The fully computerized International Registry for security interests in aircraft and the Aircraft Protocol will become effective towards the beginning of 2005

B. Patrick Honnebier*

Of Counsel

Gomez & Bikker

Amsterdam

1. Introduction

In June 2004 a decision was taken by the Preparatory Commission[1] to establish the International Registry for the recording of international interests in aircraft objects in Shannon, Ireland[2]. The creation of this international registration system finds its origin in the Convention on International Interests in Mobile Equipment (Convention or CIME) and the Aircraft Equipment Protocol (Protocol or AEP)[3]. The main objective of these instruments is to facilitate the asset-based financing and leasing of aircraft objects. Under the Convention and Protocol the term aircraft objects means aircraft frames, aircraft engines and helicopters (Chapter IV Convention and Chapter III Protocol). The international interests that have been vested in these objects may be registered in the forthcoming international system. The latest developments concerning the Convention and Protocol are discussed in more detail below.

The International Registry will be operated by the ‘Registrar’ under the watchful eye of the ‘Supervisory Authority’. The Irish company Aviareto will operate and the International Civil Aviation Organization (ICAO) will supervise the International Registry[4]. The international creditors will be provided with a secure registry to record their interests in aircraft objects and to establish the priority of their interests vis-à-vis competing creditors within and outside the insolvency of the debtor. The principal functions of the Supervisory Authority are to appoint, supervise and, if needed, dismiss the Registrar. It is envisaged that the International Registry will be operational towards the beginning of 2005. The realization of the much needed electronic International Registry is a major achievement. For the first time in the history of international property law a registration system will be established in which international security interests can be recorded. Additionally, until now it has been unthinkable that the holder of a registered security interest could be afforded adequate protection against third parties and insolvency administrators at the global level.

The tasks of the Registrar and Supervising Authority are laid down in the Convention (Article 17). Moreover, the CIME regulates the privileges, immunities and liability of these institutions. The Registrar will be strictly liable for compensatory damages for any loss suffered due to errors, omissions or system malfunctions. This body is granted a limited amount of defenses. The Supervisory Authority is a body having international legal personality. To a large extent, the Convention provides for its immunity from process. The registration system is an electronic, internet-based service. It will be available on-line twenty-four hours a day, seven days a week. Access to the International Registry is open to all parties that comply with the registration requirements, regardless of whether they are situated in Contracting States or non-Contracting States (Article 26 CIME). The system is designed, however, to prevent the recording of interests without the required prior electronic consent. The checking of the registration applications, the registrations themselves and the responses to searches will be processed automatically by the computer. This process will not require human involvement. The international interests and other registrable rights may be entered in the International Registry. The registration of an interest has effect from the moment that the registration is searchable.

The International Registry is based on the property law principle of ‘notice filing’. This means that the recorded data give notice to third parties that an international interest has been vested in a specific aircraft object. If a party needs further information it must make enquiries with the registrant. Therefore, the international registration system is not based on the property law principle of ‘deed registration’. It does not require the filing of specific deeds or other documents[5]. Accordingly, the International Registry will provide public notice to prospective creditors who need to investigate if any secured interests have already been vested in aircraft objects. Currently, most aircraft and engines are either leased to airline companies or these objects are owned by a combination of financiers and the airlines themselves. Frequently, an aircraft is partly-owned and its acquisition is financed by several lenders. Furthermore, the International Registry is based upon a strict ‘first-in-time’ registration. Accordingly, the international registration system will enable the holders of registered international interests to preserve their priority with regard to subsequently registered interests, unregistered interests and the administrator in the insolvency proceedings of the debtor. It is expected that the International Registry will be able to function at low cost, given the fact that it will be operated electronically. Finally, it is envisaged that the international registration system will reduce, at the global level, the costs of financing aircraft objects by 2 %. In turn, this will result in savings for the aviation sector of about $ 5 billion each year[6]. These substantial financial benefits may encourage interested parties to create a regional or even global registration system for mortgages in immovable property[7].

2. The Convention on International Interests in Mobile Equipment as applied to Aircraft Objects will enter into force shortly

As mentioned above, the establishment of the International Registry has its roots in the Convention and Protocol[8]. These instruments were realized in Cape Town, South Africa, on November 16, 2001 at the conclusion of a Diplomatic Conference[9]. Without any doubt, the CIME and AEP represent the most innovative set of regulations in the history of international aviation finance law. The Diplomatic Conference was held under the joint auspices of the International Institute for the Unification of Private Law (UNIDROIT) and the International Civil Aviation Organization. Representatives of 68 States and 14 international organizations attended. Upon the conclusion of the Conference 20 States signed the Convention and Protocol. It is important to note that since that time 7 additional States have signed both instruments. These 27 Signatory States are equally representative of both the economically developed and the developing regions. At this moment in time Ethiopia, Nigeria, Panama, Pakistan and the United States have already ratified the CIME and AEP or have acceded to these instruments. Many other States are currently involved in ratification procedures with regard to adopting these instruments. Furthermore, the European Bank for Reconstruction and Development is willing to provide the Russian Federation with technical assistance in relation to the acceptance and implementation of the Convention[10]. In addition, the new regime explicitly provides that a Regional Economic Integration Organization (REIO) may ratify these documents. Therefore, the European Commission[11] has put the acceptance of the CIME and AEP on its agenda[12]. Currently, it is co-ordinating with the twenty five Member States of the European Union with a view to the signing and conclusion of specific Articles of the Convention and Protocol. These provisions concern jurisdiction, recognition, enforcement of judgements and insolvency matters[13]. The great importance of this project lies in the fact that the European Commission has come to the conclusion that the Convention and Aircraft Equipment Protocol will be advantageous to the financiers, airline companies and consumers of the member states[14]. It endorses the view that the CIME/AEP will provide for the needed solid uniform European property regime which will make the financing of aircraft objects more available and less costly[15]. This point of view has persuaded the European Commission to instigate the necessary procedure. When a REIO accepts the CIME/AEP it has the rights and obligations of a Contracting State, to the extent that the REIO has competence over the matters governed by the Convention. Some of the Member States, however, questioned the European Union’s competence to conclude international agreements, particularly in relation to the substantive insolvency provisions of the CIME/AEP. Nevertheless, the European Commission and these states recently ended this dispute concerning competence as regards the texts. Therefore, the Commission could push forward its proposal to accept the Convention and Protocol to the Council of the European Union in order to obtain its required approval. Consequently, the European Union’s acceptance[16] of specific Articles of these instruments will most likely take place in the near future. Additionally, the obstacles on the path toward the ratification of the other Articles of the Convention and Protocol by the individual European Member States have been removed.

The Convention entered into force on April 1, 2004, which is three months following the deposit of the third instrument of ratification[17]. It is only valid, however, as regards a category of objects to which a Protocol applies (Article 49(1) CIME). This means that the Convention cannot operate independently from the relevant Protocol. The AEP will be the first Protocol to enter into force. For that purpose it requires ratification by eight States (Article XXVI(5) AEP). As has been mentioned above, five States have already accepted it. Singapore is very close to accession. Canada, Kenya and Vietnam are also well advanced on the road toward ratification or accession. It is accordingly expected that the Protocol, and therefore the ‘Convention on International Interests in Mobile Equipment as applied to Aircraft Objects’, will have entered into force towards the beginning of 2005.

3. The objective and structure of the Convention and Protocol

Personal property security law governing aircraft equipment financing has been, since the beginning of the aviation industry, an unstable body of law. This particular kind of law reached the state of intolerable complexity and insecurity toward the last quarter of the twentieth century. It was thus that in 1988 the Governing Council of UNIDROIT took the initiative to solve the problems that existed in relation to security and leasing interests in cross-border transactions. In particular, the study[18] on the International Regulation of Security Interests in Mobile Equipment provoked UNIDROIT to develop a modern and comprehensive international security statute that would provide for the needed legal stability. This ambitious project required close collaboration between UNIDROIT, ICAO, IATA[19], other institutions and interest groups, which in turn resulted in the conclusion of the Convention and Protocol in Cape Town. The main reasons for the introduction of the CIME are the following. Traditionally, many States would apply the lex rei sitae (also known as the lex situs) conflict of laws rule to establish the law governing the security interests in movables. In a practical sense, however, mobile equipment does not have a specific situs. Therefore, the lex situs rule is considered to be completely inadequate in relation to objects that are continuously moving from State to State in the ordinary course of business. In the case of space assets, these objects are not connected to a State at all. Consequently, an international regime that provides for the recognition, enforcement and priority of proprietary rights in mobile equipment was needed.

The principal objective of the Convention is the efficient financing of mobile equipment. In general, the term mobile equipment encompasses objects which by their very nature are used internationally. Examples of such objects are aircraft, satellites, trains, ships, movable oil-rigs and containers. The Convention itself, however, is not equipment-specific. The Diplomatic Conference decided on a two-instruments approach. The CIME is a framework Convention incorporating general provisions. The regime relates only to certain categories of mobile equipment, which are defined in separate Protocols. It applies through separate Protocols to three different categories of mobile equipment: a) airframes, aircraft engines and helicopters; b) railway rolling stock; and c) space assets (Article 2(3)(a-c)). The AEP is the first Protocol that has been completed. The Railway Rolling Stock Protocol and Space Assets Protocol will be adopted in due course. Different international registration systems will be created for these different types of mobile equipment. Therefore, different Registrars to operate these systems and Supervisory Authorities to oversee them will be established. For example, it is expected that the International Organization for International Carriage by Rail (OTIF) will be the supervisor of the International Registry for the recordation of international interests in railway rolling stock. Furthermore, Protocols and their own international registration systems for mobile oil rigs, ships, trucks and containers may follow at a later stage[20].

The Aircraft Equipment Protocol has been created to provide a practical approach to the most important issues in civil aviation financing. As stated above, the provisions of the CIME are not equipment-specific and they are controlled by special Protocols. The AEP demonstrates the essence of the Convention/Protocol structure. On the one hand, it attunes the Convention to meet the demands of the aviation industry, while, on the other, it does not interfere with its fundamental principles. For example, it contains two alternative sets of insolvency provisions designed to adjust the general insolvency provisions of the Convention if a Contracting State has made a specific declaration to this effect. The AEP provides the Contracting States with a choice between a ‘hard’ insolvency regime and a ‘soft’ regime (Articles 30(3) Convention, XI and XXX(3) AEP). According to the Preamble of the Protocol it only relates to aircraft equipment. In turn, under the AEP this term means aircraft objects: airframes, aircraft engines and helicopters (Articles I(2)(c) and II(1) AEP).

4. The Convention and Protocol resolve the problems that currently exist

The Convention and Protocol have been designed to solve the problems that presently obstruct the financing of aircraft equipment. They particularly address the secured transaction issues that currently exist in relation to international asset-based financing and leasing of aircraft objects. To date, the national property law regimes have dominated the financing of such objects. At present the main problem is, however, that there exists a great diversity of property law regimes at the international level. More specifically, there is no uniform international law dealing with security interests in aircraft objects. Moreover, previous international attempts to codify secured interests in these objects have been unsuccessful.[21] Particularly the complexity and diversity of the national property rights have accounted for this fact. The past has proved how difficult it is to transcend the dogmatic issues that exist in the legal proprietary regimes of many States. As a result, the financiers’ security interests differ from state to state. Accordingly, it is uncertain as to whether their rights can be upheld against third parties in other countries. Moreover, the absence of uniformity in relation to security interests creates barriers to the financing of aircraft objects. Besides, the existing ‘Convention on the International Recognition of Rights in Aircraft (Geneva Convention, 1948)’ is inadequate. The biggest problem is that being merely a conflict of laws treaty[22], it does not provide for uniform substantive property law. Consequently, no proprietary rights can be derived from it[23]. For that reason the Geneva Convention has, from the outset, been regarded as a provisional body of rules[24]. Furthermore, it has not been ratified at a global level. In addition, many important aviation finance jurisdictions have not accepted it. Finally, the Convention takes no account of new developments in international financing practice, such as the fact that presently many aircraft engines are financed separately.

To solve all the problems at hand, the regime of the CIME/AEP establishes a uniform system for the creation, enforcement, registration and priority of autonomous international interests in aircraft objects. To have effect against third parties, the international interests must have been registered in the International Registry for aircraft objects[25]. Therefore, the establishment of the Registry is an absolute requirement for the success of the regime of the Convention and Protocol. As mentioned above, this international registration system will be operated by the Irish company Aviareto. The holders of registered international interests are chargees, conditional sellers and lessors. They can uphold their interests both within and outside the bankruptcy of the debtor, provided that their interests were registered prior to the commencement of the insolvency proceedings.

5. The remedies of the holders of registered international interests under the Convention and Protocol

 The CIME/AEP provides the holders of international interests with a range of default and insolvency-related remedies. These remedies only relate to the parties inter se (articles IX(3) AEP and 7(2) CIME). However, the CIME/AEP regime draws an important distinction[26] between the remedies which may be granted by the parties to the chargee, the person entitled under a security agreement, on the one hand, and the remedies which are available to a conditional seller or lessor, on the other (articles IX AEP and 10 CIME). The CIME/AEP incorporates this distinction since extensive remedies can be made available to the holder of an international interest. In many common law and civil law countries these remedies are available to a conditional seller or lessor by law, or may be granted to them, as they are the owners of the aircraft. However, in the majority of civil law countries the same remedies are not available to a chargee and cannot be granted to it by the parties. For these reasons, under the CIME/AEP the above-mentioned special rights are available to the chargee only where the chargor has agreed to such remedies (articles IX AEP and 8 CIME). In this respect, too, the CIME/AEP regime proceeds from the freedom of the parties to contract. The parties may agree between themselves[27] on the remedies set out in the CIME/AEP which they regard as desirable in respect of their specific legal relationship[28]. The new regime reflects the fact that the market in aircraft is characterised by the extremely high standard of the sophistication of the market participants. For example, many airlines are owned (to a large extent) by the state or have other affiliations with it. Furthermore, the parties to aircraft transactions are experienced in negotiating and concluding such transactions. Besides, the parties concerned traditionally commission highly qualified financial and legal experts to represent them when concluding these complicated transactions. For that reason, some kind of “mandatory consumer-related law” to protect (national) airline companies is non-existent in current international air law[29], and the same is true for the CIME/AEP. The creation of inequality is disadvantageous for a market in which only equal parties come together. This holds true both for the law and the economy. Consequently, it is legitimate for the CIME/AEP to expect that the parties will lay down their mutual rights and obligations in agreements which are tailor-made to suit them. Obviously, which remedies the holders of an international interest will in fact be able to stipulate depends entirely on the economic and financial leverage of the parties in a specific situation. For instance, currently it is definitely a buyers’ market as far as the acquisition and leasing of aircraft objects is concerned.

6. The forthcoming beneficial impact of the Convention and Protocol

As was pointed out earlier, the principle objective of the Convention and Protocol is to facilitate the financing of aircraft objects and to reduce their costs. For that purpose it establishes the above-mentioned comprehensive legal framework to protect security and leasing interests in such objects. As a decrease in legal risk will lead to a decrease in overall expense, in the future the financing of mobile equipment will become less costly. A globally performed economic study on the matter at hand shows that the CIME/AEP will generate, on a conservative basis, billions of dollars in savings on a yearly basis. The new regime will attract significant, long-lasting micro-economic and macro-economic benefits. The beneficial impact of the CIME/AEP on the cost of obtaining aircraft financing will be shared not only among the financiers and manufacturers, but also among airline companies[30], their shareholders, employees and passengers[31]. The first practical effect of the CIME/AEP is the recent announcement by the Export-Import Bank (Ex-Im Bank) that it will reduce its ‘exposure fee’ on export financing for U.S. large commercial aircraft. Buyers of such aircraft in any state that has adopted and implemented the CIME/AEP will receive a one-third reduction in the bank’s fee[32]. With this substantial reduction in costs the Ex-Im Bank is encouraging countries to adopt the kind of legal framework that will enable their airlines to upgrade and expand their fleets by reducing the risk in cross-border asset-based financing and leasing of aircraft.

7. The current legal impact of the Convention and Protocol

Some Courts already apply the new regime of the CIME/AEP. For example, in 2002 a Court of Appeal in the Netherlands decided that the general Dutch property law doctrine of ‘Accession’ (Natrekking) does not apply to aircraft engines that are attached to large aircraft frames which are registered in the national registry[33]. Engines are not considered parts of the airframe to which they are attached and they can be the objects of separate security interests[34]. Last year the Court of First Instance of Aruba, which is an autonomous part of the Kingdom of the Netherlands[35] and has its own air law, ruled in the same direction as the Dutch Court of Appeal[36]. This case, however, concerned the financing of aircraft engines that are attached to small aircraft that are not registered in Aruba’s national registry. These important rulings have been influenced by, and they are entirely in line with, the Convention of Cape Town and the Aircraft Equipment Protocol. Under the new regime engines are regarded as distinct aircraft objects which can be financed and registered separately (article I(2)(c) AEP). However, both decisions are completely in conflict with the controversial Dutch view that in all circumstances the ownership of an engine passes to the owner of an airframe as soon as it is attached to it. It has been suggested that: “From the moment of installation, an engine loses its separate existence and becomes a component part of the aircraft, after which it is not possible to create a security right on the engine”. For that reason, this view contends that the regime of the CIME/AEP infringes Dutch property law[37]. The following statement concerning the proprietary status of engines in civil law jurisdictions in general stresses a similar point of view. “The application (of the regime of CIME/AEP) to aircraft engines is not compatible with the civil law concept that component parts of an aircraft cannot be made subject to a security right if such a component part is considered an integral and indispensable part of that other object”[38]. All the above-mentioned assumptions are incorrect, however. In the Netherlands the substantive property law governing aircraft and engines is regarded as a lex specialis. Most other European civil law states concur in that respect. These objects occupy an exceptional position in the property law systems of these states, both in dogmatic and conceptual terms. The general rules of property law are not fully applicable. Under the present special rules of air law, engines are generally not considered as integral and indispensable parts of the airframe. The reason for this is that most engines are not intended for permanent use on a specific airframe[39]. On the contrary, most frequently engines are temporarily or coincidentally used, leased or exchanged based on engine-pooling arrangements and engine interchange agreements. In these cases the owner of the airframe and the owner of the engines is not the same person. Consequently, these engines are not intended for permanent use on a specific airframe. Besides, currently engines can easily be attached to or detached from an airframe, without damaging the airframe or the engines. For these reasons, in Belgium, France, Germany, Italy, the Netherlands, Switzerland and many other continental European civil law states most engines are not considered to be integral or indispensable parts of the aircraft[40].

8. The Consolidated Text of the Convention and Protocol

The Diplomatic Conference adopted a resolution[41] to entrust the Joint Secretariat[42] of the Conference with the drawing up of a Consolidated Text of the Convention and Protocol. Its purpose is to facilitate the application and implementation of the rules contained in the CIME and AEP in a user-friendly manner. The reason for this is that the Convention and Protocol must be read and interpreted together as a single instrument (Article 6(1) CIME)). Therefore, this document reproduces the combined effect of the regime of the CIME/AEP with regard to aircraft objects. The Consolidated Text is designed as a useful working tool for those involved in aviation finance. It has been drafted by the Joint Secretariat of UNIDROIT and ICAO with great care to ensure full conformity with the objective and text of the CIME/AEP. The Consolidated Text may be cited in the contracts relating to the financing of aircraft objects. However, it is not a Convention in itself and it is not subject to acceptance procedures by States. The only legally binding instruments are the CIME and AEP. If any discrepancies exist between the Convention and Aircraft Equipment Protocol on the one hand, and the Consolidated Text on the other, the former two documents have priority[43].

9. Concluding remarks

The Convention on International Interests in Mobile Equipment as applied to aircraft objects will enter into force towards the end of 2004. It provides for the necessary legal certainty with regard to the financing of aircraft equipment. The instrument brings about uniformity, at the global level, with regard to specific aspects of the property laws of the Contracting States. The CIME provides, inter alia, for an autonomous international interest which may be constituted in certain categories of mobile equipment. Under the regime of the CIME/AEP the holder of an international interest is or may be granted extensive remedies that the parties may in large part supplement or restrict. Where such an interest is registered in the International Registry, it can be upheld against any person in any Contracting State. The Registry will be established in Shannon, Ireland towards the end of 2004. The international registration system will be operated by the Irish company Aviareto and the organization ICAO will supervise the operation. The creation of the International Registry for the recordation of international interests in aircraft equipment is a major achievement. It is expected that the establishment of the International Registry will substantially reduce the costs of financing aircraft objects at the global level, which, in turn, will result in savings of billions of dollars for the aviation sector on a yearly basis. Furthermore, the beneficial impact of the Convention and Protocol will be shared not only among the financiers and manufacturers, but also among airline companies, their shareholders, employees and passengers. Without any doubt, the CIME and AEP represent the most innovative set of regulations in the history of international aviation finance law.