COVID-19: Considerations for rolling stock lessors
Louise Mor and Patrick Moore, Partners from WFW’s Assets & Structured Finance Group, write that as rolling stock operators face continued disruption to their businesses due to the impact of COVID-19, lessors should be aware of eight key points, and to be proactive in staying ahead of any changes facing the rail sector.
The impact of COVID-19 is being felt strongly across the European rail industry and further afield, and we have seen a significant number of lessees seeking rent reductions or holidays, or even termination of their contracts, as a result. While it is unclear how long current restrictions will last (and, indeed, lockdowns may return if there is a resurgence of the virus), it is to be expected that lessors will face further requests for financial accommodation. Analysts SCI Verkehr estimate a 40 per cent reduction in continental European passenger traffic for 2020, with almost an almost 20 per cent decline for freight transport. Lessors should be proactive in staying ahead of the changing situation.
1. Take advice early
One key difference between European rolling stock leasing and other large asset sectors, is that rolling stock leases are often governed by the local law of the customer. Therefore, a lessor may have a range of lease terms and governing laws to consider across its portfolio. Each jurisdiction will have its own quirks of interpretation, concepts of generally applicable law, and governmental approach to combatting the pandemic and alleviating the economic effects.
Lessors should confirm whether their leases provide for the unconditional payment of rent, and if they include a contractual force majeure provision. Lessors should also establish whether the lease’s governing law applies general concepts such as ‘hardship’ or other rules based on fairness, which may cut across ‘hell or high water’ payment provisions. Parties may have remedies where, due to events beyond their control, they are no longer in the situation they originally signed up to. Lessees may be able to claim that, as they are no longer receiving any benefit from the rolling stock they are unable to use, they should not have to pay rent. This argument may apply even where the contract puts such risk firmly in the court of the lessee.
One key difference between European rolling stock leasing and other large asset sectors, is that rolling stock leases are often governed by the local law of the customer.
If such rules exist, it is important to understand the procedure for invoking them. For example, can a lessee simply allege hardship, or must a court first rule that the impact of COVID-19 constitutes hardship, and thus entitles them to remedies? Can the lease be terminated absent such a ruling? And is there a requirement for the parties to renegotiate if one party believes they are no longer getting a ‘fair deal’? This will enable lessors to respond promptly and accurately to lessee claims.
As lessors may not be familiar with all aspects of the legal systems governing their leases, particularly in leases governed by a law other than that lessor’s preferred choice, it is vital to understand where generally applicable laws could vary or supplement the lease terms. This may be a good time to review and update any jurisdictional questionnaires obtained prior to entering the lease.
Anecdotally, to date lessees are generally invoking commercial, rather than legal, arguments in their requests for accommodation. However, as the situation develops, it may be that lessors begin to push back on requests and lessees turn to more legalistic arguments on which to base their claims.
We recommend taking advice on the potential arguments that lessees may make at an early stage, so that lessors are well-equipped to respond to lessee communications on a timely basis. Given the plethora of new government regulations and stimuli packages in Europe, and the legal variations across any lease portfolio, it is unlikely to be a case of ‘one size fits all’ for lessors when it comes to formulating their approach.
2. Obligations may not be one-sided
Lessors will argue that non-payment is not connected to the impact of the virus – it is unlikely that a rent payment simply cannot be made, if funds are available. Lessees’ financial difficulties resulting from reduced revenue during travel restrictions, for example, may not be considered an event outside its control which prevents it from satisfying its payment obligations (although in some jurisdictions it could be an event triggering a lease renegotiation to make it more ‘balanced’).
However, obligations to maintain rolling stock – which will lie with the lessee on a dry lease and the lessor on a full-service lease – may well be something that physically cannot be carried out. Whether due to restrictions on movement or staff unavailability due to illness, lessors with maintenance obligations should ascertain what defences are available to a breach of contract resulting from a failure to maintain the rolling stock. This will need to be looked at on a case-by-case basis, both from a contractual perspective and the wider governing law.
3. Increase lessee monitoring
It remains important for lessors to monitor their lessee’s financial condition and to ensure they are receiving financial reports and forecasts in accordance with the lease terms.
It remains important for lessors to monitor their lessee’s financial condition and to ensure they are receiving financial reports and forecasts in accordance with the lease terms. Where lessors have the right to request additional financial information or reports, they should consider doing so.
Bear in mind also the impact of protective measures and ‘bail-outs’, which will factor into decisions on whether/how financial accommodation should be granted to particular lessees. On the passenger side, changes to the revenue risk mechanism in the lessee’s concession agreements will also impact lessee cash flow.
4. Local law insolvency procedures
Where there is a risk of a lessee’s insolvency, lessors should consider when such issues may trigger a termination event under the lease terms and take advice to determine the jurisdiction in which any insolvency process is likely to be conducted; the key features which may act to limit enforcement action (e.g. any moratorium or ‘stay’ which may be imposed); and the process by which the lessor could repossess leased assets from the insolvent operator. Lessors should also consider the likelihood of other creditors petitioning for the lessee’s insolvency and the duties to which its directors are subject, which may bring forward the time at which an insolvency process is likely to commence and/or the need for standstill arrangements to be implemented.
5. Emergency Measures
In addition to general insolvency laws, temporary legislative measures may prevent them calling a default or taking enforcement action against a lessee. Advice may be needed to establish who is subject to the measures on a cross-border deal – does such measure bind a creditor in that jurisdiction, or is it only to protect debtors in that jurisdiction? In what circumstances can it be invoked?
Where the lessor may need to repossess assets, lessors should consider what advance preparations can be made for remarketing the assets and the arrangements under which they may be maintained and/or stored pending sale or re-leasing.
7. Financing arrangements
Financing agreements may require the lessor to deal with all or some leases in a specified manner, particularly when a financing is linked to a specific lease or concession (although portfolio financings may also require lessors to take or not take certain action in compliance with the finance agreement). Payment adjustments or other lease amendments may require the consent of or notification to lenders. This will have timing implications for any agreement with the lessee, as facility agents will need time to take instructions from lenders.
Financing agreements may require the lessor to deal with all or some leases in a specified manner
Lessors should confirm whether their finance documents contain a Material Adverse Change clause or other event of default which could be triggered by the effects of COVID-19. If lease receivables are reduced, the impact on financial covenants may trigger a lock-up period or event of default, though as these are usually tested by reference to periodic accounts, it is likely to be some time before the issue arises. However, where a breach is anticipated, lessors should consider what, if any, steps can be taken to mitigate it. Should waivers be required, this will also take time.
It may be wise to discuss such issues with financiers before they arise, to allow time to find solutions before an event of default crystallises.
8. Relationships are key
Due to the pandemic’s global nature, the impacts are being felt by all industry participants. Rather than proceed immediately to default and enforcement (in a difficult market), it is vital for parties on all sides to work together to mitigate problems as they arise. This requires a commercial approach, but one that is rooted in an understanding of the legal environment in which the parties are operating. When going into negotiations with a lessee, it is essential that you know what the terms of the lease, and all applicable laws both require, and allow, you to do. Forewarned is fore-armed.
Louise Mor is a Partner in WFW’s Assets & Structured Finance Group in London, with significant expertise in the rail and aviation sectors. Her transactional experience includes portfolio, secured debt, common terms platform, ECA-supported and Islamic financings, leasing company and asset acquisitions, operating leases and sales. She has represented several of the world’s largest leasing companies, operators and banks and has recently acted for Alpha Trains, Ermewa, NatWest and UKEF.
Patrick Moore is a Partner in WFW’s Assets & Structured Finance Group in London. He specialises in finance transactions and restructurings across the transport sectors, with a particular focus on rail, aviation and shipping. Patrick regularly advises banks, funds, borrowers and operators on cross-border syndicated and private placement loans, restructurings involving more than one class of debt, leasing transactions, export-credit backed financings, preferred equity investments and structured products.