Aviation insurance in the context of leasing and financing Heather Wilmot, Director Norton Rose South Africa
Introduction Growth of air travel = new aircraft Pressure on airlines to upgrade fleet more frequently Environmental (emissions tax schemes) New and additional aircraft are very expensive Ownership in aircraft and engines has passed from airlines to finance companies: Banks Leasing companies Banks / lessors need security for repayment of loan Insurance is one form of security Insurance is NOT a guarantee How does insurance fit in in the context of financing and leasing? How, when and in what circumstances is a bank / lessor entitled to insurance cover?
Basic acquisition options Acquisition options: 1. Purchase with own financial resources or external non-aircraft related sources, e.g. capital markets 1. Leasing company / Operating lease Airline leases aircraft from lessor Lessor retains ownership Lessor has an interest in the rental and the residual value of the aircraft Lessor will want many types of security including insurance cover 2. Finance lease Bank owns aircraft until repayment of loan Bank has an interest in the repayment of the loan and the aircraft as security Bank will want many types of security including insurance cover Factors considered when determining appropriate option: Tax Accounting Insolvency Local aviation authority Instruments of security, e.g. mortgages, international interests (Cape Town Convention)
Basic financing structure Loan Banks Manufacturer Mortgage, Assignment of Lease and Insurances Purchase Agreement Lease Lessor / SPC Purchase Agreement Assignment Assignment of Insurances Airframe and Engine Warranties Airline
An insurer s role How does insurance fit in in the context of financing and leasing? How, when and in what circumstances is a bank / lessor entitled to insurance cover? Aircraft = main form of security for repayment of loan / rentals Mobile by nature = significant risk of disappearance or destruction Additional security must be put in place: Mortgage International Interest (Cape Town Convention) Assignment of lease proceeds Insurance cover Insurance Hull (All Risk and War and Allied Risk) Liability (Passenger and Third Party)
Three main themes of aviation insurance in the context of financing and leasing 1. Hull and Aircraft Spares If aircraft is lost or damage, insurance proceeds (cost of repair or replacement) may be paid directly to bank / lessor What happens if the aircraft is lost due to theft by primary insured (airline) Aka Repossession risk insurance 2. Legal liability Bank / lessor entitled to insurance cover for any claims made against them arising out of the operation of the aircraft, e.g. passenger claims Only covers claims arising in its capacity as bank / lessor, not in any other capacity, e.g. as manufacturer, repairer Does this extend the insurer s risk profile and exposure? The bank / lessor may be located in a plaintiff friendly jurisdiction that has no link with the aircraft or accident. 3. Breach of Warranty Insurance is NOT a guarantee. It is subject to compliance with terms and conditions. Is the bank / lessor still entitled to cover if the airline doesn t comply with the policy? Is the bank / lessor still entitled to cover if the airline misrepresented facts when applying for the policy? What if the bank knows about the airline s non-compliance or misrepresentation?
The position prior to AVN67 Pre-1980 s: Finance and lease documentation much shorter and simpler Most transactions include following obligation on airline: the operator shall ensure that the aircraft is properly insured at all times Breach of Warranty endorsement AVN28, January 1959 Protect innocent party from having its cover voided due to breach by primary insured No extension of cover BOW seen as no extension of cover (Hull) Considered risk of liability to third party on the part of a financier to be nil (Liability) Placement of insurance developed as transactions became more complex Pressure on insurers to consider vast documentation and complex transactions and confirm cover Practice developed where endorsement etc were agreed subject to the policy coverage, terms, conditions and limitations Individual manuscript endorsement Led to uncertainty and dissatisfaction amongst banks, airlines and insurers
AVN67 The Airline / Lease Contract Endorsement February 1991 Attempt to standardise the method and language of cover to financiers for a nominal additional premium Enable insurers to react quickly and confidently to requests for cover Finance / leasing documentation reviewed by broker not underwriter 1. Section 1: Hull and Aircraft Spares Financier / lessor = Contact Party = Loss Payee 2. Section 2: Third Party Liability cover Separates financier / lessor s interests from the interest of the airline Excludes legal liability cover for claims arising out of different capacity, e.g. as manufacturer 3. Section 3: Breach of Warranty protection Applies to all insurances provided under Sections 1 and 2 Knowledge of breach: Provides BOW protection provided that the financier / lessor has no actual or constructive knowledge of the act or omission Misrepresentation or non-disclosure: Does not specifically include cover in the event of a misrepresentation or non-disclosure by the airline Therefore, possibility that if the policy is avoided based on a misrepresentation or non-disclosure, there is no cover for the financier / lessor Criticism of AVN67: Lessors, financiers and brokers were not consulted or involved in development of AVN67 Section 1 could be interpreted to include repossession risk cover (i.e. if the aircraft is lost due to theft by the primary insured) Uncertainty regarding cover where there has been a misrepresentation / non-disclosure Uncertainty regarding knowledge of breach - constructive
AVN67A, May 1993 More inclusive process - numerous parties involved in drafting, including lessors, brokers and lawyers User friendly 1. Section 1: Hull and Aircraft Spares Mirrors Hull and Aircraft Spares Insurance endorsement in AVN67 Financier / lessor = Contact Party = Loss Payee 2. Section 2: Third Party Liability cover Mirrors Legal Liability endorsement in AVN67 Separates financier / lessor s interests from the interest of the airline Excludes legal liability cover for claims arising out of different capacity, e.g. as manufacturer 3. Section 3: Breach of Warranty protection Applies to all insurances provided under Sections 1 and 2 Knowledge of breach: Deletes reference to constructive knowledge Provides BOW protection provided that the financier / lessor has not knowingly condoned the act or omission Misrepresentation or non-disclosure: Specifically includes misrepresentation or non-disclosure by the airline Cover for financier / lessor still valid if there is a misrepresentation or non-disclosure by the airline Criticism of AVN67A: Generally accepted in London market Dissatisfaction on the part of US-based financiers Section 1 could be interpreted to include repossession risk cover (i.e. if the aircraft is lost due to theft by the primary insured) Uncertainty regarding acquisition of knowledge of breach in a capacity other than an financier / lessor, e.g. as manufacturer
AVN67B, October 1994 1. Section 1: Hull and Aircraft Spares Mirrors Hull and Aircraft Spares Insurances endorsement in AVN67 Financier / lessor = Contact Party = Loss Payee 2. Section 2: Third Party Liability cover Mirrors Legal Liability Insurances endorsement in AVN67 Separates financier / lessor s interests from the interest of the airline Excludes legal liability cover for claims arising out of different capacity, e.g. as manufacturer 3. Section 3: Breach of Warranty protection Applies to all insurances provided under Sections 1 and 2 Knowledge of breach: Provides BOW protection provided that the financier / lessor has not knowingly condoned the act or omission Only applies to knowledge obtained in capacity as financier / lessor If knowledge obtained in capacity as e.g. manufacturer, cover still valid Misrepresentation or non-disclosure: Mirrors AVN67A Specifically includes misrepresentation or non-disclosure by the airline Cover for financier / lessor still valid if there is a misrepresentation or non-disclosure by the airline
AVN67A vs AVN67B 1. Section 1: Hull and Aircraft Spares Same basic cover AVN67B: Includes right of insurers to the benefit of salvage 2. Section 2: Third Party Liability cover Same basic cover 3. Section 3: Breach of Warranty protection Knowledge of breach: Neither refer to constructive knowledge AVN67A: No reference to knowledge obtained in another capacity AVN67B: Invalidation of cover only applies when knowledge of a breach is obtained in capacity as financier / lessor; If knowledge of a breach is obtained in another capacity as e.g. manufacturer, the cover is still valid Misrepresentation or non-disclosure: Both expressly include cover in the event of a non-disclosure or misrepresentation
Unintended consequences of AVN67B 1. Hull and Aircraft Spares: Repossession risk insurance cover Section 1 could be interpreted to include repossession risk cover (i.e. if the aircraft is lost due to theft by the primary insured) 2. Legal liability cover: Extension of insurer s risk Section 2 could extend an insurer s risk Claims arising from Air Philippines crash made in the US based on the domicile of the financier and lessor based on negligent entrustment No other jurisdictional link to the US Illinois courts dismissed motions to dismiss due to forum non convenience, and confirmed jurisdiction Insurers obliged to settled claims in terms of US law Form of extra-territorial jurisdiction NB: Insurers to consider domicile of financiers / lessors as may extend risk
AVN67C, August 2007 Preamble Adds obligation to notify insurer if airline is no longer obliged to insured aircraft Simplifies endorsement term 1. Section 1: Hull and Aircraft Spares Financier / lessor = Contact Party = Loss Payee Under section 3 (3.3), specifically excludes cover for loss due to theft by airline 2. Section 2: Third Party Liability cover Separates financier / lessor s interests from the interest of the airline Excludes legal liability cover for claims arising out of different capacity, e.g. as manufacturer Includes legal liability cover for liability to pilots and crew (not employed by insured) 3. Section 3: Breach of Warranty protection Applies to all insurances provided under sections 1 and 2 Repossession Risk Insurance: Excludes cover for loss due to theft by insured Knowledge of breach: Provides BOW protection provided that the financier / lessor has not knowingly condoned the act or omission Only applies to knowledge obtained in capacity as financier / lessor If knowledge obtained in capacity as e.g. manufacturer, cover still valid Includes as Contract Parties lease servicer and managers Misrepresentation or non-disclosure: Same cover as AVB67A and AVN67B Specifically includes misrepresentation or non-disclosure by the airline Cover for financier / lessor still valid if there is a misrepresentation or non-disclosure by the airline
AVN67B vs AVN67C Preamble AVN67C: Adds obligation to notify insurer if airline is no longer obliged to insured aircraft Simplifies endorsement term 1. Section 1: Hull and Aircraft Spares Same basic cover AVB67C: under section 3.3, specifically excludes loss due to theft by insured 2. Section 2: Third Party Liability cover AVN67C: Includes legal liability cover for liability to pilots and crew (not employed by insured) 3. Section 3: Breach of Warranty protection Repossession Risk Insurance: AVN67C: Specifically excludes loss due to theft by insured Knowledge of breach: AVN67C: includes lease servicer and managers as Contract Parties Misrepresentation or non-disclosure: AVN67B and C: Confirm validity of cover in the event of a non-disclosure or misrepresentation by the primary insured
Some restrictions and limitations on insurance cover Commons exclusions and limits War and Allied Risks Hull: Can effect War and Allied Risks cover under a separate policy Liability: Can re-write War and Allied Risks exclusion into All Risks policy Confiscation by state of registration, i.e. expropriation = political risk, not a war risk Type Grounding E.g. Q400 s Hi-jacking Must show loss or damage Geographical limits Limits on passenger legal liability cover Alternation or cancellation of cover during term Change in circumstances Acceptable market practice determined by market (Lloyds) Cancellation on notice All Risk: 30 days War Risk: > 7 days Immediate cancellation First Gulf War 9/11
Questions and answers Presenter details Heather Wilmot Director, Aviation Norton Rose South Africa heather.wilmot@nortonrose.com +27 (0)11 685 8901
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