Mexico: Discharge Of Mortgages And Its Incidence In Respect To Engine SWAP

Last Updated: 26 June 2015
Article by Viridiana Barquín

When analyzing the right that a Lessee may have to conduct an engine swap under an aircraft lease agreement and the mechanisms to protect the rights and interests of each party that holds title in respect to the corresponding assets that involves the aircraft after such engine swap, we need to consider what happens with an engine installed in an aircraft subject to a mortgage, pledge or a lien. A common concern is that the engine could be considered as part of the mortgaged property and furthermore, a major concern is that the owner of the engine could lose the property rights thereon and that the engine could be considered owned by the owner of the aircraft.

Pursuant to Article 2, of the Civil Aviation Law1, "aircraft is any vehicle capable to flight autonomously in the aerospace to transport passengers, cargo or mail". Pursuant to the Civil Aviation Organization, "an aircraft is any machine that can derive support in the atmosphere from the reactions of the air other than the reactions of the air against the earth's surface".2

Therefore, we note that the Civil Aviation Law by definition, does not include specifically the engines as part of the aircraft, so it is an insufficient definition since no reference is made to the property rights of the parties concerning to each of the assets comprising the unit; however, if evidence of ownership rights by the owner of the engine is provided, it would not be considered as part of the mortgaged property nor as owned by the owner of the aircraft, but it is important to take into account certain elements and practical problems when dealing with the discharge of a mortgage over an aircraft where an engine different from the one originally installed has been discharged and released. A discharge will normally occur when (i) the aircraft has been sold, or (ii) the mortgage has been paid out and the mortgage is legally terminated.

In either case, there are different parties with property rights to be recognized: the new owner of the aircraft in case (i) above, the party being released from the obligations under the mortgage in case (ii), and in both cases, the owner of the engine(s) that had been swapped.

The Civil Aviation Law, has no specific regulation related to mortgages, pledges or liens over an aircraft or its parts, and unfortunately when the Civil Aviation Law entered into effect it repealed and omitted many provisions that the Law of General Communications ("Ley de Vías Generales de Comunicación", "LVGC" by its acronym in Spanish)3 actually contained in respect to mortgage of aircraft and the pledge of engines and spare parts4. However, the Civil Aviation Law provides that any and all documents by which the ownership possession are acquired, prevented, extinguished, modified, encumbered, or any other rights in-rem over Mexican civil aircraft, must be registered5 at the Mexican Aviation Registry ("RAM"). Although, it has been explained above that Mexican law does not consider that if an engine is swapped and installed in an aircraft, such engine would be part of the same as if it were a sole and single asset, it is important to note that, the physical repossession of the engine installed due to an engine swap would only be possible if it is redelivered by the counterparty willingly or through a prior judicial order.

In that sense, and analysing the event that a judicial order would be required, it is understood that the lessee was the party with the obligation to reinstall both of the engines originally received with the aircraft, and therefore is the first liable before the owner of the engine swapped, and secondly the counterparty that would not accept to redeliver the engine willingly (for instance, the new owner that it is acquiring the aircraft without knowledge that one of the engines was swapped and is owned by another company). The procedure to obtain this judicial order involves then the filing of suit against the lessee by the owner of the engine swapped, claiming the rescission of the relevant engine lease agreement, and demonstrating the default incurred by the lessee thereunder and to provide evidence of the property rights of the owner of such engine to be recognized and enforced6.

The above, without prejudice of the rights of enforcement of (a) the new owner of the aircraft that it is acquiring the same without knowledge of the property rights of the owner of the engine swapped; and/or (b) the party being released of the obligations under the mortgage being cancelled and released due to the payment of the obligations that were secured by such mortgage. Considering that, the Civil Aviation Law does not include specific provisions (such as those that were included in the LVGC, but that were thereafter lapsed with the entry into force of the Civil Aviation Law), to differentiate the security interests applicable to the aircraft to those applicable to the engines and the relevant requirements for easy identification of each asset; we should go to the applicable law which in this case corresponds to Federal Civil Code7 which in accordance with Article 2893, the Mortgage is defined as a right 'in rem' conformed over an asset that it is not delivered to the Creditor, and conferring the right to such Creditor, to be paid with the value of the mortgaged property, in the event that the secured obligation, is in default, in the priority order established by law; and, in accordance with Article 2856, the Pledge is defined as a right 'in rem' conformed upon a transferable asset in order to guarantee the compliance of an obligation and its payment priority. In spite of this, the perfect identification of the assets subject to an aircraft mortgage, has some difficulties; situation that does not occur if the security interest to be created corresponds exclusively to an engine, in which case, would not be a mortgage but a pledge the lien that would have to be constituted.

And what happens for example, if contrario sensu, there is an engine that was originally installed in an aircraft over which a mortgage has been already released but it is now installed on a different aircraft with a mortgage in full force and effect and that has not been canceled?

Whereas, there will be clear to the competent authority that the aircraft is not a indivisible unit, and that the lessee will be obliged to restore the original engine if it was replaced from the aircraft on which originally installed, to another (with costs involved in respect thereto); it is also evident that in practice, all such determinations would not be that simple nor so expeditious in the event that a confusion exist due to an engine swap, as to the rights of any counterparty acquiring in good faith.

Under all these approaches, it is valid to bring the question of whether we should re-evaluate our practice and make a new assessment in respect to the most suitable kind of security interest that should be constituted in respect to an aircraft as a whole; or, in respect to an aircraft and the engines, respectively. Maybe it is time to consider that the enforcement of a pledge could be less complicated than the mortgage, or maybe, it is time to consider the option to separate the assets having two different contracts: a mortgage in respect to the aircraft (without the engines), and a pledge, in respect to the engines individually and separately from the aircraft.

Originally published June 15, 2015

Footnotes

1.- Published on May 12, 1995 in the Official Journal of the Federation ("Diario Oficial de la Federación", "DOF" by its acronym in Spanish), last modification published on January 26, 2015.

2.- ICAO Annex 1, Annex 6 Part I, Definitions and General Regulations relating to Licensing, 1.1 Definition (July 2006, tenth edition).

3.- Published on February 19, 1940 in the DOF, last modification published on July 14, 2014.

4.- This LVGC (repealed by the Civil Aviation Law in effect), clearly and specifically distinguished under Article 362, that the aircraft would be subject to mortgage and, on the other hand, the engines and parts would be subject to pledge. In addition, Article 364 specified the requirements that must be contained in the mortgage and/or pledge agreements in order to identify the mortgaged and/or pledged property, therefore, in addition to the requirements under the applicable law, a description of the mortgaged aircraft and/or pledged equipment, registration marks, specification of model and manufacture, the manufacturer serial number and all the information necessary to undoubtedly identify the aircraft or the engine.

5.- Article 47, I.

6.- An aircraft or engine lease agreement is a commercial contract in nature and by such; it must be resolved in Mexico under the rules established by the Commercial Code "(Codigo de Comercio)", Articles 1377 through 1390, which regulate the ordinary process ("Ordinary Commercial Procedure") and its stages. On the other hand, there is a summary procedure ("Executive Commercial Procedure") regulated under Articles 1391 through 1414, that is almost identical to the Ordinary Commercial Procedure and involves the same stages and requirements, although such are resolved within shorter statutory periods making it in fact a more expeditious process. The principal difference between these two proceedings is however that in the Executive Commercial Procedure the plaintiff is able to obtain the order for the securement of enough assets of the Lessee that would serve as guarantee of the amount of its claim from moment when the process initiates. This allows plaintiff to be certain that in the event it shall prevail in its claim against Lessee after all instances have been exhausted, there will be enough assets to guaranty that the indemnity obligations of Lessee as ordered by the resultant judgment will be able to be met in full, eliminating the risk that Lessee shall be found not to have enough assets to honor the payment obligations to which it shall be condemned after a long and tedious Ordinary Commercial Procedure.

7.- Published on August 31, 1928 in the DOF, last modification published on December 24, 2013.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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