English High Court finds early termination sums under JOLCO arrangement not a penalty

13 May 2025

FW Aviation (Holdings) 1 Ltd v VietJet Aviation Joint Stock Company
[2025] EWHC 928 (Comm)

In FW Aviation (Holdings) 1 Ltd v VietJet Aviation Joint Stock Company, the English High Court found that a clause under a Japanese Operating Lease with Call Option (“JOLCO”) arrangement which provided for early termination sums from a defaulting airline did not amount to a penalty provision.

Facts

The case arose from the lease of four aircraft (“Aircraft”) to VietJet, the defendant airline in the case, under a JOLCO arrangement. Such JOLCO arrangements typically involve the following features:

• The aircraft is purchased by a special purchase vehicle (“Lessor”) with equity capital supplied by Japanese investors and debt to finance the remainder.
• The aircraft is leased by the Lessor to an airline, sometimes via a sub-lessor, making the airline a sub-lessee (as was the position in this case).
• The airline has one or more options to purchase the aircraft during the lease (“Purchase Option”), at a pre-agreed valuation, at agreed points during the leases.
• If the Purchase Option is not exercised, the aircraft must be returned to the Lessor at the end of the lease in accordance with the lease.

The borrowing by the Lessor from the banks was supported by security held by a security trustee/security agent (“Security Trustee”), and the Lessor assigned most of its rights to the lease (including the sub-lease) and granted a mortgage over the Aircraft to the Security Trustee as part of the security package. After VietJet failed to make the rental payments due during the Covid-19 pandemic, the Security Trustee served it with a notice to terminate the leases, requiring VietJet to redeliver each Aircraft. The lenders subsequently sold its claims to FWA, the claimant in the case.

FWA then brought a claim in the English High Court to enforce its security rights and recover various sums and possession of the Aircraft. The court decided that FWA succeeded in its claim and rejected VietJet’s application for relief from forfeiture, noting that equitable remedies, such as relief from forfeiture, are subject to the doctrine of clean hands. Among other things, the court found that VietJet’s conduct in orchestrating a campaign designed to interfere with FWA's efforts to export the Aircraft and, in turn, both to permit VietJet to raise and maintain its claim to relief from forfeiture and to compel the re-leasing of the Aircraft to VietJet, was “egregious”.

In a subsequent judgment, the court considered FWA’s attempt to enforce clause 19.3 of the sub-leases (“Clause 19.3”), under which VietJet was obliged to pay various sums in the event of termination following an event of default (“Termination Sums”). VietJet contested the claims, arguing that these claims, if successful, would mean that VietJet would be required not only to hand over the Aircraft but also to pay sums tantamount to their value.

Decision

The question before the court was whether VietJet was liable to pay the Termination Sums, and if Clause 19.3 was a penalty. The court concluded that Clause 19.3 was not penal.

As established in Makdessi v Cavendish Square Holdings [2015] UKSC 67 (“Makdessi”), under English law, where a challenged clause is susceptible to review as a penalty, the test is whether the clause “imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation”.

In the present case, it was not in dispute that the first test in Makdessi (that the provision had to be a secondary obligation) had been met, and the court found that the protections built into Clause 19.3 were legitimate and were neither “extravagant, exorbitant or unconscionable” nor “wholly disproportionate” to the interests sought to be protected.

As to legitimate interest in particular, the court found that the scheme established by Clause 19.3 reflected the parties’ (including VietJet’s) expectation that there should be protection for the parties whose capital was at risk in the transaction (namely the lenders and the equity investors) while allowing VietJet to fund the acquisition of the Aircraft without the use of its own capital and at a significantly lower cost than other forms of commercial financing.

Further, the court held that determination of legitimate interest may include the interests of third parties, which in this case included the equity investors. These equity investors were vulnerable in the case of default and the obligation to pay the Termination Sums served the legitimate interest by mitigating the risks to the Lessors of early termination. Specifically, the equity investors (through the Lessors) invested their own capital to finance (in part) the acquisition of the Aircraft, partly to take advantage of tax incentives in Japan from which VietJet also benefited in the form of a lower blended cost of funding. The court found that if VietJet were to default, those tax advantages would be at risk since, aside from the investors’ recovery of their investment and return being at risk, it was inevitable that they would also face an acceleration of their tax liabilities, with likely consequential cashflow issues.

The court also found that the scheme established by Clause 19.3 was not disproportionate. Among other things, if the JOLCO were terminated early, not only would the investors lose the return they had expected, but their tax liability might also be increased or brought forward through the loss of the accelerated depreciation that the investors would otherwise have enjoyed under the JOLCO. Timely payment of the rentals which ensured that the JOLCO arrangement remained viable and the structure did not collapse (leading to the loss of the tax benefits and preventing cash flow problems on the part of the equity investors) was therefore a consideration of the court. The Termination Sums, accordingly, compensated the equity investors for the losses that they incurred as a result of early termination (including the loss of tax advantages which it was intended that they received). Further, such sums were not disproportionate as these dealt with potential eventualities such as VietJet being unwilling or unable to comply with provisions in the sub-leases relating to return or maintenance of the Aircraft and the potential costs involved in recovering the Aircraft and restoring it to a condition to be sold or on-leased.

In reaching its decision that Clause 19.3 was not penal, the court considered the context of the transaction, noting that VietJet was a sophisticated commercial actor with significant experience in aircraft financing. In addition, the court found that VietJet was familiar with JOLCO arrangements, including the rationale behind such arrangements. VietJet was also aware that JOLCO agreements are structured to incentivise certain behaviours by the lessee parties.

Thus, the court found that VietJet was liable to pay the Termination Sums notwithstanding that the Aircraft had been repossessed, and the payment of such sums was not a penalty.

Significance of the decision

The significance of this decision may be considered from the perspective of the relevant parties to a JOLCO transaction: namely the debt provider, the equity investor, and the lessee.

From the perspective of a debt provider, this case has not directly impacted upon on its rights as a secured creditor; but it has affected how equity claims are valued and has resulted in more scrutiny being placed on the scope of excluded property (i.e. property which is not assigned in favour of the banks under the lessor security assignment) when negotiating JOLCOs.

For the equity investor, the case re-affirms the English law position on penalties and a lessor’s claims for termination sums (in addition to retaining title to the aircraft) following a default by an operator. The equity investor can, in such a scenario, potentially benefit from the operator’s default. This would impact upon on how Japanese lessors/equity investors view their claims following a default by the operator especially in terms of discounting or sale of such claims to third parties.

Where the lessee is concerned, though JOLCOs may have similar traits to financings, there are severe risks for the lessee in terms of loss of aircraft and potentially large claims following a default. This has already impacted how lessees have sought to limit transfers by debt or equity participants, as well as greater scrutiny on the provisions dealing with management time and secured obligations at the negotiation stage. Obviously, given the severe consequences associated with such financings, the lessee may wish to prefer JOLCO creditors ahead of other creditors in times of severe cashflow.

Position under Singapore law 

While the English court had applied Makdessi in the case above, the leading case under Singapore law is Ethoz Capital v Im8ex Pte Ltd & Ors [2023] 1 SLR 922, which affirmed the Singapore Court of Appeal’s decision in Denka Advantech Pte Ltd & Anor v Seraya Energy Pte Ltd & Anor and other appeals [2021] 1 SLR 631 (“Denka”). In Denka, the Singapore Court of Appeal declined to apply the approach in Makdessi and instead held that the prevailing test applicable when determining whether the secondary obligation in question was a penalty was to be determined by reference to Lord Dunedin’s tests in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Ltd [1915] AC 79 (“Dunlop”). The key difference in the Dunlop test is the focus on whether the liquidated damages are a genuine pre-estimate of loss, which is a narrower conception than the test in Makdessi discussed above.

In Denka, the Singapore Court of Appeal observed that it is possible in the majority of cases that the same result or outcome would ensue regardless of whether the test in Dunlop or in Makdessi is applied. Where straightforward damages are concerned, legitimate interests will rarely extend beyond compensation for the breach (which was observed by the court in Makdessi). However, in the present case, it is less clear whether a Singapore court applying the test in Dunlop would place the same weight on the legitimate interests of equity investors in ensuring that the JOLCO arrangements were viable in determining whether the Termination Sums were penal, with the focus likely to be on whether the Termination Sums were a genuine pre-estimate of loss and the tax advantages which may have been lost as a result of the collapse of the structure. It is worth noting also that the Singapore Court of Appeal in Denka observed that the principles in the second appeal contained in ParkingEye Ltd v Beavis, which was heard with Makdessi, are inconsistent with the principles in Dunlop as the legitimate interest ParkingEye had had little to do with compensation for loss, and the reasoning contained therein was a step too far from the fundamental tenets of contract law as they presently stand.

Hence, given the current divergence in position between English and Singapore law, airlines (or lessees) may wish to consider using the latter as the governing law for JOLCOs.

Reference materials

The judgment is available on the UK National Archives website www.nationalarchives.gov.uk.