Graham Tyler, Co-Global Head of Asset Finance, and Rakhi Savjani, Counsel, at Pillsbury law, discuss how to maintain dialogue with customers during the COVID-19 crisis.
The aviation sector is currently experiencing possibly the most severe and far reaching challenge that it has ever encountered globally, as a consequence of the Coronavirus (COVID-19) pandemic. Borders are closing, flights are being cancelled in staggering volumes and airlines are grounding significant parts of their aircraft fleet. There is of course an impact on suppliers, third-party service providers and, as is often forgotten, the employees of all these companies.
Unfortunately, there will be some casualties, but the industry will rally round and those who align with each other now will forge even closer and stronger commercial relationships.
Here, we have addressed some of the headline issues that airlines, lessors and financial institutions will face under their existing arrangements.
A failure to pay: Many airlines are already in negotiations with their lessors and financiers for rent holidays or reductions, and this in turn will have potential knock on effects for some lessors in respect of their non-recourse financing obligations and covenants. While it is unlikely that non-payment by an airline is going to trigger an immediate event of default being called, or a guarantee being enforced, certainly no airline should assume this and instead should proactively engage with its counterparts to agree a temporary commercial solution. That process might require the airline to provide details as to what government assistance or other credit lines it could access. Non-payment can be an early warning sign of a possible future insolvency, but as opposed to a rush to repossess it is more likely that most counter parties will be collaborative.
There has been some discussion already about the “hell or high-water” clause in leases and/or force majeure provisions. A hell or high-water clause provides that the lessee’s obligation to continue to pay rent and other sums due is absolute and only subject to some negotiated common sense carve-outs like total loss. Most clauses do not cover the worldwide grounding of an aircraft (think the 737-Max scenario) and certainly not a pandemic like COVID-19. While recent experiences may see some renewed attention from airlines to risk allocation in new documentation, time spent now trying to construct arguments around the existing clauses is likely to be time and money wasted. Far better to engage with the lessors and financial institutions to agree alternative but temporary arrangements.
Similarly, mention of force majeure in lease and finance transactions is likely to lead the majority of obligors up a blind alley based on existing documentation typically seen. In the absence of express contractual provisions, both English law and New York law will not, by default, excuse a party from performance of its obligations due to events beyond its control. While this may not rule out some lessees trying to rely on their own local laws, contractually that should not be relevant nor trump the documented provisions.
Mention has been made by some as to whether an airline can rely on illegality clauses or the doctrine of frustration as a means to avoid payment. Clearly it is dangerous to say this absolutely cannot happen, but it is difficult to see how a court could find that a lease or loan has become illegal to fulfil as consequence of COVID-19. Similarly, we feel it highly unlikely that an obligor will be able to successfully persuade a court that a lease or loan has been rendered impossible to perform at law. The courts in both England and New York have historically set a very high bar for any claim of contractual frustration to succeed, and there is no reason to suppose that might change in the immediate future.
Financial covenants: The financial covenant tests will provide an early indicator that a business may be struggling and typically provide lenders with a default to rely on. Loss of income and deterioration in aircraft values are likely to negatively affect financial covenant compliance. Consequently, borrowers should try and predict early on whether any covenants may be breached and, if so, what options they may have to rectify this. Dialogue and a constructive approach with the lenders will prove to be a more attractive proposition than silence.
Information undertakings: Lease and loan documentation all require obligors to keep their counterparties informed of material contracts, potential breaches, and amendments or waivers in relation to them. What is likely of most importance is information about the asset itself – is it grounded, if so where is it being kept, and is ground risk cover in place? If there are long term engine maintenance total care style arrangements in place, then is the airline still paying the third party or should the lessor or bank be looking to the alternative contractual arrangements that it has in place as back-up? It is the practicalities that are going to be of most concern for now.
Front foot lessors and lenders: Some lessors and lenders may want to be more proactive and actively encourage an airline lessee to engage, particularly if they feel that information and/or a game plan is slow in being put forward. In wanting to engage on any possible payment deferrals without waiting for payment defaults or financial covenant test dates, a lessor or bank could look to the material adverse change event of default as a catalyst to encourage quicker and more comprehensive engagement. The inclusion and terms of these clauses and indeed their actual interpretation vary widely, but it seems hard to argue against COVID-19 not adversely impacting the prospects of almost any airline.
Don’t be left waiting for that last Uber: No lessor or financial institution wants to be the last person left with an asset that it can no longer repatriate as a consequence of it being caught up in insolvency style proceedings. We would advocate that lessors and financial institutions should be actively engaging with local counsel in the jurisdiction of any airlines that they perceive to be on a high-risk watch to understand the necessary steps to take should the need arise. Most lessors are very well experienced in enforcement and repossessions, but sometimes the banks are not so well prepared and often don’t have the internal resources to act nimbly. Some early preparation and risk management now may prove useful for the future.
Keep talking: If lessees and borrowers do not comply with their obligation to inform lessors and lenders of a breach, then difficult questions are posed. There will be no appetite for a knee jerk reaction and with worldwide travel bans in place, questions arise over how a large-scale repossession could even be orchestrated, let alone which new lessee would take aircraft. While lessors and lenders need to be careful before waiving defaults and ensure that they reserve their rights to enable them to take action in the future, premature action is unlikely to be the answer. A combination of government intervention to assist airlines and lease and debt restructurings for non-recourse financings are likely to be the immediate focus of attention, with opportunities perhaps arising for some shrewd buyers. So keep calm and maintain dialogue - we are all in this together.
