The perils of short-term aircraft leases
They can come in handy, especially if you need a jet while waiting for delivery of a factory-fresh model. Just be sure you understand all the financial questions these deals raise.
An aircraft buyer waiting for delivery of his new Gulfstream G650 once complained that the manufacturer “wasn’t promoting instant gratification.” Who could blame him? The scheduled delivery was eight years away. With a wait like that if you don’t have another aircraft that you don’t mind flying for the better part of a decade, you might as well buy one to tide you over.
Fortunately, the wait for factory-new aircraft rarely lasts as long as eight years; two years is more typical, though, of course, the length of the delay depends on the model. Almost no one wants to buy an aircraft to operate for just two years, so many buyers who face waitsconsider leasing an airplane on a short-term basis.
A “short-term” jet lease runs one to three years, and there are three typical places to find one. First, if you’re buying a factory-new aircraft, its manufacturer may have a preowned one it took as a trade-in and would be willing to make available as interim transportation. Second, financial institutions that have aircraft coming back after leases expire are often not ready to sell them right away, especially if doing so would mean recognizing a loss; they may prefer to lease them for a couple of years instead. Finally, aircraft owners and lesseessometimes find that they temporarily have no use for a jet and would prefer to lease it out—perhaps to a sub-lessee for the remainder of the term of the head lease.
In many ways, long-term leases are easier to negotiate because the longer the term, the more leasing is comparable to owning. In fact, the vast majority of long-term jet leases arise because a company or individual asks a financial institution to purchase the aircraft and lease it back. In that case, the buyer (now the lessee) expects to be responsible for all fixed and variable operating costs, just as if he were the owner. The financial institution, on the other hand, takes the residual risk on the aircraft’s value on lease termination. All thisis customary and non-controversial.
But a one- to three-year lease is a different animal, and a large gap often looms between the desires and expectations of lessor and lessee. The lessor—especially if it’s a financial institution—usually has no appetite for retaining any risk, exposure or expense related to the aircraft. Banks, after all, have a constitutional unwillingness to provide financing that involves appreciable risk. The lessee, on the other hand, regards the aircraft as a temporary solution to its needs. It’s generally not interested in treating the airplane like something it owns, and certainly not in pouring money into it.
This issue is particularly nettlesome during negotiations about the lessee’s responsibility for maintenance. Suppose you plan to lease an aircraft for a year and an eight-year inspection will come due during the term. You’ll have no interest in paying for that inspection; nor will you be happy that the time required to conduct it and fix discrepancies will keep it out of service and effectively shorten your lease. A reasonable lessor should be willing to share the cost of that inspection with you and make some accommodation regarding downtime. In this example, you might be responsible for one-eighth of the inspection cost and receive an extension to the lease term that covers most ofthe downtime.
Unfortunately, prorating costs between lessor and lessee doesn’t help much with unscheduled maintenance. Obviously, if the aircraft requires additional maintenance because of negligent operation by the lessee, the lessee should stand tall for that. In other cases, help may be available. Insurance covers some unscheduled maintenance, such as foreign-object damage to an engine. If the aircraft is enrolled in maintenance programs or under warranty, the responsibility for unscheduled maintenance may well be transferrable to a third party. Engine manufacturers like Rolls-Royce and General Electric offer comprehensive coverage of scheduled and unscheduled maintenance on the engines as longas the lessee makes the hourly payments during the lease term, and some airframe manufacturers offer similar programs, as do independent providers such as JSSI. The more programs you add, the more you reduce the financial risk of an unscheduled maintenance event for both parties.
Many operators shy away from airframe programs because they can be very expensive. So if the windshield needs to be replaced in the second month of a 12-month lease, who should pay? Unless the replacement is the result of the lessee’s negligent operation, it’s hard to see why the lessee should pay. Making the lessee responsible for such repairs would just be a windfall for the lessor, who might as well hope that everything else on the aircraft would need to be replaced during the lease as well. A reasonable solution here is for the parties to agree that the lessee’s exposure is limited to a per-flight-hour maintenance reserve payment to cover the costs of unscheduled—or perhaps all—maintenance.
What if the aircraft lacks upgrades or equipment that the lessee considers essential? Should the lessee spend hundreds of thousands of dollars to make improvements to an aircraft it doesn’t own and will fly in for only a year or two? Probably not, but don’t count on the lessor to pay for them, either. Still, many improvements will add significant value to the aircraft, so the parties might negotiate a cost-sharing arrangement that takes into account the assumed life of the improvements and the term of the lease.
Finally, don’t neglect pre-lease due diligence in a short-term lease. Depending on the lease term, you may want to do a full-blown prebuy inspection to ensure that the aircraft is in good condition before you operate it. At a minimum, a test flight, engine borescopes and logbook review are essential.
Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.