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U.S. Bank National Association v. Southwest Airlines Co.

July 20, 2009


The opinion of the court was delivered by: Denise Cote, District Judge


This breach of contract dispute concerns the condition of leased aircraft upon their return to the lessor at the conclusion of the lease. Just prior to the end of the lease, the lessee replaced valuable engines and parts with inferior engines and parts, and returned planes that were worth millions of dollars less when compared to their prior condition or to the other planes in the lessor's fleet. Plaintiff U.S. Bank National Association and lessee/defendant Southwest Airlines Company ("Southwest") have both moved for summary judgment. For the following reasons, each party's motion is granted in part and denied in part.


The following facts are undisputed, unless they are identified as being advanced by either the plaintiff or Southwest. On or about June 1, 1987, the Connecticut National Bank ("Lessor"), predecessor in interest to the plaintiff, agreed to act as a trustee on behalf of Chrysler Capital Corporation ("Chrysler" or "Owner Participant"), predecessor in interest to Daimler Chrysler Capital Services (debis) LLC ("Daimler"), to take title to certain aircraft and engines, and to lease the aircraft and engines to Southwest.*fn1 It thereby leased three Boeing 737-3H4 aircraft (the "Aircraft") to Southwest ("Lessee") for twenty years in three substantively identical lease agreements (collectively, the "Lease").*fn2 Each Aircraft had two General Electric model CFM 56-3-B1 engines, bringing the total number of engines leased to six (the "Leased Engines"). The Lease was later amended to extend its terms by several months for each Aircraft. The three Aircraft were ultimately returned by Southwest in January and February, 2008.

1. Lease Provisions

Plaintiff's breach-of-contract allegations principally concern Southwest's obligations to return engines and parts of a certain "value" and "utility", as described in Sections 5 and 8 of the Lease. To put these and remaining claims in context, the relevant contractual provisions are quoted here.

Section 1 of the Lease defines "Aircraft" and acknowledges that it may include engines substituted under the terms of the Lease. It defines the Aircraft as the Airframe delivered and leased hereunder (or any airframe substituted for such Airframe pursuant to Section 10(b) hereof) together with the Engines originally installed thereon and leased hereunder (or any engine substituted for any of such Engines pursuant to the terms hereof), whether or not any such initial or substituted Engines may from time to time be installed on such initial or substituted Airframe or may be installed on any other airframe or on any other Aircraft.

(Emphasis supplied.) The definition of "Engine" also includes properly substituted engines. The Lease defines an Engine as (i) each of the two CFM International Model CFM 56-3-B1 engines listed . . . in the initial Lease Supplement in connection with the Airframe, whether or not from time to time installed on such Airframe or installed on any other airframe or on any other aircraft; and (ii) any engine which may from time to time be substituted, pursuant to the terms hereof, for any of such engines. (Emphasis supplied.)

Section 5(a) of the Lease, at the center of the instant controversy, describes the condition in which the Aircraft were required to be delivered upon their return, including any engines substituted for the Leased Engines (the "Replacement Engines"):

[U]pon termination of this Lease . . . Lessee . . . will return the Aircraft to Lessor . . . . At the time of such return, the Airframe will be fully equipped with two Engines (or other engines of the same make and model or two other engines of the same or another manufacturer of equivalent utility and value, and suitable for installation and use on the Airframe without impairing the value or utility of the Aircraft) duly installed thereon. Also, at the time of such return, such Airframe and Engines . . . shall be in . . . as good operating condition as when delivered to Lessee hereunder, ordinary wear and tear excepted, or, in the case of any such engines owned by Lessee, shall have a value and utility at least equal to, and shall be in as good operating condition as required by the terms hereof with respect to Engines constituting part of the Aircraft but not then installed on the Airframe . . . . In the event that Lessee . . . shall then be using an on-condition maintenance program . . . Lessee agrees that each such Engine . . . will have at least 1,750 hours or cycles remaining before the next scheduled engine removal. (Emphasis supplied and removed.) A "cycle" is one take-off and landing. Neither "value" nor "utility" are defined terms in the Lease.

Section 8, meanwhile, governs Southwest's replacement of "Parts," which were defined as all parts installed on an Airframe or Leased Engine except for items that Southwest had leased from a third party. This provision also uses the terms "value" and "utility". Section 8(a) provides that Lessee may . . . remove in the ordinary course of maintenance, service, repair, overhaul or testing, any Parts . . . provided that Lessee, except as otherwise provided in [Section 8(c)] will, at its own cost and expense, replace such Parts as promptly as practicable. All replacement Parts . . . shall be in as good operating condition as, and shall have a value and utility at least equal to, the Parts replaced. (Emphasis supplied.) Under Section 8(c), Southwest was permitted to make "alterations and modifications" to the Aircraft provided that [n]o such alteration, modification or addition shall materially diminish the value or utility of such Airframe or such Engine, or materially impair the condition or impair airworthiness thereof below the value, utility, condition or airworthiness immediately prior to such alteration, modification or addition assuming such Airframe or such Engine was then of the value and utility and in the condition and airworthiness required to be maintained by the terms of this Lease Agreement. (Emphasis supplied.)

Plaintiff's breach of contract claims are also premised on Section 7(a) of the Lease, which forbids discrimination in maintenance. This "non-discrimination" clause required Southwest to maintain, service, repair and overhaul . . . the Aircraft (x) so as to keep the Aircraft in good operating condition, ordinary wear and tear excepted, (y) so as to keep the Aircraft maintained in the same manner and with the same care as used by Lessee with similar aircraft owned by Lessee, and (z) so as to keep such Aircraft in such condition . . . to enable the applicable airworthiness certification for such Aircraft to be maintained in good standing at all times under the Federal Aviation Act. (Emphasis supplied.)

The Lease also includes provisions governing legal disputes arising between the parties. Section 15, entitled "Remedies," provides that, under certain circumstances whose application the parties dispute, Southwest must reimburse attorneys' fees and costs incurred by the Lessor:

In addition, Lessee shall be liable, except as otherwise provided above without duplication of amounts payable hereunder, for any and all unpaid Rent due hereunder before, after or during the exercise of any of the foregoing remedies and for all reasonable and actual legal fees and other costs and expenses . . . incurred by Lessor . . . and the Owner Participant in connection with the return of the Airframe or Engine in accordance with the terms of Section 5 or in placing such Airframe or Engine in the condition and airworthiness required by such Section. (Emphasis supplied.) Finally, Section 23 of the Lease contains a choice-of-jurisdiction clause selecting the Southern District of New York, and Section 24 contains a choice-of-law clause designating New York law.

2. The Participation Agreement

Connecticut National Bank, Chrysler, and Southwest also signed a Participation Agreement for the Lease on June 1, 1987. Section 7(c) of the Participation Agreement provides that Southwest will indemnify the bank and Chrysler from any and all liabilities, obligations, losses, damages, penalties, claims, actions, suits, out-of-pocket costs, expenses and disbursements (including reasonable legal fees and expenses and Transaction Expenses to the extent not required to be paid by the [Connecticut National Bank] pursuant to Section 16 but excluding internal costs and expenses such as salaries and overhead), of whatsoever kind and nature (collectively called "Expenses") imposed on, incurred by or asserted against any Indemnitee or any successors . . . arising out of (A) the Operative Documents [containing the Lease] (including, without limitation, because of Lessee's failure to perform any covenant, condition or agreement contained therein . . . ) or the enforcement of any of the terms thereof . . . (C) the ownership . . . use, operation, condition, maintenance, overhaul . . sale, return or other disposition of the Aircraft. (Emphasis supplied.)*fn3

3. Other Documents

Before executing the Lease, the parties negotiated a term sheet, dated May 20, 1987 (the "Term Sheet"). The Term Sheet explained that, upon their return to Lessor, the Aircraft must be FAA certified, in compliance with Lessee's FAA approved maintenance program . . . shall be in as good operating condition as when originally delivered to Lessee, ordinary wear and tear excepted . . . and shall have no less than 1,750 hours remaining on each engine and airframe until the next scheduled engines removal . . . . Lessee shall have treated the Aircraft similarly to other Boeing 737-300 Aircraft in its fleet. (Emphasis supplied.) The Term Sheet did not describe Southwest's rights to return Replacement Engines or Parts, or the requirement that any substituted items be of equal "value" and "utility" to items they were replacing.

In December 1987, a Daimler employee prepared an internal memorandum entitled "Lease Summary" (the "Daimler Memorandum"). The Daimler Memorandum included the following description of the condition in which the Lease required that the engines be returned:

The Aircraft will be FAA certified, in compliance with [Southwest's] FAA approved maintenance program and in compliance with all applicable airworthiness directives and manufacturer's mandatory service bulletins, shall be in as good operating condition as when originally delivered to [Southwest], ordinary wear and tear excepted, shall be in a passenger configuration and shall have no less than 1,750 hours remaining on each engine and on the airframe until the next scheduled engine removal . . . . (Emphasis supplied.) The Daimler Memorandum does not mention a "value" and "utility" requirement.

4. Measuring "Value and Utility"

Expert Opinions Much of this lawsuit concerns the meaning of the phrase "value and utility" as used in Sections 5 and 8 of the Lease. The parties have submitted expert testimony addressing this subject.

Plaintiff's technical experts, Walter Andrushenko and Clive Medland, both testified that "value and utility" is a common term in aircraft leases and is included in leases to prevent the replacement of valuable items with less valuable items.

Andrushenko testified that the phrase "value" refers to an engine's "maintenance value," which is the the value of the shop visit to refurbish the engine and the value of the life of the parts that are within that engine, primarily, and certain modifications that are time-scheduled with engine refurbishments . . . . [It is] the value of the engine, value of the parts that comprise that engine, plus the cost to repair or refurbish those parts.

In the context of Section 5 of the Lease, Andrushenko did not believe that "value" meant "fair market value." Medland, however, testified that "value" in Section 5 means "fair market value."

The plaintiff also points to a 1987 practice guide (contemporary to the Lease) explaining that equipment leases customarily permit the lessee to remove severable additions to the equipment, as long as the removal of the additions does not reduce the equipment's "value" and "utility". Robert P. Davis, Leveraged Leasing of Capital Equipment: A Practical Guide to Negotiating Certain Non-Tax Issues from the Lessee's Perspective, in Leveraged Leasing 1987, at 77-78 (PLI Commercial Law & Practice, Course Handbook Series No. A4-4191, 1987).

Southwest's expert Patrick J. Harris reported that the term "value" could relate to eighteen different types of value, including replacement cost, reproduction cost, fair market value, ...

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