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Currently, when a UK airline enters insolvency, its operations cease, aeroplanes are grounded and passengers are stranded – in part due to the heavy industry regulation and, in part, because of complex aeroplane financing arrangements.

A Clear or Cloudy Flight Path? The UK’s Future Airline Insolvency Regime

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Currently, when a UK airline enters insolvency, its operations cease, aeroplanes are grounded and passengers are stranded – in part due to the heavy industry regulation and, in part, because of complex aeroplane financing arrangements. Any operational continuity enabling the repatriation of passengers would be a loss-making activity likely to deplete the amount of money available to the company’s creditors; a result that would be contrary to the aim of UK insolvency processes in general. This starkly contrasts with insolvent U.S. airlines, all of which have been in U.S. chapter 11 bankruptcy and continued their operations until restructured. The UK government proposals for reform would introduce very different systems for airlines.The recent and notable insolvency of two UK airlines includes the administration of Monarch Airlines in 2017, which required the repatriation of approximately 110,000 passengers at a cost of £60 million, and the compulsory liquidation of Thomas Cook in 2019, which required the repatriation of approximately 150,000 passengers at a cost of approximately £100 million. In both cases, the repatriation of passengers was funded by the UK taxpayer and through the Air Travel Organiser’s Licence (ATOL) scheme. The administration of Monarch Airlines generated an appetite for a review of airline insolvency by the UK government’s Department for Transport.The final report on the airline insolvency review (AIR) was published in May 2019. The AIR makes recommendations, including the introduction of a:1. Special Administration Regime for airlines (SAR) that enables airlines to keep flying for as long as required to repatriate passengers;2. Flight Protection Scheme, a formal repatriation regime funded by consumers at the point of sale in the form of a passenger levy (expected to be approximately 49 pence for the first five years, dropping to around 40 pence thereafter); and3. Regulatory “toolkit” for the Civil Aviation Authority (CAA), the UK’s aviation regulation, which, among a number of oversight measures that monitor an airline’s financial health, allows the CAA to issue a temporary licence. The temporary licence will allow an airline to operate aeroplanes to repatriate customers. In January 2020, the UK airline Flybe appeared to have delayed its possible insolvency by making a deal with the government to delay tax repayments. This news, together with the recent compulsory liquidation of Thomas Cook, highlights the need for the implementation of a new insolvency regime for airline insolvencies. The AIR proposes recommendations for an innovative airline insolvency regime; however, at a point before legislative implementation, that new regime will cause uncertainty as to its effect on creditors, who could see reduced proceeds in the event of insolvency.This alert is relevant to airline companies in financial distress and their directors and creditors (in particular lessors and lenders), as well as insolvency practitioners.<h4>THE CURRENT REGIME: THE CAPE TOWN CONVENTION AND ALTERNATIVE A</h4>The aeroplanes used by UK airlines are either leased or mortgaged to lenders. These leasing arrangements and/or financial security packages add a layer of complexity that requires consideration in the event of an insolvency.The Cape Town Convention (and its related Aircraft Protocol) (the “Cape Town Convention”), is an international treaty that was made part of the UK’s domestic law in 2015. The Cape Town Convention alters the restrictions on certain creditors on their enforcement of aeroplane security and leases. In a regular adminstration, creditors (including lessors) are bound by a moratorium preventing them from taking any legal action. “Alternative A” is a regime introduced by the Cape Town Convention. Under Alternative A, when an airline has entered into a UK insolvency process, the airline must before the end of a 60 day waiting period (the “Waiting Period”) return the leased or mortgaged aeroplanes to the relevant creditor (the “Aeroplane Creditor”), or cure all defaults (other than the entry into the insolvency process), preserve and maintain the value of the relevant aeroplane, and undertake to perform all continuing obligations under the relevant agreement. At the end of the Waiting Period, the Aeroplane Creditor may repossess the aeroplanes, as any administration moratorium, preventing the enforcement of security or repossession of the leased aeroplanes, ceases to apply. Alternative A means that the continuation of trading during administration is, for practical purposes, unachievable for airlines in a UK administration.<h5>Administration or Liquidation?</h5>It is rare for any Aeroplane Creditor to wait until the end of the Waiting Period to repossess its aeroplanes, as the majority of UK airline insolvencies result in an immediate collapse of the trading business. Also, on insolvency, the CAA revokes an airline’s operating licence, grounding its aeroplanes. With the operation of Alternative A, airlines must, as described above, preserve and maintain the value of the relevant aeroplane during the Waiting Period. This is an obligation that is financially burdensome and often, coaxes an airline to proceed with a timely liquidation as opposed to an attempt to rescue.<h4>SAR</h4>The SAR, proposed by the AIR, has as its central aim the repatriation of stranded passengers, not the continued operation of the airline until a sale or restructuring. The SAR will allow an airline to continue operating for a period sufficient to repatriate passengers. To enter into the SAR, the financially stressed airline must provide 14 days’ notice to the Secretary of State for Transport of its intention to either enter into administration or seek a winding-up order. The notice period, in essence, gives the CAA time to ‘gear up’ for the airline’s failure.The AIR recommends that the SAR should, among other recommendations, be designed to:1. include a moratorium on creditor action, both during the 14 day notice period and the repatriation of passengers;2. provide a grant, loan or indemnity for the insolvency practitioner (appointed administrator or liquidator) to do his or her job; and3. control creditor action – e.g. the insolvency practitioner should have the power to dismiss liens in overseas jurisdictions, which may result in the detention of an aeroplane.Once SAR has fulfilled its primary objective of passenger repatriation, the SAR process will switch to normal administration.<h4>PROBLEMS</h4><h5>Concerns about the SAR</h5>To keep an airline running, the cooperation of numerous parties, including the airline’s creditors (among others, including lessors, lenders and trade creditors) is required. These parties will have little incentive to assist the airline if they are unlikely to be paid. In the case of other ‘special’ administration regimes, for example in the rail industry, suppliers that are required to facilitate the continuity of service are, in effect, given ‘super-priority’ payments, either by advance payment, or by assurances that they will be paid as ‘expenses of the administration’.Currently, Aeroplane Creditors have a right to repossess their aeroplanes, even where there is an insolvency moratorium in place (see The Current Regime: The Cape Town Convention and Alternative A). The SAR does not appear to oblige the Aeroplane Creditor to allow an airline continued use of their aeroplanes for the purposes of repatriation. Consequently, if the airline requires use of the aeroplanes, the Aeroplane Creditor would need to agree to not: (a) repossess the aeroplanes, and/or (b) terminate the agreement. The Aeroplane Creditors are given a ‘ransom’ power.It is yet to be seen how significant the effect of implementing SAR will be on Aeroplane Creditors. To assess any changes to the rights of Aeroplane Creditors, careful consideration will need to be given to the precise wording of the draft legislation giving effect to the SAR.<h5>Reduced Funds Available for Creditors</h5>In addition to ‘priority’ payments of certain creditors who assist in the repatriation of passengers, which will be seen as ‘expenses of the administration’ (see Concerns of SAR), there remains a risk that the Flight Protection Scheme will not cover the cost of repatriation. Any surplus costs would essentially, be an expense of the administration. Together, these expenses would deplete the pool of assets available for distribution to other creditors. If creditors perceive that the cost of repatriation will be significant, they will be deterred from lending to airlines. The risk of not receiving their money back in the event of an insolvency has increased. Airlines are likely to end up paying more in financing costs, which may, in turn, cause more airlines to become financially stressed.<h5>Cross-Border Recognition</h5>A difficulty may arise in ensuring that the SAR moratorium is observed by non-UK creditors. The Recast Regulation on Insolvency Proceedings 2015 provides for mutual recognition and cooperation between the EU and the UK, as such, a moratorium in force in the UK would apply automatically in the EU member states. UNICTRAL Model Law on Cross-Border Insolvency (the “Model Law”) would assist in other jurisdictions that have implemented the Model Law by providing for recognition in these countries.<h5>No-Deal Brexit</h5>In a no-deal Brexit scenario, EU regulations will cease to apply to the UK, which will be considered a third-party state. Accordingly, there will not be automatic recognition of a UK insolvency moratorium in the majority of the EU member states. There are also only few EU member states (Greece, Poland, Romania and Slovenia) that have adopted the Model Law, which would make the principal of mutual recognition more uncertain in non-implementing jurisdictions.<h5>Insolvency Practitioners – Grant, Loan or Indemnity</h5>As the primary aim of SAR is the repatriation of passengers, insolvency practitioners will require comfort that they will not incur personal liability where some additional debt is incurred while facilitating repatriation, or they will not take appointments. To combat this risk, the AIR suggests that the Secretary of State for Transport could have the power to provide the insolvency practitioner with either a grant, loan or indemnity.<h5>State Aid</h5>State aid is as an advantage in any form whatsoever conferred on a selective basis to undertakings by national public authorities<a class="anchor" href="#_ftn1" name="_ftnref1" id="_ftnref1">[1]</a>. In scenarios where airlines have continued to operate throughout an insolvency process (examples include: AirBerlin and Alitalia), there has been a degree of government funding<a class="anchor" href="#_ftn2" name="_ftnref2" id="_ftnref2">[2]</a>. Briefly, where government funding has been provided, the two key questions that arise are: (1) whether the funding amounts to state aid, and (2) whether the state aid has been approved by the European Commission. If funding is considered state aid and has not been approved by the European Commission, that funding would constitute unlawful aid. The recent financial distress of Flybe has re-sparked the debate on state aid. There has been a complaint made by Flybe’s competitors that the assistance Flybe has received constitutes state aid.<div data-type='hr' style='border-top: 3px solid #bbb'></div><a class="offset" href="#_ftnref1" name="_ftn1" id="_ftn1">[1]</a> <a href="https://ec.europa.eu/competition/state_aid/overview/index_en.html">https://ec.europa.eu/competition/state_aid/overview/index_en.html</a>.<a class="offset" href="#_ftnref2" name="_ftn2" id="_ftn2">[2]</a> “Airline Insolvency Review: A call for evidence”, R3 Response.

A Clear or Cloudy Flight Path? The UK’s Future Airline Insolvency Regime

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Howard Morris

Senior Of Counsel

Business Restructuring + Insolvency