The Blue Sky Decision Stormy Skies for Aircraft Financings

1. The Blue Sky Decision Stormy Skies for Aircraft Financings William J. Glaister and Julian Acratopulo Wednesday 5th September 2012 Cape Town Convention Academic Conference, Oxford University

2. Executive Summary Introduction Aviation financing transactions Review of Blue Sky litigation Commercial impact of Blue Sky decision Cape Town Convention as the solution and the case for UK ratification Proposed UK Aviation Provisions: Discussion CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

3. Aviation Financing Transactions CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

4. Blue Sky Litigation - Facts • Parties • Balli Group plc (UK co.) and the Alaghbands • Controlled 3 English SPVs – Blue Sky One, Blue Sky Two, Blue Sky Three • Blue Airways LLC (Armenian co.) – wound up • Mahan Air – Iranian private airline • PK Airfinance US Inc. • Aircraft • Blue Sky SPVs each acquired 1 B747 “Package 1” aircraft – and leased them to Blue Airways, who chartered them to Mahan • PK provided finance for 3 additional “Package 2” aircraft – mortgage granted by Blue Sky Two and Blue Sky Three over Package 1 aircraft as additional collateral • US sanctions against Iran • 2008 TDO issued by BIS against Balli, Mahan, Alaghbands and Blue Airways • Aircraft de-registered from Armenian register • Mahan purported to transfer title to aircraft to themselves under Option Agreement CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

5. Blue Sky Litigation – Mortgagee Claim • SPVs acknowledged obligation to deliver up to PK • Mahan asserting trust against SPVs • Separate Mortgagee - Claim Applicable law: • Question for the court: which law applies to govern validity of mortgage as a security interest over aircraft? • Mortgages expressed to be governed by English law • English law decides as a first step which law to apply, according to its choice of law rules CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

6. Blue Sky Litigation – Decision • Lex situs • Law of the place where the aircraft is physically located at the time mortgage is created (or is effective, if subject to conditions) • Lex situs as the orthodox conflict rule for tangible movables • Exclusion of doctrine of renvoi • Domestic law of lex situs • “without reference to its private international law/choice of law rules” • Application to the Blue Sky mortgages • Second aircraft – Armenian registered, location unknown • “In absence of proof of any other law”, English law applied and mortgage was valid • Burden of proof on Mahan to establish situs – evidence unsatisfactory • Third aircraft – UK registered, location Netherlands • Applying Dutch domestic law, mortgage would not create a valid mortgage (hypotek) under Dutch law, therefore mortgage was held to be invalid • Outcome at odds with Dutch law: Dutch court would hold mortgage to be valid as would apply lex registri (England) at the time mortgage created. CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

7. Blue Sky Litigation – Observations • Lex Situs • Court rejected PK submission that applicable law to govern validity of transfer of property interests in aircraft should be lex registri • Court sympathetic to Miliet J (Macmillan v Bishopgate) view that the objective of achieving uniformity of result was a task for international conventions rather than common law • Renvoi • Commercial clients struggle to reconcile outcome: Dutch example • English choice of law policy driver difficult to justify • Practical difficulties: Court focussed on problem of doubtful or conflicting evidence of the private international law rules of the situs. How is that different from ascertaining domestic law? • Concern that conflict of law rules should be easy to apply: Court mindful of transactional context CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

8. Blue Sky Decision – Commercial Impact • Valid ELM as a security interest requires aircraft to be located in England (including English airspace) at relevant time • Commercial impracticality – e.g. operational restrictions, regulatory and tax concerns • Cost implications • Location of aircraft in international airspace - lack of a situs jurisdiction • Otherwise, assess whether a security interest has been validly created under the domestic law of the lex situs • Parties must accept that scope of the “ELM”, including exact rights and remedies, will be determined by the domestic law of the lex situs • Requires analysis of lex situs on a case by case basis, depending on aircraft location at relevant time (and assuming aircraft is not in international airspace) • Acceptable security interest may not be available • Limitations of lex situs advice • Our experience is that local counsel’s response frequently imports a choice of law determination, notwithstanding the direction to exclude the applicable private international law rules in that jurisdiction • Courts in other states may be bound by Blue Sky decision (e.g. Cayman Islands) or find it persuasive • Effect on parties’ selection of English law to govern transaction • Shift to other competing legal systems • In particular, New York law and other Cape Town Contracting States, e.g. Ireland CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

9. Cape Town Convention and Aircraft Protocol • Connecting factors • Debtor location • Airframe registration • International interest • Articles 2 and 7 of Convention • No reference to national law requirements for creation of interests • Right in rem • Creditors’ rights and remedies under the treaty, including insolvency regime (subject to Contracting State “opt-in” declaration) • Choice of law? • Article VIII of Aircraft Protocol – choice of law governing contractual interests (subject to Contracting State “opt-in” declaration) • No express choice of law rule regarding proprietary interests • References to applicable law, including characterisation of agreements creating international interests • Application of Cape Town to Blue Sky scenario, if the UK had ratified prior to creation of relevant English law mortgages? CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

10. UK Aviation Provisions - Discussion • Aircraft objects, including engines • Outright title transfers – i.e. sales • UK Aviation Charge • Express choice of law rule • Proper law • Lex registri – entire law • Lex situs – entire law CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

11. Further Discussion CTC ACADEMIC CONFERENCE - BLUE SKY PRESENTATION

12. The Blue Sky Decision – Stormy Skies for Aircraft Financings