Lessons learned from airline insolvencies

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Publication July 16, 2018

Introduction

Airline insolvencies differ from insolvencies of companies in other business sectors in a number of key respects:

  1. the financing arrangements for the manufacture and purchase of aircraft, and the associated ownership and leasing arrangements, can be extremely complex and often vary considerably from case-to-case;
  2. the airline industry is heavily regulated and the regulations to which airlines are subject can impose limitations on the manner in which they operate and the ease with which enforcement action can be taken; and
  3. the valuable assets involved in operating an airline’s business (and the subjects of a key part of a financier’s security package) are, by nature, moveable and their movement in the ordinary course – and the ability to move them with ease between different jurisdictions at short notice – can introduce complicated questions of conflict of laws and cross-border insolvency in distressed situations.

The recent administration of Monarch Airlines brought these and other issues into sharp relief, and is considered in the final part of this article.

There is no special insolvency procedure in England and Wales applicable to airline insolvencies. However, the implementation of the Cape Town Convention (and its related Aircraft Protocol (the “Protocol”)) by the International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 (the “2015 Regulations”) has curtailed restrictions which ordinarily apply to the exercise of third parties’ rights on the commencement of insolvency proceedings (for example, the moratorium applicable in administration).

Insolvency proceedings

The commencement of insolvency proceedings with respect to an airline can mean different things from the perspective of the parties involved, depending on the type of proceedings and how they have been instituted. It is possible in certain circumstances (and depending on the jurisdictions involved) to use certain proceedings in a strategic and pre-planned manner so as to preserve the value of the airline’s business. However, in circumstances in which insolvency proceedings are instigated unexpectedly or in a haphazard fashion – whether by the directors of the airline or other stakeholders – a financier or lessor can be left with a limited amount of control, the outcome can be considerably less certain and the overall effect can be one of value destruction.

An insolvency office-holder appointed to an airline which has entered into insolvency proceedings will inevitably face a huge task of assimilating and processing a large amount of information very quickly at the outset of a case and dealing with a number of counterparties and stakeholders. The burden on the insolvency office-holder will be considerable, although in circumstances in which the insolvency office-holder’s firm has had a number of weeks or months of prior involvement with the airline, they will be better-placed to take decisions quickly once appointed. Considerations as to passenger and public safety can affect markedly the roles and responsibilities of those involved in an airline insolvency.

Post- as well as pre-insolvency, a lessor or financier should have regard to the practicalities on the ground when considering whether or not to take enforcement action (for example, gaining access to the aircraft and any storage facilities); however, much may depend on the type of proceeding to which the operator has, or will, become subject.

The commencement of insolvency proceedings may trigger cross-default provisions in an airline’s contracts with other parties (which may, for example, result in the termination of leases and sub-leases). The extent to which counterparties will be entitled to rely on such termination provisions will depend on the jurisdictions involved and whether there are applicable prohibitions on ipso facto clauses (i.e. termination provisions which are triggered by the commencement of insolvency proceedings) under the relevant insolvency laws.

The effect of the 2015 Regulations is to adapt the UK’s insolvency regime in certain key respects relating to enforcement of security over airframes and aircraft engines, in the case of leases and security agreements entered into after the enactment of the 2015 Regulations. It is necessary for the debtor to have consented in writing to the exercise of the creditor’s remedies under the 2015 Regulations in the event of a default, but it suffices for these purposes for the debtor – as is now common practice – to do so in the relevant mortgage deed or security agreement at the outset of the financing. Under the 2015 Regulations, upon the occurrence of a relevant insolvency-related event (for example, the commencement of administration), the insolvency practitioner is required to:

  1. give possession of an aircraft object in respect of which a relevant “international interest” has been registered under the Cape Town Convention to the creditor at the earlier of the expiry of 60 days or the date on which the creditor is otherwise entitled to possession; or
  2. cure all defaults (other than the default constituted by the commencement of insolvency proceedings) and agree to perform all continuing obligations under the relevant agreement.

Once the 60-day waiting period has expired (if applicable), the administration moratorium preventing the enforcement of security and repossession of leased assets ceases to apply and the court’s power to order the disposal of secured or leased property is disapplied. From that point, it is not necessary for the creditor to obtain a court order for possession and, once possession has been obtained, the creditor has the right to deregister and export the aircraft (with the assistance of the CAA).

It is prudent for a financier or lessor to act swiftly when faced with an airline that has gone into administration. In particular, a lessor should seek confirmation from the administrator that they will pay for his usage of aircraft as an expense of the administration. In this connection, it may be advisable to exercise contractual rights of termination under the lease in order that it is clear that any continued usage of the aircraft is done on terms that make it clear that the lessor will receive payment for ongoing usage.

In the event of an airline entering into insolvency proceedings, it may be necessary for the responsible insolvency office-holder or a lessor or financier to take action to recover property in a large number of jurisdictions, depending on the size and geographical reach of the airline’s business. In all cases, it will be necessary to seek local advice, since complex questions of cross-border insolvency law and conflicts of laws are likely to arise, particularly with regard to the entitlements and priorities of secured creditors. It may be necessary for the insolvency office-holder to seek local advice at an early stage in order to form a view as to the extent to which their appointment in England and Wales is likely to be recognised in other jurisdictions and if it will be necessary formally to seek recognition in other jurisdictions as a precondition to being able to gain access to, maintain and preserve the relevant aircraft.

The advent of the Cape Town Convention means that – quite apart from operating licence issues which are likely to arise following an insolvency filing – a continued period of trading for an airline in insolvency proceedings in the UK is unlikely. This position can be contrasted with the position in certain other jurisdictions, which are more conducive to continued trading of an airline which is subject to insolvency proceedings. For instance, there are numerous examples of US Chapter 11 proceedings in respect of US and foreign airlines (including the Colombian airline, Avianca) in which the relevant carriers have continued to operate throughout, which has largely been attributable to the willingness of lessors and other creditors to support the restructurings undertaken. Recent similar examples in Europe include Alitalia in Italy and Air Berlin in Germany, which was able to continue operating flights for a number of months following its entry into insolvency proceedings with the financial support of the German government.

One of the features of the UK Government’s Airline Insolvency Review which commenced in April 2018 will be to examine options to enable a temporary period of continued operation of an airline following the appointment of administrators, perhaps with governmental financial support. It will be interesting to see how the proposals develop in the course of the review period and the recommendations which are ultimately made.

Security deposits and maintenance reserves

It is common, on the entry by a lessee into insolvency proceedings, for disputes to emerge in relation to entitlements to security deposits and maintenance reserves. The nature and status of such amounts varies from case to case and it will be necessary carefully to consider the terms of the lease and any related agreements in order to ascertain the question of entitlement to those amounts in subsequently-commenced insolvency proceedings.

The purpose of a security deposit is to serve as “security” for the payment by the lessee of rent and other payments under the lease and the performance by the lessee of the other obligations under the lease. Despite being characterised as security, such amounts rarely constitute a security interest properly so-called. As such, in an ordinary case, the application of security deposits will not be precluded by the administration moratorium since there will normally be no question of the enforcement of security.

As with security deposits, leases will typically provide that maintenance reserves payments will become the property of the lessor immediately on payment and the lessor will be at liberty to commingle the amounts paid with its own cash resources. Similarly, the administration moratorium does not normally restrict the application of maintenance reserves.

Liens and powers of detention

In certain circumstances, particular creditors of an airline are able to obtain proprietary or detention rights over an aircraft ranking higher than those of the lessor, owner or mortgagee of that aircraft. Where the Cape Town Convention applies, certain overriding non-consensual rights and interests similarly have priority over registered interests without having been themselves the subject of registration. These are specified in the 2015 Regulations to be possessory liens in respect of work done on the aircraft and any right to detain the aircraft arising under an Act of Parliament (e.g. in respect of unpaid air navigation charges or airport charges).

Where a lien or a priority right arises, the financier will be required to discharge the debt owing before it can obtain access to the aircraft. In the case of the exercise of a fleet lien of the type described above, this is capable of giving rise to extreme hardship to financiers and can erode the value of their security significantly.

Monarch Airlines

Prior to its entry into administration on 2 October 2017, Monarch Airlines was an airline operating scheduled flights from five UK airports to destinations in the Mediterranean and the Canary Islands. Along with many airlines worldwide, it had encountered difficult market conditions and, in 2014, it underwent an extensive restructuring process. Although the group returned to profitability in 2015, continued challenging conditions in the European aviation market led to further deterioration in the group’s financial position in the course of 2016. Monarch underwent a business review in 2017 and, in the autumn of that year, KPMG was engaged to run a sales process for the group’s airline operating and travel businesses and to formulate a contingency plan to help preserve value and minimise passenger disruption in the event that it was not possible to find any sale or investment solution that would restore the group to profitability. The sale process was ultimately unsuccessful. With the group’s Air Travel Organiser’s Licence (“ATOL”) due to expire on 30 September 2017 and all other options having been exhausted – and in light of the continuing difficult market conditions – the directors of Monarch resolved to place the company into administration. The administration order was made with effect from 4am on 2 October 2017 and KPMG partners were appointed as joint administrators.

Following as well as prior to their appointment, the administrators assisted the CAA in the repatriation of Monarch customers who were stranded overseas. The (prospective) administrators and the CAA had concluded that it would not be possible to use Monarch’s existing fleet for this purpose and had therefore worked to assemble a fleet of especially-leased aircraft and shadow aircrews for the purpose in and around key destinations.

The administrators rolled out an extensive communications programme in the very early stages of the administration, in conjunction with the CAA, using legacy Monarch systems and their own website, in order to provide customers with the necessary information and options available to them in the circumstances.

The administrators commenced the return to lessors of leased aircraft and related equipment shortly following their appointment. By the end of the first week of the administration, all the leases had been terminated and the lessors were taking steps to gain access to the aircraft and move them to different airports. The process of gaining access to the aircraft was not entirely straightforward, however, and the lessors first needed to reach agreement with certain airports and other authorities (the CAA on behalf of NATS and Eurocontrol), which had asserted liens in respect of unpaid charges, before being able to take possession of the aircraft. Nevertheless, within six weeks of the administrators’ appointment, all aircraft had been returned to the lessors and moved to alternative locations.

In parallel with the exercise of returning aircraft to the lessors, the administrators sought a judicial review of the decision of the coordinator for the allocation of slots at certain airports – Airport Coordination Limited (“ACL”) – to refuse to allocate Monarch the slots to which it had been entitled following its entry into administration. On appeal, the Court of Appeal held that an undertaking did not inevitably cease to be an “air carrier” when it became unable to operate air transport services (reversing the Divisional Court on the point); even an airline that had no reasonable prospect of resuming air transport services qualified as an air transport undertaking, even though it might be a failed undertaking. The Court of Appeal was of the view that matters relating to an airline’s financial circumstances and its ability to continue trading were not within the remit of ACL and instead should be dealt with in the course of the licensing process. Accordingly, the Court of Appeal made a declaration that Monarch was entitled to be allocated the slots in question and made an order requiring ACL immediately to allocate those slots to Monarch.

A number of important practice points can be drawn from the early stages of the administration of Monarch, including:

  1. The timing of any insolvency appointment is key. In particular, considerations of passenger and pilot safety – as well as obtaining certainty as to the location of aircraft – are paramount. The pre-dawn filing of Monarch allowed an optimum outcome on all such fronts.
  2. Close engagement and cooperation with the CAA is critical to achieving an outcome that is the best achievable in difficult circumstances. In particular, the administrators’ interaction with the CAA in the passenger repatriation exercise ensured that all passengers (and not only those with ATOL protection) were able to be repatriated safely in the early stages of the administration, with a minimum cost to the administration estate. In the Monarch case, the CAA’s pragmatic and responsive approach, in pursuit of its consumer protection objective, allowed the delivery of optimal outcomes. It is to be hoped that the CAA and its equivalent regulatory bodies in other jurisdictions will take a similar approach in future insolvencies, although each case will of course vary depending on its own facts and circumstances.
  3. A comprehensive, multi-platform communications programme following an insolvency filing will assist in the efficient management of customer expectations and reduce the adverse consequences of the insolvency filing from a public perception perspective, including on social media.
  4. Administrators should cooperate as far as possible with lessors in returning leased aircraft in circumstances in which their continued use is not required for the purposes of the achievement of the purpose of the administration.
  5. Slots allocated to an airline which enters into, or is already subject to, insolvency proceedings are potentially valuable assets which are capable of being exchanged for consideration, thereby increasing realisations for the benefit of the administration estate and returns to creditors generally.

This article is an abridged form of a practice note on airline insolvency which was first published on LexisPSL Restructuring and Insolvency.


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