An insight into airline insolvencies

Publication October 2018


Key points

  • The nature of an airline’s business can create unique challenges from the perspective of the various actors involved in insolvency proceedings. Insolvency office-holders, financiers and lessors alike will likely need to have regard to local law considerations and the practicalities of securing access to, and recovering, aircraft in a number of jurisdictions worldwide.
  • In the current legal and regulatory environment, it is unlikely that an airline which enters into insolvency proceedings in the UK will continue to operate flights, even for a limited period, in order to allow the repatriation of passengers to the UK. This is not necessarily the case in other jurisdictions.
  • The administration of Monarch Airlines emphasised the importance of closely involving the Civil Aviation Authority (the CAA) in the planning stages for the commencement of insolvency proceedings relating to a UK airline, and the necessity of accompanying an insolvency filing with a comprehensive, multi-platform communications programme.
  • The Interim Report of the UK’s Airline Insolvency Review published in July 2018 contemplates wide-ranging changes to the UK legal and regulatory regime relating to insolvent airlines, to allow more effective and efficient repatriation and protection of passengers in the event of an insolvency of an airline. The findings of the Final Report, will be published in Winter 2018/19.

Introduction

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

  • 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.
  • 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.
  • 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.

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 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.

The entry into administration of Monarch Airlines one year ago brought certain of the above-described issues into sharp relief. The challenges presented in the Monarch Airlines case served as a catalyst for the UK Government’s Airline Insolvency Review which commenced in April 2018 and which published an Interim Report in July 2018. The Review is scheduled to conclude in Winter 2018/19 with the publication of its Final Report. The Review is considered in the final part of this article.

Insolvency proceedings

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. 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.

It is prudent for a lessor or financier to act swiftly when faced with an airline that has gone into administration. In particular  and assuming for the moment that a lessor is not minded immediately to elect to exercise default remedies  it should seek confirmation from the administrator that he 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 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. 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 recognition in other jurisdictions in order to gain access to, maintain and preserve the relevant aircraft.

The Cape Town Convention

The effect of the 2015 Regulations is to adapt the UK’s insolvency regime in certain key respects relating to enforcement of security and leases 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, security agreement or lease at the outset of the transaction. 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

  • 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.
  • 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.

The advent of the Cape Town Convention means that  quite apart from the 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. See, however, “Airline Insolvency Review” below. 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.

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, for example, 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

Monarch Airlines encountered difficult market conditions throughout the period 2014 to 2017 and, following an abortive sales process in autumn 2017 and, in view of the imminent expiry of the group’s Air Travel Organiser’s Licence (ATOL), the airline entered into administration in the early hours of October 2, 2017. The timing of the filing was key, since it helped safeguard passengers and crews, as well as achieving certainty as to the location of the aircraft in the fleet.

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. Within six weeks of the administrators’ appointment and following the discharge of liens to which airports and other authorities had exercised in respect of unpaid charges, 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 to refuse to allocate Monarch the slots to which it had been entitled following its entry into administration. It was held on appeal that Monarch was entitled to be allocated the slots in question; under the applicable EU Regulation, even though Monarch had no reasonable prospect of resuming air transport services, it met the requirement of being an air transport undertaking, albeit a failed undertaking (Monarch Airlines Ltd v Airport Coordination Ltd [2017] EWCA Civ 1892). Matters relating to an airline’s financial circumstances and its ability to continue trading were not within the remit of the slots coordinator and instead should be dealt with in the course of the licensing process. In view of this ruling, the administrators were able to exchange the slots allocated to Monarch for valuable consideration, thereby increasing realisations for the benefit of the administration estate and returns to creditors generally.

Airline Insolvency Review

In July 2018, the Airline Insolvency Review published its Interim Report, which set out the Review’s initial views on potential options for meeting the immediate repatriation requirements following the failure of an airline. The Report represented the end of the formal consultation phase, and the Review is now working to develop its recommendations for publication in the Final Report, which is expected later in 2018 or in early 2019. The focus of the Report is on repatriation of passengers, but it also considers potential alternative models to those currently available for the protection of passengers in the event of airline insolvency and the available options for reform of existing arrangements for passenger protection to put them on a more commercial basis. The principles underlying the review are that

  • The beneficiaries of protection available in the case of airline failure should pay for the protection received, with the exposure of taxpayers correspondingly reduced.
  • Risk should be allocated efficiently to those passengers which are best-placed to manage them.
  • Market distortions should be minimised wherever possible, to avoid putting UK-registered airlines at a competitive disadvantage relative to their foreign competitors.
  • Simplicity for passengers is paramount, in terms of understanding the protections available and minimising the impact on them of an airline’s insolvency.

In terms of repatriation of passengers, the Report identifies that a successful repatriation exercise should achieve certainty and clarity in the minds of passengers in terms of the measures in place and expectations on passengers, including through the use of a tailored communication programme, in order to give passengers confidence that their interests are being catered for in an affordable manner. There is a recognition in the Report that there is unlikely to be a one-size-fits-all repatriation solution for every airline insolvency  particularly in the case of large airlines  and that it will likely be necessary in any given case to implement a combination of measures, including

  • Self-organised repatriation, where passengers make their own travel arrangements.
  • Organised charter, where the airline’s services are replicated by the use of readily-available charter aircraft, a solution which was successfully deployed in the case of Monarch Airlines).
  • An orderly wind-down involving the short-term continuation of the airline’s own flight schedule using its existing fleet and resources.

Of these options, it appears that an orderly wind-down was the route preferred by most respondents, which ensures the least amount of disruption to passengers; however, its utility is highly dependent on the continuation of key licences and the successful retention of existing crew and IT and safety arrangements, at a time which is difficult and stressful for many of the airline’s employees. Furthermore, its success would depend on the ready cooperation of third parties which are involved in the day-to-day operation of an airline’s fleet and, since continued operation may not be in those parties’ interests, the Report recognises that it may ultimately be necessary for any proposals for reform to provide for some level of coercion of those critical parties to ensure their compliance. There is also a recognition of the need for administrators to obtain sufficient funding for the prepayment of the significant liabilities required to be incurred for the purposes of any repatriation exercise, and the fact that, under the existing administration regime, administrators’ duties to creditors are not always consistent with the incurring of the substantial operations which are necessary. The Report acknowledges the critical role played by the CAA in effecting a successful repatriation of passengers and notes the desirability of adapting the legal and regulatory environment to allow for the inclusion of a mechanism in the licensing framework that would allow an orderly wind-down rather than – as is usual currently – the speedy suspension or withdrawal of an insolvent airline’s operating licence.

The Report highlights the haphazard nature of the protection measures currently available to passengers, under which the extent of a passenger’s protection in the event of an airline insolvency invariably depends on the manner in which they booked their airline ticket. Certain available protections overlap and some passengers lack protection against insolvency altogether, with many passengers failing fully to understand the options available to them. A number of potential methods of financial protection of passengers are under consideration by the Review, including insurance-based or levy-based solutions which may be made mandatory for all passengers, and certain non-financial measures, such as awareness-raising programmes around available protection for passengers. In regard to the latter, the expectation is that such measures will be more effective if they are introduced to complement any financial solution, rather than operating on a standalone basis.

The Review is operating to a very tight timetable and the findings of its Final Report are eagerly awaited in the airline industry.

The original version of this article first appeared in the October 2018 edition of Corporate Rescue and Insolvency journal, published by LexisNexis.

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