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Navigating Turbulence: a comparative analysis using GARI of Chapter 11, UK schemes and domestic procedures12 August 2024

With many airlines having weathered the storm of the Covid-19 pandemic, one common theme with airline restructurings has been a clear reliance on the United States’ Chapter 11 bankruptcy proceedings – particularly over their domestic jurisdictions or other viable jurisdictions (such as a UK scheme of arrangement or UK restructuring plan). But when seeking to restructure, why have many airlines tended towards Chapter 11 bankruptcy proceedings as an internationally recognised restructuring procedure and shied away from the UK schemes?

Using Watson Farley & Williams’ Global Aviation Resource Index (“GARI”), an online tool which allows users to compare data and scores for aviation restructuring procedures, aircraft repossession rights and aircraft deregistration rights in over 100 jurisdictions, we aim to provide some explanation as to why this has been the case.

"DIP financing helps enable the debtor to implement the rescue plan and service its near-term obligations and operating expenses. "

The moratorium: stemming the tide of enforcement

One of the central mechanics of many (but not all) restructuring procedures is the imposition of a moratorium (or the “automatic stay” to use the terminology of the US Bankruptcy Code), which generally speaking temporarily prevents creditors from exercising remedies or taking other actions against the debtor or its owned or leased assets. This grants the debtor valuable breathing room in during critical stages of the restructuring.

The Chapter 11 “automatic stay” is a powerful tool as the US Bankruptcy Code defines the debtor’s ‘property’ broadly, ensuring that the automatic stay extends to its property wherever it may be located. The US bankruptcy court has also historically sought to enforce the stay on an extraterritorial basis and, whether or not it may be legally recognised and given effect in jurisdictions outside of the United States, given the economic influence of the US in international commerce, well advised creditors will not risk violating it. Additionally, the stay is triggered automatically from the filing of the petition to commence Chapter 11 proceedings. For most airlines such as Avianca, LATAM, Aeromexico and SAS, whose operations extend beyond their domestic jurisdiction, this plays a crucial role in the selection. For LATAM, the benefit of the Chapter 11 automatic stay outweighs the power of any moratorium available to it under local Chilean bankruptcy law; although a local moratorium may be broader in scope, actions prohibited by it apply only locally.

In a UK scheme of arrangement, no moratorium is imposed but a relatively more permissive moratorium under a separate standalone procedure can be invoked alongside the scheme and therefore in practice its usefulness is comparatively limited.

Rights and risks: tools to help navigate the process

Unilateral termination of leases

During a restructuring, airlines may need to trim down their fleet of leased aircraft to reduce operational costs on routes which are no longer profitable. Chapter 11 is more debtor friendly in this regard compared to UK schemes and many local procedures in other jurisdictions, as it provides debtors with the power to ‘reject’ unexpired leases to rationalise their fleet. This right would not have been available to Aeromexico, LATAM or Avianca in under any restructuring procedure in their domestic jurisdictions (and was indeed utilised, with Aeromexico’s and Avianca’s emergence from Chapter 11 each resulting in fleet reductions of around 15% and 25%, respectively).

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"Another aspect in which the UK scheme is favourable to the debtor over a Chapter 11 bankruptcy is the associated costs and length of the restructuring process."

Debtor in possession financing

One of the most obvious impacts of the Covid-19 pandemic was, due to the widespread grounding of aircraft and decline in global travel, a reduction in airlines’ liquidity. As a result, the availability of ‘debtor in possession’ (“DIP”) financing under Chapter 11 posed a crucial benefit to airlines. DIP financing helps enable the debtor to implement the rescue plan and service its near-term obligations and operating expenses. In return, a Chapter 11 bankruptcy offers DIP financiers additional protections such as first-priority liens on unencumbered assets, higher-ranking liens ahead of existing liens on encumbered collateral, court approval of the financing terms and stricter controls on the borrower’s use of the funds (the monitoring costs for which are covered by the debtor). Such financing arrangements, whilst possible under a UK scheme of arrangement (and under Avianca’s, LATAM’s or SAS’s domestic procedures), are not generally available because there are no corresponding incentives (outside of what might be contained in the proposed scheme itself) and, consequently, no market for such financing products has emerged in the UK. Both Avianca and Aeromexico emerged with DIP financing, each of which granted DIP financiers with the right to convert their debt into equity.

Voting thresholds and management

When it comes to the final stages of the restructuring plan, an important consideration for the debtor will be the creditor approval thresholds. Chapter 11 proves more advantageous here as the final restructuring proposal must be approved by more than 50% of creditors by number and more than two-thirds of creditors by value, while a UK scheme of arrangement requires more than 50% of creditors by number and more than 75% by value. The need to meet a higher threshold in the final stages of restructuring will make it more difficult for airlines to have the rescue plan approved or sanctioned by the court, as it will need work harder to secure a greater majority of creditor support. Some of the domestic jurisdictions present much more attractive figures in this regard – had Aeromexico or Avianca opted to restructure in their domestic jurisdictions, they would only be facing a requirement for 50% approval from creditors by value (and 50% approval from creditors by number for Aeromexico). However, this is just one factor which is unlikely to singlehandedly drive an airline’s decision towards a different procedure.

One key advantage of a UK scheme of arrangement, however, is that the debtor can select the creditors to which the restructuring applies, whereas Chapter 11 proceedings mandatorily apply to all creditors. Furthermore, under the UK restructuring plan (which is very similar to a UK scheme of arrangement), cross class cram-down is permitted (within the bounds of the Cape Town Convention, where applicable) meaning that approval by all classes of creditor is potentially not required and the restructuring plan can be imposed on one or more classes of creditors in circumstances where the threshold majority in that class did not agree to it. Cross class cram-down, when used aggressively, may not always be effective – Malaysia Airlines turned away from a proposed UK restructuring plan in favour of a UK scheme of arrangement partly due to creditor hostility to a cram-down being used in such manner.

One downside to Chapter 11 is that, while it is commonly referred to as ‘debtor in possession’ (DIP) restructuring procedure, it is only a ‘partial’ DIP restructuring procedure, as some actions required for the continued running of the debtor’s business require court approval, potentially disrupting the debtor’s ability to fully manage its own assets and affairs during what can often be a lengthy restructuring process. The UK scheme of arrangement, meanwhile, offers a wholly DIP process, enabling the debtor to maintain in full control of its business without court supervision of its assets.

Cost and speed: a long-haul slog or short-haul stint

"Chapter 11 proceedings and a UK scheme of arrangement both primarily seek to preserve the debtor, its business and its value, and are internationally recognised restructuring procedures."

Another aspect in which the UK scheme is favourable to the debtor over a Chapter 11 bankruptcy is the associated costs and length of the restructuring process. A Chapter 11 restructuring typically takes significantly longer and tends to be more expensive than a UK scheme of arrangement. While heavily fact dependent, generally speaking the process in the UK can usually be wrapped up much more quickly (typically in 90 days or less against Chapter 11’s lengthier one-to-three-year estimation), and much more cheaply (with estimated costs of US$5-10m against Chapter 11’s estimated costs of US$10-25m). Both Aeromexico’s and Avianca’s Chapter 11 process took around 20 months each to conclude, and SAS’s Chapter 11 process is still ongoing after their initial filing in July 2022. For these airlines, the other benefits (such as the international ‘automatic stay’ and the availability of DIP financing) outweighed the expected timeframe.

Tried and tested

One final point to note is with respect to precedent availability. Although both the UK scheme of arrangement and the Chapter 11 procedure have been available for several years (with both having relevant precedents that relate to the aviation sector), the Chapter 11 procedure has a considerably higher number of cases that relate to the aviation sector. From this perspective, there is a greater level of familiarity with the process (particularly for creditors) which may provide assurance to airlines when selecting an appropriate restructuring procedure.

Perhaps a greater number of high-profile UK schemes of arrangement being implemented (such as the Malaysia Airlines scheme in 2021) will offer greater encouragement for airlines to look to the UK as a viable jurisdiction for restructuring in the future.

Conclusion

Chapter 11 proceedings and a UK scheme of arrangement both primarily seek to preserve the debtor, its business and its value, and are internationally recognised restructuring procedures. The key features of Chapter 11 that are most attractive to airlines include the international applicability of the “automatic stay” and the incentives encouraging DIP financing, resulting in the Chapter 11 route being well-trodden ground for airlines, both domestic and international to file in the US.

Based on figures calculated using GARI, Chapter 11 proceedings emerge with a higher debtor friendliness score (72% compared to 63%) while the UK scheme of arrangement has a higher creditor friendliness score (74% compared to 60%). However, as we have seen with Malaysia Airlines veering away from a UK restructuring plan in favour of a UK scheme of arrangement, pursuing aggressively debtor-friendly measures (particularly those which are untested in the airline restructuring context), can risk putting pressure on an airline’s commercial relationships with its creditors. The most effective debtor-friendly procedures are those which are more balanced.

That said, the speed, cost-efficiency, and flexibility of a UK scheme of arrangement, together with its more surgical, targeted approach towards creditor selection, should not be under-estimated. The lower costs and relative speed associated with a UK scheme allows for greater value preservation of the debtor (and is one reason why UK schemes remain relevant).

Overall, airlines have tended towards the Chapter 11 procedure when seeking to restructure due to its international scope, tried-and-tested nature, and overall debtor-friendliness. However, there are some notable benefits to the UK scheme of arrangement as discussed above. Given that many of the world’s aircraft outside of the Americas are subject to English law governed leases, it may be that European and Asian airlines increasingly look more towards a UK scheme of arrangement or a UK restructuring plan for restructurings (particularly now there are now precedents with Malaysia Airlines and Virgin Atlantic) when assessing what is most suitable for their individual circumstances.

If you are interested in better understanding an airline’s options for restructuring in their domestic jurisdiction against the UK scheme or arrangement or Chapter 11, or if you would like to compare restructuring processes in up to four jurisdictions at once you can access GARI here.

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