THE MOST INNOVATIVE SET OF REGULATIONS IN THE HISTORY OF PROPERTY LAW IN THE EUROPEAN UNION:

THE CONVENTION ON INTERNATIONAL INTERESTS IN MOBILE EQUIPMENT AND PROTOCOL THERETO ON MATTERS SPECIFIC TO AIRCRAFT EQUIPMENT

B. Patrick Honnebier

Of Counsel

Gomez & Bikker

Amsterdam

1.      Introduction

This contribution to the Edinburgh Law Review concerns the Convention on International Interests in Mobile Equipment (CIME) and the Aircraft Equipment Protocol (AEP). More specifically, it focuses on the beneficial effects of these instruments on the Member States of the European Union[1]. Furthermore, this article concludes that the new regime is a prospective stepping-stone towards the unification of European security interests in aircraft and of any other interests. The CIME/AEP were concluded at a Diplomatic Conference in Cape Town, South Africa in November 2001[2]. Representatives of 68 states and 14 international organisations attended. Upon the conclusion of the Conference 20 states signed the CIME and AEP. It is important to note that since that time 6 additional states have signed both instruments. These 26 signatory states are equally representative of both the economically developed and the developing regions. At this moment in time, many African, Asian, and American countries are in the midst of ratification procedures in relation to the adoption of these instruments. Moreover, the Commission of the European Union is currently co-ordinating with the fifteen Member States with a view to ratification. The Commission’s action plan is discussed below. The Convention will enter into force following the deposit of the third instrument of ratification or accession and the Protocol following the deposit of the eighth such instrument. It is expected that the CIME/AEP will enter into force in the first half of 2004. The provisions of the CIME are not equipment-specific. 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[3]. In general, the term mobile equipment encompasses objects which by their very nature are used internationally. For example, aircraft, satellites, trains, containers and ships. For the purpose of the AEP, however, it includes only airframes, aircraft engines and helicopters. The AEP is the first Protocol that has been completed. The Railway Rolling Stock Protocol and the Space Assets Protocol are already at an advanced stage of preparation with a view to adoption in due course. Moreover, Protocols for registered ships, mobile oilrigs, containers and trucks may follow.

This article is structured as follows. It discusses: 1) the conflict of laws problems in Europe concerning aircraft financing, 2) the property law problems in Europe concerning aircraft financing, 3) the inadequacy of the Geneva Convention, 4) the regime of the CIME/AEP that solves the problems at hand, 5) the CIME/AEP as a potential stepping-stone towards uniform security interests in Europe, and 6) the ‘Official Commentary’on the CIME/AEP.

2.  The conflict of laws problems in Europe concerning aircraft financing

In international practice the following three legal devices are used most frequently in relation to the financing of aircraft objects[4]: a charge under a security agreement, a conditional sale under a title reservation agreement and a lease agreement. If these methods of finance are to work effectively, to reduce economic risk and to promote the availability of money from the banks and other private financial institutions they require a secure legal regime. Considering the substantial funds needed for the financing of the acquisition or use of aircraft objects, it is imperative that this regime protects the financier’s rights when the debtor defaults. The problem is, however, that presently there exists a great variety of municipal conflict of laws rules regarding the recognition, enforcement and priority status of foreign proprietary interests in such objects. As a result of the absence of a uniform conflict of laws rule there is a large degree of legal uncertainty at the international level and in particular at the European level. The reason for this is that, traditionally, most Member States of the European Union apply the lex situs, also known as the lex rei sitae, the conflict of laws rule in relation to the recognition of property rights in movables. In general it is the law of the situs where the equipment is situated at the time that the property right is created which is applicable[5]. These European jurisdictions require, however, that the characterisation of the kinds of foreign interests that may be protected in the forum state is addressed by means of a subsequent transposition. Therefore, the prospective recognition, enforcement and priority status of a foreign security interest depends on its similarity to an existing national proprietary right of the new situs. In a practical sense, however, aircraft objects do not have a specific situs. As these objects are continuously moving from state to state in the course of business, they are only temporarily or coincidentally connected to a state. Consequently, there is a danger that each time an aircraft object crosses a border the interest constituted therein will not be recognised or enforced. For that reason, the lex situs rule is considered to be manifestly inadequate in relation to mobile equipment. The possibility that the rights of the financier may not be upheld abroad is regarded as a considerable economic risk. It will negatively influence the financier’s confidence in the financial transaction. As great economic risk leads to substantial costs, the lex situs rule hinders the financing of aircraft objects.

3.      The property law problems in Europe concerning aircraft financing

Even if a ‘satisfactory’ uniform conflict of laws rule could be created, it could not solve the problem that presently national property laws dominate the financing of aircraft objects. In general there is a great diversity of property law regimes at the international level and in particular at the European level. More specifically, in the European Union there is no uniform law dealing with security interests in mobile equipment. Moreover, previous international attempts at codifying secured interests in aircraft have been unsuccessful.[6] In particular, the complexity and diversity of the national European 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 the European states. The reason for this is that Scotland and many European civil law jurisdictions are very restrictive with regard to the creation and effects of security interests, as they have closed proprietary regimes. Furthermore, currently Scotland and some continental European states are still more or less hostile to non-possessory security interests. As a result, the financier’s proprietary interests differ from state to state and accordingly it is uncertain as to whether its rights can be upheld against third parties in other European countries. Consequently, the absence of uniformity in the European Union (EU) in relation to the security interests of the financiers and airline companies creates barriers to the financing of aircraft objects. Therefore, the EU needs a secure international system of law to facilitate the use of the above-mentioned three legal devices which in turn will make the financing of aircraft objects more easily available and at lower costs.

4.      The inadequacy of the Geneva Convention

Furthermore, the existing ‘Convention on the International Recognition of Rights in Aircraft (Geneva Convention, 1948)’ is inadequate. Although the reaching of an international agreement on one jurisdiction recognising specific proprietary interests duly created under the laws of and recorded in another state was an achievement in 1948, it has been regarded from the outset as no more than a provisional body of rules[7]. The major problem is that being merely a conflict of laws treaty, it does not provide for uniform substantive property law. Consequently, no proprietary rights can be derived therefrom[8]. At that moment in time, however, a Convention providing for uniform rules for aircraft financing was not an option. Moreover, the four categories of rights in aircraft[9] that have to be recognised by the Contracting States are of American origin. These typical American security interests, for example the rights to acquire or posses an aircraft for a period longer than six moths, have not been incorporated into the national property law regimes of most European states[10]. Furthermore, although the Convention endorses the view that the lex situs is unsatisfactory and replaces it with the more identifiable lex registry conflict of laws rule, its applicability is highly conditional upon specific circumstances. For example, it has not been ratified on a global level. Moreover, a third of the Member States of the European Union have not accepted it, including the United Kingdom. Finally, the Convention takes no account of new developments in international financing practice, such as the fact that at present aircraft engines are financed and registered separately.

5.      The regime of the CIME/AEP solves the problems at hand

The Convention and Protocol resolve the problems at hand. Without any doubt, these instruments represent the most innovative set of instruments in the history of property law in the European Union. The CIME/AEP is certainly regarded as the most important regulation ever to be made in the area of international financial aviation law. The key objective of the new regime is to facilitate the asset-based financing and leasing of aircraft objects, to increase their availability and to reduce their costs. The CIME/AEP contain a set of uniform substantive provisions relating to property law. Furthermore, these instruments introduce rules in respect of the recognition, enforcement and priority status of interests in aircraft objects. For this purpose, the CIME/AEP provide for the creation of an autonomous international interest which has a proprietary character. The Convention has a pragmatic approach in relation to the establishment of such an interest. The definition of an international interest accommodates both the traditional civil law and the functional North American common law systems of property law. The unique international interest encompasses the following national legal devices: a) security agreements; b) title reservation agreements; and c) various forms of leasing agreements and the equivalents thereof. As mentioned above, these are the methods of finance which are used most often in respect of aircraft objects. Furthermore, the Convention establishes an International Registry at which an international interest may be registered. Following international registration, and depending on its priority status, the holder can exercise its international interest against any party in any Contracting State. This rule applies both in the case of and outside the insolvency of the debtor.

Additionally, in a detailed manner the regime of the CIME and its Protocols lays down the extensive remedies of the holder of an international interest in the event that the other party defaults. These important remedies only relate to the parties inter se (article IX(3) AEP and 7(2) CIME). However, the CIME/AEP regime draws an important distinction[11] 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[12] on the remedies set out in the CIME/AEP which they regard as desirable in respect of their specific legal relationship[13]. The new regime reflects the fact that the market in aircraft is characterised by the extremely high standard of the sophisticated 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[14], 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. The prophesy that the CIME/AEP, allegedly having their roots in American law, will lead to harsher bargains that will be dictated by a class of financiers which is not known for its propensity to under-reach where the over-reaching is not forbidden by law is unrealistic. It is just as naïve to predict that the ‘marginal airline debtor’, who must borrow where he can on whatever terms offered, will become an expertly shorn lamb for whom the wind will not be tempered[15]. 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 lease of aircraft objects is concerned.

As pointed out earlier, the principle objective of the CIME/AEP 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 also become less costly in the European Union. 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[16], their shareholders, employees and passengers[17]. 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 European state that has adopted and implemented the CIME/AEP will receive a one-third reduction in the bank’s fee[18]. With this substantial reduction in costs the Ex-Im Bank is encouraging European and other 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.

6.      The CIME/AEP as a potential stepping-stone towards uniform security interests in Europe

Although, as discussed above, in Europe the law of property in relation to aircraft financing is still a national affair, significant changes are expected in the future. The Convention of Cape Town and the Aircraft Equipment Protocol provide explicitly that a Regional Economic Integration Organisation (REIO) may accede to these documents. In 2003, the European Commission[19] has put the acceptance of the CIME and the AEP on its agenda. 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. Currently, it is co-ordinating with the fifteen Member States of the European Union with a view to ratification. The Commission 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. This point of view has persuaded the European Commission to instigate the necessary procedure. However, when a REIO accedes to the CIME/AEP, it has the rights and obligations of a Contracting State. In that case the Member States of this REIO no longer have independent authority in relation to the legal issues covered by its regime. Therefore, some of the Member States have raised the question of the competence of the European Union to conclude international agreements concerning all[20] the legal issues covered by the CIME/AEP. Nevertheless, at this moment in time the European Commission seems determined to persevere in its plan to ratify these instruments. Consequently, a ratification procedure by the European Union will be a short process.

The adoption of the CIME/AEP by the European Union will have the following consequences. After the introduction of the CIME/AEP the currently closed property law systems of Scotland and the continental European civil law countries will be extended. In the future two different levels of proprietary regimes will govern a security agreement, a title reservation agreement and a lease agreement. On the one hand, these legal devices will be covered by the international regime of the CIME/AEP which will only relate to aircraft objects and, on the other, by the applicable national proprietary regime concerning all other objects. Furthermore, the adoption of the CIME/AEP will establish the very much needed European uniform regime for the creation, enforcement, registration and priority of an autonomous international interest. This new regime will provide for a dogmatic as well as conceptual change in the rigid Scottish and continental European approach to the creation and effects of real rights. Moreover, the regime of the CIME/AEP can be used as a stepping-stone towards the unification of any other European security interests.

Finally, some Courts that are directly located in or indirectly connected to the European Union 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. Engines are not considered parts of the airframe to which they are attached and they can be the objects of separate security interests[21]. This year the Court of First Instance of the self-governing South American state of Aruba, which is an autonomous part of the Kingdom of the Netherlands and has its own air law, ruled in the same direction as the Dutch Court of Appeal[22]. 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[23]. 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”[24]. 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[25]. 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 air 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 France, Germany, Italy, the Netherlands, Switzerland and many other European civil law states most engines are not considered to be integral or indispensable parts of the aircraft[26].

7.   The ‘Official Commentary’ on the CIME/AEP.

Professor Sir Roy Goode[27], CBE, QC has written the ‘Official Commentary’[28] on the ‘Convention on International Interests in Mobile Equipment and Protocol thereto on Matters Specific to Aircraft equipment’[29]. Professor Goode undertook his valuable task pursuant to Resolution No. 5 which was adopted at the Diplomatic Conference. He was the Chairman of the Drafting Committee in Cape Town. He prepared the Official Commentary in close collaboration with the Joint Secretariat of UNIDROIT and ICAO. Furthermore, Professor Goode worked in co-operation with the Chairpersons of various legal Committees that participated in the realisation of the CIME/AEP. Moreover, he duly examined many comments that he received from States and observers on drafts that were presented to them.

The format and structure of the Official Commentary are as follows. Next to the Introduction the Commentary contains five Parts that are discussed briefly below. Part I provides a brief history of the Convention and Aircraft Equipment Protocol. Part II contains an overview of the key-objectives, the two-instrument approach, the principles and contents of the Convention. This chapter focuses on the reasons for the creation of this instrument and its most revolutionary form. Part III provides an overview of the Aircraft Equipment Protocol. It discusses the need for this Protocol, its purpose and contents. As stated in the Introduction to this article, 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, this instrument 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). Part IV and Part V of the Official Commentary contain an analysis of the provisions of the CIME and AEP respectively. In a logical step they focus on the applicability, aspects, objectives and conditions of these instruments. Furthermore, these chapters provide an extensive commentary as to the form and substance of all their articles. To clarify issues that may be difficult to comprehend, illustrations and alternative illustrations are provided. As mentioned above, the Convention is based on a two-instrument approach as it is not equipment-specific. It applies through separate Protocols to three different categories of mobile equipment: a) aircraft objects; b) railway rolling stock; and c) space assets. However, the Protocols for railway rolling stock and space assets have not yet been realised. Therefore, the Official Commentary does not deal with these forthcoming instruments. Nevertheless, in relation to the effects of the Convention, it gives several illustrations which relate to the financing of railway rolling stock and space assets, as the relevant Protocol will become effective in the near future. For instance, in relation to ‘The effects of an international interest as against third parties’, the Official Commentary gives eleven comments and nine illustrations which include the position of the owner of an aircraft, a charge on a railway wagon and the lease of a satellite. Furthermore, the Formal Commentary entails twelve pertinent Annexes. For example, Annex I, II and III provide the English texts of the CIME, AEP and the Final Act of the Diplomatic Conference respectively. Furthermore, Annex IV contains the Consolidated Text of the CIME/AEP. Its purpose is to facilitate the application and implementation of 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 complete 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. The Convention and Protocol contain new, extremely complicated and detailed terms and provisions. Therefore, there is a need for a working tool that interprets and clarifies these instruments. The Official Commentary, containing numerous comments and illustrations, has been written for that purpose. Professor Goode has provided a highly useful, neutral and unbiased source that has been prepared most diligently to ensure complete conformity with the reasoning and ideas of the Diplomatic Conference. Consequently, the Official Commentary is very interesting, instructive and essential for both legal academics and practising lawyers who are interested in international aviation finance.