• Countdown to Cape Town: March 1 Begins a New Era in Aviation Finance
  • February 20, 2006 | Author: David G. Mayer
  • Law Firm: Patton Boggs LLP - Dallas Office
  • Most people who understand aircraft finance probably do not understand the Cape Town Convention. But ready or not, on March 1, 2006, the Cape Town Convention will enter into force. It will, together with the related Aircraft Protocol, apply to nearly every aircraft financing and sale transaction that occurs in the United States and in many other parts of the world.

    What Is the Cape Town Convention?

    The Cape Town Convention refers to "The Cape Town Convention on International Interests in Mobile Equipment" (Cape Town or CT). For aircraft, the related law is called the "Protocol to the Convention on International Interests in Mobile Equipment on Matters specific to Aircraft Equipment (Cape Town, 2001)" (Protocol). Cape Town and the Protocol work together as one body of law and are, in this article, called the Cape Town Treaty. The Cape Town Treaty provides uniform laws to facilitate aviation finance, leasing and purchasing worldwide.

    Which Countries Have Ratified the Cape Town Treaty?

    Eight countries must ratify the Protocol for the Cape Town Treaty to enter into force and the last of the eight, Malaysia, ratified the Protocol in November 2005. The other seven countries that ratified the Protocol consist of the United States, Ireland, Ethiopia, Nigeria, Oman, Pakistan and Panama. See U.S. Ratifies Cape Town Convention, by David G. Mayer, Business Leasing News (Dec. 2004). Another country, Senegal, ratified the Cape Town Treaty on January 9, 2006.

    *Tip: The Cape Town Treaty (as a whole) enters into force in a country that ratifies it, called a Contracting State, on the first day of the month following the expiration of three months after the date of the deposit of its instrument of ratification, acceptance, approval or accession regarding aircraft objects. As a result, the Cape Town Treaty will become effective for Senegal on May 1, 2006.

    What Is the Essence of the Cape Town Treaty?

    The Cape Town Treaty fundamentally provides notice to the world of interests in aircraft equipment in support of aircraft asset-based financing transactions. It covers "international interests" in commercial aircraft, aircraft engines and general aviation assets, including corporate aircraft and helicopters, referred to generally as "aircraft objects." CT creates a simple registration process and creditor-friendly laws for secured transactions and sales of aircraft objects. The Cape Town Treaty provides that the first to register wins in a contest for priority in an aircraft object. Creditors and debtors will register interests in aircraft objects electronically, at one central registry in Ireland called the "International Registry." As an electronic notice filing only, no documents will be filed at the International Registry. The Federal Aviation Administration (FAA) will remain the national registry in the U.S. and the "point of entry" to the International Registry for aircraft ownership to be registered in the United States.

    *Tip: An organization called Aviareto operates the International Registry. According to its web site, "Aviareto, a joint venture between SITA SC and the Irish Government, has a contract with the International Civil Aviation Organization (ICAO) to establish and operate the International Registry as required by the Cape Town Treaty. The company draws on the joint strengths of SITA and the Irish aviation sector. As part of the implementation process for the Cape Town Treaty, the Secretary General of ICAO issued a global tender in January 2004 for an organisation to establish, and act as Registrar for, the International Registry. Aviareto, based in Dublin, Ireland, performs these functions on a not for profit, cost recovery basis, as required by the Cape Town Convention." ICAO is the "Supervisory Authority" of the International Registry. Article 17(2) of the Convention and Article XX(5) of the Protocol describe its functions. The International Registry will be available electronically (by computer) at http://www.internationalregistry.aero/ when it goes "live."

    The Devil Is in the Details

    As the old saying goes, "the devil is in the details" under the Cape Town Treaty. It includes many definitions of crucial importance, as well as provisions that may seem simple but carry significant complexity and substantive rights. One extremely important definition is "aircraft object." An aircraft object refers specifically to:

    • Engines -- 550 rated takeoff horsepower or more or 1750 pounds of thrust

    • Airframes -- certified for 8 persons or carries in excess of 2750 kg (6063 lbs)

    • Helicopters -- certified for 5 persons or excess of 450 kg (992 lbs)

    • Fractional shares of the above

    The term "international interests" in aircraft objects is another core term under the Cape Town Treaty. It refers to rights that may arise under a security agreement (an agreement that grants rights in collateral), lease agreement or title retention agreement (such as a conditional sale). For more on the definitions, rights, remedies and interests under Cape Town, see The Cape Town Convention: New Complexities and Opportunities, by David G. Mayer and Frank Polk, LNJ's Equipment Leasing Newsletter (Oct. 2005).

    *Warning: The failure to understand and perfect your interests in an aircraft object under the Cape Town Treaty can destroy the priority of your interests and/or dramatically reduce the value of your rights in or title to an aircraft object. As an organization involved in aircraft finance, leasing and/or selling, you should assure that your counsel understands the registration procedures and the substantive laws in the Cape Town Treaty. Without the right help, it will be more difficult to achieve a competitive edge in the market, retain your intended rights, title and interest in your aircraft object on and after March 1, 2006, and avoid serious errors in your transactions. The Cape Town Treaty will not apply to any transaction that closes before March 1, 2006, unless you make changes to the existing transactions that create a new international interest (e.g., a mortgage lien) or provide for an international interest (e.g., a purchase option in a lease) in the aircraft object. A second lien or even a subordination arrangement can create a new international interest and trigger the provisions of the Cape Town Treaty. All proposals, commitments, lease documents, loan documents and security agreements should change to accommodate the Cape Town Treaty requirements. A "further assurances" clause without more substantive provisions for post-March 1, 2006 transactions will generally be inadequate and potentially detrimental to aircraft owners and financiers under the Cape Town Treaty.

    What Value Does the Cape Town Treaty Create?

    Cape Town is expected to reduce the cost of financing available to airlines and general aviation, create uniform laws in each ratifying country (Contracting State) and assist parties in buying, selling, leasing and financing aircraft and engines. For example, Cape Town creates laws on perfecting and filing interests in aircraft as well as on defaults, remedies, insolvency, priorities, title and aircraft deregistration. See Aviation Finance Players Focus on Potential Impact of Cape Town Convention, David G. Mayer, Business Leasing News (March 2005).

    *Tip: Stay tuned to the impact of other countries ratifying the Protocol. Once a country becomes a Contracting State, you may need to change your financing, leasing and/or purchasing strategy or documentation. You may be able to obtain approvals for transactions that you previously could not secure. You should study the rights each country adopts under the Cape Town Treaty, as each country can select certain provisions through "declarations" that will enter into force or not enter into force on important issues such as bankruptcy-type relief.

    What Are Seven Steps to Registering Under the Cape Town Treaty?

    The Cape Town Treaty will apply to most aircraft transactions in the U.S. Where do you start? Here are seven steps, through questions you should ask, to determine generally when to register your aircraft objects under the Cape Town Treaty:

    Step 1: Is your transaction a lease, sale or financing of any aircraft object?

    • If no, stop; CT and the Protocol will not apply.

    • If yes, continue toward registration under the Cape Town Treaty.

    Step 2: Is the aircraft object registered in a Contracting State (a country that ratified Cape Town)? OR

    Is the debtor, borrower, lessee, or conditional or other buyer situated in a Contracting State?

    • If no to both questions, stop; the transaction falls outside of the Cape Town Treaty and is subject to local law and other applicable conventions, if any.

    • If yes to either question, continue toward registration under the Cape Town Treaty.

    Step 3: After March 1, 2006, did your transaction create or provide for a new international interest (such as a lease), "registrable non-consensual interest" (such as a vendor's lien) or "prospective international interest" (a right to security interest in the future) of either (1) creating a new international interest in an existing transaction OR (2) by entering into a new transaction creating an international interest, registrable non-consensual interest or prospective international interest.

    • If no to (1) and (2), stop; this transaction is subject to U.S. or other national law and not the Cape Town Treaty.

    • If yes to either question, proceed with registration under the Cape Town Treaty and national law filings.

    Step 4: If your transaction is subject to the Cape Town Treaty, identify employees or representatives with authority to use or arrange for the use of the International Registry in transactions. Each named transaction party, as shown in a registration, are called "transacting entity user" (TUE).

    *Tip: As a creditor or debtor in a transaction subject to the Cape Town Treaty, such as a lessor, in an aircraft lease transaction, confirm, at the inception of a transaction, that the lessee and lessor (TUEs) each:

    • Appoint an "administrator" for the deal such as a trusted employee or representative (who may be an employee or a non-employee of the lessor/lessee/debtor/TUEs);

    • Arrange for the administrator to appoint users of the International Registry (who must be employees of the TUE); and

    • Consider appointing a professional user entity (PUE), such as a title company, law firm or professional services provider, that regularly use the International Registry and, as a result, will probably offer greater efficiency, accuracy and speed than a TUE in effecting registrations at the International Registry.

    *Technical Point: You can find the rules on TUEs, RUEs and PUEs in the regulations for the International Registry.

    Step 5: Check all "declarations" at the International Registry for the Contracting State applicable to your transaction to determine your substantive rights and remedies.

    Step 6: Negotiate proposal, commitments and documents taking into account all prior steps and provisions of Cape Town and the Protocol that should be included in these documents.

    Step 7: Search the International Registry before closing for conflicting interests. Then, if the registry is clear, register electronically in accordance with procedures at the FAA and International Registry. Concurrently, file conveyance documents for recordation at the FAA at funding/closing.

    *Tip: Use the last days of this countdown to Cape Town to read the Cape Town Treaty thoroughly. Locate knowledgeable counsel. Appoint your administrators immediately. Test your access to the International Registry. Seek all approvals to use the International Registry. You will not have access without the International Registry's approval. Expect some delay and technical difficulty with the International Registry as it ramps up in the early days to handle a substantial, perhaps overwhelming, volume of registrations.

    Conclusion

    The Cape Town Treaty created the International Registry system. The system is a unique, untested and, for many people, a difficult challenge. Even with the right help, financing and leasing transaction closings may slow down for a while until the aviation finance community figures out how to use this complex yet promising international law in the pursuit of profitable aircraft financing, leasing and sales business worldwide. However, one point is clear and certain: The Cape Town Treaty will change how business in aviation finance is done, forever, starting March 1, 2006.

    *Warning: Do not wait until March 1, 2006 or assume that Cape Town works like any other filing system. It is more like the Personal Property Security Act electronic filing system in Canada than the Uniform Commercial Code (UCC) system in the U.S. Using parallels to the UCC may help orient you to the new process, but avoid any substantive comparisons.