Cape Town Convention: Complex Questions and Significant Opportunities

The Treaty's scope and impact extends from commercial airlines to general aviation, including corporate aircraft and helicopters. Cape Town is intended to expand the sources, increase the amount and lower the cost of financing available to airlines and general aviation. In addition, it establishes comprehensive laws in each ratifying country (“Contracting State”) that should facilitate buying, selling, leasing and financing aircraft and engines. For example, Cape Town creates laws on perfection and filing interests in aircraft as well as on defaults, remedies, insolvency, priorities, title and aircraft deregistration. Aviation Finance Players Focus on Potential Impact of Cape Town Convention, David G. Mayer, Business Leasing News (March 2005), available at www.pattonboggs.com/Newsletters/Bln/Release/bln_2005_03.htm#1).

The Treaty can and should also facilitate aviation financing by: 1) increasing the predictability and consistency of legal systems affecting aviation deals, 2) reducing the risk of leasing/financing aircraft, 3) encouraging investment of capital in aircraft worldwide at higher economic returns by relying on higher asset valuations in aircraft transactions, 4) improving the availability and speed of remedies under uniform rules, and 5) preserving freedom of contract, which is a core principle of the Treaty.

Background and Structure of Treaty; Effective Date

Each type of equipment covered by Cape Town, including aircraft, space assets and railroad rolling stock, will have its own protocol. Cape Town and each protocol will work and must be read together as one consolidated text. Cape Town becomes effective with respect to a specific type of equipment when the protocol relevant to that equipment enters into force.

The Protocol for aircraft only has been ratified www.unidroit.org/english/implement/i-2001-convention.pdf) by seven countries: the United States, Ireland (most recently July 9, 2005), Ethiopia, Nigeria, Oman, Pakistan, and Panama. To enter into force, the Treaty must be ratified by one additional country (U.S. Ratifies Cape Town Convention, David G. Mayer, Business Leasing News (Dec. 2004), available at www.pattonboggs.com/Newsletters/Bln/Release/bln_2004_12.htm#2). Since the United States is a Contracting State, the Treaty will apply to all aircraft transactions involving a U.S. registered aircraft and related engines that meet the minimum size requirements. Rumors abound as to the countries that will next ratify the Treaty or Protocol. Whether they proceed swiftly or slowly, it is almost certain that the Treaty will be in force some time in 2006.

The effective date for the Protocol will be the first day of the month that occurs 3 months after ratification by the eighth country. For example, if the eighth country ratifies on Nov. 21, 2005, the Treaty will enter into force and apply to all U.S. transactions as of March 1, 2006.

Declarations By Contracting States

The Treaty gives Contracting States a number of policy decisions relating to default, remedies, insolvency rights and certain perfection issues, which a Contracting State must accept or reject when ratifying the Treaty. Contracting States express their choices with regard to these options in the form of four types of “Declarations” that the Contracting State must submit when it ratifies the Treaty. Transaction parties should understand and routinely check the Declarations in every Contracting State in which the parties do business. These Declarations will be searchable at the International Registry. CT Articles 39, 40, 60; 54(2), 54(1), 55, 54(2) and 48(2), 53 and 52.

When the Treaty Applies to a Transaction; Importance of Definitions

The following considerations determine whether the Treaty applies to a transaction:

1) (a) Is the aircraft registered in a Contracting State? or (b) is the debtor (borrower, lessee, conditional sale buyer or seller under a bill of sale) “situated” in a Contracting State? and

2) Does the aircraft or engine meet the minimum size requirements? and

3) Does the relevant documentation affect or create an “international interest” in an “aircraft object”?

The Treaty applies when the answer is “yes” to either item 1 (a) or b) and the answer is also “yes” to both items 2 and 3. See: Protocol Articles IV(1), I(2)(a), (b), (c), (e) and (l); CT Art. 3(1).

In evaluating the Treaty it is essential to apply the full meaning of its definitions. One crucial definition in the Protocol, “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 1750 pounds of thrust or 550 horsepower. While the current system at the Federal Aviation Administration (“FAA”) has a higher threshold (750 rated takeoff horsepower), amendments to the FAA regulations will conform its engine size rule to the Treaty. A business debtor is “situated” in a Contracting State, in general, when it is incorporated, registered or has its chief office there. CT Art. 4.

The Treaty relates only to “international interests” in aircraft objects, which may arise under a security agreement, lease agreement or title retention agreement and assignments, amendments, subordinations and subrogation of these interests. Cape Town does not include contracts of sale and ownership interests, but the Protocol links them to the Treaty as the equivalent of an international interest. Protocol Articles III and V.

Another significant concept is represented by the term “prospective international interest,” which arises under Article 1(y) of Cape Town. It means “an interest that is intended to be created or provided for in an object as an international interest in the future, upon the occurrence of a stated event (which may include the debtor's acquisition of an interest in the object), whether or not the occurrence of the event is certain.” The primary purpose of a prospective international interest is to allow a creditor to establish the priority of (not just perfect) its interest in an aircraft object prior to closing the transaction. CT Art. 19(4).

The International Registry: A Significant Change in the U.S.

One of the most significant changes in U.S. law will occur in the method of perfecting interests in aircraft objects. The Treaty establishes an International Registry to be located in Ireland (“International Registry”). The International Registry is a computer-driven, notice-based system with no documents to be filed. It will operate 24 hours per day, 7 days per week (unlike the FAA which operates business days from 7:30 a.m. to 3:45 p.m., Central Time).

If the Convention applies to a transaction, parties must register a notice of their interests in an aircraft, helicopter or engine with the International Registry or their interest will be unperfected. The parties will also have to make certain filings at the FAA as a condition precedent to making a registration with the International Registry.

FAA Functions Expanded

On Jan. 3, 2005, the FAA published the final rule (Docket No. FAA-2004-19944) (Final rule, http://dms.dot.gov/search/document.cfmdocumentid=309524&docketid=19944) implementing the Treaty, as required by the Cape Town Treaty Implementation Act of 2004, Public Law 108-297 (H.R. 4226), Aug. 9, 2004 (“Implementation Act”). The revisions to 14 C.F.R. Parts 47 and 49 implementing the Treaty announced in the Jan. 3, 2005 Federal Register become effective immediately upon the Treaty's entry into force. This legislation and the U.S. Declarations establish the FAA Civil Aviation Registry, located in Oklahoma City, as an entry point through which the registration of liens and international interests in aircraft objects must be authorized (this is known as an “authorizing entry point”). FAA Issues Final Rules to Implement the Cape Town Convention, David G. Mayer, Business Leasing News, (Jan. 2005), www.pattonboggs.com/Newsletters/Bln/Release/bln_2005_01.htm#2.

The Treaty and the Implementation Act assure that the FAA continues to play an integral role in aircraft registration and financing. The legislation contemplates that parties will continue to: 1) register aircraft at the FAA (required), 2) record liens against aircraft at the FAA (required for U.S. registered aircraft), and 3) record liens against engines at the FAA (not required but recommended). As a result, the recordation of liens against U.S. registered aircraft at the FAA is a condition of a party's ability to register a corresponding lien at the International Registry. In its expanded role, the FAA is named the “registry authority” in the United States. Protocol Art. 1(o).

Registration Procedure and Sequence

After the Treaty is effective, the procedure for perfecting a lien against a U.S. registered aircraft must follow a certain sequence. First, transaction parties must file a document (such as a security agreement or lease) with the FAA for recordation, along with AC Form 8050-135, at which time the FAA will provide the filing party with a unique authorization code. Second, the filing code will then be used when the filing party registers its corresponding international interest with the International Registry. Finally, the transaction parties will be responsible for making electronic registrations directly with the International Registry. It is vital that the parties strictly follow these procedures because failure to do so could result in a registration at the International Registry that is invalid and unperfected.

The United States has adopted additional rules and procedures for dealing with prospective international interests. If transaction parties want to perfect a prospective international interest in a U.S.-registered aircraft, the parties must follow the procedures outlined above. However, the initial filing with the FAA will involve only AC Form 8050-135 and the parties will not file the corresponding documents with the FAA at that time (since this filing occurs prior to closing, the documents will not exist). Upon the filing of the AC Form 8050-135, the parties will receive their unique authorization code from the FAA and will proceed to register their prospective international interest with the International Registry as outlined above. Transaction parties should note one important deadline in regard to the perfection of prospective international interests at the FAA. U.S. law requires the parties to file the underlying recordable documents with the FAA within 60 days after they file the AC Form 8050-135 with the FAA to allow the creditor to retain its priority created by the filing of the prospective international interest at the International Registry.

Registrable Documents at International Registry

The registration of international interests, prospective international interests and registrable non-consensual rights and interests will be made at the International Registry. CT Art. 1(ll). The registration may include the interests evidenced by a security agreement, (CT Art. 1(ii)); title reservation agreement (conditional sales) (CT Art. 1(ll)); leasing agreement (CT Art. 1(q)); assignments (CT Art. 1(b)); assignments and contracts of sale (ie, a bill of sale) (CT Art. 1(g)). In addition, the Treaty covers subordination agreements (CT Art. 16(1)(e)), subrogation agreements, prospective assignment agreements (CT Art. 1(x) and 16(1)(b)); prospective sale agreements (CT Art. 1(z)); prospective leasing agreements (CT Articles 1(q) and 1(y)); guarantee contracts (Protocol Art. I(j)); commitment or proposal letters covering prospective international interests; and amendments, discharges and extensions to any of the above. CT Art. 16(3).

Each agreement or transaction must be analyzed to properly characterize the agreement, regardless of its name, and to determine whether the parties must register their respective interests and in what capacity.

Substantive Rights, Remedies and Priorities

The Treaty provides that the transaction parties may exercise freedom of contract. Under this principle, the parties may include provisions on rights, remedies and priorities as they see fit. In many jurisdictions outside the United States, the key question for many lessors and lenders is simply (despite the terms in my deal): Can I get my aircraft back after a default occurs?

Remedies ' Recovering an Aircraft and More

This question may represent the most crucial issue for credit decision-makers in international or cross-border transactions. Recognizing the importance of recovering an aircraft object, the Treaty provides substantial remedies. However, the Treaty provisions cannot and do not supplant realistic country risk assessment, and it is arguable that none of these remedies are available unless the aircraft object is located in a country that has ratified the Treaty.

To achieve the objectives of expediting the recovery of an aircraft object and related damages, Article 8 of Cape Town allows a creditor after events of default to:

• Take possession or control of aircraft object charged to it;
• Sell or grant a lease of any such objects; and
• Collect or receive any income or profits arising from aircraft object.

Article 10 of Cape Town gives specific remedies to a conditional seller and lessor after an event of default to:

• Terminate its agreements; and
• Take possession of the aircraft objects; and
• Apply for court order to enforce the above.

The rights given in Articles 8 and 10 may be restricted by a Contracting State's Declaration, which provides that all remedies must be made by leave (ie, order) of court.

Article 12 of Cape Town allows the parties to agree to additional remedies (such as liquidated damages and specific performance) unless such remedies are not permitted by national law or Article 15 of Cape Town.

Unless a Contracting State has stated otherwise in a Declaration, Article 13 gives an owner or creditor the right to seek a speedy hearing and interim relief pending a final determination of a dispute on the merits. As a result, a creditor has the right to seek an interim order to preserve or obtain possession of the assets (similar to a temporary restraining order) in any Contracting State. See: CT Art. 55.

Article 15 (Derogation) of Cape Town allows parties by written agreement to vary from, or establish some limits on, certain remedies. Additionally, Article 15 prohibits the parties from changing certain rights that are intended to provide protection to a debtor (eg, in exercising certain remedies provided in Article 13, the creditor must act in a commercially reasonable manner and the debtor cannot agree to waive that obligation).

For a creditor to utilize self-help in a default situation, 1) the Contracting State must allow such a remedy through its Declarations and 2) creditors and debtors (lessees, conditional buyers and borrowers) must agree in writing to self-help provisions in leases, security agreements and conditional sale agreements.

In the past, obtaining possession on an aircraft has only been half of the battle; and the other half has been obtaining the deregistration of the aircraft in a foreign country. Cape Town offers help in this area. Article IX of the Aircraft Protocol allows a creditor to deregister and export an aircraft, if that debtor has agreed to such remedies in the relevant documents.

To cancel the aircraft registration, a creditor must: 1) obtain prior consent in writing required from the holder of any senior lien (this rule differs from the Geneva Convention which requires the consent of all lien holders); and 2) request the deregistration of the aircraft. The ability of a creditor to be successful in the deregistration of an aircraft remains uncertain unless the Contracting State has opted into the remedies found in Article XIII of the Aircraft Protocol. Article XIII makes it easy for a creditor by providing for the use of an irrevocable “de-registration and export request authorisation” (which is similar to a de-registration power of attorney). If the appropriate de-registration and export request authorization is filed in connection with a request to deregister an aircraft, the aviation authority shall “expeditiously co-operate with and assist” the creditor in the deregistration of the aircraft. A suggested form of de-registration and export request authorization is attached to the Protocol.

Priorities Under Cape Town

Cape Town uses a straightforward system for determining the priority of international interests (including prospective international interests) in aircraft objects, including their proceeds. CT Art. 29(6). Unless varied by written agreement (CT Art. 29(5)), the first to make a valid registration at the International Registry wins (CT Art. 29(1)) regardless of knowledge of a prior interest in an aircraft that has not been registered (CT Art. 29(2)(a)).

Liens Perfected Before Cape Town

On the other hand, rules regarding perfection and priorities of liens that have been perfected prior to the effective date of Cape Town will not be impacted by Cape Town. Cape Town Article 60, states that Cape Town ” … does not apply to a pre-existing right or interest, which retains the priority it enjoyed under … ” applicable law. The only exception is that a Contracting State may declare that existing interests must be registered as new filings at the International Registry within a minimum 3-year transition period. As a result, creditors and debtors should check the relevant Declarations in each country in which filings become subject to the Treaty for this provision. The United States did not opt for retroactive application of Cape Town.

In light of the language contained in Article 60, debtors and lenders will likely disagree on priority derived from perfected, pre-exiting rights. Lenders will insist that the parties take steps necessary to perfect a lien under Cape Town and debtors may resist the added time and expense involved to achieve the additional perfection under Cape Town. A prudent lender will include language in current credit documents that will require the debtor to execute all documents and take all necessary steps to perfect an interest under Cape Town, once it becomes effective.

New Issues and Risks

After overcoming the threshold question of whether the Treaty applies to a transaction and giving consideration to the perfection, priority and remedies, each buyer, seller, lessor, lessee or lender will still face a raft of new issues and risk factors. For illustration only:

• Where do I conduct a search for registration, ownership and liens ' the International Registry or the applicable national registry (such as the FAA Civil Aviation Registry) or both?
• Where and when do I have to file or register my ownership, leasehold or security interest ' the International Registry or the applicable national registry (such as FAA Civil Aviation Registry) or both? How do I make a registration on the International Registry and how do I know that it is complete and correct?
• How will a registration of a prospective international interest affect my transaction? Should I register a prospective international interest at the International Registry? What protections exist to prevent a party from improperly filing a prospective international interest?
• How does the Treaty deal with the perfection and priorities of non-consensual liens? How do I identify or mitigate risk of liens that are not filed, but may have priority?
• If I amend, assign or subordinate certain rights after a closing, how does that affect my prior registration at the International Registry?
• After the Treaty is effective, is it necessary or advisable to perfect (or re-perfect) a pre-existing interest at the International Registry or is my current perfection (for example, at the FAA) adequate?

The parties may answer some of the questions by drafting appropriate provisions in their agreements and gaining a good understanding of the Treaty. It is beyond the scope of this article to answer these questions, and, in any event, the answers will change depending on the transaction involved in the analysis.

Conclusion

By evaluating the Treaty and preparing required documentation now, aviation industry players can minimize the pressures of closing deals under the Treaty's rules. They can also learn the ropes of the Treaty sufficiently to answer questions that may arise in negotiations and prepare their organizations to compete under the new law that arguably will complicate, yet should facilitate, aviation finance worldwide. Although the learning curve may be steep, in the long run, the Treaty should provide greater uniformity, certainty and predictability that should create new opportunities and horizons for the aviation, finance and leasing industries.

In a follow-up article next month, the authors will discuss the available options to a diligent and responsible lender, seller, buyer, lessor or lessee, including how legal opinions and title insurance can mitigate risk under Cape Town.

The Cape Town Convention on International Interests in Mobile Equipment (“Cape Town” or “CT”) and the related Aircraft Protocol (“Protocol”) (www.unidroit.org/english/conventions/mobile-equipment/main.htm) continue to advance slowly toward an expected effective date in 2006. When the Protocol enters into force it will affect virtually every commercial and business aviation transaction in the United States and many other nations around the world. Although Cape Town and the Protocol (collectively, the “Treaty”) promise to facilitate aircraft financing and provide new financing opportunities, the Treaty also poses numerous questions and requires new approaches to documenting and closing aviation transactions.

The complexity of the Treaty should not be understated, but neither should its potential value to aviation finance. It creates a new and simple registration system; yet its deceptive simplicity may set a trap for the unwary. To fully understand and evaluate issues presented by the Treaty, it is important to read the Convention on International Interests in Mobile Equipment and Protocol Thereto on Matters Specific to Aircraft Equipment, Official Commentary, Professor Sir Roy Goode CBE, QC, University of Oxford, Sept. 2002.

Scope and Impact of Treaty

The Treaty's scope and impact extends from commercial airlines to general aviation, including corporate aircraft and helicopters. Cape Town is intended to expand the sources, increase the amount and lower the cost of financing available to airlines and general aviation. In addition, it establishes comprehensive laws in each ratifying country (“Contracting State”) that should facilitate buying, selling, leasing and financing aircraft and engines. For example, Cape Town creates laws on perfection and filing interests in aircraft as well as on defaults, remedies, insolvency, priorities, title and aircraft deregistration. Aviation Finance Players Focus on Potential Impact of Cape Town Convention, David G. Mayer, Business Leasing News (March 2005), available at www.pattonboggs.com/Newsletters/Bln/Release/bln_2005_03.htm#1).

The Treaty can and should also facilitate aviation financing by: 1) increasing the predictability and consistency of legal systems affecting aviation deals, 2) reducing the risk of leasing/financing aircraft, 3) encouraging investment of capital in aircraft worldwide at higher economic returns by relying on higher asset valuations in aircraft transactions, 4) improving the availability and speed of remedies under uniform rules, and 5) preserving freedom of contract, which is a core principle of the Treaty.

Background and Structure of Treaty; Effective Date

Each type of equipment covered by Cape Town, including aircraft, space assets and railroad rolling stock, will have its own protocol. Cape Town and each protocol will work and must be read together as one consolidated text. Cape Town becomes effective with respect to a specific type of equipment when the protocol relevant to that equipment enters into force.

The Protocol for aircraft only has been ratified www.unidroit.org/english/implement/i-2001-convention.pdf) by seven countries: the United States, Ireland (most recently July 9, 2005), Ethiopia, Nigeria, Oman, Pakistan, and Panama. To enter into force, the Treaty must be ratified by one additional country (U.S. Ratifies Cape Town Convention, David G. Mayer, Business Leasing News (Dec. 2004), available at www.pattonboggs.com/Newsletters/Bln/Release/bln_2004_12.htm#2). Since the United States is a Contracting State, the Treaty will apply to all aircraft transactions involving a U.S. registered aircraft and related engines that meet the minimum size requirements. Rumors abound as to the countries that will next ratify the Treaty or Protocol. Whether they proceed swiftly or slowly, it is almost certain that the Treaty will be in force some time in 2006.

The effective date for the Protocol will be the first day of the month that occurs 3 months after ratification by the eighth country. For example, if the eighth country ratifies on Nov. 21, 2005, the Treaty will enter into force and apply to all U.S. transactions as of March 1, 2006.

Declarations By Contracting States

The Treaty gives Contracting States a number of policy decisions relating to default, remedies, insolvency rights and certain perfection issues, which a Contracting State must accept or reject when ratifying the Treaty. Contracting States express their choices with regard to these options in the form of four types of “Declarations” that the Contracting State must submit when it ratifies the Treaty. Transaction parties should understand and routinely check the Declarations in every Contracting State in which the parties do business. These Declarations will be searchable at the International Registry. CT Articles 39, 40, 60; 54(2), 54(1), 55, 54(2) and 48(2), 53 and 52.

When the Treaty Applies to a Transaction; Importance of Definitions

The following considerations determine whether the Treaty applies to a transaction:

1) (a) Is the aircraft registered in a Contracting State? or (b) is the debtor (borrower, lessee, conditional sale buyer or seller under a bill of sale) “situated” in a Contracting State? and

2) Does the aircraft or engine meet the minimum size requirements? and

3) Does the relevant documentation affect or create an “international interest” in an “aircraft object”?

The Treaty applies when the answer is “yes” to either item 1 (a) or b) and the answer is also “yes” to both items 2 and 3. See: Protocol Articles IV(1), I(2)(a), (b), (c), (e) and (l); CT Art. 3(1).

In evaluating the Treaty it is essential to apply the full meaning of its definitions. One crucial definition in the Protocol, “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 1750 pounds of thrust or 550 horsepower. While the current system at the Federal Aviation Administration (“FAA”) has a higher threshold (750 rated takeoff horsepower), amendments to the FAA regulations will conform its engine size rule to the Treaty. A business debtor is “situated” in a Contracting State, in general, when it is incorporated, registered or has its chief office there. CT Art. 4.

The Treaty relates only to “international interests” in aircraft objects, which may arise under a security agreement, lease agreement or title retention agreement and assignments, amendments, subordinations and subrogation of these interests. Cape Town does not include contracts of sale and ownership interests, but the Protocol links them to the Treaty as the equivalent of an international interest. Protocol Articles III and V.

Another significant concept is represented by the term “prospective international interest,” which arises under Article 1(y) of Cape Town. It means “an interest that is intended to be created or provided for in an object as an international interest in the future, upon the occurrence of a stated event (which may include the debtor's acquisition of an interest in the object), whether or not the occurrence of the event is certain.” The primary purpose of a prospective international interest is to allow a creditor to establish the priority of (not just perfect) its interest in an aircraft object prior to closing the transaction. CT Art. 19(4).

The International Registry: A Significant Change in the U.S.

One of the most significant changes in U.S. law will occur in the method of perfecting interests in aircraft objects. The Treaty establishes an International Registry to be located in Ireland (“International Registry”). The International Registry is a computer-driven, notice-based system with no documents to be filed. It will operate 24 hours per day, 7 days per week (unlike the FAA which operates business days from 7:30 a.m. to 3:45 p.m., Central Time).

If the Convention applies to a transaction, parties must register a notice of their interests in an aircraft, helicopter or engine with the International Registry or their interest will be unperfected. The parties will also have to make certain filings at the FAA as a condition precedent to making a registration with the International Registry.

FAA Functions Expanded

On Jan. 3, 2005, the FAA published the final rule (Docket No. FAA-2004-19944) (Final rule, http://dms.dot.gov/search/document.cfmdocumentid=309524&docketid=19944) implementing the Treaty, as required by the Cape Town Treaty Implementation Act of 2004, Public Law 108-297 (H.R. 4226), Aug. 9, 2004 (“Implementation Act”). The revisions to 14 C.F.R. Parts 47 and 49 implementing the Treaty announced in the Jan. 3, 2005 Federal Register become effective immediately upon the Treaty's entry into force. This legislation and the U.S. Declarations establish the FAA Civil Aviation Registry, located in Oklahoma City, as an entry point through which the registration of liens and international interests in aircraft objects must be authorized (this is known as an “authorizing entry point”). FAA Issues Final Rules to Implement the Cape Town Convention, David G. Mayer, Business Leasing News, (Jan. 2005), www.pattonboggs.com/Newsletters/Bln/Release/bln_2005_01.htm#2.

The Treaty and the Implementation Act assure that the FAA continues to play an integral role in aircraft registration and financing. The legislation contemplates that parties will continue to: 1) register aircraft at the FAA (required), 2) record liens against aircraft at the FAA (required for U.S. registered aircraft), and 3) record liens against engines at the FAA (not required but recommended). As a result, the recordation of liens against U.S. registered aircraft at the FAA is a condition of a party's ability to register a corresponding lien at the International Registry. In its expanded role, the FAA is named the “registry authority” in the United States. Protocol Art. 1(o).

Registration Procedure and Sequence

After the Treaty is effective, the procedure for perfecting a lien against a U.S. registered aircraft must follow a certain sequence. First, transaction parties must file a document (such as a security agreement or lease) with the FAA for recordation, along with AC Form 8050-135, at which time the FAA will provide the filing party with a unique authorization code. Second, the filing code will then be used when the filing party registers its corresponding international interest with the International Registry. Finally, the transaction parties will be responsible for making electronic registrations directly with the International Registry. It is vital that the parties strictly follow these procedures because failure to do so could result in a registration at the International Registry that is invalid and unperfected.

The United States has adopted additional rules and procedures for dealing with prospective international interests. If transaction parties want to perfect a prospective international interest in a U.S.-registered aircraft, the parties must follow the procedures outlined above. However, the initial filing with the FAA will involve only AC Form 8050-135 and the parties will not file the corresponding documents with the FAA at that time (since this filing occurs prior to closing, the documents will not exist). Upon the filing of the AC Form 8050-135, the parties will receive their unique authorization code from the FAA and will proceed to register their prospective international interest with the International Registry as outlined above. Transaction parties should note one important deadline in regard to the perfection of prospective international interests at the FAA. U.S. law requires the parties to file the underlying recordable documents with the FAA within 60 days after they file the AC Form 8050-135 with the FAA to allow the creditor to retain its priority created by the filing of the prospective international interest at the International Registry.

Registrable Documents at International Registry

The registration of international interests, prospective international interests and registrable non-consensual rights and interests will be made at the International Registry. CT Art. 1(ll). The registration may include the interests evidenced by a security agreement, (CT Art. 1(ii)); title reservation agreement (conditional sales) (CT Art. 1(ll)); leasing agreement (CT Art. 1(q)); assignments (CT Art. 1(b)); assignments and contracts of sale (ie, a bill of sale) (CT Art. 1(g)). In addition, the Treaty covers subordination agreements (CT Art. 16(1)(e)), subrogation agreements, prospective assignment agreements (CT Art. 1(x) and 16(1)(b)); prospective sale agreements (CT Art. 1(z)); prospective leasing agreements (CT Articles 1(q) and 1(y)); guarantee contracts (Protocol Art. I(j)); commitment or proposal letters covering prospective international interests; and amendments, discharges and extensions to any of the above. CT Art. 16(3).

Each agreement or transaction must be analyzed to properly characterize the agreement, regardless of its name, and to determine whether the parties must register their respective interests and in what capacity.

Substantive Rights, Remedies and Priorities

The Treaty provides that the transaction parties may exercise freedom of contract. Under this principle, the parties may include provisions on rights, remedies and priorities as they see fit. In many jurisdictions outside the United States, the key question for many lessors and lenders is simply (despite the terms in my deal): Can I get my aircraft back after a default occurs?

Remedies ' Recovering an Aircraft and More

This question may represent the most crucial issue for credit decision-makers in international or cross-border transactions. Recognizing the importance of recovering an aircraft object, the Treaty provides substantial remedies. However, the Treaty provisions cannot and do not supplant realistic country risk assessment, and it is arguable that none of these remedies are available unless the aircraft object is located in a country that has ratified the Treaty.

To achieve the objectives of expediting the recovery of an aircraft object and related damages, Article 8 of Cape Town allows a creditor after events of default to:

• Take possession or control of aircraft object charged to it;
• Sell or grant a lease of any such objects; and
• Collect or receive any income or profits arising from aircraft object.

Article 10 of Cape Town gives specific remedies to a conditional seller and lessor after an event of default to:

• Terminate its agreements; and
• Take possession of the aircraft objects; and
• Apply for court order to enforce the above.

The rights given in Articles 8 and 10 may be restricted by a Contracting State's Declaration, which provides that all remedies must be made by leave (ie, order) of court.

Article 12 of Cape Town allows the parties to agree to additional remedies (such as liquidated damages and specific performance) unless such remedies are not permitted by national law or Article 15 of Cape Town.

Unless a Contracting State has stated otherwise in a Declaration, Article 13 gives an owner or creditor the right to seek a speedy hearing and interim relief pending a final determination of a dispute on the merits. As a result, a creditor has the right to seek an interim order to preserve or obtain possession of the assets (similar to a temporary restraining order) in any Contracting State. See: CT Art. 55.

Article 15 (Derogation) of Cape Town allows parties by written agreement to vary from, or establish some limits on, certain remedies. Additionally, Article 15 prohibits the parties from changing certain rights that are intended to provide protection to a debtor (eg, in exercising certain remedies provided in Article 13, the creditor must act in a commercially reasonable manner and the debtor cannot agree to waive that obligation).

For a creditor to utilize self-help in a default situation, 1) the Contracting State must allow such a remedy through its Declarations and 2) creditors and debtors (lessees, conditional buyers and borrowers) must agree in writing to self-help provisions in leases, security agreements and conditional sale agreements.

In the past, obtaining possession on an aircraft has only been half of the battle; and the other half has been obtaining the deregistration of the aircraft in a foreign country. Cape Town offers help in this area. Article IX of the Aircraft Protocol allows a creditor to deregister and export an aircraft, if that debtor has agreed to such remedies in the relevant documents.

To cancel the aircraft registration, a creditor must: 1) obtain prior consent in writing required from the holder of any senior lien (this rule differs from the Geneva Convention which requires the consent of all lien holders); and 2) request the deregistration of the aircraft. The ability of a creditor to be successful in the deregistration of an aircraft remains uncertain unless the Contracting State has opted into the remedies found in Article XIII of the Aircraft Protocol. Article XIII makes it easy for a creditor by providing for the use of an irrevocable “de-registration and export request authorisation” (which is similar to a de-registration power of attorney). If the appropriate de-registration and export request authorization is filed in connection with a request to deregister an aircraft, the aviation authority shall “expeditiously co-operate with and assist” the creditor in the deregistration of the aircraft. A suggested form of de-registration and export request authorization is attached to the Protocol.

Priorities Under Cape Town

Cape Town uses a straightforward system for determining the priority of international interests (including prospective international interests) in aircraft objects, including their proceeds. CT Art. 29(6). Unless varied by written agreement (CT Art. 29(5)), the first to make a valid registration at the International Registry wins (CT Art. 29(1)) regardless of knowledge of a prior interest in an aircraft that has not been registered (CT Art. 29(2)(a)).

Liens Perfected Before Cape Town

On the other hand, rules regarding perfection and priorities of liens that have been perfected prior to the effective date of Cape Town will not be impacted by Cape Town. Cape Town Article 60, states that Cape Town ” … does not apply to a pre-existing right or interest, which retains the priority it enjoyed under … ” applicable law. The only exception is that a Contracting State may declare that existing interests must be registered as new filings at the International Registry within a minimum 3-year transition period. As a result, creditors and debtors should check the relevant Declarations in each country in which filings become subject to the Treaty for this provision. The United States did not opt for retroactive application of Cape Town.

In light of the language contained in Article 60, debtors and lenders will likely disagree on priority derived from perfected, pre-exiting rights. Lenders will insist that the parties take steps necessary to perfect a lien under Cape Town and debtors may resist the added time and expense involved to achieve the additional perfection under Cape Town. A prudent lender will include language in current credit documents that will require the debtor to execute all documents and take all necessary steps to perfect an interest under Cape Town, once it becomes effective.

New Issues and Risks

After overcoming the threshold question of whether the Treaty applies to a transaction and giving consideration to the perfection, priority and remedies, each buyer, seller, lessor, lessee or lender will still face a raft of new issues and risk factors. For illustration only:

• Where do I conduct a search for registration, ownership and liens ' the International Registry or the applicable national registry (such as the FAA Civil Aviation Registry) or both?
• Where and when do I have to file or register my ownership, leasehold or security interest ' the International Registry or the applicable national registry (such as FAA Civil Aviation Registry) or both? How do I make a registration on the International Registry and how do I know that it is complete and correct?
• How will a registration of a prospective international interest affect my transaction? Should I register a prospective international interest at the International Registry? What protections exist to prevent a party from improperly filing a prospective international interest?
• How does the Treaty deal with the perfection and priorities of non-consensual liens? How do I identify or mitigate risk of liens that are not filed, but may have priority?
• If I amend, assign or subordinate certain rights after a closing, how does that affect my prior registration at the International Registry?
• After the Treaty is effective, is it necessary or advisable to perfect (or re-perfect) a pre-existing interest at the International Registry or is my current perfection (for example, at the FAA) adequate?

The parties may answer some of the questions by drafting appropriate provisions in their agreements and gaining a good understanding of the Treaty. It is beyond the scope of this article to answer these questions, and, in any event, the answers will change depending on the transaction involved in the analysis.

Conclusion

By evaluating the Treaty and preparing required documentation now, aviation industry players can minimize the pressures of closing deals under the Treaty's rules. They can also learn the ropes of the Treaty sufficiently to answer questions that may arise in negotiations and prepare their organizations to compete under the new law that arguably will complicate, yet should facilitate, aviation finance worldwide. Although the learning curve may be steep, in the long run, the Treaty should provide greater uniformity, certainty and predictability that should create new opportunities and horizons for the aviation, finance and leasing industries.

In a follow-up article next month, the authors will discuss the available options to a diligent and responsible lender, seller, buyer, lessor or lessee, including how legal opinions and title insurance can mitigate risk under Cape Town.