Function and Nature of the Letter of Intent in the Sale and Purchase of Aircraft

2021-11-16 Newsletters

At the initial stage of the negotiation of the sale and purchase of aircraft, the parties usually express in writing their seriousness and degree of commitment to the negotiations by means of the Letter of Intent (LOI).

This document lays the foundations for the future sale and purchase contract and has the function of establishing the main points of transaction that will be repeated and developed in the future sale and purchase contract, but without obliging the parties to proceed with the sale, but only to continue the negotiations that may culminate in the sale, if due agreement is reached.

Contents of the Letter of Intent:

-Initial or reference purchase price of the aircraft, as during the course of negotiations, and in view of inspections, it may change.

-Subjecting the effectiveness of the LOI to the satisfactory outcome of the visual inspection, if any.

(Otherwise the LOI will not be signed).

-The delivery by the buyer to the Escrow Agent of a dollar deposit in an amount varying from 5% to 10% of the proposed value of the aircraft, within a specified period after acceptance of the LOI.

(Normally, this deposit is returnable to the buyer, so that after the pre-purchase inspection of the aircraft, the buyer can withdraw from the transaction and recover the deposit. However, it may sometimes be agreed that this is not the case, which represents the maximum degree of commitment on the part of the buyer).

Dates of commencement of the pre-purchase inspection and/or closing of the aircraft purchase and sale agreement.

Location and extent of the pre-purchase inspection and test flight of the aircraft.

-Designation of the party to pay the costs of the transaction.

(These costs may include the aircraft position flight to the facility where the pre-purchase inspection is conducted, the cost of the return flight in the event of rejection of the aircraft after such inspection, (if any), taxes and customs charges, and the distribution of Escrow agent’s fees.

If negotiations continue and the deposit is not withdrawn, the deposit may be subject to payment of some of these costs or compensation in the event of a possible breach by the seller, which will have to be expressly reflected in the future contract of sale).

-The requirement of a clean and unencumbered title deed (if applicable).

-The requirement of the condition of airworthiness and adequate state of maintenance of the aircraft.

-The requirement of the exclusivity of the buyer, as necessary prerequisites for the sale.

-Any other information that the parties deem appropriate: if the positioning flight is to be used as a test flight to save costs, the location of the aircraft for delivery to the buyer, the existence and deadline for obtaining financing for the purchase, etc.

-The express mention that the LOI is subject to the execution of a mutually acceptable Purchase Agreement.

(Such mention determines the nature of the Letter of Intent, to which we will return later).

 

The parties may proceed directly to the conclusion of the sales contract in order to accelerate the transaction, if circumstances and good understanding are conducive to this. However, the signing of a pre-contract or letter of intent strengthens the initial trust between the parties and has certain advantages:

1.- The buyer is assured of the reservation of the aircraft and that it will not be offered to another buyer during the agreed period of time.

2.- The seller clears up possible doubts regarding the buyer’s financial situation, from the moment that, through the Letter of Intent, he obtains greater legal certainty with regard to:

-The conclusion of the sale and purchase within the agreed period;

-The financial situation of the buyer (through the deposit).

-The concurrence of a waiting period if the buyer is still awaiting the necessary funds for the purchase of the aircraft, which is often the case.

 

Nature and effects of the letter of intent:

The concept of the Letter of Intent is a figure of Anglo-Saxon creation that has also found its fit and configuration in Spanish law, although its nature has had to be developed by case law and doctrine, the conclusions of which we synthesise below.

The LOI is issued at the beginning of the negotiations and documents a series of preliminary deals as acts that the interested parties carry out in order to discuss and specify a future contract, but it does not have the power to oblige the parties to proceed with the sale and purchase of the aircraft. To this end, a new subsequent agreement must be concluded between the parties, which will include the points covered by the letter of intent.

It is considered that the letter of intent does not constitute a true contract, as it does not contain all the necessary elements of a contract, and therefore does not have the force to oblige the parties to execute the agreements contained therein.[1]

The elements that make up a contract are: consent, object and cause, in application of case law and the provisions of Article 1450 of the Civil Code:

 

Article 1450 C.C.:

“The sale shall be perfected between buyer and seller, and shall be binding on both, if they have agreed on the thing which is the object of the contract and on the price, even if neither the one nor the other has been delivered”.

The object cannot be determined in the LOI when it is not certain whether the aircraft meets the requirements that would make it suitable for sale, nor of its true value, as the pre-purchase inspection has not yet been carried out. Therefore, neither the price can be determined, nor the consent can be given to close the transaction. This lack of information is typical of the early stages of negotiations and does not allow us to speak of a contract.

It is important to point out that this is the difference between the LOI and the pre-contract. The pre-contract constitutes a binding figure for the parties that sign it, which does constitute a real contract in itself, with all the elements of the contract perfectly defined, but with the particularity that the parties have decided to suspend its effectiveness and execution to a later moment.

An example of a pre-contract is the purchase option.

An option to purchase an aircraft where the parties have already carried out a pre-purchase inspection, have already agreed on the price of the aircraft and its suitability, and have already negotiated all points relating to costs, risks and delivery conditions. However, by will of the parties, the sale cannot take place at that time, and it is left to the buyer’s discretion to request its sale within a certain period of time.

Since the pre-contract as such does oblige the parties to proceed with the contract of sale when this is required, the court can substitute itself for the will of the parties and oblige performance.[2] Likewise, if performance is not possible, the provisions of the Civil Code on breach of contract can be applied.

In the light of the above, the more detailed the conditions of the sale and the characteristics of the aircraft in the LOI, the more the LOI resembles the concept of the binding pre-contract, but it can only be qualified as such when all the elements of the contract are fully configured, so that the LOI does not need a subsequent contract to perfect the sale and close it. This is not possible without the pre-purchase inspection having taken place and all the ancillary matters required by the contract having been dealt with.

This does not mean that the LOI has no binding force whatsoever. Regardless of the returnable or non-returnable nature of the deposit that may be agreed, the parties must respect what has been agreed and will be liable for the damages caused by non-compliance with the LOI.

In order to determine the liabilities arising from breach of the LOI, we must not turn to the rules governing breach of contract, but to the precepts that make up the tort and the generic obligation not to harm another, under a series of requirements developed by case law.

These requirements are set out in the following judgement 440/2012 of 25 September 2012 of the Provincial Court of La Coruña. This ruling analyses the scope of what it calls the “initial negotiations” or Letter of Intent in aircraft operations, and sets out the requirements that must be met for its breach to give rise to compensation:

 

SAP A Coruña 440/2012, 25 September 2012:

“…the “letter of intent” of 29 February 2008 cannot be qualified as a contract, nor as a pre-contract; it is merely an agreement to initiate conversations on a possible business with a predefined framework on the price and object but pending to be specified. Moreover, the same ‘letter of intent’ expressly provides for the possibility of not reaching an agreement, with the deposit being returned. It considers that the “letter” does not give rise to purchase obligations

The perfection of the contract, being the contract a bilateral legal transaction, exists with the concurrence (article 1261 of the Civil Code) of consent, object and cause. And consent (article 1262), with the concurrence of the coinciding and opposing declarations of will – offer and acceptance – of the contracting parties……

 (a) It was proved that “Inveravante Inversiones Universales, S.L.” was unaware of the specifications of the aircraft (except for the generic model),

(b) The price is not certain either, in a double sense: (i) The aforementioned Mr. Jose Ramón (“Ceox Aviation, S.L.”) clarified that the price fixed in the letter of intent was a “reference point”, but not the final price; it could be subject to variations when negotiating the details that appeared.

The purpose of the pre-contract ….. is to form a contract. It already contains the elements of the definitive contract; it is already a complete contract, containing its basic lines and all the requirements, the parties being obliged to collaborate in order to establish the definitive contract. However, the contracting parties voluntarily postpone the conclusion of the contract. Whose effectiveness or putting into effect is left to the will of both contracting parties……. A distinction must be made between (i) the unilateral, which does not require subsequent activity by the parties to develop the contractual bases contained in the agreement, the expression of will of one of the parties being sufficient for the contract to become firm, perfect and binding. A typical example is the pre-contract of option to purchase, the perfection of which depends exclusively on the expression of the will to opt. (ii) The bilateral or “pactum de contrahendo”…

If it is being stated that this is a very complex contract, involving lawyers, with customs and tax implications, international relations, etc., it cannot be reduced to something so simple. Neither was “Inveravante Inversiones Universales, S.L.” aware of the contract, nor was it agreed how it was to be paid, and it is not possible that it was a cash payment. Proof of this is that the “letter of intent” of 29 February 2008 expressly contemplates that the final agreement will not be reached, in which case the deposit must be refunded. Since the essential elements are not determined and a new agreement is required at a later date, these are merely preliminary agreements.

As a general rule, mere prior agreements are irrelevant for the law, as they do not produce an obligation, as they do not generate obligations for the parties [ Ts. 3 June 1998 (Roj: STS 3626/1998, appeal 881/1994 )]. However, in the cases in which there is an unjustified rupture of these prior agreements, the obligation to repair the damage generated by “culpa in contrahendo” can arise …..

The judgment of 14 June 1999 (Roj: STS 4182/1999, appeal 3396/1994 ) listed the elements that must be present for the breach of preliminary negotiations to be considered unlawful: (a) the assumption of a reasonable situation of trust with respect to the conclusion of the contract; (b) the unjustified nature of the breach of contract; (c) the effectiveness of a damaging result for one of the parties; and (d) the causal link between this damage and the trust created.

Some of the above-mentioned judgments include the following compensation scenarios: (a) The expense which I have borne. (b) The damage that I have caused myself by the expectations created. (c) The damage caused by the loss of opportunities.

The “letter of intent”, both at international and national level, does exist. And it is binding. It is more than mere initial soundings of positions, or the sign of a certain desire to continue. It is a commitment that I will negotiate with a minimum of seriousness and interest. So the cause for justifying the rupture must be external and more or less objective. Justifying reasons would be that I cannot obtain the financing I was hoping for, that the specific characteristics of the jet are not what I initially expected, a sudden change in the international economic panorama, that on analysing the contract it becomes apparent that the costs are soaring, or that the guarantees offered are insufficient from an industry average, or the reliability of the aircraft (during the negotiation, several Falcon aircraft fall, which casts doubt on its technology or similar circumstances), and so on. But not a simple “I found a better offer”.

This important judgement is confirmed by the appeal lodged against it with the Supreme Court:

 

STS 330/2013, 25 June 2014:

“the so-called Letter of Intent documented in the case file, finally signed by both parties on 29 February 2008, does not constitute a true pre-contract but mere preliminary negotiations.

The judgment under appeal interpreted the document of 29 February 2008 as preliminary discussions or preliminary negotiations, i.e. as acts carried out by the interested parties with a view to discussing and finalising a future contract.

The Court of Appeal, in classifying the letter of intent as preliminary dealings and not equating it to the legal concept of the pre-contract referred to in art. 1451 CC, respects the doctrine of this Court by emphasising that “since the essential elements are not determined, and a new subsequent agreement is required, they are simply preliminary dealings [ STS of 21 March 2012, RC 931/2009 ]….

In the present case, “the declaration of intent was not to enter into the contract, but As the STS of 14 December 2006 states, “the pre-contract requires that the object be perfectly determined and thus, in the pre-contract of sale the thing sold and the price are stated; if they were not determined and a new agreement was needed, it would be mere prior agreements, without binding effect”; in the same sense the STS of 7 September 2010, RC 5036/2006 , among others. This Chamber has also distinguished between the bilateral promise to buy and sell with the definitive contract of purchase and sale: the former must be configured as a preparatory contract or pre-contract, the effects of which cannot be identified with those produced by the perfection of the purchase and sale…”.

Finally, attention should be drawn to one of the examples set out in both judgments: The Purchase Option, as a typical example of a unilateral pre-contract, which should not be confused with the Letter of Intent, when the text of these judgments reads as follows:

“A typical example is the pre-contract of purchase option, the perfection of which depends exclusively on the emission of will of the desire to opt”.

This is regulated in Article 1451 of the Civil Code.

Article 1451. C.C.:

 “The promise to sell or buy, there being conformity in the thing and in the price, shall entitle the contracting parties to reciprocally claim the performance of the contract”.

Once the LOI is signed, the deposit is sent to the Escrow agent’s account and the purchase contract begins to be negotiated. The Escrow Agent, or the person designated for this purpose, simultaneously with the negotiation of the contract, will check if the aircraft is indeed free of charges and will consult the International Registry and the information of the national registration of the aircraft that will be provided by the parties.

Finally, the signed LOI can be submitted to the buyer’s Aircraft Registration Office, as it is a document required by the (Spanish) Aircraft Registration Office in order to make a reservation of registration, which is granted for a period of 6 months, during which a provisional registration must be applied for before obtaining the definitive one.

 

[1] Rafael Bernad Mainar also puts it this way in his article “En torno a la naturaleza jurídica del precontrato”, published in the Revista Crítica de Derecho Inmobiliario – Núm. 742, March 2014. Id. vLex VLEX-512008142. Link: https://vlex.es/vid/torno-naturaleza-jura-dica-512008142?from_fbt=1&forw=go&fbt=preview  [Spanish only]

[2] This is stated by Héctor Daniel Marín Narros in his article “El precontrato”, available at Id. vLex VLEX-394230734. Link: https://vlex.es/vid/precontrato-394230734?from_fbt=1&forw=go&fbt=preview [Spanish only]

 

 

Written by: Irene Sanchez del Rio Moreta, Of Counsel for Aviation, Lupicinio Cluster

 

 

For more information:

C/ Villanueva 29, 28001 Madrid
T: +34 91 436 00 90

Av. Diagonal 520, 08006 Barcelona
T: +34 93 488 28 02

info@lupicinio.com