Equipment leasing professionals know the general provisions for lease transactions: rent, defaults, remedies and indemnification. However, when the subject of the lease is an aircraft, railcar, or vessel, lessors need additional provisions to protect their investment, ensure regulatory compliance, and preserve residual value. This article outlines key asset-specific provisions for these specialized equipment leases.
Registration and Regulatory Requirements
Generally, aircraft must be registered with the aircraft registry maintained by the aviation authority in the country in which the aircraft will be primarily operated. The aviation authority in that country also governs operational and regulatory requirements. In the United States, the Federal Aviation Administration (FAA) maintains an ownership registry for eligible owners of “airworthy” aircraft and records of related leases and security interests. Aircraft leases typically require the lessee to keep the aircraft validly registered in the lessor's name and to maintain a valid airworthiness certificate. Furthermore, the lease often includes the lessor's right to deregister and export the aircraft upon default or end of term.
Unlike aircraft and vessels, there is no system for governmental registration of railcars or locomotives.
Vessels may be documented or registered in various countries. The state of registry (i.e., the “flag state”) maintains records of ownership and encumbrances and governs operational requirements. If the “flag state” is the U.S., the vessel would be documented with the U.S. Coast Guard National Vessel Documentation Center (NVDC) and the NVDC would maintain the history of ownership and encumbrances. Leases should identify a vessel’s flag state, applicable classification society, and for U.S.-registered vessels, trade endorsements (e.g., coastwise, fisheries, recreational or foreign trade).
Maintenance, Inspection, and Return Conditions
Detailed maintenance obligations are critical to preserving the value of capital-intensive, long-lived transportation equipment. To avoid end-of-term disputes, leases should include robust return conditions specifying physical condition, documentation, and required inspections upon redelivery.
Aircraft lessees are typically required to maintain and return the aircraft in compliance with related airworthiness and other aviation regulations, manufacturer’s warranties and maintenance programs, required insurance coverages and other applicable standards. Lessees may also be required to compensate the lessor if the aircraft or engines are operated in excess of a certain number of hours or another limit. The related provisions are usually detailed and address not only the airframe, but also the engines, parts and records, and related inspections and reporting. In larger transactions, deposits or other credit support might be required to ensure compliance.
In addition to compliance with applicable laws and regulations, railcar leases require the lessee to comply with the Association of American Railroad’s Rules for Interchange (Interchange Rules). Railcar leases typically require the lessee to preserve the railcars in good order, condition and repair; and to maintain, repair and modify the railcars to comply with the Interchange Rules and applicable law. However, railcars may sometimes be leased under a so-called “full-service lease,” wherein the lessor pays the costs of routine periodic maintenance (but not abuse or damage repair). In addition to typical lease return conditions, railcar leases require that railcars be returned empty and free from residue and free of corrosion. A lessee will be liable to replace, or reimburse the lessor for, costs of replacing gates, hatches, loading and unloading appliances and other removable parts unless the obligation is assumed by a responsible railroad.
Vessel classification societies are non-governmental organizations that enforce technical standards for vessel design, construction and ongoing maintenance. For classed vessels, lessors may require the vessel to remain “in class,” certifying ongoing compliance with these standards.
Insurance Requirements
Lessors should maintain standard insurance requirements for each asset class and highlight these requirements early in negotiations. Across all asset classes, agreed-value or stipulated-loss provisions ensure that insurance proceeds cover the lessor's outstanding investment and expected return in the event of a total loss.
Aircraft leases typically require comprehensive liability, hull all-risk and war risk coverages that satisfy pertinent requirements relating to the carrier, amounts and other policy terms. The nature of the intended operation and related liability risks are reflected in the stringent liability coverage requirements especially regarding the lessor’s rights pursuant to breach of warranty and other related endorsements.
Railcar leases commonly require general liability insurance, physical damage insurance, and any additional insurance required by law. Like typical equipment leases, railcar leases require prior written notice of intended cancellation or material change of insurance, and that policies name the lessor as loss payee with respect to physical damage and as an additional insured with respect to liability coverage.
Vessel insurance should include hull and machinery coverage, protection and indemnity, pollution cover, and where applicable, war-risk policies. Lessors may also require breach of warranty coverage.
Operational Use and Subleasing
Transportation equipment leases should define the permitted scope of use.
Aircraft leases typically include the lessee’s agreement to comply with the operation-specific regulations of the applicable aviation authority (e.g., FAA). Non-domestic operations may be permitted, but only if not prohibited by law or insurance coverages or if unlikely to result in greater liability or asset-related risks. Business aircraft leases typically contemplate subleasing to accommodate certain structural or operational considerations. Commercial aircraft lessees often require the right to sublease. In both cases, any subleasing would be conditioned upon, among other things, compliance with laws and insurance requirements, and the sublessee’s acknowledging the lessor’s enforcement and other rights.
Railcar leases generally prohibit a railcar from being shipped outside of the U.S. and Canada, and perhaps Mexico, without the lessor’s consent. Leased railcars will likely be prohibited from transporting explosives, flammable products or other hazardous or environmentally regulated commodities.
Vessel leases often include geographic limitations that should prohibit operations outside insurance coverage. The lease should also address subleasing and sub-chartering. Time charters, where the lessee retains operational control, may be permitted, while bareboat charters transferring control to an unvetted third party may require lessor consent. All subleases should include subordination provisions protecting the lessor’s rights.
Title, Liens and Security Interests
Leases of transportation equipment should require maintenance of asset registration and covenants to keep the asset free of liens and encumbrances, with robust remedies if liens are imposed.
Although the laws of other countries could be different, in the U.S. the legal considerations regarding title, lien and enforcement issues involve an overlapping of state, federal and international laws. The Uniform Commercial Code (UCC) and other state law determines title, validity, enforceability, and lien creation; perfection and priority, except if superseded by federal (i.e., FAA) or international (i.e., Cape Town treaty) laws, including applicable filing or registration requirements. Aircraft leases typically require title and lien searches and appropriate filings or registrations with the applicable state recording offices, the FAA Registry and the International Registry.
UCC Article 9 is preempted with respect to railcars. In the U.S., security interests are recorded with the Surface Transportation Board (STB). However, perfection against rolling stock is all that an STB filing accomplishes. Whether or not a security interest is enforceable is a question of state law; priority of liens and security interests is determined by state law and, when applicable, bankruptcy law. In Canada, security interests are recorded with the Registrar General (registraire général).
The lessor’s title to a vessel is reflected in the flag state’s certificate of title. Unlike the law applicable to aircraft and railcars, U.S. law does not grant perfected security interest status to vessel lessors under leases intended to create security interests. Therefore, it is not possible to file such leases with the NVDC. As a precaution, however, lessors may file a memorandum of the lease with the STB and a UCC financing statement.
Conclusion
While standard lease provisions provide a foundation, the unique characteristics of aircraft, railcars, and vessels demand tailored asset-specific provisions. Lessors who draft comprehensive terms will better protect residual value and mitigate risk. Engaging experienced transportation finance counsel early in the transaction is advisable and asset-specific provisions should be considered essential—not optional—in every transportation equipment lease.
