U.S. Court Favors Aircraft Financier in Non-Citizen Trust Case
District court case shines a light on the extent and limits of a lender’s duties in both structuring loan transactions and exercising remedies.
On January 25, 2018, the United States District Court for the Northern District of Indiana, South Bend Division, awarded a $2.3 million summary judgment to aircraft financier 1st Source Bank for loan defaults by borrower Wells Fargo Bank Northwest, National Association, solely in its capacity as owner trustee, and the borrower’s personal guarantor, Joaquim Salles Leite Neto. See 1st Source Bank v. Neto, No. 3:15-CV-261-JD, 2018 WL 571941, at *1 (N.D. Ind. Jan. 25, 2018).
The case shines a light on the extent and limits of a lender’s duties in both structuring loan transactions and exercising remedies. In this case, a Brazilian citizen used an owner trust to obtain a U.S. aircraft registration and avoid payment of Brazilian taxes. The aircraft was later confiscated by the Brazilian government, and the lender, unable to foreclose on its collateral, sued the debtors and the insurers. The lender, while ultimately successful, had to defend arguments that it (1) negligently misrepresented that the ownership structure complied with Brazilian laws, (2) failed to mitigate its damages and (3) impaired the collateral.
Aircraft Seized by Brazilian Authorities for Tax Evasion
In 2009, Neto, a Brazilian citizen, hired Wells Fargo to act as owner trustee of an aircraft trust. A company affiliated with Neto, Quest Trading LLC, was the beneficial owner of the aircraft under the trust agreement. Neto created the trust in order to purchase a Dassault Falcon 2000 business jet and register it with the U.S. Federal Aviation Administration. The aircraft was based in and flown predominantly within Brazil for Neto’s personal use. In January 2011, Neto caused Wells Fargo to borrow $6 million from 1st Source Bank and pledged the aircraft to the lender as collateral. Neto also issued a personal guarantee of the loan obligations to the lender.
In June 2012, the Brazilian authorities confiscated the plane, alleging that the U.S. registration and trust ownership of the aircraft had been improperly used to avoid the payment of Brazilian import tax. In September 2014, the borrower ceased making payments on the loan to 1st Source Bank. 1st Source Bank then accelerated the loan. When the loan was not repaid, the lender filed a suit against the borrower and the guarantor, and also brought a claim against the aircraft’s insurer for losses arising from government confiscation. The lender recovered over $3 million from the insurer, and sought summary judgment against the borrower and the guarantor for the remaining unpaid debt balance.
Lender Not Liable for Seizure
The borrower and Neto counterclaimed against 1st Source Bank for negligent misrepresentation, asserting that the lender had advised them that Brazilian laws permitted their contemplated use of the aircraft with a U.S. registration and trust ownership structure. To support this argument, Neto pointed to language in the term sheet stating that the lender believed the terms of the financing to fall within applicable U.S. and Brazilian laws, and that the borrower would be responsible for all taxes and duties associated with operating the aircraft. He also argued that he had relied on the fact that 1st Source Bank issued the loan to imply that the structure and contemplated use of the aircraft was permitted under Brazilian laws. The court rejected the counterclaim, noting that Neto had established the trust structure prior to seeking the loan and that the term sheet language could not be construed as advice on the legality of the aircraft’s registration or ownership structure. The court also noted that there was no evidence that the lender was aware that the aircraft would not be used for business purposes—the basis for its seizure in Brazil.
Lender Not Obligated to Further Pursue Brazilian Government and Insurer
Finally, the borrower and Neto raised two defenses to 1st Source Bank’s claim—impairment of collateral and failure to mitigate damages—both of which were rejected by the court.
The defendants argued that the lender should have done more to secure the release of the plane by the Brazilian government, and that their failure to do so had impaired the collateral. The court rejected the defense, noting that Neto, and not 1st Source Bank, was responsible for the aircraft’s seizure, and that 1st Source Bank had done all that it could to obtain its release. These efforts included warning Neto that Brazilian-operated aircraft registered in the U.S. were being confiscated by the Brazilian authorities as soon as it learned of this development—a warning that Neto did not heed. Once the plane was seized, the lender also successfully prevented the Brazilian authorities from selling the aircraft by notifying them of its security interest. The court observed that the defendants did not suggest any other actions that 1st Source Bank could have taken, particularly given that the Brazilian government had refused to release the aircraft for anything less than its full market value plus the import tax payable.
The borrower and Neto also claimed that 1st Source Bank failed to mitigate its damages by settling the insurance claim for less than 100 percent of the outstanding loan balance. The court rejected this argument on the basis that the duty to minimize losses does not give rise to a duty to collect the loss from anyone in particular. The court further noted that 1st Source Bank was not contractually bound to seek payment from the insurer before calling on the guarantee.
This case serves as a useful reminder that borrowers should take care and responsibility in structuring the tax and cross-border aspects of their aircraft ownership arrangements. It also illustrates how the law will protect lenders who take commercially reasonable measures to enforce their security and mitigate their damages.
This article was written by Melissa B. Jones-Prus who is counsel in Pillsbury Winthrop Shaw Pittman’s Aviation, Aerospace & Transportation practice located in the New York office.
Melissa Jones-Prus is a counsel in the firm’s Finance practice, primarily representing clients who are active in the aviation sector. Melissa represents lenders, lessors, airlines and trustees in connection with all forms of transportation asset-backed financings, leveraged and tax leases, operating leases, as well as capital markets offerings, such as portfolio securitizations, EETCs and Exim bonds. She also represents buyers and sellers of high value capital equipment. Melissa also has experience advising aircraft creditors on debt restructurings, including in airline bankruptcies.