Dry Lease Agreements: What to Check Before Signing

Dry leases require lessees to source their own flight crew, presenting a range of unique challenges – and opportunities. But what are the key “small print” items that business jet lessees should study in any contract?

Michele Wade, a partner at Jetstream Aviation Law, says there are many items a lessee should consider before signing a deal to lease an aircraft. For instance, they should ask questions of the lessor, obtain professional advice on anything they do not understand, and ensure the final written lease addresses the important terms.

In a dry lease, Wade says, the lessee will write two checks – one for the lessor for the lease of the aircraft and another to the independent source providing the crew.

“The lessee may want to inspect the aircraft and review the records before signing the lease,” she adds. “The aircraft lease will generally not contain any representation from the lessor as to the condition of the aircraft.”

Moreover, the lease may contain a representation that the lessee will operate the aircraft in compliance with applicable laws and regulations, and so the lessee must confirm that the aircraft operations comply with such requirements (such as Federal Aviation Regulations in the US).

Any operation that does not comply will risk the insurer denying coverage if a claim is made, while the FAA may seek penalties, Wade warns.

“Nor should the lessee be an entity formed primarily to operate the leased aircraft,” she adds. “A sole purpose entity operating the aircraft may appear to be an escape from liability, but sole purpose entities are not eligible to operate aircraft on passenger-carrying flights under Part 91, which makes any such flight they conduct an illegal operation.”

With larger aircraft there should be a ‘truth-in-leasing’ clause at the end of the lease, Wade adds. “The lessee has ‘operational control’, and the responsibility and liability that accompanies operational control. Because the lessee has operational control liability, it is important to confirm that the lessee’s operations are covered by the insurance.”

And, in the US, relevant state departments of revenue may impose a sales or use tax on lease payments, Wade highlights, so lessees should determine if they must pay such a tax.

Potential for Millions of Dollars of Liability

David M. Hernandez, Business Aviation & Regulation Sub-practice Chair at Vedder Price, says he is astonished “that people lease aircraft and expose themselves to potentially millions of dollars of liability and regulatory enforcement without any idea whatsoever of the risks”.

The consequences could be devastating, resulting in legal battles, lawsuits, breach of contract claims, insurance denials and more.

Hernandez outlines a range of questions that lessees should ask, in areas such as operational control of the aircraft to payments for fuel and airport fees. “Simply put, leases are extraordinarily complex, and most people simply don’t understand them.

“Sadly, many times lessees don’t want to hire an experienced aviation attorney to review the documents,” he adds. “I firmly believe that most lessees spend more due diligence selecting a pet than doing due diligence on an aircraft and lessor.”

Maintenance and Redelivery Lease Terms

Tristan Brouard, Associate Vice President, Asset Management at ACC Aviation, points to a range of small print items a lessee should consider that go beyond some of the more obvious items such as lease term, rates and security deposits.

Brouard suggests lessees should check any details related to maintenance responsibilities and opening balances. A ‘maintenance reserve opening balance’ refers to the amount of money that a lessor must allocate at the beginning of a lease term to cover future qualifying maintenance events, such as airframe base checks, engine overhauls and life- limited part replacements.

It's pretty standard for the lessor to provide an opening balance on a lease, and the reserve is then typically funded by the lessee through regular contributions, and any remaining balance is typically retained by the lessor, depending on the terms of the lease agreement.

“The specific details of the maintenance reserve, including the initial opening balance, the contribution schedule, and the conditions for its use, should be clearly outlined in the lease agreement between the lessor and the lessee,” Brouard highlights.

“The lessee should pay close attention to how these terms are drafted and the mechanics of lessor contributions and the definitions of qualifying maintenance events.”

Brouard says lessees should also ensure they understand the redelivery conditions. “It is crucial for both parties to clearly define and agree upon these, any penalty rent, and maintenance responsibilities at the beginning of the lease agreement, establishing specific maintenance and repair standards, outlining the condition in which the asset should be returned, and setting clear guidelines for the redelivery process.”

Regarding the potential for penalty rent, which comes into effect when the lessee fails to return the aircraft in a certain redelivery condition on an agreed date, this usually equates to a multiple of the standard monthly rental, perhaps 150-200%.

“Regular communication and documentation throughout the lease term can help prevent misunderstandings and disputes during the redelivery process,” Brouard says.

Insurance, Risk of Loss and Indemnity Provisions

Joanne Barbera, a Founding Partner focussing on aviation law at Barbera & Watkins, LLC, warns that parties to a lease may be tempted to pay more attention to scheduling and rent than to areas like insurance, risk of loss, return condition and indemnity provisions. But these latter terms are critical if something goes wrong.

According to Barbera there are some areas that lessees should insist on in the agreement. As a basic example, she advises they should ensure that the lessor is the owner of the aircraft, and if so, are there any other lenders or lessees attached to the aircraft – and if so, how that could affect the leasing arrangements.

“If the lessor is not the owner, how does the lessor have the right to lease the aircraft?” she says.

Lessees should also check if the lessor has a relationship with any of the pilots the lessee intends to engage to fly the aircraft. “A close relationship such as employer/employee, husband/wife, or even certain other connections could make the lease an improper ‘wet’ lease and create FAA enforcement, tax, insurance and other issues for the parties,” she says.

And the lessee should also check where the aircraft is registered and based; any sales, use, property or other taxes that the lessor has paid; any exemptions from such tax that the lessor has claimed; and any tax delinquencies involving the lessor or the aircraft.

“How does the lessor intend to treat the lease for sales, use and similar tax purposes?” she asks. “Depending on the locations and taxes involved, and the terms of the lease, the lessor’s tax planning and implementation can affect the taxes to be paid by the lessee (and vice-versa).”

Select the Right Team...

A spokesperson for the National Aircraft Finance Association (NAFA) said that perhaps the first question should focus on understanding who you are speaking with. “Is it a finance broker or the actual lessor?

“If you have been presented with a term sheet, what is the commitment level of the lessor to follow through on the terms being presented?”

Another consideration may be any potential options for an early buy-out of the lease, the ability to substitute the aircraft for another of equal or lesser value, and the potential to purchase the aircraft at the end of the lease term.

Before getting into documentation, however, the NAFA spokesperson said lessees should first surround themselves with the right team, including an aircraft broker, tax counsel, legal counsel, aircraft operator and maintenance manager. They will be able to evaluate your requirements and outline and negotiate appropriate terms.

“The first benefit in this approach is that it will make it easier to present your transaction to potential lessors,” the spokesperson explains. “The second is being better able to evaluate the terms presented by each lessor,” in everything from maintenance records, to annual aircraft utilization or hangar requirements.

“Each of these terms can take up a lot of ink in the lease, so having an experienced team in your corner is going to make the lease negotiation more straightforward as well as ensuring the lessee is able to comply with the terms of the lease.”

“You wouldn’t hire an auto mechanic to fill a cavity,” concludes Hernandez. “You’d hire a dentist. Lessees should hire the right professional to assist with any highly complex and risky endeavour such as a dry lease.” 

More information from:
ACC Aviation: www.accaviation.com
Barbera & Watkins: https://bwaerolaw.com
Jetstream Aviation Law: https://jetstreamlaw.com
National Aircraft Finance Association: www.nafa.aero
Vedder Price: www.vedderprice.com