-ional finance lw adopt new aircraft mortgage …the ünidroit -ional avfation finance lw...

THE üNIDROIT -IONAL AVfATION FINANCE L W REE'ûRM PRûJECT

Preparing the World to Adopt a New Aircraft Mortgage Convention

by Anda Djojonegoro

A t h e s i s submi t t ed t o t h e Facu l ty of Graduate S t u d i e s and Research i n p a r t i a l f u l f i l h e n t o f t h e requirernents

f o r t h e deg ree of Master o f Laws (LL.M)

Institute of Air & Space Law McGill University Montreal , Quebec

Canada

O Anda Djojonegoro February 2000

Acquisitions and Acquisitions el Bibliographie Services seNices bibliographiques

The author has granted a non- exclusive licence aiiowing the National LI- of Canada to reproduce, loan, distnïute or sel copies of this thesis in microform, papa or electronic formats.

The author retains ownership of the copyright in this thesis. Neither the thesis nor substantial extracts fiom it may be printed or otherwise reproduced without the author's permission.

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A t p r e s e n t , i n t e r n a t i o n a l a t t e n t i o n is focused on an

emerging draft t r e a t y concern ing s e c u r i t y i n t e r e s t s i n

mobi le goods. Highly valued mobile assets (such as a i r c r a f t )

by nature move from one jurisdiction t o another, and

t h e r e f o r e , an i n t e r n a t i o n a l convent ion d e a l i n g the c r e a t i o n

and r e c o g n i t i o n of p r o p e r t y r i g h t s i n such goods is

necessary. This t h e s i s w i l l c o n c e n t r a t e on the laws

govern ing t h e t a k i n g of a i r c r a f t a s s e c u r i t y .

The d ra f t UNIDROIT Convention, once approved and

irnplernented by s t a t e s , would i n t r o d u c e a v a s t degree of

economic b e n e f i t s to a i r l i n e s and t h e i r r e s p e c t i v e

governments, ranging from lower banking i n t e r e s t rates t o

more c r e d i t being genera ted , a l 1 o f which w i l l b e n e f i t

n a t i o n a l economies and t h e t r a v e l i n g p u b l i c a t Large.

Given the s t r o n g a t t i t u d e shown by a m a j o r i t y of states

t h a t reflects t h e i r unwi l l i ngness t o s u r r e n d e r some b a s i c

l e g a l p r i n c i p l e s r e l a t i n g t o p r o p e r t y r i g h t s , t h e a u t h o r

considers it proper t o under take t h i s work, which w i l l

c o n c e n t r a t e on impor tan t legal problems relating t o

i n t e r n a t i o n a l a i r c r a f t f i nanc ing .

C e t t e t hèse e s t en l i g n e d i r e c t e avec l e p r o j e t en

cours de reforme du d r o i t a é r i e n i n t e r n a t i o n a l s u r l a

s é c u r i t é des aéronefs . Les équipements mobiles de grande

va leur , t e l qu 'appl icable aux avions et l e u r s p ièces ,

déménagent df une j u r i s d i c t i o n à l ' a u t r e , par là , une

convention s u r l a c r é a t i o n e t l a reconnaissance des d r o i t s

p r o p r i é t a i r e s dan les équipements mobiles deviens

i n é v i t a b l e .

Une f o i s approuvée e t implantée par l e s gouvernements,

l a p ropos i t ion drUnidroi t promet des bénéf ices économiques

s i g n i f i c a t i f s aux t r anspor teurs a é r i e n s e t l e u r s

gouvernements r e s p e c t i f s , sous l a forme de taux d ' i n t é r ê t s

banca i res p lus f a i b l e s à un accès a des c r é d i t s p l u s

importants , bénéfices q u i vont éventuellement se r e f l é t e r

auprès des voyageurs.

Selon de l ' a t t i t u d e des é t a t s m a j o r i t é qui r é f l é c h i t

l e u r s répugnances à abandonner des pr inc ipaux de d r o i t

relatif aux d r o i t s de p ropr ié te , Ir au teur t e n t e de

p r e s e n t e r une analyse q u i se concentre à des problèmes l é g a l

relatif aux f inances d'aéronef in ternat ionaux.

F i r s t and foremost , 1 wish t o ex tend my d e e p e s t

g r a t i t u d e t o my s u p e r v i s o r Professor Richard Janda who has

always been a g r e a t sou rce of i n s p i r a t i o n and guidance

throughout t h e complet ion o f t h i s t h e s i s .

T h i s t h e s i s has been completed wi th t h e v a l u a b l e h e l p

and s u p p o r t of t h e fo l lowing persons:

-Professor Michael Milde, Direc to r of t h e Center of A i r and

Space Law, whose encouragement and academic s u p p o r t has made

a i r and space iaw s t u d i e s i n Montreal n o t o n l y p o s s i b l e , but

memorable.

-Jeffrey Wool, P a r t n e r a t t h e Firm o f Pe rk ins & Coie, who

has provided m e w i th t h e g r e a t e s t i n s i g h t on t h e UNIDROIT

P r o j e c t and who has urged m e t o undertake t h i s c h a l l e n g i n g

wor k

S p e c i a l i ndeb tedness is owed t o my p a r e n t s f o r t h e i r

c o n s t a n t s p i r i t u a l suppor t and, above a l l , my h e a r t f e l t

g r a t i t u d e t o my wife, Gian i t a , wi thout whom t h i s t h e s i s

would n o t have been completed.

iii

Abstract .............................................. i

Résumé ............................................... ii

Acknowledgements .................................... iii

Table of Contents .................................... iv

C-TER 1 INTRODUCTION .............................. 1

1 . Background ....................................... I T I . Scope of Research ................................ 3

CEAPTER 2 THE AVIATION INDUSTRP AtlD ITS SOüRCES

OF F m - ............................... 10 .... f . The Aviation Industry's Capital Requirements 10

A . Overview ..................................... 10 ................ B . Future Airline Capitalization 12

11 . Historic Review of Aircraft Financing

Techniques ...................................... 15

A . The E a r l y Years of Aviation .................. 15

B . Post World War II Era ........................ 16 C . The Enerqy Crisis Decade of the 1970s ........ 20

III . Aircraf t Financing in View of the Airline

Crisis .......................................... 23

CflAPTER 3 LEGAL AND ECûNWIC OBJECTIVES FOR REFüRMiNG

CREDITOR PROTECTION LkWS POR AIRCRAFT .... 30

1 . Credit Enhancement Devices in Aircraft Finance

Transactions .................................... 30

A . Equipment Trust and Conditional Sales ........ 30

......... . B Chatte1 Mortgage and Aerial Hypothec 3 2

........................... . C Leasing Agreements 35

II . Principal Objectives for Reforming Creditor

Protection Laws for Aircraft .................... 37

A . Economic Considerations ...................... 38

1.The Importance of Credit Valuation in

Aviation Financing ........................ 38

........... 2.The Economic Value of Collateral 40

B . Key Legal and Political Problems ............. 4 1

1 . Non-recognition of Title or Security Interest ................................... 4 2

......... . 2 Deprivation and Repossession Risks 43

3 . De-registration and Export Authorization Delays ..................................... 44

4 . Bankruptcy Laws Which Impede Aircraft .............................. Repossession A 5

5.Choice of Law Issues ....................... 47

6.Sovereign Immunity ......................... 48

CHAPTER 4 THE INTERNATIONAL LEGAL REG- M R AIR-

FINANCING TRANSACTIONS ................... 49 1 . International Legislation and Rights in

Aircraft ........................................ 49 A . The Rome Convention on Precautionary Arrest of

Aircraft 1933 ................................ 51

B . The Geneva Convention on the International Recognition of Rights in Aircraft 1948 ....... 53 1 . Scope of the Geneva Convention 1948 ........ 57

a) Rights Recognized ..................... S 7

.................. b ) Registration of Rights 59

.......... C) Privileged and Priority Claims 60

d) Transfer of Aircraft Between

Registries .............................. 62 e ) Spare Parts ............................. 63

............ f) Enforcement by Judicial Sale 65

2 . Problems with the Geneva Convention 1948 .. 67 C. The 1988 UNIDROIT Convention on International

Financial Leasing ............................ 72 II . Prospects of Harmonizing the Law Governing

Security Interests in Aircraft ................... 75 A . International Initiatives to Reform Secured

Transaction Laws ............................. 75 B . The UNIDROIT Agenda .......................... 76

C. The Draft UNIDROIT Convention on Inter-

national Interests as Applied to Aircraft

Equipment ..................................... 81 1) Creation of an International Interest ... 84 2) Default Remedies ......................... 86 3) Effects of Registration and Priority

Rules ................................... 8 9

4) The International Registration System ... 9 1

5) Assignment of International Interests ... 93 6) Jurisdiction ............................ 94 7) Relationship with other Conventions ..... 95

C. Prospects of the Proposed UNIDROIT

Convention .................................. 102

vii

1. Background

Aircraft are regarded as highly movable ob jects,

capable of crossing political boundaries within a relatively

short period of time. Aircraft are also high-value assets

having great economic value. They represent valuable

collateral as a basis for extending aviation credit.

This thesis focuses on the economic problems of

aircraft financing as a cornplex international commercial

activity, one that is increasingly affected by the

globalization of credit economy, whereby:

(a) the internationalization and the huge growth of the

air transport industry has made financing of highly-

valued assets such as aircraft, become heavily

reliant on multiple sources of funding.

Consequently, the financing of aircraft can involve

parties spaming different countries;

(b) the high moveability of aircraft as collateral has

led to the worldwide distribution of assets

translating to greater physical distances between

the actual location of the aircraft and its

registered owner; '

Yet, the legal remedies available to a financier as to

the recoverability of the collateral in the event of default

by the borrower, greatly differ in each jurisdiction. This

is because each legal system may have its own provisions

relating to the treatment of rights in property over

aircraft, including its legal enforcement measures.

Depending on the location of the aircraft at the Lime

remedies are sought, the laws of certain jurisdictions can

be more accommodating to foreign creditors, whereby prompt

recourse to the value of the asset is readily available. In

other jurisdictions, treatment towards security can be

hostile where legal enforcement may take seaeral years-

Hence, reliance on the l ex s i t u s has generated many

uncertainties for aircraft financiers. 2

'sec R.M Goode, "Security in Cross-border Transactions"

(1998) 33 Tex Intrl L-J. 47-

'~ee P.R. Wood, Comparative Law of Security and Guarantees

(London: Sweet & Maxwell, 1995) at 5.

II. Scope o f Rerearch

The economics of c r e d i t a r e s imple . I n s h o r t ,

e x t e n s i o n s o f c r e d i t rnust be p r o f i t a b l e f o r bo th t h e

borrower and c r e d i t o r . For t h e borrower, c r e d i t is s e e n as a

fund-genera t ing mechanism which i s c r i t i c a l f o r f i n a n c i n g

i ts d a i l y o p e r a t i o n s and /o r expansion p l a n s . On a l a r g e r

s c a l e , c r e d i t money a l s o f u e l s t h e growing econorny. The

c r e d i t o r , on t h e o t h e r hand, sees t h e ex t ens ion o f c r e d i t a s

a t o o l t o enhance s a l e s and e a r n i n t e r e s t a t t h e same t i m e . 3

However, it is impor tan t t o n o t e t h a t n o t a l 1 c r e d i t i s

s e e n a s be ing p r o f i t a b l e . On one hand, a c r e d i t o r w i l l g a i n

b e n e f i t s o n l y i f t h e borrower f u l f i l l s h i s o b l i g a t i o n s . A

d e f a u l t i n g borrower would s u r e l y mean l o s s of p r o f i t s f o r

t h e c r e d i t o r . On t h e o t h e r hand, a borrower w i l l e n j o y

economic g a i n s from t h e l o a n i f t h e r e t u r n s o f inves tment

a r e g r e a t e r t h a n t h e i n t e r e s t pa id . The borrower w i l l n o t

p r o f i t from t h e t r a n s a c t i o n i f t h e c r e d i t o r charges a h i g h

i n t e r e s t r a t e . 4

' ~ e e N.B. Cohen, " H a m n i z i n g the Law Governing Secured

Credit: The Next Frontier" (1998) 33 Tex I n t ' l L .J . 173.

' ~ e e ibid.

I n t h e l e g a l con tex t , problems o f c r e d i t economy

a s s o c i a t e d w i t h a i r c r a f t f i nanc ing a r e ve ry o f t e n t h e r e s u l t

of a weak framework of s ecu red t r a n s a c t i o n s . According to

Nuria de l a Pena, t h e s e problems have t h e i r r o o t s i n t h e law

and l e g a l i n s t i t u t i o n s themselves . I n b r i e f , t h e y can be

e x p l a i n e d a s fol lows:

( a ) j u r i s d i c t i o n s wi th less developed l e g a l systems rnay

pose d i f f i c u l t i e s f o r t h e t a k i n g o f s e c u r i t y ove r

a i r c r a f t . For example, some l e g a l regimes l i m i t t h e

t y p e s of p r o p e r t y t h a t can s e r v e a s c o l l a t e r a l .

Others may be u n f a m i l i a r w i th c e r t a i n t y p e s o f

c r e d i t enhancement dev ices . Hence, unaccommodating

l e g a l regimes may prove t o be u n a t t r a c t i v e f o r

a i r c r a f t f i n a n c i e r s and would l i k e l y r e s u l t i n t h e

r e f u s a l o f t h e g r a n t i n g of credit;

(b) f i n a n c i e r s f a c e g r e a t d i f f i c u l t i e s when t h e y need t o

de te rmine t h e i r p r i o r i t y ranking a g a i n s t a

p a r t i c u l a r a s s e t . Under some j u r i s d i c t i o n s , a

secu red p a r t y may f a c e g r e a t c h a l l e n g e s i n

de te rmin ing i ts p r i o r i t y ranking a g a i n s t o t h e r

c l a i m a n t s of t h e c o l l a t e r a l i z e d a s s e t . F u r t h e m o r e ,

t h e r e i s no uniform method o f p u b l i c i z i n g security

i n t e r e s t s . I t is p o s s i b l e that any unknown competing

or hidden clairns against the collateral may render

the financier's security interest subordinate to

third parties;

seizing and repossessing the collateral may take

several years in certain countries, rendering the

aircraft inoperative. In some cases, the process far

exceeds the economic Life of the asset. Particularly

in countries where repossession requires judicial

involvement, repossession can be quite costly. 5

Given the internationality of most aircraft

transactions, this research paper attempts to examine the

role of international law governing such transactions in the

light of increasing international pressures to reform the

international legal framework related to secured

transactions. Accordingly, much attention will be dedicated

to the law reform project sponsored by the International

Institute for the Unification of Private Law (UNIDROIT) and

CO-sponsored by the International Civil Aviation

Organization (ICAO) . Both organizations are in the process

' ~ e e N. de la Pena, "Reforming the Legal Framework for

Security Interests in Mobile Property" (19991 2 Unif. L. Rev. 347

at 350 .

of drafting an international convention which contains

provisions that better protect airline creditors.

In view of the price of an aircraft today (e .g , 8-777

having a List price in excess of USS150 million), and the

total value of aircraft orders anticipated ovcr the next

decade, airline cornpanies will require substantial

capitalization if they have to pay cash for aircraft. Hence,

it has been a growing practice that airline companies resort

to alternative methods of fleet financinq, such as aircraft

leases and hire-purchases. Consequently, greater reliance

will be placed on aviation credit.

Decisions to extend aviation credit depend highly on

the risk assessment of a particular airline and its

goverment, as the creditor seeks to establish the extent of

whether a reliable legal system and institutional framework

exists in the airliners base country.

On the above note, renowrLed economist Heywood F l e i s i g

observed that, "many problerns in access to credit arise from

defects in the Iegal, regulatory and institutional framework

for extending redit."^ This observation is further

supported by a recent study which suggests that adherence to

the UNIDROIT Convention would result in substantial cost

savings for aircraft financing transactions, and increase

their overall credit rating. 7

Many authors have contributed exhaustive scholarly

research to the legal aspects of aircraft financing and the

international conventions that deal with this subject

matter. The notion of real rights in aircraft, as applied to

international settings, has been carefully examined by

taking into account the applicable international rules as

well as comparable national conceptions.

- --

6 See H. Fleisig, "The Right to Barrow" (April 1995) 44

Viewpoint 5 (The World Bank, Private Sector Development

Department) . '~ee UNIDROIT Convention, infra note 167. See also A.

Saunders & 1. Walter, Annotated Project Outline on the Proposed

Convention on International Interests in Mobile Equipment as

Applicable t o Aircraf t Equipment through the Aircraf t Equipment

Protocol: Economic Dpact Assesment (Study prepared under the

auspices of INSEAD and the New York University Salomon Center,

1998) [hereinafter Economic Impact Assessment] . For a

reproduction of the Economic Impact Rssessmen t , see ( 1998 )

XXI1I:VI Air IS Sp. L. 339.

Thi s t h e s i s does n o t endeaoor t o add ano the r l a y e r o f

p e r s p e c t i v e t o t h e numerous e x i s t i n g works on t h e l e g a l

a s p e c t s of a i r c r a f t f i nanc ing ; r a t h e r , it w i l l c o n c e n t r a t e

on t h e economic problems of a i r c r a f t f i n a n c i n q and

i n t e r n a t i o n a l e f f o r t s d i r e c t e d a t improving and harmonizing

t h e i n t e r n a t i o n a l l e g a l framework f o r secured t r a n s a c t i o n s

i n a i r c r a f t and its a s s o c i a t e d equipment. Consequently, t h i s

t h e s i s a l s o examine t h e d r a f t i n t e r n a t i o n a l i n s t rumen t on

i n t e r n a t i o n a l i n t e r e s t s i n mobile equipment j o i n t l y

undertaken by UNIDROIT and ICAO.

Thi s t h e s i s is d iv ided i n t o f i v e chap te r s :

-Chapter Two provides a g ~ n e r a l i n t r o d u c t i o n t o t h e

commercial a s p e c t s of t h e a v i a t i o n i n d u s t r y and i ts s o u r c e s

o f f i nance . I t examines t h e p r o s p e c t s of f u t u r e a i r l i n e

c a p i t a l i z a t i o n and b r i e f l y reviews t h e h i s t o r y o f a i r c r a f t

f i n a n c e techniques . The c h a p t e r concludes wi th a d i s c u s s i o n

on t h e causes of t h e r e c e n t Asian economic crisis. Th i s

c h a p t e r concludes by a rgu ing t h a t c r e d i t r i s k , e s p e c i a l l y i n

c o u n t r i e s wi thout well-developed f i n a n c i a l and s e c u r e d

t r a n s a c t i o n laws, becomes one o f t h e most impor tan t d r i v i n g

f o r c e s behind t h e u rgen t need f o r a v i a t i o n f i n a n c e law

reform.

-Chapter Three reviews commonly used security devices in

aircraft finance transactions and examines the current

legal, economic and political issues associated with

international aircraft finance.

-Chapter Four focuses on the prevailing international law

relating to aviation finance. It begins with an analysis of

the conventions

effectiveness

applicable

accommodating

aircraft objects and t h e i r

the modern practice

aircraft finance and concludes with a special section on the

U N I D R O I T proposal embodied in a draft convention on

international interests in mobile equipment as applied to

aircraft objec t s .

-Chapter Five sets forth the analysis, swnmary and

conclusion flowing from the preceding discussion.

THE AVIATION InDVSTRP AND ITS SOWRCES OF FïNANCE

1. The Aviation Industry and its Capital Roquirewnts

The l a s t decade of the 2oth century was a highly

unstable macroeconomic era for the commercial air transport

industry. The world's airlines lost USSl5.6 billion on their

international scheduled services during the first half of

the 1990s'. In the second half, the airlines suffered the

chain-effects of the worldwide financial recession that

stemmed from Mexico and Southeast Asia between 1994 and

1997. Altogether, the economic consequences and effects of

the crises have lingered towards the end of the millennium.

As global economic and financial conditions start to show

signs of recovery, the air transport industry will

undoubtedly endeavor to make up for its record losses and

business opportunities in the last several years - this

being its first order of business in the new millennium.

' ~ e e IATA, Annual Report 1999 (Montreal: IATA, 1999) at 6.

-10-

The prospects of the air transport industry over the

new millennium are promising. The International Air

Transport Association (IATA) reports USS3.1 billion in net

profits for its mernber airlines in 1998, for revenues of

USS142.7 billi~n.~ There is also expected to be an increase

in air travel of 5.5 percent per annum between 1998-2002,

which is highly attributable to the forces of market

liberalization and an increase in world trade, resulting in

more flights and lower costs. 10

'~ee ibid. at 8. Analysts at IATA consider the net profit of

USS3.1 billion (which is 2.2 percent of revenue) to be quite

reasonable given the sharp decline of average load factors during

the economic crisis. The present low fuel prices and interest

rates factors are attributable to the airlines' profit margin.

%iee ICAO, Outlook for Air Transport to the Year 2005

(Montreal: ICAO, 1995). ICA0 reports that the worldls scheduled

passenger traffic (in tems of passenger-kilometers performed)

increased at an average rate of 8.9 percent between 1960-1995.

Forecasts through the year 2005 show that the highest growth in

passenger traffic is expected to corne from the airlines of the

Asia/Pacific region at: 8.5 per cent per annum, followed by the

traffic of airlines of the Middle East, Latin America and Europe,

which are anticipated to grow at an average annual rate of 5.5,

5.0 and 4.5 respectively. Meanwhile, traffic projections for both

North American and African airlines are estimated at around 4 per

cent per annum.

B. E'uture Airline Capitalization

I n o r d e r t o meet t h e a n t i c i p a t e d growth of pas senge r

t r a f f i c , 'l which i s t h e key element of eve ry component i n

t h e commercial a i r t r a n s p o r t bus ines s , a i r l i n e s undoubtedly

w i l l have t o expand t h e i r a i r c r a f t f l e e t . I t should a l s o be

t a k e n i n t o account t h a t , i n o r d e r f o r a i r c r a f t t o be

economica l ly e f f i c i e n t and n o i s e and emiss ion c o n t r o l s

cornpl iant , a i r l i n e s w i l l have t o i n v e s t i n modern and newer

a i r c r a f t . Consequently, a l a r g e body of t e c h n i c a l l y o b s o l e t e

a i r c r a f t , such a s t h e o l d e r turbo-props c u r r e n t l y s e r v i c i n g

r e g i o n a l markets, would have t o retire and be r e p l a c e d w i t h

j e t s . 12

A s i n t e r n a t i o n a l a i r t r a f f i c grows, t h e s i z e o f t h e

world' s a i r l i n e f l e e t i n c r e a s e s . I n 1998 , t h e r e were 1,463

t u r b o j e t a i r c r a f t o rde red a t an es t i rna ted va lue o f USS84

%ee ibid. Althougn passenger t r a f f i c growth w i l l Vary by

region because of d i f f e r i ng regional f ac to r s , ove ra l l demand for

new aircraft : is very l i k e l y t o increase . On a regional l e v e l ,

Europe and North America a r e considered es tab l i shed a i r t r a v e l

markets and, consequently, the requirement f o r new a i rp lanes w i l l

be expected from these regions. However, Asia must not be

overlooked as it rebounds from the crisis and is an t i c ipa t ed t o

grow f a s t e r than average.

l Z ~ i r c r a f t pu t ou t of operation w i l l average around 250 per

year s i nce very feu a i r c r a f t a r e considered useful and s a f e i n

passenger t rançpor ta t ion beyond 30 years.

b i l l i o n . I3 According t o Boeing p r o j e c t i o n s , t h e w r l d f leet

w i l l r e a c h 28,600 i n t h e nex t 20 y e a r s from t h e p r e s e n t

12,600 a i r p l a n e s i n s e r v i c e today. O v e r a l l , a i r c r a f t

a c q u i s i t i o n by t h e y e a r 2008 w i l l r e q u i r e a d d i t i o n a l c a p i t a l

1 4 of USS1.1 t r i l l i o n . Na tu ra l ly , w e w i l l see a l a r g e and

growing need for money i n o r d e r t o a c q u i r e a i r c r a f t . How

w i l l new c a p i t a l be rnobilized t o fund t h e s u b s t a n t i a l number

of a i r c r a f t r e q u i r e d t o rneet t r a f f i c growth?

I n p r i n c i p l e , t h e r e a r e t h r e e methods of r e s o l v i n g t h e

a i r l i n e i n d u s t r y f s c a p i t a l problerns:

( a ) t o i n c r e a s e t h e i r borrowing power;

( b ) t o reduce t h e i r own c a p i t a l inves tment and seck

a d d i t i o n a l funding through t h e s t o c k markets ; and

?Se@ ICAO, "Annual Review of Civil Aviation 1998" (1999)

54:6 ICA0 Journal 29. Out of 1,463 orders, 929 aircraft were

delivered. The number of turboprop aircraft delivered was 78,

%oeing forecasts that the composition of the world f l e t

by the year 2018 will be: 17% regional jets, 23% intemediate-

sized airplanes, 54% single-aisle airplanes and 6% 747s or larger

airplanes. See Boeing, Current Market Outlook 1999,

(c) to increase government support and subsidies. ~5

While any of the three aforementioned alternatives may

provide a solution to the problems related to capital, calls

for increased government assistance may prove to be

unworkable, given that most airlines today are privatized or

are in the process of privatization. On the other hand,

reduction of capital investment often implies a reduced

level of service. 16

It should also be noted that in terms of private

capital formation in general, there would be massive

additional capital required to fuel the growing economy over

the next decade. The estimates point to trillions of dollars

of investment in new plants and equipment required by

capital intensive industries such as the energy,

telecornrnunications, information processing and transporta-

tion sectors. Consequently, the airline industry would alço

have to compete for available capital resources to meet i t s

daily and non-daily expenditures, including the acquisition

of new aircraft.

L 5 ~ e e G.A. Wiegers, 'The Outlook for Air l i ne Capital

Formation" (1979) 7:3 Int. Bus. L. 162.

'"ee ibid.

II. Historie R e v i e w of Aircraft Financinq Techniques

A. The Early Years of Aviation

When airline companies were still in their infancy, air

transportation was considered a highly speculative venture.

High ratings were given to those carriers which were "fit"

and "able" in the operational context, rather than in

management standards. Access to credit was not easy and,

hence, aircraft acquisitions were mainly financed by private

equity money. It was not uncommon for an investor to act as

the airline operator and business partner at the same

tirne.'' Furthermore, the industry had a relatively simple

capital structure, and because it did not require large

overheads, funding iesources came mainly from individual and

private investors. 18

As the years went by and the airline industry rapidly

developed, it required additional capital to finance its

growing fleet. Meanwhile, individual investors were still

unwilling to extend credit. Consequently, the air transport

industry turned to the public to seek new ways of funding.

Attracted by the tremendous growth of the airline industry,

" ~ e e G.D. Brown fi W.T. Ashby, "Airline Financinq" (1949) 16

J. Air L. h Corn. 460.

"~ircraft unit costs before the War were relatively

affordable without participation of third party lenders.

the public demonstrated its interest to participate in the

development of the air transport industry by purchasing

airline stock, even when it meant that there would be no

irnmediate reward for their investment. Accordingly, this

process was later on facilitated by the introduction of

convertible preferred stocks which allowed airlines to offer

large amounts of cornmon stock significantly above market

prices . L 3

B. The Post World W a r II Era

Shortly after the World War and until the late 1 9 6 0 ~ ~

airlines were drawn to other methods aircraft financing.

Faced with new and substantial capital necessities as a

consequence of their growing fleet and increasing traffic

demands, most U.S. carriers have been able to obtain long

term (10-20 year) debentures for sale to the public and

institutional investors, such as insurance companies.

"~ee Brown h Ashby, supra note 17.

'O~ee J. D. Lambert, "Survey of Domestic and International

Aspects of Aircraft Equiprnent Financinq" (April 1963) 18 Bus. L

627 [hereinafter Lambert] citing D. 1. Johnston, Legal Aspects of

Aircraft Finance (LL .M Thesis, McGill Univers i ty , 1961)

[unpublished] at 18.

In a d d i t i o n , t h e s u b s t a n t i a l increase i n t h e price of

a i r c r a f t Z 1 forced carriers to i n c u r large amounts of medium

long-term bank c r e d i t s yea r s ) through s y n d i c a t e d

l o a n s , where 7 y e a r s i s cons ide red t o be t h e u s e f u l l i f e o f

a p i s t o n engine-powered a i r c r a f t . 22 F u r t h e m o r e , con t inued

a i r l i n e so lvency provided t h e r e q u i r e d p u b l i c confidence i n

t h e i n d u s t r y and consequent ly a s s u r e d l e n d e r s that it was

safe t o ex tend the medium and long-term funds needed by t h e

a i r l i n e s . Meanwhile, non-U.S. a i r c a r r i e r s con t inued t o

a c q u i r e t h e i x aircxaft by way of bank l o a n s and government

g r a n t s , and t o a c e r t a i n e x t e n t , through U.S. Export-Import

Bank Loans. 2 3

.! --Se@ Lambert, supra n o t e 20,

%ee ibid. I n l i g h t of p r o t e c t i n g the i n s t i t u t i o n a l

lenders ' i n t e r e s t , t h e loan agreements requ i re t h a t t h e

carr ier /borrower mainta in a f i x e d debt-equity r a t i o .

Addi t ional ly , these t r a n s a c t i o n s were o f t e n secured by a mortgage

inden tu re on a i r c r a f t equipment and o t h e r a s s e t s of the c a r r i e r .

"se@ H.F. Olson, "Acquisi t ion and Financing of A i r c r a f t by

r Carr iers" i n Secured Financing f o r the Transportatian

Industry (New York: P r a c t i c i n g Law I n s t i t u t e , 1979) a t 749.

During t h e post-war per iod, and a s a d i r e c t r e s u l t of t h e cold

war, where m i l i t a r y demands involved the u t i l i z a t i o n o f t r a n s p o r t

a i rplanes . rnanufacturing i n d u s t r i e s were s t i m u l a t e d i n t o

producing more aircraft, and thus, increased t h e p r i c e o f new and

used a i r c r a f t . This was considered as a favorable per iod f o r t h e

a i r t r a n s p o r t indust ry , and consequently, the i n d u s t r y r e l i e d

more on commercial loans r a t h e r than e q u i t y f inancing,

At the time of rapid technological evolution in the

1960s, the air transport industry went £rom piston-engine

aircraft to turbo-props and jets, which substantially

increased the size and range of commercial aircraft. This

era was considered favorable to U.S. carriers and,

consequently, there was increasing availability of capital

through banks and institutional credit and a significant

appreciation in the market value of airline stocks. For

those carriers requiring additional debt, but lacking proper

security to guarantee their loans, several aircraft lease

structures were utilized with options to purchase at a low

and bargain price at the end of the te~m.'~

Through leasing, carriers were able to obtain new

aircraft equipment without having ta deposit substantial

funds as down-payment. Furthemore, this was a way of

conserving significant working capital and was soon viewed

as a popular alternative to straight commercial borrowing.

Most importantly, leasing arrangements enabled carriers to

ï 4 ~ e e S. R. Kruft, "Leveraged Aircraft Leases : The Lender' s

Perspective" (1989) 4 4 Bus. L. 737.

benef it £rom c e r t a i n " t ax advantages", a l l owing them t o

deduct r e n t a l payments a s a bus ines s expense. z5

A s a consequence of t h e d e c l i n e i n e a r n i n g power and

r a p i d d e p r e c i a t i o n o f a i r c r a f t and a i r c r a f t equipment i n t h e

mid 1960sZ6, U.S. carriers were no l o n g e r a b l e t o t a k e f u l l

advantage o f t h e i r a v a i l a b l e investrnent t a x c r e d i t wi th

r e s p e c t t o a i r c r a f t and i t s a s s o c i a t e d f l i g h t equiprnent.

A l t e r n a t i v e l y , t h e s t r u c t u r i n g of a i r c r a f t l e a s e s p u r e l y a s

a f i n a n c i n g v e h i c l e became a common p r a c t i c e . I n a pure

a i r c r a f t l e a s e , t h e investrnent t a x c r e d i t and d e p r e c i a t i o n

deduc t ions a r e passed t o t h e l e s s o r of t h e a i r c r a f t . The

c a r r i e r , on the o t h e r hand, r e c e i v e s b e n e f i t i n t h e form of

a lower i n t e r e s t r a t e a p p l i e d

cases, t h e r e g i s t e r e d ownership

l e s s o r . 27

The s i m p l e f i n a n c i a l l e a s e

t o t h e lease c o s t , I n sucn

o f t h e a i r c r a f t i s wi th t h e

was l a t e r developed t o be a

" leveraged" l e a s e , wi th i n v e s t o r s c o n t r i b u t i n g 20 t o 40

p e r c e n t o f t h e c a p i t a l . Na tu ra l ly , t h e y a l s o assumed a

"~ee 0.1. Johnston, "Aircraft Leasing" (1963) 9 McGill Law

Journal 32.

"see Lambert, supra note 20.

" ~ e e J. V. Babcock, "US Ai rc ra f t Leasing" i n S. Hall, ed.,

Aircraft Financinq (London: Euromoney Publications, 198 9 ) 68.

higher risk with a higher return on investment. Meanwhile,

the lessor/lender received a fixed rate of return having a

priority in the security interest. This structure seemed to

have attracted even more institutional lenders in becoming

parties to leveraged aircraft lease transactions. 2e

C. The Energy Crisis E r a of the 1970s

The global financial situation in the 1970s was plagued

by an oil and banking crisis. The price of oil increased

sharply in 1973, followed by the collapse of the global

banking sector. For the air transport industry, bank credit

and institutional long-term funds became difficult to

obtain. The banking sector, on the other hand, sought

lending opportunities at the international level and

targeted developing countries (sovereign borrowers). The

relationship was rnutual, as the economic policies of the

developing countries also encouraged off-shore borrowing in

order not to use up their own resexves. The substantial

"~he definition of leverage, according to Black's Law

Dictionary, is "the ability to finance an investment with a small

amount of one's own funds, such as a down-payment, with the

balance consisting of borrowed funds. The use of a smaller

investment to generate a larger rate of return through

borrowing." See J.R. Nolan & J.M. Nolan-Haley, Blackrs Law

Dictionary" (St. Paul: West Publishing, 1991) at 628.

dernand for new funds did not consequently result in full

access to the money markets. The bond market, for instance,

was difficult to access. Those still wishing to borrow would

be regarded as high-risk borrowers and institutions were

only willing to lend to the strongest credit airlines at

abnormally high rates. Furthermore, a security was required

for the loan, which came in the form of high-value mobile

assets, including aircraf t . ''

The econornic turmoil of the 1970s escalated airline

unit costs and made it increasingly unfavorable for rapid

increases in lending. But this did not completely prevent

the air transport industry from counteracting, as the

problem of raising capital for the industry was facilitated

by two changes:

(a) aircraft manufacturers became more involved with

raising capital for their airline customers by

extending them short-term credit on a secured basis,

or, by making extensive use in export sales

supported by national credit agencies, such as the

Export-Import Bank of the United States, the

'%ee 1. Spight, "The Syndicated Bank Loan" in S- Hall ed.,

Aircraft Financinq (London: Euronioney Publications, 1991) 47.

C r e d i t s Guarantee Department i n t h e UK and, the

Compagnie F r a n c a i s e d 'Assurance pour l e Commerce

E x t e r i e u r i n France; 30

t h e e s c a l a t i n g p r i c e s o f a i r c r a f t u n i t s have forced

a i r l i n e s t o l e a s e a i r c r a f t , r a t h e r t h a n borrow money

t o p u r c h a s e a i r c r a f t . T h i s e r a was a l s o

c h a r a c t e r i z e d by t h e emergence of a c o n s o r t i a o f

banks o f which purchased a i r c r a f t f o r t h e purpose o f

l e a s i n g them a g a i n t o t h e a i r l i n e s . The b e n e f i t s t o

t h e c o n s o r t i a were t a x c o n c e s s i o n s and l e g a l

ownership of t h e a i r c r a f t . The c o n s o r t i a o f banks

s o o n deve loped i n t o s p e c i a l purpose l e a s i n g

companies, of which t h e two l a r g e s t i n t h e 1980s

were Guinness P e a t A v i a t i o n (GPAj o f I r e l a n d a n d

I n t e r n a t i o n a l Lease F inance C o r p o r a t i o n ( I L F C ) o f

the U n i t e d S t a t e s , 3 1

%ee J. D. Hanson, ' Manufacturer's Support: An Overview" i n

S. Ha l l ed . , Aircraf t Financinq (London: Euromoney Publ ica t ions ,

1991) 197; C- Thaine, "Role of the Manufacturer i n A i r c r a f t

f inancinq" (1989) 17 I n t ' l Bus. L. 212; M. Ghonaim, The Legal

Aspects of Aviation Finance in Developing Countries (LL .M Thesis ,

M c G i l l Universi ty, 1991).

%ee R. Doganis, Flying Off-Course: The Economics o f

International Airlines, (London: Routledge, 1995) a t 7.

Non-U.S. carriers, however, continued to depend on

funds generated from their operations, loan or goverment

subsidies and, sometimes Eximbank loans, guarantees and in a

few instances, leasing.

III. Aircxaft Financinq in View of the Airline Csisis

In mid-1997, a financial crisis devastated East Asia,

once regarded as one of the most successful emerging

markets. Untii the crisis occurred that year, East Asian

economies had enjoyed an outstanding economic performance,

with a consistent annual GDP growth in the region of 5 to 8

percent over the last three decades. 32

The boom in capital inflows to Asia in the years

leading up to the crisis, which attracted almost half of the

total capital inflows to developing countries of nearly

USSIOO billion, 33 was intermediated in large part by

domestic banks, fuelling rapid credit growth. When cornbined

with regulatory failure to strike a balance between the

guarantees necessary for financial stability and bank

7 -5ee T. Lane, The A s i a n F i n a n c i a l C r i s i s : W h a t Have We

L e a r n e d ? " (1999) 36 Finance h Development; "Asiars Economic

Crisis" The Economist (15 November 1997) 19.

33~ee W. Bello, "Rethinking Asia: Inviting Another

Catastrophe" The Far Eastern Economic Review (12 Auqust 19991.

supervision and regulation to minimize excessive risk-

taking, high risk h a n leverage ratios relative to output,

rendered financial systems extremely vulnerable to

liquidity, market and credit ris ks. 3 4

Analysis of the problems in East Asia reveals that its

causes revolve mainly around privats foreign debt, and not

public debt. However, other factors that contribute towards

the crisis were:

(a) the failure to reduce the domino-effect triggered by

the large external deficits and stock market bubbles

in several South East Asian States which originated

in Thailand;

(b) the maintenance of pegged exchange rate regimes for

too long, which encouraged external borrowing and

Led to excessive exposure to foreign exchange risk

in both the financial and corporate sectors; and

"IMF, World Economic Outlook (Washington: IMF, 1998); IMF,

The A s i a n C r i s i s : C a p i t a l Market Dynamics a n d S p i l l o v e r , IMF

International Capital Markets (Washington: IMF, 1998) ; S. Fisher,

"The Road to a Sustainable Recovery in Asia" (Address to the

Singapore World Economic Forum, 18 October 1999) [unpublished] ,

(c) lenient rules on legal lending limits and financial

oversight, led to a sharp deterioration in the

quality of banks' loan portfolios. 3 5

Until early 1997, Asiars airline industry was

flourishing. The staggering regional economic growth,

increasing air transport liberalization, and the enormous

tourism potentials of countries such as China and Thailand,

rendered Asia as the one of the most attractive markets and,

the fastest growing region for passenger and freight traffic

in the world.

When the financial crisis devastated East Asia causing

the collapse of regional economies and consequently the

devaluation of national currencies, air travel of local

origin became increasingly expensive, especially when

denominated in Asian currencies, resulting in higher

capacity and weaker demand. Responsible governments could

.

3 5 See, J. Stiglitz, "The Role of International Financial

Institutions in the Current Global Economy" (Address to the

Chicago Council on Foreign Relations, 27 January 1998)

[unpublished]. See also, S. Fisher, "The Asian Crisis: A View

from the IMF" (Address to the Midwinter Conference of the

Bankersf Association for Foreign Trade, 22 January 1998)

[unpublishedl; J. Booman, "Asian Crisis: World Must Cooperate to

Find Solutions" The [Singapore] Straits Times (4 March 1999) .

lend Little assistance to their flag carriers while

operating under the strict budgetary constraints imposed by

international creditors - notably the World Bank and the

IMF.

As a result, the East Asian air transport industry has

faced immense challenges over the past two years. Effects

from the crisis on Asian air carriers have included

bankruptcies, employee layoffs, aircraft grounding and route

restructuring, as well as the cancellation or deferral of

aircraft financing arrangements, causing a further effect on

îhe aircraft market. The combined operating revenue of the

Association of Asia Pacific Airlines IAAPA) for the i997/98

fiscal year dropped by 3.5 percent and reported a collective

loss of USS843.8 million. Carriers also suffered high losses

and escalating debt levels, which exceeded their equity in

the worst cases, by a factor of 10 . 3 6

Those carriers unable to meet their debt obligations

confronted threats of aircraft repossession proceedings.

Arnong thosr carriers is Sempati Air, the Indonesian private

%ee "How the

Interavia Business

Jarrett, "Into a New

Year of the Tiger Bit Boeing" (1999) 54:627

h Technology 28 [hereinafter

Daun" (1998) 34:8 Asian Business

Boeing] ; 1.

4 8 .

airline which has been forced to shut down its operations

and later filed for bankruptcy. Philippine ~iriines (PAL)

suspended its routes and was required to reschedule its debt

payments to about 1000 creditors owed USS2.2 billion. In

addition, PAL was locked into accepting a rehabilitation

program that included a reduction in fleet size, disposal of

excess assets and layoffs of approxirnately 13.000 of its

workforce. Other airlines that were affected similarly

include, among others, Garuda Indonesia, which was deemed

technically bankrupt with a foreign debt of over USS400

million and Thai Airways which has sold 3 DC-10s and failed

to take delivery of nine aircraft in 1998.37

The sharp currency declines throughout Southeast Asia

has also created troubles for aircraft manufacturers such as

Boeing and Airbus, as the financial crisis has made mrst

airlines in the region either cancel or defer delivery of

aircraft orders from these manufacturers. 38 With the sale

"~ee Boeing, supra note 36.

%ee ibid. The airlines are: Cathay Pacific Airlines

(withdrawing 20 B-747s between 1997-99) , EVA Airlines (cancelled 12 Airbus orders in 1999 and delayed delivery of 5 8-747s due in

2000), Garuda Indonesia (to cut 39 aircraft by terminating

leases, including the return of 6 newly delivered B-737s, 6 MD-

Ils, sold 5 DC-10s and cancelled orders for 6 B-737s and 6 B-

7 7 7 ~ ) ~ Korean Airlines (sold 6 B-747s and 2 MD-Ils in 1999),

and acquisition of new aircraft denominated in US dollars,

such currency declines make Boeing and Airbus products

signif icantly more expensive. For example, in Indonesia,

where in early 1998 local currencies plummeted to 80 percent

of their original value, the price of new commercial

aircraft became 80 percent more expensive.

Ironically, it is in the Asia Pacific region that both

airframe manufacturers are expecting to find the most sale

opportunities. According to surveys conducted by the Center

for Asia Pacific Aviation, airlines in Asia are the world's

biggest users of large wide-body aircraft, of which some 30

percent of the aircraft currently in service across the

region, are in the 350 to 400 category. 39

Although the Asian air transport industry is presently

recovering from this crisisr4' regional carriers continue to

face intricate pzoblems with respect to aircraft financing.

Malaysian Airlines (arranged USS100 million for aircraft sale and

lease-backs, sub-leased 15 aircraft and delayed deliveries of 8

8-777s and 6 B-747s up to 3 yearsl, Singapore Airlines (deferred

purchase of Il A-340s) and Thai Airways (sold 3 DC-10s and

delayed delivery of 17 Boeing aircraft due in 2002). 39 See Boeing, supra note 14.

'OP. Harbison, "Asia's Airlines: The Real Thing or Just

Virtual Recovery?" (October 1999) 25 Aviation Anaylyst 9.

Aging aircraft and engines must be replaced, whereas fleet

sizes must be increased to meet the projected capacity for

growth in the next millennium.

LEGAL AMI ECON-C OBJECTIVES FOR REFORMING CREDITOR

PROTECTION LAWS AS APPLIED Tû AIR- OBJECTS

1. Credit Enhancement Devices in Aircraft Finance

Transactions

Security devices protect and safeguard the interests of

a creditor in the event that a debtor fails to fulfill its

obligations - a mechanism which allows creditors prompt

access to the aircraft and associated equipment.

Furthemore, it will give creditors a superior priority

claim against the asset .

A. Equipment Trust and Conditional Sales

Historically, commercial aircraft financing techniques

evolved f rom railroad equipment financing . 'l The legal

structure of equipment trust was invented in the early l g t h

century and was primarily intended for financing railroad

equipment.42 At that time, there was no legal device

available to create a security interest in movable

41~ee L.D. Adkins & D. Billyou, "Current Developments in

Railroad Eqipment Financing" (1957) 12 Bus. L. 207.

4 2 ~ e e M. D. Rice, "Railroad Equipment Financing" (198 9) 18

Trans. L. J. 85.

equipment. Although mortgages on real property were common,

a security interest in persona1 property in absence of

possession was considered illegal. 4' .

Hence, the equipment trust was invented. Under this

structure, an investor (or group of investors) would finance

the acquisition of equipment for the purpose of leasing it

to a third party. This could be done by way of deferring

legal title to the equipment until the full purchase price

is paid. In the meantirne, the equipment user retains

physical possession of the equipment. The payment of the

purchase price might come in the form of lease, rent or

installments. Eventually, once al1 rent due has been paid

for, the "lessor" will have legal title and become the owner

of the equipment. 4 4

The use of equipment trust, either by way of retention

of title to the leased equipment by a trustee in favor of

the party providing the funds or, by way of a conditional

sale agreement where the title is withheld for the benefit

4 3 ~ e e ibid. 44 See M.D. Rice, "Current I s sues i n A i rc ra f t Finance" (1991)

56:4 J. Air L. & Corn. 1027.

of the equipment manufacturer, were considered useful

devices in railroad equipment financing. 4 5

B. Chattel Mottgaqe and Asrial Hypothrc

C h a t t e 1 mortgage. Originally derived from the French

words 'mort" which means dead and "gage" meaning pledge, 46

the chattel mortgage is a security device used within Common

law systems and once regarded as the most commonly used

security instrument in aircraft finance transactions. 47

Barron a n d O'Brian provide the following definition of a

chatte1 mortgage:

" [a]n agreement vesting in the creditor the title

to the chattel, defeasable by performance on the

part of the debtor of the obligation for which

title to the chattel is conveyed as sec~rity.'~~~

?3ee ibid.

4 6 ~ e e D. H. Bunker, The Law of Aerospace Finance i n Canada

(DCL Thesis , M c G i l l University, 1988 1 136 [ h e r e i n a f t e r Bunker]

c i t i n g J. A. Barron & A. H. OrBrian, Chat t e l Mortgages and B i l l s

o f Sale (Toronto: Canada Law Journal Company, 1897) 1.

"~ee Lambert, supra note 20 a t 650. 48 See J. Cohen, The Challenge of Aircraft Financinq and its

Legal l l np l i ca t ions (LL-M Thesis, M c G i l l Univers i ty , 1996)

[unpublished] a t 38 c i t i n g J, A. Barron & A. H. O'Brian, supra

note 40.

Prior to the 1960s, the chatte1 mortgage procedure was

better adapted to aircraft financing than other rnethods of

aircraft finance transactions, including conditional sales.

There are three main reasons for this:

(a) the chatte1 mortgage cculd be used to create a first

or subordinated interest on an owned property, even

if such property had been previously encumbered as a

result of a pre-existing debt. Conversely, such a

practice would be impossible in conditional sale

transactions;

(b) generally described property could be mortgaged,

prcvided that applicable local recording

requirements are satisfied. This rule extends to

spare parts and other accessories attached to the

encumbered aircraft;

(c) the likelihood of the chattel mortgagees' tort

liability exposure for damages arising out of an

event caused by the secured aircraft, is minimal

when compared to the risk borne by title-holders in

title-based aircraft financinq. 4 9

I n t h e 1980s, t h e advantages of utilizing chattel

mortgages as s e c u r i t y devices was soon weakened by t h e

enactment of a number of laws i n t he United States. First,

the adoption of Section 504 of t h e US Federal Aviation

AC^," a s amended, has eliminated t h e risk of t o r t l i a b i l i t y

for injuries t o and death of persons, o r darnage t o o r l o s s

5 1 of p rope r ty imposed on security t i t l e - h o l d e r s . Secondly,

section 1 1 6 (5) of t h e US Bankruptcy granted security

title-holders priority mer chattel mcrtgagees in reclaiming

t h e i r assets in the event of bankruptcy. 5 3

The a e r i a l h y p ~ t h e c ~ ~ on t h e other hand, is the C i v i l

Law counte ipa r t of the chatte1 mortgage and is c h a r a c t e r i z e d

as a non-possessory pledge. Although C i v i l law systems do

' 9 ~ e e Lambert , supra n o t e 20 a t 651 citing F. E. Hines,

"Legal Difficulties i n Secured A i r l i n e Equipment Financing"

(1948) 15 J. Air L. & Corn. 13.

"49 U.S.C. 5 1404 (1976).

"see ibid.

" ~ l O.S.C. S 516 (51 (19761.

%ee aià.

'%ee Cohen, supra note 48 citing R, Rodiere, D r o i t des

T r a n s p o r t s Terrestres et A e r i e n s (Paris: Dalloz, 1990) at L5.

n o t g e n e r a l l y recognize t h e n o t i o n of non-possessory p ledge ,

where posses s ion o f t h e secuzed o b j e c t rests wi th the

c r e d i t o r , t h e C i v i l law system p e r m i t s r e g i s t r a b l e moveable

o b j e c t s t h a t a r e e a s i l y i d e n t i f i e d and l o c a l i z e d such a s

s h i p s and a i r c r a f t . Unl ike mortgages i n Common l a w , hypothec

deeds have t o be drawn up by a n o t a r y and p e r f e c t e d by be ing

r eco rded i n a p u b l i c r e g i s t e r i n o r d e r t o be e f f e c t i v e . "

C. Leasing Aqrecrmcrnts

Leasing i s a key and growing sou rce of funds f o r t h e

a i r l i n e i ndus t ryS6 and a i r l i n e s r ega rd a i r c r a f t Leasing a s

t h e p r e f e r r e d method o f a i r c r a f t a c q u i s i t i o n , f o r a v a r i e t y

o f reasons . From a n economic p o i n t of view, l e a s i n g has

enab led a i r l i n e s t o avo id making huge down-payments and

heavy c a p i t a l comrnitments a s opposed t o pu rchas ing

a i r c r a f t . " Equal ly impor tan t , l e a s i n g has p e r m i t t e d

a i r l i n e s t o b e n e f i t from t a x a t i o n i n c e n t i v e s , which

under l ies t h e p r i n c i p a l d i f f e r e n c e between l e a s i n g and

"Sec i b i d .

5 6 ~ e e R. Gr i t t a h P. Lynagh, "Aircraft Leasing: Panacea o r

Problem?" (1973) 5:I Trans. L. 3 . 12.

"Sec W. W. Eyer, "The Sale, Leasing and Financing o f

Zlircraft" (1979) 45 J. Air L. h Com. 231.

purchas ing . There are many def i n i t i o n s of l e a s i n g , 59 but

i n i t s s i m p l e s t terms, a l e a s e is:

"a c o n t r a c t of h i r e whereunder one p a r t y , the

lessee o b t a i n s t h e use of an a s s e t i n r e t u r n f o r

the payment of r e n t t o t h e owner of the a s s e t ,

the l e s s o r . "'O

I n p r i n c i p l e , l e a s e s can be c l a s s i f i e d as capital (or

f inancial) and o p e r a t i n g l e a s e s . 6' Other s p e c i f i c t y p e s of

l e a s e s , such a s "dry lease", " w e t l e a ~ e ' ~ , "double-dip

lease" , "g randfa the r lease" , "Irish lease", "Musashi lease*,

'e~ee T. M. Clark, "Aircraft Acquisitions: Lease or

Purchase?" (19741 2:4 Int. Bus. L. 90.

"~ee Bunker, supra note 46 at 23. Bunker cited sevexal

definitions of leasing from accounting and tax, as well as legal

perspectives.

60~ee S. Holloway, Airc ra f t Acquisition Finance and Air l ine

Credit Analysis (Great Britain: Pitman, 1992) at 140.

%.A. Greenspon, "Documentation of Aircraft Operating

Leases" (1989) 18 Int. Bus, L. 227. According to Greenspon, a

capital lease is a financing instrument whereby a lessee

(airline) can acquire use of an asset for most of its useful life

by paying a specific amount of rent over the term of the lease

and where the total rent paid will amortize the lessor's capital

investment in the asset. On the other hand, an operating lease is

a short-term lease whereby the lessee (airline) cari acquire use

of an asset for a fraction of its useful life at a fraction of

its cost.

"underwater l e a s e " and numerous o t h e r s evolve £rom t h e

p r i n c i p l e o f c a p i t a l and o p e r a t i n g leases . " Although t h e

s t r u c t u r e and phi losophy of l e a s e s o f t e n sounds ve ry

cornplex, t h e y a r e a c t u a l l y q u i t e s imple .

I t is impor tan t t o no te , however, t h a t d e s p i t e t h e i r

f ancy names, a comrnon l e g a I element i n leasing i s title

r e t e n t i o n , whereby a legal t i t l e o f t h e a i r c r a f t i s u s u a l l y

h e l d by a t r u s t e e a c t i n g on beha l f of the l e n d e r s ( t i t le-

based s e c u r i t y i n t e r e s t ) . The l ende r s ' b a s i c o b j e c t i v e i s t o

e n s u r e t h a t t h e y w i l l r e c e i v e t h e i r p r i n c i p a l and i n t e r e s t

payments r e g a r d l e s s of any change i n c i rcumstances . Should

an e v e n t of d e f a u l t occur , t h e l e n d e r s would expec t t h e

r e t u x n o f a v a l u a b l e and marketable a i r c r a f t . 6 3

II. Principal ûbjmctivei for Reforming Creditox Pzotection

Laws for Aitcraft

As a i r c r a f t c o n s t a n t l y move between p o l i t i c a l bo rde r s ,

a f i n a n c i e r needs t o be a b s o l u t e l y s u r e o f h i s a b i l i t y t o

r e c o v e r and r eposses s a i r c r a f t i n t h e e v e n t of a d e f a u l t o r ,

6 2 ~ e e Bunker, supra nate 46.

%ee Kruft, supra note 24 at 738.

a t l e a s t , be aware o f t h e i n h e r e n t r i s k a s s o c i a t e d w i t h

i t . 64

A. Economic Considerations

1. The Importance of C t e d i t Valuation in Aviation

Financins

One o f t h e most important d r i v i n g forces behind t h e

i n c r e a s i n g complexi ty o f a v i a t i o n f i n a n c e t r a n s a c t i o n s i s

t h e a l l o c a t i o n o f r i s k s between t h e p a r t i e s i nvo lved i n such

t r a n s a c t i o n s . 65 Assess ing t h e a i r l i n e s t c r e d i t , t h e r e f o r e ,

becomes a c r i t i c a l a s p e c t . 6 6

Holloway i d e n t i f i e s some of t h e p r i n c i p a l r i s k s of a

g e n e r a l n a t u r e which f i n a n c i e l s should be aware o f :

( a ) c r e d i t r i s k s posed by t h e o b l i g o r ;

( b ) a s s e t a c c e s s r i s k ;

(c) a s s e t v a l u e r i s k ;

( d ) r i s k s as a result of t h e p h y s i c a l l o s s o f o r damage

t o aircraft ;

(e) l i a b i l i t y r i s k s a r i s i n g o u t of t h e u se o f a i r c r a f t ; - -- - - - - -- - - -

"sec Greenspon, supra note 61 a t 229. 65 See Holloway, supra note 60 a t 209.

%ee R. S. Sowter, "Lease Finance f o r Airl ines" (1979) 4:1

Air L. 20.

( f 1 political ris k;

(g) tax risk; and

(h) currency rate and interest ri~k.~'

Prior to considering the above risks, and in view of

various methods of financing an airline, an assessrnent

should also be made based on the following questions:

(a) whether the lending guaranteed by an export credit

agency, in this case, a financier's primary

security, will be the guarantee of the export credit

agency to repay the financier in the event of

default;

(b) or whether in the case of Lending to the governmcnt

sector (government agencies, state-owned airlines or

against government guarantees), the financier's

concern would be placed on the goverment's

cornmitment to honor repayment obligations;

(c) or whether in asset-based financing, where the

aircraft (asset) is the principal security to the

transaction, the prime concern of the financier

would be on the priority of the security interest it

has over the secured asset;

67~ee Holloway, supra note 60 at 209,

(d) o r whether t h e l end ing is based on t h e a i r l i n e r s

c r e d i t a lone . 68

2 . Economic Value of Collateral

I t is e s s e n t i a l t o v e r i f y t h a t an a i r l i n e has t h e power

t o borrow money and c r e a t e s e c u r i t y i n t e r e s t s i n i t s a s s e t s .

An a i r l i n e w i t h weak c r e d i t w i l l p l a c e g r e a t e r r e l i a n c e on

t h e resale va lue of t h e a i r c r a f t a s s e c ~ r i t ~ , ~ ~

Consequently, t h e economic va lue o f c o l l a t e r a l f o r a

l e n d e r is of g r e a t importance i n de te rmin ing f i n a n c i n g

s t r a t e g i e s where t h e assetrs v a l u e a s s e c u r i t y i s a c r i t i c a l

f a c t o r i n p x i c i n g t h e whole t r a n s a c t i o n . I f t h e f u t u r e

res idual va lue of a i r c r a f t i s f o r e c a s t e d t o be high, l e n d e r s

might be more a t t r a c t e d i n t o s t r u c t u r i n g a more a t t r a c t i v e

method of f i nanc ing , o r , banks may o f f e r l a r g e r l oans . sa

60 See A. Robinson "Assessing an A i r l i n e r s Credit : The

Lender' s Perspective" i n S .A. D. Hall, ed., A i r c r a f t Financinq

(London: Euromoney Publications, 198 9) 151.

6 g ~ e e Holloway, supra note 60 a t 123. Ï O See M. JI Durham h D. P. Garton, "Selecting the

Appropriate Structure: The Decision-Making Process" i n S.A.D.

Hall, ed . , A i r c r a f t FinancUig (London : Euromoney Publications,

1989) 27 a t 33 .

One popular trend of aircraft financing techniques,

asset-based financing, depends on clear evidence that

aircraft can retain a certain market value in order to cover

the financier's capital costs and expected returns. The idea

is that in the event of default, the aircraft used as

security must be quickly returned and put back into

operation with another operator. In this case, the aircraft

must also stand on its own value-7L Accordingly, the

financial condition of the airline, or goverment

quarantees, becomes less important in asset-based

transactions where asset itself serves as the primary

guarantee. 72

B. K e y Leqal and Political Problems

When an aircraft is put on cross-border operations, the

differing systems of aircraft registration, commercial

codes, legal frameworks and overall political instability of

many jurisdictions generate vast problems and concerns as to

"~ee S. Pierce, 'The Industryf s Requirements : The Growth of

Asset-based Financing" in S .A- D. Hall, ed., A i r c r a f t F inanc ing

(London: Euromoney Publications, 1989) 3 at 7.

"~ee F. Kennedy, "Financing National Rirlines in Developing

Countries" in S.A. D. Hall, ed., Aircraft F i n a n c i n g (London:

Euromoney Publications, 1989) 39 at 41.

whether the financier will be able to repossess the aircraft

quickly in the event of a defaul t .

In security-based aircraft financing, the financier has

to ensure that the airline has validly acquired title and

that the financier himself has acquired a valid first

priority security interest. This also applies to title-based

financing whereby the financier has to verify that title-

retentian devices are generally recognized worldwide.

By virtue of the Convention on the International

Recognition of Rights in Aircraft 1948'', customary

international practice regards a lease or security interest

in aircraft to be deemed valid if constituted in accordance

with the Law in which the carrier is ~ertified.'~ However,

it is not possible to generalize as to how a country would

treat foreign security interests as the Law of property

rights must u s u a l l y conform to the Laws of the individual

States as the foms of secured transactions, be it chattel

mortgages, hypothecs or title-retention devices, which Vary

" ~ e e Geneva Convention, i n f r a note 9 8 .

" ~ e e Geneva Convention, infra note 9 8 , a r t . 1 (Il (a) .

from coun t ry t o count ry . I t is p o s s i b l e t h a t one o r more

d e v i c e s a r e unknown w i t h i n c e r t a i n j u r i s d i c t i o n s . 7s

Although t h e Geneva Convention has been s igned by most

c o u n t r i e s , t h e convent ion h a s n o t been r a t i f i e d by a

m a j o r i t y of s i g n a t o r i e s . Accordingly, t h e r i g h t s c r e a t e d

under t h e laws of non-contract ing s t a t e s w i l l no t have t h e

same impact a s t h o s e c r e a t e d by c o n t r a c t i n g s t a t e s .

F u r t h e m o r e , t h e Convention does n o t have a n erga omnes

e f f e c t , meaning t h a t ownership r i g h t s a r e on ly p r o t e c t e d

when an a i r c r a f t f l i e s e x c l u s i v e l y between c o n t r a c t i n g

s t a t e s . 7 6

2, Deprivation and Reposaession Rïsks

When an a i r l i n e i s based i n a p o l i t i c a l l y u n s t a b l e

coun t ry , t h e a i r l i n e may be a t r i s k of be ing exposed t o a

weak l e g a l system. F i r s t , t h e system may b e l a c k i n g a body

of commercial law, which does n o t p r o t e c t h o l d e r s of t i t l e

o r s e c u r i t y i n t e r e s t s i n a i r c r a f t . Secondly, i ts l e g a l

75 See W. W. Eyer, supra note 57 at 242.

'%ee M. Chobaux, "Ensuring the Law is on your Side"

(January 1994) Asset Finance & Leasing Digest 21.

processes are slow or uncertain and its judiciary may be

susceptible to political interference. 77

Deprivation occurs when a financier is deprived of

access to an aircraft. For example, the state where the

aircraft is located at the time of repossession may deny

entry and exit visas to recovery crews. Important manuals

and technical and maintenance records belonging to the

aircraft must also be recovered. Failure to recover the

aircraft's current records may burden the financier by

having him perform a heavy check on the repossessed aircraft

in order to re-establish its maintenance credentials. The

inability to do so would render the aircraft unmarketable. 78

Desegistration and Expost Authorization Delayr

The issue of political risks is one of the most common

issues in cross-border financing, from both commercial and

legal perspectives. These risks can range from confiscation

by the host government, to a refusal on the part of local

aviation authorities to issue the necessary aircraft export

licenses/export authorizations, or to other actions

exercised by a host government which prevent or delay

77 See Holloway, supra note 60 at 262.

'%ee ibid.

realization of the creditor's rights to repossession. : 9

Some devices that are used tu increase t h e degree of

cornfort include signed and undated deregistratiun fortns,

export licenses for the aircraft, a blank power of a t t o r n e y

signed by the airline and a government undertaking to

facilitate or refrain from hindering deregistration.

However, since most airlines are owned by governments, and

in view of the accumulated capital Lnvested in the aircraft,

there is no guarantee that the operator or its government

would be willing to cooperate in the repossession of the

aircraft by foreigners. BO

4 . Bankruptcy Lawr which -de Aircraft Repossession

Under the mechanism of insolvency laws of most

jurisdictions, a borrowerrs liquidator or bankruptcy

administrator, can challenge a validly created security

being deemed to be a preference or a f r a u d u l e n t conveyance

i n favour of the rnortgagee. A preference is deemed given if

a bankrupt Company allows anything t h a t can be constituted

as granting preferential treatrnent to a creditor or

79 See A. Littlejohns & S. Hall, "Legal Issues in Aircraft

Finance" in S .A. D. Hall, ed., Aircraft Financinq (London:

Euromoney Publications, 1989) 219 at 223.

Holloway, supra note 60 at 228.

g u a r a n t o r , s o as t o p u t such a creditor i n a better position

than o t h e r c r e d i t o r s , B 1

An excep t ion can b e found i n S e c t i o n 1110 of t h e US

Bankruptcy Code,02 which e s s e n t i a l l y p r o h i b i t s bankruptcy

c o u r t s and t r u s t e e s i n Chapter 11 r e o r g a n i z a t i o n s from

i n t e r f e r i n g wi th t h e r i g h t s o f owners and s e c u r e d p a r t i e s ,

i n compliance wi th t h e p r o v i s i o n s o f t h e a p p l i c a b l e s e c u r i t y

agreement, l e a s e or c o n d i t i o n a l s a l e c o n t r a c t . The r i g h t of

t h e s ecu red p a r t i e s , l e s s o r s and c o n d i t i o n a l vendors t o

r e p o s s e s s a i r c r a f t , a i r c r a f t engines, p r o p e l l e r s , a p p l i a n c e s

o r s p a r e p a r t s is suspended i f , w i t h i n a s ix ty-day w a i t i n g

p e r i o d , t h e debtor a g r e e s t o perform a l l o b l i g a t i o n s and

c u r e e x i s t i n g d e f a u l t s . 8 3

" ~ e e A. L i t t l e johns h S. Hall, supra note 79 a t 231.

"11 U.S.C. S 1110 (1982)

or a de t a i l ed discussion of S 1110 of t h e Bankruptcy

Code and i t s his tory, see Goldman, Album & Ward, "Repossessing

t h e S p i r i t of St. Louis: Expanding t h e Protection of Sections

1110 and 1168 of the Bankruptcy Code" (1985) 4 1 Bus. L. 29; G. S.

Gerstell 6, K . Hoff-Patrinos, "Aviation Financinq Problems Under

Section 1110 of the Bankruptcy Code" (1907) 61 Am. Bankr. L, J.

1; R. Greenspon, "AirLine Reorganizations in t h e US and t h e i r

Impact on the In t e re s t s of Ai rc ra f t Lessors and Secured

Creditors" (1986) 1 4 Intl. Bus. L. 100.

5 . Choice of Law Issues

C o n f l i c t s of law i s s u e s a r e i n h e r e n t t o c ross -border

f i n a n c i n g s . The cons t an t movement of a s s e t s adds t o t h e r i s k

o f j u r i s d i c t i o n a l c o n f l i c t . Therefore , f i n a n c i e r s wishing t o

r e p o s s e s s a n a i r c r a f t should be aware o f t h e d i v e r g i n g

systems o f law which can impose thernselves : 8 4

( a ) Governing law. While t h e cho ice of law s e l e c t e d by

t h e p a r t i e s i n a t r a n s a c t i o n , g e n e r a l l y governs most

i s s u e s i n connect ion wi th t h e c o n t r a c t , one must

n o t e t h a t t h e law of t h e a c t u a l p l a c e where t h e

c o n t r a c t i s s igned (lex loci contractus) may govern

some m a t t e r s regard ing v a l i d i t y and e n f o r c e a b i l i t y ;

( b ) Lex s i t u s . Some j u r i s d i c t i o n s , e s p e c i a l l y t h o s e o f

non-cont rac t ing s t a t e s t o t h e Geneva Convention may

l o o k a t t h e phys i ca l l o c a t i o n of t h e a i r c r a f t t o

de te rmine t h e v a l i d i t y o f t i t l e t r a n s f e r o r c r e a t i o n

o f s e c u r i t y r i g h t s ;

(c) Lex forum. The law of t h e state where the c o u r t

chosen t o hea r a d i s p u t e governs j u r i s d i c t i o n a l and

procedural mat t e r s , as w e l l as any assessment o f

damages. While it i s g e n e r a l l y safe t o choose a

forum on a non-exclusive b a s i s , o r even, one which

8 4 See Holloway, supra note 60 at 211.

-4 7-

acco rds t h e cho ice of governing law, it would be

e a s i e r f o r f i n a n c i e r s t o select t h e forum where t h e

judgment w i l l be enf orced.

6. Sovereign ïmmunity

There are f e a r s t h a t when government-owned a i r l i n e s a r e

brought t o c o u r t , t h e y w i l l r a i s e t h e d e f e n s e of sove re ign

immunity. However, i t has been a g e n e r a l l y accep ted p r a c t i c e

t h a t a s l ong a s t h e a i r l i n e is cons ide red t o b e conduct ing

commercial o p e r a t i o n s , accord ingly , t h e a c q u i s i t i o n and

f i n a n c i n g o f a i r c r a f t a r e t o be regarded a s p u r e l y

commercial t r a n s a c t i o n s , r e g a r d l e s s of whether one o f t h e

p a r t i e s t o t h e t r a n s a c t i o n a c t s on beha l f o f a government o r

government e n t i t y . While most sove re ign immunity de fenses

a r e u n l i k e l y t o p r e v a i l i n most c o u n t r i e s , i t is p o s s i b l e

t h a t goverment-owned a i r l i n e s r a i s e a r e l a t e d de fense

c l a iming t h a t t h e enforcement of a l e a s e o r s e c u r i t y

i n t e r e s t w i l l v i o l a t e p u b l i c o r d e r by i n t e r r u p t i n g its

n a t i o n a l a i r s e r v i c e . 86

" ~ e e ibid.

'%ee W. W. Eyer, supra note, 57.

THE -IONAL L&GAL REG= FOR

AIR- FINANCïNG TRANSACTIONS

1. International L e g i s l a t i o n and Rights i n Aircraft

International work in legislating matters related to

recognition of title and mortgages in aircraft began as

early as 1925. In that year, the International Chamber of

Commerce established a special commission consisting of

legal experts in the field of air law known as the CITEJA

(Comité International Technique d'Experts Juridiques

Aériens) which had the following basic objectives:

(a) to set-up a program for the examination of air law;

(b) to prepare tcxts for international conventions on

air law;

(c) to elaborate a single international code for air

law . 8 7

or or a review of CITEJA's history see J.J. Ide, "The

History and Accomplishments of the International Technical

Committee of Aerial Legal Experts (CITEJA) " (1932) 3: 1 J, Air L.

& Corn. 27.

Since its establishment, CITEJA has been engaged in the

preparation of a number of major international air law

conventions. The adoption of the ce lebra ted Warsaw

Convention for the Unification of Certain Rules Rela t ing to

International Carriage by Air 1929'' represents CITEJA' s

principal achievement.

Shor t ly a f t e r CITEJA was established, it was charged t o

begin work on a d r a f t convention that would provide a basis

for the international recognition of security interests in

a i r c r a f t , comparable to custornary practice in maritime

law. 90 By 1931, the commission had produced two draft

conventions. The first d ra f t contained provisions dealing

%e Convention f o r the Unificat ion of Cer ta in Ru1 es

Rela t ing t o International C a r r i a g e by Air, signed at Warsaw, 12

October 1929. Authentic French Text: II Conférence Internationale

de Droit Privé Aérien, 4-12 Octobre 1929, Varsovie [Warszawa

19301 pp. 220-233. Englisti Translatian: ScheduLe ta the United

Kingdom Cârriage by Air Act, 1932, 22 & 23 Geo.5, ch.36.

'%ee R.O. Wilberforce, "The International Technical

Cammittee of Experts in Air Law" (1947) 1 I .L .Q . 509.

"see i b i d . See also C.S. Doskow, "Transitory Chattels and

Stationary Law" (1959) 26 J. A i r L. 6 Corn. 36 at 47 [hereinafter

Doskow] ; Rice, supra note, 40 at 1055. iinder customary practice

in maritime law, the validity of interests in ships are

determined by the l a w of the state where the vesse1 is registered

for nationality purposes.

w i t h t h e ownership of a i r c r a f t and an a e r o n a u t i c a l r e g i s t e r .

The second d r a f t covered mortgages and o t h e r s e c u r i t i e s . 9 1

The CITEJA d r a f t s were no t submi t ted t o an i n t e r n a t i o n a l

con fe rence u n t i l s h o r t l y b e f o r e t h e end o f t h e Second World

War . 92

A. The Rome Convention on Precautionaxy Arrest for

Aircraft 1933

Lenders r ega rd p recau t iona ry a r r e s t a s a u s e f u l method

t o g u a r a n t e e t h e payment of a deb t . This is p a r t i c u l a r l y

t r u e a s l ong a s t h e arrest s e r v e s t h e b e n e f i t of p r i v a t e

i n t e r e s t s . However, p r ecau t iona ry arrest may t h r e a t e n t h e

g e n e r a l i n t e r e s t i f t h e a r r e s t causes economic d i s t u r b a n c e s

i n a i r t r a n s p o r t . 93

The Convention f o r t h e U n i f i c a t i o n o f C e r t a i n Rules

R e l a t i n g t o t h e Precaut ionary A t t a c h e n t o f ~ i r c r a f t ' ~ s e e k s

"Sec C.W. Shawcross & K.B- Beaumont, Air Law (London:

Butterworths, 1966) a t 585.

3 ' ~ e e ibid.

3 3 ~ e e N .M. Matte, Treatise on Air-Aeronautical Law (Toronto :

Carswell, 1981) 497.

9 4 ~ e e Convention for the Unification of Certain Rules

R e l a t i n g t o the Precautionary Arrest o f Aircraf t , signed a t Rome,

29 May 1933, 192 L.N.T.S. 289 , [hereinafter Rome Convention]. See

t o p reven t t h e s e i z u r e of a i r c r a f t r e g i s t e r e d i n a

C o n t r a c t i n g S t a t e from a r r e s t o r d e t e n t i o n i n a n o t h e r

C o n t r a c t i n g S t a t e , provided t h a t such s e i z u r e would

s e r i o u s l y i n t e r r u p t p u b l i c , commercial o r s t a t e

t r a n s p o r t a t i o n and t h a t t h e fo l lowing c i r cums tances apply :

( a ) t h e a r r e s t must be a form o f p r e - t r i a l o r i n t e r i m

r e l i e f , and n o t an enforcement o f a judgment debt;'=

( b ) t h e a i r c r a f t must be e x c l u s i v e l y a p p r o p r i a t e d t o a

s t a t e o r p o s t a l s e r v i c e o r , i n service on a regular

l i n e o f p u b l i c t r a n s p o r t ; 96

( c ) i n c a s e of a i r c r a f t a p p r o p r i a t e d t o a commercial

t r a n s p o r t , imrnunity a p p l i e s o n l y when t h e a i r c r a f t

is ready t o s t a r t t h e journey, u n l e s s t h e a r r e s t is

i n r e s p e c t of a c o n t r a c t d e b t i n c u r r e d for t h e

purposes o f t h e journey which t h e a i r c r a f t is about

t o make. 97

a l so C.W. Shawcross 6 K.B. Beaumont, Air Law (London:

But temorths , 1951) a t 499.

3 5 ~ e e i b i d . , a r t . 2 (1).

'"ee i b i d . , a r t , 3 (1) (a ) & (b) . "sec i b i d . , a r t . 3 (c) .

Presently, there are only 28 States parties to the

Convention. Neither the United States nor the United Kingdom

is a party to the treaty.

B. The Geneva Convention on the International Recognition

of Riqhts i n Aircraft 1948

Driven by its strong economic interest in facilitating

aircraft exports to other countries and backed by a

sophisticated method of equipment financing, the United

States realized the importance of defining an

internationally accepted standard of property rights in

aircraft. Furthermore, there was a growing number of

aircraft financed by US corporations at that time, where the

United States became particularly concerned when aircraft

they had financed became exposed to a foreign jurisdiction

with a hostile treatment towards property rights in

aircraft . 98

Consequently, the United States becarne the strongest

advocate for the preparation of an international aircraft

mortgage treaty that sought to protect the security interest

'%ee Matte, supra note 93 at 5 5 4 .

-5 3-

o f t h e i r financier^.'^ Hence, t h e c a l l i n g f o r t h e adop t ion

of an a i r c r a f t rnortgage t r e a t y r ece ived growing suppor t from

t h e i n t e r n a t i o n a l community. The fo l lowing were t h e

suppor t ing ci rcurnstances p r e v a i l i n g a t t h e t i m e :

( a ) i n c r e a s i n g a i r c r a f t f u n c t i o n a l i t y raised t h e va lue

of modern a i r c r a f t cons iderab ly ;

(b) newer a v i a t i o n technology improved a v i a t i o n s a f e t y ;

(c) s i g n i f i c a n t developments i n t h e i n su rance s e c t o r

p rovided g r e a t e r a s su rance and conf idence i n a i r

t r a v e l . 'Oo

Pursuant t o an assembly r e s o l u t i o n of t h e I n t e r n a t i o n a l

C i v i l Av ia t ion Conference, which met i n Chicago i n 1 9 4 4 , t h e

conference was i n v i t e d t o g i v e c o n s i d e r a t i o n t o t h e e a r l y

convening of a n i n t e r n a t i o n a l a i r law conference f o r t h e

purpose of adop t ing a convent ion d e a l i n g wi th a i r c r a f t

mortgages. For t h a t purpose, t h e conference was t o u s e for

' g ~ e e R.O. Wilberforce, "The Internat ional Recognition of

Rights i n Aircraf t" (1948) 2 I.L.Q. 4 2 1 [here inaf te r

Wilberforcel 1 ; S. P. Honig, The Legal S t a t u s of Aircraf t (The

Hague: Martinus Nijhoff, 1956) a t 79.

loOsee, 1. P. Diederiks-Verschoor, Introduction t u A i r Law,

(Boston: Kluwer Law, 1991) a t 161.

its deliberations, the earlier draft conventions prepared by

CITEJA. 'O1

In accordance with such a recommendation, CITEJA

continued its intensive study on the subject and Later

decided to consolidate the two draft conventions. Following

the end of the Second World War, the ICAO Legal Comrnittee,

which took over the functions of CITEJA, resumed earlier

efforts to prepare a convention on the international

recognition of rights in aircraft. In 1948, the second ICAO

Assernbly in Geneva adopted the Convention on the

International Recognition of Rights in Aircraft, which was

signed by fourteen States and came into force on 17

Septernber 1953. 'O2

Io'see E. Warner, "PICAO and Development o f A i r Law" (1947)

14 J. Air L . & Corn. 9 .

'O'see, Convention on the International Recognition of Rights

i n Aircraft, signed in Geneva, 19 June 1948, 310 U-N-T-S. 151,

T.1-A-S. 2847, 4 D.S.T. 1830, ICAO Doc. 7620 [hereinafter Geneva

Convention]. For a complete his tory o f t h e l eg i s la t i ve process o f

t h e Geneva Convention, see Report and Commentary o f the Legal

Committee of ICAO on the D r a f t Convention Concerning the

International Recognition o f Rights i n Aircraft, ICAO Doc, 4627,

LC/63.

The Geneva Convention was endowed with a simple

structure, consisting of 23 articles that touch upon the

creation, perfection, and recognition of rights in aircraft.

Lord Wilberforce, who signed this instrument on behalf of

the United Kingdom, noted that the drafting of the

Convention involved one of the rnost elaborate exercises ever

undertaken in international Law, since it attempts to

address issues arising from a specific area of law,

variously regulated under a wide divergence of national

conceptions, concerning real rights in aircraft that move

between several countries. 103

The Convention provides a solution to the problerns of

recognizing and enforcing financiers' rights in aircraft, on

the condition that such rights have been created in

accordance with the laws of the State where the aircraft is

duly registered. Thus, in addition to its significance for

operating lessors of aircraft, purchasers, lessees, and

secured financing parties who take a mortgage as security,

the Geneva Convention also serves to inform Contracting

States of their respective rights concerning lease,

ownership, and secured interests. The basic objectives of

the Convention are: - - -

?àee Wilberforce 1, supra note 98.

( a ) c r e d i t o r p r o t e c t i o n f o r l e n d e r s who have f inanced

t h e purchase of a i r c r a f t , wi th t h e a i r c r a f t i t s e l f

s e r v i n g a s t h e main s e c u r i t y f o r t h e loan;

( b ) t h e p r o t e c t i o n o f t h i r d p a r t i e s who a r e e i t h e r

d i r e c t l y o r i n d i r e c t l y involved i n t h e f i n a n c e o f

t h e a i r c r a f t . P r o t e c t i o n is a l s o a f f o r d e d t o t h i r d

p a r t i e s who may have hidden charges i n r e s p e c t o f

t h e a i r c r a f t ;

(c) t h e p r o v i s i o n of r u l e s d e f i n i n g p r i o r i t y d a i m s

a g a i n s t a i r c r a f t ; and

( d ) t h e f a c i l i t a t i o n o f t h e t r a n s f e r of a i r c r a f t between

n a t i o n a l i t y r e g i s t e r s . 104

The Geneva Convention dues no t o b l i g a t e c o n t r a c t i n g

s t a t e s t o make changes t o t h e i r own laws r e l a t i n g t o

p r o p e r t y r i g h t s . It onLy requires c o n t r a c t i n g s t a t e s t o

r ecogn ize t h o s e r i g h t s c a r r i e d by a i r c r a f t created and d u l y

r e g i s t e r e d i n a n o t h e r c o n t r a c t i n g s t a t e . The r i g h t s

recognized under t h e Convention a r e :

'04see ibid. See also, Geneva Convention, supra note 102,

arts. 1, III, I V , V, V I 1 & I X .

r i g h t s o f p r o p e r t y o r ownership i n a i r c r a f t ; l o 5

r i g h t s t o a c q u i r e a i r c r a f t by purchase coupled by

posses s ion o f t h e a i r c r a f t , such a s h i re -purchase o r

c o n d i t i o n a l s a l e s ; l o6

r i g h t s t o possess ion of a i r c r a f t under l e a s e s of s i x

months o r more, which inc ludes one of t h e f e a t u r e s

of equipment t r u s t ; L07

mortgages, hypotheques and s i m i l a r r i g h t s i n

a i r c r a f t which a r e c o n t r a c t u a l l y c r e a t e d a s s e c u r i t y

f o r payment of an indebtedness . "loe

I t i s impor tan t t o n o t e t h a t t h e s e r i g h t s a r e no t

v a l i d a t e d by t h e onv vent ion."^ Con t r ac t ing S t a t e s a r e f r e e

t o cnoose whatever method t h e y wish o f s e c u r i n g an i n t e r e s t

over an a i r c r a f t , provided t h a t such a i n t e r e s t is

r e g i s t e r e d i n a p u b l i c r eco rd and c o n s t i t u t e d i n accordance

wi th t h e law of t h e S t a t e i n which t h e a i r c r a f t is

r e g i s t e r e d a s t o n a t i o n a l i t y . 110

'''see Geneva Convention, supra note 102, a r t 1 (1) (a ) . '06see ibid., art. 1 (1) (b) . '07see ibid., a r t . 1 (11 (c ) . 'OB!3ee i b i d . , art. 1 (1) ( d l .

" ' ~ e e Wood, supra note 2 at 265,

'Iosee Geneva Convention, supra note 102, art. 1 (1) (i)

The principal reason why the drafters of the Convention

did not provide for a global standard for the constitution

and creation of security rights, was mainly due to the lack

of agreement as to which law is to govern a contractual

creation of an interest.''' Furthermore, the drafters found

great difficulty in finding an expression that would

describe security interests in aircraft in such a way as to

embrace aLl legal systems. 112

b) Registration of Rights

In order to effect recognition, an interest rnust be

recorded.'13 An unrecorded interest will not qualify for

international recognition. 11* Ironically, the Geneva

Convention does not impose an obligation for states to

maintain a record, nor does it properly define the meaning

" ' ~ e e A. Kadletz, Conf l ic t s o f Laws i n Private International

Air Law: The Contracts o f Carriage by A i r , Aviation Insurance,

Airrraft Purchase, Finance, the Crea t i o n o f Securlty R i g h t s i n

A i r c r a f t and a Common General P a r t (LL-M Thesis, McGill

University, 1996) at 142 citing O. Riese, Luftrecht (Stuttgart:

K.F. Koehler, 1949) a t 375.

'I2see Wilberforce 1, supra note 98.

LL3~ee Geneva Convention, supra note 102, art, 1 (d) ( ii) . "4~ee i b id .

of "pub l i c r e c ~ r d " . " ~ It should a l s o Se assumed t h a t t h e

Convention l eaves d i s c r e t i o n t o s t a t e s on whether t o keep a

s i n g l e a e r o n a u t i c a l r eco rd o r , s e p a r a t e n a t i o n a l i t y and

mortgage r eco rds . There i s no doubt t h a t s t a t e s wi thout a

r e c o r d may no t be f u l l y a b l e t o en joy t h e b e n e f i t s of t h e

Convention s i n c e unrecorded r i g h t s a r e s u b o r d i n a t e t o

recorded r i g h t s . 116

C) Privileqed and Priority Claims

Aside from t h o s e r i g h t s enumerated under A r t i c l e 1 of

t h e Geneva Convention, t h e r e a r e o t h e r r i g h t s having

p r i o r i t y over Article 1 r i g h t s . I n o r d e r of t h e i r rank,

t h o s e r i g h t s are"':

'"~ee Geneva Convention, supra note 102, a r t . 1 (1) (ii) . ?Sec Diedericks-Verschoor, supra note 100 a t 165. 1 i 7 Sec B.J.H Crans, "Selected P i t f a l l s and Booby-traps i n

A i r c r a f t Finance" (1992) L7:l Air & Sp. L. 45 c i t i n g K. Rijks,

H e t Verdrag van Geneve (Thesis, Leiden Universi ty, 1952) a t 181,

Compare, D.I. Johnston, "Legal Aspects of A i r c r a f t Finance"

(1963) 29 J. Air L. & Corn. 317. According t o Johnston, t h e o r d e r

of rank a r e as follows: (1) c o s t s of j u d i c i a l s a l e ; (2 ) sa lvage

and p rese rva t ion claims; ( 3 ) claims a r i s i n g from damage t o

persons on ground; ( 4 ) a r t i c l e 1 r i g h t s ; and (5) o t h e r r i g h t s

according t o t h e i r s t a t u s under t h e n a t i o n a l law of t h e a i r c r a f t .

(a) claims based on immigration, customs and a i r

navigat ion charges imposed by na t iona l l a ~ ; l ~ ~

(b) c o s t s of t h e j u d i c i a l s a l e which a r e l e g a l l y

chargeable under t he law of t h e Contract ing S t a t e

where the sa l e t akes place;11g

(c) claims i n respect of t h e s a l e of spare parts;'''

(d) claims f o r a i r c r a f t salvage and/or ext raordinary

expenses associa ted with t h e preservat ion of t h e

a i r c r a f t; 12'

( e ) claims a s a xesul t of i n ju ry t o persons o r damage t o

proper ty caused by t h e a i r c r a f t , provided t h a t such

i n j u r y o r damage occurred on the su r face of t h e

Contract ing S t a t e where the execution sale of t h e

a i r c r a f t takes place. Such a d a i m i s l imi ted t o 20

per cen t of t h e execution s a l e p r i c e aga in s t

'''sec Geneva Convention, supra note 102 a r t . XII. 119 See ibid., ar t . VI1 (61.

'"sec ibid., a r t . X. lxSee ibid., a r t . I V (21 ( a ) & (b). Aïso known as

"pr ivi leged c l a h s " , these a r e r i gh t s i n rem which have t o be

respected only i f the lex s i t u s ( t he law s t a t e where t he rescue

and preservat ion took place) recognizes them as having pr iv i lege .

Reference t o t h e term "extraordinary" expenses s h a l l include a l 1

non-ordinary and recurring expenses, which a r e associated with

r epa i r s t o t h e a i r c r a f t .

c r e d i t o r s c la iming under Article 1 o f t h e

C ~ n v e n t i o n ; ~ ~ '

( f ) purchase o p t i o n s , l e a s e r i g h t s and mortgage

r i g h t s . 123

d) Transfer of Aircraft Between Registries

Article I X o f t h e Geneva Convention was p r i m a r i l y

des igned t o d e a l wi th t h e r i s k s of a secu red c r e d i t o r when

t h e a i r c r a f t used a s s e c u r i t y i s t o be s o l d (and

subsequen t ly d e r e g i s t e r e d ) i n ano the r s t a t e . The Convention,

t h e r e f o r e , p r o h i b i t s t h e t r a n s f e r o f a i r c r a f t from one

n a t i o n a l r e g i s t r y of a Con t r ac t ing S t a t e t o a n o t h e r r e g i s t r y

of a n o t h e r c o n t r a c t i n g s t a t e , excep t when t h e fo l lowing

circurnstances apply:

( a ) a f o r c e d s a l e i n execu t ion s u b j e c t t o a r t i c l e VIT;

( b ) a l 1 h o l d e r s of recorded r i g h t s have been d u l y

n o t i f i e d and g iven consent t o t h e t r a n s f e r . 124

Yet, t h e Convention f a i l s t o p reven t a t r a n s f e r from

one C o n t r a c t i n g S t a t e t o a "non-contract ing" State. 125

" '~ee ibid., a r t . vfI (51.

'%ee ibid. , art . 1 (1) . 1'4~ee ibid., art. IX.

Article IX rnakes r e f e r e n c e t o "holders of r eco rded r i g h t s "

but i s u n c l e a r whether h o l d e r s of " p r i o r i t y r i g h t s " under

Art icle I V are also ~ 0 v e r e d . I ~ ~ Another weakness is t h e

absence of a mandatory d e r e g i s t r a t i o n p r o v i s i o n once an

a i r c r a f t becomes e l i g i b l e f o r s u b s e q u e n t r e g i s t r a t i o n i n

ano the r s t a t e . This e n a b l e s t h e double r e g i s t r a t i o n of

a i r c r a f t , which con t r avenes Article 18 of t h e Chicago

Convention r e g a r d i n g dual r e g i s t r a t i o n of a i r c r a f t . "'

e) Spare P a r t s

The i n c l u s i o n of s p a r e p a r t s under t h e Geneva

Convention r e f l e c t s t h e s i g n i f i c a n t p r o t e c t i o n r e q u i r e d f o r

a i r c r a f t f i n a n c i e r s as spare p a r t s g e n e r a l l y account fo r 25

percent of t h e aircraft purchase p r i c e . 126

L25~ee M.V. Polak, "Conflicts of Laws in the A i r " (1992)

18:2 Air & Sp. L. 83.

"%ticle IV (3) of t h e Geneva Convention does not require

privileged cla ims to be "recorded", instead, a "note" on the

record must be entered within three months frorn the date of t h e

t e m i n a t i o n o f the salvage or p rese rva t ions operations.

' " ~ e e Convention on International C i v i l Aviation, signed a t

Chicago, 7 December 1944 , 15 U.N.T.S. 295, ICA0 Doc. 730016 art.

1 0 . i Z B S e e G.N. Calkins Jr., "Creat ion and I n t e r n a t i o n a l

Recognition of T i t l e and Security Rights i n Aircraft" (1948) 15

J. Air L. & Corn. 177.

The Convention d e f i n e s s p a r e p a r t s a s " p a r t s of

a i r c r a f t , engines , p r o p e l l e r s , r a d i o appa ra tus , i n s t rumen t s ,

a p p l i a n c e s , f u r n i s h i n g s p a r t s o f any of t h e foregoing , and

g e n e r a l l y any o t h e r a r t i c l e s of whatever d e s c r i p t i o n

main ta ined f o r i n s t a l l a t i o n i n a i r c r a f t i n s u b s t i t u t i o n f o r

p a r t s o r a r t i c l e s r e m ~ v e d . " ' ~ ~ The Convention does n o t

s t i p u l a t e a l 1 t y p e s of s p a r e p a r t s , bu t r a t h e r , p rov ides

C o n t r a c t i n g S t a t e s wi th t h e o p t i o n t o dec ide whether t h e y

would i n c l u d e s p a r e p a r t s w i t h i n t h e scope of t h e

Convention. Spare p a r t s may be used a s s e c u r l t y f o r

indebtedness , provided t h a t :

( a ) t h e law o f t h e Con t r ac t ing S t a t e where t h e a i r c r a f t

i s r e g i s t e r e d provides f o r t h e i r i n c l u s i o n ;

(b) c r e a t i o n of r i g h t s i n s p a r e p a r t s must r e l a t e t o an

indebtedness i n connec t ion wi th t h e f i n a n c i n g o f

a i r c r a f t . Th i s i s because s p a r e p a r t s , u n l i k e

a i r c r a f t , do n o t posses s t h e i r own n a t i o n a l i t y .

Hence, t h e Geneva Convention p r o h i b i t s t h e

r e c o g n i t i o n o f independent s e c u r i t y d e v i c e s i n s p a r e

p a r t s ;

Z 2 9 ~ e e Geneva Convention, supra note 102, a r t . X ( 4 ) .

"O~ee ibid. , art. X ( 1) . "'sec ibid.

(c) t h e y a r e s t o r e d a t a s p e c i f i e d p l a c e o r places;13'

( d ) a n a p p r o p r i a t e p u b l i c n o t i c e s p e c i f y i n g t h e

d e s c r i p t i o n of t h e r i g h t , t h e r i g h t h o l d e r ' s name

and addres s and t h e r eco rd i n which such r i g h t s i s

recorded is e x h i b i t e d a t t h e p l a c e where t h e s p a r e

p a r t s a r e l oca t ed .

f) Enforcement by Judicial Sale

The o n l y method of enforcing a r i g h t a g a i n s t a i r c r a f t

i s through a fo rced j u d i c i a l s a l e . l I4 F u r t h e m o r e , t h e Geneva

Convention p reven t s any c r e a t i o n o r t r a n s f e r of r i g h t s by a

person wi th knowledge o f t h e j u d i c i a l sale.L35 AS r ega rds

procedure , t h e c o n t r o l l i n g law r e l a t i n g t o t h e proceedings

of a j u d i c i a l s a l e is determined by t h e law o f t h e forum

where t h e sale t a k e s p l ace . However, c e r t a i n requirements

must b e observed:

13'see i b i d .

%ee ibid.

' 3 4 ~ e c T. Conlon, "The ~ r c r a f t Mortgages Convention: The

United Kingdom Moves Toward Ratification" (1977) 4 3 J. Air L. &

Corn. 731. t35 See Geneva Convention, supra note 102, a r t . VI.

t h e d a t e and p lace of s a l e s h a l l be set a t least s i x

weeks p r i o r ta t h e j u d i c i a l sale; "6

t h e execut ing c r e d i t o r s h a l l f u r n i s h t h e cciurt o r

o t h e r competent a u t h o r i t i e s with c e r t i f i e d e x t r a c t s

of t h e a i r c r a f t records; 13'

t h e execut ing c r e d i t o r s h a l l g i v e p u b l i c n o t i c e o f

t h e s a l e a t t h e p lace where t h e a i r c r a f t is

r e g i s t e r e d f o r n a t i o n a l i t y purposes, i n accordance

with t h e law of t h e f l a g state;13'

t h e above n o t i c e s h a l l be d ispatched a t l e a s t one

month p r i o r t o e x e c ~ t i o n ; ' ~ ~

t h e execut ing c r e d i t o r s h a l l provide n o t i f i c a t i o n a s

t o t h e d a t e and p lace of t h e j u d i c i a l s a l e t o a l 1

recorded r i g h t holders of t h e a i r c r a f t by r e g i s t e r e d

a i r mai l ; 140

A s it concerns t h e d i s t r i b u t i o n of proceeds of t h e

judicial sa le , t h e Convention provides t h a t preference be

given t o those having p r i o r i t y over claims of t h e execut ing

- -

136~ee i b i d . , a r t . VI1 ( 2 ) ( a ) .

L'7~ee i b i d . , a r t . VI1 ( 2 ) ( b l .

L 3 B ~ e e ibid.

13%ee ibid.

I4'see i b i d .

c r e d i t o r . 141 Consequently, j u n i o r c r e d i t o r s may r e c e i v e

no th ing unless a l 1 proceeds of t h e sa le cove r a l 1 s e n i o r

l i e n s and r i g h t s .

Problems w i t h the Geneva Convention 1940

O v e r a l l , t h e Geneva Convention i n h e r i t s a vast degree

of complexi ty . In t h e i r a t t empt t o i n c o r p o r a t e major l e g a l

concepts p e r t a i n i n g t o r i g h t s i n a i r c r a f t i n t h e l e g a l

ins t rument , t h e framers of t h e Convention had t o d e a l w i th a

s p e c i f i c f i e l d of law, t h a t even many legaL systems f i n d

extrernely c h a l l e n g i n g and d i f f i c u l t - t h e c r e a t i o n , e f f e c t s

and p r i o r i t y of s e c u r i t y r i g h t s i n a i r c r a f t . 142 Although t h e

d r a f t e r s had o r i g i n a l l y env i s ioned a u n i f i c a t i o n t r e a t y t h a t

would u n i f o m l y r e g u l a t e r e a l r i g h t s i n a i r c r a f t , t h e

a t t empt was u n a t t a i n a b l e f o r t h e fo l lowing r easons :

( a ) a l a c k o f p receden t f o r such a s t a n d a r d f o m ; and

(b) t h e d i v e r g i n g n a t i o n a l concept ions of s e c u r i t y

r i g h t s t o b e accommodated made it q u i t e imposs ib l e

t o d r a f t a t r e a t y i n a r e l a t i v e l y s h o r t

'42~ee Wilberforce 1, supra note 98.

%ee ibid. Wilberforce noted the following:

" [T]he United S t a t e s had a h ighly developed technique

of a i r l i n e f inance, evolved by p r a c t i c e and analogy

Hencefor th , t h e d r a f t e r s agreed t h a t t h e i r focus would

n o t be d i r e c t e d a t a t t empt ing t o u n i f y p r o p e r t y r i g h t s laws

i n a i r c r a f t , bu t r a t h e r , t o e n a c t a t r e a t y t h a t would a l l ow

S t a t e s t o r e t a i n t h e i r own laws r e l a t i n g t o a i r c r a f t

mortgages. P re sen t ly , t h e r e are g r e a t problems f o r c o u n t r i e s

i n c o n s i d e r i n g whether t o r a t i f y t h e Geneva Convention:

( a ) t h e Convention does no t make a clear r e f e r e n c e a s t o

t h e law governing t h e c r e a t i o n of i n t e r e s t s i n

a i r c r a f t ; '44

- - - - ~ - -

from r a i l r o a d finance; i t was not prepared t o throw

overboard a system which was serving w e l l i n p r a c t i c e

f o r t h e uncer t a in ty of an u n t r i e d and undeveloped

method. Other na t ions could be d iv ided i n t o two

c a t e g o r i e s . The f i r s t , which included t h e United

Kingdom and t h e major i ty of o t h e r S t a t e s , had not y e t

formulated t h e i r own domestic law of charges on

a i r c r a f t ; t h e second, which included France, I t a l y and

some South American coun t r i e s , had t h e i r own n a t i o n a l

laws on t h e s u b j e c t which conformed n a t u r a l l y with t h e

r e s t of t h e i r r e spec t ive l e g a l systems. While t h e

f i r s t ca tegory might have been r e a d i e r than t h e second

t o accept some i n t e r n a t i o n a l system c r e a t e d de novo,

n e i t h e r could be expected t o e n g r a f t on t h e i r own

immature na t iona l l e g i s l a t i o n s on t h e s u b j e c t t h e

e l a b o r a t e cons t ruct ions of t h e United S t a t e s lawyers." i 4 4 See Geneva Convention, supra note 102, a r t . 1. Although

t h e absence to a clear re fe rence of t h e law is hard ly no t i ceab le ,

t h e fo l lowing provis ions :

it does no t p r o t e c t secured p a r t i e s w i t h r e s p e c t t o

a l 1 a i r c r a f t , The Convention merely p r o t e c t s

c r e d i t o r s wi th r e s p e c t t o f o r e i g n a i r c r a f t and n o t

t o domes t ic c r e d i t o r s w i t h r e s p e c t t o f o r e i g n

c r e d i t o r s in domest ic a i r c r a f t ;

t h e Convention only refers t o p r i o r i t y r i g h t s i n

terms of t h i r d p a r t y r i g h t s . It does no t t a k e away

any p r i o r i t y g ran ted by n a t i o n a l laws i n t h e case of

s a l v a g e and i n t h e c a s e of g o v e r m e n t s e i z u r e of t h e

a i r c r a f t pursuant t o customs and immigrat ion

proceedings. 146

"[plrovided that such rights have been constituted and

are recorded in a public record in conformity with the

law of the Contracting State whose nationality the

aircraft possesses [,.] "

does not point out the specific municipal Law of such state.

Furthemore, the Convention completely haves contracting States

to freely choose whatever form of security device. So for

instance, a Civil law country that does not recognize a

"mortgage" will be required to recognize a mortgage over aircraft

pursuant to the Geneva Convention. See generally J.M. Fortier,

Real Rights in Aircraft (LL.M Thesis, McGill University, 1980)

[hereinafter Fortier]; F.E.Hines, "Legal Difficulties in Secured

Airline Equipment Financinq" (1948) IS S . Air L. & Com. Il;

I4'see Fortier, supra note 140.

"%ee Geneva Convention, supra note 102, art. II, IV and

XII; B.J.H. Crans, "The UNIDROIT Convention on International

Interests in Mobile Equipment and the Aircraft Equipment

Protocol: Some Critical Observations" (1998) XXII1:VI Air & Sp.

(d) t h e scope o f t h e Convention is l i m i t e d t o t h e

r e c o g n i t i o n of s e c u r i t y i n t e r e s t s i n a i r c r a f t .

Because it is n o t a mortgage t r e a t y , an

i n t e r n a t i o n a l s t a n d a r d form o f s e c u r i t y was n o t set

L47 up ;

(e) t h e r e is no requirement f o r S t a t e s t o m a i n t a i n a

r e c o r d o r system f o r r eco rd ing s e c u r i t y i n t e r e s t s . 148

Despi te i ts f laws , a s no ted earlier, many p r a c t i t i o n e r s

and s c h o l a r s s t i l l r ega rd t h e Geneva Convention a s one of

t h e rnost comprehensive p r i v a t e i n t e r n a t i o n a l law i n s t r u m e n t s

e v e r d r a f t e d . The Convention h e l p s t o a d m i n i s t e r a s o l i d

l e g a l frarnework f o r p a r t i e s t h a t ho ld p r i v a t e law c l a i m s

w i t h r e s p e c t t o a i r c r a f t .

During t h e 50 y e a r s s i n c e it was opened f o r s i g n a t u r e ,

t h e Geneva Convention has been of v i t a l importance t o

prospective a i r c r a f t o p e r a t o r s and pu rchase r s , a s w e l l a s t o

--

L. 227 a t 280. Mr. Crans cited paragraph 1 4 (5) of the UK

A i r c ra f t Mortgaging Order 1972 which provides a bas i s a s t o why

the United Kingdom has been hes i t an t t o r a t i f y t he Geneva

Convention. Under English Law, contractual s ecu r i t y r i g h t s such

a s mortgages have no p r i o r i t y over over common law r e p a i r e r r s

l i e n s and s t a t u t o r y r igh t s .

' 4 7 ~ e e Doskow, supra note 90 a t 45.

L 4 8 ~ e e Calkins, supra note 128 a t 156.

creditors who finance the sale and lease of aircraft

destined for use in signatory countries. The Convention has

successfully unified, under an international regime, certain

sacred principles of air law previously defined exclusively

under national law. On the other hand, it continues to rely

on national law to resolve more complex problems,

particularly the conflict of laws. In other words, as

underlined by Diederiks-Verschoor, "the Geneva Convention

merely provides rules relating to or designed to avoid

conflicts of law. " 14'

Presently, the Geneva Convention has 69 ratifications

out of a total of 79 parties since it first opened for

signature. Important jurisdictions such as Canada,

Australia, Japan, UK, India, China and Indonesia have not

ratified the Convention. Without a total global acceptance

to fulfill its objectives, a global system whereby each

state would be required to recognize validly created

interests in other nations, would not be achieved. ' ' O

L49~ee Diederiks-Verschoor, supra note 100 at162,

L50~ee DOS~OW, supra note 90 at 46.

C . Tho 1988 IRSIDROIT Convention on International Financial

Leasing

There have been many attempts to provide an

internationally accepted definition and categorization of

leasing. Unfortunately, attempts have failed mainly because

a number of jurisdictions have been inclined to rnaintain

their own perceptions of leasing. Hence, in 1974 the

governing council of UNIDROIT saw that there was an urgent

need for uniforrn rules on international leasing.

Subsequently, a study group was formed to prepare a draft

convention which will focus on tripartiteL5' international

financial leasing. 153

C I "'See P. Pompongsuk, I n t e rna t i o n a l Leas ing: Impact on

I n t e r n a t i o n a l A i r Law T r e a t i e s (LL.M Thesis, McGill University,

1997) at 116 citing A. Hornbrook, ed., "Introduction to Leasing - UNIDROIT" (19861 W. Leasing Y.B. 41 at 41.

'5'~ee i b i d . , at 118. Generally, there are two independent

contracts in a leasing transaction: between the lessor and lessee

and, hetween the supplier and lessor. It was envisaged that the

convention would regard these transactions as a single

transaction, which, for the purposes of this convention, is known

as a triangular or tripartite relationship.

:'=~ee M. K. Kantaatma ja, "International Financial Leasing-

DNIDROIT 1987" in Wiradipraja E.S. & Kantaatmaja M. .K., eds.,

Hukum Angkasa dan Perkembangannya (Bandung : Remadj a Karya, 198 8 )

at 79; R.M. Goode, "Conclusions of the Leasing and Factoring

Conventions" (July 1988) J. Bus. L. 347; R.M. Goade, "The

The complexity and predominance of tax issues in

leasing agreements initially posed a problem of achieving

uniform standards to be incorporated in the draft

convention. Additionally, there was the issue of security

interests in movables. However, since the elements of a

lease are generally the same, the drafters agreed to avoid

the problem, and instead, introduced a new concept called

the sui gener is financial lease. 1 5 4

Thus, the Convention on International Lease Financing

was adopted under the auspices of U N I D R O I T in 1988.L55

Pursuant to the Preamble,"' the Leasing Convention seeks to:

(a ) remove legal impediments to the international

financial leasing of eqnipment;

Proposed New Factoring and Leasing Conventions" (1987) J. Bus. L.

318. msee Kantaatmaja, supra no te 153 c i t i n g UNIDROIT,

Explana tory Report on the Draf t Convention on International

Financial Leasing (Rome: UNIDROIT, 1987).

"%ee Convention on International Financial Leasing, signed

a t Ottawa, 20 May 1988, 27 I.L.M. 932 [ h e r e i n a f t e r UNrDROIT

Leasing Convention] . lS6see Preamble of t h e lJEIIDROIT Leasing Convention.

(b) maintain a fair balance of interests between the

different parties to the transaction;

(c) make international financial leasing more available;

(d) adapt the rules of law governing the traditional

contract of hire to the distinctive triangular

relationship of the financial leasing transaction;

and

(e ) formulate certain uniform rules relating primarily

to the civil and commercial law aspects of

international financial leasing.

Nonetheless, the U N I D R O I T Leasing Convention mainly

deals with the contractual relationship between the Lessor,

lessee and supplier. Given the complexity and sophisticated

character of aircraft transactions, parties will usually

draw-up their own agreement containing tailored provisions

which allocate their rights and responsibilities. This

renders the Leasing Convention irrelevant for most aircraft

finance transaction^'^^

L57~ee S. S. McGairl, "The Proposed UNIDROIT Convention:

International Law for Asset Finance (Aircraft)" (1999-2) 4 Unif.

L. Rev. 439 at 446.

II. Proapacts o f Earaionizing the Law Governinq Secur i ty

A. International Init iat ives to Refow Secured Transaction

The international efforts directed towards drafting

uniform rules in order to better protect creditors'

interests in general movable assets was first initiated in

1968. In that year, a study was conducted under the auspices

of the United Nations International Commission on

International Trade Law (UNCITRAL) in attempt to find

solutions to the problems associated with the non-

recognition of foreign forms of security in the context of

international equipment financing, with a view to harmonize

the laws of this field. Unfortunately, the study concluded

that such a goal was too difficult to attain at that tirne, 158

?Sec "Report of t h e üN Cornmission on I n t e r n a t i o n a l Trade

Law on t h e Work of its Third Session" (UN Doc. A/8017) i n

UNCITRAL Yearbook 1970, vo l . 1, Par t Two (New York, 1970) a t 143-

145; "Report of the Secre tary General: Study on s e c u r i t y

i n t e r e s t s " (UN Doc. A/cn.9/131) i n IMCITRAL Yearbook 1977, vol.

V I I I , P a r t Two (New York, 1977) a t 171-221; "Report of t h e

S e c r e t a r y General: s e c u r i t y i n t e r e s t s ; f e a s i b i l i t y of uniform

r u l e s t o be used i n t h e f inancing of t rade" (UN Doc. A/CN.9/165)

i n üïVCITRAL Yearbook 1979, vo l . X , P a r t Two (New York, 19791 a t

81-87; "Report of t h e Secre ta ry General: Secur i ty i n t e r e s t s ;

i s s u e s t o be considered i n t h e p repara t ion of uniform rules (CM

B. The UNIDROIT Agenda

UNIDROIT is an independent i n t e r - g o v e r m e n t a l

o r g a n i z a t i o n having i t s headqua r t e r s i n Rome. The

o r g a n i z a t i o n was o r i g i n a l l y set up i n 1926 a s a n organ of

t h e League o f Nat ions . A f t e r i ts d i s s o l u t i o n i n 1 9 4 0 ,

UNIDROIT was r e - e s t a b l i s h e d pursuant t o a r n u l t i i a t e r a l

agreement known a s t h e UNIDROIT cha r t e rL5 ' The p r i n c i p a l

o b j e c t i v e of UNIDROIT, a s c o n s t i t u t e d i n t h e Cha r t e r , i s " t o

examine ways of harmonizing and c o o r d i n a t i n g t h e p r i v a t e law

of S t a t e s and groups of S t a t e s , and t o p r e p a r e g r a d u a l l y f o r

t h e adop t ion by v a r i o u s S t a t e s of uniform l e g i s l a t i o n i n t h e

f i e l d of p r i v a t e la^."'^^ The C h a r t e r i s c u r r e n t i y adopted by

f i f t y - e i g h t S t a t e s . 161

I n accordance wi th t h e Cha r t e r , U N I D R O I T has sought t o

harmonize p r i v a t e law by sponsor ing nurnerous d r a f t treaties

and convent ions i n v a r i o u s a r e a s o f law, many o f which have

been adopted a t d ip loma t i c conferences . Among rnuch o f

Doc. A/CN.9/189) i n [RJCITRILL Yearbook 1980, vol. X I , Part Two

( N e w York, 1980) a t 89-95 [hereinaf ter 17NCITRAL Reports] .

I5'see Charter o f the International I n s t i t u t e for the

Unif icat ion o f Private Law, 15 March 1 9 4 0 , 15 U.S.T. 2494,

T.1.A-S. No. 5743, U.K.T.S. 1965 No. 54.

" '~ee ibid. , a r t . 1.

L6L~ncluding I t a ly , Japan, The Russian Federation, China,

India, France, Germany, t he United Kingdom and the United Sta tes .

UNIDROITfs work serving as a basis for international

agreements are the UNIDROIT Leasing Convention, the

UNIDROIT Convention on International Factoring ( 198 8 ) '63 and

the 1980 United Nations Convention on Contracts for the

International Sale of Goods. 164

Immediately following the adoption of the UNIDROIT

Convention on International Financial Leasing in 1988, a

member of the Canadian delegation proposed that UNIDROTT

begin workinq on another international convention, one which

would exclusively provide for unif orm rules governing

security interests in mobile equipment. The underlying

background for this Canadian initiative was motivated by a

desire, shared by some other drafters of the UNIDROIT

Leasing Convention, to expand upon certain international

recognition principles provided under the Leasing Convention

to include the broader issues surrounding the enforcernent of

security rights. 165

'6'~ee UNIDROIT Leasing Convention, supra note 155.

l6lSee [TNIDROIT Convention International Factoring, 20 May

1988, 27 I.L.M. 943.

: 6 4 ~ o r a complete list of t r e a t i e s and o t h e r i n t e r n a t i o n a l

agreements prepared by UNIDROIT, see http://m.üNIDROIT.org.

LES~ee R.C.C. Cming, "The Draft üNIDROIT Convention i n

I n t e r n a t i o n a l I n t e r e s t s in Mobile Equipment" (1998) 30 UCC J.

365.

Henceforth, pursuant to a UNIDROIT Governing Council

Resolution in 1993, a study group was formed in order to

prepare a draft convention on international interests in

mobile equipment. In preparing the draft convention, the

study group sought to address two main legal problems:

( a ) creditors* ris ks associated with the

unpredictability and uncertainty of the law of the

jurisdiction in which mobile assets are located ( l e x

s i t u s ) ; and

(b) the non-recognition of non-possessory security

interests, particularly in Civil law jurisdictions

where the security in movables have to be physically

pledged to a financier. 166

In view of the above problems, this UNIDROIT initiative

cornes at a critical time, given the increasing concerns

I6?3ee S . Wool, 'The Next Generation of International

Aviation Finance Law: An Overview of the Proposed üNIDROIT

Convention on International Interests in Mobile Equipment as

Applied Aircraft Equipment" (1998) XXII1:VI Air & Sp. L, 245

[hereinafter Wool] citing Shilling, "Some European Decisions on

Non-Possessory Security Rights in Private International Law",

(1985) 34 Int. & Comp. L. Q. 77-93

a s s o c i a t e d wi th t h e r ecogn i t i on and enforcement o f f o r e i g n

s e c u r i t y i n t e r e s t s i n mobile eqt~ipment . A s t h e s e h i g h l y

movable o b j e c t s c r o s s j u r i s d i c t i o n s i n t h e o r d i n a r y c o u r s e

of bus ines s , consequent ly t hey become exposed t o v a r i o u s

n a t i o n a l laws ( l e x s i t u s ) , each wi th i t s own d i f f e r i n g

p r o v i s i o n s r e l a t e d t o t h e t r ea tmen t of p r o p e r t y and s e c u r i t y

r i g h t s . Therefore , t h e u n p r e d i c t a b i l i t y o f laws p r e s e n t s

g r e a t r i s k t o f i n a n c i e r s as t h e r e are no gua ran tees t h a t

t h e i r s e c u r i t y i n t e r e s t i n a moving c o l l a t e r a l w i l l be

recognized i n a p a r t i c u l a r j u r i s d i c t i o n . 16'

Thus, bo th t h e u n c e r t a i n t y and u n p r e d i c t a b i l i t y o f t h e

lex s i t u s r e l a t i n g t o c la ims i n f o r e i g n s e c u r i t y be ing

cha l l enged by o t h e r c r e d i t o r s , may cause f i n a n c i a l l o s s e s

f o r t h e h o l d e r s o f s e c u r i t y i n t e r e s t s . Without doubt , such

r i s k s have a l s o caused most banks and f i n a n c i a l i n s t i t u t i o n s

t o avo id cons ide r ing mobile c o l l a t e r a l a s t h e b a s i s f o r

ex t end ing c r e d i t . 168

Cornmon law j u r i s d i c t i o n s t e n d t o t a k e a l i b e r a l

a t t i t u d e towards s e c u r i t y , d i f f e r e n t Erom t h e C o n t i n e n t a l

16?see Wool, supra note 166. See also A. Djojonegoro, "The

UNIDROIT Proposal f o r a Unifom Law: A New Aircraft Mortgage

Convention?" (1997) XXI1:II Ann. Air & Sp. L, 54.

?Sec Economic Impact Assesment, supra note 7 .

Civil Law states. The preferential treatment of the Common

law systems towards security can be explained as follows:

freedom for parties to create security interests in

an object;

greater autonomy for parties ta a security agreement

in agreeing upon the rights and remedies of the

secured Par ty ;

self-help remedies such as repassession and sale

without a court order are permitted.'6g

On the other hand, the Continental Civil law states

tend ta respect the legai rights derived from the original

s i t u s , provided that, the laws of the new si tus recognizes

those rights. Consequently, there is no guarantee that a

security interest created in one jurisdiction may be

considered valid in the new jurisdiction. Although it is

possible that the laws of the new s i t u s afford greater

benefits t u the holder of security interests than do the

IG9see R.M. Goode, "Transcending Boundaries of Earth and

Space: The Preliminary Draft UNIDROIT Convention on International

Interests in Mobile Equipment" (1998-1) Unif. L. Rev. 62.

laws of the original s i t u s , it still presents a great degree

of uncertainty for the secured Party. 170

C . The Draft UNIDROIT Convention on International

Interests a s Applied t o Aircraft Equipment

UNIDROITfs efforts culminated in its July 1994 release

of the Draft Convention on International Interests in Mobile

Equipment . "' Thereafter, the draf t Convention has undergone modifications and improvements and has been circulated to

government experts worldwide for consideration.

Driven by inherent economic motives to help the world's

airlines meet the swelling demand for aircraft over the next

20 years, and in response to a request from UNIDROIT to

provide recommendations on the preparation of an

international treaty dealing with security interests in

mobile equipment, the leading aerospace manufacturers joined

with financial institutions and leasing companies to

'''see P.B. Harsen & J.A. Heilbock, "UNIDROIT Project on

Security Interests: How the Project Affects Space Objects" (1999)

63 J. Air L. & Corn. 21.

'"sec Preliminary Draft DNIDROIT Convention on International Interests in Mobile Equipment [hereinafter CTNIDROIT Convention].

For a reproduction of the ûNIDROIT Convention, see ICA0 Ref.

LSC/ME/3-WP/2 - 4/1/00 Appendix 5 .

organize an informal group known as the Aviation Working

Group. "* The group succeeded in convincing the UNIDROIT

study group that their respective interests are related to

broader aviation sector objectives, namely the potential to

facilitate asset-based aircraft financing and leasing.

On the recommendations of both the Aviation Working

Group and IATA, an instrument was designed to supplement the

UNIDROIT Convention with particular provisions reflecting

aviation finance and practice - the Aircraft rotoc col . '73 In

short, the Convention - Protocol framework dernonstrates the

following advantages:

"'~embers of the international grouping are Airbus

Industrie, Boeing, Bombardier, Boulioun Aviation Services, Chase

Manhattan Bank, CIBC Wood Gundy, Crédit Agricole Indosuez,

Deutsche ErkerhsBank, General Electric Aircraft Engines, GE

Capital Aviation Services, International Lease Finance Corp.,

Kreditanstalt fur Wideraufbau, Pratt & Whitney, Rolls-Royce

Capital Limited, Singapore Aircraft Leasing Enterprise and

Snecma . If3see Preliminary Draft Protocol to the Preluninary Draft

CMIDROfT Convention on International Interests in Mobile

Equiprnent on Matters Specific to krcraft Equipment [hereinafter

fircraft Protocol] . For a reproduction of the Aircraft Protocol, see ICA0 Ref. LSC/ME/3-WP/2 - 4/1/00, Appendix 6.

( a ) it maintains the general p r i n c i p l e s and n a t u r e of

t h e Convention d e s p i t e i ts rnul t i - face ted c h a r a c t e r ;

and

(b) 1 w i l l allow prospective contracting states to

adopt and r a t i f y t h e Convention in p a r t , based on

t h e relevant p r o v i s i o n s cover ing c e r t a i n t y p e s of

equipment a s t a t e wishes t o be bound t o .

Moreover, t h e U N I D R O I T p roposa l has also been p laced on

t h e agenda of t h e ICAO Legal Sub-cornmittee. Successful

lobbying a t t h e i n t e r n a t i o n a l l eve l has prompted ICAO to

a u t h o r i z e its Legal Sub-cornittee t o study proposa l s and

r e p o r t t o t h e Legal Cornmittee. Pursuant t o a Legal Comrnittee

p roposa l , t h e 32"d ICAO Assembly has endorsed a

recommendation to :

( a ) commend the ICAO and UNIDROIT Secretariars for their

ongoing e f f o r t s and ma jur c o n t r i b u t i o n s t o

deve loping and promoting t h e proposed t r e a t y

i n s tnunen t s ; and

{b) urge the ICAO Legal Cornmittee to pursue further

j o i n t work w i t h U N I D R O I T aimed a t complet ing the

draft texts, i n c o n s u l t a t i o n with t h e Aviation

Working Group and m'TA, wi th a view t o submi t t i ng

them to a Diplornatic Conference at the earlisst

possible date. 174

Creation of an International Interest

Unlike its predecessor, the Geneva Convention, the

UNIDROIT Convention introduces a distinct new genus of

property right~."~ It provides for the creation and effects

of an international interest, a process which does not

derive from any particular national law, and therefore,

becomes independent f rom the various categories of similar

national interests created under its own domestic laws. The

Convention defines an international interest in mobile

equipment as an interest in a covered object which is:

(a) granted by the chargor under a security agreement;"'

(b) vested in a person who is the conditional seller

"'ICAO Assembly, Thirry Second Session, Montreal, 22

September - 2 October 1998, Legal Commission, Report, A32-WP/195, P/42.

"'~ee M.J. Stanford, "Completion of a First Draft of

üN1DROITrs Planned Future Convention on International Interests

in Mobile Equipment" (Address at a meeting organized by Agip

S . p . A . , Rome, 29 April, 1996) [unpublished] . I7=.See UNIDROIT Convention, supra note 171, art. 1 (1) . "'sec i b i d , , art. 2 (2) (a) .

under a title reservation agreement;''' or

(c) vested in a persan who is the lessor under a leasing

agreement. 179

Additionally, an agreement creating an interest under

t e UNIDROIT Convention must meet the following

requirements:

(a ) be in writing;ls0

(b ) relate to an object over which the creditor, seller,

or lessor can enter into an agreement;lal

(c) p r o p e r l y identify the object;la2 and

( d ) identify the secured obligation. 183

Upon satisfaction of the above requirements, the

international interest will become valid and enforceable

between the parties in any contracting state. A domestic

security interest which conforms to the simple conditions of

Article 8 automatically qualifies as an international

''@~ee i b i d . , art. 2 ( 2 ) (bl . " '~ee ibid., art. 2 (2) (c) . ' " ~ e e ibid., art. 7 (a)

'"sec ibid., art. 7 (b) . " * ~ e e ibid. , art 7 (cl . lg3see ibid., art. 7 (d) .

interest.

Certainly, this new concept is a novelty when compared

to the recognition concept provided in the Geneva

Convention, as the latter does not purport to create an

international interest, but merely provide a promise by each

adherent state that it will recognize rights created by

others, provided they are constituted in accordance with the

law of the State of the aircraft's nationality.lg4

2) Default Remedier

The UNIDROIT Convention introduces self-help

repossession principles required to better assure creditors

because obtaining court rulings can be lengthy and costly. 185

The self-help repossession principle, which is borrowed from

Common law, might not be recognized in Civil law States

since the concept of self-help repossession is not part of

the legal system. In most Civil law jurisdictions,

repossession requires a court ruling.

'"compare ITNIDROIT Convention, supra note 171, art. 2 (2) (b)

6 ( c ) 6 Geneva Convention, supra note 102, art. 1 (a) - (d ) . 135 See generally, Sinclair Roche h Temperley, ed., Industry

Report, Repossession of Aircraft and Insolvency in EC Countries

(London: Lloyd's of London Press, 1993).

In order to strike a balance between Common law and

Civil law concepts, the drafters of the Convention

accordingly inserted a provision that would require a court

ruling to authorize the exercise of certain remedies. ' O 6

Furthermore, upon ratification, States may also make a

declaration by reserving the right not to permit the

exercise of self-help remedies within their jurisdiction,

The Convention provides the parties with complete

freedom to specify the types of default or any event ather

than default, which will give rise to remedy provisions in

the convention/protocol. Therefore, should an event of

default occur in the course of the performance of a secured

obligation, the secured party under a security agreement may

exercise the following judicial remedies singly or in

combinat ion:

(a) seize the secured asset;le8

(b) sel1 or grant a lease on the secured asset;"'

(c) collect income or profits which arise from

'?3ee CWIDROIT Convention, supra note 171, a r t . 12 (2)

Alternative A.

'"Sec i b i d . , ar t . Il.

'"~ee i b i d . , ar t . 8 (1) ( a ) . 1e9~ee i b i d . , ar t . 8 ( 1 ) (b) .

management of the secured as set; lgO

(d) deregister the aircraft for nationality purposes; lgl

(e) export and physically transfer the aircraft object

£rom the territory in which it is s i t ~ a t e d . ~ ~ ~

The Convention sets forth the following remedies in

event of default by the conditional buyer, under a title

reservation agreement or the lessee under a leasing

agreement:

(a) termination of the conditional sale or lease

agreement; Ig3

(b) repossession of any object to which the agreement

relates; lg4

(c) application for a court order authorizing any of

the above acts. L95

Additionally, this U N I D R O I T Convention/Aircraft

Protocol provides a tirnetable according to which a court

'90~ee i b i d . , art . 8 (1) (c) . '"sec A i r c r a f t Protocol, supra note 173, a r t . I X ( 1 ) ( a ) . "'sec i b i d . art . I X ( 1 ) ( b ) .

Ig3see 17NIDROIT Convention, supra note 171, ar t . 10 ( a ) .

lg4see i b i d .

lg5see i b i d . , ar t . 10 (b)

shall rendex a final r u l i n g , not s u b j e c t t o any appeal , w i t h

r e spec t t o a remedy claimed by t h e secured party. lg6

Effects o f Reqistration and Priori- Rules

Contrary t o t h e general notion of s e c u r i t y r i q h t s a s

appl ied i n most Civil Law States, whereby r e g i s t r a t i o n

validates and perfects an i n t e r e s t , "' t h e UNIDROIT

Convention does not require a n interest t o be r e g i s t e r e d in

order to become e f f e c t i v e . The Convention simply deerns

r e g i s t r a t i o n as se rv ing t h e purpose of g iv ing p u b l i c n o t i c e

the exis tence i n t e r e s t third p a r t i e s . 198

i 3 6 The propasal implicating t h e tirneframe t o which à. cour t

s h a l l render a final ru l ing has been left blank a w a i t i n g

consensus mong the drafters of the Convention. On previous

d r a f t s , it has been proposed t h a t a r u l i n g shall be rendered no

Later than 30 days after the lodging of such instrument

i n i t i a t i n g t h e proceedings with the cour t . See A i r c r a f t

Protocal, supra note 173, art. X.

"'se@ S.A. Bayitch, Aircraft Mortgage (Miami: University of

Mimi Press, 1953) a t 3 3 .

' g B ~ e e UNIDROIT Convention, supra note 171, a r t . 27 ( 1) . See

a l s o R.C.C. Cuming, "Considerations i n the design of an

I n t e r n a t i o n a l Registry for Interests in Mobile Equipment" (1999-

2 ) 4 Unif. L. Rev. 276. Professor Cuming descr ibed t h e term

" r e g i s t r a t i o n " a s :

' [ t Ihe f i n a l s t e p i n t h e c r e a t i o n of property rights

in assets. In other words, property r i g h t s i n t h e

a s s e t s vest i n a named pzrson when t h a t person becomes

t h e r e g i s t e r e d owner of t h e a s s e t s a s a resalt of an

Therefore, provided that an interest meets the basic

requirements of the UNIDROIT Convention, it will be valid

between the parties to a transaction creating such an

interest, irrespective of whether it is registered or not.

Nevertheless, the Convention encourages registration in

order to ensure and protect the interest-holder from al1

other competing third-party claims. L39 The Convention

therefore supports the first-to-file principle, whereby the

first person to register an interest will have priority over

al1 prior unfiled and al1 subsequent interests, filed or

not . 'O0

Non-consensual interests, which are those arising from

e n t r y i n a p u b l i c record o r r e g i s t r y . I n t h i s context ,

r i g h t s are c r e a t e d through t h e r e g i s t r a t i o n process .

The term a l s o i s a l s o used t o r e f e r t o a legal

r e v i r e m e n t t h a t must be met i f t h e r i g h t s i n p roper ty

c r e a t e d by c o n t r a c t o r otherwise a r i s i n g under Law a r e

t o be enforceable a g a i n s t o t h e r persons cla iming

i n t e r e s r i n t h e proper ty . Reg i s t r a t ion does no t create

t he r i g h t , bu t is a p r e r e q u i s i t e t o l e g a l r ecogn i t ion

of t h e p r i o r i t y of t h e r i g h t i n t h e c o n t e x t of a

c o n f l i c t x e s u l t i n g from a competing c l a h t o t h e

p roper ty [...] "

' "~ee 17NIDROIT Convention, supra note 171, a r t . 27.

'ao~ee üNIDROIT 1995, Study LXXII - Doc. 16 (Rone: IJNIDROIT,

19951 a t 20.

statutorily or judicially-preferred national creditors

(either under attachent, execution, or by way of a lien), 202

will have priority over an international interest. The

UNIDROIT Convention requires that States declare or provide

a list of preferred nationai creditors on the day of

adherence to the Convention. 202

4 ) The International Rsqistration System

The UNIDROIT Convention establishes an asset-based

international registry which will record al1 filings of

international interests, including prospective international

interests, assignrnent of international interests and

subordination of international interests. 203 1n an asset-

based registry, al1 filings would be recorded by reference

to the manufacturer's serial number. 204

The registry would also coordinate with local

registration facilities, which may be designated as

operators of registration facilities. These local operators

would be located in each contracting State and possibly

-

'O1see U N I D R O I T Convention, supra note 171, ar t . 3 8 .

'02see i b i d .

'03see ITNIDROIT Convention, supra note 171, art. 15.

204~ee Aircraf t Protocol, supra note 173, art. X I X (1) .

l o c a l a i r c r a f t r e g i s t r y o f f i c e s . 'O5 F i l i n g s made w i t h t h e

s a t e l l i t e r e g i s t r i e s would be t r a n s m i t t e d t o , and pooled i n ,

t h e c e n t r a l r e g i s t r y ' s da t abase . 206 A p a r t y i n t e n d i n g t o

f i l e o r conduct a s e a r c h on a p a r t i c u l a r i n t e r e s t w i l l

conduct such a c t i v i t i e s e i t h e r through t h e l o c a l

r e g i s t r a t i o n f a c i l i t i e s o r w i th t h e c e n t r a l r e g i s t r y .

A t t h i s p o i n t , t h e drafters of t h e UNIDROIT Convention

have sugges ted two a l t e r n a t i v e s u i t h r e g a r d t o t h e s t r u c t u r e

of the I n t e r n a t i o n a l Reg i s t ry :

( a ) a s t r u c t u r e i n which an in te rgovernmenta l e n t i t y

w i l l o p e r a t e and r e g u l a t e t h e r e g i s t r y ; and

( b ) a s t r u c t u r e i n which an intergovernrnental e n t i t y

only regulates t h e r e g i s t r y o p e r a t o r , i n which t h e

o p e r a t o r cou ld be a p r i v a t e e n t i t y . 2.07

The p roposa l t h a t i m p l i c a t e s a n independent a f f i l i a t e

of IATA a s t h e e n t i t y which w i l l o p e r a t e t h e r e g i s t r y ,

r e c e i v e d s t r o n g r e s e r v a t i o n s . These r e s e r v a t i o n s reflect t h e

concerns over t h e l a ck of IATA's a p p r o p r i a t e a u t h o r i t y t o

'n5~ee I7NIDROIT Convention, supra note 171, art. 16 ( 2 ) . '06see ibid.

' 0 7 ~ e e Aircraft Protocol , supra note 173, art. XVT

Alternative A & B.

operate an international registry. Others have pointed out

that IATA's status as a private entity/association, rather

than as an inter-governmental organization, may result in

the absence of support from potential contracting tat tes'^'.

5) Assignments of International Interests

As an event of default by the lessor under its loan

agreement with the lender is often attributable to a

corresponding lease default by the lessee, therefore, the

lender would most likely be in contest with the lesseers

jurisdiction when exercising his rights (either rights of

cancellation of the lease subject to the lease assignrnent or

repossession of aircraft) . 209 On that note, security and

lease assignments are covered under the UNIDROIT

C~nvention,~'~ in order to safeguard the lenderrs rights from

being challenged by the other competing daims of the

le~sor,~~' especially in jurisdictions without well developed

'Oasee ibid. IATA is a private association of airlines, not

an organization of States or a group of governments. However,

since some of IATA1s member airlines may be State-owned companies

or divisions of their respective governments, IATA can also be

considered a quasi-governmental association.

'09see I'Oçee

?IlIn

CO llateral

üNIDROIT 1995, supra note 188 at 15.

IRIIDROIT Convention, supra note 171, art. 29 - 38. most aircraft finance transactions, the lender' s

includes an assignment of the aircraft lease (in

law regarding the assignment of general intangibles. 2 12

6 ) Juridiction

The UNIDROIT Convention provides four bases where a

court of a Contracting State may exercise jurisdiction to

grant judicial relief:

(a) the secured object is within the territory of such a

state; 213

(b) either one of the parties to the transaction is

located within the tzrritory of a Contracting

State;'14 and

( c ) agreement between the parties to submit to

jurisdiction of a particular co~rt.~'~

a d d i t i o n t o t h e mortgage), where t h e lender has t h e r i g h t s t o

rece ive payrnents d i r e c t l y from t h e lessee i n the event of d e f a u l t

by the l e s s o r . See a l s o R.J. Goldstein, "Ai rc ra f t T i t l e

Reg i s t ra t ion and Per fec t ion of Lien Rights i n Aircraft" (1979) 4

Air L. 2.

'%ee ibid.

'L3~ee üïVIDROIT Convention, supra note 171 ar t . 40 (1; (a).

'I4see ibid., a r t . 40 (1) (b) . 2L5~ee ibid., ar t . 40 (1) (c) .

7) Relationship with other Conventions

Geneva Convention 1948. The reiationship between the

Geneva Convention and the UNIDROIT Convention/Aircraft

Protocol deserves much attention.'I6 This is especially true

as many legal and political considerations may impede the

future success of reforming international aviation finance

law.

It must be borne in rnind that there are conceptual

differences between the two treaty instruments. Analyzing

the critical shortcomings of the Geneva Convention, while

at the same time, comparing its outdated provisions to

those belonging to the UNIDROIT Convention/Aircraft

Protocol, is important. The following are highlights of the

main differences between the conventions to help better

understand the underlying philosophy of how the two

instruments will be c~ordinated:'~'

(a) the Geneva Convention relies heavily on its conflict

of laws rules. It does not contain substantive

provisions regarding the creation of rights in

aircraft nor does it create rights in aircraft. This

-

""ee Wool, supra note 166.

2 1 7 ~ e e Wool, supra note 166 a t 2 7 1 .

is especially true of those provisions which relate to

registration of rights, priority rules and procedural

requirements in connection with the attachment and

judicial sale of aircraft which are out of date;21s

( b ) the U N I D R O I T Convention, on the other hand, introduces

a new genus in property rights called the

international interest, which does not exclusively

der ive £rom national law. It has been designed to fit

the contours of sophisticated international aviation

finance; 219

(c) there is no comprehensive priority regime in the

Geneva Convention. Furthermore, the existing priority

rules rely on the law of the flag of the air~raft;~~'

(d) there is no international publication of rights

recorded in the Geneva Convention as rights and

interests are recorded in national registries. Unlike

the Geneva Convention, the U N I D R O I T Convention

introduces an international registration system

"'sec Geneva Convention, supra note 102, a r t s . 1 - X I I .

219~ompare ibid., art 1 with lJNTDROIT Convention, supra no te

171 a r t s . 2 & 7.

' * ' ~ e e Geneva Convention, supra no te 102, a r t s . IV, VI VI1

( 4 ) 1 (5) & (6).

whereby filings and searches can be conducted on a

one-stop basis through the international registry;'*l

(e) the Geneva Convention regards spare parts as an

extension of the aircraft. Consequently, they cannot

be treated as abjects of rights on its own. In order

to be treated as a secured object under the

Convention, spare parts must fulf il1 certain

requirements e.g. be stored in a specified place,

identified as being a security and rernain in a stored

location. The UNIDROIT Convention/Aircraft Protocol

sets forth provisions that regard spare parts as

separate a~sets;~~'

(f) there is only one method of enforcement against

aircraft which is through judicial sale. Additionally,

certain formalities prior to execution would have to

be observed. The basic and speedy remedies available

under the UNIDROIT Convention/Aircraft Protocol

"I~ompare Geneva Convention, supra note 102, art. 1: (1) (i)

with UNIDROIT Convention, supra note 171, art. 15.

Z22~ompare Geneva Convention, supra note 102, art. X & XVI

with Aircraft Protocol, supra note 173, art. 1 (2) .

r e f l e c t t h e c u r r e n t p r a c t i c e s and c h a l l e n g e s o f modern

a i r c r a f t f i nance . 223

I n view of t h e above, s e v e r a l a l t e r n a t i v e s as t o t h e

a p p r o p r i a t e l e g a l r e l a t i o n s h i p between t h e Geneva

Convention and t h e U N I D R O I T Convention were sugges t ed by

t h e a v i a t i o n i n d u s t r y s e c t o r : t o supersede t h e Geneva

Convention o r , t o c o o r d i n a t e t h e two t r e a t y i n s t r ~ r n e n t s . " ~

While supersed ing t h e Geneva Convention i n whole would

c o n s t i t u t e a s i g n i f i c a n t improvement t o a v i a t i o n s e c u r e d

t r a n s a c t i o n s laws, it would a l s o cause a g r e a t d i s r u p t i o n

t o t h e e x i s t i n g i n t e r n a t i o n a l l e g a l f ramework .225 First,

t h e r e would be a p o l a r i z a t i o n o f systems governing a v i a t i o n

f i n a n c e , t h e Geneva system and UNIDROIT system. Secondly,

it would be i n e v i t a b l e t h a t t h o s e S t a t e s f a v o r i n g a

n a t i o n a l i s t i c approach towards t h e t r ea tmen t o f s e c u r i t y

r i g h t s i n a i r c r a f t would c r e a t e an unfavorab le env i ronnen t

'4.7

- - k o m p a r e Geneva Convention, supra note 102, a r t , VI1 w i t h

UNIDROIT Convention, supra note 171, chap. III and Aircraf t

Protocol, supra note 173, chap. II.

'"sec UNIDROIT 1996, Study LXXII - D o c , 23 (Rome: UNIDROIT,

1996) a t 6 .

'25~ee ibid.

to t h e improvement and legal reform of i n t e r n a t i o n a l

a v i a t i o n f i n a n c e law.

Ln o r d e r t o keep t h e e x i s t i n g legal framework r e l a t i n g

t o a i r c r a f t f i n a n c e i n t a c t and thereby cause t h e l e a s t

d i s r u p t i o n t o the e n t i r e system, the Geneva Convention would

be kept a l i v e t o a c e r t a i n extent. I n p r i n c i p l e , t h e

UNIDROIT Convent ion /Aircra f t P ro toco l and the Geneva

Convention would be coord ina ted i n t h e fo l lowing mariner:

( a ) t h e Geneva Convention w i l l maintain i ts c o n f l i c t s o f

laws p r i n c i p l e under Article 1 ( 1) (i) , e n s u r i n g

minimal d i s r u p t i o n o f t h e e x i s t i n g l e q a l o r d e r . Th i s

c o o r d i n a t e d approach aims t o r e t a i n t h e c o n f l i c t s of

laws p r i n c i p l e w h i l e supersed ing outdated

p r o v i s i o n s . S t a t e s which are p a r t i e s t o bo th t h e

U N I D R O I T Convent ion /Aircra f t P ro toco l and t h e Geneva

Convention would, i n p r i n c i p l e , keep t h e r e f e r e n c e

t o t h e " l a w " a s p rovided i n t h e Geneva Convention. 226

T h i s s imply means t h a t r i g h t s c r e a t e d i n accordance

w i t h t h e l a w of a Geneva Convention c o n t r a c t i n g

state would still be recognized by o t h e r Geneva

Convention S t a t e s , p rovided t h o t t h e ref e r e n c e t o

'?5ee Geneva Convention, supra nate 102, art. 1 (1) (d) (i) .

-99-

the "law" of such a Contracting State shall include

substantive laws of the UNIDROIT Convention/Aircraft

Protocol; 227

(b) the term aircraft, as provided in the Geneva

onv vent ion^^', is replaced by the terms "airframes",

"aircraft engines" and "he~icopters";~~~

(c) reference to the "public record"230 of a Contracting

State provided in the Geneva Convention, would be

replaced by the UNIDROIT Convention' s International

~ e ~ i s t r ~ ; ~ ~ '

(d) in the event of any inconsistencies between the two

conventions, the UNIDROIT Convention/Aircraft

Protocol will pre~ail;~~'

(e) provisions relating to the sale of aircraft in

execution under the Geneva Convention will prevail,

" ' ~ e e Airc ra f t Protocol, supra note 173 , art. XXII ( 1 ) . '%ee Geneva Convention, supra note 102, a r t . X V I .

'"~ee Airc ra f t Protocol, supra note 173, art. X X I I (1) (2) . The UNIDROIT Convention does not deal with third party parts or

components other than a ircraf t engines.

?Sec Geneva Convention, supra note 102, art. 1 (1) (ii) . '31~ee UNIDROIT Convention, supra

232~ee Airc ra f t Protocol, supra

(2).

note 171, art. 15 - 28.

note 173, art. XXII (1) &

provided that, parties to a transaction expressly

opt for such remedie~.'~~

Rome Convention 1933. The U N I D R O I T Convention

Contracting States who have not made a reservation in

respect of non-judicial r e r n e d i e ~ , ~ ~ ~ would be in violation of

the Rome onv vent ion,^^^ and therefore, the U N I D R O I T

Convention/ Aircraft Protocol shall supersede the Rome

Convention.

UNIDROIT Financial Leasing Convention 1988. Although

regarded as a useful instrument in creating international

law relating to lease transactions, the multi- dimensional

financing methods of international aircraft acquisition

requires a more sophisticated and specific international

instrument to govern aircraft transactions. Furthermore, the

provisions of the U N I D R O I T Convention/Aircraft Protocol is

superior to that of the UNIDROIT Leasing Convention.

Henceforth, the ü N I D R O I T Convention/Aircraft Protocol

t 3 3 ~ e e ibid., art. XXII (1) & ( 3 ) . ' 3 4 ~ e e ibid. , art. XXIII.

'%ee Rome Convention, supra note 94, art. 2 (1).

supe r sedes t h e Leas ing Convention a s it r e l a t e s t o a i r c r a f t

ob j ects . 236

D. Prospects of the Propored VNIDROIT Convention

By keeping t h e g e n e r a l i t y o f t h e Convention, and

the reby , having d i f f e r e n t p r o t o c o l s supplement and modify

t h e Convention a s it r e l a t e s t o each equipment, makes t h e

Convention - Pro toco l framework a t r u l y un ique one. The

a i r c r a f t equipment s e c t o r , wi th t h e suppor t of t h e a v i a t i o n

i n d u s t r y , has been f a r ahead when compared t o o t h e r s e c t o r s

covered by t h e Convention - t h e y were t h e f i r s t t o deve lop a

p r o t o c o l . Meanwhile, t h e r e has been no i n d i c â t i o n o f when

t h e o t h e r s e c t o r s might fo l low s u i t .

I n l i g h t of t h e r e l a t i v e l y less r a p i d movement of t h e

o t h e r s e c t o r s , and should t h e r e be no i n t e r e s t o r speedy

a t t e m p t by any o t h e r s e c t o r t o develop a p r o t o c o l , it wuuld

be q u i t e u s e l e s s t o i n s t i t u t e a Convention-Protocol

framework. I n s t e a d , a s i n g l e ins t rument d e a l i n g e x c l u s i v e l y

w i t h s e c u r i t y i n t e r e s t i s s u e s i n a i r c r a f t would be more

d e s i r a b l e . 237

'36~ee Aircraft Protocol , supra note 173, ar t . XXIV.

'37~ee ICA0 Legal Sub-cornmittee, Second J o i n t Session,

Montreal 24 August - 3 September 1999, Report, LSC/ME/2-WP/14.

The degree of political pressure for the legal reform

of aircraft financing is expanding from within the

international community. Economic globalization is fueling

the imperative for legal reforrn, pressuring governments to

offer greater stability, transparency, and accountability.

These elements are being demanded by international

investors comprising of western nations and private donors,

who have poured hundreds of millions of dollars into various

legal reform projects devoted to this purpose. The private

donors carry western legal models in their briefcases,

intended for introduction and implementation within eastern

legal systerns. These models, although successfully

implemented in their originating States, are not necessarily

compatible with domestic notions of law in other countries.

The aerospace industry will undoubtedly play a crucial

role in the developrnent and expansion of international

aviation. This is clearly evidenced by the extent of the

enormous demand for aircraft forecasted by the aerospace

manufacturers as well as ICA0 and IATA.~~' Furthemore,

more airlines are becoming privatized as their respective

governments gradually disengage £rom capital support and

subsidies.

Consequently, new sources of funding must be devised.

Resort is often made to asset-based financinq techniques as

a form of credit extension, in which the aircraft itself

serves as the underlying security for the transaction. By

that token, highlight is placed on the weaknesses of the

existing national principles and legal systems relating to

the creation, registration and enforcement of rights over

aircraft, as well as the role of international law in

dealing with the subject matter.

The chairman of the UNIDROIT study group preparing the

initial draft UNIDROIT Convention, Professor R. M. ~ o o d e , 239

wrote that the proposed UNIDROIT Convention, once adopted,

'promises to be one of the most important ever to be

concluded in the field of private commercial law." However,

one must rernember that international legal processes,

2 3 E ~ e e re levant subchaptcrs in Chapter 2.

'Igsee R.M. Goode, 'The Prel iminary Draft üNIDROIT Convention

on In te rna t iona l In te res tç i n Mobile Equipment: The Next Stage"

(1999) 2 Unif. L. Rev. 265.

p a r t i c u l a r l y i n t h e f i e l d o f p r i v a t e i n t e r n a t i o n a l a i r law,

a r e long and d i f f i c u l t . Fu r themore , t h i s p r o j e c t has been

regarded a s having been s t e e r e d by i n d u s t r i a l a c t o r s t h a t

r e p r e s e n t t h e powerful commercial i n t e r e s t s o f t h e i r

c o r p o r a t i o n s .

Although promising t o g e n e r a t e economic b e n e f i t s f o r

n a t i o n a l a i r l i n e s and governrnents, t h e r e have been f e a r s

t h a t t h e U N I D R O I T p roposa l l a r g e l y t e n d s t o r e f l e c t t h e

i n t e r e s t s o f ae rospace rnanufacturers and o t h e r commercial

e n t i t i e s . T h i s c a r e f u l l y c r a f t e d p roposa l , once i n c o r p o r a t e d

i n t o a b ind ing i n t e r n a t i o n a l t r e a t y , would o b l i g e

C o n t r a c t i n g S t a t e s t o undertake major l e g a l r e f o m s t h a t

r a d i c a l l y a f f e c t v a r i o u s n a t i o n a l laws and r e g u l a t i o n s .

While s p e c i f i c l e g a l reform p roposa l s may be u r g e n t l y

needed, o t h e r s may be less a p p r o p r i a t e , and u l t i m a t e l y prove

incompat ib le w i t h c r u c i a l n a t i o n a l i n t e r e s t s and fundamental

n a t i o n a l p r i n c i p l e s of p r i v a t e a i r law.

Indones ian s c h o l a r M. K. Kantaatma j a is among many i n

s u p p o r t o f p r o t e c t i n g n a t i o n a l r u l e s . P r o f e s s o r Kantaatma j a

n o t e s t h a t d e s p i t e t h e e x i s t i n g i n t e r - r e l a t i o n s h i p between

r e l e v a n t p r o v i s i o n s o f i n t e r n a t i o n a l and n a t i o n a l l a w , any

a t t e m p t t o create uniform i n t e r n a t i o n a l r u l e s w i t h o u t having

due regard to their admissibility in national legal systems

will result in unworkable complexity. 240

Ulrich Drobnig, who prepared the UNCITRAL Study on

Security ~nterests~~' in 1968, also noted that "it would

probably be difficult to obtain sufficient goverment

support for an international conference dealing with the

relatively technical topic of security interests; and even

if the text of an international instrument could be agreed

upon, national parliaments would probably be slow and

perhaps even reluctant to ratify such a text." Conversely,

f o r airlines and governments who are willing to s u r r e n d e r

their interest in setting and implementing national policy,

the draft convention promises to introduce certain economic

benefits .'42

Nonetheless, in this conclusion, the author believes

that to highlight the polarization of arguments with respect

to the prospects of the future Convention, would assist in

identifying certain advantages, as well as weaknesses, of

the UNIDROIT proposal, as to whether the convention would

' 40~ee M. K. Kantaatma ja, S e c u r i t y R i g h t s i n Indones ian

A i r c r a f t : An Air Law Perspec t i ve (Bandung: Alumni, 1 9 8 9 ) a t 322.

' 4L~ee iJNCITRAL Repor ts , supra note 158.

'4'~ee Economic Lmpact Assesment, supra note 7.

materially benefit airlines and governments. Accordingly,

the persona1 views of the author will conclude this chapter.

Advan tages. The UNIDROIT proposal would produce

comprehensive reform in international secured transactions

laws - it deals with al1 aspects relating to the creation,

registration, priority rules and enforcement of security

interests. In the previous chapters, the author has linked

the consequences of differing secured credit regimes - both

the substantive principles and their procedural

effectuation, with the uncertainties for financiers rhat

would result in higher transaction costs. Indeed, the

problem may even be worse, because secured credit law is

designed to operate largely without court supervision. These

reforms are crucial to facilitating modern aviation finance.

In order to determine whether such satisfies the

requirements for legal and economic efficiency, it must meet

the following requirements:

(a) the constitution of a security interest must be

simple, inexpensive and universally recognized;

(b) procedures for enforcing a security interest must

permit expeditious non-judicial remedies;

(c) detennining superior and/or hidden claims against

collateral must be quick, inexpensive and easy. For

example, allowing public access to registries and

having professional, profit-oriented corporations

run the operation of an international registry

(instead of goverment bodies) are among the

principal elements of an effective and well-managed

registry;

(d) the system must afford protection to the secured

party against third party claims, including secured

and unsecured creditors, trustee in bankruptcy and

purchasers of collateral.

There can be no doubt that the U N I D R O I T Convention/Aircraft

Protocol meets the above requirement by virtue of the

provisions set forth therein.

Weaknesses. Same States may regard the U N I D R O I T

proposa1 as having some intolerable weaknesses and, thereby,

formulate objections towards the draft treaty on the

following basis:

(a) an international interest is created when simple

requirements are met.243 Needless to Say, such new

techniques of securing an interest over an object

will likely contravene most Civil law regimes

regarding the creation of rights. For example, sorne

countries require a notary's presence at the time of

the constitution of an interest. Others require

perfection (registration with a public/governrnent

authority) in addition to the notary's presence. The

UNIDROIT Convention does not stipulate any of the

above formalities;

(b) the aviation industry sector and other related

sectors highly involved in promoting the draft

treaty (such as the financial sectors) guarantees

that certain economic benefits will be enjoyed by

governments if they adhere to this Convention.

Conversely, what we would probably see is very

little direct monetary benefit passed to airlines.

Instead, the benefits would simply be an increase in

their overall credit rating;

(c) the UNIDROIT Convention/Aircraft Protocol does not

provide direct solutions to the issue of political

risk. One of the central features of the Aircraft

2 4 3 ~ e e üNIDROIT Convention, supra note 171.

-109-

Pro toco l i.e. speedy j u d i c i a l r e l i e f and de-

r e g i s t r a t i o n / e x p o r t a u t h o r i z a t i o n may b e r e s e r v e d by

Con t r ac t ing S t z t e s which make a d e c l a r a c i o n upun

adherence. The Convention, t h e r e f o r e , can a c h i e v e

Little i n t h i s r ega rd wi thout t h a s e p r o v i s i o n s ;

(d ) t h e convent ion r ega rds t h e r e g i s t r a t i o n process as

s e r v i n g t h e purpose of p u b l i c i z i n g an i n t e r n a t i o n a l

i n t e r e s t . Therefore , the c r e a t i o n of an i n t e r e s t

dues n o t depend on r e g i s t r a t i o n . This May be i n

c o n f l i c t wi th most c o u n t r i e s , p a r t i c u l a r l y t h o s e

be longing t o t h e C i v i l law system where r e g i s t r a t i o n

i s still regarded a s a l e g a l p roces s to "perfect" a

s e c u r i t y i n t e r e s t ;

( e ) pu r suan t t o t h e A i r c r a f t P r o t o c o l f s i n t e r n a t i o n a l

i n so lvency r u l e s , creditors of a i r c r a f t and a i r c r a f t

equipment w i l l have t h e r i g h t t o require t h a t t h e

bankrupt a i r l i n e c u r e a l1 d e f a u l t s and perforrn al1

f u t u r e o b l i g a t i o n s under t h e agreement and r e l a t e d

t r a n s a c t i o n documents. The a i rLine must a l so give

posses s ion of t h e a i r c r a f t o b j e c t t o t h e o b l i g e e .

These actions must be conducted w i t h i n a p e r i o d of

no t less than a s p e c i f i e d number of days from t h e

in so lvency date. The au tho r b e l i e v e s t h a t this

p r o v i s i o n may prove t o be unworkable s i n c e t h e

underlying philosophy of bankruptcy laws and

proceedings is the general balancing of al1

creditors interests. A preferential treatment given

to those with capital intensive assets (such as

aircraft and aircraft equipment) may be

unacceptable;

the convention calls for the establishment of an

international registry. Meanwhile, there have been

strong proposals that IATA assume the responsibility

for the registry. While the final determination of

who will operate the registry for the initial 5-year

term has not been made, certain lobby groups are

working to promote IATA within the influential

States actively involved in preparing the draft

Convention. The author suggests a provision to be

inserted in the draft Convention to allow al1

Contracting States to agree on an impartial process

for the selection of the registry operator.

Furthemore, final determination should be based on

criteria such as cost, timeliness, error rates,

language, accessibility etc.

Finally, the author concludes that the Convention's

success will depend upon the overall acceptance of its final

objectives: a global framework of security rights in

aircraft. Interestingly, debates during the ICAO Legal-

subcommittee sessions held in March and August 1999 clearly

reflect that government representatives are still far from

establishing a firm grip on the underlying philosophy and

principles of the Convention. The cornmon questions posed by

government representatives are:

(a) what will this Convention do to the existing

property rights laws in Our country?;

(b) will this Convention harm Our national air carriers

( e . g . disrupt national air service in the event of

aircraft repossession) ?;

(c) how much will Our government/airline save by

adhering to this Convention?

There is plenty of work to be done for governments in

the advent of the new millennium. A third round of

discussions of the ICAO Legal-subcornmittee will take place

in Rome in March 2000. The discussions are expected to

result in a recomendation to bring the draft Convention

into the framework of ICAO's Legal-Committee. Thereafter,

and upon the recomendation of the committee, a diplomatic

conference would be convened to consider the draft

Convention. Finally, it is important that when government

representatives meet at the diplornatic conference, due

regard is given to balancing al1 the interests that would be

served by the proposed treaty i .e. governments, airlines and

the traveling public, rather than those particular

(political and commercial) interests the treaty seeks to

benefit .

1. TREATIIS, LEGISLATION, OFFICIAL D-S

Convention f o r the Un i f i ca t i on o f Certain Rules Relat ing

t o In ternat ional Carriage by Air, signed at Warsaw,

12 October 1929. Authentic French Text: II Conférence

Internationale de Droit Privé Aérien, 4-12 Octobre

1929, Varsovie [Warszawa 19301 pp. 220- 233. English

Translation: Schedule to the United Kingdom Carriage

by Air Act, 1932,; 22 & 23 Geo.5, ch.36.

Convention for the Uni f i ca t ion o f Certain Rules Relat ing

t o the Precautionary Arrest o f A i r c r a f t , signed a t

Rome, 29 May, L933, 192 L.N.T.S. 289, ICAO. Doc.

150/AT/30/9/11/1945.

Convention on International Financial Leasing, signed a t

Ottawa, 20 May 1988, 27 I.L.M. 932.

Convention on In ternat ional C i v i l Aviat ion , signed a t

Chicago, 7 December 1944,lS U.N.T.S. 295, ICAO Doc.

7300/6.

Convention on the Interna t ionaI Recognition of Rights i n

A i r c r a f t , signed a t Geneva, 19 June 1948, 310

U.N.T.S. 151, T.I.A.S. 2847, 4 U.S.T. 1830, ICA0 Doc.

7620.

Federal Aviat ion Act o f 1958, 49 U.S.C. 5 1404 (1976)

Bankruptcy Act o f 1898, 11 U.S.C. 5 516 (5) (1976) & S

1110 (1982)

IATA, Annual Report 1999 (Montreal: IATA, 1999) . IATA, Asia Paci f ic Air Transport Forecast 1980-2010

(Montreal: TATA, 1997) . ICAO, C i v i l Aviat ion Annual Report, (Montreal:

ICA0,1998) .

ICAO, Outlook for Air Transport t o the Year 2005 (Montreal :

ICAO, 1995) - ICAO Doc. 4627, LC/63, Report and Commentary of the Lêgal

Committee o f ICAO on the D r a f t Convention Concerning

the In ternat ional Recognition o f Rights i n A i r c r a f t .

ICAO Assembly, T h i r t y Second Sess ion , Montreal , 22

September - 2 October 1998, Legal Commission,

Report , A32-WP/195, P/42.

ICAO Legal Sub-committee, Second J o i n t Ses s ion , Montreal

24 August - 3 September 1999, Report , LSC/ME/2-

WP/14.

IMF, World Economic Outlook (Washington: IMF, 1998) .

Report of t h e UN Commission on I n t e r n a t i o n a l Trade Law on

t h e Work of i ts Th i rd Sess ion ( U N Doc. A/8017) i n

UNCITRAL Yearbaok 1970, vo l . 1 , P a r t Two (New York,

1970) a t 143-145.

Report of t h e UN Commission on I n t e r n a t i o n a l Trade Law on

t h e Work of its Thi rd Sess ion ( U N Doc. A/8017) i n

U N C I T W Yearbook 1970, vo l . 1, P a r t Two (New York,

1970) a t 143-145.

Report of t h e S e c r e t a r y General: Study on s e c u r i t y

i n t e r e s t s ( U N Doc. A/cn. 9 /13 l ) i n UNCITRRL Yearbook

1977, vol. VITI, Part Two ( N e w York, 1977) a t 171-

221.

Report o f t h e S e c r e t a r y General: s e c u r i t y i n t e r e s t s ;

f e a s i b i l i t y o f uniform r u l e s t o be used i n t h e

f i n a n c i n g o f t r a d e (UN Doc. A/CN.9/165) i n CTNCITRAL

Yearbook 1979, o . X , P a r t Two ( N e w York, 1979) a t

81-87.

Report o f t h e S e c r e t a r y General: S e c u r i t y i n t e r e s t s ;

i s s u e s t o be cons ide red i n t h e p r e p a r a t i o n of

u n i f o m r u l e ç (UN Doc. A/CN.9/189) i n CWCITRAL

Yearbook of 1980, vol. XI, Fart Two (New York, 1980)

at 89-95.

UNIDROIT 1987, Explana tory Report on the Draft Conva t i o n

on In ternat ional Financial Leasing (Rome : U N I D R O I T ,

1 9 8 7 ) .

UNIDROIT 1995, Study LXXII - Doc. 16 ( R o m e : U N I D R O I T ,

1995).

UNIDROIT 1996, Study L U I 1 - Doc. 23 (Rome: U N I D R O I T ,

1996).

Preliminary Draft CNIDROIT Convention on In ternat ional

I n t e r e s t s i n Mobile Ecpipment, ICA0 Ref. LSC/ME/2-

WP/2 - 4/1/00, Appendix 5. Preliminary Draft Protocol to the Preliminary Draft

UNIDROIT Convention on In ternat ional I n t e r e s t s i n

Mobile Equipmen t on Ma tters S p e c i f i c t o A i r c r a f t

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