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A Step to Go Further in Aviation Deals: Due Diligence of an Aircraft Lease

05 February, 2020

Aviation is a huge industry where many airlines operate aircrafts by virtue of leasing. According to the International Air Transport Association (“IATA”), since the 1980s, when aircraft operating leases[1] represented less than 5% of the overall aircraft operating market, the number of aircraft operating leases has grown significantly[2] and airlines have realized the advantage of aircraft leasing; adding aircraft to the current fleet for a convenient period of time, without the economic risk of aircraft ownership[3]. In 2017, IATA predicted that approximately half of the all aircrafts worldwide will be under an operating lease in the next decade[4] .

A lease is a contract between a lessee, a lessor, and sometimes a third-party financier, where the lessor grants the lessee the use of an asset for a specific period of a time in exchange for predetermined and regular lease payments. Lease agreements in the aviation industry generally include the term of the lease, monthly lease payments, required maintenance, and return condition for the aircraft, termination conditions, and whether or not there is an option for the lessee to purchase the aircraft for a discounted price at the end of the lease term[5].

No doubt that those provisions are not enough to consider the risks in an aviation lease deal which may occasionally arise and requires due diligence. We have highlighted some other issues below that may have crucial results not only limited to the lease agreements themselves but also the decision-making process of pricing in a merger - acquisition deal of an aviation company.

Assignment and Sublease

Lease agreements generally stipulates assignment restrictions which in principle prevent one or both parties from assigning its rights and obligations determined under the contract to any other third party. Assignment clauses aim to prevent any change on the identity of the lessee. However, considering the future business plans of the investor after the transaction, assigning the lease agreements may be necessary. In that case, amendment arrangements on assignment clauses have to be made before the deal or necessary guarantees have to be obtained from the target.

Change of Control Clause

The provision of change of control is a clause to protect the same level of business capability, generally, in favor of lessor. Such lease agreements with change of control clauses have to be included in the scope of the due diligence deal comprising of a guarantee provided by the target upon the consent of the lessor in order ensure that there is no obstacle risking such transaction. Otherwise, the investor’s expected fleet may be downsized after the transaction, since such deal without the consent of lessor will be deemed as an event of default in terms of the lease agreement. To avoid such consequences, the consent of lessor has to be obtained by the target before the transaction.

Sanctions & Export Regulations

Investors should also consider any legal restrictions stipulated under lease agreements on their relevant trade activity being conducted with specific countries or individuals during the due diligence process. Most of the lease agreements include a restriction regarding transaction or relations with Specially Designated Nationals (SDN) and Blocked Persons defined by The Treasury Department’s Office of Foreign Assets Control (OFAC[6]) or Export regimes of the relevant countries. Moreover, even the process of the due diligence may result in liability in terms of restrictions and sanctions for the parties.

Governing Law and Jurisdiction

To assess potential risk regarding lease agreements, the governing law is one of the main aspects to be considered. Since the terms provided in the lease agreements determines whether the event of defaults in addition to applicable laws in case of any dispute, an assessment should be conducted in terms of the specific legal system which is directed under the disputed lease agreement. If such legal system is not comfortable for investor as the potential due diligence conductor aiming at transferring the company or merging, an amendment regarding the clause of governing law should be included in the scope of the due diligence deal comprising of a guarantee provided by the target to be made before the transaction. As a proof of having less restricted ground while amending the lease agreements as one of the core aspects of the due diligence reports, due to the common law system and the freedom of contract principles, most common preferred governing laws of lease agreements are New York law and English law .

On the other hand, the expenses and costs which may be incurred during the legal procedures must be highlighted as they may be considered as considerable burdens for the parties and may vary from country to country. Therefore, while outlining the general risks which may be faced regarding the lease agreements, change of the jurisdiction in the contracts may be considered to reduce such possible court expenses and litigation costs.

[1] For more information on the aircraft operating leasing, please see; http://www.herdem.av.tr/aircraft-operating-leasing-in-turkish-law?utm_source=Mondaq&utm_medium=syndication&utm_campaign=LinkedIn-integration#_ftn3

[2] For more information on the growth of aircraft leasing industry, please see; Vitaly S.Guzhva/Sunder Raghavan/Damon J.D’Agostino, Aircraft Leasing and Financing, Principles Of Aircraft Leasing Versus Ownership (Chapter 3), 2019, p. 66.

[3] International Air Transport Association, Guidance Material and Best Practices for Aircraft Leases, Montreal-Geneva, 2017, p. xvi.

[4] International Air Transport Association, ibid., p. 1.

[5] Vitaly S.Guzhva/Sunder Raghavan/Damon J.D’Agostino, ibid., p. 76.

[6] “The Office of Foreign Assets Control administers and enforces economic sanctions programs primarily against countries and groups of individuals, such as terrorists and narcotics traffickers. The sanctions can be either comprehensive or selective, using the blocking of assets and trade restrictions to accomplish foreign policy and national security goals.” For more information on OFAC, please see; https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_general.aspx#basic

Author: Aslı Naz Ünlü

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