Global | Publication | June 2021
The lasting legacy of the COVID-19 pandemic is yet to be fully understood by the aviation industry but there are certain assumptions that can be made. It is widely understood that substantial budget cuts have been, and are likely to continue to be, made by aircraft owners and airlines leading to a corresponding reduction in fleet sizes. Up until the global grounding of the airline industry, there had been a boom in the delivery of new aircraft with fleet sizes seeing unprecedented growth in the past decade. The surge in deliveries means a flood of newer, more fuel-efficient aircraft as well as a growing number of ageing mid-life aircraft which require spare parts support. What then will be the destiny of those surplus, less efficient aircraft?
The market for the commercial dismantling and recycling of aircraft and the marketing of spare parts has seen a trend of growth. The maintenance cost savings to be made in installing used serviceable parts salvaged from retired aircraft has been a key driver in this growth. In 2019, Fortune Business Insight reported that the market was estimated to be worth US$4.57bn globally with some projections seeing this increasing to US$5.40bn by 2027. As a result, aircraft owners and operators are likely to become increasingly familiar with end-of-life consignment arrangements as a means to extract the most from the residual value of aircraft deemed to be beyond their useful economic life. With the recertification process of the Boeing 737-MAX variant well advanced, during the coming months and years we may see a surge in aircraft retirements.
In this article, we will summarise what a consignment programme is, why it may be an option for a range of aviation industry participants and the considerations and pitfalls that such arrangements entail.
In short, this is an agreement where an aircraft owner (the consignor) delivers an aircraft, or aircraft components, to a supplier (the consignee) who dismantles the asset and, acting as an agent for the consignor, markets the salvaged parts for lease and sale. The consignee will charge a commission on the revenue generated from the sale or lease of the parts with the remaining revenue (after deduction of costs) being for the account of the consignor. Properly managed, this can lead to a win-win situation for both consignor and consignee in relation to otherwise uneconomic assets.
Common circumstances in which the need for consignment agreements may arise post-COVID are:
When approaching any new consignment arrangement, it is important for the consignor to consider the following key points before going to the market:
The following additional considerations and risks need to be taken into account:
| Delivery | Much of the value in parts removed from an aircraft will be attributed to the provenance and standard of the aircraft documents. There has been a trend over recent years for back to birth commercial ownership trace on major parts and not just life-limited parts (LLPs). and Owners are more likely to attract higher sales prices if the aircraft documents and records are maintained to a good standard. |
| Which party bears the risk of storage and transportation costs? |
Whilst the majority of consignment companies will have in place storage/hangar keepers’ liability insurances, one of the key commercial considerations is which party bears the risk in the transportation of parts to and from repair facilities. Recovering the costs of cargo lost or damaged in transit is typically governed by industry practice and for travel by air, recovery is limited to the Montreal Convention. This means that high value parts, for instance APUs, IDGs, avionics and engine LLPs, risk being inadequately insured. |
| What security/collateral is available? |
In the case of financed aircraft, the existing security/collateral package is unlikely to be fit for purpose following teardown. In place of traditional security/collateral packages, you are more likely to see an assignment of receivables and/or payments into a charged/pledged bank account. |
| When is the owner paid? |
Typically, the consignment company would look to recover teardown, storage and repair costs before the owner receives revenue from the parts sold. However, much will depend on the respective parties’ negotiating positions and external market factors. |
| Export control |
Owners should have measures in place to ensure there is visibility and control with respect to the end users to whom parts are sold. Whilst title traditionally passes from owner to consignee to end user, the back to back nature of the structure means that owners should ensure due diligence is undertaken in respect of the checks and balances which the consignee has in place to prevent, or mitigate against, infractions of export control laws and regulations. |
| Liability and reputation |
Whilst we would expect credible consignment companies to have reasonable product liability and hangar keepers liability insurance, there are reputational considerations which come with selling parts which are subsequently involved in aircraft accidents. This should be considered against the overall commercial benefit derived from selling the parts. |
| Taxes and customs |
It is important to consider regional taxes and customs duties in respect of the sale and movement between jurisdictions of consignment parts as these can be significant. For example, the sale and movement of parts which are intended for installation on commercial aircraft can typically qualify for “qualifying airline” VAT treatment and airworthiness import duty treatment within the EU and the UK, meaning taxes and duties are not due. However, care would need to be taken where aircraft and/or parts are being moved for tear down or parting out, as these exemptions may not apply, and the onset of Brexit is leading to additional compliance burdens even if ultimately the tax treatment is unaffected |
A material portion of the global fleet of aircraft remains grounded at the moment which has created something of a buyer’s market in the consignment world. Now that the end of the pandemic is in sight, and with it a return to air travel, this landscape will change. Nevertheless, whilst the industry inevitably changes and delivery streams at aircraft manufacturers are gathering pace again, the consignment market is likely to remain a prominent feature beyond the current horizon.
Publication
Miranda Cole, Julien Haverals and Emma Clarke of our Brussels/ London offices are the authors of a chapter on procedural issues in merger control that has been published in the third edition of the Global Competition Review’s The Guide to Life Sciences. This covers a number of significant procedural developments that have affected merger review of life sciences transactions.
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