Corporate jets versus commercial aircraft: The key differences for financiers
Financing corporate jets involves different risks to commercial aircraft deals. Graeme McLellan and Paul Ng, partners with Stephenson Harwood, talk about the differences between commercial and corporate aircraft, and the challenges financiers might face when financing corporate jets.
The corporate jet finance market has started to recover from the turmoil of recent years. Prices have fallen from their inflated peak in 2008 and margins have increased considerably. Combined with the historically attractive residual values (which are in part due to the relatively low usage of such aircraft), the market is again attractive to financiers, who are returning to or entering the market for the first time.
In many respects the financing of corporate jets is very similar to commercial aircraft financing. The entities and documents involved and set out in the diagram below will mostly be familiar to commercial aircraft finance lawyers, with the main exception of the involvement of a specialist operator and (depending on the operator) possibly a separate maintenance provider.
Corporations and high net worth individuals (HNWIs) rarely have more than one or two aircraft and this gives rise to various issues such as:
- HNWIs, in particular, tend to like being able to refer to owning their jet and, as a result, may be less willing to consider leasing the aircraft;
- Corporations or HNWIs may regard their acquisition and financing of a jet as just another deal for their usual (or in-house) lawyers who may have no asset finance experience and require careful guidance;
- The sheer volume of documents required can come as a surprise to customers (and their usual lawyers) and expectations need to be carefully managed from the outset; and
- Customers (and their usual lawyers) may be dealing with some issues (eg, Cape Town registration) for the first time and again they may need assistance from other parties.
Existing financial arrangements
Particularly in relation to HNWIs, customers may have complex existing wealth management or financial structuring arrangements. A careful balance needs to be struck between excessive investigation of such (sometimes secretive) arrangements and obtaining the required degree of comfort about the validity and effectiveness of security documents.
Complex family trust structures may require a degree of investigation to ensure the validity of a share mortgage over the SPC.
In relation to personal guarantees, financiers need to use appropriate covenants to ensure the assets supporting the guarantee remain held by the guarantors, in a sufficiently liquid form and in the expected jurisdictions – financiers also need to confirm the execution requirements for guarantees to be valid as (for example) in certain jurisdictions a spouse must also execute a personal guarantee for it to be enforceable.
HNWIs with wealth or income concentrated in currencies other than US dollars may also wish to obtain at least part of their jet financing in such other currencies.
Throughout the 2000s it became more common for financing documents to include periodic (typically annual) loan-to-value (LTV) testing, particularly where customers were successfully resisting requests for guarantees.
Breach of the agreed LTV ratios typically triggers a mandatory partial prepayment obligation to bring the LTV back within agreed parameters. There needs to be an agreed methodology for conducting such LTV testing and often this will be based on looking at the then current Blue Book valuations, sometimes with the option of obtaining a subsequent, more specific (desktop) valuation where the Blue Book indicates only a marginal breach.
Where the financing is not purely in US dollars there also needs to be an agreed methodology for converting loan amounts into dollars (being the valuation currency) for the purposes of such LTV testing.
Mandatory partial prepayments triggered by failure to satisfy LTV tests are sometimes treated differently from other prepayments as they arise as a consequence of market conditions and are therefore beyond the control of the customer. Lenders may agree to waive prepayment fees and allow such prepayments to be timed to mitigate interest (and any other swap) break costs.
PDPs and aircraft completion
Pre-delivery payment (PDP) financing continues to be readily available in the private jet market. Each of the main manufacturers has its own approach to providing financiers with a security interest over the purchase agreement (including build-out rights) and the main financiers will have negotiated a base position with each of the main manufacturers.
Financiers also need to consider the precise timing of title transfer and the proposed condition of the aircraft at such time. Unlike with commercial airliners, where title to the aircraft is transferred by the manufacturer when the aircraft has been fully fitted out and completed, with private jets it is common for title to be transferred at delivery of the bare (or “green”) aircraft which subsequently goes to a (sometimes third-party) completion centre for interior fit out.
Obviously effective security needs to be in place at each stage of: PDPs being financed; title transfer; during completion (which may be in a different jurisdiction from the manufacturer); and at and after final delivery.
Financiers should also investigate the nature and scope of any relevant import duties and document the requirement that they are in fact paid. Private jets often attract significantly higher rates of import duties than commercial airliners – for example in India the difference in the applicable rates of duty can exceed 20%.
Certain financiers were agitated in 2008 when the customs authorities in India seized a number of private jets which had been imported without payment of the relevant duty on the basis that it had been claimed they would be used for commercial/charter purposes.
Operator and maintainer
As corporates and HNWIs rarely have more than one or two jets, they will generally have to engage a third-party specialist operator to arrange crew, insurance, catering, flight planning, parking of aircraft, administration, etc. Such an operator may also provide maintenance, repair and overhaul services, or these may be provided by a separate maintainer appointed either by the customer or the operator.
Financiers will want to know that the operator will perform certain obligations (including in relation to operations and insurance) in accordance with the terms of the facility agreement and that the operator will co-operate with the financier in relation to repossession after a default – these (and other) arrangements are included in a Tripartite Agreement between the financier, its customer and the operator.
Aircraft management agreements and tripartite agreements can take different forms depending on regulatory, taxation and other factors in the relevant jurisdictions. For example, in some jurisdictions, including China and Hong Kong, the aircraft management agreement is often structured as a lease of the aircraft to the operator and the aircraft is registered in China / Hong Kong in the name of the operator in its capacity as lessee – the tripartite agreement then needs to protect the financier from any adverse impact on repossession which could result from the operator terminating the lease following a customer default and any deregistration of the aircraft resulting from such lease termination. The financier may therefore want a contractual right to step into its customer’s position and assume responsibility for performing the lease.
Financiers need to be comfortable with the operator proposed by their customer as the operator’s actions can affect the residual value, result in unexpected liens and impact on any repossession process following default by the customer (particularly if an operator is trying to protect a wider relationship with the defaulting customer’s family and friends).
The financial stability of the chosen operator is also important, as recent operator insolvencies in the Middle East have demonstrated.
Customers may decide to change operators from time to time, whether because they wish to relocate their aircraft or because they prefer different crew/catering. Customers are often surprised that this change of operator will involve at the very least replacement security documents and can require complete restructuring of a financing (for example if an aircraft originally financed on a secured debt basis is to be moved to a jurisdiction which does not recognise the concept of a chattel mortgage) – expectations need to be managed carefully.
Financiers need to consider the degree of involvement and security they require in relation to any proposed charter arrangements. Typically short-term or ad hoc charters are of little interest to financiers but they do take an interest in longer-term arrangements in order to protect their recourse to the asset and also because they may in fact wish to have the option to continue with a long-term lucrative charter arrangement even following a default by their customer.
Financiers also need to look carefully at what warranties and other manufacturer support/service is being provided. As with commercial airliners, it is usual to take security over the manufacturer’s warranties in relation to the airframe and engines while still enabling the customer/maintainer to utilise such warranties. In addition, the customer/maintainer may also be entering into maintenance service plans (MSPs), particularly in relation to the engines and/or APU – these can have a positive impact on residual values and financiers may also seek security interests over such arrangements.
Finally, limited recourse financing of jets for corporations and HNWIs is now rare. But in the boom years financiers were often prepared to waive the requirement for a guarantee in order to obtain the financing mandate in an increasingly competitive market.
When the market subsequently turned and LTVs rose (in many cases exceeding 100%), customers with no other relationship with a bank and no guarantee obligations were sometimes known to invite their financier to come and collect the aircraft rather than start making mandatory partial prepayments after LTV testing.
The presence of a guarantee should hopefully ensure the customer performs all of the above obligations in the expected manner and ensure that any problems are dealt with properly rather than the customer simply walking away.