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Posted November 8, 2011 3:40 PM
By Fay Sanders

Loophole in aircraft mortgages poses threat to lawyers and financiers

Top aircraft finance lawyers are in talks with UK government ministers to resolve a major loophole in English law aircraft mortgages. A working group of UK aviation lawyers, which was set up in August by Philip Shepherd QC of London-based barristers chambers XXIV Old Buildings to tackle inconsistencies in English law brought to light following the Blue Sky One Ltd case last year.

English law currently dictates that when a title is transferred from an aircraft or aircraft engine, the validity of the mortgage is determined by the laws of where that entity is situated, otherwise known as lex situs. The Blue Sky case involved PK AirFinance US Inc.’s attempts to repossess two of six Boeing 747-400s it had been leasing to UK group Balli Aviation, which had defaulted on its loan repayments. However, a UK High Court found that the mortgage was invalid since one of the aircraft had been located in Amsterdam at the time it was purchased and it also failed to be recognised by Dutch law.

It is understood that the lex situs working group is currently in discussions with the Department for Business, Innovation and Skills (DBIS) as to how to address concerns raised by the Blue Sky case and that a decision is expected later this month.

The DBIS is focusing on whether to move forward with ratifying the Cape Town Convention; an international treaty designed to facilitate the financing and leasing of aviation equipment by reducing creditor risk and improving legal predictability, two sources close to the situation told this news service.

However, although some UK proponents of the Cape Town Convention view the treaty as an opportunity to deal with lex situs, there is debate as to whether Cape Town ratification on its own removes the problem. "The Cape Town Convention can only fix lex situs if it is ratified by all relevant countries,” said Gavin Hill, aviation finance partner at Vedder Price London. “It applies if the debtor is situated in a contracting state or if the aircraft is registered in a contracting state, so ratification by the UK would not be a fix for many transactions; such as an English law secured financing of a Japanese-owned aircraft that is leased to a Dutch airline and registered in The Netherlands."

It is still unclear as to how the government would rectify the lex situs issue, but the working group is understood to be making a number of suggestions, including the possibility of adopting a new law.

Meanwhile, aircraft financiers and their lawyers are viewing the repercussions of the Blue Sky Case with “a degree of panic,” according to Paul Briggs, head of aviation at UK-headquartered law firm Bird & Bird. “Steps are being taken to create new mortgages wherever possible unless there is concrete evidence that existing mortgages were validly created in accordance with lex situs principles,” he explained.

It is not uncommon for aircraft to fly extra legs exclusively to be within UK airspace when a mortgage is closed, but this practice is widely considered unattractive from a commercial perspective. For example, in a deal completed last month, it is understood that Emirates declined to fly its new Airbus A380 (MSN 077) through UK airspace via Hamburg, so the transaction had to be carried out using New York law mortgage.

In certain cases, second English law mortgages are being created or if there is any uncertainty then a New York law mortgage is required, Briggs noted. “English law is often the governing law of choice for business people and financiers throughout the global aviation industry but if a New York law mortgage is required, there is a risk that all transaction documents will be governed by New York law which could have a pre-eminently damaging effect on the London aviation legal and financing community,” he said.

In a further twist, some US law firms have been actively contacting their clients to warn them away from aircraft mortgages under English law, one UK aviation lawyer noted. “There has been a definite movement of financiers switching from English law mortgages to New York law mortgages since last year,” he said, adding that this poses a distinct worry for London-based law firms.

Even if the Cape Town Treaty were a viable solution, “the London industry could be permanently damaged by the time UK ratification is effective, according to Briggs, who stressed the situation is “urgent”.

By Fay Sanders

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