This article deals with the offshore arrangements put in place in the typical aircraft financing transaction involving the establishment of a special purpose offshore company ("SPC") in the Cayman Islands, although the use of other vehicles, such as exempted limited partnerships will be touched upon. Cayman Island's SPC's have been used in almost all types of aircraft financing transactions, including export credit backed financings, tax leases (in particular German and Japanese leveraged leases), securitisations and enhanced equipment trust certificate transactions.
The continued popularity of the Cayman Islands as the jurisdiction of choice for offshore aircraft financing is highlighted not only by the volume of aircraft financed (over 600 through Maples and Calder in the last year) but the quality and innovation of the transactions as evidenced by the structuring through Cayman entities of transactions awarded the coveted Airfinance "Deal of the Year" and "Leasing Deal of the Year" for 2001 (the US$2.05 billion BAE Systems securitisation and Air Canada General leveraged leases, respectively). Other recent deals that have received awards include the Air 2 US US$1.1 billion securitisation in 1999 which was awarded "Deal of the Year" and the Iberbond Intol for Iberia in 1999 which won the "Most Innovative Deal of the Year".*
Why Cayman Islands SPC's?
The typical Cayman Islands offshore leasing structure vests ownership of the aircraft with an SPC which acquires the aircraft through funding by way of loan from the lender. The aircraft is then leased by way of operating lease to the airline. The SPC will typically be established as an "off-balance sheet vehicle" with its issued share capital held by an offshore trust company on charitable or purpose trusts. The lender will typically take security over the aircraft, over the SPC’s rights as lessor and usually security over the issued share capital of the SPC itself.
The attraction of this structure from a lender’s perspective is as follows:
- ownership of the aircraft does not vest with the airline but with an SPC owned and controlled by a trust company which holds title in an off balance sheet capacity. Ownership therefore vests in a vehicle which is unlikely to be hostile to the lender in a default scenario when the lender seeks to enforce its security. From the lender's perspective this "ownership" arrangement may provide the lender with advantages that are closer to those that would come with retaining title to the aircraft itself whilst avoiding the consolidation of the aircraft on its own balance sheet. The assignment by the SPC of its rights under the lease with the airline will also give the lender effective control of the enforcement of rights of the SPC as against the airline under the lease;
- in the event of default if the lender seeks deregistration in the airline’s jurisdiction, the lender should be able to count on the exercise of the deregistration rights rather than having to rely solely on a mortgagee’s rights. Certain jurisdictions do not recognize the mortgagee’s right to deregister and may otherwise limit the mortgagee’s remedies (for example to a local judicial sale), thus making exclusive reliance on a mortgagee’s rights potentially unsatisfactory for the lender;
- the principal loan and security documentation will be entered into by the SPC rather than the airline, thereby avoiding potential enforcement problems in the airline’s own jurisdiction where the legal system may be very different from the English or American system. The Cayman Islands, for example, is a common law jurisdiction (where English common law will be of persuasive authority) and the basic legal framework will be instantly recognisable to the English practitioner. The "unfamiliar legal system" consideration alone has, for example, led to the offshore structuring in the Cayman Islands of transactions for a large number of airlines in the People’s Republic of China where the relevant airlines have been permitted to establish the SPCs as on-balance sheet vehicles;
- in addition to legal certainty, ownership of the aircraft will be in a jurisdiction with political, economic and social stability which may give comfort to a lender in cases where the airline is based in a jurisdiction where there is perceived risk;
- ownership of the aircraft will vest in a bankruptcy-remote structure which should be unaffected by the bankruptcy of the airline, thus avoiding the significant difficulties that could arise if title to the aircraft vested with the airline or in a special purpose subsidiary or affiliate established by it; and
- taxation or, more properly, the absence of taxation and therefore the absence of withholding tax on account of any charge to tax is a principal reason for establishing the SPC in an offshore jurisdiction. The Cayman Islands currently have no legislation that provides direct forms of taxation. Accordingly, the adoption of an offshore leasing structure in the Cayman Islands is entirely tax neutral. In order to give comfort that the no-tax regime will continue the SPC may obtain from the Cayman Islands Government a guarantee against the imposition of taxation in the future, known as the "Undertaking as to Tax Concessions", which undertakes to exempt the recipient SPC and its shareholders, for a period of twenty years, from most forms of relevant taxation if introduced in the Cayman Islands during that period. Thus, the lender may be assured not only that the SPC structure will not involve adverse tax consequences based on current legislation but that that will remain the situation for the duration of the transaction.
Ownership of the SPC
The issued share capital of the SPC (usually US $1,000) will typically be registered in the name of a local trust company as trustee of a charitable or purpose trust established pursuant to a declaration of trust by the trustee. This ensures that the SPC is not consolidated on the balance sheet of the lender, the airline or the trustee. The trustee will usually be the same entity that serves as administrator (see below).
Typical powers or discretions included in the charitable or purpose trust would restrict any disposition of the shares in the SPC or its winding up. These tend to be drafted as provisions prohibiting the trustee from taking such actions without the consent of the lender. This is usually not thought to be a degree of control that would give a lender control or consolidation issues in its home jurisdiction.
Following the termination of the transaction the trust will terminate and the trust property (namely, the net asset value of the SPC, which will be the issued share capital and any transaction fees earned by the SPC net of its expenses) will be distributed by the trustees to such one or more charities as the trust document provides.
The SPC will enter into an administration or management agreement usually with the trustee as administrator. This agreement will set out the services to be provided by the administrator to the SPC. The principal service will be to provide directors and officers to the SPC. It may be convenient to include the lender as an additional party to this agreement to take covenants from the administrator in respect of the business and management of the SPC which the lender may then enforce directly.
As a commercial matter the lender should not be so aggressive in its demands to control the SPC that it risks the SPC being regarded as a nominee or agent of the lender and disregarded as a separate legal entity, or that it falls within controlled foreign company legislation in the UK or within equivalent legislation in other jurisdictions. It is typically considered sufficient for the lender to take covenants from the administrator to procure that the directors it supplies do not cause the SPC to engage in other transactions and to procure that the SPC performs its transaction obligations (although, of course, falling short of an obligation on the part of the trustee/ administrator to expend own funds).
If there is no other provision in the transaction documentation to meet the SPC’s ongoing fees and expenses (for example, through the payment of additional rent under the lease) the airline (which will typically be directly responsible for meeting the offshore costs) may be included as an additional party to the administration agreement to undertake to meet these costs.
The Cayman Islands are the domicile of a significant number of subsidiaries of first class financial institutions providing local administrative services to SPCs.
A first class offshore administrator, coupled with the typical "security package", should afford the lender a high degree of confidence in adopting the offshore structure.
The SPC will usually grant security over the aircraft in the form of a mortgage and will always grant security over its rights under the lease with the airline, which will allow the lender to enforce directly the rights of the SPC as against the airline on a default. The SPC will typically also grant a deregistration power of attorney permitting the lender, acting in the name of the SPC, to deregister the aircraft on a default. Under Cayman Islands law such a power of attorney when granted to secure an obligation owed to the lender will be irrevocable until that obligation is discharged.
Frequently, the lender will also take security over the issued share capital of the SPC which will give the lender the ability to take control of the SPC on a default.
The trust arrangements in respect of the issued share capital of the SPC will need to accommodate the security either by express permissive provisions or by the "flawed asset" approach providing that the shares are settled on the trust subject to the security.
As an alternative to a security, the lender may consider a call option arrangement requiring the trustee to transfer the shares to the lender on request and usually on payment of par value.
Limited Recourse and Commercial Benefit
The SPC is a corporate entity and its directors will be subject to the typical common law duties of care and skill and to the fiduciary duties (the Cayman Islands have applied the English common law principles.). Of primary relevance here is the duty of a director to act in that which he believes to be his company’s commercial interests.
Exempted Limited Partnerships
ELP's are an increasingly popular vehicle and a significant number of operating lease transactions have recently been undertaken in the Cayman Islands through the limited partnership structure. Based on the Delaware model, the limited partnership is managed by a general partner and the investors or limited partners benefit from limited liability. The ELP may offer a more attractive regulatory regime and/or tax treatment in certain jurisdictions. As with SPC's, an ELP may also obtain a tax exemption undertaking.
The Cayman Islands continues to be the leading offshore jurisdiction for aircraft financing transactions and has fully complied with OECD and FATF initiatives on tax transparency and anti-money laundering legalisation.
Further information including Firm Memoranda can be obtained from the Firm's website at www.maplesandcalder.com.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.