Aircraft Finance in Canada

By Donald G. Gray

Posted: 11th August 2011 09:32

Aviation Jurisdiction.

Canada is a federal state, consisting of a central federal government, 10 provincial and three territorial governments.  Under Canada’s constitution, international and interprovincial transportation and bankruptcy matters fall within federal jurisdiction, while property and civil rights, including security interests in personal property, remain the responsibility of the provinces.

The laws of Quebec are based upon the French civil law system while the laws of all other Canadian jurisdictions come from British common law.

Cape Town Convention.  Canada signed the 2001 Cape Town Convention on international interests in aircraft, which resulted from a Canadian initiative. It has passed the necessary implementing legislation, but has not yet fully proclaimed that legislation or ratified the treaty.

The Federal Government is currently completing its review of legislation that potentially conflicts with Cape Town.  Ontario, Quebec, Alberta, Nova Scotia, Saskatchewan, Newfoundland & Labrador, Northwest Territories and Nunavut have passed provincial implementing legislation.

In the meantime, in 2005 the Federal Government did proclaim the amendments to Canada’s bankruptcy legislation (see below) to implement Cape Town “Alternative A” (an enhanced version of US 1110).

Aircraft Title and Registration.  Canada, as party to the 1944 Chicago Convention, maintains the Canadian Civil Aircraft Register (CCAR) pursuant to the Aeronautics Act (Canada).

Unlike the federal shipping registry, which records title and encumbrances, the aircraft register was established only to record operators (i.e., those with “legal custody and control”) of Canadian aircraft.  It is specifically provided that the CCAR is not a title or encumbrances register.

Under an aircraft lease agreement, the air carrier/lessee, rather than the owner/lessor, will therefore be registered as the “owner” for purposes of the Act (several years ago, because of confidentiality concerns, Transport Canada Aviation (TCA) ceased its practice of permitting Certificates of Registration to be endorsed to indicate that aircraft were under lease from specified lessors).

Accordingly, Canada did not ratify the 1948 Geneva Convention on the International Recognition of Rights in Aircraft and does not maintain a central aircraft register for the purposes of that Convention.

Pending ratification of Cape Town, the question of aircraft title and encumbrances remains subject to the jurisdiction of the provinces, each with a similar system for the recording and enforcement of rights in movable personal property.

For the obvious reasons, and because Ontario still only allows searches by “debtor” instead of by “asset”, any aircraft finance transaction must first confirm a clear chain of title to the aircraft. Other provinces allow asset searches in order to confirm registered encumbrances by aircraft registration or serial number.

Checking title is relatively simple when the aircraft is being acquired from the manufacturer or from a Geneva or Cape Town Convention jurisdiction, such as the US, where an aircraft title and encumbrances report and opinion can be obtained. Otherwise, to the extent practicable, it is necessary to establish title by reviewing bills of sale or other conveyance documents from the manufacturer or from the exporter/seller of the aircraft from such jurisdiction.

The identity of the registered “owner” should also be confirmed with a search of the CCAR, which requires evidence from the applicant for such registration that it has “legal custody and control” of the aircraft.  Such evidence is normally a bill of sale or lease agreement from the last registered owner (whether registered in Canada or elsewhere).

Security Interests. While the Personal Property Security Act (PPSA) system, as stated above, is generally designed to allow searches only by debtor, all PPSA jurisdictions, except Ontario, permit searches against an aircraft itself, by registration or serial number, thereby simplifying the process.

The provincial PPSAs (the Quebec Code is similar) state that, in the case of movable assets “normally used in more than one jurisdiction” that are “equipment”, it is the laws of the location of the debtor’s “chief executive office” (“domicile” in Quebec) that establish the validity and priority of security interests, rather than the laws of the location of the equipment itself.

This is similar in effect to the US UCC, producing the desirable result of “one registration – one search” for all of North America.  This is also, of course, the worldwide objective of the Cape Town Convention.

Leases. Each PPSA jurisdiction contains its own, although generally similar, rules as to when leases must be registered as security interests.

While there are a number of very technical court decisions that differentiate between a “true” lease, for which registration is optional, and one which “secures payment or performance of an obligation”, which must be registered, it is always advisable to register notice of any lease as it is an inexpensive process and the consequences of not doing so can leave the lessee in the very undesirable position of being an unsecured creditor rather than owner.

Moreover, in all provinces, leases for a term of more than one year must now be registered, even if not intended as security documents.

An additional benefit of registration is that, as a registered secured party, a lessor is entitled to notice when any other secured party of that debtor elects to take steps to enforce against and sell its collateral.

Other Priorities.  Provincial law also governs the rules for the priority of purchase money security interests, repairers’ liens, assignments of collateral, attachments to the collateral (for example, as between different owners of engines attached to the aircraft), security interests against related collateral (such as spare parts, security deposits or maintenance reserves) and other potential priorities.

Sale/leasebacks and Securitizations.  It is no longer necessary to cancel the Certificate of Registration and re-register a Canadian aircraft because of a sale-and-leaseback or assignment to facilitate a securitisation, including to a foreign lessor.  This is because, while the nature of the legal custody and control of the aircraft has changed, the party with such custody and control has not.

Accordingly, it is now necessary only to notify TCA of the change within seven days after closing, by providing a copy of the new document under which the registered owner retains such custody and control.

Legal Opinions.  In the past, Canadian legal opinions in aircraft finance transactions have tended to be complex and heavily qualified because of the various jurisdictions and lack of a central title and encumbrances registry.  The recipient is thereby generally left to satisfy itself as to the adequacy and completeness of the steps taken.

Experienced aviation counsel should be able, however, based upon a review of the aircraft’s status, to simplify the process by advising as to what searches and registrations, as a practical matter, are required or advisable.

Counsel should then be in a position to report that all reasonable steps have been taken to confirm that the appropriate party has good title and priority over any encumbrance which could reasonably be expected to affect the aircraft.

Insolvency and Repossession.  While provincial law governs the ability to repossess and enforce upon security, federal law governs bankruptcy and insolvency.

The federal Bankruptcy and Insolvency Act and/or Companies’ Creditors Arrangement Act (CCAA) generally govern the rights of lessors and aircraft secured financiers to realise upon their collateral in an insolvency.  Formerly, neither of these statutes contained the protections afforded to aircraft financiers given by Section 1110 of the US Bankruptcy Code.

With the implementation in Canada of Cape Town “Alternative A” (notwithstanding that Canada has not yet ratified the Treaty), both statutes have been amended to provide a “60-day cure or return” rule similar to US 1110.

The principal differences between the CCAA and US 1110 are as follows: (i) the CCAA (which is most often used by Canadian airlines to restructure) is driven by judicial discretion while the US Code is rule based; (ii) the initial CCAA court order (generally proposed by the debtor in conjunction with major stakeholders) sets the rules for the stay and restructuring; (iii) under the CCAA, operating lessors are entitled to demand post-filing rent or prompt repossession; (iv) the CCAA does not contain a right to disclaim labour contracts; (v) a trustee is appointed as “monitor” by the court to supervise the debtor’s activities and report to creditors and the court; and (vi) there is no automatic priority for post filing credit under the CCAA.

The Transamerica decision in the Air Canada CCAA restructuring confirmed that, while Air Canada could request a “payment moratorium” on a consensual basis from lessors pending reaching restructuring agreements, absent such agreements, full contractual post-filing rent must be paid until the aircraft is available for redelivery.

Air Canada had argued that Transamerica should only have been entitled to the “FMV” rent that had been offered to that lessor, until such time as the aircraft was taken out of service. Negotiations continued for some months after that time, until they were broken off and the aircraft redelivered.  The court implied that such a decision might not have been made in the case of a financing lease.

Tax Aspects of Leasing.  In Canada, most tax-based leasing disappeared with the 1989 amendments to the Income Tax Act which limited the after-tax financing advantages available to lessors.

The depreciation that can be claimed by lessors is now generally restricted to the amount in any given year that would have been a repayment of principal had the lease been a loan, with the lease payments being treated as blended payments of principal and interest.

The Supreme Court of Canada has also ruled that a lease will generally always be treated as a lease for tax purposes, thereby largely eliminating the tax distinction between operating and finance leases in Canada.

Lessees and lessors may, however, elect in certain cases that the lessee shall also receive depreciation for Canadian tax purposes.

Aircraft leasing does also continue to thrive in Canada for off-balance-sheet financing or title retention security purposes.

There is no longer withholding tax payable on lease or loan payments to non-Canadian aircraft lessors or lenders other than to non-resident persons that are related to the payor and not resident or deemed to be resident in the US.

Canada’s “value-added” Goods and Services Tax (GST), (Harmonised Sales Tax (HST) in certain provinces) continues to apply to aircraft leasing and must be paid by the lessee (although technically levied on the lessor) except for rent paid to non-Canadian lessors.

GST is, however, subject to input tax credit and refund by the Federal Government for GST paid in respect of commercial activities. Normally, lease payments for commercial aircraft will attract GST at the rate of 5% of each payment.

Other Recent Developments. In the Canada 3000, Zoom and Skyservice Airlines bankruptcies, NAV Canada and certain airport authorities sought to assert a lien similar to Eurocontrol rights for unpaid charges in priority to the interests of aircraft lessors.

The Supreme Court of Canada has now basically established that if an air authority is able to seize an aircraft before its lease is terminated or the aircraft is repossessed it will be able to detain the aircraft until paid.  These issues are currently being reviewed in the appeals in the ongoing Skyservice Airlines insolvency proceedings.

 

Donald Gray is Co-chair of the Blakes Aviation and Aerospace Group and is a Partner in the Financial Services Group. He advises a number of aircraft lessors, financiers, manufacturers, and domestic and international airlines on aircraft finance and aviation commercial and regulatory law matters.

Donald was a Canadian delegate to the Unidroit/ICAO sessions, which enacted the Cape Town Convention in 2001. He has also served on the Legal Advisory Panel of the AWG since the formation of the panel in 2000 including as chair of the Panel from 2006 to 2008. He has also served as vice-president and general counsel of an international charter airline, an Air Canada regional connector, and an international cargo carrier. Donald is an active aircraft owner and IFR  rated pilot. He holds Canadian, United States and South African aviation documents.  Donald can be contacted on +1 416 863 2750 or by email at donald.gray@blakes.com

 


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