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UNIVERSITY OF LAGOS SCHOOL OF POSTGRADUATE STUDIES FACULTY OF LAW

FINANCING OF ROVING ASSETS (SHIPS & AIRCRAFTS)

SEMINAR PAPER 14

COURSE TITLE: SECURED CREDIT TRANSACTIONS II

OKONMAH NGO-MARTINS (MAT.NO – 109061034) & OKE-LAWAL IFEDAYO (MAT.NO – 099061061)

JULY 2011

LECTURER - DR. O. AMOKAYE & DR. OTUBU

Financing of Roving AssetsBy Group 14

INTRODUCTION

The term ‘Financing’ is the science and practice of raising and expending revenue. It connotes “more than simply the face amount of a loan and include interest rate, the term, the rate of repayment, and other terms and conditions, and means a loan on terms that the borrower can repay”.1

“Financing of roving assets” would therefore entail the science and practice of raising and expending revenue for the acquisition and operation of roving assets. It will include the interest rate of the loan, the term of the loan transaction, the rate of repayment and other terms and conditions of the credit transaction. The aim is usually to finance the acquisition and operation of the asset and the asset is often times used as security for the credit transaction.

The relevant question therefore is what is a roving asset? The Oxford Advanced learner’s dictionary defines ‘Roving’ to mean “travelling from one place to another and not staying anywhere permanently.” ‘Asset’ on the other hand connotes “property, real or personal, tangible or intangible, legal or equitable, which can be made available for or may be appropriated to the payment of debts.”2 Therefore, one can safely conclude that Roving Assets are properties in the form of mobile objects used for transportation. It will include assets such as Ships, Aircrafts, Railway Rolling Stocks3 and Space Assets. However, ships and aircrafts shall be the focus of this paper.

Ships and aircrafts are both expensive chattels used for transportation. They both wander the world; one on the water, the other in the sky, and are rated the most experienced and most expensive travelers of the world's legal systems. However, because of the huge sums of money involved in their acquisition, investors and businessmen alike often shy away from venturing into any business that requires their use4.

The underlying objective of this paper is to review the legal regime regulating the major financing options utilized in the industry in financing roving assets with

1 Words & Phrases permanent edition vol. 16A page 7172 Words & Phrases permanent edition vol. 4A page 503 Rolling Stock includes waggons, trucks, carriages of all kinds and locomotive engines used on railways. See Words and Phrases vol. 4 page 109 4 P.R. Woods “the Law and Practice of International Finance Series” (Sweet & Maxwell) 2nd

Edition Vol. 2 page 561

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a view to proffering suggestions aimed at improving the system and enhancing financiers’ confidence thereby encouraging the inflow of funds into the industry.

Section 1 of this paper reviews briefly the various financing options available for the acquisition and operation of roving assets. Section 2 takes an in depth analysis of ship financing and the various security packages utilized in securing these investments. Section 3 reviews the various peculiarities regarding aircraft financing while section 4 attempts a comparative analysis of the legal regime of both ship and aircraft financing and proffers recommendations.

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SECTION 1

FINANCING OPTIONS FOR SHIPS & AIRCRAFTS

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UNDERSTANDING THE MEANING AND NATURE OF A SHIP & AIRCRAFT

Section 444 of the Merchant Shipping Act No. 27 2007 defines a "ship" as “a vessel of any type whatsoever not permanently attached to the sea-bed, including dynamically supported craft, submersibles of any other floating craft which shall include but not limited to Floating Production Storage and Offloading (FPSO) platform as well as Floating Storage and Offloading (FSO) platform.”

Generally, a ship is any structure, whether completed or in the course of completion, launched and intended for use in navigation and not propelled by oars. It can be said therefore that a ship includes every description of vessel used in navigation provided it is not propelled by oars such as canoes and include a hopper or dump barge, a lighter, hovercraft and an oil drilling rig. As such it is safe to say that anything designed or adapted for use at sea or in navigable waters would qualify as a ship.5

A ship is usually referred to in the famine gender as ‘she’ or ‘her’. It must be recognised that a ship is not merely a physical asset but also a legal person and an entity in law which can sue and be sued in her own name to protect or enforce her legal rights. It bears a name, which along with other particulars of the ship are registrable in a chosen port of registry6. Such registration confers nationality on the ship and entitles it to fly the national flag of that country where it is registered. It also confers the right to diplomatic protection and consular assistance.7

Registration of a ship usually confers title or ownership on the party or parties registering it. Notionally, there are 64 parts in a ship and as such not more than

5 L.Chidi Ilogu “Legal and Financial Implications of Maritime Liens & Mortgages” Modern Practice Journal of Finance and Investment Law Vol. 4 No. 3 page 1 at page 26 See section 21- 27 Merchant Shipping Act No.27 20077 L.Chidi Ilogu “Legal and Financial Implications of Maritime Liens & Mortgages” Modern Practice Journal of Finance and Investment Law Vol. 4 No. 3 page 1 at page 2

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64 persons can be registered as owners and co-owners of a ship or shares therein.8

On the other hand, section 78 of the Civil Aviation Act 2006 defines ‘Aircraft’ as “any machine that can derive support in the atmosphere from reactions of the air other than reactions of the air against the earth surface.”

Also, for the purpose of considering the right that can be created in respect of an aircraft, the word “aircraft” has been defined to “include the airframe, engines, propellers, radio apparatus, and all other articles intended for use in the aircraft whether installed therein or temporarily separated therefrom”9

In view of the above, rights could be exercised over the whole aircraft as a single unit or over a component part of an aircraft for example an aircraft engine. Also, it is possible for the hull and the engine of an aircraft to be subject to different legal relationships and consequences. For example while the hull or mainframe may be owned out rightly by an airline, the engine could have been acquired under a lease agreement.10

FINANCING OPTIONS

1 EQUITY FINANCE

Equity finance is a means by which a corporation raises capital through the issuing of shares and stocks. This is contrasted with “debt financing” which is the raising of capital by issuing bonds or borrowing money.11 It entitles the investor to share in the risks and rewards of the business and it’s usually without any set time span. In order to liquidate his investment, the investor is required to sell his shares.

2 DEBIT FINANCE

8 Section 17(2)(b) of the Merchant Shipping Act prescribes that a person shall not be entitled to be registered as owner of a fractional part of a share in a ship; but any number of persons not exceeding five may be registered as joint owners and of a ship or a share in them9 See article XVI of the convention on the International recognition of the right in aircraft (Geneva) 1948 which came into force in Nigeria by virtue of section 73(1) of the Civil Aviation Act 200610 Callistus Uwakwe “Introduction to Civil Aviation Law in Nigeria” 1st edition 2006 (Aviation Publishing and Consultancy Co. Ltd.) page 11811 The Black’s Law Dictionary 6th Edition

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This type of financing is essentially in two forms – bond or note issues and term loans

a. Bond or Note issue – these are loans made by sophisticated investors and evidenced by transferable debt securities issued by the borrower (issuer) to the initial lenders (subscribers). The issue is arranged by investment banks (managers) who enter into subscription agreement with the issuer whereby the managers, in return for a fee, agree to procure subscribers for the security. They do this with the help of an offering circular which is a prospectus containing financial statements and other information about the issuer and the issue.12

The securities are often listed on a stock exchange to enlarge the number of investors who can invest in them such as insurance companies, mutual funds and pension funds who may be restricted by regulation to listed securities. Listing on the exchange is essentially to make potential investors eligible and not because of the advantage of exchange trading. This is because most trades are usually between the parties and not on the stock exchange.13

b. Term loans – these are loans for a fixed term, cancellable only if certain conditions are satisfied and repayable prematurely only on the event of default. By contrast over drafts or ‘lines of credit’ are cancellable and repayable on notice from the bank. The object of a term loan is to improve the predictability of the finance.14

A term loan could either be a bilateral loan or syndicated loans. Bilateral loans are loans between a borrower (and sometimes a guarantor) and a single bank. A syndicated loan on the other hand comprises a number of banks since a single bank may not on its own be willing or able to advance the whole amount required for the loan transaction. The essence of syndication is that two or more banks agree to make loans to a borrower on common terms governed by a single agreement between all the parties15

Another form of debit finance particularly applicable in the Middle East as a means of financing the aircraft sector is Islamic Finance. This has accounted

12 Philip Wood “International Loans, Bonds, Guarantees, Legal Opinions” (sweet & Maxwell 2009) Vol. 3 page 19313 Ibid.14 Ibid. Page 315 Ibid.

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for the continuous growth of the aviation sector in the Middle East despite rising oil prices and the general downturn in Western economies. Several airlines have stated their intention to purchase their aircraft in a Shariah compliant manner.16

Islamic finance, also known as participant banking, is the provision of Islamic financial services, instruments and transaction in accordance with Islamic commercial jurisprudence and Shariah principles which prohibits the payment or acceptance of interest fees for loans of money for a specified term as well as investing in business that provide goods or services considered contrary to Shariah principle.17

The underlying difference between Islamic financing and conventional interest based financing is in the understanding and treatment of money. While the conventional interest-based finance holds that money has intrinsic value of its own and as such can generate return without recourse to asset creation, Islamic finance recognise no intrinsic utility for money except where is it used in the creation of assets.18

Recently the Central Bank of Nigeria (“CBN”) issued a license to Jaiz Bank International Plc (“JBI”). Making it the first fully fledged Islamic Bank in Nigeria. On January 13, 2011, the CBN’s released two guidelines meant to serve as the frame work for the regulation and supervision of institutions offering non interest financial services in Nigeria. These guidelines are the Guidelines on Shariah Governance for Non-Interest Financial Institutions in Nigeria and Guidelines on Non-Interest Window and Branch Operations of Conventional Banks and other Financial Institutions. Also, the Securities and Exchange Commission, on February 8, 2011, released the Rules on Islamic Fund Management. The release of these documents by the relevant operators is meant to drive the development of the Islamic financial market in Nigeria.19

It is hoped that with the introduction of Islamic finance into Nigeria, the acquisition of assets such as aircraft would be funded in Nigeria through such medium.

16 Simmons & Simmons (Online), Islamic Aircraft Finance, http://www.simmons-simmons.com/docs/islamic_aircraft_finance_new.pdf, May 20, 201117 Detail Solicitors “The Emerging Islamic Finance market in Nigeria – Outline and Challenges” BusinessDay Thursday 19 May 2011, page 3518 Ibid.19 Ibid.

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http://www.simmons-simmons.com/docs/islamic_aircraft_finance_new.pdf

http://www.simmons-simmons.com/docs/islamic_aircraft_finance_new.pdf


3 CONDITIONAL SALE/TITLE RETENTION

This involves the sale of an asset to a debtor on terms that the debtor is not to acquire title to the asset until the asset has been paid for. Under this method of financing the seller transfers possession immediately. If the buyer becomes insolvent without having paid the debt, the seller retakes possession. The object of the transaction is to enable the buyer to acquire the goods on credit so that he pays for them when he re-sells them but at the same time to give the seller ‘security’ for the unpaid purchase price thereby protecting the seller against the insolvency of the buyer.20

4 LEASE

Leasing is a form of financing for the acquisition of Roving Assets. A lease can be defined simply as a contract of hire by which, the owner of the asset i.e. the lessor grants the right of possession and use to the person requiring the asset i.e. the lessee for an agreed period of time and for a specific rent.21 Leases are usually distinguished by reference either to finance lease or operating leases.22

a. Finance Lease – there is no detailed statutory definition of a finance lease. However, these are leases under which the risks and rewards of ownership are substantially transferred to the lessee while the aggregate capital payments, which are substantially equivalent to the initial market value of the aircraft, are made in installments as agreed under the lease terms. It is a long term investment.23

The transaction usually involves three parties – the manufacturer/supplier, lessor and lessee. The manufacturer manufactures and supplies the asset to the lessor pursuant to the lessee’s specifications.24

The lessor’s service is usually limited to financing the asset, while the lessee pays the maintenance costs, taxes and has the option of purchasing the asset of the lease at a nominal price. The lessor may however undertake

20 Philip Wood “Title Finance Derivatives, Securitisations, Set-off and Netting” (Sweet & Maxwell 1995) page 621 R.O. Omosun “Aircraft Financing Options” Modern Practice Journal of Finance and Investment Law October, 2000 Vol.4 No.4 page 22222 Ibid.23 Ibid. Page 22324 C.E. Uwakwe “Introduction to Civil Aviation Law in Nigeria” (Aviation publishing and Consultancy Co. Ltd. 2006) page 121

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under the lease to perform other functions like registration, obtaining of operational/airworthiness certificate in the case of an aircraft.25

Finance leases are usually created to secure credit transactions mostly between financial institutions that assist their customers in obtaining expensive assets, like aircraft which the customers ordinarily would not be able to afford.26 The characteristics of a finance lease are as follows:27

i. The term of the lease is likely to cover a substantial part or the whole of the asset’s useful life.

ii. The lease will normally contain a provision ensuring that in the event of an early termination of the lease, the lessor recoups the payment which it would have received had the lease continued (normally after an allowance has been made to take account of the accelerated payment and/or the realizable value of the asset).

iii. The risk of ownership such as malfunction loss, destruction and obsolescence will lie with the lessee.

iv. The asset will be supplied in the first instance by a third party (such as manufacturer or dealer) and selected by the lessee.

v. The benefit of the residual value of the asset at the end of the leasing period (after the lessor has recovered the cost of acquiring the asset and any financing charges) will be for the lessee.

b. Operating Lease – this leaves the risk and reward of ownership principally with the lessor while the lessee makes rental payments as agreed under the lease terms. It is usually for a short period that may be extended. One of the advantages of this to lessee is that it reduces investment risks.28 The characteristics of an operating lease are as follows:

i. the lessor will expect to lease the asset many times to different lessees during the working life of the asset.

ii. the lessor will deal with and bear the costs of matters such as repairs, maintenance and insurance.

iii. the risks of ownership such as malfunction, loss, destruction and obsolescence will lie with the lessor.

25 Ibid.26 Ibid.27 R.O. Omosun “Aircraft Financing Options” Modern Practice Journal of Finance and Investment Law October, 2000 Vol.4 No.4 page 22228 Ibid.

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iv. the lessor will normally have acquired the asset without reference to (and before being approached by) the lessee, and will often have specialist technical knowledge about it.

v. the benefit of the residual value of the asset (which will normally be substantial) at the end of the lease period will be for the lessor.

In view of the above, it is clear that an operating lease is akin to a simple contract of letting whereas a finance lease is similar to a hire-purchase agreement in which the lessee finances the acquisition of the whole or substantially the whole, of the cost of the acquisition of the asset.29

5 EQUIPMENT TRUST

Furthermore, roving asset may be financed in Nigeria by means of an equipment trust30. Under this financing structure, the equipment is purchased by a trustee who is financed by the sale of equipment trust certificates issued to a syndicate of banks or other financing institutions. The trustee then leases the equipment to the buyer and holds the benefit of the lease and the equipment itself on trust for the holders of the equipment trust certificates.31

6 SECURITISATION

Receivables32 such as aircraft/ship leases are securitised assets and may be the subject of securitisation. A typical securitised transaction will occur where the owner of the receivable or the securitised asset (in this case the expected rent, freight or hire) sells the receivable to a third party (which is usually a special purpose company i.e. an SPV33). The purchaser in turn borrows money (either from the bank or by conventional bond or note issue to sophisticated investors) to finance the purchase price and repays the borrowing out of the proceeds of the receivables bought by it.

29 Ibid.30 This form of financing was developed in the United States in order to finance rolling stock and other item of expensive equipment31 Philip Wood “Title Finance Derivatives, Securitisations, Set-off and Netting” (Sweet & Maxwell 1995) page 832 Receivables are expected revenue33 An SPV is usually a thinly capitalized single purpose company whose shares are held by somebody other than the seller of the receivable

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In order to ensure that the receivables are sufficient to repay the investors on time, there may be various forms of credit enhancement. For instance, a third party may give a guarantee to the SPV or the seller may agree to make a subordinated loan to the SPV. The SPV will in turn be required to pay any surplus income from the receivables (that is after the repayment of the loan has been made) to the seller which could be in the form of service fees. This enables the seller to take all the profit resulting from the transaction.

In this section, we have attempted a review of the various financing options available to both ship and aircraft financing. Section 2 of this paper will consider in greater details the common financing option utilised in ship financing and the security package available to such financing options.

SECTION 2

SHIP FINANCING

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Ship financing essentially entails financing ship purchases and shipping operations. The origins of the customary codes for ship finance, according to the legend Justinian and hence other academics, could be traced to the traditional Sea Law of the Island of Rhodes. However, English Admiralty Law which has played a significant role in the development of International Maritime Law took its genesis from the laws of Oleron - a small Island off the Mouth of Charente in the Bay of Biscay.34

The laws of Oleron expressly acknowledged the possibility that a master of a vessel could pledge his ship to a lender in return for an advance and no doubt this customary transaction formed the origin of the now obsolete security transactions of bottomry and respondentia whereby a master of a ship could, for the purpose solely of obtaining supplies of repairs necessary to enable the vessel to return to its home port, pledge the vessel by means of bottomry bond or pledge the cargo by means of respondentia. The liens were of doubtful value because the lien holder lost the right to be repaid if the ship or cargo was lost.

34 Ibid.

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However, modern communications and developments have rendered these methods of raising money on the security of a vessel obsolete since the funds for necessaries can now be supported by the credit of the owner as opposed to the credit of the vessel35.

Ship financing poses a major challenge to banks and financial institutions. It is somewhat complex and distinct from financing other large tangible assets such as real estate. This is in view of the distinct features associated with ships. These features are as follows:36

Capital intensity – high cost of ships and its operation Mobility – it travels anywhere in the world Volatile market – fluctuating prices of vessels and freight earnings Limited information – as to organisational/ownership structure and

audited accounts of shipping companies

The common financing options available to ship financing are charter party and term loan. These financing options are discussed in more details.

1 CHARTER PARTY

A charter-party is essentially a lease transaction. Simply put, a charter-party is a written, or partly written and partly printed, contract between a ship owner and a merchant, by which a ship is let or hired for the conveyance of goods on a specified voyage, or for a defined period of time. A vessel might also be chartered to carry passengers on a journey. Put differently, a contract or an agreement for the carriage by sea of a complete cargo (or passengers) or for the employment of a vessel for a voyage or series of voyages or for a specified period is always contained in a charter-party.37

Usually, charter-parties contain provisions as to the description of the ship, the voyage or time, the cargo, the freight or hire, the signing of the bills of lading, loading and discharge, demurrage and damage for detention, exception, cesser of liability, lien, penalty, arbitration and other stipulations. The charterer takes over the vessel for either a certain period of time (a time charter) or for a

35 Ibid.36 L.Chidi Ilogu “Legal and Financial Implications of Maritime Liens & Mortgages” Modern Practice Journal of Finance and Investment Law Vol. 4 No. 3 page 1 at page 1937 Nigerian Companies and Allied Matters Law & Practice First Edition, Vol. 5 – Shipping Laws of Nigeria by Deji Sasegbon at pg 1388

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specified point-to-point voyage (a voyage charter), giving rise to these two main types of charter agreements.

Under a voyage charter, the vessel is let out to the charterer for a specific voyage. The ship owner will be paid ‘freight’ which will cover the costs, including the fuel and crew, as well as its profit. A set time known as the ‘laytime’, will also be provided for the loading and discharging operations. If these operations exceed the permitted laytime, the ship owner will be compensated by demurrage at the rate set down in the charter. Voyage charters frequently seek to extend the charterer’s contractual obligations to the bill of lading holder as well. This will be done by virtue of a clause providing for the issue of bills of lading incorporating the terms of the charter.

A voyage charter will usually contain two special remedies for the ship owner in the event of non-payment of freight or demurrage. These are a lien on cargo i.e. a right to detain the cargo pending payment and a lien on sub-freights i.e. a right to intercept sub-freights due to the charterer from its sub-charterer.38

On the other hand, in time charter the vessel is hired for a specific period of time. Payment is by means of ‘hire’ calculated daily but usually payable in advance. Hire will start to run when the vessel is ‘delivered’ and will cease when she is ‘redelivered’, the charter specifying where and when these operations are to take place. Time charters do not usually require that the bills of lading incorporate the terms of the charter and the cargo will not usually be owned by the time charterers. Also, such bills are frequently marked ‘freight prepaid’. Thus the ship owner will be unable to exercise a lien on cargo. Therefore the usual remedy in the event of default is a lien on sub-freights. Also, time charter usually provide for a further remedy, which is not found in voyage charters. This remedy is the right to withdrawal which essentially gives the ship owner the right to terminate the charter in the event the hire is not paid punctually or in full.39

REMEDIES OF A SHIP OWNER

The ship owner’s right of lien (either lien on cargo or sub-freight), in the event of default by a charterer are essentially self help remedies. A lien on cargo is a right to detain the cargo until the freight is paid. This is a possessory lien and at common law there is an implied right to lien for freight and general average.

38 Simon Baughen “Shipping Law” (Cavendish Publishing Limited) 2nd Edition page 17139 Ibid. page 172

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Contractually parties can provide for a right to lien for other charges such as advance freight, dead freight or demurrage. The common law lien binds third parties. However, the contractual lien is not binding on third parties.40

Therefore if a contractual lien in a charter is to bind a bill of lading holder, the bill must incorporate the terms of the charter and the language of the charter lien clause must be apt to cover a lien against both charterer and bill of lading holder. In the case of a time charter, in which the bill of laden usually contains the clause ‘freight prepaid’ the ship owner will be precluded from exercising any right of lien on the cargo. However, such a clause will not affect the ship owner’s right to lien as against a charterer who has not in fact paid freight.41

The lien on sub-freights operates by way of equitable assignment. It is a right to intercept sub-freights (or sub-subfreights) before they get paid to the head charter. This right is exercised by giving notice to the sub-charterer, or to other charterers further down the chain. The ship owner can only use the lien to claim amounts due under the head charter at the date the notice is given. The lien will still be effective even when a freight prepaid bill of lading is issued provided the freight has not in fact been paid at the date of the notice.42

If the sub-charterer, having received notice, pays the freight to the charterer, it is at risk of having to make a double payment to the ship owner if the ship owner later substantiates its claim against the head charterer. In such instance, the sub-charterer may protect itself by paying the money into the court pursuant to an interpleader provision.43

In addition to these self help remedies, the ship owner may exercise his statutory lien over the ship by instituting an action at the Federal High Court pursuant to section 1(1)(a), 2(3)(f) & 5(4) of the Admiralty Jurisdiction Act44

2 TERM LOAN

40 Ibid. page 21041 Ibid.42 Ibid.43 Ibid. 21144 Cap A5 LFN 2004 section 1(1)(a) provides that the admiralty jurisdiction of the Federal High Court includes the jurisdiction to hear and determine any question relating to a proprietary interest in a ship or aircraft or any maritime claim specified in section 2 of this act. section 2(3)(f) prescribes that a reference in this Act to a general maritime claim is a reference to a claim out of an agreement relating to the carriage of goods or person by a ship or to the use or hire of a ship whether by charter-party or otherwise

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As indicated earlier a term loan is a legally enforceable loan arrangement in which the lender receives interest at predetermined intervals with re-payment of the principal sum after a specified period.

Generally, the security structure for a shipping loan comprises of a number of elements. It could take the form of an assignment of earnings such as hire from a charter-party, out of which the loan is to be repaid. It could be an assignment of insurances on the vessel or an assignment of compensation for any requisition for hire or for title. A one ship company may sometimes take the form of a pledge on the share of the company in order to give the lender the alternative of selling the company instead of the vessel in the event of default. The lender may wish to do this to preserve a beneficial charter which could be terminated by the charterer if the ship were sold.

MORTGAGES

Also, loans may be secured on several ships owned by the same company or more commonly, by several one ship companies. This is usually referred to as fleet mortgages. Ship owners often arrange for ships in their fleet to be owned by separate companies in order to isolate the financial risk associated with each ship and to forestall the sister ship action whereby one ship can be arrested for debts of another. In such a Case each ship owning company will guarantee the loan to the borrowing company and secure the guarantee by a mortgage on its ship. Care should however be taken to ensure that the guarantees are not liable to be avoided on the grounds that the guaranteeing companies received no corporate benefit for their guarantees or that the guarantees are transactions at an undervalue voidable on insolvency45.

The true origin of ship mortgage is unknown. However, we do know that bottomry – the pledging of a ship by the master to a lender away from the home port, existed in Greek law of the fourth century B.C. Bottomry is also found in Roman law and all the subsequent codes. This means of financing, however, became impracticable by the nineteenth century with the advent of steel ships and the need for large amounts of capital.46

45Mfon Ekong Usoro (online), Mortgages and Liens, http://www.paulusoro.com/publications/Mortgages%20and%20Liens.pdf, May 9, 2011.46 William Tetley “Maritime Liens and Claims” (International Shipping Publication) 2nd

edition page 473

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http://www.paulusoro.com/publications/Mortgages%20and%20Liens.pdf


Financiers, in particular, did not wish to lose their claim if the ship were lost, as was the rule in bottomry. In order words, they did not wish to be partners with the ship owner in a common venture. Rather they wanted the possibility of investing with the security. If the security were lost, it was essential to them that their claim survived against the debtor. Bottomry, therefore, became virtually extinct in the nineteenth century and ship mortgage emerged.47

The modern ship mortgage is one of the three major contributions of the common law to the law of maritime liens, claims and mortgages.48 In the eye of civil law, a mortgage on ship violated the basic principle that only immoveable property (i.e. buildings and lands) could be hypothecated and ship had been deemed to be moveables by article 190 of the French Code de Commerce of 1807. Only in the last half of the nineteenth century did civil law jurisdictions modify this position and it was to require a statute in each case.49

Under the common law, ship mortgage gives an immediate right to property, if not ownership, to the mortgagee who can take possession by a simple notice without the necessity of court proceedings.50 The ownership principle of ship mortgage arises from the Roman fiduciary principle; the mortgagee is the owner of the ship who in turn allows the mortgagor to have the use of the ship. The mortgagee retains the right to take possession and has the power to dispose of the ship or share in respect of which he is registered.51

However, it should be noted that most modern ship mortgage statutes usually stipulate that the mortgagee shall be deemed not to be the owner.52

SHIP MORTGAGE UNDER NIGERIAN LAW

47 Ibid.48 The other major contributions are maritime lien for collision damages and extensive use of the writ in rem. One could also add the mareva injunction and the no cure/no pay salvage49 William Tetley “Maritime Liens and Claims” (Op. Cit.) page 473. Also, the hypotheque system applicable in civil law jurisdiction confers no immediate right to possession of the property, but only a right against the proceeds of sale of the property which must be enforced in court unlike in mortgages50 The mortgagee may, however, elect to enforce his mortgage in the Admiralty Court in which case the resulting judicial sale will free the vessel from all liens and other encumbrances see The Cerro Colorado (1993) 1 Lloyd’s Rep. 58 at page 60 51 William Tetley “Maritime Liens and Claims” (Op. Cit.) page 47352 See the U.K Merchant Shipping Act of 1995 at schedule 1 paragraph 10; section 9 of the Canadian Shipping Act and section 57 of the Nigerian Merchant Shipping Act 2007. However, in the U.S, there is no such stipulation see Chemical Bank N.Y Trust Co. V S.S. Westhampton 358 F. 2d 574 at page 584 where it was held that legal title passes under the mortgage

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Under Nigerian law, a legal mortgage can be created either in respect of a ship registered in Nigeria, or a share in such ship as security for a loan or other valuable consideration.53 Where such mortgage on a ship is produced to the Registrar at the ship’s port of registry, the Registrar is obligated to record the mortgage in the register.54

A mortgagor is required by law to disclose in writing to the mortgagee the existence of any maritime lien, prior mortgage, or other liability in respect of the ship to be mortgaged in which he is aware of prior to the execution of any mortgage. Where the mortgagor fails to comply with the requirement to disclose, the mortgage debt shall, at the election of the mortgagee, become due and payable, notwithstanding anything to the contrary in the mortgage.55

Also, the law allows the creation of successive mortgages in relation to a ship and the Registrar is obligated to record such mortgages in the register in the order in which they are produced. The Registrar is required to endorse and sign a memorandum on each mortgage, stating the date and time of the record.56

In the event that more than one mortgage are registered in respect of a ship or a share in a ship, the priority of mortgages, notwithstanding any express, implied or constructive notice, shall be in accordance with the date in which each mortgage is recorded in the register and not according to the date of each mortgage itself.57

Furthermore, the right of a mortgagee to a registered mortgage shall be preferred to any right, claim or interest in the ship of the other creditors of the bankruptcy or any trustee or assignee on their behalf as a registered mortgage shall not be affected by any act of bankruptcy committed by the mortgagor after the date in which the mortgage is registered.58

Every registered mortgagee has absolute power to dispose of the ship or share in respect of which he is registered, and to give effectual receipts for the purchase money. However, where there are more than one registered mortgagees of the same ship or share in a ship, a subsequent mortgagee cannot, except pursuant

53 Section 53(1) Merchant Shipping Act No. 27 200754 Ibid. Section 53(2)55 Ibid. Section 54(2) & (3)56 Ibid. Section 53(3)57 Ibid. Section 56(1)58 Ibid. Section 56(2)

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to an order of a court of competent jurisdiction, sell the ship or share without the consent of the prior mortgagee.59

The law also retains ownership of the mortgaged ship or share in the ship in the mortgagor and the ownership right of the mortgagee in relation to the ship or a share in the ship is limited only for the purpose of enforcing his security for the mortgage debt. 60

MARITIME LIEN

The relevance of lien to this paper is that it constitutes a security package used in financing the operations of a ship. Also, prior maritime lien or other lien may surface after a ship may have been sold or mortgaged to a mortgagee unaware of the lien. In instances where the proceeds of the sale are insufficient to satisfy the varying competing claims, the issue as to priority becomes relevant.

The legal idea of a lien as giving some benefit to the claimant over and above a simple legal claim for a remedy against a particular defendant is common to both civil and common law jurisdictions.61 The label lien creates a proprietary right which can be described as a privileged claim upon a vessel arising from the services rendered to it or injuries caused by it, which hovers, attaches to and remains with the vessel irrespective of who is in actual possession thereof at the given time.62

It is a right which arises from the general maritime law and is based on the concept that the ship (personified as the res) has itself caused harm, loss or damage to others or to their property and must itself make good that loss or damage. The ship, in other words, is deemed to be the wrongdoer and not its owners and is therefore liable to the party who suffers as a result of such wrongdoing. Upon the occurrence of the wrongful act, a maritime lien arises in favour of the party concerned and attaches as a right in and against the property of the ship concerned.63

59 Ibid. Section 57(2)60 Ibid. Section 57(1)61 D.C. Jackson “Enforcement of Maritime Claims (LLP professional Publishing) 3rd edition page 43162 L.Chidi Ilogu “Legal and Financial Implications of Maritime Liens & Mortgages” Modern Practice Journal of Finance and Investment Law Vol. 4 No. 3 page 1 at page 463 Ibid.

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The history of maritime lien dates back to the development of common customs and practices of the Admirals in England and France in the 14 th century. These customs and practices became codified in France as the Consolato Del Mare and the Lex Maritima and by 1681 became consolidated into the Ordonnance de la Marine. Such customs and practices recognised the right of seamen to their wages and salvors of ships or cargo to reward and so these were accorded preferential treatment over other claims before the local and later Admiralty Court as right directly enforceable against the vessel concerned.64

Such claim became the forerunners of the rights or interest referred to as maritime liens in modern maritime law of most common and civil law countries. This category of claims now recognised as “maritime liens” under English law can be traced to the 1851 case of the “the Bold Buccleugh” in which the court highlighted the salient features of a maritime lien. The court held that a maritime lien was a right which “travels” with the ship into whosoever’s possession it may subsequently go. As such the right or interest does not depend on possession – as in the case of the possessory lien nor on notice through filing before any ship or other registry as in the case of a mortgage.65

It is therefore often referred to as a “secret” lien. It is also said to be “indelible” until acted upon by the Admiralty Court in an action in rem and it is good against the whole world including a bonafide purchase for value without notice of the existence of the lien.66

Under Nigerian law, ‘Maritime lien’ is as provided in the Merchant Shipping Act No. 27 2007. Section 66 of the Act prescribes as follows:

“The following claims shall be secured by maritime liens on the ship – a. Wages and other sums due to the master, officers and other

members of the ship’s compliment in respect of their employment on the ship;

b. Disbursements of the master on account of the ship;c. Claims in respect of loss of life or personal injury occurring whether

on land or on water in direct connection with the operation of the ship;

64 Ibid. Page 565 Ibid.66 Ibid.

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d. Claims for salvage, wreck removal and contribution in general average;

e. Claims for ports, canal and other waterways, dues and pilotage dues.”

The foregoing maritime liens are accorded priority over any mortgage or preferential rights registered under the Act or which arise under the law relating to bankruptcy or any other law.67 Such claims are valid irrespective of whether the claims secured by the liens are against the owner or against the demise or other charterer, manager or operator of the ship and the claims remain attached to the ship notwithstanding any change in ownership or in the registration of the ship.68

Furthermore, as among the maritime liens listed above, priority shall be accorded in the order in which they appear except that the lien contained in section 66(1)(d) shall take priority over all others in the event the others were registered prior to the time when the operations giving rise to the liens contained in section 66(1)(d) was performed.69

However, it should be noted that the law does not require the registration of lien by a lien holder. Therefore, the provision stipulating that the lien contained in section 66(1)(d) will take priority over all others in the event the others were registered prior to the time when the operations giving rise to the liens contained in section 66(1)(d) was performed can only mean that the lien in section 66(1)(d) will take priority if the occurrence of other liens predates the occurrence of the lien contained in section 66(1)(d).

Furthermore, a maritime lien shall be extinguished at the expiration of one year from the date in which the claim secured by the lien arose, except prior to the expiration of the one year period the ship was arrested and the arrest leads to proceedings for a forced sale.70

In addition to the liens listed above, section 69 recognises another set of maritime lien preferred above registered mortgages. It stipulates as follows:

67 Section 67 Merchant Shipping Act No. 27 200768 Ibid. Section 70(1) & (2)69 Ibid. Section 68(1)70 Ibid. section 72

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“Notwithstanding any other law relating to the priority of liens, the lien or right of retention which – a. a shipbuilder may have to secure claims for the building of the ship;b. a ship repairer may have to secure claims for the repairers of the

ship, shall be postponed to all maritime liens set out in section 67(sic) of this Act, but may be preferred to registered mortgages or preferential rights as long as the ship remains in his possession.”

However, it should be noted that the lien created in the foregoing provision is extinguished as soon as the ship builder or ship repairer ceases to be in possession of the ship.71

In view of the foregoing, in the event of a forced sale, the proceeds of the sale shall first be applied in satisfaction of the costs awarded by the court and arising out of the arrest and subsequent sale of the ship. Thereafter, the balance shall be distributed in satisfaction of the claims made in respect of maritime liens listed under section 66 of the Act. Then, the claims of the preferential rights listed under section 69 of the Act shall be satisfied before the holders of registered mortgages and other preferential rights registered shall be satisfied.72

STATUTORY LIEN

In addition to the lien referred to above, the Admiralty and Jurisdiction Act73 creates a different class of lien known as statutory lien. Section 5(4) prescribes as follows:

“in any other claim under section 2 of this Act, where the claim arises in connection with a ship and the person who would be liable on the claim in an action in personam (in this Act referred to as the relevant person”) was, when the cause of action arose, the owner or charterer of or in possession or in control of the ship, an action in rem may (whether or not the claim gives rise to a maritime lien on that ship) be brought against – (a) that ship, if at the time the action is brought the relevant person is

either the beneficial owner of that ship in respect of all the shares in it or the charterer of the ship under a charter by demise; or

71 Ibid. Section 69(2)72 Ibid. Section 7573 Cap. A5 laws of the Federation of Nigeria (LFN) 2004

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(b) any other ship of which, at the time when the action is brought, the relevant person is the beneficial owner in respect of all the shares in the ship”.

Section 2(3) of the Act lists several claims bordering on damage done by a ship, whether by collision or otherwise; damage received by the ship, loss of life or personal injury sustained in consequence of a defect in a ship or in the apparel or equipment of a ship; loss of or damage to goods carried by a ship; an agreement relating to the carriage of goods or persons by a ship or to the use or hire of a ship, whether by charter-party or otherwise; salvage (including life salvage of cargo or wreck found on land); general average; pilotage of ship; towage of a ship or an aircraft when it is water borne; goods, materials or services supplied or to be supplied to a ship for its operation or maintenance amongst others.

By the combined provisions of section 2 and section 5(4) of the Act, an action in rem may be instituted in relation to these claims (even though they are not maritime claims) when the person who would be liable is the owner or was the charterer or one in possession or control of the ship as at the time the cause of action arose.

In Tawa Petroleum Products v. Owners of M.V Sea Winner74 the Court distinguished maritime liens from statutory liens when it held as follows:

“the position of a creditor who has a proper maritime lien differs from that of a creditor in an unsecured claim in this respect that the former, unless he has forfeited the right by his own lasches, can proceed against the ship not withstanding any change in her ownership, whereas the latter cannot have an action in rem unless at the time of its institution the res is the property of his debtor.”

In view of the above it is clear that the Admiralty Jurisdiction Act does not change the position of the law regarding maritime lien. However, it creates a different class of lien which can only be enforced in rem provided the person liable was at the time when the cause of action arose the owner, charterer or in custody or in possession of the ship.

CONFLICT OF LAWS

74 (1980 – 1986) NSC vol. 2 page 25 at 34 – 35

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As indicated earlier, ships are commonly used as a means of transportation of goods and passengers from one point to another. Every such exercise carries along with it or acquires in its course various competing legal interest of owners, charterers, suppliers, builders, repairers, other trade creditor and even employees of the ship. These interests sometimes become the subject of litigation in foreign jurisdictions under the laws different from those applicable in the ship’s home State of registration.75

This international colouration associated with the operation of ships creates conflict of laws cases bordering on jurisdiction or choice of forum, choice of law and sometimes the recognition of the foreign judgment. For instance, in Ioannis Daskalelis Case76 a Greek ship was repaired by a US ship repairer, but the repair bill was not paid. The ship sailed to Vancouver, British Columbia where she was arrested and sold by the Court, but the proceeds of the sale were not sufficient to pay all the creditors. The question before the Court was whether the claim of the repairer should be given the status of a maritime lien in order to be accorded priority over the claim of the mortgagee. In the US where the claim had arisen the claim had maritime lien status, but no such status existed under the law of the forum which is Canada. The Court of Exchequer found in favour of the mortgagee, but the Supreme Court of Canada reversed this decision and held that the repairer had priority as the Canadian Court would recognise and enforce a maritime lien acquired under the law of a foreign State.77

However, in the Halcyon Isle Case78, a case having similar facts and issues, the Privy Council reached a different conclusion. In this case a British ship was repaired by the same American ship repairer as had repaired the Ioannis Daskalelis and the repair bill was again not paid. The ship sailed to Singapore where she was arrested and sold by the Court, but the proceeds of sale were not sufficient to pay all the creditors. The question before the Court was whether the claim of the repairer should be given the status of maritime liens as to have priority over the claim of a mortgagee. In the place where the claim had arisen (USA) the claim had maritime lien status, but no such status existed under the law of Singapore. The High Court of Singapore found in favour of the mortgagee, the decision was upturned by the Court of Appeal but the Privy Council by a 75 L.Chidi Ilogu “Legal and Financial Implications of Maritime Liens & Mortgages” Modern Practice Journal of Finance and Investment Law Vol. 4 No. 3 page 1 at page 276 (1974) 1 Lloyd’s Report 17477 Ibid. Page 2078 (1980) 2 Lloyd’s Report 325

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majority of 3:2 restored the decision of the High Court. The decision was predicated on the fact that under English law, the question whether a claim has maritime lien status is to be decided according to the law of the forum and unless the claim has a maritime lien status under English law, the English court will not recognise or enforce it as a maritime lien.79

It is such developments and the possible inequitable experiences of the parties concerned that informed the 1926, 1967 and 1993 International Conventions on Maritime Liens and Mortgages which aim at establishing some uniform rules for the recognition and enforcement of these competing interests, within the legal systems of the contracting party and ratifying nations.80

However, much uniformity has not been achieved due principally to the lack of consensus on conflict of laws principles governing the creation and operation of maritime liens. This often results in a lien being attached or lost as a ship sails from one country to another. Also, the conflict between the operating interest of (ship owners, salvors and crew) and financial interests of lenders continue to pose some difficulty in accepting the priority of maritime liens over mortgage in some jurisdictions.81

Consequently, many national laws are yet to implement any of these conventions thereby leaving the proprietary rights attached to a ship exposed to divergent enforcement regimes.82

Section 3 of this paper will consider in much details the common financing option utilised in aircraft financing and the security package available to such financing options.

79 Ibid. Page 2180 Ibid.81 L.Chidi Ilogu “Legal and Financial Implications of Maritime Liens & Mortgages” Modern Practice Journal of Finance and Investment Law Vol. 4 No. 3 page 1 at page 1082 Ibid.

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SECTION 3

AIRCRAFT FINANCING

_____________________________________________

Aircraft financing essentially entails financing aircraft purchases and aircraft operations. The techniques of financing aircraft and the documentation, including challenges bordering on private international law are similar in many respects to ship mortgages. This is essentially due to the fact that aircrafts are expensive and extremely mobile assets.

Borrowings from ship registration legislations are everywhere apparent even though the legislators have deemed it fit to make improvements in certain instances. However, it should be noted that aircrafts are often financed not on the security of mortgages but by financial leases. Also, while the one-ship company is common, the one-plane company is not.83

Another difference flows from the importance of spare parts in aircraft financing, especially engines. Airlines may substitute engines or take engines on lease. 83 Ibid. page 562

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These items of equipment can form a substantial portion of the cost of an aircraft and hence of the security, but many legal systems are unsuccessful in bringing these separate pieces within the scope of effective charges. The 1948 Geneva Aircraft Convention made a somewhat unrealistic stab at the matter. The Cape Town Aircraft Convention offers a comprehensive alternative.84

The common financing options available to aircraft financing are finance lease and term loan. These financing options are discussed in more details.

1 FINANCE LEASE

The rising cost of aircraft raises questions on the viability of outright purchase of aircraft as an economic option. The fair market value of an A737 – 300R aircraft is about $32 Million, with this price becoming more prohibitive by the day; most airlines have devised ways of reducing their capital expenditure burden by opting for the lease option.85

Besides the cost implication, the tax consideration may be another incentive for aircraft leases. The most common arrangement is for banks to finance the purchase of the aircraft and lease it to an airline operator. In such situations, the leases are structured to enable the bank take the benefit of capital allowances. However, in cross border leases, a well structured lease would entitle both the lessor and the lessee in their respective jurisdiction to reap the benefit of tax allowances through what is referred to as the double dip lease structure.86

A typical aircraft lease occurs where a specially formed lessor buys an aircraft from the manufacturer with a loan from a syndicate of banks and leases it under a finance lease to the airline which operates, maintains and bears all the risk of the aircraft and pays rentals sufficient to cover the loan plus equity in the lessor. The lessor/owner mortgages the aircraft to the banks and assigns the lease, manufacturer’s warranties, insurances and requisition compensation to the banks by way of security. The lessor or its shareholders/partners obtain tax capital allowance for tax purposes which are passed on to the lessee by way of rental reduction.87

REGISTRATION OF LEASES84 Ibid.85 Ibid.86 Ibid.87 Philip Wood “International Loans, Bonds, Guarantees, Legal Opinions” (Sweet & Maxwell 2009) page 29

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Nigerian law88 imposes an obligation on parties to register with the Nigerian Civil Aviation Authority (“NCAA”) an aircraft which is the subject of a lease by a foreigner. The law prescribes as follows:

“An aircraft is eligible for registration if it is –

(1) Owned by:(i) A citizen of Nigeria,(ii) An individual citizen of another State who is lawfully admitted for

permanent residence in Nigeria,(iii) A corporation lawfully organized and doing business under the laws

of Nigeria and the aircraft is based and primarily used in Nigeria(iv) A government entity of Nigeria or political subdivision thereof; or(v) A foreign person who has leased the aircraft to one of the persons

described in paragraphs (i) – (iv) above, provided that:(A) The aircraft may remain on the Nigerian registry only for

as long as the lease remains in effect; and (B) The certificate of registration includes the names and

addresses of the lessee and, if different, the operator of the aircraft;

(2) Not registered under the laws of any other State; and(3) The aircraft is not more than 22 years old, unless the aircraft is used

exclusively for general aviation purposes.”

In view of the forgoing an aircraft lease involving a foreign lessor is required to be registered in Nigeria. The purpose of registration is to enable individuals intending to obtain information to access the register of legal interest for the purpose of obtaining such information.89

REPOSSESSION BY THE LESSOR

Aircraft leases would usually contain a long list of events the occurrence of which amount to a default by the lessee and would entitle the lessor to repossess the aircraft. The most prominent of these events is the failure by the lessee to make rental payments due by it on the due date.90

88 Paragraph 4.2.1.2 Civil Aviation Regulation 200989 R.O. Omosun “Aircraft Financing Options” Modern Practice Journal of Finance and Investment Law October, 2000 Vol.4 No.4 page 22290 Ibid.

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Invariable the lease will make provision for the taking of possession of the aircraft in the event of a default by the lessee in the terms of the lease. Thus, it is usual for the lessor to recover possession without judicial intervention. In such instance the lessor will apply to the NCAA for the de-registration of the aircraft if he is either in possession of a valid de-registration power of attorney or is in possession of the certificate of registration.91

Also, recourse may be made to Court where in the opinion of the lessee the recovery by the lessor is unjustified. However, provision is usually made in the lease for the indemnification of the lessor if the taking of possession will involve the lessor in the civil offence of trespass. But if the recovery is unjustifiable then the lessee will be liable in damages. This is because the lease usually provides that the lessee will have a right of quiet enjoyment of the use of the aircraft provided he is not in default under the term of the lease. 92

On default by the lessee, the lessor may seek the return of the aircraft and damages for breach of the lease. Damages sought may comprise not only of the rent due but of future rent where the breach in question is a repudiatory breach.93

Generally, where a lessor terminates the lease in the exercise of a right under the lease it can recover damages for any breach on the part of the lessee up to the date of termination but not thereafter. Thus, rent arrears (and interest thereon) will be recoverable but future rent will not.94

In Lombard v. Butterworth95 parties had entered into a hire purchase agreement for a period of 5 years. Clause 6(a) of the agreement provided that in the event of the plaintiff repossessing the goods the defendant was to pay the plaintiff all rents in arrears and all future rents that would have fallen due and damages for breach of contract. The first two rentals were promptly paid but the next three were late. After due notice had been issued, the plaintiff repossessed the goods and filed an action for damages claiming the arrears of rent and 12 rentals due after termination. Nicholls L.J at page 541 referring to the dictum of

91 Paragraph 4.2.1.3 Civil Aviation Regulation 200992 R.O. Omosun “Aircraft Financing Options” Modern Practice Journal of Finance and Investment Law October, 2000 Vol.4 No.4 page 22293 Ibid.94 Ibid.95 (1987) Q.B page 527

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Lord Denning M.R. in Financings Ltd. V Baldock (1963) 2 Q.B. 104 held as follows:

“when an owner determines a hire purchase agreement in exercise of a right so to do given him by the agreement, in the absence of repudiation he can recover damages for any breaches up to the date of termination but not thereafter, and a ‘minimum payment’ clause which purports to oblige the hirer to pay larger sums than this is unenforceable as a penalty.”

The rational for not permitting the recovery of future rents is predicated on the fact that since the lease was terminated by the plaintiff upon the defendant’s breach (and not by the repudiation of the lease by the defendant) there were no future breaches to permit recovery of future rentals.

2 TERM LOAN

It is less usual for an airline to finance the acquisition of an aircraft by a straight forward loan because there may be no tax advantages. In this instance, however, a specially formed lessor buys an aircraft from the manufacturer with a loan from a syndicate of banks and leases it under a finance lease to the airline which operates maintain and bears all the risks of the aircraft and pays rentals sufficient to cover the loan plus equity in the lessor. The structure would normally comprise a term loan secured by a mortgage on the aircraft concerned and a security assignment of the lease, manufacturer’s warranties, insurances and requisition compensation to the banks by way of security.96

MORTGAGE

Under Nigerian law, mortgages of aircraft may exist as legal or equitable mortgages. A legal mortgage takes effect as a transfer to the mortgagee of the mortgagor’s title and interest in the aircraft. The transfer is conditional since the mortgagor retains the right to redeem the aircraft upon payment of the mortgage debt. Any provision which purports to exclude this right of redemption is void. The mortgage may be created by oral agreement between the parties

96 P.R Wood “the Law and Practice of International Finance series) Vol. 2 (Sweet & Maxwell) page 550

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though, in the case of an aircraft, prudence would dictate that it is put in writing. 97

An equitable mortgage on the other hand, is an executory agreement to transfer legal title only. Thus there is no actual transfer of legal title even though Nigerian courts in their equitable jurisdiction are empowered, upon the mortgagee’s application, to order such transfer in certain circumstances. The mortgagor (as in the case of a legal mortgage) has an inalienable right to redeem the aircraft upon payment of the mortgage debt.98

The more usual occurrences of equitable mortgage are where an agreement has been made to effect a legal mortgage or where a prior legal mortgage has already been created over the aircraft. (Indeed, any mortgage effected subsequent to a legal mortgage over the same property will necessarily be equitable since legal title to chattels is indivisible). As the former takes effect as a contract it must be supported by consideration. The later, however, takes effect as an assignment and, as such, consideration will not be necessary.99

MORTGAGE OVER SPARE PARTS

By Article X(4)100 ‘spare parts’ means “parts of aircraft, engines, propellers, radio apparatus, instruments, appliances, furnishings, parts of any of the forgoing, and generally any other articles of whatever description maintained for installation in aircraft in substitution for parts of articles removed.”

Airlines often pool engines and agree to provide spare engines to each other. This is usually regulated by the mortgage or lease. The important issues are whether spare engines located in a store can be subject to a non-possessory chattel mortgage101 even though they are not attached to the aircraft and whether removed engines can still be subject to the mortgage. States which allow non-possessory chattel mortgages will allow this mortgage.102

97 Graham McBain and Richard Hames “Aircraft Finance Registration, Security and enforcement” (Longman) Vol. 2 1990 Nigeria at page 798 Ibid.99 Ibid.100 Convention of the International Recognition of Rights in Aircraft (Geneva) 1948101 Non-possessory chattel mortgage is a mortgage of chattels in which actual or constructive possession is not granted to the mortgagee102 Philip Wood “the Law and Practice of International Finance Series” (Sweet & Maxwell) Vol. 2 page 564

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In those countries objecting to non-possessory chattel mortgages, the mortgage has to be brought within an exception e.g. for industrial equipment if at all.103 Other countries which object to non-possessory chattel mortgages specifically authorise the mortgage of spare parts, provided they are kept in a specified place (where a public notice of the mortgage is exhibited) and recorded in the aircraft mortgage register.104

Under the Common law which is applicable in Nigeria, non possessory chattel mortgage is permissible. Therefore, spare engines and other parts may be made subject to the mortgage and endorsed as such on the Certificate of Registration.105 In order for such mortgage to be recognised under Nigerian law, the spare parts must remain in the place or places specified and an appropriate notice specifying the description of the right, name and address of the holder of this right and the record in which such right is recorded is exhibited at the place where the spare parts are located so as to give due notice to third parties that such spare parts are encumbered.106 A mortgage of spare parts which takes effect as a floating charge is not however acceptable.

Also, practical and legal difficulties may occur when the spare parts are, or become, attached to other aircraft in accordance with pooling arrangements or if they become subject to encumbrances in other jurisdictions. Hence, the mortgage will usually provide that:

a. Spare parts may only be utilized on other aircraft if the operators of such aircraft know of, and accept, the mortgagee’s interest;

b. All parts removed from the aircraft will remain subject to the mortgage until replaced with parts which are capable of being mortgaged. The later when attached, will immediately become subject to the terms of the mortgage;

c. Such parts as may subsequently become attached to the aircraft will be unencumbered and shall be of the same or equivalent type, value, condition and (where relevant) with the same time and modification status as any parts they may be replace; and

103 The list of such countries include Latin American countries like Argentina, Chile and Mexico and EU countries like Australia Denmark and Switzerland104 An example of such county is France 105 Graham McBain & Richard Hames “Aircraft Finance Registration, Security and Enforcement (op. Cit) Nigeria page 12 106 Article X of the Convention of the International Recognition of Rights in Aircraft (Geneva) 1948

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d. The mortgagee will be indemnified by the mortgagor in respect of any loss sustained by reason of the fact that spare parts might be, or become, subject to any adverse interest of a third party whether such parts are attached to the aircraft at the material time or at some future time.

MORTGAGE OF FUTURE PARTS OF AN AIRCRAFT

Mortgage of future part of an Aircraft envisages a situation where a replacement engine owned by the mortgagor is installed on the mortgaged aircraft. The question therefore is whether the engine is automatically covered by the original mortgage as an accessory or whether some new act is required to perfect the extension of the mortgage to replacement engine. Some countries do treat the new engine as an accessory covered by the mortgage without the need for a new registration or the performance of any other act provided that the original mortgage was expressed to extend to the subsequently installed engine.107

However, under the common law, mortgages of the future parts of an aircraft are ineffective if the goods were not owned by the mortgagee at the material time (whether because they were owned by a third party or because they had not yet come into existence) unless there was some “new act'' effectively transferring those parts (when acquired by the mortgagor) to the mortgagee. No “new act'' is, however, required to transfer the beneficial ownership in the future goods to the mortgagee if value is given and the goods are sufficiently identifiable as at the time of entering into the mortgage, in accordance with the principles of equity.108

The mortgage therefore usually provides that the mortgagor shall indemnify the mortgagee should any such future parts be subject to any adverse interest of a third party. Such an indemnity is, in reality, of little financial value since recourse is often had to the security as a last resort, the mortgagor having insufficient other assets to meet its obligations.109

107 Philip Wood “the Law and Practice of International Finance Series” (Sweet & Maxwell) Vol. 2 page 565108 Graham McBain & Richard Hames “Aircraft Finance Registration, Security and Enforcement (op. Cit) Nigeria page 12; see also Halsbury’s Laws of England Vol. 4 paragraph 603109 Ibid. Page 13

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However, with the domestication of the Convention of the International Recognition of Rights in Aircraft (Geneva Convention) 1948110 into Nigerian law111, it will appear that where the law of a country permits the mortgage of spare parts of an aircraft, the right of the mortgagee to the mortgaged property shall not be extinguished even where the mortgaged spare part is replaced by similar parts.

While there is no express provision in Nigerian law for the mortgage of future parts (including engines), in practice the Registrar of Aircraft will permit mortgages which include a term covering future parts to be lodged in the Registry of Aircraft alongside the Certificate of Registration and other particulars.112

REGITRATION OF AIRCRAFT MORTGAGES

The NCAA113 is obligated to maintain a legal interest Aircraft register in which all mortgages in respect of an aircraft will be registered in order to constitute effective notice to third parties.114

RECOVERY OF POSSESSION BY THE MORTGAGEE

In the event of default, the mortgagee may peacefully take possession of the aircraft and subsequently sell it provided it is a stipulated term in the mortgage or the mortgagor has otherwise agreed. Often, however, there are good practical reasons for the mortgagee to proceed by way of court order in the case where the mortgagor resists repossession rather than convey the property by way of a private sale. The following instances will suffice:115

(a) In the event of the wrongful taking of possession by the mortgagee, damages may be very high, especially those in relation to third parties such as lessees who may incur loss as a result of such seizure.

(b) The taking of possession may involve the mortgagee in the civil offence of trespass (though this possibility is often catered for in the mortgage by a

110 Article X(2)111 Section 73 of the Civil Aviation Act No. 6 2006112 Graham McBain & Richard Hames “Aircraft Finance Registration, Security and Enforcement (op. Cit) Nigeria page 13113 Nigerian Civil Aviation Authority114 Paragraph 4.2.1.6 of the Nigeria Civil Aviation Regulations 2009115 Graham McBain & Richard Hames “Aircraft Finance Registration, Security and Enforcement (op. Cit) Nigeria page 13

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term that the mortgagor indemnifying the mortgagee for any liabilities incurred thereby).

(c) The NCAA may refuse to grant to the mortgagee the requisite operating licences, airworthiness certificates and other permissions necessary for the continued operation of the aircraft.

(d) A mortgagee in possession would be required to maintain the aircraft in necessary repair and be diligent in collecting revenues. It would be liable for sums lost through its own negligence and default. It would also be required to pay outgoings before applying the profits earned by the aircraft to discharge the debt owed to it by the mortgagor.

(e) A private sale by the mortgagee of the aircraft may be challenged on grounds such as the authority of the mortgagee to pass good title, the right to sell, the lack of a sale at the best price and the infringement (or diminution in value) of the rights of other parties possessing security or other interests in and/or claims against either the aircraft or the mortgagor.

PRIORITY

There is no express provision under Nigerian law as to the priority of interest created in respect of an aircraft. However, the claims of any mortgagees in respect of any registered mortgages over the aircraft will rank prior to the lease. Also, prior to all claims including that of any such mortgagee will be the entitlement of the Court Sheriff to recover costs in respect of the enforcement of any claim to possession of the aircraft following the issue of the writ of fieri facias.

It is also likely that persons having liens (such as those arising from the salvage of the aircraft or preservation operations of the aircraft) would have priority over registered mortgages and all other rights in the aircraft. This is so where the law of the Contracting State where the operations of salvage or preservation were terminated creates a right conferring a charge against the aircraft. In such instance, the rights created shall be recognised by the Contracting States.116

116 Article IV(1) of the Convention on the International Recognition of the Rights in Aircraft (Geneva Convention) of 1948

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Furthermore, the rights created as a result of the salvage of the aircraft or the preservation operation of the aircraft shall be satisfied in the inverse order of the dates of the incidents in which they arose and such rights are required to be registered within 3 months from the date of the termination of the salvage or preservation operations in order to be enforceable.117

CONFLICT OF LAWS

As indicated earlier, aircraft is a capital intensive and very mobile object. Its operation is not limited to one territory and as such the enforcement of security rights created in respect of aircraft raises issues of international dimension as a result of the conflict in the laws of various jurisdictions. Security interest created in one jurisdiction may not necessarily be valid against third parties in another jurisdiction where the aircraft may be found and even if it is valid, the transaction will be governed by the laws of the state where the equipment is found and not the law of the financier or legal owner of the equipment.

In view of these varying legal issues and the right enforcement problems, the question therefore is how to ensure that the interest of financiers and aircraft equipment owners are secured and realisable in the event of default by the lessee or user of the aircraft in order to encourage such financiers and aircraft equipment owners to confidently finance and participate in the acquisition and leasing of aircraft?

This need resulted in the adoption of the Convention on International Interest in Mobile Equipment and the Protocol on Matters Specific to Aircraft Equipment which came into force on April 1, 2004. The convention is designed to establish an international legal regime for the creation, enforcement, registration and prioritising of security interests held by charges, conditional sellers and lessors in three categories of mobile equipments which are (a) air frames, aircraft engines and helicopters (aircraft object) (b) railway rolling stock, and (c) space assets.

The underlying basis of the convention and protocol was the formulation and adoption of a legal framework that would satisfy and eliminate the problems associated with asset-based financing and leasing of aircraft, so as to encourage the acquisition and financing of aircraft equipment.

117 Ibid. Article IV(2),(3) & (4)

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In order for parties to be subject to the provision of this convention, the interest must be an international interest constituted under Article 7 of the convention118 and the document must have been registered with the International Registry set up pursuant to Article 16 of the convention. Also, the convention will apply when, at the time of the conclusion of the agreement creating the international interest, the debtor is situated in a contracting state regardless of whether or not the creditor is situated in a non-contracting state.119

Furthermore, the convention provides for remedies available to the chargee in the event of default. Such remedies include taking possession or control of the object charged; sell or lease of the charged object; collect or receive income or profits arising from the management or use of the charged object or apply to the Court for an order authorising or directing any of the above.120 However, a chargee intending to either sell or lease the charged object is required to give reasonable prior notice in writing to the other interested persons as defined in the Article.121

In addition to the above, the chargee and all other persons interested may agree that ownership of any object covered by the security interest shall vest in the charge in satisfaction of the secured obligation and the court may on the application of the charge order that the ownership of the charged object shall vest in the charge.122

Also, the creditor may procure the de-registration of the aircraft and export and physical transfer of the aircraft object from the territory in which it is situated. However, the creditor shall not exercise the above remedies without the prior consent in writing of the holder of any registered interest ranking in priority to that of the creditor.123

118 Article 7 prescribes that “An interest is constituted as an international interest under this Convention where the agreement creating or providing for the interest: (a) Is in writing; (b) Relates to an object of which the charger, conditional seller or lessor has power to dispose; (c) Enables the object to be identified in conformity with the Protocol; and (d) In the case of a security agreement, enables the secured obligations to be determined, but without the need to state a sum or maximum sum secured.” In view of this, a lease contact of sale mortgage or loan agreement would qualify as documents constituting an international interest119 Article 3 & 4120 Article 8 (1) & (2)121 Article 4, Interested person is defined in Article 1 as the debtor, a surety or guarantee or one who issues a letter of credit or any form credit insurance or any other person having right in or over the object122 Article 9

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SECTION 4

RECOMMENDATIONS AND CONCLUSIONS

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As it stands currently, Nigeria is a cargo importing nation as against a ship owning nation. Thus, most of its shipping lines are involved in the chartering of vessels for the purposes of transportation. The situation is similar in the aviation industry where most aircrafts operated by airlines are acquired via short term leases (ordinary lease). This, as indicated earlier, is due primarily to the prohibitive cost of acquiring these assets.

FINANCING

It is hoped that with the introduction of Islamic Banking into the Nigeria financial system, the banking sector will be viable enough to finance the acquisition of these assets either by way of direct purchase or through a finance lease. As more people are likely to imbibe the culture of banking due to the prohibition of the payment of interest rate under Islamic financing thereby increasing the financial base of the bank available for the funding of huge capital project such as the acquisition of roving assets.

123 Article IX (1) of the protocol to the convention on international interest in mobile equipment on matters specific to aircraft equipment

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Also, investors are likely to engage such form of banking since the high cost of procuring loans as prevalent in the current banking system in Nigeria will be eliminated and the risk of the project will be jointly shared by both the investor and the financier.

Furthermore, it is suggested that these companies should consider raising funds through the capital market. Presently, no airline or shipping line is listed on the Nigerian stock Exchange. Other financing options such as equipment trust and securitisation should be adopted in the financing of roving assets.

LEASES

The main reason why recourse is made to this form of financing is because the finance is cheaper (when compared to bank loans) and it is commercially secured as the lessor or ship owner as the case may be may terminate the transaction and re-possess the asset.

It will be observed that unlike aircraft lease, there is no requirement under Nigerian law for the registration of leases in ship financing. This may be so because registration could be inconvenient in respect to short term transactions such as a voyage charter or a time charter unlike aircraft lease which are usually for a long duration. However, an unscrupulous charterer may exploit this loop hole in our laws and register such ship in his name. This is particularly so when the ship has been hired as a demise charter and for successive voyages.

Furthermore, at the expiration of the lease period the ship owner is usually entitled to demurrage and could exercise common law right of lien over the cargo on the vessel. This is unlike aircraft lease where the lease terminates at the expiration of the lease and the lessor is entitled to take possession of the aircraft. Any outstanding rent therein can only be recoverable by instituting an action.

MORTGAGES & LIENS

Furthermore, in respect of the security package under ship financing, it should be noted that both mortgages and lien are valuable security packages in financing both the acquisition and operation of a ship. However, the area of divide between ship financiers and operators is in respect of the issue priority in the event the value of the asset upon sale is insufficient to satisfy the creditors.

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It is suggested that the secret nature of liens coupled with the priority accorded maritime liens under Nigerian law make it inequitable to ship financiers whose interest are secured by mortgage. Our view is predicated on the fact that an intending financier may be unaware of existing liens on the ship prior to executing a mortgage. Furthermore the list of items constituting maritime lien are numerous and could encumber the asset materially.

Therefore, it is suggested that a lien holder should be obligated under the law to register his interest in order to give notice to prospective lien holders/financiers of existing encumbrances on the ship. Thus the concept of the registration of legal interest in a ship as available under the Nigerian Civil Aviation Act, in respect of aircraft, should be introduced into the Merchant Shipping Act. This will make it mandatory to register any form of interest relating to the ship including lien and charter party.

Furthermore, it is suggested that there should be specific statutory provision requiring the registration of future/replacement part of an aircraft as it is still arguable under Nigerian law as to whether such parts will be enforceable under a mortgage in view of the common law position. We are of the view that this will further strengthen the security package regarding aircraft financing and enhance the confidence of financiers regarding their security.

Also, it is worthy to note that there may be need to amend the relevant tax laws in Nigeria in order to avoid a situation of double taxation particularly in respect of aircraft mortgage. Our view is predicated on the fact that both stamp duties and capital gains tax are payable upon the transfer of asset to the financier and on completion of the transaction and subsequent re-transfer of the asset from the financier to the investor. This will pose a problem to mortgages in the aviation sector since financiers are expected to take ownership of the asset upon the execution of a mortgage.

However, this challenge may not arise in respect of ship mortgage as the mortgagor retains ownership over the ship or his share in the ship irrespective of the mortgage and the ownership right of the mortgagee in relation to the ship or a share in the ship is limited only for the purpose of enforcing his security for the mortgage debt.

CONFLICT OF LAWS

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The lack of consensus on conflict of laws principles which should govern the creation and operation of maritime liens among nations have resulted in uncertainty as to the governing law in respect of ship operation. Also, the conflict between the operating interest of (ship owners, salvors and crew) and financial interests of lenders continue to pose some difficulty in accepting the priority of maritime liens over mortgage in some jurisdictions.

This state of affairs makes investors wary as to the enforceability of their security and has led to the insertion of jurisdiction clauses or arbitration clauses indicating the seat of arbitration in the charter in order to protect their rights and investments and limit their losses.

It is suggested that a consensus as to these issues among nations and the enactment of a treaty regulating these issues and acceptable to nations will help make certain the applicable laws and enhance investors confidence in ship financing.

Furthermore, it is suggested that an international convention recognising an international interest in ship similar to the Convention on International Interest in Mobile Equipment and the Protocol on Matters Specific to Aircraft Equipment which applies to aircraft be enacted in respect of ships. This will elevate a mortgage constituted in accordance with the convention and registered accordingly from the uncertainties of differing municipal laws.

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