October 23, 2014
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Olympic and Beyond: Airworthiness as a Delivery Condition and the Importance of Acceptance Certificates
In an aircraft sale or lease transaction, the condition of the aircraft at delivery or re-delivery typically is heavily negotiated. In certain circumstances the result of these negotiations is a requirement that the aircraft be delivered in “airworthy” condition. This article will examine ACG Acquisition XX LLC v. Olympic Airlines S.A.1, a closely followed case in the English courts, as well as some recent cases in the United States courts that demonstrate (i) the uncertainty surrounding use of the term “airworthy”, (ii) the consequences of accepting delivery or re-delivery of an aircraft that is supposed to be airworthy or in a specified condition when it is not in the required condition and (iii) the importance of clear contractual provisions that allocate risk as to the condition of an aircraft after delivery.
ACG v. Olympic Airlines
The Olympic case involved an operating lease agreement between ACG and Olympic relating to a Boeing 737-300 aircraft and the related acceptance certificate. The lease agreement required ACG to deliver the aircraft to Olympic “as is, where is” and in the condition required in Schedule 2 (except for certain items noted as discrepancies). Schedule 2 required, among other things, that the aircraft be in airworthy condition. ACG delivered the aircraft to Olympic, which signed an acceptance certificate for the aircraft and placed the aircraft into service. After the aircraft completed 112 flights over approximately 21 days, defects were discovered that eventually that led the Greek Civil Aviation Authority to suspend the aircraft’s certificate of airworthiness and ground the aircraft. In response to the grounding of the aircraft, Olympic ceased paying rent and maintenance reserves. ACG sued to recover amounts due. Olympic counterclaimed, among other things, to recover damages on the basis that the aircraft was not in airworthy condition upon delivery. After an appeal was taken from a decision of the Commercial Court, the Court of Appeal recently issued its decision in Olympic.
In its decision, the Court of Appeal held that the clear and unambiguous language contained in the lease agreement and acceptance certificate was enforceable not only to preclude Olympic from ceasing to pay rent, but also to preclude Olympic from claiming damages for improper delivery condition. At delivery, Olympic signed and delivered an acceptance certificate to ACG that included a confirmation by Olympic that the Aircraft complied in all respects with the condition required at delivery, including the conditions required by schedule 2 to the lease agreement, subject only to discrepancies noted on an annex. The lease agreement provided that it was a condition to Olympic’s obligation to accept delivery of the Aircraft that the Aircraft must be in the condition required in schedule 2 to the lease agreement (except for any identified discrepancy items) and that delivery by Olympic of the acceptance certificate would constitute conclusive proof that (i) Olympic had examined and investigated the aircraft, (ii) the aircraft and related documents were satisfactory to Olympic, and (iii) Olympic had irrevocably and unconditionally accepted the aircraft without reservation (except as noted in the discrepancy annex).
In addressing Olympic’s claims that the aircraft was not airworthy at delivery, the Commercial Court found as a matter of fact (and the Court of Appeal did not dispute) that unbeknownst to either ACG or Olympic, the aircraft was not in airworthy condition at delivery. The Commercial Court, in dictum, defined “airworthy” by reference to maritime law and held that an aircraft would not be airworthy if a prudent operator of an aircraft would have required that defects be made good before permitting the aircraft to fly had he known of the defects. In other words, even an unknown defect could render an aircraft unairworthy. Although the Court of Appeal did not itself articulate a definition of the term “airworthy,” it rejected the maritime-based definition articulated by the Commercial Court because in the charter of a ship, the owner of the ship is responsible for its maintenance, crewing and navigation, whereas in an aircraft operating lease, the lessor is in the role of a finance party—it neither operates nor is responsible for the maintenance of the aircraft. The Court of Appeal also pointed out that the complexity of modern passenger aircraft is such that a contractual mechanism to measure compliance with a required delivery condition is necessary to avoid years of uncertainty and to allocate the risk of defects of which neither lessor nor lessee is aware. The Court of Appeal ruled that the lease agreement was sufficient to allocate this risk to Olympic and acknowledged that short of complete disassembly of an aircraft, it is impossible fully to inspect an aircraft and eliminate all risk of undiscovered defects upon delivery and that “… the parties know that neither of them can be absolutely certain of an aircraft’s condition at the point at which the lessee is called upon to accept delivery and the on-going risk.” The lease agreement provided Olympic with ample opportunity to inspect the Aircraft and its technical records and to have discovered, and required the rectification of, discrepancies prior to delivery, and Olympic availed itself of those opportunities.
Despite its finding that the aircraft was not airworthy at delivery, the Commercial Court held that the language in the lease documents was sufficient to preclude Olympic from revoking its acceptance of the Aircraft or ceasing to pay rent, but that it could, under the terms of the Lease Agreement, nevertheless seek to recover damages for the deficient delivery condition of the Aircraft. However, Olympic was estopped under the facts of the case from doing so because ACG had relied in good faith to its detriment in accepting redelivery of the Aircraft from the previous operator based on Olympic’s confirmations of acceptance and satisfactory condition set out in the Acceptance Certificate and the Lease Agreement. The Court of Appeal rejected this reasoning and held that the language of the lease agreement and the acceptance certificate alone was sufficient to preclude Olympic from seeking damages based on the delivery condition of the Aircraft.
In issuing his decision, Tomlinson LJ said:
“In my judgment, the natural meaning of the relevant provisions is clear. There is no ambiguity about paragraph 2(e) of the Certificate of Acceptance—the lessee confirms that the aircraft at delivery complied in all respects with the condition required under clause 4.2 and Schedule 2, except for the items listed on Annex 2. Clause 7.9 provides that delivery by lessee to lessor of a certificate in that form will be conclusive proof that the aircraft and the aircraft documents are satisfactory to the lessee. For my part, I have no difficulty with what is meant by the aircraft being “satisfactory” to the lessee. The contract provides only one yardstick by which the lessee's satisfaction with the aircraft is to be measured, and that is compliance with the condition required by Schedule 2, as spelled out by clause 4.2(a). When the lessee confirmed that the condition of the aircraft at delivery complied in all respects with that required under Schedule 2, the lessee was confirming that the aircraft was satisfactory to it in the only sense in which it was entitled, or expected, to express its satisfaction.”
The decision sends a clear message that aircraft leases and their related certificates of acceptance should be construed in accordance with their plain, unambiguous terms, and that the risk allocation set forth in those documents between lessee and lessor should be given effect.
Recent United States Cases
A number of recent decisions in the United States further highlight the uncertainty created when a seller or lessor agrees to deliver an aircraft in airworthy condition and the importance of utilizing clear and unambiguous acceptance certificates.
Pritchard Enterprises, Inc. v. Adkins2
In Pritchard, the seller of a Cessna aircraft warranted to the buyer among other things that the aircraft would be in an “airworthy condition” at the time of sale. The buyer arranged to have the aircraft and its records inspected. During the inspection, the buyer’s representatives identified 35 discrepancies from the required delivery condition, all of which were rectified prior to delivery. On the delivery date, the buyer’s representative successfully flew the aircraft and the parties completed the sale of the aircraft. Approximately 10 months thereafter, following five successful flights, numerous mechanical problems were discovered that the buyer’s expert said required correction in order for the aircraft to be considered airworthy. The buyer, claiming that the defects existed at the time of sale and rendered the aircraft not airworthy, sued the seller, seeking to rescind the purchase of the aircraft or recover damages.
The court found that the buyer did not prove that the aircraft was not airworthy at the time of sale, in part because the alleged defects were not sufficient to affect the “airworthy condition” of the aircraft.3 In reaching this decision, the court applied a definition of “airworthy” proffered by the seller (the sale agreement did not define the term): “a flight-by-flight determination that evaluates the physical aspects of the aircraft … to determine an aircraft’s safety and ability to undertake a given flight…” (emphasis supplied).
JDI Holdings LLC v. Jet Management, Inc.4
In JDI Holdings, the seller of a Cessna Citation 650 agreed to deliver the aircraft to the buyer in an airworthy condition. The court found that the aircraft was airworthy at delivery, based largely on the testimony of the seller’s expert witnesses that the defects that the buyer cited did not affect airworthiness. The court also relied on the fact that no airworthiness defects were detected in pre-closing inspections that were not rectified or in flights conducted immediately after the closing. Although neither the contract nor the court defined “airworthy,” the court found that the term “airworthy condition” was well understood by those in the aircraft industry, and that “different mechanics can have differing views and opinions on what is and is not airworthy.” The court further stated that “an opinion on airworthiness attests only to the condition of an individual item at that point in time; it could break the next day.” (emphasis supplied).
The Pritchard, Tice and JDI Holdings decisions turn on the failure of the buyers to sustain their burden of proof and do not foreclose the possibility that if the court had found that a defect at issue rose to the level of affecting airworthiness, and if the buyer could prove that the airworthiness defect existed at the time of delivery (these facts were established inOlympic), the buyer might have a claim against the seller for deficient delivery condition even though the buyer had accepted the aircraft. It is unclear whether the buyers inP ritchard and JDI Holdings executed acceptance certificates. However, as was the case in Olympic, such a claim should be precluded by a sufficiently clear acceptance certificate and sale agreement.5
The cases summarized above provide lessons for the parties to an aircraft sale or lease agreement. These include:
Clear and Unambiguous Acceptance Certificate. The seller or lessor should require the buyer or lessee to execute an acceptance certificate that contains (i) clear language in which the buyer or lessee unequivocally, irrevocably and unconditionally accepts delivery of the aircraft and confirms that the aircraft is satisfactory and in the condition required at delivery, and (ii) an express waiver of any and all claims and warranties (express or implied) related to the condition of the aircraft at or after delivery and acceptance.
Airworthy Does Not Have a Clear Definition. To the extent an aircraft is required to be “airworthy,” parties should consider defining “airworthy” in their underlying agreement. Absent a definition of “airworthy” in a sale or lease agreement, a court could look to the U. S. Federal Aviation Regulations for the definition: “Airworthy” means the aircraft conforms to its type certificate and is in a condition for safe operation.” 14 C.F.R. 3.5(a). This definition has the potential to be susceptible to unknown defects as was the case in Olympic.
Airworthiness Should Be a Condition Precedent, Not a Warranty. Where possible, sellers and lessors should fashion any agreement to deliver an aircraft in “airworthy” condition as a condition precedent that is satisfied or waived at delivery, as opposed to a warranty that survives delivery or a covenant that could give rise to a claim for damages after delivery.
1 ACG Acquisition XX LLC v. Olympic Airlines S.A. (in special liquidation),  EWHC 1070 (Civ. 369).
2 Pritchard Enterprises, Inc. v. Adkins, 858 F. Supp. 2d 576 (E.D.N.C. 2012).
3 See also Tice v. Ron Farish Aircraft, Inc., No. 11-91-293-CV, 1993 WL 13141539 at *2 (Tex. App. July 22, 1993) (unpublished), where the aircraft was required to be in airworthy condition at the time of sale, but the aircraft suffered an electrical system failure approximately two months after delivery and acceptance by the buyer. The court did not define “airworthy” but held that the buyer failed to prove that the defects which presumably would have affected airworthiness in fact existed at the time of sale.
4 In JDI Holdings LLC v. Jet Management, Inc., 732 F. Supp. 2d 1205 (N.D. Fla., Pensacola Div. 2010).
5 While the Olympic decision is not binding precedent in the United States, a recently decided New York case supports the conclusion that a clear acceptance certificate in which a party confirms that an aircraft is in the condition required by a contract, will preclude that party from later claiming otherwise. See Wells Fargo Bank Northwest, N.A. v. US Airways, Inc., 100 A.D.3d (First Dept., 2012). In the US Airways case, US Airways returned aircraft to Wells Fargo at lease-end and Wells Fargo executed a redelivery certificate confirming that US Airways had redelivered the aircraft to Wells Fargo in the condition required by the leases except for defects noted on a schedule, and that by executing the certificates, Wells Fargo certified that US Airways had fully performed its obligations under the leases and that the aircraft were redelivered in compliance with the requirements of the leases. The US Airways court found that Wells Fargo’s execution of the redelivery certificate precluded it from later claiming that the aircraft did not satisfy certain redelivery conditions. A discussion of the US Airways case can be found in the November 2012 edition of the Vedder Price Global Transportation Finance Newsletter at www.vedderprice.com/US-Airways.