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COVID-19 – considerations for rolling stock lessors2 April 2020

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As in many sectors, the impact of COVID-19 is being felt strongly across the European rail industry and further afield. A wide variety of approaches is being taken by governments worldwide with respect to rail operations, from continued operation with increased cleaning regimes on trains to the total suspension of services. Already we are seeing cases of lessees seeking rent reductions or holidays, or even outright termination of their contracts, as a result of difficulties brought about by the impact of COVID-19. As rolling stock operators face continued disruption to their businesses, lessors should be aware of the following points, and be proactive in staying ahead of the changing situation.

"Each jurisdiction will have its own quirks of interpretation, concepts of generally applicable law, and (of course) its own governmental approach to combatting the pandemic."

  1. Take advice early, and bear in mind the geographical spread of customers.

One key difference between European rolling stock leasing and other large asset sectors, such as aviation or shipping, is that rolling stock leases are generally not governed by English or New York law as standard, but rather by the local law of the customer. 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 (of course) its own governmental approach to combatting the pandemic and alleviating the economic effects.

Lessors should review their leases to confirm whether they provide for the unconditional payment of rent, and if they include some form of contractual force majeure provision. However, beyond the express terms of the lease one should also establish whether the governing law of the lease applies general concepts such as “hardship” or other rules based on fairness, which may cut across those “hell or high water” provisions. Under certain jurisdictions the parties may have remedies where, due to events beyond their control, they are no longer in the situation they originally signed up to. As an example, lessees may be able to claim that, as they are no longer receiving any benefit from the rolling stock as they are unable to use it, they should not have to pay rent. This argument may apply even where the contract seeks to apportion such risk firmly in the court of the lessee.

If the relevant jurisdiction has such rules, it is important to understand the procedure for invoking them. For example, can a lessee simply allege hardship, or must it apply to the court for a ruling that the impact of COVID-19 constitutes a hardship, and thus entitles them to remedies? Can the lease be terminated absent such a ruling? This will enable lessors to respond promptly and accurately to lessee claims.

Further, does the relevant jurisdiction require the parties to try to renegotiate the contract if one party believes they are no longer getting “a fair deal” due to, for example, new government restrictions and reduced usage of the railways?

These points should be checked as lessors may not be entirely familiar with all aspects of the legal systems governing their leases, particularly in the more “unusual” leases governed by a law other than that lessor’s preferred choice. While a review of the contract is essential, it is also necessary to understand where generally applicable laws could vary or supplement the terms. This may be a good time to review and update any jurisdictional questionnaires obtained prior to entering into the lease.

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.

"Commercially, a lessor may want to take a different approach to a lessee’s request for a rent reduction or holiday."

2. Remember obligations may not be one-sided

Lessors will argue that any non-performance issue relating to payments is not connected to the impact of the virus – it is unlikely in today’s world of remote working that a rent payment simply cannot be made at all, if funds are available. Any financial difficulties of the lessee resulting from reduced revenue during restrictions on travel, for example, may not be viewed as an event outside its control which prevents it from satisfying its payment obligations (although in some jurisdictions it could be considered an event which warrants a renegotiation of the contract to make it more “balanced”).

On the other hand, the obligation to maintain the rolling stock – which will lie with the lessee on a dry lease and with the lessor on a full-service lease – may well be something that physically cannot be carried out at this time. Whether that is to do with restrictions on movement or staff availability due to illness, a lessor with maintenance obligations should ascertain what defences it may have to a breach of contract resulting from a failure to maintain the rolling stock. Again, this will need to be looked at on a case-by-case basis in the context of the contractual terms and the governing law of the lease. Careful consideration also needs to be given to what any government restrictions actually say. For example, is the lessor legally prohibited from having staff attend the site to carry out maintenance, or is this a decision it took to protect its staff? These types of distinction may be relevant in determining whether or not the lessor has a defence to any non-performance.

Commercially too, a lessor may want to take a different approach to a lessee’s request for a rent reduction or holiday where that lessor needs to ask the lessee for accommodation on the lessor’s inability to perform maintenance. As always, lessors should seek to maintain good communications with lessees about any difficulties which may arise on either side.

3. Increase lessee monitoring

Whilst lessees may be facing financial difficulties at this time, it will be important for lessors to monitor the financial condition of their lessees and to ensure that they are receiving financial reports and forecasts in accordance with the lease terms. Where the lessor has the right to request additional financial information or reports on the lessee’s financial condition, it should consider doing so.

Lessors should also consider the likelihood of other creditors petitioning for the lessee’s insolvency.

4. Be aware of 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 terms of the lease and take advice to determine the jurisdiction in which any insolvency process is likely to be conducted; the key features of such insolvency process which may act to limit a lessor’s enforcement action (e.g. any moratorium or ‘stay’ which may be imposed); and the process by which the lessor would be able to repossess the 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 (in each case) 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. Remarketing

Where it is likely that the lessor will need to repossess assets from a lessee, either as a result of the lessee’s insolvency or on termination of the lease, a lessor should consider what preparations it can make in advance for the remarketing of the assets and the arrangements under which they may be maintained and/or stored pending sale or re-leasing.

6. Check any interplay between financing arrangements and leases

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 the lessor to take or not take certain action in compliance with the finance agreement). The agreement of payment adjustments or other amendments to the lease may require the consent of or notification to lenders. This will have a timing implication for any agreement with the lessee, as facility agents will need time to take instructions from the lenders, who may need to obtain internal approvals to grant consent.

"It may be wise for lessor borrowers to discuss such issues with their financiers before they arise."

7. Check financing arrangements – new lending

Is there a Material Adverse Change (MAC) clause or other drawstop which could be triggered by the impacts of COVID-19?  Can the lessor make any repeating representations which are to be made on the drawdown date?

8. Check financing arrangements – borrower breach

Is there a MAC clause or other event of default which could be triggered by the effects of the pandemic? In particular, if lease receivables are reduced, the impact on any financial covenants may trigger a lock-up period or event of default, though as these are usually tested by reference to annual audited accounts or semi-annual accounts, it is likely to be some time before a breach will be shown to have occurred.

It may be wise for lessor borrowers to discuss such issues with their financiers before they arise, to allow time to find solutions before an event of default crystallises.

As has been seen over recent days and weeks, the spread of COVID-19, and nations’ responses to it, is an extremely fast-moving situation. It will serve lessors well to confirm their understanding of their rights and remedies across their suite of documents. It is sadly inevitable that lessors will see more requests for payment adjustments, and even lease termination notices, as this pandemic continues and the economic fall-out develops.

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