The Applicability of the Cape Town Convention to Changes to an Existing Transaction
By Erin Van Laanen and Maria Gonzalez
The Convention on International Interests in Mobile Equipment (the “Convention”), as supplemented by the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment (the “Protocol”) (collectively, the Cape Town Convention or “CTC”), is a set of laws designed to streamline perfection, priorities and remedies for lessors, lessees, buyers, sellers and financiers of aircraft equipment. The CTC applies to a transaction when, at the time of conclusion of the agreement creating or providing for the relevant CTC interest, the debtor or seller is situated, or the aircraft is registered, in a contracting state. Often the original transaction will undergo some type of change, such as an extension or modification, adding or removing equipment from the transaction, or assigning or novating the transaction in favour of a new party. This article discusses various scenarios where the previously documented and completed transaction undergoes changes, and under what circumstances the CTC applies to those changes.
This chapter assumes that the underlying transaction fell within the scope of the CTC when it was originally concluded (unless otherwise indicated) and that the transaction documents are governed by United States law.
Assignments and Novations
The rules regarding assignments and novations under the CTC are complex, and at times confusing. The CTC defines an assignment as “a contract which, whether by way of security or otherwise, confers on the assignee associated rights with or without a transfer of the related international interest”. Under applicable local law, an assignment may create a novation (which is typically a three-party document where the assignor is released from all obligations and the assignee and debtor or lessee enter into a new agreement between themselves); however, the CTC does not define the term “novation”. Under the CTC, the characterisation of the document is determined by its terms as viewed in relation to the CTC. Over the ten years that the CTC has been in place, best industry practice in the United States has resulted in the following treatment of assignments and novations under the CTC.
In order for an assignment to fall under the CTC (whether it be an outright assignment or an assignment for security or collateral purposes), the assignment must assign the “associated rights”, which are defined in the Convention as “all rights to payment or other performance by a debtor under an agreement which are secured by or associated with the object”. Article 32 of the Convention sets out the formal requirements for an assignment of associated rights that transfer the related international interest: the assignment must (i) be in writing, (ii) enable the associated rights to be identified under the contract from which they arise, and (iii) in the case of a security assignment, enable the obligations secured by the assignment to be determined in accordance with the Protocol. If an assignment does not also assign the associated rights, then it is ineffective under the CTC to transfer the related international interest (i.e. where a new debtor steps into a transaction, as discussed below).
Determining whether an assignment should be considered a novation can be a tricky matter. Therefore, in order to ensure that the assignee is properly perfected in the case of an assignment or novation (whether the change in the creditor is under a security agreement or a lease agreement), the safest approach is to make the following registrations on the International Registry created by the CTC (the “IR”): (i) register an assignment of the original international interest by the prior creditor, as assignor, in favour of the new creditor, as assignee; and (ii) register a new international interest between the new creditor and the debtor. The reason for this approach is that if the assignment is considered a novation under the CTC, then the registration of an assignment of the original international interest has no effect, since the original interest is considered terminated. If the assignment is considered a novation under the CTC and the parties do not register a new international interest, the rights of the new creditor would not be properly perfected. The only way to ensure that the new creditor is properly perfected is to register both the assignment of the underlying international interest and a new international interest. This approach may seem duplicative; however, since there is no definitive interpretation as to how a court would view the registration of an assignment if the assignment is considered a novation, the best approach is to do both registrations.
An assignment made in conformity with CTC formalities transfers to the assignee the related international interest and retains all priorities of the assignor thereunder. Alternatively, a novation creates a new international interest between the assignee/creditor and the debtor. Therefore, questions can arise in connection with novations when there is an existing international interest (such as a lease) which would take priority over the new international interest created by the novation. In this instance, a subordination of the prior interest to the new interest is the proper course of action instead of discharging and re-registering the prior interest. The reason is that discharging the prior interest and re-registering that interest after the new novated interest, without underlying documentation and agreement among the parties, could call into question the effectiveness of the re-registered interest (since there would be no writing to support the discharge and re-registration of the prior interest).
The concept of assignment under the CTC is not relevant to the scenario where a new debtor steps into the transaction. Where an assignment only affects the current debtor under a registered interest (i.e. a new lessee or grantor is stepping into the transaction), then no assignment should be made (however, a security assignment of a lessee’s interest is a registerable interest). The reason is that an international interest is created by a creditor (not a debtor) and only a creditor retains associated rights that may be assigned under the CTC. Therefore, in the instance when a new debtor is stepping into the transaction by way of assignment, a new international interest should be registered between the existing creditor and the new debtor. The original international interest with the original debtor can either be discharged or left in place. Unless there is a compelling reason to discharge the original interest, most parties leave the original interest in place until the transaction has been terminated in due course.
Where a transaction is subject to an assignment or novation, it is important to determine if the right to discharge any existing interests needs to be transferred to the assignee, so that the relevant interest can be discharged at the proper time by the true party in interest (see chapters by McAfee & Taft in earlier editions of this publication, which address the right to discharge in more detail).
Finally, under United States law, when making new international interest registrations in connection with a change in a transaction, it is necessary to file any supporting documentation with the Aircraft Registry of the Federal Aviation Administration (the “FAA”), as the designated authorising entry point, in order to obtain a proper unique authorisation code for the new international interest registrations.
Extensions and Renewals
Careful examination is necessary in connection with any amendment to a credit agreement, security agreement or lease in order to determine whether such amendment will have an impact under the CTC. The CTC does not specifically address extensions and renewals but the Official Commentary (Third Edition) to the CTC (the “Commentary”) states that an amendment may give rise to a new international interest, which will not be protected by the initial registration but is required to be separately registered. Based on the Commentary, an extension or renewal creates a new international interest that must be registered in order to protect the priority of the creditor’s position in relation to the extension or renewal period. While this may seem to be a redundant act (since the original international interest has already been registered), the concept behind the additional registration is that an extension or renewal is a new obligation that needs to be registered in order to perfect the interests created thereunder.
While some amendments will give rise to new international interests, others will not, and it is important to recognise the difference between the two. The main difference between an amendment that will and one that will not give rise to a new international interest is whether the amendment materially alters or fundamentally changes the underlying documents to such an extent that the amendment is essentially creating new obligations not previously covered by the underlying document. On the other hand, if the amendment is merely changing the method of payment, the maintenance or insurance provisions, or documenting a name change for the creditor or debtor, those amendments will not give rise to new international interests.
Under the CTC, if an amendment gives rise to a new international interest, then the creditor must register the new interest in order to properly perfect its interests, since the new interest created by the amendment would not be protected by the initial registration. Amendments that extend payment terms, extend a lease term, increase the loan amount or extend a security interest to an obligation not previously secured, are examples of the types of amendments that would give rise to a new international interest, and such amendments would not be protected by the initial international interest registrations. The common factor among these types of amendments is that the original international interest is in some way enlarged, and those additional obligations are not protected by the original international interest.
A refinancing or amendment to a credit agreement that extends the maturity date or increases the amount of the loan would also give rise to new international interest, and such rights thereunder would not be protected by initial registrations. (This should be contrasted with an amendment to a security agreement or credit agreement that provides for a further advance which is already secured by the agreement; in such case, the amendment would not give rise to a new international interest because the further advance is already included in the obligations that were secured with the original international interest.) As noted above, if the relevant aircraft is registered in the United States, the parties will also need to amend the underlying security agreement, and file the amendment with the FAA in order to comply with the United States’ entry point requirement to obtain the required unique authorisation code. Once the FAA has issued the code, the parties may then proceed to register the new international interests on the IR.
Similarly, a lease amendment that extends the term of a lease will also give rise to a new international interest because the extension to the term is a new obligation not covered by the original international interest. In order to properly perfect the interest created by a lease extension, the parties must register a new international interest because the extension is materially altering the initial term in the underlying lease, such that the extension is not covered by the international interest registration completed in connection with the underlying lease.
The IR contains a functionality that permits amendments to a registered interest. While the IR has this option, the amendment function should only be used when there is an error in the registration particulars (e.g. manufacturer, model, serial number or party name). The amendment function should not be used in connection with an amendment agreement that swaps out collateral, assigns the security agreement to another creditor, extends a lease term or maturity date or increases the loan amount. Rather, such amendments should be registered as new interests (as discussed above). The amendment function on the IR was established in order to give users a way to correct ministerial errors in registration particulars.
A registration of an amendment on the IR involves the continuance of an existing registration in a modified form (i.e. changing the registration particulars). If a registration contains an error in the manufacturer name, model or serial number, then an amendment to the registration to correct that information will be treated as a new registration for the correct aircraft object and a discharge of the previous registration, with priority ranking from the time the amending registration is completed. If a registration needs to be amended to correct the name of one of the parties listed therein, that will require the consent of the parties listed in the original registration, as well as the new parties.
When a registration is discharged, the party consenting to that discharge will also be deemed to consent to the discharge of all amendments to that registration; such discharges will be effected automatically.
Amendments to Bring a Transaction Within the Scope of the CTC
Given the ongoing adoption and ratification of the CTC by new states, questions arise when parties to an existing transaction desire to amend their transaction for the sole purpose of falling within the scope of the CTC after the relevant state has ratified the CTC. There is no definitive procedure for such action; however, one common practice is for the parties to reconstitute their transaction by entering into new documents which can amend and restate the existing documents or contain new grants of security or leasing rights. However, parties should use caution in amending documents in this way, because such amendments may bring questions involving tax implications, retained priority of the underlying interests, and other local law issues.