Sorry, my mistake: Aircraft lease novation dispute illustrates how English law approaches drafting errors

When the case of Sata Internaçional – Azores Airlines SA v Hi Fly Ltd and Another¹ came before the English High Court recently, it provided an interesting worked example of the remedies available when an executed agreement turns out not to reflect what the parties actually intended.

Facts

The claimant, SATA Internaçional – Azores Airline (the Airline) leased an Airbus A300 (the Aircraft) pursuant to a lease agreement between itself as lessee and Hi Fly Limited (Hi Fly) as lessor (the “Lease Agreement“). The Lease Agreement was due to expire on 15 March 2021. By 2019, the Airline was in financial difficulties and fell behind on its lease payments.

In April 2020 the second defendant, Aircraft Engine Lease Finance Ltd (AELF), agreed to buy the Aircraft from Hi Fly. Contemporaneously with the sale, the Lease Agreement was to be novated from Hi Fly as the existing lessor to AELF as the new lessor and then immediately terminated.

It had been agreed between AELF and Hi Fly that 1 September 2020 would be designated as the economic closing date (the ECD) which meant that, regardless of the actual date of transfer of the Aircraft, AELF would enjoy the economic benefits of ownership from the ECD. As a result of this mechanism the agreed purchase price of the Aircraft was to be reduced by the rent payments “actually received” following the ECD.

At the time that the Aircraft was sold to AELF, the Airline owed Hi Fly just under USD 3 million in unpaid rent, maintenance reserve payments and default interest. Of this amount, around USD 1 million related to rent that had been outstanding before the ECD. It was undisputed between the parties that this amount was owed to Hi Fly.

The sale and novation consisted of the following three principal agreements relevant to the dispute which were:

1. A sale agreement between Hi Fly and AELF pursuant to which Hi Fly sold the Aircraft to AELF.
2. A novation agreement between Hi Fly, AELF and the Airline pursuant to which AELF became the lessor under the Lease Agreement (the “Novation Agreement“).
3. A termination agreement pursuant to which AELF agreed to the early termination of the Lease Agreement in return for a lump sum payment by the Airline to AELF (the “Termination Agreement“). Pursuant to this agreement all amounts owing to AELF under the novated Lease Agreement were satisfied by the lump sum payment.

All of the above agreements were concluded contemporaneously on the closing date of 8 April 2020 (the “Effective Time“).

The dispute

A dispute arose as to the approximately USD 2 million in unpaid rent that had accrued between the ECD and the Effective Time.

The Airline argued that the Novation Agreement provided that the rent for the period after the ECD ceased to be due to Hi Fly and became due to AELF instead. This would mean that the Airline’s obligation to pay the rent had been satisfied by the lump sum payment under the Termination Agreement and was no longer due.

Opposing the Airline’s view, Hi Fly and AELF argued that the Novation Agreement did not transfer the right to recover post-ECD rent to AELF, and that such rent was still due to Hi Fly.

The legal issues

The High Court (Paul Stanley KC sitting as a Deputy High Court Judge) was faced with two questions.

1. First, as a matter of construction, did the Novation Agreement transfer the right to recover rent relating to the period from ECD from Hi Fly to AELF, depriving Hi Fly of its right to recover it?
2. Second, if it did, was that by mistake, which would justify the Court rectifying the Novation Agreement?

Construction

Working out whether the Novation Agreement transferred the right to recover rent accruing after the ECD to AELF required an examination of the language and structure of the following clauses of the Novation Agreement. The three critical clauses were clause 2.1, clause 2.3 and clause 7.3. The relevance of these clause can be summarised as follows:

• Clause 2.1 contained, as is industry standard in novation agreements, provisions releasing each of Hi Fly and the Airline from their respective obligations to each other under the Lease Agreement at the Effective Time. Clause 2.1 was expressed to be subject to clause 2.3 and clause 7. 
• Clause 2.3 preserved any claims between Hi-Fly and the Airline that may have arisen prior to the Effective Time. 
• Clause 7.3, provided that the rent due for periods before the ECD was to be “paid” and “remained payable” to Hi Fly but required the Airline to pay rent due on or after the ECD to AELF. The drafting of Clause 7.3 was unusual in that the reference point was the ECD rather than the Effective Time (which, consistent with the provisions of clause 2.1 and clause 2.3, is more commonly used). This point went to the heart of the dispute.

Before considering the clauses the Court summarised the key principles of contractual construction, which are as follows:

1. Construction in English law is objective and it never involves inquiring into what the parties subjectively intended.
2. The Court construes a written agreement in the context of the factual circumstances known (actually or presumptively) to all its parties.
3. The Court construes a written commercial agreement on the assumption that its parties will generally intend to achieve commercially sensible results. Properly understood, construction is not a fight between commercial common sense and language, but a dance.
4. The Court does not, in construing a contract, take into account either the parties’ subjective beliefs or their negotiations.

Applying these principles, the Court held that “the language and structure of the novation agreement are clear, and admit only one possible interpretation“. Hi Fly released all of its rights under the Lease Agreement, subject to clauses 2.3 and 7. Since clause 7.3 provided a specific regime for a particular class of payment obligations from a specified date, any contradiction between clauses 2.3 and 7.3 had to be resolved in favour of clause 7.3. 

Accordingly, the Court agreed with the Airline. On its true construction, the Novation Agreement provided that rent accrued after the ECD was payable to AELF.

Rectification

Hi-Fly and AELF also argued that, regardless of what the agreement actually said, that was not what they thought they had agreed. They therefore asked the Court to rule on whether the Novation Agreement should be rectified due to mutual mistake—specifically, a shared misconception that the agreement would allow Hi Fly to recover arrears that accumulated after the ECD and prior to the Effective Time.

The Court applied the principles on rectification as set out in FSHC Group Holdings Ltd v Glas².

For rectification to be granted, the Court needed to be convinced that, at the time the Novation Agreement was entered into:

1. All parties subjectively believed that the Airline would remain liable to pay rent to Hi Fly after the ECD and each of the parties knew that the others had that expectation from their mutual communications.
2. Alternatively, both Hi Fly and AELF held this belief, and the Airline actually knew (or “wilfully shut its eyes to”) the fact that at least Hi Fly had that belief.

The outcome

On the balance of probabilities, following the evidence of five witnesses and a detailed review of the correspondence between the parties and various drafts of the Novation Agreement, the Court determined that the parties held a mutual belief that Hi Fly would retain the right to recover the outstanding rent. The Judge further observed that had it been necessary to do so, he would have found that the alternative condition was satisfied, namely, that the Airline was aware that Hi Fly expected to receive payment of the arrears.

Part of the Judge’s reasoning was based on standard industry practice: he observed that the intuitive expectation in a novation would be that significant pre-novation arrears due under an aircraft lease should remain payable to the previous lessor. The draft Novation Agreement provided otherwise but the Chief Operating Officer of the Airline had not read it, so it could not have influenced his thinking. It followed that his most likely starting point would have been the standard position.

Accordingly, Hi Fly and AELF were entitled to have the Novation Agreement rectified to reflect a shared common intention that all such sums relating to the period prior to the Effective Time were to remain due to Hi Fly. This created a debt of USD2 million owed by the Airline to Hi Fly.

The Court acknowledged that this was an “unusual finding to make in a commercial context“, emphasising that the courts normally apply seriously intended and carefully drafted agreements “as they are written” in order to promote commercial certainty.

However, there were three features that took this case outside of the norm:

1. The very point was subject to regular communication around the time the Novation Agreement was made.
2. The Airline accepted that both Hi Fly and AELF had the same positive belief that rent would remain due to Hi Fly.
3. The standard presumption is that the executed contract accurately records the parties’ agreement. However, in this case that presumption was comprehensively rebutted despite the care that went into drafting such contract, because the evidence showed that the COO of the Airline had formed the relevant belief despite never having read or paid attention to the agreement.

Key takeaways

This case demonstrates the importance of carefully checking every agreement to ensure that the wording accurately reflects the parties’ intentions. Although rectification was ordered here, the outcome was rare and exceptional.

It also offers a compelling illustration of the distinction between interpreting a contract – an objective exercise – and considering whether it warrants rectification, which requires a subjective assessment.

Finally, for those considering litigation, the judgment demonstrates the extent to which email and other correspondence will be analysed. A person who might receive tens or hundreds of emails every day will be asked to look in isolation at communications which may have been written days or months apart, and will face questioning on issues which have since become prominent, but may not have been at the time. This is a daunting prospect for any potential witness and should serve as a note of caution when considering the viability of a rectification claim.

Footnote

1. [2024] EWHC 2762 (Comm)
2. [2019] EWCA Civ 1361, [2020] Ch 365.