Capetown Treaty - Aircraft Sales Investment Group

After a great deal of speculation and debate, the Cape Town Convention on International Interests in Mobile Equipment and the Aircraft Protocol (collectively, the "Convention" or "Treaty") has now been ratified by the requisite number of countries and will be in effect on March 1, 2006. As discussed below the Convention will have a substantial impact on aircraft transactions involving aircraft and engines that reach a certain minimum size requirement.

All of these matters will be discussed in more detail in this paper but it is important to know why you should care about this Convention. First, the United States has ratified the Convention and has adopted certain amendments to the Transportation Code (Subtitle VII, Part A of Title 49 of the United States Code) and FAA Regulations (14 CFR §§ 1, et seq .) to implement the Convention in the United States.

As a result of the ratification by the United States , under the terms of the Convention, it will apply to all transactions involving aircraft that are certificated for at least eight seats (including crew), helicopters that are certificated for at least five seats (including crew) and engines rated at least 550 horsepower.

And perhaps the most important point is that the Convention creates new laws pertaining to aircraft transactions and the perfection of interests in aircraft and engines. After March 1, 2006, it will no longer be enough to conduct searches, and to file documents, at the Federal Aviation Administration ("FAA"), although that must still be accomplished. In addition to dealing with the FAA you must also conduct searches, and register interests in aircraft and engines, at an International Registry ("CTIR") created by the Convention. If you are a seller, purchaser or lender in an aircraft deal and fail to follow the simple but rather technical procedures set forth in the Convention your interest will be unperfected and you could lose your aircraft (or lien), to competing creditors or a subsequent purchaser -- even if that party had prior and actual knowledge of your interest.

The Convention is an ambitious and unique treaty that establishes comprehensive laws in each ratifying country (known as a Contracting State) dealing with most significant aspects of buying, selling, leasing and financing aircraft and engines, including issues relating to default, remedies, insolvency, priorities, title, aircraft deregistration and the perfection and filing of liens against airframes and engines that meet certain minimum requirements.

The minimum size requirements are such that the Convention will apply to the following: aircraft certificated for at least eight seats (including crew), helicopters certificated for at least five seats (including crew) and all engines rated at equal to or greater than 550 horsepower or the equivalent. The Convention defines this type of equipment as "Aircraft Objects."

The types of interests in Aircraft Objects that can be perfected by registration with the CTIR are: security interests, leasehold interests, conditional sale agreements (referred to in the Convention as "title reservation agreements"), and ownership interests as evidenced by a contract of sale. These are referred to as "international interests" in the Convention. Other interests or documents that are provided for in the Convention are amendments, assignments, subordinations and subrogations related to international interests; and certain non-consensual liens,.

Among other things, the Convention creates the CTIR, which will be located in Ireland, where essentially all interests in aircraft, helicopters and engines must be registered in order to be perfected (under the Convention, a "registration" of an international interest is the equivalent to "perfection" of an interest in an Aircraft Object). The CTIR will create a web-based registry system that can be accessed at all times, whether to conduct searches or to register international interests in Aircraft Objects.

As noted above, the United States has ratified the Convention and as such it will become the law of the land on March 1, 2006. Four different documents are the keys to understanding how the Convention will be implemented in the United States: (a) amendments to the Transportation Code, (b) amendments to the FAA Regulations, (c) Declarations adopted by the Senate when the U.S. ratified the Convention, and (d) the Convention itself.

There is a fairly widespread misunderstanding in the industry that the Convention will not be applicable to transactions that occur in the United States or to transactions which affect United States registered aircraft; however, this is entirely wrong. In fact, because the U.S. has already ratified the Convention, it will be an integral part of every U.S. transaction involving aircraft and engines that meet the minimum size requirements noted above.

The first point to consider is whether the Convention will create significant changes to United States law. While the Convention does contain substantive law regarding default, remedies and insolvency, the changes to U.S. law will be minimal because these sections of the Convention have been modeled after United States and Canadian laws. Notwithstanding that fact, counsel and interested parties must familiarize themselves with the Convention to determine if documentation in current use should be changed to accommodate the new laws contained in the Convention.

There are many areas where the laws and procedures set forth in the Convention differ from the current U.S. system and three of the primary areas are addressed below: (i) the aviation lien perfection system, (ii) rules relating to priority of liens, and (iii) the Convention's recognition of a "prospective" international interest, which allows parties to perfect interests in Aircraft Objects prior to closing a transaction.

In light of the above, an obvious question is, "will the CTIR eliminate the need for the FAA Civil Aviation Registry?" The answer is no. The FAA Civil Aviation Registry will continue to have an important role in connection with the registration of aircraft and the perfection of liens in aircraft and engines. As part of the ratification and implementation of the Convention in the United States , Congress has adopted certain amendments to the Transportation Code and directed the FAA to adopt final regulations that deal with the implementation of the Convention in the United States. The new legislative and regulatory schemes contemplate a continuation of the traditional FAA system that has served the aviation community so well over the years while recognizing the need to implement the Cape Town system. As a result, Congress has designated the FAA as an "exclusive entry point" that must be used to gain entry to the Cape Town CTIR and has adopted legislation that blends the two systems together.

The amendments to the Transportation Code and FAA Regulations, which are not applicable unless and until the Convention comes into effect, will establish a system that can be summarized as follows:

In addition to the above steps, parties will be required to create an account with the CTIR, by providing certain info rmation to establish their existence and identity and, of course, to provide the CTIR with a credit card to pay for filings and searches at the CTIR.

A summary of the preliminary questions that must be asked to determine if Cape Town applies to any given transaction is set forth on Exhibit A in a PDF file for you to download.

In addition to perfection issues, the Convention creates a new law with regard to the determination of the priority of liens or claims in an Aircraft Object. Currently, priority rules in the United Sates are governed by applicable state laws, with one exception contained in the Transportation Code. The general rule is that the first to file a security interest or lien at the FAA Registry located in Oklahoma City has priority over all other liens and claims against the aircraft or engine, unless the filing party has "actual notice" of another claim or right in the aircraft or engine. 49 U.S.C. Section 44108 (a). Conflicts and arguments relating to "actual notice" have resulted in a certain level of confusion, frustration and inconsistent priority rules in the United States ; and led to the only Supreme Court case dealing with liens and aviation laws, Philko v. Shacket , 462 U.S. 464, 103 S.Ct. 2476, 76 L.Ed.2d 678 (1983). That rule (and resulting conflicts) will be changed and simplified when the Convention is in effect because there is one priority rule: whoever registers their interest first at the CTIR has priority over all other interests. The existence of "actual notice" is simply not relevant to the determination of the priority of competing liens or interests. ⁵

Another difference between the Convention and the current FAA system is that the Convention allows the perfection of interests in Aircraft Objects through the registration with the CTIR of a "prospective" international interest. This allows parties to a transaction to perfect their rights in an aircraft, helicopter or engine before the transaction closes, which has not been allowed under the current FAA system in the United States. In implementing this portion of the Convention in the United States, Congress adopted certain new and unique procedures and requirements, with dire consequences if you fail to satisfy these requirements. Among other things, a party must first file a required form (AC Form 8050-135) with the FAA when establishing a prospective international interest and it must then register the prospective international interest with the CTIR. Federal law provides that the parties then have sixty (60) days to file the relevant documents (e.g., bills of sale, security agreements or leases) for recordation with the FAA. If the parties fail to make such a filing, the Transportation Code provides that the interests are no longer valid (i.e., perfected).

In light of this unusual approach to prospective international interests you need to be very familiar with the new laws or consult with legal counsel that has expertise in this area.

Prospective international interests will also be tricky because a current owner or lender will be reluctant (at best) to allow or consent to the registration of a prospective international against an Aircraft Object prior to receiving a loan payoff (in the case of a lender) or the purchase price (in the case of an owner). Security agreements and loan agreements currently contain prohibitions of the placement of a competing lien on the relevant collateral and it is likely that lenders will add similar language which prohibits any party from placing a prospective international interest on the collateral. As a result, the use of a prospective international interest will need to be the result of a good deal of thought and negotiation among the relevant parties, including the current, lender, owner, prospective lender, prospective owner and any intermediaries.

Parties who use the CTIR are referred to as "transacting users" and anyone who plans to use the CTIR will be required to create an account with the CTIR by providing certain information to establish their existence and identity and provide a method of payment of the various charges that will be made by the CTIR.

As part of establishing an account with the CTIR, the transacting user must appoint an administrator (who must be an individual) and who is authorized to interact with the CTIR on behalf of the transacting user. That is, any filings or registrations to be made at the CTIR on behalf of the transacting user can only be made by the administrator and parties who have been designated by the administrator to act on her behalf.

The costs for using the CTIR have now been established and some of the more common charges will be:

Establishing an account (required):	$500 for a five year license
Registering international interest in an aircraft:	$100, for one aircraft and its engines
Search of CTIR records:	$35, for one aircraft and its engines

A more detailed listing of costs, both direct and indirect is set forth on Exhibit B and is available as a PDF file.

A final and important question to explore is: "what effect will the Convention have on liens or interests in Aircraft Objects that are already perfected-if I am already perfected will I have to file a new lien under Convention?" The answer is simple. The United States adopted the Convention in a way that all liens against aircraft and engines that are properly perfected at the time the Convention is effective, will be "grandfathered" and their perfection will continue to be effective after Convention.

Nevertheless, it can be argued that a lender would have some benefit from having a lien that is registered under the Convention, even if the lien was created and perfected prior to the effective date of the Convention. As a result there will be tension between a lender who may want to take the steps to register a security interest under the Convention (even though it is properly perfected at the FAA) and a borrower who does not want to spend the time or the money necessary to accomplish that registration.

If parties to an agreement that is in existence prior to the effective date of the Convention (i.e., an interest created before March 1, 2006 ), decide to register their interest at the CTIR, it is not as simple as you would think. The general consensus among people who have studied the Convention is that the Convention only applies to interests created on or after its effective date and, therefore, to take advantage of the Convention interested parties would have to create and execute new documents (for example, in the form of an amended and restated security agreement) and register that interest at the CTIR.

Anyone working in this field must familiarize themselves with a number of new laws, documents and concepts. Among other things, to fully understand how to use and comply with the Convention, one must read and understand the following:

Additionally, since all registrations with the CITR will be done through a web-based computer system, one must become familiar with the details and nuances of that system.

To complicate matters, the Convention Regulations, CITR Procedures and the CITR computer system are not currently available to the public; although the proponents of the Convention have indicated that all of these items will be made available in the near future.

While the decision to register an international interest under the Convention is optional, the failure to register such interests at the CTIR can be fatal to the interests of an owner, lender, lessor or lessee. Likewise the failure of any lawyer or consultant who fails to advise the client regarding the Convention would be considered malpractice or malfeasance. This is primarily driven by the priority provisions of Convention which, as noted above, are simple and clear: the first party to have a registered and "searchable" interest under the Convention wins. This is a critical matter that must be emphasized: if you hold an interest in an Aircraft Object that is covered by the Convention, you must perfect that interest by following the procedures outlined above. Failure to do so could result in the loss of your interest, or at least the loss of priority, to competing creditors or a subsequent purchaser -- even if that party had prior and actual knowledge of your interest.

In light of the significant changes in both substantive and procedural laws relating to the perfection of ownership and security interests in aircraft and engines, the aviation industry must come to grips with the fact that the traditional and comfortable way of closing a transaction will come to an end and that the industry will go through an educational process in learning the best practices in dealing with the Convention and closing aviation transactions. Anyone who is active in the aviation field must give a great deal of thought as to how to conduct aircraft closings, and whether old approaches to closings should be modified or scrapped. For example, should you

We have had the luxury of watching the Convention develop from a distance and over time, knowing that ratification and implementation would be years away, if ever. Now, we know that the Convention will be in effect on March 1. 2006. Now is the time for the industry to commence an active and in-depth analysis of the Convention to be prepared for a new and different way of closing aircraft transactions.

About the Author of this Article. Frank L. Polk, is an aviation lawyer with McAfee & Taft, located in Oklahoma City, Oklahoma, www.mcafeetaft.com . He can be reached at 405-552-2201 or frank.polk@mcafeetaft.com .

The Cape Town Convention and Aircraft Transactions in the United States

The Cape Town Convention and
Aircraft Transactions in the United States