Denial; Anger; Bargaining; Depression; Acceptance: The five stages of loss apply to a great many human situations including our internalization of the new economic order. The sooner we ‘Accept’ our new economic world- the sooner we will see a return to a dynamic market. The decade of boom years in used aircraft sales led to a gradual evolution in how aircraft transactions were done. Soon we will muse nostalgically of the time when buyers paid more for ...
THE NEW NEGOTIATING PARADIGM...
Denial; Anger; Bargaining; Depression; Acceptance: The five stages of loss apply to a great many human situations including our internalization of the new economic order. The sooner we ‘Accept’ our new economic world- the sooner we will see a return to a dynamic market.
The decade of boom years in used aircraft sales led to a gradual evolution in how aircraft transactions were done. Soon we will muse nostalgically of the time when buyers paid more for lightly used aircraft than new ones simply to avoid the two or three year waiting period for new aircraft deliveries. At that time- sellers could dictate most of the sale terms because- in the end- there was always another buyer.
The transaction standards from that era no longer apply- and new norms are developing.
THE NEW MARKET CONDITIONS
In early 2009- the number of sellers in the business aviation marketplace greatly outnumbers the pool of ready- willing and able buyers. In addition to aircraft openly available on the market- there is a looming aircraft inventory off market- waiting for financing to return; and a growing list of delivery positions that have been abandoned- or are being held by parties with no desire or intention to take delivery.
Demand is being suppressed by a few intersecting factors:
• There is the recent- irrational disdain for business aircraft that has captured the imaginations of our elected officials- and which requires any publicly traded company to justify (or dump) their aircraft.
• There is the general and legitimate uncertainty in the economy that leads many to cut their flight departments to reduce costs.
• And there is the shortage of reasonable financing. Even if a lender has the capacity to lend- and is comfortable with the borrower- lenders concerned about declining aircraft values are lending on very low loan-to-value ratios (70% or less).
• Finally- the current market has a gross mismatch of buyer/seller enthusiasm. Sellers are pressed to sell quickly due to immediate financial needs and public relations pressures- while buyers are hesitant and concerned that aircraft values might drop five or ten percent from the time the contract is signed to the closing date.
NEW TRANSACTION TERMS
Deposits – higher or lower; harder or softer:
In a buyer’s market- you might think deposit amounts are going to go down (favoring the buyer). That is not necessarily the case. First- with aircraft values in a tailspin- there is a risk that a buyer may choose to forfeit a small deposit if the buyer finds an aircraft that is so much less expensive that the loss of the deposit is justified.
Therefore- a seller should seek a deposit that truly keeps the buyer committed at the agreed price. In this market- sellers would rather have a sale than a deposit.
Second- a substantial deposit will allow the seller to filter out the dilatants – and in a down market there are many speculators. With the relative unavailability of credit- the seller needs to find a capable buyer. Now more than ever before- sellers should conduct extensive due diligence on their buyers to not lose precious weeks dealing with a buyer that cannot ultimately close the deal.
Buyers will want ‘soft’ (liberally refundable) deposits so they can keep their options open- especially in a declining market. Sellers will- of course- prefer the opposite. When a deposit goes ‘hard’ (non-refundable) is ultimately determined by negotiation- and in this market- a well-qualified buyer can extract significant flexibility.
Financing contingencies – the unthinkable:
Only a few months ago it was inconceivable to include contract provisions making a purchase obligation contingent on the buyer obtaining reasonable financing. At this point- such a contingency is almost a necessity from the buyer’s perspective (unless the consequences of a breach are small- or if the buyer can pay cash). The risk of not being able to find financing may be a risk that both parties need to share.
Lenders have become scarce and unpredictable. Qualified buyers may not be able to secure financing- and that may come late in the transaction- in the form of an insufficient appraisal. Even if a financing contingency is accepted- the seller should negotiate some protection. The transaction documents should require the buyer to make a good faith effort to finance the deal- and the seller needs to be able to observe the process. If the financing falls through and the buyer is permitted to walk away as a result- the seller should be entitled to some consideration- perhaps in the form of a partial forfeiture of the deposit.
In recent years- buyers expected aircraft to be delivered in nearly perfect condition with “all systems operational” and current on all maintenance. Times have changed. Some sellers are under a mandate to sell the aircraft with no further investment. Sellers that are in bankruptcy generally cannot make any meaningful investment to rectify discrepancies- or even pay to ferry the aircraft- so the buyer has to step up for some costs and expect to be made whole by an offset to the purchase price at closing.
A rapid closing generally favors a seller- so in a buyer’s market you would expect transactions to take longer (deeper inspections and lengthier negotiations over rectification). However- a smart seller will press for a fast closing- and should be willing to sacrifice price to gain speed. This is particularly true in a market with declining values.
When a seller is not willing or able to remedy identified discrepancies- closing takes place sooner- with the buyer taking the time to rectify the discrepancies post-closing. Motivated sellers should price aggressively- keeping the transaction on a very short leash with specific timeframes for each step. This is not a good time to argue over whether a $10-000 repair is required under the agreed delivery condition.
As the market cools- sellers (and buyers) need to look more closely at the remedies that they have given themselves in the event the other party breaches. Oddly- we have seen contracts where both parties have limited remedies to the forfeiture or return of deposits. Needless to say- this is a hollow remedy for the buyer since the seller has not made a deposit.
In fact- you could argue that there never was a binding purchase agreement in such case- but instead simply an option to sell at the seller’s discretion. The buyer needs the right of specific performance (forcing the seller to sell as agreed) in addition to return of the deposit.
In the glory days of aircraft sales- when a buyer defaulted- a seller would happily take the deposit and waive any other remedies- because the seller could put the aircraft back on the market and sell it quickly to another buyer. Sellers should now want the ability to force the buyer to purchase the aircraft at the agreed price. Of course- buyers will resist agreeing to this remedy if they are mindful of the situation.
WORKING WITH A WEAK SELLER
Many sellers are in financial distress. This creates several key risks that should be considered and- if possible- addressed.
Aircraft condition redux:
Depending upon how long the seller has been in distress- the aircraft may fall into arrears on deferrable and discretionary maintenance and repair. This can be resolved by purchase price adjustments- but you do need to enter the transaction with a high level of caution and due diligence.
Liens- warranties and service agreements:
Distressed sellers often fail to pay service providers (MROs- management companies- FBOs and even government fees). In addition to traditional- recorded liens- you need to clear out the possibility of non-recorded- statutory liens. Similarly- the vitality of aircraft warranties- software licenses or pre-paid/flat-rate service contracts may be in jeopardy if the seller has suspended payments.
Part of your due diligence should include identifying and contacting each of these parties to determine if money is owed. The closing should include (if needed) distributions of the purchase price to bring these parties current and to ensure clear title and effective warranties and service agreements.
With a struggling seller- the terms of the closing escrow are critical. Any lien (including potential liens arising before closing) and any closing fees or seller payments due at or after closing should be paid out of the escrow. You have to assume that the seller cannot and/or will not be of any assistance to you post-closing. The escrow should include key documents (warranty assignments- licenses and records) so that you have unfettered rights at and after closing.
Keep in mind that you may be paying a purchase price that is less than the balance owed to a lender or others. If this is the case- the seller needs to fund the escrow before closing in an amount sufficient to cover the deficiency- plus all of the closing obligations and costs. Make sure that the facility that did the final work on the aircraft has been paid (or will be paid at closing).
BANKRUPTCY - THE ELEPHANT IN THE ROOM
The bankrupt seller: If a seller is bankrupt from the outset of the transaction- you are simply dealing with a reorganizing or liquidating entity. In many cases the seller is managed by the same executives that managed pre-bankruptcy- in which event the transaction will proceed normally- subject to bankruptcy court approval. Management authority is often shuffled immediately after a bankruptcy- so make sure that you are dealing with a person who is authorized to negotiate the sale.
Once you have a signed deal- it will be contingent upon approval by the applicable bankruptcy court. This approval might create some delay (particularly if there is any creditor objection)- but the approved transaction results in an asset that is judicially cleared of any adverse claims. Do not expect a bankrupt seller to invest much in the transaction (either in ferry flights or repairs). The creditors just want the asset sold without further investment or delay.
If a seller files for bankruptcy post-closing- there is a chance that the transaction could be unwound or renegotiated if it was unduly preferential and unfair to the creditors. If the transaction is truly at arm’s length- with market terms- then this is very unlikely. However- if the buyer was an ‘insider’ or affiliate- it is possible that the transaction will be scrutinized to see if the seller was fairly treated. For example- if the aircraft is to be sold to a key executive- a founder or an affiliated company- the selling company creditors are going to scrutinize the transaction to see if the company received full value.
If the seller files for bankruptcy mid-transaction- the buyer could be in for quite a ride. Any unfulfilled obligation of the bankrupt seller (like your pending purchase transaction) at the moment of bankruptcy becomes avoidable by the seller- so the purchase could be unwound. I
In most cases- the bankrupt entity will want the aircraft sold- and the deal should get done and approved by the bankruptcy court. However- if the transaction comes under scrutiny by creditors or the seller itself- there will be inevitable delay- and possible rejection of the contract- leaving the buyer with limited remedies.
In most cases- the ‘stay’ in bankruptcy law prevents a buyer from declaring a breach of the agreement (for delay or otherwise)- and a buyer will be forced to ride out the process.
Greg Cirillo is a partner and Gary Horowitz a Special Counsel with the Washington- D.C. law firm Wiley Rein LLP- representing private and commercial operators- owners- lessors and financiers in structuring the sale- acquisition- ownership and operation of aircraft- and providing Federal tax and state sales and use tax planning services.
Greg can be reached at Tel: +1 703-905-2800- email firstname.lastname@example.org.
Gary can be reached at Tel: +1 703-905-2845- email: email@example.com