Lease Return Language – “without regard to hours and cycles”

Lease Return Language – “without regard to hours and cycles”

Lease Return Language – “without regard to hours and cycles”

Almost all leases contain clauses that describe the condition that the aircraft and engines must meet at the end of the lease term.  These “return conditions” stipulate the aircraft configuration, the status of the airframe maintenance, the time remaining on major components, other details that the lessee must meet when the aircraft is redelivered to the lessor.  As with all clauses in a lease agreement, the authors and negotiators spend hours ensuring the words in each of these clauses accurately reflect the decisions and agreements of the parties.  Unfortunately, even the best agreements are fraught with misinterpretations.

One clause that is often misunderstood and has a track record of court rulings is the clause that allows an engine replacement or substitution.  At the end of the lease, the collateral engine or the engine that was delivered with the airframe may not be available, may not meet return conditions, or may simply be inconvenient for the lessee to return.  Many leases provide a clause that describes the conditions for a Replacement engine to be included in the Aircraft return.  This often states the Replacement engine must be of equal or greater value and utility.  However, as well meaning as the author intended, there seems to be controversy and consternation with the parenthetical that intends to clarify how to determine the value and utility.  This clause, “the Replacement engine must be of equal or greater value and utility (without regard to the number of hours or cycles)”, creates a problem.

Simply searching the internet for the words “without regard to hours or cycles” and you will find this clause in numerous leases as it has proliferated among the leasing companies.  Unfortunately, it is AVITAS’s opinion that compliance with this clause is unachievable.

As an appraiser, there is a limited amount of criteria you can use to determine the value of an aircraft or engine.  When comparing two engines of the same type, the two major data points for determining the value of each engine are 1) cycles remaining on the Life Limited Parts (LLP) and 2) the number of hours the engine has accumulated since its last performance restoration or engine shop visit.  In other words, the primary method of determining the fair market value of each engine is by considering the hours and cycles on the engine.  Keep in mind however, that if hours and cycles are not considered in determining the value and utility of the engine, a deep dive into the records, traceability of LLPs, configuration, mod standards, borescope results, trend monitoring, repair history, accident/incident history, etc. will have to be done which has a high likelihood of uncovering other issues affecting the engine’s value.

The big deal here is that there may be huge sums of money riding on the interpretation of this clause.  If a lessee proposes to replace an engine that has recently had a full performance restoration and received a new set of LLPs, with an engine that is nearly run out, the value difference between these two engines could be measured in the millions of dollars.  This clause alone can make a profitable lease become a loss.

AVITAS has been involved with many lease returns where this clause has come into play.  On every one of these lease returns, there has been a long, protracted, even hotly contested discussion as to the meaning of this clause, how to comply with this clause, and the established court rulings on this clause.

The takeaway from this discussion – If you have this clause in your lease agreement and there is a replacement engine being proposed with the aircraft return, take the time to determine the appraised difference in value between the collateral engine and the replacement engine, and be prepared for a longer than normal return process.