June 2006 Issue No. 54

Welcome to the June 2006 edition of
Business Leasing and Finance News
formerly Business Leasing News

About BLFN: David G. Mayer, a Business Group partner at Patton Boggs LLP, founded this monthly e-newsletter in January 2002. BLFN’s mission is to provide leasing and financing strategies for your success.

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FOUNDER'S NOTE
By David G. Mayer

This issue of BLN focuses on the increasing complexity in making international investments. Although many countries offer transactional opportunities, the lead article discusses how and why company boards increasingly seek out objective analysis of political or country risk before they commit to a new project, transaction or other investment overseas. The second article describes one of the solutions to country risk. When a finance or leasing company evaluates investment or finance risk, the company may require its customers to maintain repossession insurance. Repossession or political risk insurance can mitigate political or country risk of losing or experiencing a delay in repossessing an asset, such as a corporate jet, an energy facility or even technology assets, as a result of adverse government actions. The third article covers an emerging, highly controversial issue in aviation – FAA user fees. The airlines have proposed that business aviation pay an additional $1.5 billion to $2 billion per year to fund the FAA starting as early as 2007. Finally, as a complement to the first and second articles, Leasing 101 defines “political risk” and “country risk” in the context of investing in and financing assets or projects outside the United States in cross-border or international transactions.

Thanks for reading BLN! Good luck this month with achieving a strong finish of your second quarter of 2006.

1. Boards Seek Political Risk Analysis Before Making International Investments

Just as economic growth in parts of the U.S. economy may be starting to slow down, economic growth in other countries seems to be speeding up.

India continues its torrid expansion, fueled by solid farm production and consumer spending. China enjoys strong economic growth and, in the process, is creating an almost insatiable internal demand for oil, mining and other products. In the first quarter of 2006, Brazil’s economic growth accelerated more than expected based on the recovery of industry and services. As South America’s largest economy, Brazil is expected to achieve economic growth in 2006 of 3.7 percent. European job data indicates falling unemployment in Germany and France with consumer confidence in the euro zone showing improvement. Even the World Bank reports significant growth in the economy of developing nations. See Politics & Economics section, The Wall Street Journal, S.W. Ed., Page A:6, Col. 3 (June 1, 2006); European Job Data, Consumer Confidence Brighten, The Wall Street Journal, S.W. Ed., Page A:4, Col. 3 (June 1, 2006).

Is It Time to Jump into Foreign Deals?

The attractive economic picture outside the United States surely suggests that U.S. companies should jump on business opportunities abroad, right? The answer is generally yes, but investors and finance companies must do far more than take the leap of faith into international or cross-border transactions on the belief that strong or strengthening foreign economies will translate into profit for their goods or services. Rather, making foreign investments or financing foreign assets takes the right preparation, analysis and understanding of targeted international markets. More frequently, boards of directors require (or should require) their companies to conduct political or country risk analysis as a condition to making international investments, but such advice may be hard to find.

*Term to Know: See Leasing 101: What Is “Country Risk” or “Political Risk” in International Investments?

Risk Assessment of Foreign Deals

Analyzing the risks of foreign deals involves transactional and political risk assessments. For example, in an illustration of blatant political risk, Venezuela’s President Hugo Chávez, in the last few weeks, has been stirring the economic pot in Venezuela, Ecuador and Bolivia, in an effort to thwart U.S. influence in the region and strengthen his own power. See Chávez Pushes Bolivia, Cuba Trade, The Wall Street Journal, S.W. Ed., Page A: 4, Col. 3 (May 30, 2006). He has taken steps to nationalize certain assets and most recently interfered with the shipment by Exxon of more than half a million barrels of crude oil to the U.S. See World Bank Sees Greater Growth Across Globe as Policies Pay Off, The Wall Street Journal, S.W. Ed., Page A: 6, Col. 3 (May 31, 2006).

Chávez’s actions provide an illustration of severe and unexpected political risk. Venezuela is not the only story of political risk. From a foreign perspective, there is even political risk for direct investment into the United States. A current debate rages in Congress over limiting foreign investment in the U.S. Such a move could trigger retaliation by foreign countries and limit opportunities for U.S. companies operating internationally as well as for non-U.S. companies trying to do business in the U.S. See U.S. Foreign-Investment Debate Goes Global, The Wall Street Journal, S.W. Ed., Page A: 4, Col. 1 (May 30, 2006).

Despite Chávez’s actions and the potential changes that the U.S. Congress may impose on foreign direct investment into the U.S., substantial international and cross-border business can and will get done in Venezuela and the U.S. These situations present important lessons that different rules and risks may exist for companies engaged (or about to engage) in international business. Those who know how to assess political risk or deal with a problem after the risk factors become reality stand to make substantial gains in business around the globe. See Venezuela’s Chávez Signs Energy Deal Assisting Ecuador, The Wall Street Journal (S.W. Ed.), Page A: 6, Col. 5 (May 31, 2006).

Bet the Company; Bet the Deal; Bet the Asset

Political risk analysis may be so important as to translate into a “bet the company” decision. For many finance, investment and leasing companies, it may constitute a “bet the asset” or “bet the deal” analysis. In any event, political risk decisions often start with the board of directors or other high-ranking board committees or executives. Most U.S. publicly traded, multinational companies engage in some form of political risk analysis when making investment commitments overseas. Whether they rely on the experiences and insights of their employees and/or utilize a formal process involving an independent political risk analysis, each company should produce a written record that reflects an effort to collect relevant data, demonstrate that the company has engaged in a serious discussion of the analysis, and make a reasoned decision on the risk issues based on the data and analysis.

*Tip: To make a defensible decision, as an investor, lender or lessor, consider using outside analysts who can offer insightful, knowledgeable, independent and reasoned evaluations of your proposed commitment or transaction. Inside experts can use the outside resources to validate or expand upon their best advice and sell new ideas with merit or express caution to a business’ decision-makers. The most critical element of the decision-making process is to complete this analysis before you spend a significant amount of money, your company risks its reputation or puts its personnel at personal risk. Ask for a confidential in-person report to the board, combined with the written report, to fully assess the proposed investment or transaction.

Although a written report does not constitute a guaranty of results, it should, at a minimum, demonstrate that decision-makers have not taken an unreasonable, naïve or even an embarrassing investment risk or failed to conduct an appropriate political risk analysis with the right outside help.

Factors in Political Risk Analysis

When evaluating political risk, experts delve into numerous factors, including the following:

• Political, tax law and economic stability as they affect the corporate commitment
  
  
• Existence and reliability of laws to enforce obligations of governments and parties
  
  
• Availability and speed of dispute resolution
  
  
• Ease and ability in repatriating profits and converting currency to home currency
  
  
• Adequacy of personal security for employees and representatives of the investor
  
  
• Extent of corruption exposure and reliable ways to avoid that risk
  
  
• Probability of success of exit
  

Who Can Conduct Political Risk Analysis?

How do companies put together a “dream team” for preparing this analysis for the board or other decision-makers? Ideally, a team will come from one firm with people who have relevant contacts in Washington, DC and around the globe, as well as related transactional capabilities in the affected countries. This team should help analyze and carry out integrated strategies for pursuing foreign business opportunities and/or overcoming difficult international challenges. The team should include (1) former foreign service, foreign intelligence, and military personnel who were stationed there or responsible for the area; (2) retired government civil servants and elected officials with foreign service experience; (3) international commercial lawyers who were (or currently are) involved with projects in the target country; and (4) others who may have represented the sovereign country in question.

*Tip: Perhaps the single most important individuals are those with current contacts in the target country. These individuals should provide you with real time analysis, objective information and an appropriate team of trusted, in-country resources to help you make the decision of whether to proceed with a project or transaction or maintain, expand or abandon an existing investment. A “dream team” should have members who can address, not just analyze, political risk and transaction requirements and provide solutions to problems of a political or transactional nature.

Legal Review: An Integral Part of Political/Country Risk Analysis

Political risk issues lead directly into and require legal analysis on several important fronts. For example, in today’s public companies in the U.S., the shareholders expect, and the Securities and Exchange Commission (SEC) enforces, adequate disclosure of investments in foreign countries.

*Warning: Make sure that you have team members who can assist you with the regulatory, compliance and disclosure issues. Understand that the failure to adequately disclose and analyze the nature and extent of foreign investments can trigger significant liability. For example, in Sherleigh Assoc., LLC v. Windmere-Durable Holdings, Inc., 178 F.Supp.2d 1255, 1271-72 (S.D.Fla. 2000), a disclosure statement filed with the SEC was found to be misleading because it failed to disclose the difficulties that the company was likely to have in acquiring different licensing agreements required by various countries. The court found that failure to disclose these problems materially misled shareholders.

Lawyers who comprise the team should:

• Discuss with the directors and officers (including the general counsel) the implications of the Foreign Corrupt Practice Act, the USA Patriot Act and several other relevant domestic and international laws that affect the company’s political risk analysis;
  
  
• Provide a detailed legal due diligence list that relates specifically to the target country;
  
  
• Explain other in-country and domestic issues that provide a basis for a sound investment decision in the target country;
  
  
• Draft documents that reflect the insights and knowledge of the political risk team and incorporate the laws and provisions that represent the best-practices in enforcing your rights and remedies; and
  
  
• Involve trusted in-country counsel

Damage Control: A Necessary Component of Taking Political Risk

Despite the best political risk analysis, not all deals or investments work as planned. No investment is risk-free. In cases where, despite proper analysis and documentation, a situation requires damage control, a company should have a “Plan B” solution for an unexpected political risk, turned reality, such as in the Chávez situation. In that case, the team that conducts the political risk analysis should also make available its political operatives to use their hands-on experience, local contacts and international skills to protect or attempt to save the investment, project, asset or financing from the threat or risk.

Conclusion: Foreign Investment Is a Business Risk Worth Taking

Political risk analysis is not meant to take the place of the corporate decision. Rather, it uses data, experiences, precedent and insight to enable a board of directors or its committees to analyze the political risk in a target country and make a decision based on the best resources available. With the right decision process, companies can expect to find business opportunities that can build shareholder value with reasonable risk in the expanding world economy.

Thanks to Stephen Molina (Dallas) and Ambassador Philip Kaplan (Washington, DC), members of Patton Boggs’ International Trade and Transactions Team, for their contributions to this article.

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2. Repossession Insurance Mitigates Risk of Cross-Border Financing

Many U.S. financiers and lessors engage in cross-border transactions, but not without risk. To mitigate risk of recovering their collateral or leased asset, lenders and lessors have increasingly considered or required their customers to pay for repossession insurance, either directly or through transaction pricing. Repossession insurance provides sufficient comfort for some players to bridge the gap between a deal that gets the thumbs up, and the one that goes down in flames.

Repossession insurance is a name for a type of political risk insurance coverage. Lessors and lenders use that name when their collateral or leased asset consists of highly valuable mobile assets, such as aircraft, or other moveable property or collateral, such as fixed plant, technology assets or other stationary equipment subject to possible seizure or other governmental action.

According to Aon, one of the most significant brokers, agents and advisers in political risk coverage, political risk insurance can cover various assets for:

• Confiscation, expropriation or nationalization of shareholdings or of fixed or current assets, including “creeping expropriation” and selective discrimination;
• Cancellation, suspension or withdrawal of concession permits, exploration licenses or operating licenses;
• Protection of collateral security;
• Deprivation of rights to own and use an asset, including cancellation of re-export licenses; and
• Deprivation of collateral held as security for loans.

Marsh, an MMC Company, provides similar services and coverage for political risks related to mobile assets such as equipment. Like Aon, Marsh arranges coverage for risks faced by lenders. Coverage protects against such perils as confiscation, expropriation, nationalization, requisition or sequestration – all of which involve government theft or seizure without compensation. Properly drafted, a government act that interferes with the realization of rights and remedies of a lender or lessor may trigger coverage.

LH Pitman Limited (LH Pitman) indicates that it closes transactions with credit, political, residual value or asset risk problems. LH Pitman describes its repossession insurance as: “Coverage [that] disengages country risk and allows for Transfer Risk . . . . The coverage underwrites against the adverse interference in the valid repossession of the insured equipment, by the host government or judiciary. Coverage insures against any new law, which may be introduced in the host country during the lease term and accepts those confiscatory laws which may exist at the inception of the lease.”

Generally, insurers evaluate documents covering an asset to assure their ability to step in and recover an asset after cover “perils” (risks) occur and trigger coverage. They also impose waiting periods before an insurer makes a payment for the covered peril. In each case, as with most insurance, repossession or other political risk coverage involves transfer of risk, from the insured to the insurer under carefully defined terms.

Repossession insurance often arises in business aviation transactions to mitigate the risk of leasing or lending on highly valuable corporate jets, to assure that in the exercise of remedies, the lender or lessor can recover its collateral or leased asset.

*Tip: When acquiring repossession insurance, as the insured (the person paid if the risk turns into reality) you should:

• obtain the broadest coverage with the highest payout (often just “book value” of the asset) for the country risks you perceive may arise/become reality;
  
  
• ask for the shortest waiting period before payment is made (shorter means costlier, but you do not receive a payment until the waiting period expires);
  
  
• seek the highest payment relative to a stated value of the aircraft;
  
  
• understand covered perils (the problems that trigger coverage);
  
  
• confirm that your insurers read, understand and accept the form of the primary documents such as a lease or security agreement (so they do not have a basis to resist coverage relating to the documents);
  
  
• require your customer to prepay the coverage for at least a year and include a portion of rent or fees to create an account so you can pay the coverage directly each year (unless your decide that your customer has the credit strength and reliability to pay the insurance premium when due);
  
  
• remember that some, but not all, insurance policies can be negotiated as to coverage depending on how “form” driven the carrier is;
  
  
• expect underwriters to ask for legal opinions on a number of subjects that assure them that the governing transaction documents will be enforceable against the obligated party (lessee, borrower or conditional purchaser);
  
  
• use knowledgeable brokers and lawyers to assist you; and
  
  
• include a clause in your documents that allows you to adjust pricing for your customer because rates of the coverage may change year to year and your economics may benefit or suffer if you cannot pass along adjustments in the cost of coverage during the term of your deal.
  

Repossession insurance, a type of political risk coverage, mitigates risk in many types of transactions, including equipment leasing and financing of highly valuable mobile assets, IT assets and other equipment. While not inexpensive, it may transfer enough risk away from a lender or lessor to make a deal close that otherwise would not.

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3. FAA Funding Debate Puts Airlines and Business Aviation on a Collision Course

 

In a high-stakes effort to find $10 billion of funding for the operations of the Federal Aviation Administration (FAA), the commercial airlines are pushing a plan to shift $1.5 billion to $2 billion of the FAA’s annual costs to business aviation. Ed Bolen, President of the National Business Aviation Association (NBAA), has called this initiative of the airlines an “attack” on business aviation and its 10,000 members.

The FAA Needs Lots of Money and Is Running Short

The contentious debate arises from the FAA’s need to lock in consistent levels of funding to operate the aviation system in the United States and replace its aging radar system with a satellite tracking system. The FAA programs funded from the Airport and Airways Trust Fund (Trust Fund) include the air traffic control system, facilities and equipment (navigational aids), the airport improvement program, research and development, and a portion of FAA’s operations.

The FAA’s proposed budget for 2007 is $13.7 billion, with Trust Fund receipts expected to fall short by about $2 billion. Airlines contribute about $11 billion. The Trust Fund revenues are obtained from a 7.5 percent ticket tax, a $3.30 per passenger fee per flight segment, a $14.50 charge for each international departure and arrival and a fuel tax of 4.3 cents per gallon of fuel, paid by the airlines and their passengers. Business aircraft contributes a 21.8-cent per gallon jet fuel tax and 19.3-cent gas tax. Cargo operations pay a sales-type tax of 6.25 percent of the charges for the air transportation of cargo.

As a consequence, the airlines assert that passenger and cargo airlines funded 98 percent of FAA’s air traffic control (ATC) services in 2004, equal to $8.98 billion, but consumed just 69 percent of the ATC services. The airlines believe they would save $1.5-$2 billion per year if they paid only for the costs of services they use.

The Airlines Pick a Fight Over FAA Funding

The airlines contend that they unfairly subsidize business aviation and pay too much. Business aviation argues that business jets cost less to use the system, which is strained by waves of airliners operating at peak periods at major airports around the country. Moreover, business aviation contends that a user fee system is costly to both the government and aviation industry because its administration would require a large bureaucracy and impose administrative burdens on companies.

To meet the FAA’s funding needs, the Air Transport Association, the association representing scheduled airlines, has adopted a set of principles to guide Congress in developing a funding plan. The airlines have floated a proposal based on these principles, which would impose user fees on each aircraft, whether the aircraft has one passenger or 100 passengers. These fees would be based on the number of departures and the length of time an aircraft uses the aircraft control system with some adjustments for smaller communities and night flights. The fees would entirely replace the current system, including the fuel tax paid by business jets.

The battle is young, but each side is lining up its troops. Airlines seek the support of manufacturers, pilots and travel professionals, suppliers and unions. NBAA has been directly appealing to its members in a “call to action” to jolt them into action. It also has sought the support from the politically powerful Airline Owners and Pilots Association (AOPA), which opposes user fees to fund the FAA. Perhaps as an effort to keep AOPA and its 400,000 members out of the debate, the Bush Administration has told AOPA that “private” aviation would be exempted. AOPA worries that once Congress adopts a user fee funding mechanism for the FAA, its members would remain a potential target to pay fees in the future.

*Warning: User fees, as proposed, will materially and permanently increase the costs for business aviation. If user fees become reality, purchasers, owners, lessees and other users would probably reevaluate the size or type of aircraft to buy or lease, taking into account higher cost of new user fees. Fractional share operators would have to disclose and charge the higher costs to their owners. The extra cost could adversely affect sales and leases of fractional shares or even make “jet cards” less valuable if user fees consume a greater portion of the prepaid costs of private jet travel. Manufacturers could be adversely affected as potential purchasers or lessees re-evaluate the increased operating costs of business aircraft and/or potentially cancel advance orders for new aircraft. As a result, manufacturers would produce fewer aircraft. Margin pressure on financing and leasing is already intense, with razor-thin rate spreads in most deals. Significantly higher user fees could put even more pressure on thin margins for lenders and lessors as owners and lessees realize the significantly increased cost of using business aircraft. Corporations could simply absorb the higher costs, but would have to charge executives more for personal use and disclose higher costs to shareholders that the companies pay. As an owner, user, charterer, lessee, lessor, lender, broker, bank or other finance company, you should evaluate the potential impact on your business from these proposals.

Conflict Brews as Bush Administration Shows Interest in User Fees

The current funding system expires on September 30, 2007. The Bush Administration has not yet released its proposal for funding the FAA. As a result, no one can know which way the Administration will go with certainty. However, DOT Secretary Mineta and FAA Administrator Blakey have already signaled the Administration’s interest in user fees as the conflict between interest groups heats up.

The brewing feud hit the front page of The Wall Street Journal (WSJ) on June 1, 2006. The article said: “The fight pits the major airlines against the thousands of business jets that ferry executives around the country in a battle over more than $10 billion a year in taxes and fees that go to support the Federal Aviation Administration. . .. The clash . . . is a classic battle between moneyed interests tugging at Congress to achieve their ends.”  The WSJ article focuses attention on this dispute, but the final story will not be written until the airline and business aviation interests, and their respective lobbyists, make their case in Congress.

Thanks to Greg Walden, former Chief Counsel of the FAA, from the Patton Boggs Aviation Team, for his contributions to this article.

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4. Leasing 101: What Is “Country Risk” or “Political Risk” in International Investments?

"Political risk” is also called “country risk” in the context of financial and investment decisions. These terms refer almost interchangeably to current and predictive factors in a country’s leadership, political and legal structure that may impact the soundness and potential profitability of a commercial investment in the particular country. It includes the risk of loss due to currency inconvertibility, changes of law or regulation (including tax law changes), government action preventing the repossession of equipment or goods, expropriation or confiscation and war. This analysis is commercial in character and focuses on the future risks involved in making an investment, including financing a project, asset, business or other rights or property such as intellectual property, factories, oil and gas exploration, energy projects and aircraft primarily in a foreign country.

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About Patton Boggs LLP; Recent Publications

Patton Boggs LLP is a law firm of more than 450 lawyers located throughout the United States and internationally in Doha, Qatar. Patton Boggs most recently added offices in the New York metropolitan area. The firm has done business in over 70 countries during its almost half a century of operation, and increasingly focuses on such dynamic markets as India, China, Brazil and Western Europe in business and public policy matters.

Patton Boggs has organized itself into four major practice areas: Business Transactions, Intellectual Property, Public Policy and Litigation. These groups are composed of many practice groups designed specifically to meet client needs and developing markets. I often focus on aviation, energy, infrastructure, transportation, facilities and technology matters as a member of the 120-member Business Transactions Group.

The firm provides a broad array of skills in domestic and international business transactions. BLN covers a small part of the skills available at the firm. These capabilities include equipment finance and leasing, corporate finance, secured transactions, syndications, mezzanine finance, enhanced use and other federal leasing, project finance, real estate, healthcare, pharmaceuticals and technology transactions and public policy work. We devote a significant part of our time to wind power, cogeneration and oil and gas matters worldwide. We also address related creditors’ rights/bankruptcy in structuring transactions and resolving troubled credits.

We assist our clients with buying, selling, financing, and leasing real and personal property, including business and commercial aircraft, energy assets, facilities, vehicles, production equipment, technology hardware and software, and health care equipment as well as highways and other infrastructure projects. We have specific teams for aviation, infrastructure/power, healthcare, federal leasing/finance/marketing, municipal leasing/finance, and international transactions by region or country. We provide extensive, and newly expanded, litigation resources with the addition of high-profile litigators in our New Jersey office.

You are welcome to call me at 214.758.1545 or e-mail me at . We value your contact with us on any topic, including questions arising from BLN articles or about our law practice.

Recent Publications

The following is representative of recent works by David G. Mayer:

• Aviation finance will take flight under Cape Town Treaty by David G. Mayer, Ft. Worth Business Press (Feb. 13, 2006).
  
  
• Federal Leasing: A Lifeline in a Sea of Red Ink? – The Feds need us, by David G. Mayer, ELT Magazine, the leasing publication of the Equipment Leasing Association (Jan.- Feb. 2006). Thanks to Jack Helmly of GTSI Financial Services and Michael Guiffre of Patton Boggs LLP for their editing and input on this article.
  
  
• Legal Opinions and Title Insurance Mitigate Risk Under The Cape Town Convention, by David G. Mayer and Frank Polk, aviation partner at McAfee & Taft, LNJ’s Equipment Leasing Newsletter (Nov. 2005).
  
  
• True Leases Under Attack: Lessors Face Persistent Challenges to True Lease Transactions, by David G. Mayer, Journal of Equipment Lease Financing (Special Issue, Fall 2005), a 17,000-word article. Special thanks go to the many editors, including Patton Boggs bankruptcy partner, Jeff LeForce; Patton Boggs tax partner, George Schutzer; Patton Boggs Associate, Joel A. Bannister; three members of the ELA's Legal Committee; and two Foundation reviewers. 2005 JELF ARTICLE OF THE YEAR!
  
  
• The Cape Town Convention: New Complexities and Opportunities, by David G. Mayer and Frank Polk, aviation partner at McAfee & Taft, LNJ’s Equipment Leasing Newsletter (Oct. 2005).
  
  

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Thanks to BLFN’s Team

I would like to thank BLFN’s team at Patton Boggs LLP. The team includes J. Atwood Jeter, a senior associate in the firm’s business transactions, real estate, and wind energy groups; the Patton Boggs staff editors, Paul Dumansky and Adrian Nicole McCoy; our Project Manager, Melissa Green; Claire Campbell; and our designer, Winston Jackson. Thanks also to Douglas C. Boggs, a Business Group/Securities partner and web site reviewer for BLFN, and our Marketing Chief, Mary Kimber, for assisting BLFN through our firm’s editing, design, and posting process.

All the best,

David

David G. Mayer
Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
2001 Ross Avenue
Suite 3000
Dallas, Texas 75201
(214) 758-1545 (phone)
(214) 758-1550 (fax)

E-Mail: dmayer@pattonboggs.com

© David G. Mayer 2002-2007