a delivery of an off-lease aircraft.

Why are deliveries so difficult for a lessor?

Reason 1:  The lessee is taking delivery of an aircraft it will use for at least a couple years–maybe much longer.  After delivery the lessee wants to avoid, for as long a period as possible, paying for any unplanned maintenance or modifications or having any unplanned downtime.  As a consequence, the lessee is going to be aggressive in its pre-delivery inspections and claimed delivery condition discrepancies.

Reason 2:  So much of a transition delivery is outside of the lessor’s direct control. For putting the aircraft in the required delivery condition the lessor will need to rely on not only the returning lessee, but also possibly on, inert alios, parts suppliers, an engineering firm, the airframe manufacturer and/or an MRO.   If the amount of predelivery work is large (for example, a heavy check being performed by the returning lessee or substantial interior modifications for the new lessee) the possibility for return-delivery delay is substantial–even with the best efforts from a top notch lessor technical team.

Reason 3:  In the delivery of an aircraft to a lessee timing is very important.  In a transition between lessees, the returning lessee wants the lessor to take redelivery as scheduled so that the returning lessee can stop paying rent and go “off risk” for the aircraft; and the lessor wants the new lessee to simultaneously take delivery so that the new lessee starts paying rent and goes “on risk” for the aircraft.  Unfortunately, the new lessee may not (for whatever reason) be willing to take delivery as scheduled and if so the lessor needs to manage both the returning lessee and the new lessee to avoid a gap in rent and risk allocation (as well as a gap in registration and insurance coverage).

With the above in mind, following is a discussion of some “fundamentals” the lessor’s counsel should keep in mind when drafting the delivery conditions and procedures in a lease agreement.  Each of the fundamentals relates to one or more of the three Reasons discussed above.

1. Don’t Overpromise

(a)  Avoid Mismatches

First, each and every delivery commitment by the lessor (e.g., the aircraft will be painted in the new lessee’s livery) should have either a corresponding return commitment from the returning lessee or a clear indication from the lessor’s tech team that the delivery commitment is otherwise achievable.  When I draft or review delivery conditions I usually prepare a matrix (“matrix” is my fancy word for a Microsoft Word table) with three columns and with a row for each delivery condition.  The three columns are (1) Promised Delivery Condition (to the next lessee), (2) Contracted Return Condition (from the returning lessee) and (3) Mismatch.  In the Mismatch column each row should ideally say “None”; if not, there should be an explanation of why the mismatch is ok or how the mismatch is going to be addressed.

And don’t be too creative with your drafting–where your goal is to simply match a return requirement, then (unless you have a very good reason) the wording of the delivery requirement should be a cut-and-paste from the return section of the returning lessee’s lease agreement.  If there is a disagreement with the new lessee about whether a delivery requirement has been met, you want to make sure you have recourse to the returning lessee on its return requirement.  Don’t allow the lessor to get whipsawed between two different wordings that you thought said the same thing.

Speaking of being whipsawed, when matching the returning lessee’s return conditions in the delivery conditions be careful when referring to maintenance intervals and hours/cycle/months remaining (and similar concepts).  In all cases such references should be expressly tied to the returning lessee’s maintenance schedule/program.  I learned that lesson the hard way.

(b) Use Common Sense

If you see a return condition from a returning lessee and have reason to doubt whether it will be performed, then don’t automatically match it in the delivery conditions to the new lessee.  For example, if you see a return condition that says “No part will be older than the Airframe in hours, cycles or calendar time,” before you match that return condition in the delivery conditions check with a lessor tech officer to see whether he or she thinks the returning lessee will actually satisfy that return requirement.  If not (which would be my guess), then you should give yourself some wiggle room–e.g., “no more than 150% of the age of the airframe”–or maybe not have a part-age delivery condition at all.  Another good example is “All Aircraft records will be in English.”  For some returning lessees that return condition is not going to be met–regardless of the what the lease agreement return conditions say.  It may be better to say “All Aircraft records required to be in English by [EASA/the FAA] will be in English.”  The delivery condition matrix mentioned above is helpful for working through these “in practice” mismatches with the lessor tech team; you can go through each row with a  tech officer and discuss whether the returning lessee will meet the return requirement.

(c)  Pre-delivery Modifications

Most lessees of used aircraft will want, before or immediately after delivery, some modifications to the aircraft–because of the lessee’s regulatory requirements, for the aircraft to conform to the lessee’s other aircraft or for some other reason.  There are three options for performing these modifications:

A.  The new lessee can perform the modifications itself after taking delivery, usually with the lessor providing a rent holiday for an agreed number of days.

B.  The returning lessee can perform them during the return maintenance.

C.  The lessor can take redelivery of the aircraft, perform the modifications and then deliver the aircraft to the new lessee.

From the lessor’s point of view, the first option is almost always the best.  The new lessee takes responsibility for ordering the parts, arranging any engineering, scheduling the labor and arranging any regulatory approval in connection with the modifications.  Plus the new lessee takes any risk of delay in connection with the modifications, with the lessor’s loss of rent capped at the agreed rent holiday period.

As between options B and C, the lessor’s preference is going to depend on the facts–the identity of the returning lessee, the returning lessee’s ability and willingness to accommodate the request, whether the modifications can be performed during the scheduled return maintenance (or will the aircraft downtime need to be extended), the added complexity of the lessor taking redelivery and having to register and insure the aircraft during the modification and deal with the regulatory approvals for the mods.  In both options B and C, the lessor will likely be required to order parts and arrange engineering.

Option B is generally my least favorite option.  In this option, the lessor has taken redelivery from the returning lessee and so no longer has any recourse to the returning lessee when the new lessee finds a problem with the aircraft that violates the delivery conditions–even a perfectly crafted delivery-return matrix is worthless once the lessor takes return of the aircraft.  Plus during the modifications the lessor has all the risks associated with the possession of the aircraft–risk or damage and risk of mechanical failure (both of which are real risks even for a grounded aircraft).  And during the modifications the lessor will need to register and insure the aircraft and, depending on the facts, the lessor may need to arrange for issuance of a new export CofA before delivery to the new lessee.

Regarding option C, it will be tempting to avoid option B by asking the returning lessee to perform the modifications, and in fact some lease agreements have a boilerplate provision dealing with lessor-requested maintenance and modifications at return.  But please be careful.  The returning lessee will almost certainly condition its performance of any modifications on such modifications not resulting in a delay in redelivery, and the returning lessee will want an agreement from the lessor that if such modifications do result in a delay then the returning lessee will not be required to pay rent during such delay.  That is a fair request from the returning lessee, but I can tell you from personal experience that the returning lessee will try to tie *any* delay in the redelivery to the performance of the modifications.  For example, “we couldn’t finish the required return check because of the on-going interior reconfiguration that you requested, and then when the reconfiguration was finally done we didn’t have sufficient manpower to finish the check and so redelivery will be delayed for at least two weeks and we won’t be paying rent–oh, and the interior configuration means that we cannot get an export CofA without having the new configuration approved by our aviation authority and that approval will take several weeks (during which we won’t be paying rent)–unless of course you’re willing to waive the requirement for an export CofA.”  Sometimes having the returning lessee do the work is the best option (it may be the only option), but the lessor’s tech team needs to be heavily involved in the returning lessee’s return planning and execution–it’s not just a matter of the lawyers getting the drafting right.  And, of course, don’t commit option C to the new lessee until you have a written agreement with the returning lessee in which the returning lessee agrees to perform the modifications.

Finally, you’ve probably noticed that I haven’t mentioned which party bears the cost of these modifications.  Clearly the returning lessee will not bear any costs.  As between the lessor and lessee, the burden of these costs is a matter for commercial negotiation, but note that option A is the only effective way for a lessor to cap its costs.

Option A is also the best way to avoid over-promising on modifications.

Wow, this post is already over 1,700 words and I’ve only made it through one fundamental.

To be continued in Part 2.

The Importance of Transaction Checklists

I’m a big believer is developing and using checklists in connection with legal work in general, not just in connection with transaction closings.  And to that I’m sure a lot of you will say “no duh, Brad.”  But in my experience many lawyers don’t use checklists even in connection with transaction closings and those that do often prepare the checklist just a couple days before the scheduled closing–often too late to effectively manage what needs to get done.  Instead I suspect many lawyers and paralegals rely on memory, email chains, Post It notes, and the conditions precedent sections of the relevant documents.

A well thought out transaction checklist prepared early in a transaction (at the latest when primary transaction documents are agreed) will allow a lawyer to spot logistical, commercial and other issues well in advance of the closing.  It will also provide a central location for keeping track of the status of the checklist items, developments and changes in the transaction and any other ideas and thoughts relevant to the closing of the transaction.  A checklist is also a great way to share information among the lawyers and paralegals on a deal.

When I see a young lawyer or paralegal overwhelmed with the logistics of an upcoming closing my advice is usually something like this:  “After the transaction documents are signed, closing a deal is relatively easy.  Make a detailed list of all the things that need to get done for the deal to close, and then make sure each item gets done.  That’s it.  Look at each item on the list at least once every day and ask yourself ‘what can I do to move this item forward right now?’ and then do it.  Closing a deal involves a finite number of steps; you just need to identify them and make sure they get done.”

Here’s a link to a New Yorker article about checklists.  The article is about the use of checklists in the medical profession, which use is unfortunately not as prevalent as you may expect (and hope).  (The article also has an interesting discussion of the introduction of checklists for pilots.)  Below is an excerpt about a medical checklist:

“In 2001, though, a critical-care specialist at Johns Hopkins Hospital named Peter Pronovost decided to give it a try. He didn’t attempt to make the checklist cover everything; he designed it to tackle just one problem, the one that nearly killed Anthony DeFilippo: line infections. On a sheet of plain paper, he plotted out the steps to take in order to avoid infections when putting a line in. Doctors are supposed to (1) wash their hands with soap, (2) clean the patient’s skin with chlorhexidine antiseptic, (3) put sterile drapes over the entire patient, (4) wear a sterile mask, hat, gown, and gloves, and (5) put a sterile dressing over the catheter site once the line is in. Check, check, check, check, check. These steps are no-brainers; they have been known and taught for years. So it seemed silly to make a checklist just for them. Still, Pronovost asked the nurses in his I.C.U. to observe the doctors for a month as they put lines into patients, and record how often they completed each step. In more than a third of patients, they skipped at least one.

“The next month, he and his team persuaded the hospital administration to authorize nurses to stop doctors if they saw them skipping a step on the checklist; nurses were also to ask them each day whether any lines ought to be removed, so as not to leave them in longer than necessary. This was revolutionary. Nurses have always had their ways of nudging a doctor into doing the right thing, ranging from the gentle reminder (“Um, did you forget to put on your mask, doctor?”) to more forceful methods (I’ve had a nurse bodycheck me when she thought I hadn’t put enough drapes on a patient). But many nurses aren’t sure whether this is their place, or whether a given step is worth a confrontation. (Does it really matter whether a patient’s legs are draped for a line going into the chest?) The new rule made it clear: if doctors didn’t follow every step on the checklist, the nurses would have backup from the administration to intervene.

“Pronovost and his colleagues monitored what happened for a year afterward. The results were so dramatic that they weren’t sure whether to believe them: the ten-day line-infection rate went from eleven per cent to zero. So they followed patients for fifteen more months. Only two line infections occurred during the entire period. They calculated that, in this one hospital, the checklist had prevented forty-three infections and eight deaths, and saved two million dollars in costs.”

I’ll come back to this topic later and discuss checklists for other legal tasks, like document review.