Part Two: Bilateral Investment Treaty-Like Enforcement Mechanism
Charles W. Mooney, Jr.*
I. Operation and Benefits of The Cape Town Convention: Centrality of Implementation and Compliance by Contracting States 5
A. Contracting State Compliance and the Underlying Economic Assumptions of Cape Town 5
B. Insolvency- and Enforcement- Related Provisions of Cape Town 9
C. Contracting State Non-compliance: Is There a Problem? 11
II. The Proposal: An Amendment on Investor-State Enforcement 18
A. Investor-State Enforcement: The BIT Model as Applied to Cape Town Transactions 18
1. Cape Town Creditors as Investors 18
2. The Cape Town Amendment Process 20
3. Scope and Content of the Amendment 22
a. Scope: Covered Obligations 22
b. Scope: Covered (Protected) Creditors 24
c. Implementation Provision 24
d. Structure of ISDS for Award of Damages 25
B. Current Debates on BITs and Investor-State Enforcement: Red Herring 28
C. Feasibility of a Convention Amendment on Investor-State Enforcement: Should the Problem be Addressed? 33
This essay is Part Two of a two-part essay series that outlines and evaluates two possible future international instruments.1 Each proposed future international instrument draws substantial inspiration from both the Cape Town Convention2 and in particular its Aircraft Protocol.3 In addition to both the Cape Town Convention and the Aircraft Protocol, this paper will address components of any other Protocol that might enter into force in the future.4 (For convenience, unless otherwise noted or implied from the context, subsequent references to “Cape Town” refer to the Cape Town Convention, the Aircraft Protocol and other such Protocol together that might enter into force in the future. More specific references to the “Convention” or a particular “Protocol” refer in particular to the identified instruments.) This Introduction first provides background on Cape Town then outlines the two possible future projects.5 It begins by summarizing the project presented in Part One of the essay series.6 Part One assessed the first project on its merits as well as its feasibility from practical and political perspectives. Part Two takes the same approach in presenting and analyzing the second possible future project.
The Convention and the Aircraft Protocol were opened for signature on November 16, 2001 following a diplomatic conference in Cape Town.7 While the Convention contains the basic legal regime for secured financing and leasing of equipment, the Aircraft Protocol consists of specialized provisions adapting the Convention for financing and leasing of aircraft and aircraft engines.8
The Convention and the Aircraft Protocol provide a legal regime for security interests (“international interests”) in large airframes, aircraft engines, and helicopters. The scope of the Convention’s international interest embraces the interests of a lessor and a conditional seller of an aircraft object.9 The Convention and Aircraft Protocol also apply to contracts of sale.10
At the time the Convention project began, domestic legal systems in many States were inadequate to support secured, asset-based financing. Absent reforms, some transactions could not occur at all, some could only be consummated with higher financing costs, and still others could only be accomplished with credit support of a State’s sovereign obligations.11 The Convention and Aircraft Protocol offer the necessary reforms to overcome the inadequacies of domestic regimes and have been enormously successful. Both the Convention and Aircraft Protocol entered into force on March 1, 200612 and have been adopted by fifty-four Contracting States, including the United States and the European Union.13
The success of both instruments, in particular that of the Aircraft Protocol’s international registry, inspired the development of the first future international instrument outlined in Part One. Part One contemplates the creation of a new international registry, where each adopting State would agree that the new registry would provide that State’s domestic secured transactions registry under that State’s domestic law.
The second project, as explained in this essay (Part Two), contemplates an international instrument that would be available for adoption and use only by Cape Town’s Contracting States and only in connection with Cape Town. The second project would involve an amendment of Cape Town under which adopting Contracting States would agree to binding arbitration for the benefit of investors (i.e., in Convention terminology, “creditors”))14 for the purpose of enforcing the Contracting States’ obligations under Cape Town. This enforcement mechanism would be patterned on those that have become common under various bilateral investment treaties (BITs)15 and certain other international investment agreements (IIAs).16 Such a mechanism is often referred to as an investor-state dispute settlement (ISDS) or investor-state arbitration.17
The proposal for an ISDS presented here is tentative. The goal of this essay is to provide sufficient background, analysis, and structure to support the initiation of an informed discussion that would provide for serious consideration of the proposal for a Cape Town ISDS. In addition to the specific proposal for incorporation into Cape Town, this paper seeks to introduce more generally the idea of incorporating ISDS into transnational commercial law instruments.18
I. Operation and Benefits of The Cape Town Convention: Centrality of Implementation and
Compliance by Contracting States
A. Contracting State Compliance and the Underlying Economic Assumptions of Cape Town
Cape Town is about lowering the costs of financing and leasing aircraft through embracing modern principles of asset-based financing. As explained by Saunders et al. in their 1999 study of aircraft financing (the “1999 Study”):
The key principles underlying the lender’s ability to extend asset-based financing are that a financier or lessor: (1) should be able to determine and assure itself that its proprietary interest in a financed or leased asset is superior to all potential competing claims against that asset; (2) upon default, will be able to promptly realize the value of the asset and/or redeploy that asset for purposes of generating proceeds/revenues to be applied against amounts owed; and (3) will not have their rights described in (1) and (2) above qualified or modified in the context of bankruptcy or insolvency. In this study, such principles shall be referred to as the “asset-based financing principles.”
Whether a legal system or law reform initiative embodies asset-based financing principles and is economically valuable18 depends crucially on three key factors: (1) the quality and transparency of the registry of property interests; (2) the speed with which legal enforcement is available; and (3) the ability to enforce contractual rights when a borrower or lessee is bankrupt or insolvent.19
This essay focuses on the second and third principles of asset-based financing mentioned in the passage above — prompt rights to enforcement and relief coupled with enforceability in insolvency proceedings. If the courts and officials of a Contracting State do not provide the relief on default and treatment in insolvency proceedings promised by Cape Town then the benefits of lower cost financing will not become available. Stated more precisely, achieving these benefits depends on ex ante confidence by potential creditors that, should the occasion of default or insolvency arise, the mechanisms provided by Cape Town will be available and effective.
The 1999 Study concluded that the adoption and effective implementation of the Convention and Aircraft Protocol would produce estimated economic gains of several billion dollars annually.20 Note that this conclusion is qualified by the condition that the Convention and Aircraft Protocol be “effectively implemented.”21 The study further concluded that “[t]hese gains will be widely shared among airlines and manufacturers, their employees, suppliers, shareholders, and customers, as well as the national economies in which they are located.”22 A more recent study by Vadim Linetsky (the “2009 Study”) highlights similar results by focusing on reductions in post-default repossession delays afforded by the implemention of Cape Town.23 That study estimated that savings solely from reducing repossession delay, following default, from ten months to two months would result in a total savings of $161 billion between 2009 and 2030.24 The 2009 Study’s conclusions, as with the 1999 Study, are conditioned on the effective implementation of Cape Town by Contracting States.25
There is concrete evidence that Cape Town has lowered the costs of financing in connection with officially (i.e., State) supported credits for the sale or lease of aircraft. Qualifying persons (operators, buyer/borrowers, or lessors) can receive a reduction of up to 10% of the minimum premium rates (i.e., finance charges or the equivalent) provided in the Sector Understanding on Export Credits for Civil Aircraft (ASU) which was established under the auspices of the Organization for Economic Co-operation and Development (OECD).26 This is known as the “Cape Town Convention Discount” (CTC Discount).27 To qualify, the person must be located in a Cape Town qualifying Contracting State. A qualifying Contracting State is one that has made certain insolvency- and enforcement-related “qualifying declarations” under the Convention and Aircraft Protocol.28 In addition to making the qualified declarations, a qualifying Contracting State must also “[h]ave implemented the Cape Town Convention, including the qualifying declarations, in its laws and regulations, as required, in such a way that the Cape Town Convention commitments are appropriately translated into national law.”29 As Wool has explained, “‘implementation’ of a treaty means that it has the force of national law, and in the case of conflict, prevails over any inconsistent national law.”30
By tying lower financing costs to the qualifying declarations and implementation of the Convention, the ASU’s approach clearly contemplates that the declarations and implementation will lower the risks attendant to insolvency and default. The principal effect of the insolvency-related provisions of the Convention and Aircraft Protocol do not ensure effective enforcement in actual insolvency proceedings of debtors, rather “the principal effects will take place outside bankruptcy in the form of the facilitating financing that would be unavailable (or available only at a substantially higher cost) under the prevailing domestic legal regimes of many states.”31
B. Insolvency- and Enforcement- Related Provisions of Cape Town
This Section provides an overview of the principal Cape Town provisions and declarations that are the basis for the CTC Discount.32 Article XI of the Aircraft Protocol outlines a creditor’s remedies if its debtor becomes insolvent.33 A Contracting State that is a debtor’s “primary insolvency jurisdiction”34 may use a declaration to opt for either Alternative A or Alternative B, or it may decide not to make a declaration at all.35 The adoption of Alternative A is a qualifying declaration.36
Alternative A closely resembles section 1110 of the United States Bankruptcy Code.37 Alternative A is more protective of a creditor’s interests than Alternative B.38 For this reason, a declaration that applies Alternative A is a qualifying declaration under the ASU.39 Under Alternative A, the debtor’s “insolvency administrator”40 must give possession of the relevant aircraft object to the creditor holding an international interest in the object before the expiration of the “waiting period.”41 Instead of specifying a period of time following the commencement of insolvency proceedings, such as the 60 day period provided by section 1110, Alternative A permits a Contracting State, in its declaration, to specify the applicable ‘‘waiting period’’ that will apply when the Contracting State is a debtor’s primary insolvency jurisdiction.42 For a Contracting State’s declaration to be a qualifying declaration, it must specify a waiting period of 60 days or less.43 However, as under section 1110, if the insolvency administrator or debtor ‘‘cures all defaults . . . and has agreed to perform all future obligations under the agreement,’’ the insolvency administrator or debtor ‘‘may retain possession of the aircraft object.’’44
Both “de-registration of the aircraft” (as a condition of changing the nationality by re-registering it in another State)45 and “export and physical transfer of the aircraft object from the territory in which it is situated” are remedies found in Article IX(1) which provide additional protections to a creditor when a debtor defaults.46 Related to and supplementing Article IX(1), a declaration by a Contracting State to apply Article XIII is another qualifying declaration under the ASU.47 Under that Article the debtor may issue an “irrevocable de-registration and export request authorization” (IDERA) in substantially the form specified by the Aircraft Protocol and may submit the IDERA to the registry authority for recordation.48 An IDERA authorizes a specified “authorized party” to “be the sole person entitled to exercise the remedies specified in Article IX(1).” As an “authorized party,” a creditor (or its designee, on its behalf) may exercise the remedies of de-registration, export and physical transfer without further consent or agreement by the debtor.
Another important qualifying declaration would make applicable Aircraft Protocol Article VIII, which provides that parties may agree as to the law that will govern their contractual rights and obligations.49 This qualifying declaration signals respect for party autonomy and provides the parties with additional ex ante certainty.
Finally, either of two additional qualifying declarations is necessary under the ASU for a Contracting State to be eligible for the Cape Town List. The first is a declaration under Convention Article 54(2) to the effect that remedies not expressly requiring application to a court can be exercised “without leave of the court.”50 The second is a declaration that the Contracting State will apply Aircraft Protocol Article X (other than paragraph 5) dealing with timely remedies and specifying the time limits for purposes of Article X(2) (“‘speedy’ . . . relief”) as 10 calendar days for certain remedies and 30 calendar days for others.51
C. Contracting State Non-compliance: Is There a Problem?
This Section considers whether there is a need to provide a formal remedy for a Contracting State’s non-compliance with its Cape Town obligations. The paradigmatic setting for the analysis assumes that a Contracting State fails to comply with its obligations and thereby causes loss or damage to a creditor.52 It is such a creditor that would be entitled to assert a remedy against the Contracting State.
When the Cape Town enters into force in a Contracting State, the State “is bound by international law to perform its obligations under the Convention even if this conflicts with national law.”53 A Contracting State could fail to comply with its obligations as a result of action or inaction of its courts. For example, a court might fail to honor the parties’ choice of applicable law under Aircraft Protocol Article VIII or fail to provide the timely relief required by Alternative A of Article XI. Alternatively, a Contracting State might be in breach of its obligations if the relevant officials failed to provide the required de-registration and export and physical transfer permission under Aircraft Protocol Articles IX and XIII. In these cases, it is important to distinguish between intentional violation of a Contracting State’s Convention obligations from misinterpretation or misapplication of the applicable rule. This dichotomy contemplates, for example, that there is a meaningful difference between a court’s or official’s mistake while acting in good faith and a court’s or official’s (and thereby a Contracting State’s) non-compliance with clear international obligations under Cape Town.54
Consider an example. Articles 35, 36, and 37 of the Convention55 provide an ingenious approach that incorporates the priority rules and effects of insolvency applicable to international interests (Convention Articles 29 and 3056) and applies those rules to assignments of “associated rights.”57 These assignment-related provisions work well, but they are compact and subtle. Fortunately, the Official Commentary provides clear guidance on how to apply these rules and on how to parse out the subtlety that exists.58 Nonetheless, it is easy to imagine that a court could interpret these provisions incorrectly, perhaps as a result of its lack of sophistication or because of a lawyer’s poor argumentation. One might imagine the same with respect to other provisions as well, including the Convention’s baseline priority rules found in Articles 29 and 30.59
A Contracting State’s non-compliance with Convention obligations could arise from a variety of causes. One cause might be that the State failed to implement the Convention such that it became their national law and achieved primacy over other conflicting national law. Similarly, if the Convention has not been translated into the language used by the State’s courts, as a practical matter the courts would not be in a position to apply its provisions. Even if the Convention has been fully implemented, inadequate resources, weaknesses in institutional frameworks, and lack of ready access to the courts could account for delays in providing Convention remedies to a creditor.60
Returning to the question raised above, is non-compliance with Cape Town obligations by Contracting States a problem in reality? Writing in 2012 and recognizing that Cape Town is a relatively new treaty,61 Wool argued for a “strong” presumption of State compliance with international commercial treaties generally,62 and more recently a “fairly strong” presumption of the same.63 Given the “special circumstances” in the case of Cape Town, it should “significantly increase compliance incentives.64 Such a presumption would reflect the market’s confidence in compliance so as to support the lower costs of financing and leasing that Cape Town contemplates.
Wool argued that a Contracting State’s non-compliance with Cape Town obligations would be costly and he noted several factors that make non-compliance less likely. First, the ASU provides a proxy for enforcement of Cape Town obligations inasmuch as non-compliance would impose on a Contracting State ineligibility (or loss of eligibility) for the Cape Town List.65 Second, ICAO is a co-sponsor (with UNIDROIT) of Cape Town and ICAO has “a long-standing compliance culture” in which non-compliance would impose “substantial political costs.”66 Third, because Cape Town is a part of investment law, non-compliance would send a negative signal as to a Contracting State’s investment climate and would “adversely impact its position in competing for foreign investment.67 Finally, ongoing efforts to promote a culture of strict compliance through transparency and publicity will “increase the reputational costs on non-compliance.”68 To this list one might add that non-compliance could negatively affect assessments by rating agencies in respect of debt securities secured by aircraft equipment.69 Additionally, by making the response system more “timely, interactive, and transparent” under the ASU, non-compliance becomes more costly.70 - He further noted that steps are being taken “to minimise the risk, severity, and length of unintentional non-compliance.”71
Notwithstanding these factors, there are concrete examples of States’ non-compliance with their Convention obligations. For example Gray and Marasco explain that: -
After GE Capital Aviation Services Ltd. (GECAS) attempted to terminate a lease with Air Midwest Nigeria (Air Midwest) for certain defaults, and repossess its aircraft, Air Midwest brought an action before the Federal High Court in Nigeria against GECAS to prevent the termination of the lease and subsequent repossession of the aircraft. The alarming part about this action and the resulting decision is that it only casually references the Convention and only in respect to whether Air Midwest, having no proprietary rights in the aircraft, could rely on the Convention to its benefit.2 The Nigerian court’s decision considered neither this argument nor the Convention, and, instead, because parallel proceedings had been commenced in England, the court determined that it lacked jurisdiction to hear the case. While the decision ultimately led to a favorable outcome for GECAS, it did not establish a helpful precedent.72
In Wool’s more recent article he notes that public data on such non-compliance is limited.73 Not only is Cape Town a relatively new treaty system but much of the Cape-Town related governmental activities is administrative in nature, not judicial, explaining at least in part the dearth of data.74 Based on the available data, Wool has found that non-implementation based non-compliance deals mainly with recording and enforcement issues related to IDERAs and to government-asserted non-consensual rights or interests.75 As to the IDERAs, “there have been limited instances of unintentional non-compliance.”76
Putting aside these discrete examples of non-implementation based non-compliance and assuming arguendo that they are highly aberrational, in 2012 Wool recognized that implementation problems have also produced a number of instances of non-compliance in some Contracting States.77 So long as the Convention has not been implemented in a Contracting State then it is likely that the Convention remedies would not be available in that State. This could happen either by the State failing to make the Convention a part of its national law or by not affording it priority when it conflicts with other national laws. This failure to implement creates a latent or potential non-compliance that would ripen if and when the State were called upon to perform its Convention obligations.78