Reducing the risk of an aircraft redelivery dispute

Over recent years we have seen an increasing number of disputes arising in relation to aircraft redeliveries. This article seeks to identify why they occur, the steps that can be taken to minimise the risk of a dispute and summarises a number of relevant cases to highlight areas that are frequently subject to a dispute.

Preparing for redelivery takes time in terms of the work required and can be expensive. It is this uplift in activity towards the end of the lease term as well as the expenditure that is often at the root of these disputes. A recent study of lessors undertaken by IBA during 2017 confirms that the primary reason for late redelivery is a general underestimation of the amount of work and time required in order to complete the redelivery process. Lessors and lessees need to be disciplined and plan for this activity.

The starting point for redelivering an aircraft is, of course, the lease agreement, which sets out the required redelivery or return condition. Generally this provides that the lessee has to put the aircraft into return condition and that it remains on lease, with rent (often uplifted) being payable until the process is complete.

The English Courts’ approach to contractual interpretation is to determine the objective meaning of the lease agreement by reference to the language used. While the courts are not always entirely literal in their approach, they will generally seek to hold parties to the terms of the contract they have entered into. As such, the ground work for a smooth redelivery starts with a well drafted lease agreement which crucially should contain clear, unambiguous terms and redelivery conditions, to ensure that both parties are clear on what the lease agreement requires.

Issues may still arise and so early engagement between the lessee and the lessor remains crucial. Whilst early engagement does not prevent disputes altogether, it does at least give the parties time to resolve or clarify the issues before positions become too entrenched.

In the event that a dispute cannot be avoided, it is worth noting the following cases.

If the redelivery date arrives and the lessor does not consider the aircraft to be in redelivery condition, we are often asked whether the lessor can refuse to accept redelivery of the aircraft until it is satisfied that the aircraft has been put into redelivery condition.

The decision in Attica Sea Carriers Corp v Ferrostaal (the Puerto Buitrago) [1976] (concerning the redelivery of a ship at the end of a charter where the cost of putting the ship into redelivery condition exceeded its value) provides guidance to the effect that the lease agreement must clearly stipulate that placing the aircraft in the redelivery condition is a ‘condition precedent’ to redelivery, i.e. that redelivery will not occur until this is the case. Otherwise, the requirement to meet the redelivery condition is merely an obligation which gives rise to a remedy in damages if breached by the lessee.

However, what constitutes redelivery condition can be open to debate if there is ambiguity in the drafting of the redelivery conditions. For example, what is meant when words such as “major” are used, or a lease agreement may refer to condition monitored items being in half-life condition or the maintenance life of life-limited parts where such terms are inappropriate. Equally, some redelivery conditions may be unrealistic or disproportionate - a provision that requires no scab patches is unrealistic, or was it really the intention of the parties that defects that cannot be remedied in a proportionate manner (such as a hole in the airframe to allow installation of a wifi aerial) should nonetheless delay redelivery?

Careful attention to the drafting of these provisions can avoid debate at a later date, although some disputes, such as what constitutes fair wear and tear as opposed to damage are best resolved by early engagement between the lessor and the lessee.

Another area of dispute relates to the contractual consequences of late redelivery and in particular the question of ‘penalty’ rent. Parties are free to specify in the contract the consequences of a breach, but if that consequence is deemed a penalty it is unenforceable as a matter of English law. Historically, in order to avoid being considered a ‘penalty’, it was necessary for the contractual provision to be a ‘genuine pre-estimate of loss’ which was therefore compensatory in nature rather than a sum that is there to act as a deterrent. This had led to arguments that uplifted rent provisions of 150% or 200% are unenforceable as a penalty.

However, since the Supreme Court decision in Cavendish Square Holdings B.V. v El Makdessi and ParkingEye Ltd v Beavis [2015], the test now is whether the provision is out of all proportion to the innocent party's legitimate interest in enforcing the offending party’s obligations under the contract.

These cases concerned, respectively, a share purchase agreement in which the breach of a restrictive covenant resulted in approximately $44 million of lost consideration, and a parking fine of £85 for overstaying a two hour free parking period. An example of a legitimate interest was given in the context of the parking fine, being that the manager of the car park had an interest in ensuring efficient operation of the cark so that the nearby retailers could have a high turnover of customers.

The new test has not done away with the penalty rule entirely but it does recognise that a contractual party will often have a legitimate interest which can be protected by a contractual penalty which, crucially, does not have to be a genuine pre-estimate of loss. This is helpful to lessors and effectively limits the argument by lessees that uplifted rent is a penalty.

In the event that the airline has redelivered the aircraft late, in breach of the lease agreement, the lessor is likely to be entitled to damages in respect of its losses. But what if the lessor has lost a lucrative onward sale or lease as a result of the delay?

The traditional test for recovery of damages is that you can recover losses that are either (a) foreseeable “in the usual course of things” or (b) within the reasonable contemplation of the parties, as set out by the court in Hadley v Baxendale [1854]. However, in Pindell and o’rs v AirAsia Berhad [2010] where a lucrative onward sale was lost as a result of late redelivery, the Court held that this loss was not recoverable.

Although the judge acknowledged that the parties would have contemplated that a late redelivery may result in the lessor losing a ‘follow on’ sale or lease, the judge held that damages for that loss were not within the reasonable contemplation of the parties as being likely to result from the breach and, significantly, this was not a type of loss for which the lessee “assumed responsibility”. This assumption of responsibility test is, however, likely to be relevant only where the general rule alone would lead to an unquantifiable, unpredictable, uncontrollable or disproportionate liability or where there is evidence that market expectations would be that this particular loss is not recoverable.

In this case the onward sale had been negotiated at the top of the market just before the collapse in 2008. The judge noted that late delivery is common, particularly if the aircraft is mature. The loss of the onward sale was in fact caused by extremely volatile market conditions, which meant that Pindell was unable to find another deal on similar terms.

In light of this analysis, the loss of an onward sale or lease is not something which the lessor will necessarily be able to recover, absent an express indemnity. It is worth noting that there was indemnity wording relating to late redelivery in the Air Asia lease agreement but it was held not to cover this type of loss.

Whilst disputes may arise during the course of an aircraft redelivery, both lessors and lessees can adopt measures to reduce the risk. Engaging early and focusing on the redelivery conditions sufficiently in advance of the return date will help, but if a dispute ultimately arises, the above cases provide a degree of guidance as to how an English Court may approach issues such as the amount of damages claimed.