Airline Insolvencies

As the impact of COVID-19 is felt across the globe, many airlines have grounded their fleet, ceased operating flights, and are potentially in breach of any financial covenants that they may have in their debt or lease documents, if not already in technical insolvency.

If an airline does go into insolvency, what should banks and lessors do to protect their assets? What issues, practical and legal, should they be aware of?

The Warning Signs

Creditors should take note of the warning signs, be these press reports, industry rumours or otherwise. Once an insolvency event occurs, a creditor needs to be able to move quickly and proactively. It is therefore essential that the creditor has assembled its team in advance. This may consist of legal specialists as well as the technical teams required for arranging airside access and maintenance of the aircraft.

Notice of Termination under Leases

It is vital that notices of termination are served as quickly as possible upon the occurrence of an insolvency event, not least for the reasons discussed below in respect of airport liens and detention rights. However, such notices need to be served correctly, and should not be susceptible to challenge. Important points to note when drafting these notices of termination include the following:

• Prepare the notices of termination in advance – this will require gathering together all relevant lease documentation and checking the documentary requirements for service of notice. This can take time and ideally the notices will have been prepared and signed, held undated, ready to be served upon the occurrence of the insolvency event. In connection with service of the notice, be sure that the insolvency event has actually occurred. Press reports may not be sufficient. As an example, in the recent Thomas Cook insolvency, while there were press reports and rumours of the airline entering into insolvency over the course of the weekend prior to the filing for insolvency, a notice was posted on the CAA website very early on the relevant Monday morning, promptly following the filing of the insolvency. The notice on the CAA website could then be relied upon as the trigger for the service of notices of termination.
•  Does the notice of termination correctly identify the termination event that has occurred? As mentioned above, the legal team will likely have drafted the termination notices in advance and will be waiting to serve these at the relevant time. What if the basis of the insolvency is not as expected? For example, in respect of the Thomas Cook insolvency, many lawyers expected an administration order to be filed – in fact, Thomas Cook filed for compulsory liquidation. Did the termination notice refer to the occurrence of an insolvency event broadly, or did it refer to administration? The basis for the termination must be correct in order for the termination notice to be valid.
• Ensure that you know how to serve the notices. Can they be served by email? Older leases may not allow this. Can they be served by fax? Do the fax numbers work and do you even have a fax machine anymore? What time is a notice deemed to arrive if served by fax? For example, if the airline files for insolvency in the early hours of the morning, is a termination notice only deemed received at, say, 9am later that morning in the relevant time zone? If all else fails, you may need to line up a process agent to serve the notices, in which case, where do they go, and to whom do they give the notice?
• Are any of the aircraft or engines on sublease? For good order, termination notices should be served for the subleases pursuant to any applicable subordination arrangements, even if such arrangements refer to automatic termination of the sublease upon termination of the headlease.

What happens upon the occurrence of an insolvency event?

This will depend upon the relevant applicable law of the jurisdiction in question, but there may be a moratorium imposed in respect of the airline and its assets. If a moratorium does not prevent an owner of an aircraft from seeking to recover and repossess its own aircraft, owners may experience the following issues relating to the aircraft engines when attempting to do this:

• Owner A’s engine is installed on Owner B’s aircraft – generally speaking, this scenario can be resolved easily and the two owners will swap the engines over in due course.
• Owner A’s engine is installed on the insolvent airline’s aircraft – this may be more difficult to resolve. Generally speaking, the insolvency practitioner appointed to deal with the insolvency will want to keep a tight hold of all assets of the airline and so swapping the engine out may take some time to achieve.
• The insolvent airline has one of its own engines on-wing of Owner A’s aircraft – Owner A may want to fly its aircraft to a convenient location (where maintenance can be done and where there are lower parking and storage charges), but any insolvency practitioner will be extremely cautious about allowing the engine to be flown anywhere, not least due to liabilities that it could incur. Ferry flight documentation, including suitable indemnities, may need to be agreed between the airline and Owner A.
• Owner A’s engine is in shop for maintenance – to retrieve this engine, Owner A may be required to pay outstanding maintenance charges to the maintenance provider, as well as the costs for transporting the engine from the maintenance facility.

Liens and Detention Rights

Airports and air traffic control authorities will likely be watching any insolvency scenario unfold very closely. Depending upon the local law, these entities may have liens over the aircraft as well as detention rights in respect of any unpaid parking or air navigation charges, potentially giving them a right to sell the aircraft after a specified period of time.

For example, in the UK, airports and the CAA have the right to detain aircraft for unpaid charges relating to that aircraft. In addition, English law also allows an airport or the CAA to detain an aircraft if any debt is owed by the operator of that aircraft (i.e. the airline), irrespective of whether a debt is actually owed for that aircraft. This is called the fleet lien. If all relevant charges owed by the airline to that airport or the CAA are not paid, then the airport or the CAA can proceed to sell the aircraft after 56 days. In other words, English law allows an aircraft to be sold by an airport or the CAA for the debts of another aircraft if both aircraft are being operated by the same person.

In the Thomas Cook insolvency, in some cases detention notices were posted on the aircraft operated by Thomas Cook very promptly following the initial announcement of the filing of the insolvency proceedings, and in some cases even beforehand, based on the rumours that were circulating. Whether an airport is able to do this will depend very much on the terms of its contract with the airlines, and whether the airline is already in default of any payments at the time that the detention notice is posted. The detention notice, if posted prior to the termination of the lease, may mean that the airport or the CAA will be able to impose the broader fleet lien, with the consequence that the aircraft owner may need to pay off the broader debts of the airline before getting its aircraft back.

This is the reason why lease termination notices should be served promptly – once a lease has been terminated, the airline will cease to be the operator of the aircraft and as a consequence, the airport / CAA will only be able to detain that aircraft for the outstanding charges for that specific aircraft, and not for the outstanding charges of other aircraft within the fleet.

If the UK fleet lien, or any equivalent in another jurisdiction, does apply, creditors may need to consider paying the charges owed by the insolvent airline in full in order to be able to secure the release of its own aircraft. This will ultimately be a commercial decision, but in practice, sets of creditors will likely be in contact with each other and agree to split the payment of charges in an equitable manner in order to recover their own respective aircraft.

The Cape Town Convention

A full Cape Town Convention analysis should be undertaken in respect of the relevant lease or loan portfolio. It should be clear as to what international interests have been registered on the International Registry and whether there are any IDERAs in place which can be used either as an aide or a principal means of repossession of aircraft. Different jurisdictions may have different outcomes – for example, in the Avianca Brazil bankruptcy, IDERAs had been filed and were used during the course of repossession of aircraft, but the whole process took longer than expected.

Effect of COVID-19 on Repo Efforts

Notwithstanding the above, one important matter to highlight in respect of any repossession efforts in connection with airline insolvencies during the COVID-19 crisis is how worldwide travel bans and lockdown arrangements will affect such efforts.  For example:

• Will a creditor be able to get its team lined up in the relevant jurisdictions to be able to access and maintain the aircraft, or will local resources need to be utilised for these purposes?
• Will the airports be open for access?  Airports are struggling almost as much as airlines through this current crisis with many airports shutting, operating on reduced capacity and furloughing staff.  Will the technical teams even be able to access the aircraft in order to inspect, maintain and remove them?
• If ferry flights are needed to move aircraft to more convenient places for storage purposes, will these be permitted?  Will there be sufficient crew available to operate such flights?
• If the aircraft are not able to be accessed or removed, what impact does this have on the parking charges?  Would airports consider that these continue to accrue?  If they can’t be paid, does this get taken into account for the purposes of the time period before which an airport can sell the aircraft under its detention rights?  Is that equitable?
• Will the relevant aviation authorities be able to (a) deregister the aircraft from the existing registry, and/or (b) register the aircraft in any new registry?  As at the date of this article, a number of aviation authorities were either operating on substantially reduced staffing levels or had shut for a period of time.

All these types of issues will need to be taken into account during the current circumstances and will make the process more complex. 

US Chapter 11 Proceedings

The above discussion can be contrasted to the position in the United States where it is common to see airlines file Chapter 11 proceedings, leading to a restructuring of the airline rather than enforcement and repossession of aircraft.

The general position for a debtor under the US Bankruptcy Code is that upon such a filing, there is an automatic stay, which will result in a secured creditor being prevented from repossessing its collateral, provided that such collateral is adequately protected during the stay. Therefore, provided the debtor is able to make payments or provide other adequate protection, the debtor will be able to keep possession of its assets whilst it pursues an orderly reorganization of the company. Automatic termination rights contained in leases and other contracts upon the occurrence of an insolvency of the debtor are generally prohibited from being enforced.

However, in respect of aircraft equipment, the automatic stay lasts only 60 days. For the automatic stay to continue past 60 days, the debtor-in-possession must either: (1) agree to perform all of its obligations under the relevant lease or (2) agree with the lessor to extend the stay past 60 days. If the debtor-in-possession chooses the first option, then any defaults (pre- or post-filing) must be cured by the 60th day after the filing. If the debtor-in-possession fails to have performed its obligations and cured any defaults at the end of the 60-day period, and no extension is agreed in respect of the same 60-day period, then the automatic stay will terminate and the creditor will be permitted to exercise its enforcement and repossession rights.

Therefore, when entering into Chapter 11 proceedings, an airline may elect which aircraft leases it wants to assume, and which it does not. This may be a decision that is taken immediately, or it may be taken during the 60-day automatic stay period (provided the airline has agreed to perform the obligations mentioned above).  

Summary

As indicated above, it is essential that creditors are able to act swiftly upon the occurrence of an airline insolvency in a repossession scenario so as to avoid aircraft and engines being detained or caught up in fleet liens. Organisation is key – a creditor should make sure that it knows where all of its assets are, including any off-wing engines, and ensure that it can, if possible, get the relevant technical teams in situ quickly and easily, which will involve liaising with airports, potentially around the world (something that may prove to be difficult in the COVID-19 circumstances and may require the use of local resources). The longer an aircraft or engine is sat at an airport or maintenance facility without access, the more its condition deteriorates, and the more expensive it becomes to release the asset from any charges accruing. A creditor should also be alive to the detention and lien rights afforded to relevant players in the local market.

View all of our COVID-19 perspectives here. Contact a member of our COVID-19 Legal Task Force here.