The coronavirus (COVID-19) pandemic has unleashed significant uncertainty in the global markets, which is expected to lead to distress and insolvencies across a number of industries, with the airline industry being one of the first to fall victim. Whilst the airline industry is susceptible to business failures given its sensitivity to a wide range of factors, from political instabilities, fuel prices to natural disasters and terrorism, arguably the threat from the coronavirus pandemic is unprecedented. Airline insolvencies are complex, multifaceted, cross-border operations with many variables. This article looks at some of the survival strategies that airlines may use to try to overcome and manage these turbulent times in circumstances where their operations have not completely grounded to a halt. A number of airlines are proposing to completely ground their entire operations and we plan to circulate a separate article on the options in such circumstances.
Airlines will assess engaging in aggressive (i) operational restructuring, targeted at, among others, re-aligning their business plans, cost structure and operations, and (ii) debt restructuring and liability management, involving the reorganisation of their capital structure, resolution of liabilities, and renegotiation or termination of onerous contracts. These initiatives may be pursued on a consensual basis with stakeholders or within formal insolvency proceedings.
Operational restructuring involves various initiatives such as cost cutting, cash management, route and fleet review, management enhancement, corporate reorganisation, and consolidation.
Cash management and cost cutting: One of the critical survival factors for an airline is its ability to profitably match supply with demand. Supply is largely within the control of an airline subject to certain constraints. On the other hand, whilst an airline can possibly influence demand, it cannot control it. Demand for airline services is dependent on demand for other products. Passengers take a flight not for the benefit of the flight itself, but rather to fulfill another purpose - travel to a destination for business, leisure or some other reason.
Cash is king for any distressed business, but this is even more so for an airline due to the high cash burn in running operations. Moreover, the extended value chain of an airline business not only creates many opportunities for cash leakage, it also creates room for hold-out creditors to seek leverage. It is therefore imperative that robust cash management and conservation plans are in place.
Closely related to cash management is cost cutting. The key airline management objective must be to reduce costs when unprecedented events cause such a decline in demand. It involves identifying cost centres where savings are possible, usually a very thorough process must ensue if the full benefits are to be reaped. This normally starts with some degree of headcount reduction albeit in the current circumstances, the coronavirus poses a challenge because management will also have to make an allowance for staff attrition due to poor health. Other significant costs usually relate to aircrafts, maintenance, fuel, ticket distribution etc.
Routes and fleet review: The airline's route plan and fleet plan are interconnected. Ultimately specific aircraft are required on particular routes. A review of the airline's routes can be undertaken with a view to identifying the profitable and nonprofitable routes, and the poorly performing routes abandoned. In addition, a review of passenger load factor often takes place to determine the utilisation of each aircraft. The airline may seek to terminate the leases for some of the aircraft it no longer requires early and return them to lessors. This comes with added liabilities including early termination compensation and compliance with the aircraft return conditions. The aircraft lessors need to be engaged with a view to securing their collaboration. In the context of the global pandemic, we have seen unprecedented "lockdowns" and closing of borders of entire nations. At the time of writing this article, it is unclear how long these measures will remain in place, or what the situation may be even after they are lifted. There may therefore be a strong case for being proactive and closely reviewing the terms of debt and liabilities (current and future) to understand what the options are.
Restructuring advisers often take the view that nothing is cast in stone and everything is potentially subject to renegotiation with the ultimate objective of facilitating the survival of the airline. The key is to identify the "win-win" positions in these circumstances.
Management enhancement: The existing management is often unlikely to have the resources, time or know-how to execute a stabilisation or turnaround strategy while at the same time also continuing the day-to-day running of the business. The Board is responsible for evaluating the management resourcing needs and what further support may be required. For example, a chief restructuring officer may be considered to assist the management team with some of the day-to-day firefighting. Similarly, a cash manager may be considered to assist with executing a cash management and conservation plan.
Corporate reorganisation: A part or full reorganisation of the airline's corporate structure may be required to enhance and optimise operational efficiency and facilitate new money investment. We saw this with Malaysia Airlines, where a new airline "Malaysia Airlines Bhd" was created. The transition meant that the previous legacy-laden airline company was left behind, and a new (and leaner) company emerged. Splitting an ailing company into two is not unusual or novel. It helps to isolate the loss-making and indebted parts from the debt-free, lean and profitable operations, giving the company a reasonable chance of survival. Thought should be given to operational aspects and long-term sustainability when implementing this type of structure and, in particular, the licenses such as the AOC.
Consolidation: Airline consolidation refers to the merging of airlines in order to benefit from, among others, the efficiencies of scale, reduced competition, increased purchasing power and to maximise revenue. This has been successfully used in the US following a spate of bankruptcies. The US now has four major airlines, United Airlines, Delta Airlines, American Airlines and Southwest Airlines – which control around 70% of the air travel in a country that spans a continent.
Debt restructuring and liability management
The high cost structure of the airline business, aggravated by the effects of the coronavirus, will inevitably lead to accumulation of significant domestic and cross-border debts and liabilities. The ability to manage such debt and liabilities on an international scale is critical. Preferably this is achieved on a consensual basis and if it fails, the use of an insolvency process may be explored as a tool of last resort. A critical success factor in any debt restructuring and liability management exercise is the simultaneous application of multiple strategies at the same time, such as those outlined below.
Standstill: In a consensual resolution, the creditors can be persuaded to refrain from taking any adverse action for a period of time in order to give the airline some breathing space to find a solution. In practice this can be complicated, especially when dealing with creditors who have sufficient leverage to disrupt the operations of the airlines such as the aircraft lessors or fuel suppliers. It all comes down to negotiation skills including finding win-win solutions that are workable for the relevant
Creditor classes: For the purposes of facilitating negotiations with creditors, the airline may group them into appropriate "classes" in line with the similarity of their rights or claims, and in turn prepare compromise proposals for each class. This promotes some form of fairness in treatment. As a broad example, the following classes may exist for an airline business:
- secured creditors (e.g. aircraft financiers, lessors);
- priority creditors (e.g. employees, tax authorities, airport traffic and ground handing);
- trade creditors (who are vital for the operations of the business e.g. catering, fuel); and
- unsecured creditors.
Debt reduction through compromise: Distressed airlines should not shy away from engaging with creditors to achieve a debt reduction through a compromise. In our experience, if properly advised and with the right approach, a distressed airline can often secure a compromise with at least the majority of its creditors. Creditors faced with a distressed airline may often have a range of options available to them, and will weigh the likely outcomes from the options and pursue what they believe best optimises their recovery/returns. Creditors, particularly those which are unsecured, may be wary that their actual recovery in a liquidation scenario will likely be significantly diminished. Creditors also have other considerations, such as reputational risk and long-term relationships, which the airline or its advisors have to tap into when formulating compromise proposals. This is an art, and engaging the right advisors is key. If the creditors are poorly managed, this can lead to the quick or premature demise of the airline.
Renegotiation of financing/leasing terms: This includes renegotiation of the terms of the financing and leasing agreements such as reduced interest rates, reduced lease rates or maintenance reserve rates, extension of maturity dates, reset of covenants, waiver or suspension of events of default/other breaches, clean-up periods to allow defaults to be cured, to name a few. The objective of the airline is to realign its obligations with its cash flow. The lender/lessor may agree to the renegotiated terms in return for a strategic benefit. This may be to avoid the inconvenience, obstacles and value destruction associated with enforcement, or for a consent fee, or to support the continuing survival of the airline for future business. Therefore, the key is to identify what the particular strategic benefit is in each situation.
Debt-to-equity swap: The debt-for-equity swap entails certain of the financial creditors discharging indebtedness owed to them in exchange for one or more classes of the airline's shares. In order for the participating creditors to agree to a debt-to-equity swap, they need to buy into the future business plan, the strategic plan and the prospects of the airline.
Debt-for-debt swap: This involves exchanging some of the existing indebtedness for new debt instruments at revised terms and more sustainable repayment profiles.
Deferral of payments: The airline may explore deferral of debt payments or some other form of amortisation of existing liabilities. Creditors may agree to a deferred payment structure, in order to begin to see some return and repayment on the debt.
New money: Many restructurings will require the injection of new capital, without which the restructuring is unlikely to succeed. Success in acquiring new sources of funding will depend on how attractive the restructuring proposition is, including the business plan. Investors in distressed companies tend to look forward, not backward. In other cases new money may be raised from the disposal of non-core assets. For example, in 2016, Kenya Airways was reported to have sold its premium 5:30am Heathrow landing slot for USD75 million; and Norwegian Air used its Gatwick slots (valued at around USD 380m) as collateral to help restructure its bonds in December 2019. State-owned airlines may able to turn to their respective governments for bailouts. In the wake of the coronavirus pandemic some governments may also opt to bail out privately owned airlines. Full or partial privatisation is often a part of the scenario when the government provides additional funds to help turn around its national airline - this allows it to quickly recoup its investment. An example of this is Air France, which used government bailout to effect its turnaround before achieving a part privatisation followed by a listing on the Paris stock exchange.
Use of an insolvency process
In some cases it may be impossible to achieve a resolution of the debt and liabilities without the assistance of an insolvency process. Historically, there has been somewhat of a stigma attached to filing for insolvency or bankruptcy, particularly in certain countries. Another factor is that the legislative framework in some countries may not yet be sufficiently developed to facilitate business rescue or restructuring. Instead, these jurisdictions generally facilitate some form of liquidation or wind-down.
Airlines in distress are encouraged to consider all options, and explore formal restructuring relief under local insolvency laws, if such regime exists, or alternatively, ascertain whether relief may be available internationally. Globalisation is increasingly making it possible for companies to be flexible regarding which jurisdiction they choose to file for insolvency (subject, of course, to there being sufficient connection to the relevant jurisdiction - however, given the international nature of airline businesses, this is not usually a difficult test to meet). An appropriate insolvency framework has various tools such as, among others (a) triggering a moratorium i.e. the ability to stay or prevent creditor action against the insolvent or bankrupt entity; (b) facilitating improvement in the cost structure by negotiating reductions in debt, or expunging certain onerous contracts; (c) facilitating recapitalisation or new money, potentially from new sources, as priority funding (or super-senior) over existing debt or liabilities; and (d) facilitating cram-down of hold-out creditors in relation to any restructuring proposals.
As an example, the US arguably has one of the more developed insolvency frameworks for business rescue or turnaround under Chapter 11 of the U.S. Bankruptcy Code. Given the cross-border nature of the airline business, where local law cannot facilitate a turnaround, a filing of proceedings under Chapter 11 of the U.S. Bankruptcy Code may be worth exploring. A filing under Chapter 11 can offer the full benefits of the U.S. Bankruptcy Code and in particular the worldwide “automatic stay” against collection and seizure of assets “wherever located”. In recent years foreign airlines such as Colombian airline, Avianca, have used this approach. In order to access the US Bankruptcy Courts the foreign airline must prove a connection to the US, but the threshold is low; for example, a bank account in the US may suffice. Other forums such as the UK can be explored. English regimes, such as schemes of arrangement or administration have proved to be of interest to overseas companies. The use of the foreign forums is not without legal risk or drawbacks. For example the issues surrounding politics and the enforceability of decisions handed down by a foreign court in the debtor's home country (or where the creditors reside, or where assets may be located) must also be carefully considered.
International insolvency practice, including the UNCITRAL Model Law on cross-border insolvency, has further increased options for insolvency routes which are worth exploring. For example, in order to optimise restructuring through the use of insolvency law, it is possible to conduct parallel local and international insolvency proceeding. Recently the Italian airline, Alitalia, filed for Chapter 15 bankruptcy protection in the US in order to protect its US assets, in addition to extraordinary administration proceedings in Italy.
Finally, there are instances where the existing laws of an airline’s home country are simply inadequate to facilitate a restructuring. In some cases it may be possible for the government to pass a special resolution regime targeting the restructuring of a company which is of national significance.
The views expressed herein are solely the views of the author and do not represent the views of Brown Rudnick LLP, those parties represented by the author, or those parties represented by Brown Rudnick LLP. Specific legal advice depends on the facts of each situation and may vary from situation to situation. Information contained in this article is not intended to constitute legal advice by the author or the lawyers at Brown Rudnick LLP, and it does not establish a lawyer-client
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