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By Todd K. Wolynski, partner at White & Case LLP, and Oliver Althoff, Managing Director - North America at Seabury Securities LLC.1
If you are an aviation professional in the COVID-19 era, you are likely learning about, or reacquainting yourself with, the restructuring process.
Airlines, helicopter operators and their principals and managers who have long experience in the industry are accustomed to a regular cycle of restructuring and will be familiar with many of the nuances of a business transformation and restructuring. However, other sectors of the aviation industry that have traditionally been somewhat more insulated from the airline cycle– such as maintenance and repair organizations (MROs), manufacturers and lessors–may be less familiar with the debtor side of the restructuring process. These industry participants are now engaged in a crash-course understanding of what tools exist to restructure their debts, other liabilities and their companies more broadly.
Here is practical advice on restructuring processes and considerations that aviation and aerospace professionals should take into account as they face a potential restructuring.
While no two restructurings are perfectly alike, our experience has taught us that there is a well-worn path forward. We lived that path, being at the forefront of our own turbulent restructuring turned chapter 11 that spanned more than 35 countries, 165 assets, 120 debtor entities (and equal number of boards of directors) and more than 25 major creditors. This a brief guide on how to navigate some sections of that path (albeit we left out all the gory details that may or may not have included, without limitation, sock-puppets, lederhosen and an impromptu helicopter humanitarian mission in Mozambique).
1. Assemble your team
Let us assume that you and your board have agreed that your business can be transformed and restructured, as opposed to liquidated, and that you can no longer trade your way out your problems without some form of relief from creditors, contracts or other expenses and liabilities. You have consulted with your board and are now prepared to take the path towards a restructuring. Nevertheless, before you can go forward, you will need to find competent guides. Unfortunately, one guide will not be enough.
First, you will need to appoint a legal advisor with an established restructuring practice. For aviation and aerospace businesses, this should include a firm with a deep understanding of the aviation sector, typically encompassed by firms with robust aircraft finance, aircraft manufacturing, maintenance and leasing practices. To the extent your chosen bankruptcy counsel does not have such industry experience, then consider having primary bankruptcy counsel appoint a law firm to act as special aviation or industry counsel. In addition, you will need qualified local counsel in each of the jurisdictions where your entities are organized and where your significant assets or other interests are located. In certain jurisdictions, these experts are hard to come by and may be quickly hired by your creditors (or otherwise become conflicted). So do not delay in appointing these experts, even if you will not need them for quite some time.
Your legal team is only one of the pillars of your successful transformation. You will similarly need financial and business restructuring advisors, including experts that will:
i. Restructure your company’s balance sheet and expenses, including, but not limited to, interest and lease obligations
ii. Work closely with your internal financial planning and analysis (FP&A) team to provide accurate cash and liquidity forecasting as well as reporting to your various stakeholders
iii. Restructure your fleet plans, aircraft-specific debt and leases, and OEM order book liabilities, as well as evaluate your transformation and post-restructuring business plans
In some cases, one financial advisor can fulfill all three of these roles, but in many cases, it may make sense to hire two advisors, each focusing on one particular aspect of these tasks. We know from experience that this is expensive, but your internal leadership team will need the guiding expertise as well as the outside resources to steer your process.
Next, find an experienced independent director with restructuring experience. Your existing directors may not have experience with distressed situations; and even if they do, you and your directors will need an independent director who can help make the hard decisions, because there will be many.
An experienced independent director can draw on prior restructuring experience to instill best practices in your board and management team. This independent expert’s voice ensures that the board and management understand and perform their duties in an ever-changing landscape; in addition, he/she will speak the same language as your restructuring advisors and can act as an important conduit between the company and advisors. Moreover, as you move further towards an insolvency situation, conflicts of interests can develop among directors and, potentially, between a director (or directors) and the company, leaving only the independent director to mediate disputes and to vote on necessary measures. Without a proper independent director to shepherd the process, you will find your business in a paralyzed state without good options for moving forward.
Finally, do not wait until your back is against the wall to get all members of this team in place. Ideally, you should begin assembling your resources and formulating your plan three to six months before any restructuring.
2. Plan your attack
Now that you have your team assembled, you will need to decide on your plan of attack.
The first question will be if you can proceed without a court proceeding. Not every restructuring needs to be a court-supervised process, and instead can be implemented via contract between the debtor(s) and material creditors and contract parties. When the music stops and you realize that you need to restructure your debts, expenses or other liabilities, typically your advisors (and your board) will advocate a negotiated settlement outside of any court proceeding. Obviously, everyone prefers to sort out matters contractually instead of submitting their company and economic interests to the mercy of a bankruptcy court. In addition, out-of-court restructuring is the best chance to preserve existing equity’s remaining value in the company and will likely be a cheaper option than a chapter 11 case.
In a chapter 11 filing, or analogous foreign court-supervised process, the existing equity can more easily lose control of the company, not to mention the overall process (despite current owners and management having an ability to have the first shot at presenting a restructuring plan in a chapter 11 proceeding). There are ways for equity to reassert control, including, among other paths, being the successful bidder in a potential Section 363 sale, or participation in post-petition equity investments. However, there is no guarantee that they will come out on top. This does not mean that “equity” is always safe in a negotiated contractual restructuring. Creditors who restructure their debts or other liabilities will demand concessions from the controlling shareholders. This can come in the form of a cash injection from the existing equity (similar to the approach taken by Nordic Aviation in June 2020) and/or a conversion of a percentage of creditor’s debt into equity (similar to the approach taken by Norwegian Airlines with its lessors in May 2020).
Even in a liquidation scenario, an out-of-court settlement should be attempted first. An orderly and consensual liquidation of assets is preferable to a potential chapter 7 (i.e., liquidation) or similar administration and/or liquidation proceeding in other countries. A negotiated settlement may preserve value (thereby increasing creditor returns) and shield the controlling equity, directors and management from potential litigation and reputational harm.
In addition, most creditors will favor an out-of-court restructuring and will want to avoid a chapter 11 case. Out-of-court processes are often 75 percent to 50 percent less expensive than a court process. If your company is in the zone of insolvency and unable to pay its debts when due, then you are dealing with the creditors’ money, and they will have a vested interest in ensuring an efficient and cost-effective restructuring process. In addition, some lenders or creditors may view their loan exposure differently pre- vs. post-filing. While the debtor will have long been in the lender’s work-out group (occasionally euphemistically known by terms such as “asset value preservation group”), the actual interactions, marking of the book position and propensity to sell versus keep the position in the first instance may change once a bankruptcy filing has occurred. In sum, the likelihood that your creditor will trade out of its position increases after a filing.
In case the above was not clear, chapter 11 is expensive! Do not make the mistake of running down your bank account while you negotiate with creditors. The filing fees, trustee costs, advisors and legal costs to start and run a chapter 11 case can be quite high. If you do not have a big enough war chest, you will need to secure debtor-in-possession financing (a DIP loan) to finance your case, and a DIP loan comes with many covenants and legal battles (see “Count the Money” below). In addition, DIP loans generally require unencumbered assets for collateral. Despite the administrative status of a DIP, the lack of unencumbered assets could require (i) a defensive DIP by existing lenders, or (ii) you becoming subject to a priming fight, in which case the proposed DIP lenders may attempt to wrest seniority status on some assets from existing lenders. The latter type of scenario can quickly inflict scars on your process that may last through the case. Therefore, it is best to avoid such a priming fight on the DIP if at all possible.
In an out-of-court restructuring, you will likely cover the legal and advisors’ costs of material creditors while you are negotiating. Be careful to avoid splintering creditor groups, thereby making you responsible for multiple counsel, as this will further increase your costs. However, as explained above, the cost of an out-of-court deal will be significantly less than the cost of an in-court process. That is why you will typically see “pace premiums” in any financial advisor engagement letters entitling the advisor to a premium if they keep any chapter 11 case within a specified period of time. If you do not see such a provision in your engagement letter, consider adding it; as one of our former board members once said, “I’ll pay you for how I want you to perform.”
To make matters worse, you should spend on chapter 11 preparations while trying to reach an out-of-court agreement with your creditors. You do not want to find yourself unprepared to file if negotiations break down. As a result, you will be dual-tracking: negotiating to reach a deal while working with expensive financial and legal advisors to prepare your company for a chapter 11 filing. The fees will start to pile up until sooner or later, as your liquidity dwindles, a chapter 11 filing becomes a self-fulfilling prophecy.
3. Find your allies
Assuming you have decided to engage your creditors in a negotiated settlement, you will need to understand how your creditors can either contribute to, or block, your desired outcome.
Can you reach a negotiated settlement, or will you inevitably file for chapter 11 protection? While the former is everyone’s goal, it may be improbable due to the number of relevant creditors.
Ask yourself how many of your counterparties can successfully play together in the sandbox. In a traditional financing, all related lenders typically must consent to amending the term or principal amount of a loan. This means if you have a syndicated loan that requires 100 percent lender support to amend the term and/or principal balance, it may be a long shot to secure a negotiated settlement. 2 In this situation, you should still engage with your creditors; even if you cannot secure 100 percent consent, a creditor (or group of creditors) may be your best bet in reorganizing your company. You can work with this group to create a planned chapter 11 filing–known as a “prepackaged” or “prearranged” bankruptcy. This may include securing DIP financing, supporting a sale of your assets/entities under Section 363 of the US Bankruptcy Code, and/or even helping you develop a new business plan whereby such creditors become part or all of your new equity after emergence. In most situations, time spent on “productive” engagement with your creditors out-of-court is money saved in-court.
The emphasis here is on “productive.” At a certain point, negotiations cannot last forever, and a company in financial distress may need to file to preserve value for all creditors and to jumpstart the process of restructuring the company (and its debts and other obligations).
If you have multiple creditors across multiple debt facilities, plan how to organize them. Consider establishing an ad hoc working group committee of key creditors. Determine what constellation of creditors can provide you with forbearance to buy you time for ongoing discussions and development of alternative plans. Know what individual creditor will have a veto, or stronghold on a particular debt facility or set of collateral, that could severely impact your potential transformation outcome. While you may increase the frequency of communication with those lenders potentially on a steering committee for your restructuring, do not forget you still have other minority creditors in your facilities. Communicating on a regular basis with all counterparties of any significance is important and can avoid bad surprises further down the restructuring path.
That said, your creditors may change. Claims trading is a fact of life, and certain specialty situation funds or other creditors may purchase debt positions to either make a profit via claims trading and/or to exert control over the process to secure control over the company and/or certain assets.
As you get closer to a potential court filing, the potential for shifts like these will increase, as banks look to offload their positions to others. These new entrants may force you down a different path by acting as “hold-outs” and not providing support for actions that you and other creditors previously deemed to be the preferred out-of-court transformation path. Sometimes, these new entrants can be beneficial to the process by providing a new avenue for the distressed entity. In any case, the shift can be dramatic: We recall reaching a deal in principle on a DIP with a group of creditors one evening and waking up the next day to find out that the major creditor had sold its position to a specialty fund with a completely different vision for our restructuring. The other banks got spooked and, soon there was more trading and additional new entrants.
4. Count the money
Whether you are attempting to restructure out-of-court or in-court, it is paramount to understand your cash and liquidity position through the coming weeks and months.
Do not make swift assumptions out of the gate without your advisors’ expert counsel. There may be cash accounts to which you will have access under court supervision, and other accounts that potentially fall outside of the chapter 11 filing, for which you have the latitude to determine your ongoing payments without court approval. As a result, you should place your cash accounts in separate categories: restricted; unrestricted; pledged; and unpledged cash accounts. For example, you likely will not require court approval to use funds in an account in a jurisdiction and for an entity not subject to the court process.
As part of your liquidity assessment, assuming a court filing, how long can your business operate without access to the DIP financing described above? Do you need to have the DIP in place at the time of filing to gain access to those funds early in the court process? After first- day motions in a proceeding, courts typically work on a certain prescribed or regular hearing schedule. So, can you last without a DIP until the related motion is granted? If you use an emergency hearing for a DIP, a judge may perceive that you and your advisory team did not sufficiently plan and prepare for your chapter 11 process.
Additionally, creditors will require that you and your team prepare rolling 13-week cash-flow forecasts. You will likely be asked to provide weekly reports on these cash-flow forecasts and be open to questioning by the creditors. This requirement typically exists in both an out-of-court and in-court scenario. Thus, if you do not have the resources to manage this weekly reporting rhythm, you need to rely on your advisors to handle it.
5. Filing day! Now what?
If an out-of-court solution is not achievable or has otherwise reached its limits (whether by inability to reach a deal and/or by structuring a prepackaged deal with certain creditors), then you will have to pivot and file for chapter 11. It may also be that you want to continue out-of- court discussions, but your cash burn has been too great and now you have no choice.
In any event, if you are negotiating with your creditors, you must be prepared for a potential chapter 11 filing. This applies for both US and foreign entities.
Unlike the insolvency regimes of most other countries, a company does not need to be organized or domiciled in the US to qualify as a debtor under chapter 11 of the US Bankruptcy Code. Rather, a non-US company often can file chapter 11 so long as it has “nexus” to the US, which could include some property located in the US, and there are established precedents for such filings. Therefore, especially if you are a foreign debtor, you should consult with experienced restructuring counsel to determine if chapter 11 is an option.
A chapter 11 filing may be preferable for your restructuring to a traditional liquidation, scheme of arrangement or examinership process as are found in many European countries. The US bankruptcy system has a robust history with process and procedures that seeks to maximize value for all creditors. To the extent creditor value will be maximized by keeping the business as a going concern (or even selling the business as a going concern in a Section 363 sale), the US Bankruptcy Code’s “debtor in possession” system will allow the existing management team to continue to operate the business, thereby ensuring continuity of service to its clients (including lessees) and value preservation. In addition, unlike other systems, the US Bankruptcy Code allows a chapter 11 filing even if the debtor is not insolvent. That means you do not have to wait for disaster to strike before restructuring your debts. With proper preparation and adequate creditor support, there is even the opportunity to complete a US restructuring through a “pre-packaged” or “pre-arranged” chapter 11 case that allows a company to minimize the time in (and therefore the cost of) a chapter 11 case.
For non-US based companies, it is important to check whether your jurisdiction of incorporation will recognize a primary bankruptcy proceeding in the US. Some countries recognize foreign insolvency proceedings pursuant to legislation adopting the UNCITRAL Model Law on Cross-Border Insolvency 1997. However, boards can take comfort that, subject to your creditor mix, it is unlikely that your largest creditors will violate the global reach of a US bankruptcy court’s worldwide automatic stay and instead they will respect an approved chapter 11 plan.
One additional point of consideration for operators, lessors, lenders and other global aviation, helicopter and aerospace industry participants concerns the special aviation restructuring provisions under Section 1110 of the US Bankruptcy Code and the Cape Town Convention on International Interests on Mobile Equipment (the “Cape Town Convention”). 3
You need to know whether either Section 1110 or The Cape Town Convention applies to your aircraft/ collateral. In summary, Section 1110 provides that a debtor must agree to perform its obligations under the relevant lease or debt instrument and to cure all existing defaults (other than insolvency defaults) within 60 days of the petition date (unless otherwise agreed with its lessor or secured party). Depending on the outcome of negotiations between the relevant creditor and the debtor, the debtor may still reject or abandon leased assets and/or collateral after that date. However, such an event is less likely, as the debtor’s agreement to perform under the loan or lease is a post-petition obligation (for as long as the lease is not rejected or the aircraft is not abandoned). As a result, it would be viewed as an administrative expense that would have to be paid in order for the debtor to emerge from chapter 11. In addition, under Section 1110, a debtor will not be able to “cram down” a creditor secured by qualifying aircraft equipment, although an abandonment or consensual restructuring would be possible. The Cape Town Convention, on the other hand, is an international treaty that, pursuant to its Aircraft Protocol provides, among other things, two alternative remedies for creditors in a bankruptcy scenario:
A. Alternative A provides that within a specified time period to be elected by the “Contracting State,” the debtor must give up possession of the aircraft to the relevant creditor or agree to perform all obligations under the relevant debt/lease and cure all existing defaults (other than insolvency-related defaults).
B. Alternative B provides that the debtor must, after request of the creditor, give notice to such creditor whether it will cure all defaults and agree to perform under the relevant agreement or give the creditor an opportunity to take possession of the collateral under applicable law. Absent agreement among the parties, it is up to the relevant court to determine whether the creditor can take possession of the aircraft collateral and under what terms and conditions. In general, Alternative B is similar to existing law in the relevant jurisdiction. 4
The US has adopted the Cape Town Convention, which has the force of law, but the US did not elect either Alternative A or Alternative B. 5 Such an “opt out” of the insolvency remedies is also contemplated as an available alternative by the Aircraft Protocol.
Generally, the idea is that in a US bankruptcy filing, the qualifying aviation equipment used as collateral by lenders or leased out by lessors will be protected either by Section 1110 or by the Cape Town Convention in other “Contracting States.” However, as we experienced ourselves in a few cases, and as it may likely play out now in the coming months, that assumption may not be 100 percent correct.
If a foreign airline or helicopter operator (e.g., an operator that is not an FAA-certificated US air carrier) files for chapter 11 in the US, assets owned or operated by that operator can fall between the cracks of Section 1110 and the Cape Town Convention. If such an operator files for chapter 11 and its debt/leases and related aviation collateral are under the jurisdiction of a US bankruptcy court, then the leased aircraft equipment will likely fall under Section 365 of the US Bankruptcy Code. Similar to Section 1110 and Alternative A, Section 365 also features a 60-day period, after which the operator is generally required to rent at the contract rate if it does not reject the lease and remains in possession of the equipment. 6 However, unlike Section 1110, a debtor acting under Section 365 does not need to agree to perform the agreement by day 60 and does not have to cure all previous defaults. 7 In this situation, a creditor may be able to argue that the Cape Town Convention (including the Aircraft Protocol) should apply to a chapter 11 debtor whose home jurisdiction is a “Contracting Party” that has adopted Alternative A.8 However, such an argument has not yet been fully tested in a US bankruptcy court.
On a practical note, if we see more airline chapter 11 filings in the COVID-19 world, the threat usually made by creditors to take back aircraft collateral or leased equipment will likely lose its force, given the anticipated difficulties in re-marketing repossessed aircraft. As a result, secured creditors and lessors may be in a more difficult bargaining position and will need to explore more innovative arguments and/or commercial solutions to keep their aircraft collateral and leased equipment with operators.
6. The law of unintended consequences
Finally, you should be aware of other matters that can affect your reorganization.
Does the restructured going-concern entity simply require new equity infusions, while keeping the corporate entity and subsidiaries intact, or will the organizational setup change? If there is a sale transaction, such as a Section 363 sale under the US Bankruptcy Code, will your transaction take the form of an “asset sale” or a “stock sale”? Different complications can arise under either. If you have only one or two corporate entity(ies), you may not have to devote quite as much thought to this subject, compared to a situation with a far-flung corporate structure. For example, during the Waypoint Leasing bankruptcy, we had to manage a restructuring and Section 363 execution that involved more than 120 entities and approximately 140 bank accounts in more than 35 jurisdictions. Unwinding such an entity is a logistical nightmare that involves extensive input from tax advisors and lawyers in each of the jurisdictions involved.
As a lessor or lender, you may be confronted with the need for novation of lease agreements under an asset transaction versus a stock transaction. This will leave you at the mercy of potential renegotiation with lessees and/or other third parties. You also may face transfer taxes for the ownership change that require significant planning and can have an impact on ultimate realized value, if the transfer taxes cannot be avoided.
Last, if debts have been “forgiven,” then equity owners (including individual investors) may face a risk of a “debt forgiveness” tax on the amount of debt forgiven. This can be a crushing result to individual equity owners, especially friends and family and managers who invested their money in the venture. Make sure you raise this issue early, as there are ways to structure around this result.
Seek help and stay informed. Keeping yourself informed about some of these highly technical, often esoteric processes is important to achieve a productive end result. Your actions will affect whether your business preserves or loses value. Since the strategic and tactical decisions that need to be made in advance and then during the process can be overwhelming, we encourage you to seek out advisors and guides for such a process. As they say on TV, “Do not try this at home; these are trained professionals.”
1 Todd Wolynski and Oliver Althoff were formerly colleagues at Waypoint Leasing. Mr. Wolynski was the General Counsel and Chief Administrative Officer and Oliver Althoff was the MD, Capital Markets and Treasury.
2 A chapter 11 process may require only a majority approval (e.g., 50 percent in numbers, 66.7 percent in value) to force a solution and potentially cram down (or up) other creditors.
3 The Cape Town Convention creates an international body of law to regulate interests and establish remedies in respect of qualifying mobile equipment, including under its Aircraft Protocol, Aircraft assets between conditional sellers, financiers and lessors.
4 Alternative A also provides that during the “waiting period” the debtor must preserve the aircraft object and maintain its value pursuant to the terms of the underlying agreement. Alternative B does not have any such condition. See “The Practitioners’ Guide to the Cape Town Convention and the Aircraft Protocol” published by the Legal Advisory Panel of the Aviation Working Group, September 2015.
5 Note that there are many other differences and similarities between Section 1110 and the insolvency provisions of the Cape Town Convention that are not explored in this article.
6 Note that the debtor may argue that rent under a lease during the first 60 days should not be the contracted rate but should be marked-to-market. The details of such an argument are not addressed in this article.
7 As Section 365 applies only to leases, no such 60-day period exists in respect of Aircraft mortgages granted by such a debtor, and a secured lender of such a debtor will also not obtain the cram-down protection afforded under Section 1110.
8 One possible argument may be that if the debtor has its “center of main interest” in a jurisdiction where Alternative A has been adopted, that the US Bankruptcy Court should apply the law of such jurisdiction (including its selection of Alternative A).
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