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October 2004

Drafting Effective Letters In Aircraft Purchases

Most used business aircraft transactions begin with a seemingly innocuous offer letter: Party A proposes to buy the Aircraft from Party B for a purchase price of $X. The purchase is contingent upon a successful inspection and testing.

In practice- the offer letter (or term sheet or letter of intent) is a crucial document that sets in motion a series of steps that will lead to the sale of the aircraft. There are a series of variables in each offer letter that make it impossible to prepare a standard form. While there are a finite number of core variable provisions- each offer will be a reformulation of those provisions based on the circumstances of the deal. The permutations are almost infinite.

This article discusses offer letters in general- and provides an orderly method for formulating these letters to achieve your objective.

1. LEGAL EFFECT OF AN OFFER LETTER
A letter that makes an offer and covers the salient terms of the deal (properly identifying the thing to be purchased- and stating a determinable price) forms a legally binding contract under the law of most states if the recipient makes a timely acceptance of the offer. You can load the offer up with contingencies- or you can omit core facts- and that reduces the odds that the letter creates a binding obligation. But if you take this too far – basically leaving it up to the buyer’s sole discretion whether to go forward or not – then the offer letter has little meaning or effect. If you are concerned about whether an offer is going to create a binding contract- then you should have your legal counsel involved.

Clients often tell me that they do not want an offer letter to be binding- but after some discussion- we usually conclude that the client does in fact want the letter to be binding on both sides- to a limited extent. It is critical- however- that the offer letter make it clear what is binding and what is not. At a minimum- an offer must create mutual obligations between the parties to take the first steps toward an aircraft for sale. The offer letter is generally a 'bootstrap' to a definitive purchase agreement- so it need not address every contingency- and can and should be simpler and shorter- but how much?

2. OFFER LETTER DETAIL VERSUS SIMPLICITY
In theory- an offer letter could be configured as a full-blown purchase agreement- with all of the various contingencies spelled out and necessary boilerplate tossed in. If complete- this may be the only document needed to effect the transaction (other than ancillary paperwork). The benefits are obvious. Once you have agreed to this super-offer-letter- you are prepared to move toward closing- with appropriate 'outs' to walk away from the deal.

A seller that deals in a large volume of business aircraft will often skip the offer letter process and start with a purchase agreement.

Of course- a full-featured offer letter will not get a quick response. Often it needs to be sent off to legal counsel- and legal counsel will want to quibble over the full range of details. In many cases- the quibbling will be over provisions that turn out to be irrelevant because the deal falls off for other reasons. So- for a period of days or weeks- you have an interested buyer and an interested seller accruing legal fees- but you have no tangible 'paper' progress toward closing. Quite often in such a case the buyer and seller run ahead of the paper-pushers- and they begin airplane inspections and walk-arounds with no written understanding. This can create a legal mess- and introduce potential liability since the parties are acting without any written allocation of risks and responsibilities.

An offer letter can be as simple as the single sentence highlighted at the beginning of this article. Simplicity can get the deal moving quickly- but it often leaves too much unsaid. Is the aircraft buyer irrevocably committed to buy the aircraft- or is it subject to obtaining financing? What kind of inspection will the buyer do?

Who will pay for the inspection? Does the seller have to fix what is found? Will the used aircraft be pulled off the market until the deal closes? How long does the seller have to accept or reject the offer? An overly simplified offer letter will increase the chances that the parties have a 'deal stopper' arise later in the deal.

The appropriate level of detail in an offer letter is a balance. There must be enough detail there to get the deal moving- and to address issues that may arise- but not so much detail that the paperwork ends up choking the deal- or the deal gets ahead of the paperwork.

One way to balance clarity versus expediency is to break the airplane purchase into stages. The offer letter will be a binding mini-agreement governing the first stage. The buyer will have certain inspection rights- and the seller will have obligations to make the aircraft available. If the conditions to move forward are satisfied (the buyer is ready for a heavier commitment)- the remainder of the deal should be governed by a more specific aircraft purchase agreement. Below are many of the variables to consider in your offer letter.

3. ESSENTIAL AND OPTIONAL CONTENT
a. Essential Content
i) Identify the used aircraft correctly and completely: This is a 'no-brainer' but mistakes are made. Aircraft manufacturer serial number- plus engine type and serial number are the bare minimum. If the engines are under a maintenance program- it is conceivable that between the date of the offer and closing- an engine could be swapped out to the buyer’s detriment.

Also- specifically identify the aircraft model designation. There are some gray areas where a model was produced under one designation- but owner-modified to a higher designation. For example- a Gulfstream GIV can be modified with GIV-SP components- and may be marketed as an SP. In this case- if the offer letter specifically mentions an SP- the deal can be broken if it is not a legitimate SP.

Conversely- if the offer simply mentions a G-IV- then its failure to be an SP would not be grounds for the aircraft buyer to walk from the deal. The difference in designation may have significant impact on the market value of the airplane for sale and the ability to finance the purchase price.

ii) Correctly identify the buyer and the seller: Many aircraft brokers will make an offer on behalf of an undisclosed buyer. This may or may not be legally effective. It may make the offer binding on the broker- and it may make the offer binding on the undisclosed buyer (assuming it is otherwise legally sufficient). The buyer should not feel uncommitted simply because a broker has made an offer on their behalf.

The offer letter should be addressed to the legal owner of the aircraft based on FAA registration data. If the aircraft is owned in a trust- it may be effective to address it to the beneficiary of that trust (if you know it)- but it is also recommended that the offer be copied to the trustee. The trustee ultimately will be the party signing the critical documents.

It is not unusual for a business aircraft to be generally known as 'the Acme Corporation' plane- when in fact it is owned by a trust- or a corporate affiliate of Acme Corporation- or by an individual principal of Acme Corporation. The offer is not effective unless it is made to- and responded to- by a person with authority to sell it.

iii) Name a price: The price can be subject to adjustments or contingencies described below. If you omit price- then the letter becomes a fairly meaningless document – more like a letter requesting permission to inspect. A smart seller will not open a aircraft up to inspection- or remove it from the market- on such a weak offer letter.

iv) Specify how long your offer will be held open: If the aircraft is in high demand- the seller will be hoping to juggle multiple- competing offers- and if you do not specify an end-date- your offer may be held for quite a while without a response. If your offer expires- then you have some leverage to draw a response from the seller. You can always extend the date if necessary.

v) Identify any contingencies or conditions: Be clear as to the events or circumstances that affect your price or your willingness to buy the aircraft. Examples are provided in section b- below.

vi) Incorporate the seller’s representations: If the offer is in response to a specific solicitation of offers (including an advertisement) it is strongly recommended that your offer be contingent upon the correctness of the representations made by the seller about the aircraft. Quite often an advertisement will have overly generous (or simply outdated) statements as to overhaul- service bulletin or airworthiness directive status.

b. Optional Content
The following is a list of the most common optional provisions in a typical- complete offer letter.

i) Inspection contingencies: Unless you are willing to take an aircraft strictly 'as is' (meaning without inspection)- you will need inspection contingencies. The only time a strict 'as is' deal is likely to occur is if the buyer is already the sole operator of the aircraft by virtue of an operating lease. Inspection rights can escalate from simple to exhaustive- starting with an initial walk-around- to a records review- a test flight- then a 'standard pre-buy' inspection- and may go as far as a scheduled or accelerated maintenance visit. In most cases- the cost of airplane inspection falls on the buyer.

The buyer and seller generally agree to an initial- light inspection- and if that is successful- they move on to a more detailed document and more exhaustive inspection. At each stage- there are fully negotiated walk-away rights.

Even if you intend to have a definitive purchase agreement- the offer letter should describe the level of inspection anticipated in the definitive document- and the condition that the buyer expects the aircraft to satisfy. Inspection rights are highly negotiable.

Used airplanes buyers should keep in mind that inspections (particularly so-called 'pre-buy inspections') can become a seller’s nightmare- generating a laundry list of nits that eat into the purchase price. In a worst-case scenario (for a seller) the inspection identifies an airworthiness item (such as corrosion) that scares off the buyer and leaves the seller with a large- mandatory repair job.

ii) Delivery condition: What does the buyer expect from the inspection? The simplest offer letter says that the inspection outcome will be to the buyer’s sole satisfaction. That gives the buyer a free pass to walk away from the deal since most inspections will find a squawk or two. An easy walk-away may be acceptable in the earliest and lightest inspections- since neither party will have much invested in the deal.

However- if this walk-away standard is applied to a full pre-buy- the airplane seller risks having his aircraft handed back to him unsold- with a list of squawks- some of which may need to be addressed to restore the aircraft to service. By the time an aircraft goes to pre-buy- the seller will expect the buyer to have some 'skin' in the game – either a forfeitable deposit- or a binding- conditional obligation to buy the aircraft.

There are a multitude of options to balance the interests of sellers and buyers- including definitional standards (e.g. 'all systems will be functioning within manufacturer standards-' or 'no defects or deficiencies affecting airworthiness-' or 'all items on the aircraft’s minimum equipment list will be functioning')- or dollar thresholds ('seller to pay up to $X of repairs for airworthiness items”).

There is no 'correct' or 'standard' delivery condition; rather it is based on the buyer’s tolerance for risk and a corresponding adjustment of price.

iii) Scheduling: In order to keep a deal on track- it is important to set specific dates (or days) for the completion of various steps. Inspections- definitive documentation and closing can all be placed on a firm schedule. Keep in mind that the ability to perform a formal inspection will depend on the availability of inspection 'slots' at a repair facility.

iv) Financing contingencies: Most sellers will resist- but if the buyer’s ability to buy the used aircraft hinges on getting third party financing- then this needs to be explicit.

v) Assignability of the purchase rights: A buyer may choose to have the aircraft owned by a corporate affiliate- or by an ownership trust. Sellers should not object to an assignment to an affiliated entity- but they can and will object to an assignment of the contract ('flip') to an unaffiliated party.

vi) Removal of the aircraft from the market: Before a buyer is willing to invest in inspections- fuel and flight crew- the buyer will want some assurance that it has priority to acquire the business jet aircraft for sale- and will not be trumped by another offer. This all works against the seller’s interests because other prospective buyers will begin to look elsewhere. Any priority that is given to the buyer will be limited in duration- and the buyer must have a clear accept/reject obligation.

vii) Deposits: A deposit placed with an impartial agent generally lives two lives in a successful aircraft sale. Initially- the deposit is a 'good faith- refundable' deposit established to prove the financial capacity and willingness of the buyer. In exchange for the deposit- the seller will usually take the aircraft off the market.

The initial deposit may be used by the seller to satisfy inspection costs if the buyer fails to do so. Otherwise- at the offer letter phase- the deposit is refunded if the buyer declines to buy the jet aircraft for sale.

As the transaction proceeds to a definitive purchase agreement- the deposit evolves into a true security deposit that secures the buyer’s obligation to perform under the agreement.

4. CONCLUSION
Essentially- an offer letter is a deceptively complex document. Although it may not be necessary to have an attorney involved in every offer you make- an airplane buyer and seller should be well versed on the legal and practical consequences of the offer.

The 'man behind the curtain' in all of these situations is the threat of litigation and the possibility of an adverse judgment. If- at some point- a used airplane buyer or seller does not want to buy or sell an aircraft- but they have not provided an 'out' in the paperwork- the other party may have a claim.

A seller could ask a court to force the buyer to purchase the aircraft (specific performance)- or make up the difference if the seller is required to take a lower price. Conversely- a buyer may ask a court to force the seller to sell the aircraft- or to make up the difference if the buyer is required to purchase a substitute airplane at a higher price.

In most cases of commercial disagreement- the parties find a way to work things out amicably- factoring in the cost and distraction of litigation. However- in an aircraft transaction the risk of litigation is enhanced because:

1. The value of the asset is so great
2. Its market value can fluctuate significantly over short periods of time
3. The parties may not have a long-term commercial relationship to preserve
4. The inspection process and rejection of an aircraft can generate large expenses and cause devaluation of the aircraft to the seller
5. Escrowed deposit funds often end up frozen pending final resolution making it impossible for the parties to walk away
6. Third parties like brokers and inspection facilities may stake a claim that forces the parties into litigation

A well-conceived offer letter can greatly reduce the risk of litigation- and provide a roadmap for the remainder of the deal.

Greg Cirillo is a Partner with the law firm Wiley Rein & Fielding- LLP- practicing in their McLean- Virginia office. The Aerospace & Aviation Group at WRF provides legal counsel to buyers- sellers and financiers of business and commercial aircraft. The statements herein are believed to be accurate and current; but they may be or become inaccurate due to changes in law and interpretations. Please consult your legal and tax advisor(s) before undertaking any transaction of the type discussed.

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