Julian Reddyhough, Maples and Calder (May 20, 2003)
by Julian Reddyhough, Partner, Maples and Calder (May 20, 2003)
The Cayman Islands has become the leading offshore jurisdiction for the citing of offshore owner/lessor/securitisation SPCs in asset finance transactions. We believe that over the last ten years, approximately, 20% of the output of the principal two long range commercial aircraft manufacturers are financed through Cayman Islands structures.
AIRCRAFT FINANCING STRUCTURES
The typical offshore structure vests ownership of the aircraft with an SPC which acquires the aircraft through funding by way of loan from the lender. The aircraft is then leased to the airline. The SPC would typically be established as an off-balance sheet vehicle with its issued share capital held by an off-shore trust company on charitable trust. The lender will take security over the aircraft, over the SPCs rights as lessor and usually over the issued share capital of the SPC itself.
The attraction of the structure from a lenders perspective is as follows:
- Ownership of the aircraft does not vest with the airline but with an SPC owned and controlled by a trust company which holds title in an off-balance sheet capacity. Ownership therefore vests in a vehicle which is unlikely to be hostile to the lender in a default scenario when the lender seeks to enforce its security. From the lender's perspective this ownership arrangement provides the lender with advantages that are closer to those that would come from retaining title to the aircraft itself whilst avoiding the consolidation of the aircraft on its own balance sheet. The assignment by the SPC of its rights under the lease with the airline will also give the lender effective control of the enforcement of the SPCs rights as against the airline under the lease.
- In the event of a default, if the lender seeks deregistration in the airline's jurisdiction the lender should be able to count on the exercise of the owner's deregistration rights rather than having to rely solely on a mortgagees rights. Certain jurisdictions do not recognise the mortgagees right to deregister and may otherwise limit the mortgagees remedies (for example to a local judicial sale) thus making exclusive reliance on a mortgagees rights potentially unsatisfactory.
- The principal loan and security documentation will be entered into by the SPC rather than by the airline, thus avoiding potential enforcement problems in the airline's own jurisdiction where the legal system may be very different from the English or American system. The Cayman Islands, for example, is a common law jurisdiction (where English common law will be of persuasive authority) and the basis legal framework will be instantly recognisable to the English practitioner. The "unfamiliar legal system" consideration alone has led to the offshore structuring in the Cayman Islands of transactions for airlines in the People's Republic of China where the relevant airlines have been permitted to establish the SPCs as on balance sheet vehicles.
- In addition to legal certainty, ownership of the aircraft will be in a jurisdiction with political, economic and social stability which may give comfort to a lender in cases where the airline is based in the jurisdiction where this is an area of perceived risk.
- Ownership of the aircraft will vest in a bankruptcy-remote structure which should be unaffected by the bankruptcy of the airline, thus avoiding the significant difficulties that could arise if title to the aircraft vested with the airline directly or in a special purpose subsidiary or affiliate established by it.
- Taxation, or more properly the absence of taxation, and therefore the absence of withholding tax on account of any charge to tax is the principal reason for establishing the SPC in an offshore jurisdiction. The Cayman Islands currently have no legislation that provides direct forms of taxation. Accordingly the adoption of an offshore leasing structure in the Cayman Islands is entirely tax neutral. In order to give comfort that the no-tax regime will continue, the SPC may obtain from the Cayman Islands Government a guarantee against the imposition of future taxation, known as the "undertaking as to tax concessions", which undertakes to exempt the recipient SPC and its shareholders from most forms of taxation if introduced in the Cayman Islands during the relevant period. The undertaking is usually issued for a 20 year period but this may be extended to up to 30 years where required for a particular transaction. Thus, the lender may be assured not only that the SPC structure will not involve adverse tax consequences based on current legislation but that that will remain the situation for the duration of the transaction.
THE OFFSHORE ARRANGEMENTS
Ownership of the SPC
- The issued share capital of the SPC (typically nominal) will be registered in the name of a local trust company as trustee of a charitable trust established pursuant to a declaration of trust executed by the trustee. From a corporate perspective the SPC is not consolidated with the lender, the airline or the trustee. The trustee will usually be the same entity that serves as administrator.
- Typical powers or discretions included in the charitable trust would restrict any disposition of the shares of the SPC or its winding up. These tend to be drafted as provisions prohibiting the trustee from taking such actions without the consent of the lender. This is usually not thought to be a degree of control that would give a lender control or consolidation issues in its home jurisdiction.
- Following the termination of the transaction the trust will terminate and the trust property (namely, the net asset value of the SPC, which will be the issued share capital and any transaction fees earned by the SPC net of expenses) will be distributed by the trustees to such one or more charities.
- The SPC will enter into an administration or management agreement, usually with the trustee as administrator. The agreement will set out the services to be provided by the administrator to the SPC. The principal service will be to provide directors and officers. It may be convenient to include the lender as an additional party to this agreement to take covenants from the administrator in respect of the business and management of the SPC which the lender may then enforce.
- As a commercial matter, the lender should not be so aggressive in its demands to control the SPC that it risks the SPC being regarded as a nominee or agent of the lender and disregarded as a separate legal entity, or that it falls within controlled foreign company legislation in the UK or within equivalent legislation in other jurisdictions.
- If there is no other provision in the transaction documentation to meet the SPC's ongoing fees and expenses (for example, through the payment of additional rent under the lease) the airline (which is usually the party responsible for meeting offshore costs) may be included as an additional party to the administration agreement to provide an expenses undertaking.
- The SPC will usually grant security over the aircraft in the form of a mortgage and will always grant security over its rights under the lease with the airline which will allow the lender to enforce directly the rights of the SPC as against the airline on a default. The SPC will typically also grant a deregistration power of attorney permitting the lender, acting in the name of the SPC, to deregister the aircraft on a default. A Cayman Islands law governed power of attorney when granted to secure an obligation owed to a lender will be irrevocable until that obligation is discharged.
- Frequently, the lender will also take security over the issued share capital of the SPC which will give the lender the ability to take control of the SPC on a default.
- The share charge granted by the trustee of the trust will differ in a few respects from a security granted by a parent in respect of its on-balance sheet subsidiary. These differences reflect that the trustee's role is that of a service provider rather than a commercial transaction party. It also reflects that a default is likely to be triggered by a default by the airline rather than by any default on the part of the SPC or the trustee. These differences will include a provision that each party will bear its own expenses rather than imposing an obligation on the part of the administrator as chargor to meet the expenses of the lender. It is also inappropriate to place on the trustee any obligation, whether as primary obligor or as guarantor, in respect of the SPC's payment obligations.
- The trust arrangements in respect of the issued share capital of the SPC will need to accommodate the security either by express permissive provisions or by the "flawed asset" approach providing that the shares are settled on the trust subject to the security.
- As an alternative to security, the lender may consider a call option arrangement requiring the trustee to transfer the shares to the lender on request and usually on payment of par value.
Limited Recourse and Commercial Benefit
- The SPC is a corporate entity and its directors will be subject to the typical common law fiduciary duties. Of primary relevance here is the duty of a director to act in what he believes to be his SPC's commercial interests.
- In determining the level of benefit or fee payable to the SPC the directors may be expected to undertake the usual risk-reward analysis: that is, the directors will want to satisfy themselves that the profit opportunity or fee payable to the SPC is commensurate with the perceived risk assumed.
- The importance of directors' duties for the other transaction parties is well established in common law jurisdictions. The risk is that other transaction parties, if fixed with actual or constructive knowledge of any breach of duty, may find themselves unable to enforce their contractual rights as against the SPC at the instigation of a liquidator or third party creditor.
- The solution, which avoids either a breach of duty or the payment of significant transaction fees to the company to balance the commercial risk of the assumption of open-ended loan repayment obligations, is to limit those obligations both in amount and recourse to the value of the security granted. As the SPC will grant security over all its material assets (namely, the aircraft and its rights under the lease) the lender is not being deprived of recourse against any significant asset. As the potential or theoretical downside to the SPC is limited to the loss of assets it would not have had had it not participated in the transaction and with no prospect of insolvency, the directors typically take the view that a modest transaction fee is appropriate.
OTHER TRANSACTION STRUCTURES
- The Cayman Islands also sees significant numbers of on-balance sheet subsidiaries established for onshore banks and leasing companies for finance and operating lease structures and for warehousing arrangements.
- The Cayman Islands is the jurisdiction of choice for many innovative structures including ownership and leasing through trust structures, exempted limited partnerships (securing pass-through tax treatment and favourable capital tax allowances for limited partners).
LOCAL AIRCRAFT REGISTRATION
The Cayman Islands is a popular jurisdiction for the registration of private aircraft.
The Cayman Islands is a popular jurisdiction for the registration of ship owning companies, whether those ships are flagged in the Cayman Islands or elsewhere.
The Cayman Islands is a popular jurisdiction for the establishment of joint venture vehicles for the financing, ownership and chartering of commercial tonnage, including VLCCs, through corporate or trust structures.
The port of George Town, Grand Cayman, is a port of British registry offering the attractions of British registration in a tax neutral environment. The port of George Town is a leading port of registry for private "mega-yachts" in addition to commercial tonnage.
The Cayman Islands is the jurisdiction of choice for the establishment of securitisation vehicles for industry members including the securitisation of rental income from aircraft leasing portfolios and credit card receivable securitisations from airline ticket sales. The rating agencies are comfortable and familiar with the rating of debt issued by Cayman Islands SPCs, the local capital markets industry being another cornerstone of the Cayman Islands financial industry.
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