UK: How Would Proposed Changes To The UK's Airline Insolvency Regime Affect Aircraft Financiers And Lessors?

Last Updated: 16 July 2019
Article by Alexander Hewitt and Hayley Çapani

Background

English law, including English insolvency law, is very pro-creditor. So pro-creditor that British Airways was able, in 2013, to raise over $900 million for aircraft purchases in the US capital markets via an EETC issue even before the UK had adopted the Cape Town Convention. Usually, investor insolvency law concerns prevent airlines doing EETCs if they are in non-US states that have not incorporated the Cape Town Convention and its Alternative A insolvency regime into their domestic laws – something the UK later did in November 2015. When Alternative A then became part of English law, the rights of financiers and lessors under affected transactions to repossess mortgaged or leased aircraft rapidly in an insolvency of a UK airline became even more robust. Just two years later, however, Monarch Airlines collapsed. The resulting need to fly home 110,000 stranded passengers at a cost to the UK tax payer of around £60 million led to a review of UK airline insolvency laws. On 9 May 2019, the Department for Transport published its Final Report on the Airline Insolvency Review (the AIR). If adopted, will the changes the AIR proposes weaken the position of financiers and lessors seeking to repossess aircraft from insolvent UK airlines?

The current position

When an airline goes into UK insolvency proceedings, the airline has up 60 days (the waiting period) to hand its mortgaged or leased aircraft that come within Alternative A (Affected Aircraft) back to their respective mortgagees or lessors (its Aircraft Creditors) or:

  • cure all defaults under its agreements with its Aircraft Creditors (other than being in insolvency proceedings) and preserve and maintain the value of their Affected Aircraft; and 
  • undertake to comply with those agreements in future – with any breach of this undertaking entitling its Aircraft Creditors to repossess immediately without a court order. 

This is so even if the airline is in English administration proceedings, which contain a moratorium on creditor enforcement action.

However, almost all UK airline insolvencies produce an immediate collapse of the airline. So an Aircraft Creditor will almost never have to wait 60 days to repossess Affected Aircraft in a UK airline insolvency. Before Alternative A became English law, this was partly because the UK Civil Aviation Authority (the CAA) would ground the insolvent airline's fleet. Once Alternative A had become part of English law, it imposed an obligation on airlines retaining Affected Aircraft during the waiting period to preserve and maintain the value of those aircraft. For reasons discussed in this article, that obligation is hard to fund, discouraging attempts to rescue the airline and favouring immediate liquidation instead. 

The AIR proposals

These include: 

  • changing the UK insolvency regime for airlines to make flying passengers back to the UK the first priority in an airline insolvency; and
  • creating a Special Administration Regime (SAR) for airlines. The SAR would enable airlines to operate in administration for a short period to fly home stranded passengers, prioritising this over duties to any other creditors. The SAR would also provide the CAA with greater oversight over financially distressed airlines before and in insolvency proceedings, a new regulatory toolkit and the flexibility to allow insolvent airlines to continue to fly their aircraft during repatriation operations.

Assessing the AIR proposals

Interplay with Alternative A

While Alternative A is very popular with aircraft financiers and lessors, on the face of it, the new SAR is at odds with Alternative A. However:

  • the period in which Affected Aircraft might be used to repatriate passengers would usually be over within two weeks of the airline going into a SAR, which is well short of the UK's 60-day Alternative A waiting period; and
  • the AIR appears to suggest that Alternative A would take precedence over the AIR reforms.

However, any uncertainty over an Affected Creditor's rights on insolvency could negatively impact the market. So it will be important to check this point in any draft legislation that comes out of the AIR. 

Reduced funds for creditors

Whilst the Flight Protection Scheme (discussed below) has been devised to ensure consumers meet repatriation costs, if the insolvent airline itself incurs any costs these will come out of the limited pool of assets that are available for secured and unsecured creditors, including Aircraft Creditors. This should not usually cut across Aircraft Creditors' rights to the return of their Affected Aircraft under Alternative A, but may eat into any remaining assets the airline has to meet its other liabilities to its Aircraft Creditors and others. 

In addition, under the AIR proposals, following the repatriation exercise, Aircraft Creditors will have the right to choose the destination to which they require their aircraft returned. Since repatriation flights would only be run back to the UK under the SAR, the potential need to return aircraft to other countries may increase the complexity and costs of an airline administration.

Preventing detention of aircraft overseas by relying on the Model Law in the event of a no-deal Brexit

The SAR moratorium on aircraft detention will only extend to action taken within the UK. Given that aircraft cross multiple borders on a daily basis, Aircraft Creditors would be keen to ensure aircraft on repatriation flights could not be detained overseas for local law liens. In this situation, the CAA states that the UNCITRAL Model Law on Cross-Border Insolvency (the Model Law) may assist in ensuring the SAR moratorium is recognised abroad.

However, most European states have not enacted the Model Law, relying instead on mutual recognition of insolvency proceedings under the EU Insolvency Regulation (the EIR). If, as seems a definite possibility, the UK and EU do not agree that the UK will continue to be part of a widened EIR regime post Brexit, it is unclear whether reliance on the Model Law would help prevent detention of aircraft on repatriation flights within the EU on an insolvency, when speed and certainty is key.

The Special Administration Regime

SARs in other industries, banking for example, have been effective in changing the primary objectives of administrations. However, the airline SAR will only last until the repatriation exercise is complete – which is expected to take about two weeks. It will then convert into a standard administration. For reasons discussed above, that administration may then immediately become a liquidation. 

Funding

A repatriation operation would incur significant costs and carry substantial (potentially uninsurable) risks. The AIR proposes that a Flight Protection Scheme cover all repatriation costs. This would be in the form of a 40p per-passenger levy (but set at 49p for the first five years to set up the fund). Critics have pointed out that whilst 40p sounds inconsequential, margins in the airline industry are thin, and ticket prices relatively inelastic. This may have serious implications on airlines' bottom lines.

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