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International registry goes live with registrations of fractional shares in aircraft

published in Business Leasing and Finance News | July 1, 2007

This article, written by David G. Mayer  (Patton Boggs) with contributions by Bruce Marshall (Bombardier) and Frank Polk  (McAfee & Taft), first appeared in Business Leasing & Finance News, July 2007, Issue 67 (“BLN”), and is reprinted here with the permission of BLN.

The old adage of, “Be careful what you ask for, you may get it,” may apply to the new registration system for fractional or partial interests in aircraft on the International Registry in Dublin, Ireland (“IR”). Starting June 6, 2007, the IR initiated service that allows owners to register their ownership of a fraction or partial interest in an “aircraft object.” Similarly, the lenders or lessors, among others, may register up to 15 different interests in that fractional share or portion of a whole aircraft object.

*Terms to Know: The Cape Town Convention created the IR. The related Aircraft Protocol extends the Cape Town Convention to “aircraft objects” worldwide to ratifying nations, including fractional shares. The Cape Town Convention and the Protocol together create an international “Treaty.” The term “aircraft objects” refers to aircraft certificated for at least eight seats (including crew), helicopters certificated for at least five seats (including crew) and engines rated with at least 1,750 pounds of thrust or 550 horsepower. The Treaty relates to “international interests” in aircraft objects, which 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). An “administrator” means the person with authority to act on behalf of the registry user on matters dealing with the IR under Section 2.1.1 of the Regulations for the International Registry (2005) (Regulations). A “transacting user entity” (TUE) refers to the legal entity or natural person intending to be named a party in one or more registrations at the IR under Section 2.1.11 of the Regulations.

The Fractional Share Registration

Although the original IR software did not include registration of fractional shares or partial ownership of aircraft objects, the new software changes permit such registration.

Previously, the parties to a transaction involving fractional or partial interests could not register fractional shares. As a result, the fractional industry, led by NetJets, Flexjet and Citation-Shares, created a “Subordination and Disclaimer Agreement” to establish priority and rights in fractional shares or partial interests. For more on the status of the IR’s development and progress, see International Registry Poised to Implement Fractional Share Registrations, by David G. Mayer, Business Leasing and Finance News (March 2007).

How Fractional or Partial Ownership Will Be Registered on the IR

Aviareto, the entity appointed to administer the IR, enhanced the software at the IR to enable owners and financiers to register their respective interests in a fractional share or partial ownership of an aircraft object. After extensive testing, the software became operational on June 6, 2007, and the IR is now available for the registration of fractional and partial interests in aircraft and engines.

*Tip: TUEs that use an Oklahoma City law firm or title company known to the IR may speed up signup of an administrator for the TUE.

One of the changes in standard IR procedures is that every TUE must designate a “backup contact” who can be consulted if the IR has any problems or disputes with regard to an account. The “backup contact” must be someone other than the administrator but does not have to be an employee of the TUE.

The backup contact never has access to IR or an approved account or right to work on IR. The IR has instituted procedures to speed up approvals of administrators by IR staff (to about a day or two) if the application to establish an account is made by a law firm or title company who is experienced in this area and has already gone through a certain level of diligence with the IR.

The IR system now allows a party to identify each fractional share (or partial interest) owned by any person by name and assigned percentage of interest (up to six decimal places). For example, if a purchaser of a fractional interest buys a one-half fractional share of the whole aircraft object, its interest will be shown on the IR as “50.000000%” of the whole aircraft (in decimals, not fractions). The fractional share will be registered in the name of the owner of the share. The IR will denote the original purchase of the share or partial interest as a “contract of sale.” Any financing will be denoted as an “international interest.”

The new software includes the following features:

Check the Box – appears on the “Register, Amend or Discharge Interest” page at IR and indicates a “fractional or partial interest” transaction is being registered;

16 Different Interests – listed on drop down-box of fractional interests that may be applied to each fractional interest (or partial interest), which should be same as interests that may apply to whole aircraft;

Prospective Use Only – users will not be able to partially discharge an interest created before the “go live” date (June 6, 2006);

Multiple Transactions – IR provides “Add” and “Remove” buttons to keep the “shopping” list correct or allow users to remove/correct errors. Users can check a list and get “Request Authorisation to work on Aircraft Objects,” called “multiple transactions, single listing”; (the “Authorisation Request confirmed” page will show multiple interests and will be available later in the IR’s “phase II” work on the registration software).

FAQs – a new feature is provided on the “List interests with status and give consent” page to help users better navigate the Aviareto;

FAA Authorization Code – to enter IR provided by the FAA on “Register, Amend or Discharge Interest” page at IR; and

Consents – other parties consent to registration under link under “Register or Consent to Interest” with respect to each fractional or partial ownership interest.

*Tip:
The IR has also updated its manual “User Documentation, Information and Reports” by adding “quick guides,” which are checklists to assist IR users to register transactions correctly.

No IR Policing on Registrations

Owners may actually register a percentage of ownership or rights that exceeds (or is less than) their real interests. In other words, the 50 percent financier could register an international interest in 80 percent of the aircraft object even though the registration exceeds the owner’s 50 percent interest.

Similarly, if a lender has registered an international interest in an aircraft on the IR, the system will reflect what percentage interest has been released and the remaining interest held by the lender as all or any portion of that international interest is discharged on the IR. For example, if a lender takes an international interest (i.e., a lien) in an undivided 50 percent interest in the aircraft and then discharges (releases) a 25 percent interest in the aircraft, the IR will show that lender has released a 25 percent interest in the Aircraft and retains a lien on an undivided 25 percent interest in the aircraft.

The IR system does allow a party to designate a sale or financing (lien) or lease of a fractional interest in an aircraft or an engine. However, there are no controls that stop a party from selling or granting liens that exceed a 100 percent interest in the aircraft. This functionality is consistent with the original design of the IR and similar systems such as the UCC. It relies on the parties to a transaction to file and register their interests correctly.

*Technical Points: Because both parties to a sale or financing must consent to the registration of a particular interest, this type of error should not occur, in the absence of a mistake or fraud. If a mistake occurs, the parties should be able to correct the mistake by the registration of a sale of the excess interest back to the seller and a lender could make a partial discharge of the excess international interest that it obtained by mistake.

The IR takes the view that it does not control or police the percentage of interest registered by transaction parties. The question is whether a fractional or partial owner could fraudulently or mistakenly transfer or finance an interest greater than the interest it actually owns. Although the intentional misuse of the IR is unlikely, both fractional owners and financiers alike could use the IR to create a mismatch between actual ownership and registered ownership.

*Warning: If the parties cause or permit a mismatch to occur between actual ownership and registered ownership and interests, the parties should take quick action to resolve the problem.

If the parties fail to voluntarily correct the error in registration, the parties who have been wronged may have to take legal action to rectify the record. The problem becomes serious if not resolved because Article 29(1) of the Cape Town Convention establishes priorities in aircraft and engines based on the order in which IR registrations are made, potentially allowing a party without the valid ownership or interest to have priority over the parties that does have valid ownership or interest and create a dispute over rights or interests and/or cloud title on the aircraft object.

*Tip: When buying or financing an interest in an aircraft or engines, the transaction parties should diligently examine the records of the FAA as well as review underlying documents that support the seller’s or debtor’s claim to an interest in an aircraft and/or engines. Additionally, in making corrections to the IR records, watch out for such transfers that could have other implications such as sales, use and property taxes or re-registration of the aircraft in question at a national registry such as the FAA.

Article 7 – Formal Requirements – of the Cape Town Convention provides in Article 7(b) and “Comment 5” that a “chargor” (debtor), conditional seller or lessor (and the Protocol adds the seller to this list) must have the “power to dispose” of the aircraft and engines to have a valid transfer. If the parties can prove that the transferring party does not, under applicable law, have the power to dispose of the interest to effect a transfer, the IR registration should be invalid at least with respect to the erroneous portion of interest.

*Terms to Know: The “power to dispose” covers “every form of disposition encompassed within the power and relevant to the transaction between the debtor and the creditor, whether taking the form of a grant of security interest, a sale under a reservation of title or a lease.” It includes “the right of disposal, as where the debtor [a lessee or borrower], seller or lessor is either the owner of the object or authorized by the owner to dispose of it.” The power to dispose is broader than a right to transfer or convey an interest in property. It can arise under the Cape Town Convention or under national or local law. See Official Commentary, By Professor Sir Roy Goode, International Institute for the Unification of Private Law (UNIDROIT) (2002) at 66-67.

An owner under applicable law can dispose (transfer or convey) of all or a portion of a fractional or partial ownership interest in an aircraft. The whole point of the registration system and the IR is not to throttle the parties’ rights and actions to register interests and rights, even if not correctly completed, but rather to “give transparency as the existence of international interests and other registrable interests and to avoid secret interest.” See Article 7, Comment 5 at 67 of the Official Commentary.

Mitigating the Risks of Mismatching Interests and Rights

The parties can and should mitigate the risk of incorrect registrations if they:

Use caution to match the ownership and financed interests so the registration always reflects correct international interests and ownership on the IR;

Confirm that the interests reflected in the IR are also reflected in the records of the FAA and if they do not you need to start asking questions and conducting additional diligence;

Keep a spreadsheet, if you are a fractional program sponsor, of all interests relating to an aircraft object on a spreadsheet program so you can sort the transaction history, interests, contracts of sale and discharges, together with the assigned “file numbers” at the IR, to make sure no incorrect (excess or shortfall) registration of interests in the whole aircraft objects occur at any time;

Purchase title insurance when any mismatch occurs and extra protection seems imperative in your transaction, which puts the risk on the title company that the true interests will prevail in a dispute over title or the perfection and priority of a lien; and

Add further assurance provisions to the purchase documents for the programs that specifically require corrections must be made on notice and at the expense of the party who made the error.

Conclusion

Fractional share or partial interest owners and their financiers can now register their respective interests or ownership on the IR 24 hours a day, every day of the year. With attention to the details, the fractional owners and their financiers should be able to use the IR routinely to protect their rights, ownership and international interests. However, they will have to be careful not to register a slice of the aircraft object pie that is larger (or smaller) than the one in which they actually have an interest.

David G. Mayer is the editor of BLN and a partner at Patton Boggs, Dallas office.  Bruce Marshall is Director of Legal and Contracts at Bombardier’s Flexjet.  Frank Polk is a shareholder and the senior member of McAfee & Taft’s Aircraft department.

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