A version of this article originally appeared in the July/August/September 2019 issue of the ELFA Magazine, and was co-authored with Bob Goldberg, Edward Gross, and Melissa Kopit.
Lenders and lessors financing regulated transportation assets are much more likely to achieve their investment goals if they are mindful of the existing and evolving laws, regulations and other legal matters and trends related to those assets. Provided below are summaries of some of the emerging legal issues related to air and vessel financings, and an explanation regarding a distinctive legal aspect related to rail financing.
Republic Anti-SLV LDs case
Arguably, no case generated more concerns for aircraft or equipment lessors than In re Republic Airways Holdings Inc. (598 B.R. 118, 121 (Bankr. S.D.N.Y. Feb. 14, 2019)). Relying upon enforceability tests in pre-UCC 2A precedent that were overridden when UCC §2A-504 was enacted, the Republic court refused to uphold a stipulated loss value (SLV)-based liquidated damages remedy, deeming it to be unreasonable because it shifted the decline-in-value risk to the lessee during the term of the lease. It also ignored New York precedent when refusing to enforce the related absolute and unconditional guaranties.
Liquidated damages formulas/amounts must, at lease commencement, be “reasonable in light of the anticipated harm caused by the default”; consider whether your lease documents, appraisals and other then available information support that conclusion.
Gray chartering concerns
The Federal Aviation Regulations (FARs) regulate business or personal use operations under FAR Part 91, and compensated transportation operations under more stringent FAR Part 135. Customers operating under Part 91 sometimes mistakenly or otherwise engage in illegal or “gray” chartering by making the aircraft available to related or unrelated parties and being compensated in amounts exceeding the limits provided in Part 91. Examples include “flight department company” SPE operators, illegal dry leases of aircraft and crew, and excessive timeshare agreements. The Federal Aviation Administration (FAA) is now vigorously pursuing investigations and sanctions against violators.
Consider due diligence and document requirements to avoid resulting risks (e.g., customer: fines, taxes, etc.; and lessor/lender: insurance, reputational, etc.).
News accounts of “abusive” non-citizenship and other ownership trusts have caused legislators and agencies to raise concerns that current registration practices obfuscate the identity of the true owner of an aircraft, facilitating criminal activities, terrorism and sanction violations. Based on a forthcoming U.S. Government Accountability Office audit report, new legislation could impose intrusive and impractical information gathering responsibilities for the FAA Registry and registration applicants relating to trusts and other aircraft registration.
Note the increased scrutiny and consider related due diligence and trust-related documentation and practices (e.g., recognized trustees and transparency regarding ultimate owner and operator).
Liability Safe Harbor strengthened
The FAA Reauthorization Act of 2018 signed into law October 5, 2018 addressed certain liability safe harbor (49 U.S. Code § 44112) vulnerabilities in the prior version of this statute protecting lessors, lenders and other passive parties. As revised, § 44112 no longer requires that the subject injury, death, etc. occur “on land or water,” and replaces a non-specific exclusion, “control,” with “operational control” (defined in 14 C.F.R. § 1.1).
Although these changes should address certain specious liability claims, financiers should still rely on diligence, indemnities, insurance, legal compliance and other protections.
Every railcar and locomotive you see has a large alpha-numeric mark stenciled on its sides. This is a railroad reporting mark, and it consists of a two-to-four-letter code, followed by a number. The letter code is assigned by a subsidiary of the Association of American Railroads (AAR), and the number (up to six digits) that follows is assigned by the owner of the railroad rolling stock. Frequently, the letter code relates to the owner company’s initials. Some companies have many reporting marks. The name of the owner of each reporting mark is publicly available. Examples of reporting marks: BNSF, CSX, UP, GATX and FURX.
The legal owner of a railcar may not be the AAR railcar “owner” (i.e., the owner of the reporting mark stenciled on the railcar). In lease transactions, the lessee may be the AAR railcar owner, and the lessee’s reporting marks may appear on the car. Similarly, as a result of acquisitions, mergers or sales and purchases of railcars, a railcar may bear the reporting mark of a predecessor owner.
All railcars that are in interchange service (meaning between railroads) must have a reporting mark. Reporting marks are important for two primary reasons:
UMLER – physical characteristics of the railcar (including internal and external dimensions, capacities and weights), use restrictions and prohibitions, safety inspection dates, etc.
TRAIN II – information regarding the physical location of the railcars.
Car Repair Billing Data Exchange – railcar owners are responsible for certain repairs to railcars, and there is a monthly exchange of repair bills in electronic format administered by a subsidiary of the AAR.
Car Hire Data Exchange – monthly exchange of time and mileage payment information in electronic format—administered by a subsidiary of the AAR.
The International Maritime Organization has adopted rules (IMO 2020) regarding the use of low-sulphur fuel on deepwater ships. IMO 2020 goes into effect on Jan. 1, 2020, and provides that ships may not use fuel with sulphur content higher than 0.5%. The rules apply to all ships flying the flag of a nation that has ratified MARPOL Annex VI and to all ships that carry to a port or transit waters of a nation that has ratified IMO 2020. It is estimated that over 95% of the world’s fleet will be subject to IMO 2020.
To comply, ships must either use low-sulphur fuels or be fitted with exhaust systems called “scrubbers” that clean high-sulphur fuel. Because there are options for compliance, the shipping industry has taken different approaches for compliance, with some shipowners retrofitting some or all of their ships with scrubbers, and others relying on the availability of compliant fuel at reasonable cost.
Both methods of compliance present challenges. Scrubbers are expensive (from $2 million to $10 million, depending upon vessel size), the technology has not been proven, and scrubber wastewater may adversely impact the environment. While low-sulphur fuel may be an option, there are concerns about its availability, particularly in smaller and remote ports. Implementation of IMO 2020 may also be complicated in the U.S. because 2020 is in an election year, and the administration may be reluctant to enforce the switchover due to its impact on home heating oil.
Offshore wind and the Jones Act
The growth of the offshore wind market in the U.S. has created new opportunities for Jones Act (Act) vessels because the Act likely applies to the transportation of passengers and materials between the U.S. shore and wind installation sites located on the Outer Continental Shelf. The Act requires vessels to be built in the U.S., flagged in the U.S., and 75% owned and controlled by U.S. citizens. Offshore wind projects may also involve dredging and towing (to which the Act applies) and pipe laying or pile driving (which is not implicated by the Act). Customs and Border Protection makes determinations of whether specific project activities are subject to the Act.
Margie Krumholz is the co-chair of Thompson Coburn’s Transportation and Project Finance practice group.
Bob Goldberg is a Senior Company Counsel with Wells Fargo Bank, N.A. Edward Gross is a shareholder at Vedder Price in Washington, DC. Melissa Kopit is an associate at Vedder Price in Washington, DC.
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