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Dr. Ganna Tsirat
Partner, Jurvneshservice, member of International Bar Association, Kyiv Region Bar, Center for International Legal Studies (Salzburg, Austria)
She is known as an expert in the field of aircraft financing and author to chapters on Ukraine in The Official Guide to Aircraft Registration and Tax, World Aircraft Repossession Index, Aircraft Liens and Detention Rights and Aircraft Financing both under gen. ed. G. McBain, chapters on Air Transport and Aviation Finance & Leasing in The Getting the Deal Through, International Comparative Legal Guide, Chambers, The Aviation Law Review under gen. ed Sean Gates, etc
Aircraft and Airports Finance
The most common types of aircraft financing in Ukraine are backed or secured loan, finance and operating leases that are often mixed to give a financier effective protection. All these types are used in Ukraine though the operating lease is the most attractable.
Aircraft-backed loans used in Ukraine for the purchase of business jets and helicopters are usually structured as simple mortgages (asset-based) or finance leases. Private investors or airlines typically put in about 15% of the aircraft’s value with 85% coming in the form of bank financing, including support of an appropriate ECA, if available. In the event that the aircraft is purchased by a foreign leasing company with further aircraft lease to Ukrainian airlines, the leasing companies usually work with leading banks (UMB Bank, DVD Bank, etc.) that may make club or syndicate deals.
An aircraft is a valuable asset and can be sold from time to time. If it is leased, the operator is just notified (or acknowledged) that a sale has been made. Change of the owner does not affect the lease agreement as the operator is protected by the quiet enjoinment right, which provides that neither lessor, nor any person claiming by, through or under it, will (provided no event of default has occurred and is continuing) interfere with the quiet possession, use and enjoyment of the aircraft by the lessee during the lease term. The making of an acknowledgement results in a novation agreement and re-registration of the aircraft in the name of the new owner. Before 2019 conclusion of any novation agreement did not raise any issue in Ukraine as the Civil Code of Ukraine provides a creditor the right to sell the asset it owns, or assign its rights out of agreement connected with it in favor of any third party. A local airline, as a debtor under a lease agreement, was just acknowledged about the making of an assignment due to an aircraft’s sale and payment having been made to a new lessor.
The situation has dramatically changed due to approval of the Regulation on the procedure for the analysis and verification of documents (information) on currency transactions by authorized institutions, No.8 as of 2 January 2019, as amended, by the National Bank of Ukraine. As stated in the preamble it is designed in accordance with the Laws of Ukraine On the National Bank of Ukraine, On Banks and Banking, On Currency and Currency Transactions in order to prevent local banks from conducting currency transactions of their clients that do not meet the requirements of Ukrainian legislation. A local bank has to provide comprehensive analysis and verification of currency transactions to discover a dubious currency transaction (DCT). Such DCT may be defined due to application of certain indicators listed by the National Bank of Ukraine in the Regulation. When establishing an indicator specified in the Regulation, the local bank has to carry out additional analysis of the documents to the currency transaction in order to confirm or refute its belonging to DCT. If any party to the currency transaction is located in an off-shore jurisdiction, the transaction is treated as a DCT and specially verified by the bank. The local bank has the right to use open sources in the Internet to verify the information provided by its client. Ukrainian banks usually treat that right as an obligation. For verification the client has to submit the documents that enable the bank to establish the nature and purpose of the currency transaction; correspondence or inconsistency of its essence with the content of the activities of all its participants, including foreign ones; the presence or absence of the economic feasibility of a currency transaction; study of information about the participants, their activities and business reputation; and to find out the ultimate beneficial owners (controllers) of the participants.
Last year proved that, in the main, leasing and investment companies raised aircraft financing through the sale of E notes and E certificates on the stock exchange. The benefits of this technique include, among other things, optimization of the asset structure to meet regulatory requirements and attract new investments and capital. The issue here is so-called ABS transactions, that suppose the use of proceeds from the notes to acquire a pool of aircraft that are used as security to issued notes and certificates. Issued notes and certificates are secured by each aircraft’s future lease payments and residual cash flows. This innovative technique of fund raising is called asset-based transactions (or securitization), which provides for certain structuring and ratings by rating agencies.
In order to complete the securitization, a certain pool of aircraft (the assets) are sold by their owner, an originator, to a special purpose vehicle (the SPV). As a result of such sale the assets are fully separated from the assets of the originator and its group of companies. The SPV is not a subsidiary or related person of the originator. The originator should not have any participation in the capital of the SPV or its direct participants (hence, there shall be no “return” of profits from assets in the form of dividends), have no representatives in the executive bodies of the SPV, not give any additional guarantees (other than the ordinary asset quality guarantees in a purchase contract) or loans, in no way be affiliated with the SPV (even by similar name). The SPV has separate financial statements, budget and workflow, management, etc. The sale of assets must be a “true sale”, complying with the separation and other requirements in order for the transaction to be rated and permit the issuing of securities. In addition, the originator should not act as a note underwriter or holder. Securitization features risk transfer, whose main idea is that when securitizing and selling assets the originator does not bear risks of breach of payment or other defaults of lessees for the use of assets divested in the securitization process. This risk passes to the new owner of the assets, namely the SPV.
The SPV is set up by a consultant providing trustee services that holds its shares in a trust. It could be A&L Goodbody, Walkers, Maples Group, Masson Hayes & Curran, Matheson, etc. The SPV is created either in an offshore jurisdiction or Ireland, which is the centre of everything connected with aircraft financing. If created in Ireland it is designated an activity of a company, whose constitution outlines the securitization transaction and requires all directors to be residents of Ireland, which stipulates that all taxes are paid by the SPV exclusively in Ireland. Accordingly, the SPV is a tax resident of Ireland, as confirmed by a Certificate of Residence issued in accordance with the bilateral treaty on avoidance of double taxation concluded by the governments of Ukraine and Ireland.
In addition, another entity that may be affiliated with the SPV is created. This entity will issue E notes and E certificates and we may call it the Note Issuer. the Note Issuer is also created in an offshore jurisdiction. The setting up of the SPV and Note Issuer in offshore jurisdictions is dictated by the necessity to release the Assets from any obligation but not with the desire to avoid payment of taxes. The main aim of the Note Issuer, which is stated in its constitutional documents, is to issue and sell securities, which should be placed primarily among institutional investors of various jurisdictions identified by the Articles of Association as anchor ones.
As a result of the acquisition of ownership of the assets, the SPV becomes empowered to claim and collect debt from former debtors of the originator, including the lessees located in Ukraine. The originator may itself, on the basis of separate agreements concluded with the SPV and Note Issuer, perform the functions of administering these assets, but no longer as a creditor but as a servicing agent on the basis of the relevant agreement and transfer the funds received to the SPV.
Though it is planned that payment for the assets is made solely by the SPV at the expense of the proceeds from the placement of the notes, subordinated loans can be provided to the SPV and Note Issuer to secure notes obligations. Due to these features, the credit rating of the Note Issuer and its notes is higher than that of the originator.
From an investor perspective, investing in notes is an economically viable operation because the bankruptcy risks of the originator do not affect the solvency of the SPV and Notes Issuer, which are not related parties and are not liable for each other’s obligations.
At least 6 aircraft registered in Ukraine occurred among aircraft pooled to attract financing through securitization in 2019. Correspondingly, appropriate novation agreements were concluded and local airlines requested their banks to remit lease payments under novation agreements. Due to the Regulation local banks defined these novations as DCT and requested appropriate disclosure of the documents to find out the identity of the final beneficiary owners and economic nature of the transaction. As soon as securitization provides for involvement of a lot of participants (originator, SPV, Note Issuer, institutional investors, investment advisors, etc.) local banks have to study many documents. As the documents are in English, they are translated into Ukrainian. The translation and study take a certain, usually considerable time (from 2 to 6 months), within which the local lessee is not allowed to pay under novation. This gap negatively affects the securitization and actually puts the local lessee into default. This situation, of course, lowers Ukraine’s investment attractiveness and local airlines may not hope for a reduction in rent payments for leased aircraft.
Though the Law On Ensuring the Large-scale Expansion of Export of Goods (works, services) of Ukrainian Origin by Insurance, Guarantee and Cheapening of Export Lending was directed at state support for large-scale expansion of goods (works, services) of Ukrainian origin to foreign markets was adopted at the end of 2016 and the Export-Credit Agency (ECA) of Ukraine has been the set up, it has not yet begun its fully-fledged work. Though the OECD has improved the assessment of Ukraine’s country risks, taking it from the seventh to the sixth group of the classification of countries that participated in the Arrangement on Officially Supported Export Credits and Ukraine is there with Armenia, Belarus, Georgia, Kosovo, Nigeria, Mongolia, Sri Lanka and Uganda, Ukrainian airlines can still not hope for any discounts from the “base premium” when acquiring aviation equipment.
The situation with implementation of the Cape Town Convention On International Interests In Mobile Equipment and Aircraft Protocol to it, to which Ukraine is a party, has not improved either. The CTC provides for certain mechanisms that protect the lessors’ right in the event of a lessee’s default. The IDERA application is among those mechanisms. Practical problems with IDERA have not been sorted but got even worse due to adoption of the Procedure for approval of Irrevocable Deregistration and Export Request Authorization (IDERA) PR AID REG.A 008 as of 27 June 2019. It is not registered with the Ministry of Justice of Ukraine and has even more drawbacks than the previous Instruction.
Though in 2019 the government declared its desire to support local air transportation by reducing the tax burden neither decision has yet been taken. Regional air transportation needs aircraft with low passenger capacity. Such aircraft are not produced in Ukraine, while from 1 January 2021 aircraft with a passenger capacity of 44 — 100 seats will be taxed with VAT when being imported.
The government has, since last year, talked about the transfer into concession of certain regional airports. As no formal decision on the issue has been approved different local airports were listed. An Investment Atlas of Ukraine was published on the government site on 26 January 2020. It lists Lviv Danylo Halytskyi, Kherson, Zaporizhzhya, Chernivtsi and Vinnitsya International Airports and Multimodal Cargo Hub Bila Tserkva as objects for which investments are invited. The terms of such participation are still under consideration.
All the above-stated is testimony about a range of difficulties in the financing of aircraft and airports as well as of the absence of clear government understanding on how to improve the current situation.