By Wayne Panton of Walkers and Anne Forbes of Walkers (Europe)
The last twelve months in the aviation industry have been dramatic in the extreme. During what was widely regarded as a cyclical downturn in the market, the events of September 11th saw a sharp and immediate decline in aircraft business and traffic worldwide. The ensuing panic caused by the Insurance sector's reduction of third party liability coverage and the collapse of Sabena and Swissair made 2001 arguably the most difficult year in aviation history.
All this left the distant and temperate waters of the Cayman Islands relatively unscathed. While the initial aftershock of 9/11 slowed new business worldwide, confidence is slowly returning to investors and financiers in the aviation sector. Perhaps more significant for the Cayman Islands has been the Enron collapse and the impact this may have on the future of the Cayman Islands as an offshore financing location. Considered with the recent OECD and FATF initiatives in the past few years early indications are that the prognosis is good. With recent developments in securitisation techniques and the new possibility of registering private aircraft on the Cayman Aircraft Register, the appeal of the Cayman Islands does not seem at risk of fading.
The Cayman Islands has always been the most attractive jurisdiction for aircraft financing deals for numerous reasons. Without going over this well-travelled terrain too extensively, the legal and tax regime in place is conducive to establishing and operating special purpose vehicle ("SPV") transactions. Cayman Islands Law is based on English Law so the main issues central to these transactions relating to security interests, creditors rights, corporate power, limited liability and directors' "duties" are substantially similar. The absence of any direct taxes in the Cayman Islands and the certainty that this position will continue by virtue of the Government issuing a tax undertaking provides a lender with added comfort. Establishing a Cayman SPV is quick and inexpensive and no prior authorisations or licenses need to be obtained from the Government. The incorporation process can also be expedited to a same day service for a fee if necessary. Once established, the SPV can be managed by any one of a vast number of service providers based in Cayman. All of the major international accounting firms have offices in the Cayman Islands, and the major international banks and trust companies are also well represented.
For lenders, one of the most alluring features of the Cayman Islands is that their insolvency laws are known to be creditor friendly. Lenders also benefit from a robust security package which usually comprises a mortgage over the aircraft, a charge over an account or accounts into which the lease rentals are paid by the airline, a charge or assignment of insurance policies and warranties with respect to the aircraft and engines, a charge over all the rights and interests of the SPV in and to the transaction documents, and finally a charge over the shares of the SPV. All security documents will ordinarily be executed by power of attorney outside the Cayman Islands to avoid stamp duty liability in the case of documents which grant security interests. It is worth noting that the Registrar of Companies in Cayman does not maintain a central companies’ charge register but rather each Cayman company is required to keep a Register of Mortgages and Charges which details all mortgages and charges on any of the company’s assets. While failure to make an entry does not affect the validity of the security, it is an offence under Cayman Islands Law and could have a negative impact on the good standing of the Company and possibly trigger a default.
One of the only question marks over the Cayman Islands until recently was to what extent the OECD and FATF’s international initiatives would impinge on the Cayman Islands' success as the jurisdiction of choice for SPV business.
It became clear fairly quickly that the Cayman Islands were in a better position to accommodate the position of the OECD on harmful tax practices than other offshore centers because there is no form of direct taxation in the Cayman Islands so there are no preferential or discriminatory tax practices. As a result the Cayman Islands were one of the six jurisdictions which issued an advance commitment to the OECD in May 2000 to provide for exchange of information in relation to criminal and civil tax matters to be phased in over a five year period. This allowed the Cayman Islands and the five other jurisdictions to avoid the OECD "blacklist" which was issued the following June. Those countries blacklisted will be invited to make commitments to eliminate harmful tax practices, failing which, defensive measures will be implemented by member countries on the recommendation of the OECD. Defensive measures will mean a non-cooperative jurisdiction may be subjected to withholding taxes on payments to its residents, enhanced audit and enforcement activities, the denial of deductions, exemptions, credits or other allowances relating to transactions involving uncooperative tax havens. As a cooperating member the Cayman Islands will not be subjected to any such defensive measures.
Despite the fact that the Cayman Islands has had a longstanding relationship with the Financial Action Task Force ("FATF"), in June 2000 the FATF placed the Cayman Islands on its official blacklist of countries deemed to be non-cooperative in the international fight against money laundering. The FATF's decision was apparently based on its analysis that the Cayman Islands lacked specific legislation criminalizing a failure to report a suspicion of money laundering and that the various codes of conduct which were voluntarily adhered to by the various sectors of the financial industry in the Cayman Islands, were not mandatory. The Cayman Islands Government was quick to respond to this criticism and the Cayman Islands Proceeds of Criminal Conduct Law was amended and Regulations thereunder with Guidance Notes similar to those issued in the UK were adopted. These specifically make it an offence to fail to report a suspicion of money laundering and made the voluntary codes of conduct mandatory. In addition, provisions requiring the keeping of records and mandatory training for the staff of all entities conducting relevant financial business in the jurisdiction have also been introduced. On the basis of the implementation of the foregoing, the FATF removed the Cayman Islands from its blacklist at its June 2001 plenary session.
The unexpected experience with the FATF, while certainly a disappointment, demonstrated the commitment of the Cayman Islands to the elimination of harmful tax practices and also its responsiveness to the demands of the international community. For reasons such as these, structured finance business in the Cayman Islands has continued to increase and aside from the threat of developing onshore securitisation structures, no new threats loom on the horizon. Many offshore jurisdictions have not resolved their outstanding issues either with the OECD or the FATF (and in some cases both) although the threat of sanctions from the former is decreasing as it goes through the process of reformulating its approach.
In line with the increase in structured finance business in Cayman is the implementation of securitisation techniques in innovative new structures. Two deals were completed in 2001 which may have far-reaching consequences for the airfinance industry and the Cayman Islands too.
The 'Leonardo' transaction concluded between IntesaBci and Merrill Lynch broke new ground by securitising an entire aerospace portfolio by a US$1 billion publicly rated synthetic securitisation. The motivating factors behind Leonardo were for IntesaBci to obtain Balance Sheet capital relief, and to free-up credit lines in a cost efficient manner. BAE SYSTEMS PLC completed a transaction, ‘SYSTEMS 2001’, which used a Cayman SPV in a structure that enabled it to monetise lease cash flows and raise over US$2 billion in the US capital markets to refinance existing debt facilities with respect to its regional aircraft portfolio. Both deals are considered hugely successful both by the clients and the market in general and provide benchmarks for future public and private issues and financings. Looking ahead, the structures developed for both Leonardo and SYSTEMS 2001 should help to open up new lending capacity. SYSTEMS 2001 was more than four times oversubscribed with over 100 participants from both the United States and Europe. The huge success of these two transactions and the enormous demand shown in the SYSTEMS 2001 issue will presumably prompt others into looking at similar structures and techniques in aircraft finance. While the Leonardo funding vehicles were not located in the Cayman Islands there is no reason why similarly structured deals could not benefit from the use of Cayman-based SPV’s. The extent to which the Cayman Islands has proved to be flexible, innovative and responsive to international developments make it the preferred choice for these offshore SPV transactions.
Turning then to Enron and the vast amount of speculation raised over the use of Cayman SPV’s by corporations, the early commentary suggests that there is no need to panic. Enron’s alleged use of Cayman vehicles to hide large amounts of company debts has prompted considerable anxiety across numerous industries including the aircraft finance market.
Immediately after the Enron collapse, the Cayman Islands Government offered to co-operate with the United States authorities in their investigations. However to date, no formal request for assistance has been made of the Cayman Islands on the Enron matter. So what is the effect of Enron likely to be on the use of the Cayman Islands in these offshore financing structures?
The critical factor with Enron, which distinguishes it from other off balance sheet structures, seems to be that they were trying to transfer low quality assets to third-party SPV’s in order to take these assets off balance sheet. This has attracted regulatory scrutiny and is likely to be clamped down upon in the future. However, it does not appear to be the aim of regulators to challenge banks or financial institutions which have transferred assets to an SPV in a properly structured and legally documented securitisation transaction that can be supported by legal and accounting principles with opinions and where some level of risk is retained. There is nothing to suggest that the structured finance securitisation products currently in the market are at risk of being attacked by the regulatory bodies investigating the demise of Enron.
Fairly recently, the Cayman Islands Aircraft Registry opened itself to registering aircraft that do not operate in Cayman. However any aircraft to be registered on this basis must be placed in the "Private Category" defined in the Air Navigation (Overseas Territories) Order 2001 as having "any purpose other than public transport or aerial work" and this excludes any commercial aircraft used for "hire and reward". One way in which the Cayman register might be useful for the aircraft financing industry is where aircraft need to be put into warehousing facilities. Given the recent Sabena collapse and the serious reduction in air traffic generally, where airlines have been forced to ground aircraft, this might be a particularly important new role for the Cayman Islands following 9/11.
Over the past forty years the Cayman Islands has developed a strong reputation as the leading jurisdiction for offshore financial transactions. The fact that the Cayman Islands is among the eight largest financial centres in the world shows just how successful it has been in a relatively short period of time.
The increasing number of financial service providers setting up in Cayman is testament to its success and shows confidence that its dominant position in offshore financing structures is secure. Over the past few years the Cayman Islands been challenged by the OECD and FATF initiatives, the events of 9/11 and the consequent dampening effect they had on international business and more recently intense scrutiny focussed on the Cayman connection to the Enron collapse. In each case, the Cayman Islands has been quick to respond and react, whether it be with amendments to existing legislation, or offering assistance in international and federal investigations. This demonstration of responsiveness and flexibility combined with its solid legal and tax regime will further enhance the Cayman Islands already exemplary credentials as the premier jurisdiction for offshore structures.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.