Aircraft Finance: Cape Town Convention to Further Strengthen Bermuda’s Hand

Aircraft Finance: Cape Town Convention to Further Strengthen Bermuda’s Hand

Bermuda is firmly established as the offshore jurisdiction of choice in aviation finance; however, one missing piece in the jigsaw puzzle within this sector has been the non-implementation in Bermuda of what is known as the Cape Town Convention. The Cape Town Convention on International Interests in Mobile Equipment and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment (together the “Convention”) came into force on 1 March, 2006. The Convention facilitates aircraft finance transactions by providing a regularised electronic international registry of “international interests” over moveable property (the “International Registry”), such International Registry being recognised in all Contracting States (being countries which have implemented the Convention). The Convention also sets out a framework for dispute management as well as remedies and relief available to creditors.

The UK government had already announced that it was committed to ratifying the Convention, but the timing had not been set. On 27th July 2015, the United Kingdom submitted its instruments of ratification of the Convention to the official treaty depositary. In accordance with the treaty timetable, the Convention will enter into force in the UK on 1st November 2015.Thereafter, the proposed extension by the UK to overseas territories such as Bermuda means that the Convention should come into force in Bermuda very soon afterwards. There are a number of steps to be taken before the Convention can be implemented as part of Bermuda law, but those who work in this area in Bermuda are already engaged in the task of aligning relevant domestic law with the Convention as part of such implementation process.

The importance of the Convention in relation to aircraft finance transactions is that it changes the way in which interests in aircraft and aircraft engines are documented, recorded and enforced, with the following advantages:

• Electronic registration “24/7” of an international interest in relation to an aircraft object (i.e. aircraft, airframe and aircraft engines) on the International Registry, providing an efficient and always accessible registration process, with greater transparency, allowing any registered interests to be publicly searched, identifying any competing interests in relation to the asset.
• Upon registration of an international interest such registered interest takes priority over subsequent registrations in respect of the same security and against any unregistered interests, with these simple and clear “first to file” priority rules only being varied by registration of subordination arrangements on the International Registry.
• International interests over airframes can be registered separately from interests over aircraft engines, which is helpful given the inevitable changes which result in any long term aircraft operations.
• The International Registry records irrevocable de-registration and export request authorisations (“IDERAs”), which provide the creditor with essential tools in any enforcement situation.
• Creditors can utilize clear enforcement rights, which are based on common law self-help remedies (not requiring a court order to enforce, as would otherwise be the case in many civil law jurisdictions), including taking possession or control of the secured asset, selling or granting a lease over the asset and/or collecting or receiving any income or profits resulting from the management or use of the asset.
• Registration provides certainty and a reduction in costs in the event of repossession of an aircraft or aircraft engine on an insolvency or default where the secured asset is located in a country whose laws otherwise make repossession difficult or impossible.
• Borrowers should see a discount in interest costs made available in countries which have the Convention in operation or are Contracting States, being the so-called ‘Cape Town Discount’, with airlines from such countries eligible for a discount of up to 10% on the premium of export finance provided by export credit agencies.

There have been issues surrounding how to effect a valid Bermuda law mortgage, with the lex situs rule established by recent case law confirming that the validity of the mortgage is based on the lex situs of the aircraft, being the law of the physical location of the aircraft at the time of execution of the mortgage. As a result of such case law, steps have frequently been taken to appropriately position an aircraft when a mortgage is entered into, adding to the operational and economic costs of the transaction. The Convention does not expressly address common law issues determined under the proper law of the mortgage instrument and, as such, there has been some uncertainty as to whether the lex situs rule would now be irrelevant. The UK’s response to this issue has been to include a provision in the draft International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 (the “Regulations”), which will serve to expressly override lex situs considerations when a mortgage is entered into to for which the Convention applies. Should the Regulations come into force in the UK as currently drafted, and provided that the Convention applies, this will dispel uncertainty under English law and avoid the requirement for aircraft to enter English airspace at the time of entry into an English law mortgage. Similar provisions are under consideration in Bermuda and it is likely that domestic legislation adopted by Bermuda in connection with the Convention will include wording of this nature, such that there will be no requirement to determine whether a proprietary right has been validly created or transferred pursuant to the common law lex situs rule; an international interest will have effect so long as the conditions of the Convention are satisfied.

The ratification of the Convention in Bermuda will inevitably impact on domestic law, in particular as it relates to the creation and registration of security over aircraft objects. However, the procedure by which an aircraft is registered on the Bermuda register of aircraft is likely to remain unaffected. Registration of a mortgage at the Bermuda Department of Civil Aviation will still be possible and provide the primary means by which a secured party registers its interest over an aircraft where the Convention does not apply.

The uniform legal framework provided for under the Convention will be welcomed by all parties to aircraft finance transactions using Bermuda incorporated borrowers, with simplified, lower cost, lower risk cross border transactions able to be effected, with immediate registration on the International Registry being permissible, notwithstanding any time zone differences between the parties. Creditors will be able to avail themselves of the rights and remedies enshrined in the Convention, with greater certainty as to the method and consequences of enforcement. The ratification of the Convention in Bermuda, by bringing the jurisdiction in line with the standardised approach adopted elsewhere, can only further enhance Bermuda’s position as a key player in the aircraft finance arena.