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Can Emergency Government or Regulatory Rules Frustrate Aircraft Leases? 

by Shoosmiths LLP

Published: July, 2021

Submission: July, 2021

 



The High Court has considered emergency response measures affecting the aviation sector. In two recent cases, aircraft lessors tried to enforce their lessees’ payment obligations, but were met with arguments that the leases had been frustrated.


A contract is frustrated when an event arises after its formation and renders performance impossible, illegal or radically different from that which the parties had contemplated. Frustration may discharge them from their contractual obligations.


In SalamAir SAOC v LATAM Airlines Group SA concerned the Omani government’s March 2020 decision to prohibit all passenger flights to or from Oman, in response to COVID-19. The Omani airline, SalamAir, was unable to operate its aircraft or generate revenue from them.


LATAM had supplied the aircraft to SalamAir in 2017 under three 6-year dry leases, each subject to English law and containing a “hell or high-water” clause making SalamAir’s obligation to maintain rental payments ‘absolute and unconditional irrespective of any contingency whatsoever’.


SalamAir failed to pay rentals from March 2020 onwards. By June 2020, LATAM had entered Chapter 11 bankruptcy in the USA and terminated the leases. After negotiations between the parties failed, LATAM took redelivery of the aircraft and prepared demands under three Standby Letters of Credit (“SLCs”) that SalamAir had provided as security. SalamAir applied to the High Court for an injunction to restrain LATAM from making the demands, on the grounds that the leases had been frustrated by the Omani government’s COVID-19 measures.


According to SalamAir’s evidence in support of the application, before entering the leases it had shared its business plan with LATAM, who had required SalamAir to operate the aircraft from Muscat (“the Muscat Condition”). SalamAir argued that the purpose of each lease had therefore been to enable it to operate the aircraft commercially, but that purpose had been frustrated.


The court dismissed SalamAir’s application for the following reasons:


  • The well-established status of SLCs in English banking law (as being equivalent to cash) meant their independence should be guaranteed except unless there were exceptional circumstances. SalamAir therefore needed to show a strong case for interfering with the SLCs, not just an arguable case (being the normal standard for an injunction).
  • SalamAir’s case was not strong, because several lease provisions contradicted the notion that the parties’ common purpose had been to ensure the commercial operation of the aircraft. In particular, the hell or high-water clause was fundamentally inconsistent with such a purpose. It had not mattered to the lessor, LATAM, whether SalamAir operated the aircraft at all; the Muscat Condition had only reflected LATAM’s interest in ‘the physical safety of the aircraft, and in ensuring that [they] can be safely and efficiently repossessed if it is necessary to do so.
  • Commercially, SalamAir had taken on all of the risks and rewards of operating the aircraft, whereas in return LATAM was only obliged to ensure quiet possession.
  • The hell or high-water clause was inconsistent with the idea of the COVID-19 restrictions having effectively ended the leases and discharged SalamAir from its rental payment obligation.

Wilmington Trust SP Services (Dublin) Limited & Others v SpiceJet Limited concerned the Indian Directorate of Civil Aviation’s 2019 decision to ground Boeing 737-MAX aircraft following two crashes attributed to flaws in the model’s flight control software (“DGCA Decision”).


he Indian airline SpiceJet was unable to fly two Boeing 737-MAX, leased from Wilmington Trust in 2018, and inhibited by COVID-19 flight restrictions affecting a Boeing 737-800 aircraft, leased from Wilmington Trust in 2013. Consequently, SpiceJet defaulted in its rent and maintenance payments, prompting Wilmington Trust to commence proceedings for payment of the sums due and apply for summary judgment.


SpiceJet opposed the application, saying it had a defence to the claim because (amongst other things) two 10-year dry leases for the Boeing 737-MAX aircraft had been frustrated by the DGCA Decision (unlike its counterparts around the world, DGCA’s ban continues; SpiceJet did not argue that the earlier lease had been frustrated by the COVID-19 restrictions).


Unlike SalamAir, the court favoured SpiceJet’s argument that the leases’ common purpose had been the provision of aircraft for commercial operation. Notably, the leases permitted SpiceJet to sub-let the aircraft to commercial air carriers or operators only.


Wilmington Trust relied on the hell or high-water clause, which said SpiceAir’s obligation to pay rent was ‘absolute and unconditional’ and ‘shall not be affected or reduced by any circumstances, including, without limitation: …(ii) …airworthiness or eligibility for registration under Applicable Law…’ While the court said this wording did not preclude the possibility of frustration in the circumstances experienced by SpiceJet, the specific reference to airworthiness meant it had assumed the corresponding risk, despite manufacturing defects having later prompted the DGCA Decision.


It followed that if SpiceJet was not relieved of its obligation to pay in the event of the aircraft’s total loss, there was no justification for relieving it after the DGCA Decision had temporarily deprived SpiceJet of the aircraft. The court also opined that the Boeing 737-MAX ban had only affected 10% of the leasing periods. The indefinite nature of the DGCA ban raises the possibility that the court might have decided differently, if presented with the same case later on in the leasing periods.


Despite entering judgment for Wilmington Trust, the court granted a stay of execution for SpiceJet, so that the parties could attempt ADR. Enforcing the judgment would probably have forced SpiceJet into a formal insolvency process, so a negotiated resolution offered the lessor a better chance of recovering the moneys owed.


Both cases illustrate that in the current climate, while frustration arguments may be raised in litigation, the test remains exacting and the court may only find a contract has been frustrated in the most exceptional circumstances. The decisions provide welcome confirmation for aircraft lessors that the English courts will uphold hell or high-water clauses, even where supervening official measures have decimated their lessees’ businesses. SalamAir was also an important reminder that the courts invariably decline to interfere with letters of credit.


 



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