Redelivery conditions in aircraft operating leases

Nick Harding and Kirstin MacDougall consider the drafting of redelivery conditions in aircraft operating leases, highlighting some of the pitfalls and best practice for airlines in the context of principles of contractual interpretation under English law.

Negotiating redelivery conditions is a critical part of the operating lease negotiation exercise. Redelivery conditions are, however, not always given the attention they deserve at the outset when drafting a lease. If they are not correctly drafted, the parties can end up with disputes as to what they mean and whether an aircraft complies with such conditions, or a lessee may incur substantial costs in putting an aircraft into a redelivery condition which is overly onerous or inappropriate. This makes the negotiation of these conditions crucial.

Why do problems with redelivery conditions often arise?

It is important to properly draft redelivery conditions at the outset to avoid potentially adverse consequences and disputes at the end of the lease term. However, as redelivery is often seen as being a long way off, redelivery conditions are not always given the attention they deserve. This can happen for several reasons:

• Focus on immediate concerns: Parties may be more focused on immediate concerns, such as the delivery of the aircraft, releasing cash as part of a sale and leaseback transaction, lease rentals and other commercial considerations, rather than on the redelivery conditions that will come into play years down the line.
• Lack of experience in drafting technical provisions: Parties may lack experience in drafting redelivery conditions. This can result in vague or loosely drafted redelivery conditions that are ambiguous and therefore open to interpretation. Poorly drafted redelivery conditions will inevitably come back to haunt the airline at the end of the lease term.
• Assumption of mutual understanding: Parties may assume that the parties “know what the provisions mean” and therefore less attention is paid to their drafting. However, this can be a risky approach. Often the people who negotiated the redelivery conditions may have left the company by the time the lease term comes to an end, or there may have been changes of ownership of the aircraft during the lease term, meaning the parties are not the same as they were at the outset. In both scenarios, any perceived mutual understanding and commercial relationships will be lost, and the lessor may not be incentivised to read the drafted terms in a way that is more favourable to the airline if this is not what the document actually says.

Typical redelivery provisions provide for redelivery on a fixed date, at a fixed location and in a certain condition. The aircraft should be in the same configuration as at delivery and should be free from liens (other than lessor liens), and elective modifications by the lessee should be removed (or purchased by the lessor). Inspections, ground checks, and redelivery flights should be conducted, and any discrepancies from the agreed condition should be corrected. Deregistration should also be completed.

What are the potential implications on airlines for uncertain redelivery conditions?

The potential implications for airlines of uncertain or ambiguous redelivery conditions are significant. By way of example, let us assume an airline enters into an operating lease with a lessor. Under the terms of that lease, and as is typical in such agreements, on the date that the aircraft is redelivered, the airline must compensate the lessor for the life used on the aircraft. In relation to engine Life Limited Parts (LLP), the compensation mechanism provides for the airline to pay an amount per LLP calculated as “the number of flight cycles for that LLP since new”, divided by the life limit for that LLP, multiplied by the replacement cost of that LLP.

As part of a series of lease amendments and ownership changes stretching over many years, including a change of lessee, the compensation mechanism is amended and, at the time of redelivery, provides for the LLP compensation to be based on “the total number of flight cycles accumulated on such LLP on the redelivery date”.

The parties end up in dispute as to whether the compensation needs to be calculated on each LLP based on the number of flight cycles “since new” or only those flight cycles “accumulated” during the lessee’s period of operation. If the dispute is decided against the airline it would cost over $15 million more than the airline had anticipated and risks the survival and solvency of the airline.

How will English courts interpret uncertain redelivery conditions?

When interpreting contractual uncertainty, courts typically start by giving words in a contract their ordinary and natural meaning, in the context of the agreement. [1] Only if such an interpretation would lead to an absurdity, an inconsistency within the agreement, an unreasonable result, or impose a responsibility which could not reasonably be supposed, will the court consider other factors. This applies even if the contract has been poorly drafted.

The court will construe such contracts in a business fashion and in a way which would make good commercial sense. [2] The court may consider whether words have acquired a special meaning, for example by taking into consideration the industry relevant to the contract, but only where necessary to properly interpret the contract. Similarly, a court will not easily imply a term into a contract except where it is clear that the parties' intentions depart from the contract. [3] For contracts between two businesses (which are usually sophisticated entities, experienced in their industry and with specialist aviation lawyers), the court will not construe the contract against the lessor even if there is inequality of bargaining power. The contra proferentem rule, which states that where there is doubt about the meaning of the contract, the words will be construed against the person who put them forward, is usually excluded.

There is no general overriding implicit duty of “good faith” in English law [4] yet an express duty to act in good faith is sometimes seen in aviation leases in relation to specific circumstances such as in negotiating lease extensions or granting permission to sublease. In a recent case [5] an unfavourable term allowing Qatar Airways to terminate a contract without making payment for the costs of design of business class seats (as the payment milestone had not been reached) was upheld. The meaning of the term was clear and its right to terminate was not removed by any implied duty of good faith.

Leases generally contain an entire agreement clause which effectively prevents any external evidence outside the contract from being used to guide its interpretation. Only where the meaning of words is doubtful or uncertain would such evidence be admissible.

The result of all of this is that parties to an aircraft operating lease can expect to receive little assistance from an English court in the event that poorly drafted redelivery conditions do not match their understanding of the meaning of those conditions.

What are the risks for the lessee of unfavourable redelivery conditions?

The risks to the lessee of getting the drafting wrong may include the following:

1. the continuation of the leasing of the aircraft under the Lease until the aircraft is redelivered in the correct condition;
2. the step-up of lease rentals and accrual of other costs for the lessee such as parking, maintenance, and insurance;
3. the lessor taking the aircraft back and charging the lessee for the costs it incurs in putting the aircraft into the redelivery condition;
4. an event of default may also be triggered, with all the pitfalls that follow from that including security deposits being applied, letters of credit being called, and cross-defaults being triggered into other leases with the same lessor or third-party leases and financings;
5. lessors will usually have the right to claim damages from lessees for for losses such as finance costs or the loss of a follow-on lease or sale (the merits of these claims aside, it is still a costly litigation process).

All of these consequences can be avoided with care being taken with respect to the drafting of these obligations in the lease. The Aviation team at Clyde & Co has considerable experience in advising airlines on the drafting and interpretation of redelivery conditions, and in the resolution of disputes relating to such matters. For further information please contact Nick Harding or Kirstin MacDougall.

[1] Bank of Credit and Commerce International (BCCI) SA v Ali (No 1) 2001 held the primary source for understanding what the parties mean is their language interpreted in accordance with conventional usage.

[2] Arnold v Britton [2015]

[3] Re Walkers, Winser & Hamm and Shaw, Son & Co [1904]

[4] There is a well recognised duty of rationality in exercising contractual discretion, arising from the leading case of Braganza v BP Shipping [2015]

[5] Optimares SpAv Qatar Airways Group [2022]