Most airline carriers taking part in the initial wave of airline bankruptcies earlier this decade were able to successfully reorganize in Chapter 11.
In the last year, however, the process has not been as forgiving -- Aloha Airlines Inc., ATA Airlines Inc., Eos Airlines Inc., MAXjet Airways Inc., Kitty Hawk Inc., Gemini Air Cargo Inc. and Skybus Airlines Inc. were all forced to shut down operations in the past year and liquidate their assets. Considering the extreme volatility in the price of oil and the near-unprecedented recent economic crisis, many analysts believe that it is only a matter of time before additional airlines end up in bankruptcy.
The question remains: Will the creditors of these airlines realize any value?
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Along with the increased price of oil comes a greater demand for more
fuel-efficient aircraft, resulting in higher lease rates for such
aircraft. Since many of the recently liquidated carriers either
reorganized or began operations before the increased lease rates, in
some cases such carriers have enjoyed the benefits of below-market
aircraft leases -- a far cry from the prior wave of airline
bankruptcies where carriers suffered from onerous lease rates and
looked to Chapter 11 as a means of reducing their burden. In most other
industries, the assignment of such below-market leases would be a
source of value for unsecured creditors. In the airline carrier
context, however, the dynamics are markedly different -- aircraft
lessors have the power to prevent the assignment of such leases by
withholding their consent.
To better understand this dynamic, parties investing in the airline
sector should have a basic understanding of Section 1110 of the
Bankruptcy Code, which grants creditors who lease or maintain a
security interest in aircraft equipment a variety of rights in
bankruptcy. Under Section 1110, within 60 days after the bankruptcy
filing, a debtor must cure all defaults and agree to perform all
obligations. This effectively gives an airline debtor 60 days to
determine its fate. If the prospect of liquidation looms, a debtor will
likely be forced to forgo the substantial investment necessary to cure.
Section 1110 also prevents a debtor from exercising other powers
often available in bankruptcy. But Section 1110 effectively overrides
Section 365 by providing that an aircraft creditor's right to retain or
dispose of equipment is not limited by "any other provision of this
title or by any power of the court." Given Section 1110 and the market
dynamics at play, aircraft lessors would be hard-pressed to allow a
lease to be assigned by a debtor when they could recover the aircraft
and lease it at higher rates on the open market.
Creditors have often assumed that an airline's operating certificate
is a means of creating value for the estate. Given the volatility of
oil prices, the number of startup airlines is virtually nonexistent,
resulting in relatively low demand for operating certificates.
Nonetheless, even if a bankrupt airline finds a ready buyer for its
operating certificates, the U.S. government has taken the position in
every recent case that such certificates are nontransferable. But the
government has been open to working with bankrupt carriers to identify
alternative solutions.
Although value has been more difficult to realize in recent airline
liquidations, creditors may still notice some improvement on their
bottom line. In the prior wave of airline bankruptcies, for example,
claims relating to the restructuring or termination of aircraft lease
agreements represented the lion's share of all claims, resulting in
significantly diluted recoveries to unsecured creditors. Conversely,
where a debtor has below-market aircraft lease rates, the total amount
of aircraft claims should be significantly reduced as the aircraft
lessor should be able to re-lease the aircraft at rates above what the
debtor was paying.
Creditors in the airline marketplace should consider adjusting their
expectations in light of certain obstacles imposed by the Bankruptcy
Code as well as the current economic environment. While airline
liquidations may continue to be the norm in the short term, value can
still be found in unlikely places.
Brett H. Miller is a partner and Todd M. Goren is an associate
with the bankruptcy & restructuring practice of Morrison &
Foerster LLP, based in New York.
