Two special purpose entities, controlled by JP Lease Products & Services (JPLS), in response to what it describes in court papers as “aggressive and improper tactics of their senior lender and security agent”, filed for voluntary bankruptcy filings in the US on December 17, 2021. The companies that filed for Chapter 11 protection were JPA No. 111 Co., Ltd. and JPA No. 49 Co., Ltd (the SPVs), which were set up as part of a 2017 Japanese Operating Lease with Call Option (JOLCO) financing agreement between JPLS and Vietnam Airlines for two A350 aircraft.
The SPVs have engaged New York restructuring boutique Togut, Segal & Segal to guide the SPVs through the Chapter 11 process. JPLS has engaged Vedder Price as its New York counsel in connection with the restructurings.
Vietnam Airlines has been in default since April 2020 for one aircraft and in October for the other aircraft when JPLS and the airline agreed to rent deferrals with a new payment schedule. However that schedule again entered default and negotiations were ongoing for a further change to the payment schedule. Because of what was deemed to be a lack of progress on the negotiations between JP Lease and Vietnam Airlines, CA-CIB as minority senior secured lender took the decision to sell its interest to investment fund, FitzWalter Capital Partners, which had offered to buy the loan at par.
JPLS comments in the Chapter 11 court filing that it was only made aware that FitzWalter had acquired CA-CIB’s position on December 10 and had commenced what it described as an “aggressive and improper foreclosure and sale process with respect to the Aircraft (the Foreclosure Sale) that would potentially impair the Junior Facilities and the Debtors’ equity investors and potentially disrupt the long-term lease renegotiations, as well as Vietnam Airlines’ ability to continue to operate the Aircraft”. JPLS stated that the debtors were provided with “no notice whatsoever, and only learned of this process because individuals at JPL had learned that FitzWalter had appointed an enforcement agent and visited the site and found enforcement / sale procedures terms. FitzWalter took all of these actions without notifying the Debtors.”
Once it became the senior secured lender, FitzWalter engaged Airborne Capital as the remarketing and enforcement agent, and according to the court documents, JPLS claims that FitzWalter and Airborne were pursuing a “hyper-aggressive and wholly inappropriate sale process that does nothing but artificially deflate the value of the aircraft”. JPLS claims that the sale notice, published on December 10, initiated an “extraordinarily truncated sale process for any bidders to seriously consider and diligence a complicated suite of claims and rights to proceeds arising under the Aircraft Financings”. JPLS claims that the sale process was set for over three days Dec. 15-17, where interested bidders were required to execute confidential agreements to first gain access to the data, then submit a $500,000 deposit and execute a claims assessment with evidence of unconditional committed financing, and to fund the purchase price bid by midnight on Dec. 17, when “most wire transfers around the world are closed for the weekend” as JPLS claims, with Dec. 20 as the final closing date for any sale.
JPLS further claims that the sale procedures appear to be part of a two-step foreclosure process that further depresses the price of the aircraft. “Having separated the claims and proceeds from the Aircraft themselves, FitzWalter is apparently trying to obtain the Aircraft in a further proceeding where they will be divorced from the revenue generating portions and basically become worthless pieces of metal,” according to the court papers.
JPLS states that the sale timeline was “absurd” and did not provide an opportunity for a market testing of the assets nor obtaining the highest and best priced under the circumstances, let alone at any price. JPLS further claims that FitzWalter was deliberately trying to discourage bidders from making any offers to allow it to take ownership of the assets for its own purposes. “This is particularly concerning when the Debtors understand FitzWalter has only recently acquired its position, likely at a steep discount to par, and is orchestrating a scheme to obtain the Aircraft for itself on the cheap —Aircraft that the Debtors believe have sufficient value to effectuate a return to all creditors, the TK Investors, and potentially equity holders”.
JPLS hopes that the Chapter 11 filing would void the remarketing action by FitzWalter and order a new sales or remarketing process that will more mutually benefit all parties, including the junior investors.
However, the lenders have already previewed a motion to dismiss the Chapter 11 filing by JPLS and a hearing was held in New York on December 20 that noted a number of points disregarding the claims raised in the court papers. Principally, the main argument against the filing is that an SPV does not have the right under the transaction agreement to file for Chapter 11, and that moreover the company has no nexus to the United States in that it has no residency there, nor employees and the lessee is also located outside the jurisdiction. The lease is also structured under English law, while only the mortgage is structured under New York law, which the debtors claim requires any sales process to be initiated the Uniform Commercial Code (UCC).
A UCC process defines how aviation assets should be sold in a foreclosure scenario. JPLS has filed for Chapter 11 protection to benefit from an automatic stay and prevent any action by the lenders, which the lenders claim is a breach of JPLS’ obligations under the transaction documents and a fundamental right of lenders in the JOL/JOLCO market.
The sales process for the lease claim was launched 10 December and was scheduled to run until December 17, seven days in total, and was also widely advertised in the Wall Street Journal and various other locations. Furthermore, it is believed that the lenders were not required to provide any notice for a sales process under the transaction agreements. Additionally, unsecured claims for airlines often trade in less than 24 hours, which has been the case in other recent distressed scenarios for lessees including Avianca, Philippine Airlines, Norwegian Air Shuttle and LATAM, and as such the splitting of claims sale and aircraft sale is not unusual.
JOLCO lenders finance such SPVs on the basis they are low risk and have strong rights under the agreements if things go wrong. The lenders position is that JPLS is attempting to prevent them from exercising their rights to recover their assets in an extended default situation. Indeed, they claim that there is currently no lease in place with the airline, which effectively is utilising the aircraft for free. FitzWalter’s position is that “filing for bankruptcy protection is prohibited under JOL/JOLCO financings and that JP Lease’s intentional breach of this fundamental term strikes at one of the foundations of the entire JOL/JOLCO lending market,” says Andrew Gray, partner at FitzWalter Capital. “The steps which FitzWalter Capital has taken have been necessitated by longstanding defaults, exacerbated by JP Lease standing by and doing nothing to protect the aircraft from usage without compensation”. The fear is that if this Chapter 11 action prevents lenders from acting on their fundamental rights to foreclose on the aircraft as envisaged under the operative documents, it will create a major problem for senior secured lenders all around the world – mainly commercial banks – that finance these structures.
The central factor of the debtors decision to file for Chapter 11 is due to claims that senior mortgage holder FitzWalter has been “engaging in an out-of-sight foreclosure of the Debtor’s assets with the singular goal of cashing out their claims without concern for junior creditors, the TK Investors, or the equity holder”. The debtors believe there is sufficient value to provide a return to all creditors and a distribution to the TK Investors if the two A350 aircraft assets are sold “pursuant to an organized and transparent process before this Court”. The lenders claim that JPLS has alternatives under the operative documents but have elected not to exercise their cure rights or repay the loans and instead filed for Chapter 11.
This case – in relation to the aggressive foreclosure sale tactics – has similarities with similar tactics used by a private equity firm in a distressed aircraft lease situation earlier in 2021 (full stories here and here), which led to litigation by the investors burned by the action. At the time, it was opined that such strategies that skirt very close to the legal requirements to gain control of distressed assets, which are not unusual in the world of alternative credit, may become more prevalent in the aviation industry as the impact of the pandemic pushes more entities into distressed situations.
One source commenting on this latest case, agreed that the whole process has been “edgy and super aggressive, and they are pushing the envelope as far as they can, challenging anyone else who wants to defend its interests to take them to court”. Another source has stated that the investment fund is pursuing similar strategies for other cases involving Japanese equity investors for aviation assets. “They are not trying to build a leasing platform quickly, they are opportunistically trying to extract value and move on, which is not in the best interests of the aviation industry.”
Investment funds have a very different view. In distressed scenarios, investment funds say that they are providing much-needed liquidity that is enabling senior lenders to exit difficult situations rather than remain bogged down in lengthy and costly restructuring negotiations with lessees.
In FitzWalter’s case, the company is committed to building a leasing platform and acquiring aircraft at a time when the industry is going through a difficult time. “People say this is opportunistic, but we are supporting prices when others are not,” says Gray. “What is not in the best interests of the aviation industry is calling the entire JOL/JOLCO financing market into question. If credit committees need to contemplate a real risk of SPVs filling for Chapter 11 protection and preventing them from exercising their contractual rights, then LTVs go down and margins go up. That would be a terrible outcome for the recovery of the industry.”
Sources claim that at least eight banks have sold their interests in lease transactions with LATAM, AeroMexico, VietJet, Vietnam to similar investment funds, including FitzWalter. Although junior investors are being adversely impacted by such tactics, a different perspective to take on this deal is that for senior lenders, a well secured loan for a new generation aircraft is a safe investment since it can often be recovered in full in distressed situations. Indeed, these market dynamics are viewed as the building blocks of an efficient market and why lenders can confidently continue to lend at such low margins.
JPLS maintains that it is attempting to defend its interest by filing for Chapter 11 but how the court rules on this tangled process will have ramifications for the entire JOL/JOLCO market. In the immediate pre-pandemic period, JOLCO investors were gaining comfort entering into financing for lower tier credits as the market remained so buoyant in 2019. The global downturn caused by COVID-19 impact on air travel has created worldwide distressed scenarios for a number of lessees that has led to stress for Japanese equity investors. Should this case introduce a new risk to the market, Japanese equity investors and senior secured investors could be deterred from the JOLCO sector, which has become such an important source of financing for the aviation industry.