Briefing

FWA v VietJet (second quantum judgment): Redelivery indemnities, assignments and recoverable enforcement costs

Key takeaways

The second quantum judgment in the FWA v VietJet case primarily dealt with issues relating to the cost of putting the relevant aircraft into the required redelivery condition in the leases and enforcement costs. In short, the judgment provides further support for the key contractual provisions in JOLCO transactions which will be reassuring for the aviation finance market.

The Court found that the termination provisions in the leases were not an exclusive remedy and further losses could in principle be claimed from the lessee under the contractual indemnities, e.g. the cost of putting the aircraft into the redelivery condition. The Court also found that the indemnities in the leases were intentionally wide and encompassed all the claimed enforcement costs; they were not, as VietJet contended, limited to third-party claims. The finding with perhaps the broadest significance was that the hypothetical costs of putting the aircraft into the redelivery condition (i.e. hypothetical compliance with all return conditions in the lease) were not recoverable under the indemnities; recovery was limited to the actual (and reasonable) cost incurred by FWA.

The findings on assigned rights are a reminder that each case will turn on its own particular facts (i.e. exactly what rights were assigned and when) and the wording of the relevant assignment provisions. The quality of the factual and exert evidence was also key. This was illustrated by the Court’s finding that, based on the available evidence, it could not reliably make an order in respect of FWA’s legal costs relating to enforcement. The takeaway being that if there are any anticipated issues with evidencing losses (e.g. dealing with legal invoices and privilege), they will need to be ventilated at an early stage.

The final sums awarded to FWA will be determined at a separate hearing. Our detailed analysis of this judgment is set out below.

Background and context

The FWA v VietJet case concerns Japanese Operating Lease with Call Option (“JOLCO”) transactions for four Airbus A321 aircraft: two NEO aircraft and two CEO aircraft, which were delivered to VietJet in 2018 and 2019.

Under the JOLCO transactions, Japanese equity investors provided around 25% of the purchase price (principally for tax benefits) and the balance was funded by syndicated bank debt. The aircraft were owned by Japanese SPCs. The Japanese SPCs, as “Lessor”, then leased the Aircraft to a series of SPCs owned by VietJet entities, as “Lessee” (the “Lease”), which then finally leased the Aircraft to VietJet as “Sub-Lessee” (the “Sub-Lease”). The key contractual documentation for each aircraft transaction comprised a Loan Agreement, a Head Lease and a Sub-Lease.

The personal liability of the Lessors to the Lenders was limited. The Lenders’ security consisted of a mortgage over each aircraft, security assignments to a Security Agent of interests in the Leases and Sub-Leases, and Irrevocable Deregistration and Export Request Authorisations (IDERAs) in respect of each aircraft. The security assignments were important in this case because they governed the scope of the rights that were ultimately assigned to FWA.

Because the primary benefit of the scheme to equity investors is tax savings, the contractual terms of a JOLCO deter early termination and incentivise the operator to purchase the aircraft at the end of the lease term. The former is effected by incorporating early termination payments into the leases, which were addressed in the first quantum judgment. The latter is effected by incorporating strict return conditions in the leases which require the aircraft to be returned in near ‘pristine’ condition (in VietJet’s words), making it more financially attractive for the operator to purchase the aircraft at the end of the lease. This second quantum judgment largely dealt with the application and effect of the return conditions and related indemnities in the JOLCO leases.

FWA’s involvement

VietJet defaulted on rental payments during the Covid-19 pandemic and was unable to renegotiate its position under the Leases. The Lenders then served termination notices in October 2021. FitzWalter entities acquired and took assignments of the outstanding loans from the Lenders, then replaced the Lenders as Security Trustee in the JOLCO transaction structure. Ultimately, the bulk of the assigned rights and claims were transferred to FWA; other FitzWalter entities initially retained ownership rights over the four aircraft before later transferring them to FWA.

VietJet challenged the termination of the Leases and continued to operate the aircraft without paying rent for around a year. In response, FWA brought the English proceedings seeking to (amongst other things) confirm that it had the right as assignee to enforce the Sub-Leases and recover alleged losses and damages under the leases.

The four aircraft were eventually returned to FWA after the parties agreed a consent order in December 2022, but in a condition that fell well short of what the Sub-Leases required. The delayed delivery period was the subject of various factual disputes and was said by FWA to give rise to further recoverable losses.

The procedural story so far

Judgment 1 dealt with issues relating to liability. In short, Picken J determined that the leasing of the four aircraft was validly terminated; that FWA had taken valid assignments of rights; and that FWA had standing to bring its claims.

Judgment 2 dealt with the first set of quantum issues. Picken J determined that VietJet was liable for early termination amounts payable under the leases; and an additional amount for rent during VietJet’s unauthorised use of the aircraft.

This third judgment, handed down by Mr Justice Birt, dealt with the remaining quantum claims. These included the cost of putting the aircraft into the redelivery condition, maintenance and storage costs, lost rental income, and enforcement costs.

This final judgment is comprehensive and highly detailed. We therefore focus on the main points which have broad application for aviation finance and commercial aircraft leases.

The overarching issues

The starting point for the Court was to determine what it described as the ‘overarching issues’.

Did the JOLCO contracts have an exclusive code for remedies?

VietJet contended that clauses 19 and 20 of the Sub-Lease provided a comprehensive and exclusive set of remedies available to the Sub-Lessor where it decided to terminate the leasing of the aircraft after an Event of Default. It argued that the sums awarded in Judgment 2 were a complete remedy and FWA was not entitled to claim for any additional damages or losses.

The Court approached this by analysing the construction of the relevant provisions in the context of the contract as a whole and the scheme of the JOLCO arrangement. It found that where the Sub-Lease provided for a set of remedies in the event of termination (clauses 19 and 20), it does not mean they are the exclusive set of remedies available to the Sub-Lessor. The parties did not agree that losses which were not specifically dealt with under those clauses could not be recovered under different provisions.

The Court also found that where the relevant clauses made specific provision for a particular head of loss, i.e. loss of use of the aircraft, they must be followed and FWA could not resort to other (general) indemnity provisions.

Scope of Excluded Property

JOLCO transactions typically (as in this case) have a concept of ‘Excluded Property’. The Excluded Property provisions operate to preserve the rights and expectation of the Japanese equity investors and ensure they are not available to meet Lenders’ claims. The Excluded Property was therefore not assigned by the Lenders and remained with the Lessors.

In this case, Excluded Property was a defined list of rights under the Sub-Lease that were deliberately excluded from security assignment to the Lenders. This included rights connected to tax indemnities, recovery of certain fees and expenses, the Return Conditions and some of the broader indemnities, but only insofar as those rights belonged to what the Sub-Lease called a “Relevant Person”, a category that included the Lessors and the equity investors but not a “Financing Party”.

Importantly, FWA acquired the Excluded Property for the NEO aircraft from the Lessors, but did not do so for the CEO aircraft. Therefore, FWA could not bring certain claims in respect of the CEO aircraft, but it instead sought to recover the same losses under the general indemnity provision (clause 23.1 – see below) in the Sub-Leases in its capacity as a successor to a Financing Party. However, the Court found that the rights of the Financing Parties were extinguished when the aircraft were sold, such that no further losses (i.e. maintenance, storage, lost rent etc.) could be claimed by FWA (see further below).

Capacity in which FWA claimed losses

For the NEO aircraft, FWA could sue as a permitted assign of the Lessor and Sub-Lessor and take full advantage of the general indemnity provision (Clause 23.1) in the Sub-Lease.

The position was different for the CEO aircraft. FWA could only assert claims under the general indemnity in the narrower capacity as successor to a Financing Party (which included the Security Trustee). The effect of this was that FWA could not claim under the general indemnity for losses including maintenance, storage and export costs after redelivery, and compliance with the Return Conditions etc. This had a significant impact on the end result (see below).

Scope of the general indemnity provision

Having decided the overarching issues and the scope of the indemnities that were ‘in play’, the Court then considered the parties arguments regarding the scope of what could be recovered under the indemnitees.

The scope of the general indemnity (Clause 23.1)

VietJet mounted two challenges aimed at limiting the scope of the general indemnities. First, it contended that Clause 23.1 was limited to third-party claims made against FWA and did not extend to costs that FWA incurred itself, e.g. maintenance and storage costs. This argument was rejected. The Court resolved this point by considering the plain wording of the clause itself, finding that: (a) the opening words (“the Sub-Lessee hereby agrees to indemnify and hold the Sub-Lessor… harmless from and against any and all Losses of whatsoever kind and nature…“) encompassed first-party losses and costs; and (b) there was nothing to suggest that it was limited to third-party claims. The definition of recoverable Losses was also found to be broad enough to capture first-party costs and not only third-party liabilities.

Further, reading the indemnity narrowly would have sat uneasily with the commercial purpose of the JOLCO structure, under which the Lessor (and Sub-Lessor) and its successors as financing parties were supposed to be insulated from the costs and losses relating to its ownership of the aircraft.

Second, VietJet contended that the language of the general indemnity contained a requirement of proximate or effective cause (a general principle in insurance law). The Court also rejected this argument. The Court found that the words “Losses… relating to, arising out of, or resulting from (whether directly or indirectly)” intended wide coverage and a deliberately loose causal connection. The words ‘directly or indirectly’ pointed away from any requirement for a proximate cause. This was significant because it meant VietJet’s attempts to exclude losses based on the delay in exporting the aircraft from Vietnam would fail.

In short, the Court’s analysis was grounded in conventional principles of contractual interpretation and is consistent with the market’s understanding of the JOLCO structure. The other lesson to be drawn is that, where drafters are seeking to narrow the scope of an indemnity to certain categories of claims, they need to do so clearly and expressly (e.g. by stating that it is limited to third-party claims).

VietJet also challenged FWA’s entitlement to recover costs that were incurred by other FitzWalter companies. FWA contended that all such costs were ultimately payable by FWA pursuant to a Costs Acknowledgement Deed. The Court found that this deed could have been drafted with greater precision and detail, but it was sufficiently clear that FWA was ultimately liable for all costs under the terms of the deed. Costs invoiced to other FitzWalter entities but ultimately payable by FWA were therefore recoverable.

The scope of the Return Condition indemnity (Clause 20.4)

The Return Conditions required the aircraft to be redelivered in near ‘pristine’ condition, e.g. even undamaged and fully serviceable cabin items had to be replaced if required by the Lessor (or Sub-Lessor).

When FWA repossessed the four aircraft, it performed certain works before re-leasing them to another operator. FWA did not carry out additional work to put the aircraft into the Return Condition. The question that arose, therefore, was the scope of the costs that could be recovered by FWA in respect of the NEO aircraft under this indemnity (the Court having decided that recovery was not available for the CEOs, as summarised above).

VietJet contended that Clause 20.4 only indemnified FWA for costs that it actually incurred. FWA argued that it was entitled to recover the hypothetical costs of putting the NEO aircraft into the Return Condition, even where it never intended to do so. In support of its position, FWA (a) pointed to the absence of wording to the effect that costs had to be ‘suffered or incurred’, and (b) relied on insurance cases which found that an indemnitee may recover based on the reinstatement value of property even though reinstatement never occurs.

The Court did not find much assistance in the authorities cited by the parties and considered that the point ultimately turned on the proper construction (i.e. interpretation) of the indemnity. VietJet’s position was preferred. This was principally because the clause used the word ‘indemnify’ and in general the obligation to indemnify arises when a loss is suffered (as opposed to the word ‘pay’ as used in the insurance cases relied on by FWA); and if the Lessor decided not to complete all Return Condition works, it was difficult to see why the parties would have intended the Lessor to recover the additional hypothetical cost of the work – because that would be a complete windfall. The Court stated that there “was only so far” that the inherent commercial incentives in the JOLCO structure could be pushed before the “consequences appear otherwise commercially unreasonable“.

Both parties agreed that the costs of any Return Condition work had to be reasonable to fall within the scope of the indemnity.

As a result, FWA’s claim under the Return Condition indemnity was reduced from c.US$31.1m (the hypothetical cost of putting the aircraft into the Return Condition) to c.US$5.3m (the actual cost of the works undertaken on the NEOs).

Diminution in value claim

The parties agreed that FWA was entitled to either: (a) an indemnity for the reasonable costs actually incurred in putting the NEOs in the Return Condition; or (b) damages for the difference in value between the NEOs as they were in fact returned and as in the Return Condition. FWA could then elect which one to recover at date of judgment.

The Court resolved the diminution in value issue with reference to the parties’ expert evidence. There was not much difference between the experts, but the Court ultimately preferred the evidence of VietJet’s expert. The final amount will need to be agreed by the parties or resolved by the Court.

Outcome of the residual claims

After the Court had decided the overarching points of principle and the scope of the indemnities, it went on to consider the additional individual heads of loss claimed by FWA. Generally, FWA was able to recover its losses for the NEO aircraft, but not for the CEO aircraft for the reasons outlined above.

Maintenance, storage, deregistration etc.

FWA was able to recover the following costs/losses relating to the NEOs under the general indemnity in the Sub-Leases (Clause 23.1) or the redelivery indemnity (Clause 20.7):

project management, remarketing and consultancy costs (including travel and accommodation);
aircraft parking and storage costs;
loss of aircraft maintenance and component utility (arising from VietJet’s unlawful operation of the aircraft and the delay in exporting them);
aircraft re-registration and regulatory compliance;
return of the aircraft to a flight ready condition; and
non-revenue flight and insurance costs.

The final amounts are to be agreed by the parties based on the judgment or will be determined by the Court at a later date.

Loss of rent

For the NEO aircraft, FWA succeeded in recovering lost rent for the entire period from redelivery up to the re-leasing of the aircraft. The quantum of the lost rental claim was calculated by reference to AVITAS published lease rates and amounted to c.US$18.4m.

For the CEO aircraft, the claim failed for two reasons: (i) for the period before redelivery, because the liquidated damages payable (i.e. 150% monthly rental amount) under Clause 20.4(c) was held to be the exclusive remedy for that loss during that period (otherwise there would be a double-recovery claim); and (ii) for the period after redelivery, because FWA brought its claim as a Financing Party assignee for the CEOs, not as Lessor / owner (even though it later came to own the aircraft).

FWA’s alternative claims for loss of rent between termination and redelivery in respect of the CEO aircraft were for conversion and mesne profits. Both claims failed because although FWA had a right to take possession of the aircraft in contract and under The International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015, neither amounted to a right to retain possession for any period of time or extract value from the aircraft (as ownership rights remained with other entities during this period).

Other enforcement expenses

FWA’s legal expenses in the litigation have been or will be dealt with within the English proceedings. FWA’s claim for legal costs incurred outside the litigation failed because it did not produce satisfactory evidence to support these costs and therefore could not reliably prove that they fell within the scope of the indemnities in the Sub-Leases. The question of how to evidence potentially privileged legal invoices presents practical hurdles and will need to be addressed in future enforcement cases.

Conclusions: practical implications from the judgment

The judgment provides further important guidance on the operation and effect of JOLCO transactions, which is consistent with the market’s understanding and expectations.

For lessors, the decision provides welcome support for the key commercial incentives in a JOLCO structure: the termination provisions are not an exclusive remedy and in principle further losses can be claimed under the contractual indemnities, such as putting the aircraft into the Return Condition. The Court also found that the general indemnity provision was intentionally wide and in principle encompassed all claimed enforcement costs and losses.

The judgment also provides helpful guidance on the question of hypothetical versus actual costs that are recoverable under redelivery indemnities. The result is that only actual costs are recoverable by lessors.

The judgment also provides useful guidance on the scope of assigned rights. However, it is a reminder that, ultimately, issues relating to assigned rights will turn on the particular facts of each case (i.e. exactly what rights have been assigned and when) and the wording of the relevant assignment provisions.

Finally, this judgment is a reminder that the quality of witness and expert evidence is key, in terms of being able to evidence recoverable losses (e.g. legal costs in this case) and whether costs are reasonable (i.e. the cost of maintenance and repair works). If there are any anticipated issues with evidencing losses, they will need to be ventilated with the Court at an early stage.

Dimitris Dimitropoulos, Trainee Solicitor, assisted in the preparation of this briefing.