Sunrock Aircraft Corporation Ltd v Scandinavian Airlines System Denmark-Norway-Sweden

On 29 December 1993, the appellant (SAS) entered into a sale and lease back arrangement for 2 Boeing 767-300ER aircraft in their fleet with the respondents (Sunrock), an Irish subsidiary of Sojitz Corporation, a large Japanese Corporation which specialised in such arrangements. The arrangement was set out in a series of documents for each aircraft, including a sale and purchase agreement and lease. These agreements were subject to English law and an unconditional submission was made to the jurisdiction of the English Courts

The aircraft had been built in 1989 and 1991; they each had Pratt and Whitney Engines. The sale price was $70m and $65m respectively. On 24 January 1994 the aircraft were sold by SAS to Sunrock on “an as is, where is” condition and then delivered by Sunrock to SAS under the leases; amongst the documents exchanged were Aircraft Transfer Receipts. The term of the lease for aircraft 25365 (referred to as Aircraft 1) was 65 months; it was extended under an option clause so that it expired on 7 November 2003. The lease on the other aircraft (aircraft 2) was for a period of 53 months; an option to extend was exercised so that it expired on 23 February 2004. Payments of $714,000 per month were made under the leases; these totalled over the period of the leases over $85m on each aircraft.

Prior to redelivery of aircraft 1, disputes arose between the parties under clause 19 of the lease, the redelivery clause, as to the obligations of SAS in relation to components in the engines known as Limited Life Parts (LLPs) in each aircraft and as to repairs on aircraft 1 referred to as “scab patches” on the aircraft fuselage.

Sub-clause 19.7 of the redelivery clause contained provisions for the resolution of disputes on redelivery by an independent firm of aircraft technical consultants. SAS did not consider that this was apposite for the disputes that had arisen; they entered into a redelivery agreement dated 4 November 2003 under which the dispute was nonetheless still to be referred to an independent firm of aircraft technical consultants nominated by SAS and approved by Sunrock. Aircraft 1 was redelivered on 7 November 2003 and Aircraft 2 in January 2004.

In circumstances set out in paragraphs 9-16 of the judgment of Morison J SAS declined to appoint a consultant and thereby broke the redelivery agreement; it is apparent that SAS considered that the issues of construction should be decided by the English courts rather than an expert. Morison J commented:

“In other words, having procured Sunrock to accept re-delivery of the aircraft before these issues were resolved, by entering into the re-delivery agreement, SAS thereafter reneged on the agreement for no good reason other than, I infer, that they calculated they had a better chance of persuading a court to their view of the proper construction of the Lease than persuading an informed expert.”

In consequence Sunrock had no alternative but to begin these proceedings in the Commercial Court in which they sought to recover from SAS the sums they contended were due in respect of the LLPs of the engines on both aircraft and the scab patches on aircraft 1; in respect of the latter, the claim was framed as a claim for breach of the dispute resolution agreement.

Two distinct issues arose for decision:

SAS appeal to this court with the permission of Toulson LJ. On the second issue, SAS did not appeal against the judge’s findings that they were in breach.

The issue in relation to LLPs

Before turning to the specific terms of the lease it is necessary to describe briefly the factual background as to the nature of LLPs and aircraft maintenance. It was common ground that this background was known to both parties at the time the agreement was made and therefore to be taken into account on the issue of construction.

In terms sufficiently expressed for the purposes of the issue before the court, the parts for each jet engine for this aircraft can be described as falling into three categories:

The maintenance of an aircraft engine is subject to strict conditions laid down by the manufacturer and approved by the regulatory authorities of the state of registration of the aircraft. At set intervals measured in terms of cycles of landings and take-offs and total running hours (the aggregate of the time taken on flights), various maintenance checks and tasks have to be performed. Some of these checks take place at overhauls. On-condition parts are checked, maintained, replaced or repaired as required. LLPs are cleaned and serviced and repaired or replaced if damaged; the evidence was that the work done to LLPs included cleaning, deblading (where blades which the parts hold in place are detached to allow for cleaning) and re-protection (measures to ensure the part’s continued reliability, such as spraying with protective chemicals). The regular maintenance checks and overhauls were also used as occasions to replace LLPs if they have reached the expiry of their life.

The aircraft were extended range Boeing 767s and thus were more likely to be used on long haul routes; if the aircraft were used in this way, there would be fewer landings and take offs in a given year than if they were used on short haul routes and so fewer cycles would be used for the purpose of measuring the lifetime of the LLPs. This point made by SAS is, in my view, of no significance as SAS were entitled to use the aircraft as it wished, the aircraft could be sub-leased and the engine and parts could be pooled or exchanged (see paragraph 21).

As is common in leases, SAS, as lessee, was required on redelivery to redeliver the aircraft at a specific location in a specific condition. This lease required by the redelivery clause, clause 19, the condition of the aircraft to be such “as to demonstrate that the lessee has in all respects complied with its obligations on its part contained in clause 13” (the operation and maintenance clause to which I refer in more detail at paragraph 21) and also to comply, “subject to fair wear and tear generally” with specific terms; these included in respect of the engines by sub-clause 19.2:

“b)

Components:

(i)

each and every life-limited component shall have not less than 4,000 hours remaining to the next scheduled removal under the Lessee's Approved Maintenance Programme

…..

c)

Engines:

Each Engine shall be serviceable and no individual engine shall have less than 4,000 operating hours remaining before its next scheduled removal limit or its next shop visit (as measured by its most limiting component).

If the aircraft was not in the condition required by sub-clause 19.2, the lessor was entitled to require the lessee to rectify any defects or deficiencies.

The redelivery clause then provided by sub-clause 19.9 for an adjustment; the dispute centred on the wording of this sub-clause and in particular the words which I have highlighted in bold:

“(a)

The Lessor and the Lessee agree that adjustment payments will be made based on the maintenance status of the Aircraft at re-delivery, and:

(i)

in the case of the airframe, “half time” (which shall be calculated by reference to the amount of time remaining before the next scheduled “S4C” check, as determined by Boeing's manufacturer’s planning document), or

(ii)

in the case of the Engines and Landing Gear, the maintenance status of the same at Delivery.

Adjustment payments will be made by the Lessor to the Lessee if the maintenance status of the Airframe, Engines and/or Landing Gear (as the case may be) is better than the applicable status specified in paragraph (i) or (ii) above and adjustment payments will be made by the Lessee to the Lessor if the maintenance status of the Airframe, Engines and/or Landing Gear (as the case may be) is worse than the applicable status specified in paragraphs (i) or (ii) above.

(b)

The amount of the adjustment payments referred to in clause 19.9(a) shall be determined by the Lessee choosing three facilities, each of which shall be a third party Federal Aviation Administration approved repair station (at least one of which will be European and two which shall be primarily based in the U.S.A.) from which Lessor will choose one based in the United States (for each of Airframe, Engines and Landing Gear) to provide the scope and work standards for each overhaul. Lessee will then choose two of the three Federal Aviation Administration approved repair stations quotes (one of which must be European) for such applicable work. The average costs of these two facilities shall provide the basis for adjustment payments between Lessor and Lessee.”

On and after the redelivery of aircraft 1:

The clauses of this aircraft lease followed in some respects standard forms that are in use in the industry. However, as lawyers who specialise in this field craft each lease to the particular terms which the parties want and which reflect the financial terms agreed, each lease has some of its own distinct terms. The terms may on occasions include not only a standard periodic payment but other provisions for other payments by way of compensation for the use and hire of the aircraft; such terms sometimes include a payment calculated by reference to the life of the LLPs used during the lease. SAS contended that the judge’s conclusion that a significant amount was payable under sub-clause 19.9 was a conclusion that involved confusing rent and the servicing status of the aircraft. In my view this was misconceived; the parties could easily have agreed that a further sum was payable by reference to the LLPs. The question in this case was whether the terms of the lease so provided.

A considerable amount of time was taken at the trial in relation to evidence as to the practice of the industry in relation to the meaning of terms. None of the terms of the lease had a customary meaning nor even a meaning used in practice, despite attempts made to show that terms such as “maintenance status” had a particular meaning. No assistance can be derived from looking at other leases or allowing evidence to be given in relation to what those in the industry may have thought this lease or terms in it might have meant. Unfortunately reports were provided and questions were asked of several witnesses before the judge in relation to these and many other irrelevant matters as appears from paragraphs 24-27, 32-35 and 36-41 of Morison J’s judgment.

This case is an illustration of the importance of adhering to the well known rules of construction and excluding such evidence. The rules curtail cost by concentrating the argument on the words used and excluding the irrelevant. In this particular industry, the reality of the way in which such documents are produced is, as I have said, that they are crafted by expert lawyers very familiar with such documentation in accordance with instructions from their respective business clients. The task of the court is simply to construe the text of what they have agreed in the light of the common factual background which I have set out in paragraphs 9-12. The task of the court is not assisted by evidence of the type adduced before the judge. The interests of the parties are not well served, as such evidence simply adds to the cost of what would otherwise be a fast, less expensive and authoritative interpretation of a contract by the court to the advantage of the parties, such as the international corporations in this case.

The sale and purchase agreement for the aircraft specified the aircraft by reference to schedule 1 and required by clause 3.1(d) the aircraft to be delivered with an Aircraft Transfer Receipt in the form of schedule 2 to that agreement; schedule 2 provided for the attachment to the Aircraft Transfer Receipts of the latest status reports in a mutually agreed form for the airframe, landing gears and engines. The Aircraft Transfer Receipts had attached to them Schedule 1 to the sale and purchase agreement which included in the information set out for each aircraft the total number of hours and cycles run and the number of hours and cycles since the last overhaul in respect of each engine; the Aircraft Transfer Receipt also had attached a list of the LLPs for each engine which showed the number of cycles that constituted the limit, the number of cycles used and the percentage of cycles remaining to the life of each part.

As the aircraft was delivered under the lease as soon as it was sold to Sunrock, this certificate was used for the purposes of the lease.

Clause 13, the operations and maintenance clause, imposed specific obligations on SAS:

No specific document similar to the Aircraft Transfer Receipt was required on redelivery, as the provisions of sub-clause 19.6 envisaged resolution of any issues by direct discussion and if this did not result in agreement, the dispute resolution mechanism of sub-clause 19.7. It is therefore of no assistance to the issue of construction that on redelivery the receipt had attached to it the list of the LLPs and the number of cycles used and remaining.

I have come to the clear conclusion that under sub-clause 19.9 the obligation of the parties in respect of the engines (including the LLPs) was to make an adjustment for the difference in maintenance status by reference to a comparison between what was required at the next overhaul as at delivery and redelivery and the difference in the length of time as at delivery and redelivery to that overhaul. The clause plainly did not oblige SAS to pay Sunrock a sum calculated by reference to the proportion of the life of the LLPs used during the period of the lease.

There are further reasons why I cannot accept the construction advanced by Sunrock:

Parties under contracts sometimes ingeniously try and see if the words in a contract can be made to bear a construction that will provide them with a benefit. The words in this clause are clear. Despite the ingenuity of the argument advanced by Sunrock, the construction of the words of sub-clause 19.9 is one they plainly do not bear. If it had been intended that under this lease SAS was to pay for a proportion of the life of the LLPs used during the lease as contended for by Sunrock, this should have been clearly stated; the words of sub-clause 19 of this lease simply do not and cannot be made to bear that meaning.

No evidence was adduced by Sunrock to show that the maintenance status of the LLPs on redelivery in the engine was worse than the maintenance status on delivery, in the sense in which I consider the phrase to mean; no doubt some maintenance of the LLPs was required and a cost could have been obtained for it. None was. The sole evidence adduced was the calculation for the proportion of the lifetime used. It follows therefore than no sum is due to Sunrock.

For these reasons, I consider that the judge was wrong in the view he reached on the meaning of the clause and in awarding the sums he did to Sunrock. I would therefore allow the appeal on this issue.

The scab patches

The obligation under sub-clause 19.2(d)(i) of the redelivery clause was to redeliver the aircraft frame without scab patches. Scab patches are repairs to the fuselage which are effected by riveting a piece of metal over the damaged part of the skin; the doubler so created stands proud of the rest of the aircraft skin and is called a scab patch. An alternative method of repair is a flush repair; this is effected by cutting out the damaged part of the skin and replacing it with a new part.

On redelivery, aircraft 1 had two small scab patches. These had been affixed over small dents; one was near the passenger door and the other near the service door. The scab patches had been applied in 1995 and 1997 and re-applied later; they were permanent repairs

Sunrock claimed that SAS were in breach of sub-clause 19.2(d)(i) as the aircraft had two small scab patches; they were therefore entitled to the reasonable costs of replacing the scab patches with a flush repair.

The judge found that SAS were in breach of the sub-clause; SAS did not appeal from that finding. They maintained their contention which they had advanced before the judge that no damages were payable as Sunrock had suffered no loss. Neither Sunrock nor any company within the Sojitz group had repaired the damage by the time the aircraft was sold to Icelandair. It would not in any event have been reasonable for them to do so and the failure to replace the scab patches with inserts had not affected the value of the aircraft.

It was common ground that the measure of damages for redelivering a hired chattel in damaged condition was the cost of repairs, unless it was unreasonable to effect the repairs; if it was unreasonable to effect the repairs, then the measure was the diminution of value. The applicable principles are set out in Ruxley Electronics v Forsyth [1996] AC 344, a case on a building contract. It is only necessary to refer to two passages. First a passage in the speech of Lord Jauncy at 357:

“Damages are designed to compensate for an established loss and not to provide a gratuitous benefit to the aggrieved party from which it follows that the reasonableness of an award of damages is to be linked directly to the loss sustained. If it is unreasonable in a particular case to award the cost of reinstatement it must be because the loss sustained does not extend to the need to reinstate.”

Second, a passage in the speech of Lord Lloyd of Berwick at page 366; he referred to the judgment of Cardozo J in the Court of Appeals of New York in Jacob & Youngs v. Kent, 129 N.E. 889 and then continued:

“Cardozo J's judgment is important, because it establishes two principles, which I believe to be correct, and which are directly relevant to the present case; first, the cost of reinstatement is not the appropriate measure of damages if the expenditure would be out of all proportion to the benefit to be obtained, and, secondly, the appropriate measure of damages in such a case is the difference in value, even though it would result in a nominal award.”

Sunrock’s expert, Mr Seymour, set out in his report dated 14 March 2006 reasons why scab patches can reduce the value of the aircraft and in particular the additional inspection requirements and its aesthetic effects. He estimated the cost of the repairs at $139,800. There was no challenge to that figure. He then calculated the diminution in the value of the aircraft, based on a book value of $30m as $457,000 by reference to the area of damage and its cosmetic and aesthetic appearance.

The scab patches had not been repaired when the aircraft was sold to another company in the Sojitz group in March 2005 or when it was sold to Icelandair on 31 March 2006 for $25m. The evidence was clear that the scab patches did not affect the marketability of the aircraft for leasing or its value; that was because in an aircraft of the age these were at time of redelivery, it would be extraordinary not to find scab patches on such an aircraft. It was also clear that there was no point in repairing them as they had no effect on performance or on the value of the aircraft. In cross examination, Mr Seymour, Sunrock’s expert accepted that the scab patches had no effect on the marketability of the aircraft and did not in fact reduce the value of the aircraft. Mr O’Reilly, Sunrock’s senior marketing and finance manager, accepted that the scab patches were immaterial to the value of the aircraft.

On the evidence, it was therefore clear that it would have been unreasonable to effect the repairs; furthermore the scab patches had no effect on the value of the aircraft. It followed therefore that on the evidence before the court, the damages to which Sunrock were entitled for the breach of the lease were nominal damages as they had in fact suffered no loss. Morison J reached that conclusion at paragraph 53 of his judgment

Sunrock contended that they were nonetheless entitled to damages for breach of the agreement to refer the matter for expert determination under clause 19.7 and the redelivery agreement; the amount of the damages was the cost of the repairs as that is the amount the expert would have awarded on such a reference. The judge accepted that argument at paragraphs 58 and 59

“In my judgment, there is every good reason to consider that had SAS not reneged on clause 19.7 of the Lease [and an equivalent provision in the Redelivery Agreement] an expert third party would have approached the matter as did Mr Seymour; that is, they would have adopted a repair value since it is difficult to say whether the scab patches had or would have any impact on the marketability of the aircraft. The clauses were aimed at providing a quick and easy monetary value on items in dispute on redelivery. In my judgment, it was in the contemplation of the parties that an expert determination would adopt a cost of repair methodology and that it was intended that financial adjustments should be made on that basis. That approach would obviate the need for research into market values and is a simple approach within the spirit of the mediation provisions.

In my judgment, to put the parties into the position they would have been in had SAS complied with their obligations under clause 19.7 and the Redelivery Agreement, an award of compensation on the basis of the cost of flush repairs would be appropriate. … It follows, I think, that Sunrock are entitled to judgment for the sum of US$139,800 as damages for breach of their obligation to participate in the mediation processes which they had agreed to.

It is established that damages can be awarded for a loss incurred by the failure to comply with the terms of an exclusive jurisdiction clause or alternative dispute resolution clause: for example, in Union Discount v Zoller [2002] 1 WLR 1517, this court held that a party was entitled to claim as damages the costs reasonably incurred by it in foreign proceedings which had been brought in breach of an exclusive jurisdiction clause. Another example is the decision in Croudace v London Borough of Lambeth (Court of Appeal Transcript 21 March 1986).

In the present case damages for breach of the alternative dispute resolution clause are claimed in the amount of the cost of the repairs, although, for the reasons I have set out, such a claim for the cost of the repairs could not and did not succeed on the evidence through the application of well known principles of law to the claim for breach of the repair obligation in the lease. It was nonetheless successfully contended that Sunrock were entitled to be awarded damages for failure to have the dispute determined by the expert and those damages were assessed in the amount of the cost of the repairs for breach of the repair obligation on the basis that such a claim would succeed in that way before the expert. As there was no suggestion that the evidence available to the expert would be any different to that adduced before the court, the decision must be premised on the assumption that the expert would have approached the issue of damages for breach of the repair obligation on a basis contrary to the applicable law and would have award substantial damages in the amount of the cost of the repairs contrary to established principles of law.

I can see force in the argument that such a result might follow if the terms of the contract permitted resolution by the type of clause recognised by s. 46(1)(b) of the Arbitration Act 1996, such as permitting the expert or arbiter to determine the dispute in accordance with “equity and good conscience” or ex aequo et bono”; in such a case it would not be necessary to decide the case according to law. But where the agreement is governed by English law, it is to be assumed that the expert will determine the matter in accordance with the law.

Mr Akhil Shah on behalf of Sunrock accepted that, if Sunrock could not establish that damages were recoverable as a matter of the ordinary principles of English law on the evidence that would be the same before a court and an arbitrator, he could not contend that the result would be different before an expert or arbitrator determining the issue under a contract governed by English law. He was right to accept this, as otherwise it would involve acceptance of an argument that, if it could be shown that the expert or arbitrator would or might get the law wrong in a case where there was no issue about the evidence, either the whole or a percentage (on the basis of the loss of a chance of the expert or arbitrator getting it wrong) of the damages could be recovered before a court as damages for breach of the dispute resolution clause, even though if the issue had been determined in accordance with the law nothing, other than nominal damages, would be recoverable.

In any event, there was on the evidence before the judge no basis on which the judge could have reached the conclusion that an expert would, once the law was explained to him, have awarded damages on an incorrect basis.

I therefore consider that the judge reached an incorrect conclusion on this issue and the appeal should be allowed. An award for nominal damages should be substituted for the award of $139,800.

It follows that I would allow SAS’s appeal on both issues.

I agree.

I also agree.