AINsight: Contract Issues Remain Hot as Jet Sales Cool

 - March 10, 2023, 10:53 AM
Silhouette of business jet in flight overhead
(Photo: MarcusWoeckel at Pixabay, CC0, via Wikimedia Commons)

The preowned market for business jets is trending away from the near-manic demand and harsh seller terms we have experienced over the last few years. Ostensibly driven by the pandemic fears and the exuberance of first-time buyers, purchase prices skyrocketed and enabled sellers to restrict the due diligence of purchasers who often willingly accepted severe contract limitations to close an aircraft deal.

Despite and perhaps because of these extreme market conditions, the momentum in the preowned aircraft sales market remains strong and resilient—but not impervious—to inexorable headwinds of high inflation, rising interest rates, global economic and geopolitical risks, stock market wealth contraction, and incessant discussion of a recession.

Amid these strong market forces and slightly rising inventory of used jets for sale, pricing and contractual terms in aircraft purchase and sale agreements (APAs) appear to be rebalancing roughly to pre-pandemic norms. This comes even as some sellers resist lowering their sales prices or easing back on negotiating four major issues in APAs: hard and soft deals; aircraft delivery condition; inspection scope; and defaults and remedies for purchasers and sellers.

Soft Versus Hard Purchase Contract and Forfeiting a Deposit

At the inception of a negotiation to buy and sell an aircraft, the parties should, but do not always, negotiate a letter of intent (LOI). The LOI describes the basic transaction structure that the parties ultimately incorporate into a definitive APA. To show a seller that the purchaser means business, the purchaser makes a deposit ranging from $50,000 for small aircraft to $1 million or more for large-cabin aircraft.

The seller may structure the transaction in the LOI or APA as a hard (seller-friendly) or soft (purchaser-friendly) contract. Most sellers, in my experience, still have the market power to negotiate hard contract deals. In a soft or hard contract, the purchaser arranges for an initial aircraft inspection consisting of a records review, visual inspection of the aircraft, system function checks, engine ground runs or a test flight, and an engine borescope.

Following that visual inspection, in a hard contract the purchaser notifies the seller in writing whether the purchaser wishes to proceed with a full inspection on the glide path to closing. The hard contract states that a purchaser must buy the aircraft and the deposit is non-refundable unless the seller cannot satisfy the negotiated delivery condition and comply with other mutual agreements. If that occurs and the purchaser justly rejects the aircraft, the seller returns the deposit to the purchaser minus half of the escrow fees and the transaction ends.

Pre-purchase Inspection

A soft contract may allow a purchaser to accept or reject the aircraft for any reason as late as when the mutually selected inspection facility completes and issues a written report of its findings of a pre-purchase inspection (PPI). PPI inspection reports identify discrepancies based on an aircraft operations assessment, a records review, a systems analysis and, if required by the facility, a test flight. Discrepancies broadly mean deviations in the aircraft condition or operation from airworthy or other criteria specified in the APA.

During the market buying frenzy, sellers often forced purchasers to sacrifice or accept limited PPIs of an airworthy aircraft. As the sales market evolves, sellers may not have the sway to force purchasers to buy into that approach; rather, aircraft must be airworthy and meet the agreed delivery condition.

An associated issue is not whether a PPI will occur but when it will occur. The choice stems from pragmatic assessments of timing to complete a PPI and repair discrepancies. The parties usually try to complete the PPI before closing—the pre-pandemic norm—or, if necessary, the equivalent type of inspection after the closing to accommodate tax, financial, resale and hangar space planning or to cope with intractable supply-chain delays, unavailable inspection facilities, or limited pilot training slots.

Purchasers should obtain adequate protection against unknowable, negative aircraft condition or costs to make a sensible deferral. Structures to do so include holding funds in escrow to pay for repairs, reducing the sale price, and imposing the repair costs on a creditworthy seller or guarantor or some combination.

Delivery Condition

Often highly negotiated, delivery condition refers to an aircraft that is in an airworthy or better condition as specified in the APA after the seller repairs discrepancies, at the seller's cost, to ready the aircraft for closing. Even as the market cools, sellers may still rebuff a purchaser’s request to ensure every system or part, like Wi-Fi or a microwave, functions if the item is not required to deliver an airworthy aircraft.

Even more important, purchasers should closely evaluate with technical experts whether to accept an aircraft with material damage, material corrosion, or an undisclosed history of material damage.

Additionally, sellers must deliver their aircraft with complete, consecutive, and current documents, logs, and other records, and keep all existing maintenance programs on engines, APU, and other parts in effect at the seller's cost. The records describe the history of the aircraft's operations, maintenance, damage, and repairs.

The absence of complete aircraft records can scuttle or delay a sale. A purchaser should look askance at buying an aircraft with any missing records unless the seller fully recreates them to the purchaser's satisfaction according to applicable law and manufacturer standards.

Default By Seller or Purchaser

A seller or purchaser’s failure or refusal to perform their respective obligations under their APA can result in a default under the APA followed by a significant dispute or litigation.

If the purchaser refuses to close when the seller presents the aircraft in the agreed delivery condition, the seller’s primary remedy is to keep the deposit. In this context, the deposit constitutes liquidated damages and not a penalty. It is a predetermined amount of money that the purchaser must pay as damages to the seller instead of calculating damages that may be difficult or impossible to calculate.

Not all sellers will accept liquidated damages only. Rather, they may negotiate the right to claim other damages to cover their expenses, lost sale opportunity to another purchaser, or other losses.

A similar remedy exists for purchasers if a seller defaults by refusing to close or terminates a transaction unilaterally for no reason. If the seller ends the sale, the seller returns the deposit and reimburses the purchaser for certain costs.

Some purchasers may demand more from the seller, which occurred in a highly controversial case, Jet Experts LLC v. Asian Pacific Aviation Limited, in May 2022. There, the purchaser sought to force the seller to close a sale of an aircraft that, compared to other similar and available models, uniquely suited the purchaser's medical business using a remedy called “specific performance.”

Although the seller has filed an appeal, aviation lawyers may include language in APAs that prevent or allow specific performance. Purchasers may like this remedy, while sellers may not. Sellers should note that unprovoked terminations without cause—to sell the aircraft to a higher bidder or otherwise—may trigger similar lawsuits.

Last Thoughts

APAs reflect changes in the business market of selling and purchasing aircraft. The trend toward more balanced terms seems evident and covers issues such as APA soft and hard contract structures, pre-purchase inspections, delivery conditions, and default and remedies of the parties.

The market benefits from fairness in aircraft sales just as it has suffered from sellers who have unnecessarily extracted burdensome concessions from purchasers during the overheated sales market that is now only visible in the rearview mirror.