In this series of aviation articles- we have explored the various ways to secure the exclusive use of a business aircraft. This article discusses the negotiation and documentation of a loan to purchase a business aircraft.
A typical loan used to finance the purchase of an aircraft includes the following documents:
• Letter of Intent or Term Sheet: This document is prepared by your bank to outline and summarize the terms of the deal. If the loan transaction proceeds- this document is superseded by the documents below.
• Loan Agreement: This is the primary document in the transaction that sets out all of the terms of the loan (amount- interest rate- repayment terms and all of the legal boilerplate). Often this document is combined with the following document into a 'Loan and Security Agreement.'
• Security Agreement or Mortgage: This document creates the lien in favor of the bank permitting foreclosure against the aircraft. This document may also include detailed instructions on how the aircraft is to be maintained and operated- and the bank’s authority to examine the aircraft to confirm compliance with these requirements.
In a more complex loan structure- the following documents also may be employed:
• Guaranty: In certain cases- the bank may want the support of a guaranty from either a corporate affiliate (often the parent company) or an individual.
• Assignment of Lease: When the aircraft owner/ borrower is not going to be the principal operator of the aircraft (for example- if the aircraft is being purchased for lease to another person or entity)- the bank should seek a collateral assignment of the owner/borrower of its interest in that lease. This will allow the bank to step into the shoes of the owner/borrower if there is a default on the loan.
Negotiations: Why Negotiate?
All loan documents are negotiable. In addition to simply getting the deal correct- many provisions in loan documents need to be customized to your corporate structure. Moreover- many documents 'out-of-the-box' are overreaching and unduly favorable to the bank. Most of what you should be negotiating over will be: (a) fee provisions that could cost you money during the term of the loan (over and above principal and interest)- (b) provisions that conflict with your other financings or commercial arrangements- and (c) provisions that leave you unduly disadvantaged in the event of a default.
Nobody likes to discuss provisions that apply solely in the event of default (because nobody wants to suggest that default is even a remote possibility); however- the small concessions that you win in negotiating your loan documents can go a long way in preserving your corporate or personal financial position in the event that things turn sour in the future. Negotiation establishes a fair balance between the bank’s need to be secure- and your need to give up no more of your future flexibility than is necessary.
Negotiating the Letter of Intent
The first mistake most aircraft buyers make is failing to involve their advisory team (legal and financial) in the negotiation of the letter of intent. Once a provision is in –or is omitted from— a letter of intent- it can be difficult to remedy the situation. The letter of intent is ordinarily approved by the bank’s credit officers or credit committee- and significant changes may require re-approval. The bank’s obligation to make a loan to you will evaporate if you look for changes that deviate from the letter of intent.
Some key points (in addition to basic loan terms) that should be addressed in your term sheet include:
• A comprehensive statement of all costs and fees that the borrower is to pay in connection with the loan- including appraisal costs- origination fees- aircraft inspection costs (at the outset and during the loan term)- bank’s documentation fees- bank’s consulting/underwriting fees and the bank’s legal fees.
• The principal conditions to be satisfied by the borrower and the bank prior to closing of the loan.
• Any prepayment or break-funding fees or penalties.
• All credit enhancements (guarantees- deposits- co-signers or letters of credit) that the bank is seeking.
Negotiating Loan Documents in General:
The first step in reviewing and negotiating your loan documents is to simply confirm that the documents faithfully reflect the terms set forth in the Letter of Intent. Often in drafting the documents- a key term can get dropped or misunderstood. Letters of Intent tend to be informal and non-legalistic- so the translation to a legal document can introduce errors. The Bank’s counsel will interpret any ambiguity in the Letter of Intent in a way that protects his or her client. You and your counsel should be prepared to balance the interpretations.
Do not be shy. Do not fear that it is unreasonable to severely mark up a bank’s documents. For experienced borrowers- that is the norm. To preserve friendly relations with the bank officer- have your attorney play 'bad cop' on difficult issues when negotiating with the bank.
Negotiating the Loan Agreement:
The negotiation of an aircraft loan document is no different than negotiating any other loan agreement. You should focus on issues that will result in surprise costs or penalties. Also scour the document for impractical clauses. For example- if a payment comes due on a holiday or weekend- a bank document may require that this payment come on the business day before the holiday or weekend. As a practical matter- it is much easier (and customary) for the borrower to make payment on the next occurring business day. You do not want to be in technical default over trivial issues.
Consider how this loan document meshes with your other loan and commercial agreements. While corporate aircraft are important assets- you want to make every effort to keep the aircraft financing from impairing your corporate finance options. Keep in mind that- even before the accounting shake-out following Enron- any commitment by one corporate entity to guaranty or otherwise support payment by an affiliate will affect the financial statements of the supporting company.
Negotiating the Security Agreement / Mortage:
This document will have the most aircraft-oriented clauses. In addition to creating the legal lien on the aircraft- the mortgage will contain provisions that protect the collateral value of the aircraft. It will include a requirement that you insure the aircraft at a certain value level (naming the bank as the recipient of payment if the aircraft is severely damaged or destroyed). It will include specific requirements on aircraft maintenance and repair and compliance with airworthiness directives issued with respect to the type.
It may require the payment of reserves to ensure the availability of funds for maintenance and repair. The mortgage will establish the bank’s right to examine the aircraft and its records to confirm the borrower’s compliance with all of the above. The mortgage may limit how you use the aircraft (i.e. restricting it to corporate use- and prohibiting use in specific geographic areas).
All of these points need to be considered in light of all facts. For example- perhaps the insurance levels can be reduced as the loan is paid down. It is important that the provisions relating to maintenance and airworthiness directive compliance reflect the full flexibility you have (under law and under manufacturer maintenance programs) to defer compliance- select alternative means of compliance- or comply in phases. Limits on manner of use need to match your expectations.
Most banks will let you put your corporate jet into charter use for others (quasi-commercial)- and your loan documents should reflect this. Keep an eye out for open ended charge-backs. Often a bank will reserve the right to review the aircraft or its records and charge you for its costs in doing so. Unless this review reveals a default- a borrower should not be forced to pay for it.
Mortgages are filed with the FAA Civil Aircraft Registry- and become public record. Both the borrower and the bank will benefit if commercial terms are omitted from the publicly filed document. Redaction of commercial information is permitted- but must be done in a way that clears FAA review. Finally- mortgage filings are a perpetual encumbrance on the airframe and engines of a business jet (they do not expire like UCC filings)- so when the loan is satisfied- it is important to obtain a termination from the bank.
Negotiating Guarantees and Other Ancillary Documents:
Guarantees and other ancillary documents (such as collateral assignments of leases) are highly customized documents. It is important to give the bank the support it needs- but without being overly generous. For example- if a guaranty is unavoidable- then negotiate a dollar limit to the guaranty. Also try to negotiate a point when the guaranty automatically terminates- such as a calendar date- or a reduction in the loan balance. Any other pledged assets or rights (such as maintenance reserves) can also be limited or reduced over time or as the loan balance reduces.
From Signing to Closing:
When you sign your loan documents- you set in motion a process that must be followed to closing. Work with your advisors to gather the information identified by the bank as conditions to closing. The funding of your loan is often an integral part of a larger aircraft purchase- and a hiccup in funding can trigger a default on your purchase agreements. Work closely with your bank so that timely funding is the least of your worries at the time of closing.
If your loan is tied to a purchase of an aircraft- then the bank’s lien documents (the mortgage- lease and collateral assignment of lease) need to be positioned for filing at the moment of closing and in advance of funding. You will need to coordinate the actions of the bank- the seller and any other participant in the transaction to ensure a timely closing.
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.