Liability is an inherent transactional risk to parties leasing, financing or investing in aircraft, rail or marine assets. This article summarizes the most significant of these liability risks for each of these asset classes, and available statutory or transactional protections.
Air
Although there is no federal aviation law imposing tort liability relating to aircraft, some states impose vicarious liability on parties merely because they own or have an interest in these “dangerous instrumentalities.” This “strict” liability, if imposed, would make an owner and other interest holder legally accountable for personal injury and property claims relating to an aircraft accident or incident, even if such owner or interest holder neither possessed nor controlled the operation or other matters relating to that aircraft.
With the expectation that this prospective liability risk might limit the availability of aircraft financing, Congress included a statutory protection for passive aircraft financiers when establishing the first comprehensive federal aviation laws in the 1940s. This “safe harbor,” later recodified as 49 U.S.C. § 44112, provides that lessors, secured lenders and other interest holders are liable for injury and property claims relating to aircraft only if they are in control or possession of the aircraft. Unfortunately, some courts struggled with the scope and application of Section 44112 which, until recently amended, provided that this safe harbor would override a state’s strict liability laws to the extent relating to liability for injuries, deaths or property damage “on land or water.” Another source of confusion was what constituted “control” by the party relying on the safe harbor.
Fortunately, the statute was amended in conjunction with the reauthorization of the Federal Aviation Administration in 2018 (FAA Reauthorization Act of 2018, Pub. L. No. 115-254, 132 Stat. 3186 (2018)), and now provides that the referenced financing parties are liable for injury and property claims relating to an aircraft, engine or propeller only when they are in the actual possession or operational control of that financing party. The amendments to the statute included striking “on land or water,” and inserting “operational” before “control.” The deletion of the geographical references was intended to nullify judicial decisions in which courts interpreted them too narrowly and refused to apply the preemption. The insertion of “operational” before “control” was intended to curb overly broad interpretations by a court of what might constitute “control” and instead look to FAA regulations and interpretations that focus on “operational control” for a more precise scope.
The current version of Section 44112 should give some comfort to aircraft lessors and financiers regarding their passive liability risk. However, there is still the risk that a court might misapply the safe harbor provision or that the plaintiff’s counsel might assert some other theory of liability under applicable state law or, given the mobility of these aircraft assets, the law of some foreign jurisdiction or international treaty. For those reasons, lessors and financing parties should still require the typical transactional protections, which include indemnifications and legal compliance provisions and, most importantly, liability insurance coverage pursuant to policies from reliable creditworthy insurers that contain acceptable policy scope, coverage amounts, breach of warranty and other lender/lessor endorsements, terms and conditions.
Rail
Potential liability for railcar lessors and secured parties is affected by many factors, including the Association of American Railroads (AAR) Interchange Rules, federal and state laws, and contractual provisions.
The AAR is an industry association that, among other things, establishes rules with respect to the movement of railcars among railroads, railcar repair, casualty and payment. The AAR Interchange Rules are mandatory and apply to all railcars used in interchange service. Of particular interest under the AAR Interchange Rules is the allocation of risk of damage or loss to a handling carrier. If a railcar is accepted by a receiving railroad (i.e., the railcar meets the minimal mechanical requirements under Interchange Rule 88), the receiving railroad assumes all liability for any damage caused by “unfair usage,” and liability of the delivering railroad for “unfair usage” ends. Unfair usage includes any damage resulting from derailment and collisions, parts removal, overloading, explosions, sideswiping and heat. Ordinary wear and tear is not considered unfair usage.
The U.S. Department of Transportation (DOT) has several operating administrations that apply to the rail industry. The Federal Railroad Administration (FRA) Safety Office regulates railcars through its Hazardous Material Division and Motive Power and Equipment Division, among others. These administrations adopt regulations related to railcar safety standards, maintenance and inspections. If railcars are used to transport hazardous materials, owners face liability under the Hazardous Materials Transportation Act (HMTA) and related regulations.
If a railcar spills hazardous substances, the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) and/or the Oil Pollution Act of 1990 (OPA) may apply. Under both CERCLA and OPA, responsible parties are strictly, jointly and severally liable for any costs incurred to respond to any release or threatened release of hazardous substances. Both CERCLA and OPA include liability exemptions that may apply to finance lessors and secured parties, including a common carrier exception and a secured lender exception. In transactions where the lessee or borrower is using railcars to transport hazardous materials, additional diligence on the safety record and procedures of the lessee or borrower and additional insurance coverages should be considered to mitigate liability.
While the AAR Interchange Rules and federal and state laws and regulations affect potential liability of lessors and lenders in railcar transactions, the primary ways to mitigate these risks include performing diligence of the lessee or borrower and its operations and careful drafting of the lease and loan documentation. The AAR Interchange Rules do not supplant the allocation of risk of damage and loss to lessees or borrowers under loan or lease documents. When drafting contracts, parties should pay particular attention to obligations relating to compliance with the AAR Interchange Rules and applicable laws and regulations, as well as indemnity and insurance provisions. In some transactions, secondary insurance may be desired.
Marine
When considering the addition of vessels to your equipment portfolio, it is important to carefully address the liability challenges associated with maritime leasing. A comprehensive strategy to mitigate these risks will likely come from a blend of contractual safeguards, limitations on liability exposure, regulatory compliance and insurance coverage.
Reducing liability exposure begins with careful planning and performing diligence before entering into a lease. Start by evaluating the customer’s operational, maintenance and claims history to gauge risk. The charter arrangement should contain specific requirements regarding regular maintenance, periodic inspection, compliance with all applicable laws and regulations and details on permitted use. These provisions establish the lessee’s responsibilities and help to reduce the lessor’s liability. In addition, the documents should contain indemnification provisions and well-developed insurance requirements clarifying responsibilities for damage and loss.
As mentioned in the above discussion regarding rail assets, CERCLA and OPA impose on “responsible parties” liability for oil spills. In the case of maritime assets, these responsible parties can include owners, operators and charterers. Also similar to rail assets, both OPA 90 and CERCLA contain certain exemptions designed to protect lenders who hold a security interest in a vessel to protect their financial interest, provided that they do not participate in the management of the vessel. It is important to understand that this protection is not absolute. To ensure that this defense is available, lessors may not exercise control over the vessels or their operation and must not know about regulatory violations. As drafted, the secured creditor exemption applies only to lessors holding ownership in the vessel as security and is silent on the matter of true leases. So, there is a concern that a court could limit the secured creditor exemption to a situation where the lease looks more like a financing than a true lease.
To address all of these liability concerns, it is important that all maritime charters include multiple layers of insurance coverage, including hull and machinery (H&M) coverage, marine general liability coverage, excess liability/umbrella policies, environmental liability and, potentially, mortgagee additional perils (MAP) coverage and mortgagee’s interest insurance (MII). MAP and MII coverage provide additional layers of coverage to lenders or lessors in situations that might be excluded from H&M policies or in the event of a failure of the primary insurance to pay a claim due to certain conditions.
Maritime lessors must navigate a complex landscape of liability risks and protections. Although certain legal protections exist, none of them provide absolute immunity. So, it is in the lessor’s best interest to understand the limitations of available protections, to implement risk management strategies, to ensure compliance with the conditions required for passive lessor limitations of liability and to obtain robust insurance coverage.
Conclusion
As discussed above, there are certain inherent liability risks associated with leasing or financing various types of mobile assets. These liability risks might be based on applicable laws of the relevant jurisdictions implicated by the conduct or circumstances giving rise to the liability claims and could be based on statutes, treaties or common law. In some cases, there could be a safe harbor for lessors and other financing providers with respect to their “passive” liability, but there is also risk of judicial misinterpretation or other limitations. The prudent approach to address these liability risks is to establish transactional practices that are intended to limit the likelihood of harms associated with the events or circumstances that might give rise to these risks.