The United States Chapter 11 reorganization, which is the court supervised restructuring of a company’s business and financial obligations, has become the benchmark for comprehensive restructurings. Over the last forty years, it has become a tried and tested process. In spite of the associated costs and inconvenience, Chapter 11 has proved a strategic tool that can be used to drive benefits to people across the aviation industry by enabling businesses to reduce debt, rationalise their operations and find new capital.
The threshold for foreign companies to commence a bankruptcy case in the US is low. Non-US companies only need to have “minimal assets” in the United States to file Chapter 11 proceedings. US court decisions associated with admission to the bankruptcy courts have allowed as little as a bank account and an undrawn law firm retainer to suffice.
In the United Kingdom, the alternatives to Chapter 11 are schemes of arrangement and restructuring plans. These processes are statutory procedures that allow a company to agree an arrangement with its creditors. Two key differences between the US Chapter 11 and the UK processes are the extent of court involvement and the US “automatic stay”, which is discussed further below. Chapter 11 is a court driven process that takes place inside a moratorium, which gives the debtor breathing space. The UK options do not bring a moratorium with them, and the debtor’s negotiations with its creditors take place on an ad hoc basis outside of the courts. The restructuring plan or scheme of arrangement is then used to bind creditors into the agreement.
A powerful tool for debtors in the UK restructuring plan (as compared to the scheme of arrangement) is the ability to cram down dissenting classes of creditors. In an airline context, this allows a debtor to structure a plan with multiple classes of stakeholders. If there is one supportive class, the debtor can impose an outcome on all the other classes, provided that the dissenting classes are not worse off than they would be in the event of the “relevant alternative”, which depends on the facts but is typically insolvency.
An important protection that Chapter 11 provides to debtors is the automatic stay. Once a debtor files a Chapter 11 petition in a US bankruptcy court, an automatic stay is imposed, prohibiting judgments, collection activities, foreclosures, repossessions of property and other actions by creditors to recover on a claim that arose before the bankruptcy filing for the duration of the stay. While purporting to have worldwide effect, this protection is subject to a practical limit: the automatic stay often can only be enforced effectively against companies with US assets or other connections to the US. However, a creditor with any connection to the US will usually be concerned about taking any action that will violate the automatic stay. In addition, the debtor might seek recognition of the US proceedings (and the automatic stay) in other jurisdictions.
Additionally, a Chapter 11 debtor can choose whether to assume, assume and assign or reject its contracts and leases. Debtors can use this power to unburden themselves of onerous or unprofitable agreements, or gain value by transferring under-market agreements to third parties who are willing to pay additional amounts. In an aviation context, this Chapter 11 feature gives the debtor the flexibility to conduct and implement fleet rationalisation. The debtor can also negotiate improved terms with its lessors on the aircraft that it does want to retain.
Under section 1110 of the US Bankruptcy Code, in order to retain the protection of the automatic stay, a debtor that holds a US Air Carrier Operating Certificate must, in general, cure defaults and perform ongoing obligations in respect of a lease of aircraft equipment by the 60th day after its bankruptcy filing. The US has not adopted the optional Cape Town Convention provisions which address the consequences of airline insolvency, which means there is, at least arguably, a gap in the law for non-US air carriers. A US bankruptcy court, however, may be willing to give aircraft lessors and creditors who seek relief from the automatic stay rights to exercise remedies in accordance with the Cape Town convention, so foreign airlines in Chapter 11 should be prepared to decide whether to assume or reject their leases within 60 days of filing.
Other benefits of Chapter 11 for debtors include management remaining in control of the debtor company absent fraud or gross mismanagement, and debtor-in-possession (“DIP”) financing. These features of Chapter 11, which are explored in more detail below, help to keep a business as undisrupted as possible during the bankruptcy case, so the debtor can safely negotiate with its creditors while operating its business in the ordinary course.
Under the US Bankruptcy Code, third parties do not have to continue to lend money to a debtor who has filed for Chapter 11. However, the company operating in Chapter 11 can obtain DIP financing. This is usually provided by the incumbent lender, but there will often be competition from other parties. The debtor must demonstrate to the court that it has got the best possible price for the DIP financing. Parties are willing to provide DIP financing in return for benefits such as preferred interest rates, certainty of payment and super priority liens that protect the lender in the event of the debtor’s liquidation. There will often be origination fees and exit fees on these short-term loans, and extensive protections for the lender, including by setting case milestones, in the bankruptcy court order approving the financing.
In recent Chapter 11 airline cases, airlines have been focused on finding DIP lenders with a vested interest in the airline emerging from bankruptcy, as a result of the uncertainty during Covid about whether airlines would emerge from the Chapter 11 process. DIP lenders can be active members in a Chapter 11 case: some DIP lenders have negotiated the right to receive or purchase rights to an equity position in the reorganised debtor. For example, DIP facilities with an equity conversion feature were used in the Chapter 11 processes for Avianca, Aeroméxico and Scandinavian Airlines. Before Covid, it was very unusual to see an equity conversion in a DIP facility. Going forward in a more normal environment, it is uncertain whether judges will continue to approve equity conversion features in DIP financing.
The UK insolvency processes do not incorporate the concept of DIP financing (though often DIP-like structures can be put in place). Across Europe, different jurisdictions have been implementing processes similar to Chapter 11 that include an element of the automatic stay and a DIP option since 2019. However, these are new and untested processes that rely on interpretation by local courts, which makes them unsuitable for airlines looking for certainty as they enter negotiations.
There are inevitable negatives for companies entering the Chapter 11 process. Bankruptcy cases tend to involve lots of professional advisers, which can be expensive. There are detailed disclosure requirements which the debtor can perceive as burdensome. Unexpected downturns in a market can make it difficult for a debtor to refinance a DIP or meet a milestone.
Despite these drawbacks, debtors have realised significant savings through Chapter 11. Aeroméxico achieved total savings of $605 million, while LATAM Airlines published $1 billion in savings. However, it is worth noting that airline creditors, labour and other counterparties were particularly willing to negotiate given the challenges facing the aviation industry during the Covid pandemic, whereas companies filing for Chapter 11 in the current climate may find extracting concessions more difficult.
Authored by David P. Simonds, Alex Kay, Avital Cano, and Frederik Vescio.
