Briefing Sheet on EU Sanctions and Aviation Insurance Prohibition

Regulation 2022/328 was adopted by the European Union (EU) on Feb. 25, 2022, in relation to the Russia-Ukraine crisis. The Regulation took effect on Feb. 26, 2022.

Article 3c of the Regulation has a significant impact on the aircraft leasing and financing industry, including prohibition of making aircraft available on lease to Russian entities. The Regulation is directly effective in EU members states and applies to aircraft leasing companies, banks and other investors based in the EU as well as EU nationals.

This briefing focuses on issues we have identified that flow from the prohibition in relation to aviation insurance contained in Paragraph 2 of Article 3c:

"It shall be prohibited to provide insurance and reinsurance, directly or indirectly, in relation to goods and technology listed in Annex XI to any person, entity or body in Russia or for use in Russia."

There is no "wind down" mechanism for the insurance prohibition so it went into effect on Feb. 26, 2022. It is believed that there are approximately 600 aircraft leased by Russian airlines from foreign lessors.

1. Automatic Cessation of Cover by EU Insurers (AVN 111)

Aviation policies include the AVN 111 Sanctions and Embargo Clause that provides "if, by virtue of any law or regulation …applicable to an Insurer… providing coverage to the Insured is or would be unlawful because it breaches an embargo or sanction, that Insurer shall provide no coverage…" (AVN 111). For EU insurers, this applied from Feb. 26, 2022: the affected policies were not canceled or terminated, but the coverage provided by EU insurers ceased.

Under AVN 67B, it is not yet settled (anywhere in the world) whether continuing coverage under AVN 67B creates a separate policy in favor of the lessor/lenders or is contingent upon the underlying policy still being in place. Query therefore whether AVN 111 prohibits the provision of insurance by EU insurers to (non-Russian) lessors and lenders.

Insurers are severally liable for their percentage share under a policy. To assess the percentage held by EU insurers it will be necessary to review the subscribing insurers to determine if they are EU persons. The identity of insurers is not specified in most insurance certificates. As a result, the lessor or lender may urgently contact the brokers to obtain the list of insurers. This exercise would need to look at both the main airline policy (which would cover war liability under AVN 52E) and the separate hull war policy (e.g., LSW 555D).

It is expected that AVN 111 may be less problematic under contingent/possessed policies.

2. Contingent/Possessed Policies Should Be Reviewed Urgently

Contingent/possessed policies may now be on risk to the extent that EU insurers' coverage has ceased to be effective. Such policies should be reviewed urgently to determine policy insuring clauses, conditions and exclusions.

Steps may need to be taken by the lessor or lender to preserve the right to claim and to comply with other obligations. The outcome of such analysis may feed into the repossession strategy; for example, termination of the leasing of the aircraft with a view to coverage commencing under a lessor's possessed policy.

The renewal date should be checked. On renewal, insurers may seek to exclude aircraft leased to Russian airlines or significant premium increases, unless the insurers exercise any cancellation right in the interim.

Broadly:

• "contingent" cover insures the aircraft where 1) the operator's policy fails to respond, 2) the operator fails to insure fully the perils required under the lease, or 3) lack or insufficiency of required insurance is due to error or accidental omission
• "possessed" cover insures aircraft that are 1) awaiting commencement of a lease, 2) returned on expiry/termination of a lease, or 3) repossessed (or in the course of repossession) from a lease.

Contingent/possessed policies may provide other beneficial coverage, such as reconstitution of technical records

3. Reinsurance

The usual position in Russian aircraft leasing and financing transactions is for the hull (property) and liability insurances to be issued by domestic Russian insurer(s) and reinsured into the London and international reinsurance markets.

The existence of reinsurance adds another level of complexity for a number of reasons, including 1) the reinsurers contract with the domestic Russian insurance company and, to the extent the reinsurer is a EU person, the reinsurance provided by them should be caught by the insurance prohibition, 2) the effectiveness of cut-through clauses can be questioned, 3) lessors or lenders do not have a direct claim against reinsurers for losses occurring.

4. Cancellation by Notice

As mentioned, AVN 111 does not bring about termination or cancellation of the insurance policy. An insurer that is restricted by application of AVN 111 may give 30 days' notice of cancellation of its participation in the policy.

Under AVN 67B, the airline policy may be canceled (or adversely changed) on 30 days' notice or, in respect of war risks, seven days' notice by insurers to Contract Parties.

No notice is required where the policy is automatically terminated or canceled (on its existing terms, see issue No. 5 below) or expires.

At present, there does not appear to be any war insurance risks existing in relation to Russian airlines, and there has been no attempt by the Russian state to requisition leased aircraft (such risk being covered under the hull war policy) and assuming those aircraft are located outside of conflict zones. As a consequence, if notice of cancellation or adverse change is given by insurers, it will be an open point whether 30 or seven days' notice should be given.

At this time, it is believed that insurers have not been giving blanket notices of termination or cancellation to Contract Parties in respect of Russian operators' insurances. However, this position may change.

Notice of termination may also be given if premiums are unpaid. Russian operators may encounter difficulty paying via sanctioned banks.

Such notices should be given to the contact details specified in the insurance/reinsurance certificates. These details may need to be checked urgently to ensure that they are up to date.

If notice is given, it may be necessary to confirm that it has been given validly and when coverage will terminate or be adversely changed.

Similarly, notice of cancellation may be given under the contingent/possessed policy subject to the policy terms. At this time, it is believed that no such notices have been given.

5. Automatic Termination

The war risk coverage under both hull and liability insurance terminates automatically upon outbreak of war (whether or not declared) between any two or more of France, China, Russia, United Kingdom, U.S., or hostile detonation of any weapon of war employing nuclear fission, etc. (AVN52E; LSW 555D).

War risk liability cover will automatically terminate upon the aircraft being requisitioned for title or use (AVN 52E).

War risks policies exclude losses caused by such an outbreak of war, and requisition by any government that may be specified in the policy.

For the avoidance of doubt, nuclear risks remain uninsurable (AVN 38B).

6. Lease Termination

Termination of the lease by the lessor (whether it purports to be of "the leasing of the aircraft" or of the lease contract itself) should cause the termination of coverage under AVN 67B.

Lessors and lenders should ensure that they take insurance into account when formulating termination strategy and taking any steps to terminate the lease or deregister the aircraft.

7. Requisition; Confiscation

Hull war insurance (based on e.g., LSW 555D) covers "confiscation, nationalization, seizure, restraint, detention, appropriation, requisition for title or use by or under the order of any government … or public or local authority" subject to exclusions.

If the Russian state takes obvious steps to prevent export and return of aircraft to lessors and lenders then a loss may occur under the above coverage, provided that confiscation by the Russian state has not been expressly excluded. Each policy will need to be checked for this.

Alternatively, if aircraft are not promptly redelivered to lessors at a location outside of Russia, it may not be clear whether a requisition or confiscation has occurred depending on the manner of any state involvement. This may cause difficulty establishing a loss.

If an aircraft is wrongfully withheld by an airline without evidence of state involvement, query if a constructive total loss could occur by way of deprivation of possession if the aircraft is not returned for a period of time. AVN 67C excludes claims for theft by principal insured, whereas AVN 67B does not.

If a loss is established but it is unclear whether the "all risks" or war risks policies are responsible, the slip clause AVS 103 may assist if insurers honor its intentions.

Coverage in each case will depend on the policy wording.

Separate repossession insurance policies have been available historically (LSW 147), although are uncommon.

8. Export Controls Causing Cannibalization

As a result of export controls that restrict availability of spare parts, operators may resort to cannibalization of "donor" aircraft within the fleet. Previously, claims have been made by lessors for "constructive total losses" where aircraft have been cannibalized.

Whether such activity would be covered by the airline policy or contingent/possessed policy is a complex legal and factual question.

9. Aggregate Limits

Hull insurance (whether the primary or contingent/possessed policy) may be subject to an aggregate limit per policy year for all claims. This limit applies to all aircraft, i.e., not per lessor.

If the limit is exceeded, the loss is uninsured. It is untested how the available insurance proceeds would need to be shared among lessors.

10. Governing Law and Jurisdiction

The governing law of the airline's policy may be the law of domicile of the airline. For Russian airlines, this would be Russian law. This of itself could be problematic for a number of reasons.

Despite the variance in governing law of aviation policies placed in London, there is a view that the London insurance market should want to take a consistent approach to claims handling and the starting point for analysis of policies placed in London would be English law and London market practice.

Policies are often subject to arbitration that is confidential meaning there is a lack of legal precedent which could have provided more certainty on points that otherwise would have benefited from judicial decision. In particular, the question whether continuing coverage under AVN 67B creates a separate policy in favor of the lessor/lender or is contingent upon the underlying policy still being in place. See issue No. 2 above.

11. "Losses Occurring" Policies

Aviation insurance placed in London are written on a "losses occurring" basis, meaning insurers are bound to cover the insured for losses that occur during the period covered.

For potential claims by Contract Parties for "constructive total loss" of aircraft if they are requisitioned, cannibalized or otherwise not returned, a critical question will be when the loss occurred. This can be the date of the original taking, if determinable, or a later date. For such a claim it may be difficult to determine when the "loss occurred" and in turn if this fell within the policy period.

For immediate assistance, please reach out to your Holland & Knight contacts on the Asset Finance Group.

Sanctions Contacts

Jonathan Epstein and Ron Oleynik

Litigation and Arbitration Contacts

Timothy Murray and Marisa Marinelli

Please Note: This briefing contains general statements of possible positions from the perspective of English insurance law and is intended solely to highlight potential issues for your detailed consideration; it should not be relied on and specific legal advice should be sought. This briefing does not purport to address all issues that may be relevant in any situation.