It is often reported that a struggling carrier will sometimes take equipment from a grounded aircraft in order to support its operational fleet. This practice, sometimes referred to as “robbing” or “cannibalizing”, has serious ramifications for the financier of the grounded aircraft, as such acts can cause enormous harm to collateral value and may make repossession of such equipment considerably more difficult to effect. In such situations, a financier might consider seeking redress under hull insurance policies due to the loss sustained. A recent case heard before a federal court in New York determined that such redress was unavailable under the existing insurance coverage.

The Highland Capital Management, L.P. v. Global Aerospace Underwriting Managers Limited¹ decision clarifies that financiers (both secured lenders and lessors) of aircraft do not have insurable claims under the airline’s hull insurance policy for a loss of aircraft parts, when the loss was suffered as a result of the airline’s intentional misconduct in cannibalizing parts from aircraft and engines that were subject to such financing arrangements.

Facts of the Case

Fleet Business Credit, L.L.C. (Fleet) leased an aircraft to Tower Air, Inc. (Tower), and Highland Capital Management, L.P. (Highland) made a loan to Tower, secured by an aircraft owned by Tower. In connection with these transactions, both Fleet and Highland were listed as additional insureds under Tower’s Airline Hull, Spares and Liability Policy (the Policy).² The Policy “direct and accidental physical loss of or damage to the aircraft sustained during the Policy Period,” to airframes and engines purchased by, or leased to, Tower.³

As Tower struggled financially, Fleet and Highland tried to recover the equipment covered by their respective lease and security arrangements, only to realize that the covered aircraft and engines were missing certain of their essential components and parts.⁴ Evidence at trial revealed that Tower had been cannibalizing the aircraft and engines that were owned by Fleet and financed by Highland. Furthermore, Tower failed to maintain proper records regarding the whereabouts of the missing parts, which ultimately resulted in both Fleet and Highland suffering losses.⁵ Fleet and Highland, as loss payees under the Policy, filed claims for these losses, which were denied by the insurers because the losses arose from Tower’s intentional misconduct and were not fortuitous losses under the Policy.⁶ Fleet and Highland in turn sued the insurers asserting that their claims were wrongfully denied. Following a bench trial, the U.S. District Court for the Southern District of New York granted partial summary judgment and judgment in favor of defendant insurers. Fleet and Highland appealed to the U.S. Court of Appeals for the Second Circuit.⁷

Second Circuit’s Analysis

On appeal, the only issue in dispute was the district court’s holding that Fleet’s and Highland’s losses were not covered by the Policy because their losses were not fortuitous, as defined under New York insurance law, which defines a “fortuitous event” as “any occurrence or failure to occur which is, or is assumed by the parties to be, to a substantial extent beyond the control of either party.”⁸ The district court held that the losses were not fortuitous because they arose from the intentional misconduct of Tower (the named insured) in cannibalizing the aircraft and engines, which misconduct was imputed to the other insureds having an interest in the relevant aircraft.

The appellate court affirmed the district court’s ruling.⁹ The court reasoned that because the losses suffered by Fleet and Highland resulted from the intentional misconduct of Tower, and because Fleet, Highland and Tower must be treated jointly in determining whether or not the plaintiff coinsureds’ losses were fortuitous, the losses suffered were not fortuitous as to Fleet and Highland. Fleet and Highland raised the “innocent coinsured doctrine,” which provides that misconduct on the part of one insured should not bar a recovery by other innocent co-insureds. However, the appellate court held that this argument did not trump the plain language of the Policy, which provided that the insured parties were to be treated jointly as regards All Risks coverage.¹⁰

Implications

The decision in Highland Capital has two key implications. First, the court based its decision in part on the express language of the Policy, which covered “accidental physical loss.” In the context of the insured stealing parts off an aircraft, the court’s ruling excluding theft from accidental loss makes sense. However, the court’s broader reasoning, that intentional misconduct is not accidental, may create unintended consequences. Most particularly, the court’s exclusion of intentional misconduct raises the question of whether other actions by an operator that potentially constitute intentional misconduct, such as failing to properly maintain an aircraft, could lead to an exclusion from coverage.

Second, the case highlights the dangers of having aircraft on the ground that are not in operation. Aside from maintenance issues that often arise from a nonoperational aircraft, such aircraft often become parts pools supporting other aircraft in the operator’s fleet. Since it is often difficult to chase removed parts from one aircraft to another (due to local law considerations and/or faulty record keeping), serious collateral degradation can result from such removals and, as is clear from the Highland Capital case, recovery under the insurances would likely be unavailable. Financiers would be well served to keep close tabs on all financed aircraft on the ground and conduct in-person inspections to be certain that components and parts remain installed.

_{1 Highland Capital Management, L.P. v. Global Aerospace Underwriting Managers Ltd., 2012 U.S. App. LEXIS 13421 1, No. 11-3318-cv (2d Cir. 2012).}

_{2 Id. at 2.}

_3 Id.

_{4 Highland Capital Mgmt., L.P., 2012 U.S. App. LEXIS 13421, No. 11-3318-cv at 2.}

_{5 Fleet Bus. Credit, L.L.C., 812 F. Supp. 2d at 347-49.}

_6 Id.

_{7 Id. at 1.}

_{8 N.Y. INS. LAW § 1101(a)(2) (2012).}

_{9 Highland Capital Mgmt., L.P., 2012 U.S. App. LEXIS 13421, No. 11-3318-cv at 5.}

_{10 Id. at 4.}