(a) Arguments of Brazil

6.94 Brazil argues that EDC supplements its direct financing by offering long-term loan guarantees to purchasers or lessors of Canadian regional aircraft. Brazil quotes a Canadian regional jet ("CRJ") purchaser as stating that "'Comair expects to finance the aircraft . . . through a combination of working capital and lease, equity and debt financing, utilizing manufacturers' assistance and government guarantees to the extent possible.'"²²³ Brazil cites a news report that EDC has provided "'up to $45 million in new loan guarantees'" for recent CRJ purchases which Canadian government officials reportedly stated would allow Bombardier "'to shave as much as 20 per cent off the selling price of a Canadair jet.'"²²⁴ For Brazil, this represents a substantial benefit, which has the effect of increasing the amount of EDC direct financing well beyond 85 per cent, and which may be passed along to purchasers or lessors.

6.95 In response to questions from the Panel, Brazil clarifies that its claim regarding EDC loan guarantees covers such guarantees per se as de jure export subsidies, and thus in all instances.

(b) Arguments of Canada

6.96 Canada rejects as incorrect Brazil's assertions, arguing that Brazil implies that the very fact of loan guarantees indicates the existence of a subsidy, using an example of an airline that "'expect[ed]'" to finance its aircraft through a combination of instruments, including government guarantees, "'to the extent possible'". Canada maintains that Brazil has failed to provide any evidence that the EDC has provided subsidies in the form of loan guarantees for any transaction concerning the civil aircraft sector, arguing that Brazil's "example" is not evidence but innuendo, and that Brazil thus has not met the burden of adducing a prima facie case.

6.97 According to Canada, the loan guarantee referred to in the article cited by Brazil was in fact a guarantee by the federal government, through Industry Canada, to assist in the financing of the sales of CRJs to Air Canada, not an EDC loan guarantee. In addition, Canada states, this transaction was a domestic sale. In any event, Canada argues, press reports quoting unnamed officials which are uncorroborated or do not otherwise contain material with an independent title of credibility and persuasiveness simply do not constitute a prima facie case. Contrary to Brazil's allegation, Canada argues, the EDC does not use any loan guarantees to supplement its financing activity, and Brazil's argument in this respect must therefore fail.

6.98 Canada asserts that the EDC issues conventional financial guarantees of third party payment obligations, in which cases the financial guarantor is supporting the third party's credit and will require that upon payment it will have recourse to the third party, either directly or by subrogation. Canada maintains that EDC loan guarantees are paid for by commercial fees from the recipient of the guarantee, and that there is no subsidy in this.

6.99 In response to a Panel question seeking clarification of Canada's statement that it does not use any loan guarantees to supplement its financing activity, in light of other statements suggesting that EDC does undertake loan guarantees, Canada responds that these statements are consistent. That is, Canada states, EDC provides loan guarantees on its corporate account, and EDC provides loan guarantees on the Canada Account, but EDC has not supplemented its corporate account financing (i.e., direct lending) with loan guarantees on the same transaction, which Canada states was Brazil's allegation.

6.100 In response to a Panel request for the details of any loan guarantees issued by EDC for transactions concerning the civil aircraft sector since 1 January 1995, Canada states its position that Brazil has not made a prima facie case against EDC loan guarantees, and notes the lack of adequate procedures to protect business confidential information. In this context, Canada provides to the Panel non-business confidential details of the two loan guarantees for export transactions provided by the EDC in the civil aircraft sector since 1 January 1995. The first of these was in support of the sale of two used de Havilland Twin Otters and two used de Havilland Dash 8-102s to an airline operating in the South Pacific. Canada states that the guarantee was provided at commercial rates. The second was in support of pre-shipment financing of a flight inspection system sold to a sovereign Latin American buyer, again at commercial rates.²²⁵

4. Equity infusions into corporations established to facilitate the export of civil aircraft

(a) Arguments of Brazil

6.101 Brazil argues that because of the high cost of maintaining direct financing at concessionary rates, and the toll such financing takes on its resources, EDC has developed alternative funding schemes.²²⁶ Brazil cites to a 4 April 1995 EDC press release regarding the formation, as one of "'several strategic initiatives aimed at further improving service and support to Canadian exporters'" of a new subsidiary -- Structured Finance Inc. ("SFI") -- which would "'increase the capital available to Canadian exporters by leveraging private-sector investment and structuring risk-sharing partnerships.'"²²⁷ According to Brazil, the statement indicates that "'SFI will be the vehicle through which several special purpose companies, capitalized jointly by EDC and private-sector partners, are envisaged to support key export sectors . . . .,'"²²⁸ among the first of which was Canadair RJ Capital Inc. ("CRJ Capital"), which "'will be formed on a risk-shared basis primarily between EDC and Bombardier, with each partner providing equal amounts of equity.'"²²⁹ Brazil notes that SFI's name subsequently was changed to Exinvest Inc. ("Exinvest").

6.102 Brazil argues that according to the 1995 Message of the Chairman and President of EDC, Exinvest permits EDC "'to support its customers with a unique combination of debt, equity and insurance instruments.'"²³⁰ Brazil argues that this Message announced the realization of the hopes expressed in the April 1995 statement by confirming that "'[Exinvest's] first investment is Canadair RJ Capital Inc., a 50-50 joint venture with Bombardier used specifically to finance the export of regional jets.'"²³¹

6.103 Brazil asserts that although aircraft may initially be sold to airline operators, they are most frequently then immediately re-sold to corporations, referred to in the industry as Special Purpose Companies or "SPCs,"²³² which are specifically established to own and lease aircraft. According to Brazil, the SPCs then lease the aircraft back to the airlines, a structure that is favoured for a variety of reasons, including protection against default and, in some jurisdictions, the realization of certain tax benefits. According to Brazil, these benefits result in reduced costs which may be passed along to enable the airline to achieve the lowest payments possible for the aircraft.

6.104 Brazil argues that CRJ Capital facilitates ²³³ export transactions by providing equity capital to the SPC, which supplements debt capital obtained from lenders, and asserts that in consultations, Canada declined to disclose to Brazil any pertinent information concerning the full scope of CRJ Capital's operations, asserting that the information was confidential. Brazil states that it nevertheless has been able to determine from publicly-available information that the SPC will receive 20 per cent of its capital in the form of equity from CRJ Capital and the remaining 80 per cent from lenders.²³⁴ Thus, according to Brazil, the only charge on the SPC's total capital is the charge required to service the debt, since equity owners are paid only from profits. Moreover, Brazil argues, EDC typically guarantees a portion of the debt capital supplied by the lenders ²³⁵ (see section VI.A.3.)

6.105 Brazil states that after initially purchasing the aircraft from the manufacturer, the airline re-sells the aircraft to the SPC, which leases it, typically for periods of 15 or more years, back to the airline. According to Brazil, the stream of lease payments from the airline to the SPC is used to service only the debt obligations of the SPC; since the object of utilizing the SPC device is to minimize the cost to the customer, the stream of payments is not sufficient to provide a return to the equity investors in the SPC. Thus, Brazil asserts, at the end of the lease the SPC owns a 15-year-old used airplane, the residual value of which is the sole source of whatever return will accrue to CRJ Capital, and in turn to EDC, as a supplier of equity capital.

6.106 For Brazil, this residual value alone cannot provide a commercial return to EDC as an equity investor; a 30-per cent residual value, for example, would not begin to compensate a non-subsidizing equity investor. Brazil asserts that the EDC contribution of 10 per cent of total capital²³⁶ represents half of the equity capital in the SPCs established to support the export of civilian aircraft, which means that EDC's share of the assumed 30-per cent residual value is half of that, or 15 per cent. According to Brazil, this would yield an annual return of a mere 2.74 per cent, which for Brazil demonstrates quite clearly and quite graphically that EDC equity infusions are little more than outright grants.²³⁷ Brazil further states that even a 50-per cent residual value produces an annual return of only 6.3 per cent, hardly the level of return sought by risk-taking equity investors.²³⁸

6.107 In response to a question from the Panel seeking Brazil's view on what an appropriate level of return would be for such "risk-taking equity investors", Brazil notes that in Parliamentary testimony, then-EDC President Paul Labbé identified 15 to 20 per cent as the "'return on equity that would be required to survive in the private sector'"²³⁹, and refers to an article from Airfinance Journal²⁴⁰ that cites after-tax yields on private aircraft leasing deals of between seven and 14 per cent (or 15 to 20 per cent on a pre-tax basis). Brazil also submits a chart²⁴¹ providing annual US returns on a range of low-risk to high-risk investments over the period 1991-1997, which Brazil states shows similar returns for investments involving any even nominal level of risk. Finally, according to Brazil, this rate accords with another appropriate benchmark - Bombardier's pre-tax cost of capital, which factors at 16.9 per cent.²⁴²

6.108 Brazil notes, however, that a return on EDC's equity investment of 6.3 per cent is highly speculative, presuming a 50-per cent residual value for the underlying aircraft, and states that a residual value of 30 per cent is more in line with the value projected by industry analysts,²⁴³ and in the case of a 16-year lease would yield a 2.57 per cent rate of return,²⁴⁴ a rate which fails in all but three of the last 20 years to outpace the US inflation rate.²⁴⁵ EDC's acceptance of this rate of return for its equity financing vehicle serves a purpose; according to Industry Canada's Director of Airframe Systems, Richard Dixon, it helps meet "[t]he challenge . . . to provide low cost financing to airlines with lower credit ratings," and permits "airlines with double-B credit ratings . . . to lease new planes at interest rates normally offered to double-A credit risks."²⁴⁶

6.109 Thus, Brazil argues, EDC's equity infusions into SPCs confer a benefit by lowering the lease payment required from the ultimate customer, the airline, thereby effectively lowering the price of the aircraft and making it more competitive than would otherwise be the case.

6.110 Brazil notes that the foregoing analysis assumes a 15-year lease, and that to the extent a lease exceeds 15 years, the residual value of the aircraft would be less because it is older, which would in turn affect the equity investor's ultimate return. That is, according to Brazil, the equity investors' return would be less because its pay-back would occur at a later date; for example, a 16-year lease, with an anticipated 30-per cent residual value yields an annual return of 2.57 per cent.²⁴⁷

6.111 Brazil states that in consultations, Canada declined to disclose specific information concerning the number of regional aircraft sales benefiting from EDC's equity financing vehicle. According to Brazil, EDC officials have stated that CRJ Capital "could be involved in purchasing and leasing as many as 75 jets."²⁴⁸

6.112 According to Brazil, publicly-available information indicates that CRJ Capital has been used to finance sales both to Comair and Air Canada.²⁴⁹ Brazil asserts, citing to the expert report of Grey, Clark, Shih and Associates, Ltd. (the "Clark Report") that the sale to Air Canada, which at first impression would seem to be a domestic sale, is in fact an export sale entered into with the explicit aim of promoting export sales.²⁵⁰ According to Brazil, when questioned by a Committee of Parliament concerning EDC support for sales of civilian aircraft to Air Canada -- seemingly a domestic sale and not, therefore, within EDC's purview -- EDC President Paul Labbé explained that these in fact were export sales, having been made through an SPC (a "tax vehicle") established in the United States,²⁵¹ which in turn leased the aircraft to Air Canada, thereby qualifying for treatment as an export transaction within EDC's authority. Brazil quotes Mr. Labbé as saying:

6.113 According to Brazil, EDC's equity infusion into the SPC amounts to approximately 10 per cent of the value of each aircraft, or approximately $1,500,000 to $2,000,000 for every airplane sold. Brazil argues that the present value in 1998 of benefits to Bombardier associated with these equity infusions ranges from a low estimate of US$894 million to a high estimate of US$979 million.²⁵³

6.114 Brazil argues that SPCs are designed not to earn a profit during the term of the lease; therefore, only the debt portion of their capital needs to be serviced during the 15-year or 15 year-plus period of the lease, and no payment is made to the equity investors. Thus, for Brazil, the greater the percentage of equity capital in the SPC, the lower the percentage of debt capital that actually must be serviced by the lease payments. In effect, Brazil argues, when EDC utilizes the SPC mode of support, it purchases 10 per cent of a new aircraft, with no prospect of return on this investment during the entire period of the lease, in exchange for a 50-per cent interest, 15 or more years later, in a 15-year-old or more used aircraft.

6.115 Brazil states that this equity infusion is a benefit because no private financial institution or investor would contribute equity on such unremunerative terms; and argues that were non-subsidizing private investors willing to provide funds on such terms, there would be no need for EDC, since its mission is to go "beyond what is possible by other financial intermediaries" by, in this instance, providing equity infusions to feed "the seemingly endless appetite of Canadian exporters for financial support."²⁵⁴ According to Brazil, these equity infusions go far beyond "what is possible by other financial intermediaries," and in so doing, confer benefits of the type envisioned by Article 1.1 of the SCM Agreement. Thus, for Brazil, EDC, through CRJ Capital, therefore confers a clear benefit on Canadian producers and exporters of regional aircraft by assuming an equity investor's risk in its contribution of capital, with no prospect of obtaining an equity investor's reward.

6.116 In addition, Brazil states that using Canada's words, EDC incurs a "net cost" in that no private financial institution or investor would contribute equity on such unremunerative terms, as evidenced by the apparent fact that no one other than Bombardier, the final beneficiary, has done so. Brazil submits that EDC's only return depends upon the residual value of a 15-year-old (or older) airplane, which the Finan Report²⁵⁵ and Exhibit Bra-19 establish cannot provide anything remotely resembling a commercial return to EDC as an equity investor.

6.117 Brazil further argues that because all EDC funding is de jure contingent upon export, all sales using the equity financing vehicle, including those sales to Air Canada, have been structured as export transactions, and that as a result, extension of this type of funding constitutes an export subsidy within the meaning of Article 3 of the Agreement.

6.118 Brazil states that it is aware of one other apparent SPC, Canadian Regional Aircraft Finance Transaction, or "CRAFT," which may be a successor to or replacement of sorts for Exinvest. According to Brazil, CRAFT was launched in April 1998 as an aircraft securitization structure to provide lease and loan financing for customers buying Bombardier's CRJ and Dash 8 aircraft.²⁵⁶ Brazil, referring to a chart of CRAFT's structure and operations that it submits²⁵⁷, states its understanding that EDC and the Government of Québec provide equity capital and are preferred shareholders in CRAFT.

6.119 Brazil indicates that CRAFT came to the market with an initial portfolio of 26 aircraft and a total appraised value of $458 million, which can be expanded over the next 18 months to reach 70 aircraft worth $1.1 billion.²⁵⁸ In Brazil's view, CRAFT diversifies the risk to debt holders by packaging together deals and offering portions of the total package to the debt holders, thereby lowering the cost of financing. Brazil asserts that EDC and the Government of Québec provided preferred capital to the CRAFT structure. Brazil states that it is estimated by Standard & Poor's that EDC and the Government of Québec's combined participation could exceed US$300 million.²⁵⁹ Brazil presumes that investment by the Canadian federal and provincial governments was required because the return to the other shareholders would be below the return demanded by private investors given the level of risk they would have to assume in the financing structure. In Brazil's view, by accepting below market returns on their investment, EDC and the Québec Government allow the CRAFT SPC to reduce the monthly lease cost to the aircraft lessee.

6.120 Brazil notes that it has encountered significant difficulty obtaining access to information on EDC's equity financing activities, as it has for other EDC activities. Brazil believes that in its defense of EDC's equity activities (see paras. 6.128-6.129), Canada is relying on sophistic and misleading parsing of Brazil's claim (as in Brazil's view it did during the Panel meeting on 26 November with regard to Brazil's claims concerning EDC's extension of loan guarantees). Brazil recalls here Canada's emphasis on the word "supplement" in that defence (see para. 6.99). Brazil reiterates that its factual understanding of EDC's equity financing activities is derived directly from public information issued by EDC itself. For Brazil, Canada's mere conclusory denial of facts which it has often and repeatedly held out to be true in public should not be considered by the Panel to be a sufficient rebuttal of Brazil's prima facie case.

To continue with Arguments of Canada

²²³ Comair Holdings Inc. Form 10-K, filed with the US Securities and Exchange Commission for the fiscal year ending 31 March 1998, p. 27 (emphasis added) (Exh. BRA-14); Comair Holdings Inc. Form 10-K, filed with the US Securities and Exchange Commission for the fiscal year ending 31 March 1997, pgs. 18, 39-40 (Exh. BRA-15).

²²⁴ "Bombardier first to gain from equity investments by EDC," Financial Post, 5 April 1995 (Exh. BRA-16).

²²⁵ The Panel notes that Brazil, in its comments on this response of Canada to the Panel's question, stated that Canada had not provided documents that in Brazil's view Canada indicated were being provided. The Panel understands Canada's reply to the question, recounted above, to constitute the entirety of the information referred to by Canada in that reply, and in this regard notes that Canada's reply makes no reference to documents.

²²⁶ Committee on Foreign Affairs and International Trade, 43:10 (Exh. BRA-9).

²²⁷ EDC Press Release No. 8, 4 April 1995 (Exh. BRA-17).

²²⁸ Id.

²²⁹ Id.

²³⁰ Message at 3 (Exh. BRA-7).

²³¹ Id.

²³² Transport Finance No. 74, dated 3 October 1996, at 3 (Exh. BRA-18).

²³³ The Panel notes that in its second submission, Brazil indicates that the references to CRJ Capital reflected in this and the following paragraph should have been to Exinvest, the provider of equity capital to CRJ Capital, the SPC. The references as initially made by Brazil are retained in the text of this report, to ensure that Canada's response arguments in the next section are comprehensible.

²³⁴ Id. at 3 (EDC chart of CRJ financing scheme).

²³⁵ Id.

²³⁶ Since the SPC receives 20 per cent of its capital in the form of equity from CRJ Capital, and CRJ Capital is itself 50-per cent owned by EDC, EDC's equity contribution to the SPC amounts to 10 per cent.

²³⁷ See Exh. BRA-19.

²³⁸ Id.

²³⁹ Committee on Banking, Trade and Commerce, pg. 48:22 (Exh. BRA-10).

²⁴⁰ Exh. BRA-74

²⁴¹ Exh. BRA-75

²⁴² JP Morgan Securities, "Bombardier," 1 September 1998, pg. 10 (adjusting 11 per cent to pre-tax cost of capital) (Exh. BRA-76).

²⁴³ "Consider Residual Values When Computing RJ Costs, Say Analysts," Commuter/Regional Airline News, 7 April 1997 (Exh. BRA-77).

²⁴⁴ "Evaluation of Export Subsidies Received by Bombardier Inc. and Certain Suppliers", Expert Report of Horst, Frisch, Clowery and Finan, 29 October 1998 ("Finan Report") (included as a separate attachment to the first written submission of Brazil), at Exhibit B, Table B.4.

²⁴⁵ Stocks, Bonds, Bills and Inflation, 1998 Yearbook (Exh. BRA-78).

²⁴⁶ "Ottawa Joins Bombardier in jet-leasing venture," The Globe and Mail, 5 April 1995 (Exh. BRA-8).

²⁴⁷ Finan Report at Exhibit B, Table B.4.

²⁴⁸ "Ottawa Joins Bombardier in jet-leasing venture," The Globe and Mail, 5 April 1995 (Exh. BRA- 8).

²⁴⁹ "Closing the Stable Door," Airfinance Journal, July/August 1995, p. 25 (Exh. BRA- 20).

²⁵⁰ Clark Report at pgs. 13, 21-24.

²⁵¹ Committee on Foreign Affairs and International Trade, 43:30 (Exh. BRA- 9).

²⁵² Id.

²⁵³ Exhibit B, Table B.5 of Finan Report.

²⁵⁴ Message at 2, 4 (Exh. BRA- 7).

²⁵⁵ See Exhibit B, Table B.4 of Finan Report.

²⁵⁶ Standard & Poor's Presale Report, "CRAFT No. 1 Trust 1998 - A," 17 April 1998 (Exh. BRA-70); "Turning finance into a fine craft," Airfinance Journal, June 1998 (Exh. BRA-71); "CRAFT takes off for Bombardier," Euroweek, 8 May 1998 (Exh. BRA-72).

²⁵⁷ Exh. BRA-73

²⁵⁸ Id.

²⁵⁹ Standard & Poor's Presale Report, "CRAFT No. 1 Trust 1998 - A," pg. 3 (Exh. BRA-70) (Notes that the debt portion of the CRAFT SPC will be up to $770 million in amortizing notes, with a total portfolio of aircraft at an appraised value of $1.1 billion. The difference, $330 million, has therefore to come from equity financing).