Second Circuit Affirms Right of Aircraft Purchaser to Reject Aircraft Based on Nonconformities With Contractual Delivery Conditions

The U.S. Court of Appeals for the Second Circuit recently affirmed a district court ruling in favor of an aircraft purchaser that declined to purchase an aircraft based on the seller’s noncompliance with the delivery conditions of an aircraft purchase agreement.¹ Both decisions are instructive from a commercial standpoint because they analyze issues of perfect tender, waiver and good faith in the midst of a market of defaults, restructurings and declining aircraft values.

The rulings also are notable because of the unconventional trial procedure in this case. The district court ordered the parties to submit the proposed direct testimony of each witness in written statements in advance of trial. During trial, each witness was to adopt his written statement under oath and then be cross-examined. After the plaintiff rested its case, the defendant moved for judgment on partial findings. The court granted the motion, finding that the plaintiff had been “fully heard” on all issues and had failed to prove its case.² As a result, the defendant did not present its case and its witness statements were not proffered into evidence. The plaintiff argued on appeal that the court improperly considered the defendant’s written statements. The Second Circuit disagreed, saying that the district court was capable of disregarding the statements and, in fact, had disregarded them.

The Dispute

In December 2000, UT Finance Corporation (UTF) entered into an Aircraft Purchase Agreement with Austrian Airlines Österreichische Luftverkehrs AG (AUA). AUA was to deliver to UTF one used Airbus A310-325 aircraft for a purchase price of more than $30 million. Delivery was to occur no later than March 31, 2004, and time was of the essence with respect to AUA’s performance. The agreement required that UTF take delivery only if the aircraft met specific delivery conditions, several of which were tied to airworthiness and flight safety. The aircraft was required to be in the condition required to be fully eligible to:

• receive a U.S. Certificate of Airworthiness
• be promptly registered and operated as a 180-minute ETOPS aircraft under the laws, rules and regulations of the FAA
• be promptly registered and operated under FAR Part 121

Prior to the delivery date, the parties identified numerous areas in which the aircraft did not conform to the delivery conditions. The aircraft contained two auxiliary center fuel tanks (ACTs) that were not listed on the type certificate data sheet and, therefore, were not part of the approved type design. Neither the FAA nor the aircraft’s manufacturer, Airbus, could locate any documentation of an FAA approval of this modification to the type design. The FAA also had not approved the A310-325 model aircraft for use in 180-minute ETOPS flights, although such approval had been granted by France’s civil aviation agency, the DGAC.³

As a result of these and other nonconformities, UTF declined to agree to a closing date on or before March 31, 2004. AUA claimed that the aircraft was ready for delivery in early May 2004 and that industry custom and practice required UTF to accept the aircraft with some price adjustment. UTF declined delivery because the nonconformities remained outstanding and affected the airworthiness and fundamental characteristics of the aircraft.

The Lawsuit

AUA filed a lawsuit in the Southern District of New York asserting that UTF breached the agreement and acted in bad faith by refusing to purchase the aircraft. AUA claimed that UTF’s true motivation was that the value of the aircraft had significantly decreased between December 2000 and March 2004. AUA further asserted that UTF waived its right to enforce a March 31, 2004 delivery, and that UTF acted in bad faith by refusing AUA’s attempted delivery in May 2004.

UTF’s defense was that its performance was excused because AUA failed to comply with the express conditions precedent of the agreement; also, that UTF had not waived its right to enforce a March 2004 delivery. UTF counterclaimed for its attorneys’ fees and costs incurred in defending the action.

Pre-trial discovery lasted more than a year, and included the production of tens of thousands of pages of documents by the parties and non-parties. The parties engaged several experts, including Designated Airworthiness Representatives and aviation consultants, to provide testimony on aircraft type design, ACTs, ETOPS, airworthiness, valuation and commercial practices of aircraft purchases. In New York, Washington, Vienna and Paris, the parties conducted more than 20 depositions of UTF, AUA, Airbus and FAA representatives, and experts.

Pursuant to the court’s order, the parties submitted written statements of the 15 witnesses who were scheduled to testify at trial. The written statements and other pre-trial submissions revealed that AUA sought damages of nearly $48 million, which consisted of the purchase price of the aircraft, additional work performed on the aircraft in anticipation of AUA’s lease of the aircraft to a third party following the failed delivery, “currency conversion” loss, and interest. In addition, AUA sought its attorneys’ fees and costs.

The District Court Trial and Order

The matter went to trial in May 2008. AUA proffered six witnesses, including AUA’s Director of Aircraft Asset Management, AUA’s Executive Vice President for Treasury and Asset Management, a member of AUA’s technical department, a Designated Airworthiness representative who acted as a consultant, and experts on FAA certification and ETOPS type design. Through cross-examination, UTF’s counsel obtained several admissions that the aircraft was not eligible for a U.S. certificate of airworthiness based on the presence of the ACTs, was not eligible for 180-minute ETOPS operations under FAA rules, and was not FAR Part 121 compliant. AUA’s witnesses conceded that industry custom and practice did not require the buyer to purchase a nonconforming aircraft with a price adjustment where the discrepancies affected airworthiness or safety.

At the conclusion of AUA’s case, UTF’s counsel made an oral motion for judgment on partial findings.⁴ The basis for UTF’s application was that AUA had not demonstrated that the aircraft complied with the delivery conditions, and thus did not satisfy the conditions precedent of the agreement. The district court suspended the trial and invited the parties to brief the issues.

On July 18, 2008, the court issued a written decision denying all of AUA’s claims and awarding UTF its attorneys’ fees, costs and expenses. The court found that the aircraft did not comply with delivery conditions in many material respects as of March 31, 2004. But for AUA’s argument of UTF’s waiver of the delivery date, this finding typically would have disposed of the matter, because New York recognizes the “perfect tender” rule. The court ruled that AUA failed to prove that UTF waived its right to enforce timely delivery, because the parties’ conduct postdating March 31, 2004 did not evidence an “indisputable mutual departure” from the agreement, which would be required for a finding of waiver.

In addition, the district court found that the aircraft did not conform in all material respects to the delivery conditions as of May 3, 2004. With respect to the ACTs, the FAA had not issued its formal approval to amend the A310-325 type certificate data sheet until November 2004, eight months after the delivery date had passed. The court rejected AUA’s arguments that certain “anecdotal reports” of other A310-325 model aircraft with ACTs operating in the United States were sufficient proof of prior FAA approval. With respect to approval for 180-minute ETOPS operations, AUA failed to establish that the FAA had ever granted approval of the model A310-325 for use in 180-minute ETOPS flights. In addition, the aircraft and its documentation had additional “significant deficiencies,” including no current FAA-approved airplane flight manual (AFM) and no historical data for life-limited parts in the landing gear.

The court found without merit AUA’s contention that UTF failed to follow an industry custom and practice of accepting aircraft with minor nonconformities in exchange for financial compensation. The express language of the agreement stated that AUA “hereby confirms and agrees that it is obligated to deliver the Aircraft . . . in accordance with all of the delivery conditions contained in this Agreement and that [UTF] has no obligation to purchase the Aircraft in the event such delivery conditions are not met.” The court determined that such express language abrogated any alleged industry custom, and recognized that the nonconformities were anything but minor: “The evidence . . . proves that the two unapproved ACTs affect the Aircraft’s airworthiness. Indeed, the Aircraft could not have received an FAA certificate of airworthiness until the ACTs were approved. The Court cannot imagine stronger proof that the deviations were not minor.”

Finally, the district court rejected AUA’s argument that UTF’s true motivation in declining to purchase the aircraft was the falling market value. It recognized that a buyer will take into account price movements “because non-conformities often go not to the ultimate utility of the goods, but to their value, especially resale value.” Under these circumstances, the court found it entirely reasonable for a buyer to insist on getting the full benefit of its bargain.

The Second Circuit Appeal

AUA timely appealed the judgment, contending that the district court erred in its findings regarding the aircraft’s compliance with delivery conditions and the parties’ performance under the agreement. AUA also claimed that the district court improperly relied on the UTF witness statements, and that AUA was deprived of its constitutional right to cross-examine those witnesses. UTF disputed these arguments.

On June 19, 2009, counsel for both parties appeared before a three-member panel of the Second Circuit Court of Appeals for the oral argument. Less than two weeks later, the Second Circuit affirmed the district court’s judgment, concluding that the factual findings were correct “for the reasons substantially stated in the District Court’s careful and thorough opinion, which properly draws on extensive evidence offered in direct testimonial affidavits and the cross-examination of Austrian Airlines’ witnesses.” It also concluded that the district court did not err in granting the motion for judgment on partial findings because AUA had been “fully heard” on all issues. Although noting that the trial procedure raised the possibility of improper reliance on statements not subject to cross-examination, the Second Circuit found that a careful review of the record and the district court’s extensive opinion demonstrated that the court relied only on the evidence introduced on AUA’s case and the cross-examination of AUA’s witnesses.

Award of UTF’s Attorneys’ Fees, Expenses and Costs

The agreement provided that the prevailing party in any dispute was entitled to reimbursement of its attorneys’ fees and costs. Following the judgment dismissing AUA’s claims, and upon application by UTF, the Second Circuit entered judgment in favor of UTF in the amount of $3.78 million for its attorneys’ fees, costs, expenses and prejudgment interest. Following the Second Circuit’s judgment, UTF made a subsequent application for the fees and expenses incurred in connection with the appeal. AUA satisfied the district court judgment, paid the appellate legal fees and costs, and the case settled.

Conclusion

This litigation provides important lessons to both buyers and sellers of aircraft. Specifically, it demonstrates that it is extremely important that delivery conditions are clear and that contracts address the issue of compensation for nonconformities. The latter point is significant because such discrepancies are often addressed through monetary compensation, but the industry understanding of this practice is not clear and is certainly subject to distortion in the context of a court dispute with “experts” hired by both parties.

As is well known, sellers may have a daunting task of preparing for delivery an aircraft that has been in service, especially where the delivery conditions are exacting and detailed. Sellers need to devote sufficient time and resources not only to preparing the aircraft, but also to understanding the requirements of the contract and any necessary regulatory approvals.

Diligence in the documentation of tasks associated with the actual preparation and inspection of the aircraft and records is critical to proving conformity with the contractual delivery conditions. From the buyer’s perspective, timely communication of identified nonconformities creates a track record that is helpful in demonstrating the buyer’s good faith. Finally, in the event of a default, the issuance of an explicit notice of default with a reservation of rights is important, especially if the parties continue to work together in an effort to achieve an amicable resolution. Such a notice and reservation makes it much more difficult to for a party to later assert that there has been a waiver of contractual rights by virtue of the parties’ conduct.

¹ Austrian Airlines Osterreichische Luftverkehrs AG v. UT Finance Corp., 2009 WL 1940715 (2d Cir. July 2, 2009). The authors represented UT Finance Corporation, the defendant/appellee, from the inception of the litigation in May 2004 to its conclusion in July 2009.
 
² Austrian Airlines Osterreichische Luftverkehrs AG v. UT Finance Corp., 567 F. Supp. 2d 579 (S.D.N.Y. 2008).

³ DGAC is the abbreviation for Direction Générale de l’Aviation Civile.

⁴ Federal Rule of Civil Procedure 52(c) provides that if a party has been fully heard on an issue during a nonjury trial and the court finds against the party on that issue, the court may enter judgment against the party on a claim or defense that, under the controlling law, can be maintained or defeated only with a favorable finding on that issue.