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.

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.

“Except as Otherwise Provided Herein” and Aircraft Lease Agreement Disclaimers

A common drafting comment in contract negotiations is “can we add ‘except as otherwise provided herein’ at the beginning of this sentence?”

My usual (admittedly suspicious) response when the comment is directed at my draft is always “what do you have in mind, what section in this document ‘provides otherwise’?”

If the lawyer on the other side cannot (or will not) give a good example, my response to the request will be “no.”  If the lawyer can provide a good example, then I will try to limit the exception to the example provided.

Usually a lawyer will request the “except as otherwise provided herein” exception where the drafting involves a broadly drafted waiver or limitation of liability–usually near the back of the contract where the wording is often boilerplate.  And the lawyer on the other side will say it is unreasonable for a boilerplate provision to trump a specific commercial agreement contained elsewhere in the contract.  Sounds like a fair comment, right?

If you are requested to add this exception to your draft, my advice is:  be very careful.

An example:

As discussed in another post the purpose of the disclaimer in an aircraft lease agreement is to place, as between the lessor and the lessee, all risk and responsibility for the condition of the aircraft after delivery on the lessee.

A not uncommon lessee comment on the lease agreement disclaimer is “can we change it to read ‘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 except as otherwise provided in this lease agreement?”

Like I said above, this comment sounds fair, but with this suggested addition the lessee’s lawyer may be trying to make the lessor’s obligations as to the aircraft delivery condition survive the delivery.

Although many lease agreements are (surprisingly) not very clear on this issue, the lease agreement disclaimer is intended to relieve the lessor from all responsibility with respect to the promised delivery condition of the aircraft–once the aircraft has delivered.  In other words, once the lessee has inspected the aircraft and signed the acceptance certificate (with or without waiving certain delivery conditions), the lessee should have no further rights under the provisions of the lease agreement dealing with the delivery condition of the aircraft (in the absence of a specific negotiated agreement with the lessor–which would be unusual).

In this context the more problematic delivery conditions are those that look past the delivery date.  For example, an engine delivery condition that says that each engine will have least a certain number of hours of operation until the next anticipated removal–or an AD compliance condition which provides for the lessor to clear AD for a certain period of time after delivery.  But even delivery conditions that relate only to the delivery date are fair game for the lessee if, notwithstanding the acceptance certificate, such conditions were in fact not met on the delivery date AND the disclaimer is not clear that the lessee has no recourse under the lease agreement’s delivery conditions once the lessee has accepted the aircraft.

Consequently, if you get the request to add “except as otherwise provided in this lease agreement” anywhere in the disclaimer I strongly suggest you follow the general advice above by asking the lessee’s lawyer what “other provisions” he or she has in mind.  If the answer is “the delivery conditions” then the answer should be a strong “no.”

A couple additional related notes:

  1. You may remember the ACG vs. Olympic Airlines case from a few years ago. My reading of the case, including the underlying transaction documents, is that an “except as otherwise provided in this lease agreement” clause in the disclaimer was a material factor and issue in the dispute.  Plus the lease agreement had some very vague delivery conditions (the aircraft would be “airworthy” and “in a condition for safe operation”), allowing the lessee to claim, credibly, that the aircraft was in fact not in the agreed delivery condition on the delivery date.  If you Google “ACG Olympic Airways” you’ll see lots of links to the court opinions and discussions about the case.
  1. It is common practice to address delivery condition discrepancies in the aircraft acceptance certificate, usually by allowing the lessee to return the aircraft with the same discrepancy or with the lessor agreeing to rectify the discrepancy post-delivery. When drafting rectification language, the lessor’s obligations should be drafted so that compliance can be achieved objectively and unilaterally by the lessor, without agreement or cooperation by the lessee (e.g., “Lessor will deliver to Lessee’s base a replacement armrest within 60 days after the Delivery Date”).  The rectification language should not say something like “Lessor will cause the Aircraft to comply with the delivery condition in Section [__] within 60 days after the Delivery Date” because, among various other reasons, the disclaimer in all likelihood (unless drafted very broadly) will not apply to that provision and the lessor’s agreement could be read as an ongoing warranty of compliance with that delivery condition.