ACG Acquisition XX LLC v Olympic Airlines SA

The present proceedings arise out of a lease agreement, dated 30th May 2008 (“the lease”), whereby ACG Acquisition XX LLC (“ACG”) agreed to lease to Olympic Airlines SA (“Olympic”) a Boeing 737 aircraft (“the aircraft”) for a term of five years. ACG, as the owner and lessor of the aircraft, undertook that it would be airworthy and in a condition suitable for immediate operation in commercial service and that it would comply with the detailed requirements specified in Schedule 2 of the lease as to the condition of the aircraft on delivery.

The aircraft was delivered on 19th August 2008. Olympic signed a Certificate of Acceptance, which, under the lease, was formally deemed to constitute delivery. The aircraft then went into service on 23rd August 2008. The Hellenic Civil Aviation Authority (“the CAA”) duly became the competent authority for the aircraft and granted the aircraft a Certificate of Airworthiness, a document that all commercial aircraft must have to be legally allowed to fly.

On 6th September 2008, just 15 days after it entered into service, the aircraft was grounded when broken cables that controlled the spoilers on one wing were found. While trying to repair the broken cables, Olympic discovered 14 separate categories of defects, including defects which affected other flight control surface mechanisms such as the ailerons. The state of the aircraft was such that, on 11th September 2008, the CAA took the step of withdrawing the aircraft"s Certificate of Airworthiness. Even after the aircraft had spent months at Europe Aviation, a maintenance and repair organisation (“MRO”) nominated by ACG, the CAA still refused to grant it a Certificate of Airworthiness.

Olympic"s evidence is that the cost of the work which would be required to render the aircraft airworthy would exceed the value of the aircraft. Olympic"s case is that the multiple defects discovered must have been present when the aircraft was delivered and ACG fundamentally failed to perform its obligations in relation to the delivery condition of the aircraft and it delivered an aircraft in a serious state of lack of airworthiness. In such circumstances, they contend that they are under no obligation to pay rent, that there has been a total failure of consideration; alternatively that they are entitled to counterclaim substantial damages, which damages would include any liability to pay rent.

ACG contend that the Certificate of Acceptance that the lessee was required to sign on delivery precludes Olympic from making any claim in respect of the delivery condition of the aircraft. They further contend that, in any event, there is no right to set off any counterclaim Olympic may have and that rent meanwhile remained payable in full until ACG"s recent termination of the lease on 29th March 2010. They, accordingly, apply for a summary judgment on their claim and Olympic"s counterclaim.

Alternatively, ACG apply for security for costs of Olympic"s counterclaim. ACG also have an application to amend their Particulars of Claim to add a claim for delivery up in the light of their recent termination of the lease. They also seek summary judgment on that amended claim. I granted ACG permission to amend, but adjourned the summary judgment application for seven days.

ACG has served four witness statements by Stephen Moses, a solicitor at Simmons & Simmons, two dated 26th February 2010, one dated 29th March 2010 (in support of the recent application) and one dated 6th April 2010. Olympic rely on the witness statement of John Evans, a partner in the firm of Howrey, and the documents exhibited thereto.

The principal provisions of relevance are the following.

By clause 3, ACG"s obligation to lease the aircraft was subject to a series of conditions precedent, including the execution of the operative documents (clause 3.1(c)). The “operative documents” were defined as including the Certificate of Acceptance, which was in turn defined as “a certificate in the form attached as Exhibit A to be completed and executed by lessor and lessee at the time of delivery”. By clause 3.4(c), Olympic"s obligation to accept the aircraft on lease was subject to, inter alia, the aircraft being in the condition set forth in schedule 1, part 1 and in the condition required by Schedule 2, except for any items set forth in Annex 2 in the Certificate of Acceptance and any other items agreed in writing. Clause 3.6 set out various conditions subsequent, which required Olympic to deliver to ACG certain documents within 10 days of the delivery date and receipt of the aircraft"s deregistration certificate from the Malaysian Aircraft Registry. These included at 3.6(d) a Certificate of Airworthiness.

Clause 4 dealt with delivery and the commencement of the lease. Clause 4.2(a) states:

Schedule 2 contained detailed provisions relating to the condition of the aircraft. The most important of these are: (1) that the aircraft will be in a condition suitable for immediate operation in commercial service (paragraph 1(b)); (2) that the aircraft will be airworthy, conform to type design and be in a condition for safe operation with all equipment, components and systems operating in accordance with their intended use and within limits established by the manufacturer (paragraph 1(c)); (3) that the aircraft would have a valid export Certificate of Airworthiness (paragraph 1(d)): (4) that the aircraft would have undergone immediately prior to delivery a full C-check sufficient to clear the aircraft for 4,000 flight hours, 3,000 cycles and 15 months (paragraph 1(f)): (5) that all outstanding airworthiness directives and mandatory orders affecting the aircraft would have been accomplished (paragraph 1(g)); (6) that any damages exceeding the manufacturer"s SRM (structural repair manual) limits would have been permanently repaired (paragraph 1(s)); (7) that all structural damage within SRM limits would have been noted on a damage mapping chart (paragraph 1(t)); (8) that all life limited or hard time control parts would have not less than 4,000 flight hours, 3,000 cycles or 15 months remaining to their next scheduled removal; that all calendar limited parts would have at least 15 months remaining to their next scheduled removal or overhaul; and that all on-condition/condition monitored parts would be serviceable (paragraph 2); (9) that the fuselage would contain no dents, corrosion or abrasions in excess of the SRM limitations (paragraph 4(a)); (10) that the aircraft would be in compliance with the CPCP (paragraph 11(a)); and (11) that the aircraft documents would be in accordance with the EASA requirements (paragraph 12).

Clause 4.2(f) made Olympic"s obligation to lease the aircraft conditional on ACG"s delivering the aircraft in compliance with Schedule 2. Any discrepancies could be noted in the Certificate of Acceptance, in which case ACG would have 45 days in which to correct those discrepancies, failing which Olympic would be entitled to terminate the lease. Clause 4.5(c) provided that from delivery the aircraft would be at the sole risk of Olympic and that Olympic would bear all risk of loss, theft, damages or destruction to the aircraft.

Clause 5 required Olympic to pay rent of initially US$155,000 and maintenance reserves to ACG monthly in advance. The maintenance reserves were to be released by ACG on the occurrence of specified maintenance events in accordance with clause 7.2.

Clauses 7.6 (exclusions), 7.7 (waiver) and 7.9 (conclusive proof) are central to ACG"s case and are set out below.

Clause 8.11 related to Olympic"s obligations in relation to the maintenance and repair of the aircraft. In particular, Olympic was required to keep the aircraft airworthy in all respects and in good repair and condition (subclause (a)) and to maintain in good standing a Certificate of Airworthiness (subclause (i)).

Clause 12 dealt with Olympic"s obligation to redeliver the aircraft on the expiry or termination of the lease. Under clause 12.1, Olympic was required to redeliver the aircraft in the condition described in schedule 3, which was in very similar terms to Schedule 2. In the event that it failed to do so, it was required to rectify the non-compliance or indemnify ACG against the costs of doing so pursuant to clause 12.3.

Clause 13.1 set out numerous prescribed events of default, each of which was deemed to constitute a repudiation of the lease by Olympic. Clause 13.2 provided that, following an event of default, ACG would be entitled to accept Olympic"s repudiation of the lease, enforce performance of the lease, repossess the aircraft or require Olympic to redeliver the aircraft.

Clauses 15.1 and 15.2 respectively provided for English law and jurisdiction.

Olympic"s evidence establishes an arguable factual case to the following effect.

Before the aircraft was delivered to Olympic in August 2008, it was on lease from ACG to Air Asia with a carrier based in Singapore. Olympic were able to carry out external inspections of the aircraft before the lease was signed in April, June, July and August 2008. The scope of these inspections was limited, however: the April 2008 inspection in particular was carried out at night between aircraft operations. Subsequent inspections took longer, but at no stage was Olympic able to open parts of the aircraft, inspect and/or test internal parts of the aircraft or run diagnostics save in relation to the engines. Olympic at one point asked ACG if they could inspect the airframe more closely, but ACG refused.

As is usually the case, Olympic relied heavily on the aircraft"s technical documents as accurately reflecting the maintenance status of the aircraft. In this case, it appears that the documents painted a falsely reassuring picture and recorded work which had not been carried out adequately, if at all. The aircraft was delivered to Olympic on 19th August 2008 in Singapore. It was put into commercial service as part of Olympic"s fleet on 23rd August 2008. Thereafter, the aircraft flew for the first 14 days before being taken out of service after the broken cables were discovered on its left spoiler. Olympic had actually reported to ACG in June 2008 that the spoiler cables were corroded, but by the delivery date they had been certified as having been put into proper condition, although this appears to be incorrect. While the spoiler cables were being repaired, numerous other serious defects were discovered, which led the Greek CAA to take the step of revoking the aircraft"s Certificate of Airworthiness on 11th September 2008, even though the aircraft was supposed to have just come out of a major overhaul that was to clear it for 4,000 flight hours and 15 months.

A Certificate of Airworthiness is a mandatory document required for international flight under Article 31 of the Chicago Convention 1944 and for all flight under Article 5 of Regulation EC No 216/2008. It is an internationally recognised document issued by the state of registration of the aircraft, certifying that it is safe and fit to fly. Without it, the aircraft cannot fly at all either domestically or internationally.

It is Olympic"s case, although this appears to be disputed by ACG, that many of the defects which led to the aircraft being taken out of service had actually been notified to ACG before the lease commenced and were certified prior to delivery as having been rectified, but evidently had not been. In October 2008, the aircraft was inspected at the invitation of Olympic by the manufacturer, Boeing, over a period of three days. Inspite of the fact that the aircraft was supposed to have just emerged from a C-check sufficient to fly for 15 months, Boeing recommended that the aircraft undergo another C-check, that is the second heaviest scheduled maintenance check, and a review of its compliance with applicable airworthiness directives.

Following lengthy discussions, the parties agreed that the inspection would be carried out by a third party maintenance organisation, Europe Aviation in France, beginning in January 2009. This revealed more problems with the aircraft and its technical documents. In particular, there were a number of airworthiness directives and CPCP corrosion prevention and control program tasks which had not been carried out either adequately or at all. After the aircraft eventually returned to Athens in July 2009 under a special permit to fly issued solely to enable it to return to base and not for public transport purposes, the CAA, after inspecting the aircraft and its records, required extensive further checks were carried out before the Certificate of Airworthiness could be revalidated. Its findings are set out in a letter from the Flight Standards Division, dated 17th August 2009, which stated as follows:

It is Olympic"s unchallenged evidence that the necessary works would have cost more to perform than the aircraft was worth and these were, therefore, never carried out. The aircraft has since remained parked in Athens. ACG took the stance that the condition of the aircraft was Olympic"s problem.

In summary, on Olympic"s evidence, the aircraft was in such an unairworthy condition on delivery that it would cost more than the aircraft is worth to restore its airworthiness, with the consequence that they have only had 14 days" use of the aircraft under the five year lease, and that use was only possible because Olympic and the authorities were unaware of the aircraft"s seriously defective condition at that time. Indeed, if, as the evidence suggests, the aircraft is beyond economic repair, then it seems unlikely that it would ever be granted a Certificate of Airworthiness and hence it would ever be operated again.

On 24th September 2009, ACG issued proceedings against Olympic, claiming outstanding payment of rent and maintenance reserves under the lease and damages, but not the return of the aircraft. The following day, Olympic issued their own claim against ACG, seeking damages for breach of the lease, in particular the provisions relating to the delivery condition of the aircraft. These damages represent the cost of wet leasing replacement aircraft between September 2008 and October 2009 (around €32 million), less any sums which it would have had to pay to ACG had the lease been performed and will not now have to pay, plus further maintenance costs and related expenses. On the assumption that its Defence to ACG"s claim is valid so they do not owe ACG anything, the value of the counterclaim is around €5 million.

On 2nd October 2009, Olympic ceased trading and entered a creditors" special liquidation. The proceedings are being directed on behalf of Olympic by the liquidator of the company, Ethniki Kefaleou SA, a subsidiary of the National Bank of Greece.

On 26h February 2010, a CMC took place before David Steel J at which the parties" respective claims were formally consolidated. On the same day, ACG issued their applications for a summary judgment in relation to both claims and, in the alternative, security for costs.

The following issues arise for determination:

The applicable principles are not in dispute, in particular:

Olympic also place reliance on what was said in Doncaster Pharmaceutical Co Ltd v Bolton Pharmaceutical Co Ltd [2006] EWCA Civ 661 per Mummery LJ at 18:

“The court should also hesitate about making a final decision without a trial where, even though there is no obvious conflict of fact at the time of the application, reasonable grounds exist for believing that a fuller investigation into the facts of the case would add to or alter the evidence available to the trial judge and so affect the outcome of the case.”

Whether Olympic have a real prospect of establishing that they are entitled to make a claim founded on ACG"s failure to deliver the aircraft in the condition required under clause 4.2(a) and Schedule 2.

It is ACG"s case that, however serious their breach of contract in failing to perform their primary obligation to deliver an airworthy aircraft in the condition required by clause 4.2(a) and Schedule 2, Olympic are precluded by their acceptance of the aircraft from maintaining any claim, whether for total failure of consideration or in damages in respect of such breach of contract. This is an extreme case which leads to unreasonable and uncommercial results. It means, for example, that ACG would have no liability to Olympic after acceptance of the aircraft, even if (i) the condition of the aircraft is such that it can never be used under the lease; (ii) there was no means by which this could have reasonably been discovered by Olympic on its pre-acceptance inspections; and (iii) the defective condition of the aircraft involved gross negligence on the part of ACG or those for whom it was responsible. Further, ACG"s case is that, if the aircraft can in fact be restored to an airworthy condition, then it is Olympic"s obligation to do so and redeliver the aircraft in that state to ACG and, moreover, to do so even if the cost of such restoration and repair exceeds the value of the aircraft. Whilst it is no doubt possible for the parties to conclude such a bargain, it would be a remarkable bargain for commercial parties to make and would require the clearest terms to relieve ACG of responsibility for breaching the contract in such a fundamental way.

Olympic rely, by analogy, on Tor Line AB -v- Alltrans Group of Canada (The "TFL Prosperity") [1984] 1 WLR 48, in which a vessel tendered under a charter party did not conform to the description in the contract and the owners relied on a widely drawn exclusion clause. Their argument was rejected by the House of Lords. Lord Roskill, with whom the other Lords agreed, said at page 53 that:

“Such a literal construction would mean that the owners would be under no liability if they never delivered the vessel at all for service under the charter or delivered a vessel with a totally different description from that stipulated in the preamble. My Lords I cannot think that this can be right.”

Similarly in the present case, on ACG"s construction, they would be under no liability if they delivered an aircraft which was not capable of any service under the lease and was in a totally different condition to that stipulated and required under clause 4 and Schedule 2. ACG submit that there would be such a liability if they had been fraudulent and that, absent fraud, there was no good reason why the lessee rather than the lessor should not assume the risk of latent defects and any other defects which had been discovered pre-acceptance. However, the fact that that risk involves a breach of the lessor"s obligations is a good reason why it should not be transferred to the lessee. A fortiori, given that it may involve a breach which goes to the root of the contract and which deprives the lessee of substantially or indeed all the benefit of the contract and may, absent fraud, still involve negligence or gross negligence on ACG"s part. I turn then to consider the particular contractual clauses upon which ACG places reliance.

Clause 4.5(c) provides that:

“On and from Delivery, the Leased Property will be in every respect at the sole risk of Lessee, which will bear all risk of loss, theft, damage or destruction to the Leased Property from any cause whatsoever.”