Aircraft Acquisition Contracts and Force Majeure: A Way Out for Airlines?
By Rushika Rabha
The Covid-19 pandemic has thwarted the operation of businesses across the globe, causing them considerable hardship in performing their obligations under their contracts. Complications have been brewing in the aviation sector since March when the government had begun to impose travel restrictions, thereby causing the airline companies to halt their operations. The International Air Transport Association has projected the revenue losses for the aviation industry to be $113 Billion internationally¹. Airline companies lease their aircraft from lessors under a lease agreement. According to a typical aircraft lease agreement, aircrafts are delivered in “as in, where in” basis, barring any “warranties, representations and implied terms as to the leased aircraft being fit for purpose”². In India, more than 80 percent of the commercial aircraft are leased³. In normal circumstances, when flights were operating smoothly, leasing was the best option available to minimise cash burn for the airline companies⁴. However, the pandemic has conjured such drastic changes in the circumstances, that companies have been forced to revisit their contracts and find an optimal solution during these times of commercial hardship. Airline companies are reaching out to lessors in hopes that the lessors will grant them a “rental holiday” because of the sharp fall in ticket booking post lockdown⁵. However, it is at the discretion of the lessors whether to accept or decline such requests. Commercial contracts, which include aircraft lease agreement can provide for a “Material Adverse Effect (MAE)” or a “Material Adverse Change (MAC)” clause, wherein certain contractual consequences which include the right to terminate a contract, come into force if there a material change in the condition of one of the parties, this material change can be the financial condition or operational⁶. It is to be noted that such material change must not be in contemplation of the parties while forming the contract and this change must be a temporary one. Standard lease agreements give lessors the right to declare that a material adverse change has occurred in the lessee’s condition. Nevertheless, under English law lessors should be careful in relying on this clause to declare that an event of default has occurred as it carries huge financial risks and can potentially cause reputational damage⁷. This clause can potentially be used by lessors to start negotiations with the lessees⁸. Airline companies, as lessees can rely on Force Majeure clause or the doctrine of frustration or an “illegality” clause, however, the hell or high-water clauses can impede seeking relief under the aforementioned clauses.
The Hell or High-Water Clause
The hell or high-water clause has been an inescapable provision in aircraft lease agreements ever since the leasing of equipment began as an independent discipline⁹. Such a clause is irrevocable. Although the exact language and formulation of this clause may vary from contract to contract, the meaning essentially remains the same¹⁰. It denotes that the lessee is obligated to pay the lessor the stipulated installments without failure with no regard to “the circumstances surrounding the possession and use of any property pledged to secure repayment”¹¹. Even if any sort of complications transpires be it the non-use of the equipment itself due to unforeseeable circumstances, the lessee has to pay the money regardless. This provision essentially guarantees the right of the lessor and third-party funders to be paid the installment through contractual obligations¹². In Wells Fargo Bank N.W v. Taca International Airlines¹³, the court gives a succinct explanation of lessee’s obligation under the aforementioned clause, “The Lessee’s obligation to pay all rent and all other amounts due hereunder and to perform all the terms hereof shall be absolute and unconditional and shall not be affected or reduced by any circumstances, including any set-off, counterclaim, recoupment, defense or other right which the lessee may have against the lessor”. It is only in some rare occasions that the airlines have been exempted from this clause like a breach by the lessor or hindering the “quiet enjoyment” of the leased aircraft¹⁴. Courts have also taken into account fraud or bad faith in the performance of the contract by the lessor to determine the efficacy of hell or high-water clauses¹⁵. To quote an example, in Equitex, Inc v. Ungar¹⁶, the court permits the hindering party to benefit from a willful wrongful act would be against public policy.
This prominent provision of aircraft leasing contracts makes it cumbering to default payments due to this covid-19 pandemic without facing any consequences, be it financial or legal. The alternative that is available to the airline companies is to invoke the force majeure clause or the doctrine of frustration. However, their invocation is not without its intricacies.
Force Majeure and Frustration
In English law, force majeure, which means “superior force”, is a contractual term whose existence can be extrapolated from the express provisions present in the contract¹⁷. In condensed language, the function of a force majeure clause is to “prevent what otherwise might be breach from being a breach”¹⁸ in a contract. Force majeure clauses come in a multitude of forms and it is necessary to read them as a whole with the rest of the contract¹⁹. In Lebeaupin v Richard Crispin& Co²⁰, a leading judgement on the ambit of Force majeure clause in common law, it was held that effect of the clause will vary with each instrument as the words used in the clause are to be interpreted taking into consideration the general terms and nature of the contract. The force majeure event must pass the test of externality i.e. the event must not be the result of the defaulting party’s actions, secondly, the event must be unforeseeable and inevitable, it could not have been avoided even when mitigating measures were taken and lastly, the event must lead to the performance under the contract becoming impossible²¹. The resulting relief granted by this clause is suspending or expending the time for performance under the contract. The circumstances effectuated by the pandemic can come under “epidemic” or government directive”²². In aircraft lease agreements, force majeure clauses are rare²³. If the language of the contract does not strictly provide such a clause, it is up for interpretation of the courts²⁴. Furthermore, in common law courts resorting to clauses that excuse performance or terminate the contract are not favored unless there is compelling evidence and the affected party has taken all necessary steps to mitigate the consequences of the event²⁵.
In the absence of an express provision to get relief under force majeure, parties may rely on the doctrine of frustration. The doctrine of frustration has parallels to force majeure; however, the latter is “much narrow in its relieving effects”²⁶. Lord Radcliffe elucidated the invocation of this doctrine in Davis Contractors Ltd v Fareham U.D.C²⁷, “Frustration occurs whenever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract”. The threshold for successfully pleading that a contract is frustrated is particularly high, as a mere inconvenience or hardship cannot frustrate a contract; If the court accepts such a contention, it results in the parties being freed of their obligations under the contract²⁸.
“Change in Law” Clause
The aircraft lease contracts can also contain a provision for “change in law” or “illegality” wherein the performance of contractual obligations has become illegal because of the change in the law under which the contract operates²⁹. Naturally, if the government has passed any law banning flights from operating it leads to the illegality of performance under the contract. Consequently, the airline services can take cover under this clause. In India, international flights are under a blanket ban imposed by the civil aviation ministry till the 31st of August (for now)³⁰. Only a few international flights are operating under the a “transport bubble” agreement, which refers to a temporary arrangement between two countries to allow flights into each other’s territory³¹. For domestic airlines, the scope of the “illegality” clause may allow the circumstances like suspension of flights by the government or imposition of travel restrictions to free companies of their contractual obligations³².
The Way Forward for Lessors and Airline Companies
The legal complications brought about by the pandemic are sure to have lasting effects on the way lease agreements are structured across the globe. The language of the lease agreement should be read in light of the present circumstances to ascertain whether it provides for a force majeure or illegality or hell or high-water clause so that the parties move forward with a resolution that is in consonance with the contract language. If the language of the aircraft lease contract allows this pandemic to be accepted as a force majeure event, then the lessees can access the benefits provided as relief under this clause in the contract. It would not be an optimal decision considering the present impediments on the smooth functioning of trade and commerce for the lessors to terminate lease agreements or get into new ones. As without proper avenues for remarketing an aircraft, repossessing an aircraft is not feasible economically³³. In the present market, to ease the hardship on the functioning of businesses, lessors and lessees might negotiate their payment obligations, waivers or deferrals might also be worked out³⁴. It is to be kept in mind that such solutions are short term and in the long run their agreements might need restructuring³⁵. Cost or loss sharing could be undertaken to mitigate the problems but this will be wholly dependent on the negotiating ability and the financial credibility of the lessee. Henceforth, to weather this storm airline companies have certain pathways like force majeure clauses or the doctrine of frustration to bargain their payment obligations with their lessors but the extent and feasibility of each pathway are dependent on the action their lessors will take to mitigate their risks. It is in the best interest of both parties to work out a solution that lessens litigation risks when the effects of the pandemic eventually wear off in the future.
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The author is a year II B.A. LL.B student of Campus Law Centre, Delhi University. Her submission secured a special mention in the Journal and Seminar Committee National Article Writing Competition 2020 organised in the month of August, 2020.
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