Most lenders do not deal with aircraft financing on a regular basis. Aircraft are specialty assets, no doubt, and are subject to specialized laws that are unfamiliar to lenders who do traditional real estate or equipment financing, for instance. Even larger national lenders who have regular aircraft finance portfolios generally have a small, focused group of lenders that deal with aircraft transactions.
If you are a lender long enough, though, you will probably have one or a few times in your career that one of your best customers comes to you and says, “I’m buying an airplane, you’ll finance me for it, right?” Because it is your best customer, you say, “Sure, how hard can it be?”
The fact is you can finance aircraft and you can do it safely and securely. But first, there are a few things you probably need to know.
THE AIRCRAFT PURCHASE PROCESS
First, you need to understand aircraft transaction basics and how they differ from traditional equipment finance transactions. A U.S. based aircraft purchase transaction will typically include the following steps:
- The parties enter into a Letter of Intent and the buyer places a deposit on the aircraft. The typical LOI will describe the aircraft and the basic payment terms, after which the parties will negotiate a definitive purchase agreement to address the issues described below.
- Because the FAA Civil Aircraft Registry is located in Oklahoma City, the parties typically engage a title company or law firm in Oklahoma to act as the escrow agent.
- Most aircraft sales are on an “as-is, where-is” basis, such that the seller needs to arrange for an inspection to get comfortable with the condition of the aircraft. The aircraft and related aircraft documents are usually subject to specified delivery conditions, but it is up to the buyer to get comfortable with the condition before closing. As such, most buyers arrange (at their cost) for an inspection facility to conduct a visual and mechanical inspection of the aircraft itself and an aircraft document review to determine if the aircraft is in the required condition.
- Once the inspection facility determines if there are discrepancies from the required delivery condition, the seller will correct any discrepancies to put the aircraft in the required delivery condition.
- Meanwhile, the escrow agent obtains and provides the parties with appropriate lien searches on the aircraft. Based on the lien search results, the seller will obtain any necessary lien releases to be filed at closing.
- The parties will also prepare, execute, and position closing documents with the escrow agent. These might include title transfer documents, prior lender lien releases, and any mortgage or other security documents required to document a new lender’s security interest in the aircraft.
Once everything is positioned, the parties will hold the closing where all documents will be released and filed once funds transfer. Unlike real estate deals, for instance, these closings usually involve many parties in remote locations. As such, even pre-COVID, most closings are handled by phone and email.
KEY CHALLENGES FOR LENDERS
Within the purchase process above, there are several things that a lender should consider to assure they are obtaining adequate collateral for their loan and practical first priority recourse to that collateral.
Appraisals, Pitfalls, and the Importance of Inspections
Most lenders are going to obtain an appraisal of the aircraft to determine the loan to value ratio they are going to offer to finance. But lenders should also confirm if their borrowers are securing an inspection from a reputable facility that is authorized to deal with the type of aircraft involved. Lenders should not need to be technical experts, but you may want the chance to receive and discuss a copy of the inspection report when it is produced, to look for a few red flags that could affect the value of the collateral. Among them:
- Desktop appraisals will often assume a midlife value on a used aircraft. Aircraft have a repetitive hourly, cycle (takeoffs and landings), and calendar inspections that are needed to remain airworthy. If the aircraft is overdue for one or more major checks or the engines are nearer to the end of their economic life, the aircraft value may be significantly decreased.
- Are there any major airworthiness directives or service bulletins on the aircraft that need to be completed? Many of these are minor inspections or repairs, but significant undone work might indicate an aircraft that has not been adequately maintained.
- Are the aircraft logs and other records complete? Every major piece of equipment on the aircraft needs to be properly documented or else replaced by a part that is, so most of the work in an inspection revolves around an audit of the records. Especially on older aircraft and aircraft coming out of a repossession, a lack of records can significantly reduce the value of the aircraft (maybe to the point of being worth scrap).
- Have there been any major repairs on the aircraft in the past, whether properly documented or not? Damage history can significantly impact an aircraft’s value in the marketplace.
Perfecting Your Interests
You may be surprised to find that your existing finance documents generally have the foundation you need for aircraft financing. The biggest deviation from your existing finance documents and closing checklist will be documenting, securing, and perfecting your security interests. Loans and leases for U.S. registered aircraft are subject to special rules regarding creating and perfecting security interests. Under US law (and the Uniform Commercial Code (UCC) in particular), aircraft are treated as personal property and security interests in Aircraft are generally formed under Article 9 of the UCC. However, the UCC expressly acknowledges that other statutes, regulations, or treaties of the United States can preempt the UCC, and that applies directly to aircraft.
In the case of aircraft in the United States, the Federal Aviation Administration (FAA) and the Federal Aviation Act give the FAA the authority to establish a recording system for certain conveyances, leases, and security instruments. This includes the recording of aircraft mortgage and security agreements or assignments of aircraft leases. Therefore, as part of the loan package, you will need to prepare documents that not only properly comply with the UCC but are also in form and substance adequate to be filed successfully with the FAA at closing.
In addition to the FAA regulations, the U.S. is a party to Convention on International Interests in Mobile Equipment and the Protocol on Matters Specific to Aircraft Equipment, commonly referred to as the Cape Town Convention. The Cape Town Convention created an electronic “International Registry” for the recording of ownership and security interest in certain aircraft and aircraft engines. As a result, you will want to determine whether the aircraft and the aircraft engines qualify to be registered on the International Registry, and if they do qualify, you will want to coordinate with the escrow agent to have the ownership interest and security interests registered on the International Registry.
In order to fully perfect the security interests in the aircraft itself, a bank will typically want to:
- Prepare and file an original of the aircraft mortgage/ security agreement that identifies the aircraft and owner.
- If applicable, register an international interest on the International Registry; and
- Out of an abundance of caution, file a UCC-1 financing statement.
Remember that the Collateral is Mobile – Looking Beyond Perfection to Control
In addition to simply perfecting a security interest in the aircraft, lenders should look at additional collateral that provides varying degrees of control over a mobile asset, depending on how it is owned and used. If the aircraft is subject to leasing or other interests, consider taking and recording a collateral assignment of such leases or interests with the FAA. Also, consider a pledge of ownership in the entity that owns the aircraft. This might include a pledge of the membership interests in a special purpose LLC or corporation that is the registered owner of the aircraft or the beneficial interest in a trust that is the aircraft owner. Trusts, in particular, may arise from either estate planning of the beneficial owner or an owner that does not qualify as a U.S. citizen.
If the aircraft is likely to be based internationally or operated worldwide on a regular basis, consider learning whether an aircraft management company will be hired to provide crew and logistics for the aircraft. If so, a lender could obtain a commitment from the management company to ground the aircraft for the benefit of the lender if an event of default should occur under the loan or lease.
Traditional credit enhancements are always fair game in an aircraft transaction as well, such as personal guarantees and corporate guarantees.
Be Aware of International Complications
Many of the guidelines above are addressed as to strictly U.S.-based transactions. Be aware, however, that complications may arise when international considerations come into the equation. For instance, if your borrower is purchasing an aircraft registered in another country, the closing process can be complicated such that there can be a lag between funding and registration of your security interests. Such matters need to be carefully negotiated. Customs and tax issues can also multiply when financing an aircraft with significant contacts to a foreign jurisdiction.
Do Your Due Diligence
Like any other transaction, each aircraft transaction will have its own unique facts and circumstances, and as such, you best serve your role as a lender by doing your due diligence and asking the questions with respect to those facts and circumstances. When you don’t know how these facts and circumstances may impact your transactions or you aren’t sure what questions to ask, FMJ is here to help.
If you are a lender or financial institution with opportunities to finance aircraft, the FMJ Transportation & Logistics team is prepared and available to assist you with your loan documents, perfection of security interests, and otherwise guide you through the best practices in an aviation transaction.
If you have questions about the above article, please contact Transportation & Logistics attorney Kevin Johnson at kevin.johnson@fmjlaw.com.
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