Global leisure markets may be in retreat, but at least one form of "tourism" is thriving in the pandemic: bankruptcy protection.

The decision by Latin American carriers Aeromexico, Avianca and LATAM to file for Chapter 11 bankruptcy protection in the USA, rather than their home jurisdictions, is making US bankruptcy courts a global “tourism magnet” for airline insolvencies, says an Airfinance Journal source, speaking anonymously.

This is not the first time that non-US carriers have filed for Chapter 11; Avianca, for instance, filed in 2003 in the aftermath of the 9/11 attacks.

LATAM and Avianca filed in May and Aeromexico did so in July. All three are planning to use the opportunity to restructure while also weathering the storm of Covid-19.

Latin American markets have been impacted by Covid-19-related travel restrictions as much as, if not more, than other continents, with Brazil particularly badly affected by the spread of the virus.

In late May, IATA reported that governments of Latin American countries had provided less financial support to their airlines than those in any other region, with support at that date of $300 million representing 0.8% of their airlines' 2019 revenues.

The reason why non-US carriers prefer to file in the USA has much to do with the rights it affords to the debtor, Mark Moody, partner at Winston & Strawn, tells Airfinance Journal.

“Chapter 11 in the United States has become very popular for non-US airlines seeking to restructure,” he says.

“There are several reasons why the likes of Avianca, LATAM and Aeromexico have recently filed for Chapter 11. Insolvency and bankruptcy laws vary from jurisdiction to jurisdiction; some are more favourable to creditors and some are more favourable to debtors. Chapter 11 has many debtor-friendly characteristics and that is why many of these airlines have filed for Chapter 11 recently.

“Many people think that only US airlines may file for Chapter 11. That is not the case. Provided that an airline has some connection with the US such as having a US office, flying to the US and having US bank accounts or property, that should usually be sufficient to obtain jurisdiction in the US to file for Chapter 11,” he adds.

Once Chapter 11 proceedings are initiated, they give an airline protection from its creditors, providing a breathing space for it to restructure its business and put in place a long-term plan to exit the process as a viable business.

Leo Crowley, head of insolvency and restructuring at Pillsbury Winthrop Shaw Pittman, also points out a number of benefits accruing to the debtor in a Chapter 11 filing.

“One is that the debtor remains a debtor in possession, so management and the incumbent board continue to run the company post-bankruptcy, whereas in most other jurisdictions there is either a trustee appointed or a judicial administrator, or some other official,” he says.

Crowley points out a number of other benefits of a Chapter 11 filing.

“If someone wants to sell off a subsidiary, for example a line of business or some type of portfolio, we have a streamlined process for doing so under the Bankruptcy Code.

“We have the concept of “cram down”. It’s very complicated to actually execute, but we have a process whereby a reorganisation plan can be confirmed and approved, notwithstanding some classes of creditors have voted against it.

“So, you can contrast that with Brazil, for example, which has a well-established insolvency regime where all four classes of creditor must vote for a plan for it to be confirmed.”

Automatic stay

Paul Keenan, partner at Baker & McKenzie, says that filing of a Chapter 11 case initiates a worldwide automatic stay that is extraterritorial, known as an automatic stay.

The worldwide stay provides the foreign debtor the time and opportunity to market and sell assets or negotiate and confirm a plan of reorganisation by prohibiting foreign creditors from taking action against assets of the foreign debtor even if the asset or the offending creditor is located outside the USA.

“The filing of the Chapter 11 petition operates as an automatic stay of almost all actions against the airline and its property, including lawsuits, lien enforcement by secured creditors and repossession by lessors, and other creditor action, whether or not such actions would have been taken in a court proceeding or out of court,” says Moody.

“There will undoubtedly be many creditors who do not fully recover all amounts owed to them as a result of an airline filing for Chapter 11.

“However, those creditors with administrative priority claims under the Bankruptcy Code will receive the full amount of the claim on the date of the airline’s reorganisation plan, which can be 18 months or more after the original filing date,” Moody adds.

Crowley says a key consideration is not whether an airline can meet the jurisdictional minimum to get into the courthouse. “The real question is if other nations will respect what is going on in the USA,” he says.

Rejecting contracts

Airlines may be attracted to a Chapter 11 filing by the concept under US bankruptcy law of rejecting contracts.

Rejecting a contract essentially means that the contract is deemed to be “permanently and irrevocably breached” and any claim that the counterparty may have becomes a pre-bankruptcy claim, Crowley says.

“So, if you reject an aircraft lease that might have two years left to run, that two years of future rent is treated as a pre-bankruptcy unsecured claim, which ranks ahead of the shareholders, but well behind most other categories of claims. That is regarded as a significant benefit to the debtor,” he adds.

This can be seen in the case of LATAM, which chose to file a motion to reject 19 aircraft, most which were part of enhanced equipment trust certificates (EETCs), and Japanese operating lease with call option and operating lease financing.

Keenan says that airlines may use the threat of Chapter 11 rejections to negotiate better terms with suppliers and creditors.

“It depends on the context of the reorganisation and the business climate. If the purpose of the reorganisation is to restructure funded long-term debt, such as corporate bond issuances, the company may not reject its leases if the aircraft leases are on market terms,” he says.

“The decision of whether to reject aircraft leases usually depends on whether the airline needs that particular aircraft going forward for its reorganised business, and also whether the terms of the lease are above or below market.

“Oftentimes, the company will use the threat of rejection in order to gain legal leverage to renegotiate the lease with the lessor. If the airline needs to radically reconfigure its fleet and it has numerous long-term leases, then Chapter 11 may be a useful process to affect such a reorganisation,” Keenan adds.

“Right now, in the current environment, people are not eager to repossess aircraft. And yet, the US court system is very deeply ingrained with the notion that creditors are entitled to get their aircraft collateral back or to receive adequate protection,” says Mark Lessard, head of global finance at Pillsbury Winthrop Shaw Pittman.

“In a situation where creditors are not necessarily eager to get their collateral back, there is less downside in adopting that system and less of an upside in looking for the protection of a local court, which could gum up things and make it harder both to repossess and to get the restructuring done.

“Unsecured creditors may get equity depending on the valuation of the business at exit, which can actually leave them with a stake in the future enterprise," he adds.

Moody points out that as part of the Chapter 11 process, aircraft financiers and lessors are typically asked by the airline to enter into certain stipulations in order to provide for a standstill and sometimes to agree to certain procedures should the airline decide to reject a particular lease.

“Such procedures may cover issues such as the condition of the aircraft upon a rejection, the redelivery location and allocation of costs including for the ferry flight."

Moody adds: “These items should be contrasted against what was negotiated and provided for in the underlying lease because if the airline rejects the lease under Chapter 11, it is likely that the aircraft will be returned in a condition falling short of the return conditions specified in the lease."

An airline may be more willing to negotiate rather than reject if it believes that the creditor will want to do business with it again when it emerges from bankruptcy.

As an example, bondholders in the case of Aeromexico have been able to renegotiate the terms of the repayment of their outstanding loans, perhaps with a view to working with the carrier again in the future.

DIP financing
The ability to source debtor-in-possession (DIP) financing can be a strong incentive for airlines to enter Chapter 11. A carrier is able to raise money from willing backers to provide it with working capital to restructure.

Oaktree is providing $1.3 billion of DIP financing to LATAM, while Apollo is providing up to $1 billion of DIP financing for Aeromexico. In both cases, the investors have the option of converting their loans into shares.

Crowley says it is “unusual” for there to be an equity component in a DIP financing, adding in the case of Oaktree: “In fact, when this was presented to the court, Aeromexico’s lawyer acknowledged as much.

“The practical reality is that there is not a lot of capital out there looking for opportunities to make the kind of loan that Apollo made."

Keenan says that when a company emerges from Chapter 11, it either pays off the DIP financing or uses new exit financing in order to refinance the DIP loan.
“Sometimes we do see private equity funds offering DIP loans with an eye toward eventually gaining control of the company,” he adds.
“There are certain private equity houses and hedge funds who have the appetite for lending to distressed airlines. These lenders are comfortable with the risks, the returns and how a Chapter 11 works. There has been no shortage of interest to provide the DIP financing for Avianca, LATAM and Aeromexico,” says Moody.

More Chapter 11 filings to come?

A legal source says he is aware of a number of other carriers in Latin America that have looked into the possibility of filing for Chapter 11 bankruptcy protection but subsequently came to the decision not to proceed.

The source notes that Chapter 11 filings are effective for large or complex airline groups with operations in multiple jurisdictions but may be less effective for smaller airlines.

“I believe that we are likely to see more foreign regional carriers file Chapter 11 bankruptcy cases in the United States because Chapter 11 provides many tools to successfully restructure an airline that many cases are not available under a foreign country's corporate restructuring laws,” says Keenan.

“As for the major US airlines, it will depend on how long the economic recession lasts, and whether or not the United States government continues to subsidise these companies to help them avoid having to file for bankruptcy,” he adds.

Disadvantages
Lawyers who Airfinance Journal spoke to agree that the biggest disadvantage of a Chapter 11 filing is the reputational damage that comes with it.

"What will be the attitude of investors and lenders towards the airline regarding new business when it exits Chapter 11?" asks Moody.

"I think a lot will depend on how aggressive the airline has been towards those creditors during the Chapter 11 process and whether such relationships have been retained or damaged by the positions taken by the airline during the Chapter 11 process.”

The process is also not without its costs, with high legal fees expected to be incurred by processing the bankruptcy through the US courts.