Edward K. Gross Vedder Price P.C. 875 15th Street, NW, Suite 725 Washington, DC 20005

Documentation and Enforcement Issues Relating to a Fractional

Share Financing

ABA Air Finance Subcommittee Meeting, August 9, 2008

Edward K. Gross

Vedder Price P.C.875 15th Street, NW, Suite 725

Washington, DC 20005

Phone: (202) 312-3330

Fax: (202) 312-3322

Email:[email protected]

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GENERALLY

Fractional Share Financing, Sometimes, little or no reliance on collateral

value of the fractional share interest. Most fractional share financings secured by

Customer’s % interest in an aircraft, and rights under related fractional interest documents.Could be fully or partially secured by this collateralCould be supported by fractional provider’s promise

to purchase the interest after a loan default

We’re discussing fractional financings in which the collateral is essential to the exit strategy.

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FRACTIONAL PROGRAM

When entering into a fractional program, Customer: Purchases % interest (the “Interest”) in a certain business jet

aircraft (the “Aircraft”) from a fractional interest seller (“Seller”) pursuant to a fractional interest purchase agreement (the

“Purchase Agreement”);

Hires Seller’s affiliates (Seller and its affiliates, collectively, the “Fractional Providers”) to manage and operate the related Aircraft pursuant to a management services agreement (the “Management

Agreement”);

Subjects the Interest to an exchange and availability program managed by Fractional Providers (the “Program”), Pursuant to program documents (the “Program Documents”) with

other owners of % interests in the Aircraft (“Other Owners”), and holders of % interests in other aircraft in the Program (“Program Participants”).

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Fractional Interest

“Owning” an Interest –

Essentially, commitment by Fractional Providers to make a business jet aircraft (but not necessarily the Aircraft) available to Customer, upon demand, from time to time. Limited to stipulated # of hours during each 12 month period,

consistent with proportionality of Customer’s Interest, relative to % interests owned by Other Owners.

Pays purchase price, various fees and operational charges to Fractional Providers for providing crew, maintaining, servicing, insuring and otherwise keeping Aircraft operational proportional to Customer’s percentage interest.

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Fractional Interest

Not always same Aircraft: Fractional Providers may provide different aircraft and even a

different type of aircraft.

Customer may choose different aircraft based on purpose and duration of the flight, relative cost of using the aircraft, etc. cost - based on various tangible considerations including size,

vintage, capacity, crew, and capabilities, and intangible considerations that cause it to be more or less in demand.

some “true-up” of amounts payable by Customer under the program, relating to cost of use, if Customer exceeds its available hours or it uses the Aircraft during holidays or other “premium” occasions (e.g., Christmas, the Super Bowl, the Masters, etc.).

Fractional Providers can Substitute the Aircraft/Interest.

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Other Program Participants

Recognition of Other Program Participants: Pursuant to Program Documents, Customer,

Other Owners, and other Program Participants all agree:each will have certain shared rights and restrictions

regarding aircraft subject to the Program, includinggrant of leasehold interest in program aircraft used, but not

owned by them, and

non-interference agreement by each Program Participant (including as to its transferees or lienholders) with the rights of the other Program Participants.

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Repurchase

Customer or Seller may require re-purchase At party’s election, or as a right triggered by a breach

or the occurrence of a specified event.

Repurchase price formula is based on applicable % of FMV of entire Aircraft, reduced by various net-outs (accrued obligations to FPs, charges relating to

Repurchase, “sales commission”, etc.) Greater if demanded by Customer after breach by FPs, or

pursuant to request by FPs, and

Less, if Customer exiting Program, or breached its obligations under Program Documents.

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RepurchaseConditions to Seller’s Repurchase; Customer,

conveys to Seller good and unencumbered title to the Interest,

delivers bills of sale, and makes FAA filings and IR registrations and discharges.

pays costs relating to the Repurchase (taxes, filing and registration fees, etc.), and accrued and unsatisfied Program obligations. these amounts likely addressed in the Repurchase

payment formula as net-outs from that payment.

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CONVEYANCE AND LIEN RESTRICTIONS

Customer exits Program by conveying the Interest to 3rd party, but subject to various charges and other conditions.

Customer may enter into sale/leasebacks and secured financings of the Interest, subject to various conditions and restrictions. non-interference agreement by Lender limitation on Lender’s disposition remedy after a financing

default restrictions on UCC and FAA filings, and IR registrations

absolute prohibitions against filings or registrations with respect to related engines and any prospective sale or international interest registrations

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FRACTIONAL COLLATERAL

To secure repayment of Loan and other obligations, Customer collaterally assigns/grants security interest in the following “Fractional Collateral”: Interest (including any substitute Interest) and Repurchase and other rights under Program

Documents

Customer agrees not to terminate or modify Program Documents, nor sell or encumber the Interest or rights under the Program Documents

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Lender not necessarily relying on collateral to recover the loan repayment and other obligations.Lenders may require collateral assignment of the

Repurchase right, but also require supplemental credit support (e.g., securities or a bank account, cross-collateralizing the Loan, other credit enhancement, etc.).

If Repurchase right intended to be meaningful collateral, but may be reduced by accrued program-related obligations, “commissions” or other charges, Lender may require additional collateral to cover any anticipated gap.

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Reliance on Repurchase rights, and Program’s existence means Lender must rely on creditworthiness and continued performance by Fractional ProvidersSo - default under Loan Documents may also be

triggered by a breach by Customer or the Fractional Providers under the Program Documents, or by the insolvency of or other event relating to the Fractional Providers

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Remedies

Lender may exercise various remedies upon a default

Including right to foreclose against and dispose of the Interest.

But – Lender can’t reposses or exert other physical control over related airframe or engines.

So, relying on Seller’s repurchasing the Interest upon Lender’s foreclosure and disposition, pursuant to Customer’s collaterally assigned Repurchase rights,

Independent agreement between Lender and Fractional Providers, affording Lender greater protections, rights, etc. than those collaterally assigned.

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Fractional Providers’ Acknowledgment

Fractional Providers likely to

Resist limits to their control over the Interest, (e.g., dispositions to third parties, retention of mechanics or other similar inchoate liens, and prohibitions against certain filings and registrations).

Insist upon Lender’s giving assurances with respect to non-interference with rights of Other Owners and other Program Participants.

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Examples of Acknowledgment Terms

Acknowledgment by Customer and Fractional Providers that, upon a Loan Default, Lender may exercise various remedies relating to the Interest and the other Fractional Collateral. Might be fairly limited if Lender is unsophisticated or is relying

on other credit determinants or Fractional Providers are unwilling to consider Lender’s “non-standard” remedy requirements.

Customer’s Repurchase right in Purchase Agreement often very Seller-favorable. limitations and conditions to Seller’s obligation to consummate the

Repurchase, and re-purchase price reduced by various charges, commissions and

other “net-outs” (potentially impairing Lender’s recovery of the full amount of the Loan balance and other secured Obligations).

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Acknowledgment

Fractional Providers will cooperate with Lender’s exercise of remedies to extent consistent with the Program Documents.

But, must agree that Lender’s rights and remedies in the Acknowledgment either supplement or supercede any inconsistent provisions of the Program Documents.

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ACKNOWLEDGMENT

Lender may deny Customer right to use the Interest

In connection with a foreclosure disposition, Lender may convey Interest and Program Documents to 3rd

party, with Fractional Providers’ prior written consent (not to be unreasonably withheld or delayed); Or if certain specified criteria are met, no such consent would be

required (e.g., transferee’s financial condition, assumption of Customer’s obligations under the Program Documents, payment of a transfer fee, etc.)

Lender might agree to afford the Fractional Providers a right of first refusal before transferring the Interest to the third party purchaser.

After notice of an assumption or disposition, Fractional Providers agree to accept performance under the Program Documents from Lender or a transferee

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ACKNOWLEDGMENT

Seller agrees to Repurchase the Interest, upon Lender’s demand, either pursuant to Purchase Agreement or any Repurchase terms in Acknowledgment

Examples of “overriding” Repurchase terms: Lender’s right to demand Repurchase not subject to any of the

repurchase conditions in the Purchase Agreement, including warranting title, lien status or other matters relating to the Interest entering into bills of sale, and making certain filings and

registrations relating to the Repurchase.

Repurchase payment not reduced by any amounts otherwise payable by Customer if it exercised the Repurchase provisions of the Program Documents.

Customer gets any excess, and remains liable to Lender for any Loan-related deficiency, and to Fractional Providers for any unrecovered amounts due under the Program Documents.

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ACKNOWLEDGMENT

Assurances from Fractional Providers if it limited or prohibited filings or registrations relating to the Interest, especially with respect to the related engines.

Customer acknowledges commercial reasonableness of the disposition of the Fractional Collateral and application of disposition proceeds.

Suretyship waiver or other acknowledgments by Fractional Providers that their promise to consummate the Repurchase from Lender after an Event of Default does not afford them the rights or defenses of a surety

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CLOSING FRACTIONAL SHARE FINANCING

Closing process requires significant cooperation by Fractional Providers, including the entering into of the Acknowledgment;

A sample “Responsibility Checklist” listing the closing deliverables and other closing conditions typically required in a fractional share financing is attached as Exhibit D to the materials.

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ENFORCEMENT ISSUES

Generally, Upon a Loan Default, Lender is likely to demand that

Seller Repurchase the Interest By collaterally assigned right or, if so agreed with Fractional Providers, by direct contractual

right

If Lender determines that this remedy affords it the best and most practical opportunity to maximize its recovery of the Loan balance and the other Obligations from the Fractional Collateral.

Assuming no challenges, Lender will demand and apply Repurchase payment pursuant to the collateral proceeds “waterfall” in the Security Agreement.

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ENFORCEMENT ISSUES

Unique enforcement challenges with fractionals: Conventional financing of an aircraft, lender

notifies borrower that loan is in default, andeither directs borrower to ground and store the

aircraft, or takes possession or control of the aircraft.

In fractional financing, Lender may not be able to exert control over continued operation.

Continued operation creates risks (casualty, damage, liens, additional offsets, etc.) that could impact the amounts payable as the Repurchase payment.

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Repurchase - Pre-Arranged Private Foreclosure Sale

Lender’s choices: Non-judicial foreclosure remedies recognized under the UCC

(three types; See U.C.C. §§9-610 et seq.): private foreclosure sale - where Lender identifies third party

purchaser of the collateral (e.g., Repurchase remedy) public foreclosure sale - Lender makes collateral available for sale by

public auction and strict foreclosure - lender retains collateral in full or partial

satisfaction of the secured debt.

Judicial foreclosure under laws of applicable jurisdiction (e.g., judicial foreclosures for personal property in New York are brought under N.Y. Lien Law § 206 and N.Y. U.C.C. § 9-601(a)(2)).

Non-judicial preferred (timing and costs).

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Consider notice requirements Sales under private and public foreclosure sales

governed by U.C.C. §9-612 and Article IX(4) of the Cape Town Protocol, requires 10 days or 10 or more “working days” notice or may

be governed by any applicable remedies provisions of the related security documents if require a longer notice period.

Security documents often afford grantors a longer notice period (but, typically no more than 30 days) for Aircraft collateral.

Strict foreclosures under U.C.C. § 9-620, can be effected with 20 days notice, unless additional time required by related security agreement.

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Pre-arranged private foreclosure sale of the Interest and other Fractional Collateral. must conform to applicable requirements under the U.C.C. (See

U.C.C. §§9-610 et seq.) and the Cape Town Treaty. (See Cape Town Treaty, Article 8(1); Cape Town Aircraft Protocol, Article IX.)

These requirements include (a) minimum timing requirements and (b) the commercial reasonableness requirements for the foreclosure sale. (See U.C.C. §§9-610(a) & (b) (commercial reasonableness requirement), § 9-611- 612 (notice requirements), and Cape Town Aircraft Protocol, Article IX(3).)

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Application of Cape Town Treaty: Recognizes that default remedies “shall be exercised in

conformity with the procedure prescribed by the law of the place where the remedy is to be exercised. (See Cape Town Treaty, Article 14.)

Provides great latitude in allowing the parties to contractually agree as to how remedies may be enforced. (See Cape Town Aircraft Protocol, Article IX(3).)

Loan Documents for domestic deals governed by US law - Treaty deferential to agreements by parties, focus on contractual rights agreed upon by parties and U.C.C.

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Conditions to Seller’s obligation to Repurchase: Interest being transferred to the Fractional Providers

free and clear of any liens and encumbrances created by Customer, and that Lender deliver a “warranty” bill of sale.

If Program Documents prohibited Lender from making UCC or FAA filings or IR registrations with respect to engines, Lender’s right to foreclose against and dispose of the Interest to the extent relating to the engines could be impaired.

Get concessions and assurances from Fractional Providers

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Enforcement challenges: Both the U.C.C. and the Cape Town Treaty require that all

aspects of a foreclosure sale must be conducted in a commercially reasonable manner.

Private foreclosure sales not immune from fraudulent conveyance attack (i.e., that the consideration received at such sale did not constitute fair consideration for the value of the collateral sold).

If Repurchase price equal to FMV the Interest, but similar to what Cvustomer would receive in Repurchase - should minimize risk of Repurchase being deemed either (a) a fraudulent conveyance or (b) a commercially unreasonable private foreclosure sale.

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Impact of Customer’s Bankruptcy

Automatic stay Customer’s bankruptcy filing would stay Lender’s exercise of the

Repurchase – as the Repurchase would be “an act to obtain possession of property of the estate . . . or to exercise control over property of the estate.” (11 U.S.C. § 362(a)(3).)

Lender would need to monitor other bankruptcy issues affecting secured creditors, including, without limitation, issues regarding adequate protection, Lender’s right to postpetition interest, debtor-in-possession financing (and efforts to prime or share Lender’s collateral), substantive consolidation with other entities, and chapter 11 plan restructurings and treatment of Lender and Lender’s collateral and rights under such plan.

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ENFORCEMENT ISSUESRepurchase- Pre-Arranged Private Foreclosure Sale

Lender’s collateral is comprised of rights under executory contracts entered into by Customer, so great concern regarding Customer’s treatment of such executory contracts in a bankruptcy case

whether such contracts are being assumed, assumed and assigned or rejected by Customer may also affect Lender’s interests. (See, e.g., 11 U.S.C. § 365.)