Basic Aircraft Finance
By Gregory J. Reigel
© 2006 All rights reserved.
Many individuals and businesses that have made the decision to purchase an aircraft do not necessarily have the cash to purchase the aircraft outright. Or, if they do have the cash available, tax or cash flow implications may dictate against paying cash for the aircraft. As a result, these individuals and businesses may purchase their aircraft using financing provided by a third-party.
The aircraft finance marketplace includes a wide variety of financial institutions and lenders that will finance aircraft. However, not all of these lenders are experienced with aircraft finance. As a result, some of the lenders may not be able to process aircraft financing transactions as efficiently or economically as lenders with more aircraft finance experience.
Individuals and businesses interested in financing the purchase of an aircraft should survey the marketplace and contact a number of lenders to locate a lender with experience who understands the borrower’s needs and goals. Once selected, an aircraft finance transaction will involve a number of steps and processes to complete the transaction.
Keep in mind that as the size of the aircraft and the amount being financed increase, the structure, processes and procedures for obtaining aircraft financing become more complicated. This article is only intended to provide a general overview of the basic aircraft finance transaction and will not address the nuances and variations that may be associated with more complex transactions.
Applying For Aircraft Financing
The majority of lenders handle applications for aircraft financing similarly. The lender will require that the borrower submit information regarding the aircraft including make, model, year, registration and proposed purchase price.
The borrower will also need to provide personal financial information and, if the borrower or the entity purchasing the aircraft is a corporation or limited liability company, the lender will require copies of organizational documents for any entity involved in the transaction. Further, if the financing will include personal or corporate guaranties, the lender will require similar financial and organizational documentation from each guarantor.
If the lender does not have a great deal of experience in aircraft financing, or if the purchase transaction involves a larger aircraft, the lender will likely require an appraisal of the aircraft. The appraisal will allow the lender to ensure that the value of the aircraft is consistent with and supports the lender’s “loan to equity” ratio for the particular transaction. For traditional financial institutions, it also provides back-up for the loan file to satisfy a bank examiner, who may have no aircraft finance experience, that the value of the aircraft meets the lender’s lending criteria and authority.
On the other hand, for an experienced lender, an appraisal may not necessarily be required for transactions involving small, single-engine aircraft up to larger, twin-engine aircraft. An experienced aircraft lender often-times has a good sense of the market value of these types of aircraft based upon blue-book values and similar transactions processed by the lender. These lenders are typically not traditional financial institutions (e.g. banks) and, as a result, do not have the same file documentation considerations, vis-à-vis bank examiners, as a traditional bank.
From the borrower’s perspective, the appraisal does not usually impact the purchase transaction. Although a purchase agreement may be drafted to include a contingency that the aircraft appraise at or above a certain value, usually the borrower has already agreed upon a purchase price for the aircraft prior to applying for its financing and the appraisal merely confirms whether the borrower has made a good deal.
Aircraft Title Search
The lender will obtain a title search on the aircraft to determine the current owner of record and whether any security interests, liens or other encumbrances are recorded against the aircraft. The title company will first search the FAA Registry in Oklahoma City. Then, if the aircraft is subject to the Cape Town Convention , the title company will also search the international registry in Ireland. Unfortunately for subject aircraft, this additional search necessitated by the Cape Town Convention has added both time and expense to the title search process.
After the title company has completed the necessary search or searches, it will issue a title report to the lender disclosing the current status of the aircraft’s title. If any liens, encumbrances or other title defects are disclosed in the title report, the lender will require that any issues are released or otherwise resolved to the lender’s satisfaction prior to closing. The lender will also perform name and judgment searches to ensure that the aircraft seller will be able to convey clear title to the borrower. Although the lender will expect that the borrower resolve title issues prior to closing, ultimately, curing title defects and passing clear title to the aircraft is the seller’s responsibility in an aircraft transaction.
Aircraft Title Insurance
A lender will often purchase title insurance to insure the lender’s security interest in the aircraft. The aircraft title insurer will ensure that the registration documentation (bill of sale, application for registration, etc.) are accurate and that all documents, including the lender’s aircraft security agreement, are filed in a timely manner. It will also require that any title defects disclosed by the title search be cured at or before the closing. Then, if any title issues arise after the transaction closes, the title insurer will be responsible for protecting the lender’s interest in the aircraft and resolving any covered title defects.
The loan documents typically associated with a basic aircraft finance transaction include a promissory note, aircraft security agreement, guaranty/pledge and authorization. A promissory note contains the terms of the loan and the borrower’s promise to repay the loan according to those terms. It also provides the lender with remedies if the borrower does not fulfill its obligations under the promissory note.
The aircraft security agreement pledges the aircraft as security for the promissory note. If the borrower fails to repay the promissory note, the lender will have the right to take possession of the aircraft. Once it has regained possession, the lender is able to sell or otherwise dispose of the aircraft to recover as much of the outstanding loan balance as possible. If the lender is able to sell the aircraft for more than is owed, the excess is paid to the borrower. However, after the lender offsets the amount received from sale against the outstanding balance and the lender’s costs/fees incurred in repossessing and selling the aircraft, it is unusual for an excess balance to exist.
For transactions in which the loan is being guaranteed by someone other than the borrower, that individual or business will need to execute a guaranty that obligates the guarantor to repay the loan in the event that the borrower defaults. If the borrower or any guarantor is a corporation or limited liability company, the lender will require that an appropriate official of the entity execute an authorization representing that the person executing the documents on behalf of the entity is authorized to sign and bind that entity.
Most lenders will have standard or form documents they use in aircraft finance transactions. However, depending upon the lender, the financial position of the borrower, the relationship of the borrower with the lender and the amount of the loan, many of the terms in the loan documents may be negotiable.
Either the lender or a title company on behalf of the lender will handle closing of the loan transaction. Prior to disbursing any funds, the lender will require that the appropriate parties execute the loan documentation and that any other requirements of the title insurer are satisfied. The aircraft title company will ensure the appropriate documents are received, completed, and that the documentation is accurate and filed in a timely manner to ensure perfection and priority of the lender’s interest in the aircraft. In the absence of a title company processing the transaction, a lender may utilize an experienced aviation attorney to close the transaction on its behalf.
The borrower is usually responsible for the costs incurred by the lender in processing and closing the aircraft finance transaction including application fees, title search fees, appraisal fee, title insurance premium and recording/registration fees. However, depending upon its financial condition and its relationship with the lender, the borrower often times can negotiate the allocation of costs between the borrower and the lender.
In today’s marketplace, aircraft financing is readily available. Although the processes and procedures involved in an aircraft finance transaction are similar to other finance transactions, an aircraft finance transaction involves many nuances and unique aspects. Having a general understanding of the nuances associated with an aircraft finance transaction can assist a borrower in successfully closing an aircraft finance transaction.
1 Aircraft and equipment subject to the Cape Town Convention include: (1) Airframes, that when appropriate aircraft engines are installed thereon, are type certified by the competent aviation authority to transport at least eight (8) persons including crew; or goods in excess of 2750 kilograms (6,062 pounds); (2) Helicopters, heavier-than-air machines, supported in flight chiefly by the reactions of the air on one or more power-driven rotors on substantially vertical axes and which are type certified by the competent aviation authority to transport at least five (5) persons including crew; or goods in excess of 450 kilograms; and (3) Aircraft engines, powered by jet propulsion or turbine or piston technology and: (a) in the case of jet propulsion aircraft engines, have at least 1750 lb of thrust or its equivalent; and (b) in the case of turbine-powered or piston-powered aircraft engines, have at least 550 rated take-off shaft horsepower or its equivalent.