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BOARDROOM GUIDE - NON-ASSIGNABLE CONTRACTS

Since the banner sales years from 2006 to 2008, nearly every business aircraft manufacturer has adopted a policy – and introduced the associated contract language into their standard contract template – that attempts to prohibit the Buyer from assigning the contract to an unrelated third party.

AvBuyer   |   8th January 2010
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The two heads of the ‘Non-Assignability’ coin.

Since the banner sales years from 2006 to 2008, nearly every business aircraft manufacturer has adopted a policy – and introduced the associated contract language into their standard contract template – that attempts to prohibit the Buyer from assigning the contract to an unrelated third party.

Conversely, most new aircraft buyers feel that this kind of policy unduly restricts them from dealing with a significant change in circumstances long after the contract is signed. Both parties have what they believe are legitimate reasons for taking their respective positions, but the polarity of those respective positions can, if not properly addressed during contract negotiations, prevent the deal from closing. A closer look at some of the thinking behind each position may go a long way to keeping contract negotiations on track.

MANUFACTURERS’ VIEW
First, let’s look at the issue from the manufacturers’ perspective. Production scheduling to accommodate booked order backlogs, particularly in the case of highly complex, multi-million dollar aircraft involving a wide spectrum of suppliers and subcontractors, is a fundamental element of every manufacturer’s business plan. Accurate scheduling allows the manufacturer to do a number of things essential to the long-term success of their company, including, but not limited to:

• predicting revenues and profits;
• accurately forecasting product availability to support sales efforts;
• planning material procurements, including expenditures and efficient inventory handling;
• planning labor requirements;
• assessing product demand and predicting future demand trends, enabling research & development planning; and
• assessing and reporting financial health to its shareholders, supplier chain, and customer base.

Further, manufacturers have legal and fiduciary responsibilities to their shareholders and legal responsibilities to the government (e.g., the U.S. Patriot Act) to have a clear understanding of who their customers are, prevent money laundering, and avoid doing business with parties with whom they are prohibited from contracting.

Underlying these considerations is the simple concern that if, as the booked backlog increases, existing order holders are able to sell, through assignment of their contract, delivery positions that will give a prospective buyer a position in the backlog earlier than the ‘next available’ position the manufacturer can offer them, the manufacturer will lose an incremental sale (and the incremental profit that comes with that sale), as well as confidence in their sales trend analysis and production scheduling.

Further, in nearly every case (regardless of the actual amounts involved) the manufacturer will have incurred various expenses – marketing, entertainment, demonstration flight(s), and the like – only to see the incremental sale that would pay for those expenses disappear. While buyers – the original buyers or the ‘replacement’ buyers (or both) – may not wish to concern themselves with these kinds of considerations, they are very real to the manufacturers.

Finally, there are buyers who place orders with the sole intent of speculating on the manufacturer’s backlog. They purchase a delivery position as the backlog expands expressly intending to resell it to a third party who is willing to pay a premium for an earlier delivery position. Obviously, this hurts the manufacturer, so the manufacturers who have been able to build a backlog want to prevent speculation and protect their ability to make incremental sales and profits.

BUYERS’ VIEW
On the flip side of the coin is the buyers’ perspective, and it must be discussed and understood if a ‘win-win’ solution is to be found. For the purpose of this discussion, we’ll focus primarily on ‘legitimate’ buyers and operators Domestic and global economics are cyclical. Some upswings and downturns are less dramatic than others; this latest downturn has certainly been one of the most severe (if not the most severe) in modern history, and certainly the worst affecting the global business aircraft industry.

Certainly no company or individual who decided to buy an aircraft prior to the current economic collapse saw it coming or [really] gave much thought to the prohibition on assignment of their contract to a third party: business was good, their financial situation was stable, and the aircraft was a key ingredient to their long-term business plans. Then the bottom fell out from under those plans for a number of buyers, and their ‘need’ for a new aircraft quickly became an ‘option’, and the phone boards began to light-up with calls to brokers and/or the manufacturers looking for a way out of the purchase.

Because the economic downturn clearly did not affect everyone in the same way, however, there were some ‘replacement buyers’ to be found. In the event that an ‘original buyer’ was able to find a ‘replacement buyer,’ however, the non-assignability clause created an obstacle that in many cases made the re-sale too difficult or outright impossible.

In turn, facing the same fears and challenges its buyers were facing, the manufacturers were not willing to set aside or ‘relax’ the non-assignability clause, recognizing that a precedent-setting concession could have the effect of opening the floodgate on such re-sales and assignments.

In fact, however, those individuals who were not as adversely affected by the downturn and were willing to buy distressed contracts wanted to do so at prices less than the original contract price, forcing the original buyer to weigh the alternatives of selling the position at a loss – presuming they could find a way around, or through the non-assignability clause – or defaulting on the contract and forfeiting liquidated damages.

Either way, a large number of contracts were terminated and most manufacturers were unable to react quickly enough to the changed market conditions – available buyers of new and terminated delivery positions, available credit, and price pressure – to avoid severe impact to their backlog and financial stability.

Returning to the fundamental issue, then, we must ask the question “Does a ‘Non- Assignability’ clause accomplish anything of true value if it penalilzes legitimate buyers who encounter real financial difficulty and results in an abandoned delivery position the manufacturer can’t resell?” The obvious answer is “No”, but given the reasons for creating such a clause in the first place, there must be an alternative that can accommodate the legitimate needs of the parties.

LEGAL VIEW
From a purely legal perspective, insertion/inclusion of an ‘escape valve’ – language that allows the buyer to assign the contract in the event of a specific event or set of circumstances – could be created, but then the manufacturer might not be able to book the order because a contingency, regardless of how remote it may truly be, is usually created by such an ‘escape valve.’

Alternatively, the manufacturer’s assurance and/or the buyer’s presumption that the manufacturer will, in fact, be reasonable when presented with a request from the buyer to sell and assign the delivery position based on dramatically changed financial or personal circumstances should not be relied upon.

How, then, can a compromise be struck? Clearly, the manufacturers’ primary concern is that some buyers place orders on speculation, in turn generating upward pressure on price and delivery schedules. And equally as clearly, non-speculating buyers don’t want to be penalized if something beyond
their reasonable control impacts their ability to finish paying for the aircraft.

One possible solution is to craft language that: (i) affirmatively requires the buyer to advise the manufacturer of changed financial circumstances that they believe will prevent them from completing their contractual obligations (with enough detailed informationto allow the manufacturer to verify the claim); (ii) allows the buyer to propose one or more legally-viable alternative solution(s) (possibly including resale of the delivery position to an unrelated third party – with the manufacturer’s knowledge and consent,and any upside (except, possibly, the original buyer’s cost of money) going to the manufacturer); – and (iii) allows for cancellation of the contract with something less than the liquated damages otherwise required in the event of actual default due from the original buyer.

Whether this, or other thoughtful approaches, will be successful remains to be seen. Both parties to the transaction must be willing to listen to the other party’s issues and concerns, then structure a solution that protects their position without ignoring the other side. Two things we have all learned, though, is that the recent worldwide economic crisis affected nearly everyone in the business aircraft arena – buyers, sellers, manufacturers, attorneys, brokers and consultants – and that we were all caught off-guard by the extent and the severity of the crisis.

Since everyone wants to come out of adversity stronger and wiser than they were beforehand, let’s try to put common sense back into the contracting process so that a coin toss does not automatically result in a ‘lose-lose’ outcome.

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