It is now a unanimous conclusion that the COVID-19 pandemic has resulted in the worst ever crisis in the history of the aviation industry. In 2020, we saw major airlines such as Avianca, LATAM, Thai Airways, Virgin Atlantic and Virgin Australia enter into formal insolvency or restructuring proceedings, with the majority of other airlines being kept afloat by a combination of government aid, cost-cutting measures and concessions from shareholders, employees, bondholders, lessors and other creditors. As we enter the spring of 2021, the inevitable question is: what will happen next? Which airline may fail and which will be well-positioned to benefit from an eventual recovery in international air travel?

It’s an open secret that investors have been quietly but steadily pouring money into airlines both in the public and private markets, driven by an optimism that the global vaccine roll-out will pave the way to the re-opening of international borders and unleash pent-up demand from leisure and business travellers to take the skies again. The theory being that airlines, having trimmed the fat over the past year, can emerge profitable from the crisis. At the same time, multiple threats – including new COVID-19 variants, delays in vaccine roll-out, the continuing absence of guidance from the WHO as to agreed parameters for the re-opening of borders, rising fuel prices and rising interest rates – pose a risk to the timeline for recovery. There is a general sense in the market that given the prolonged cash burn being incurred by the airlines that the day of reckoning for many of them may come sooner rather than later. During Q2 in particular, should the ability of people to travel still be limited despite vaccination efforts and health passports, a practical assessment will have to be made by creditors as to which airlines are going to make it and which to start laying termination and/or enforcement and repossession plans for, should that day of reckoning occur.

The key to dealing with such scenarios is preparation ahead of time.  The Reed Smith global aviation team is helping clients prepare for a variety of outcomes and has  put together  a basic default and asset repossession checklist which clients can use in this regard and which is included as part of this article. The checklist is drafted from the point of view of a lessor and/or a financier of an aircraft and/or aircraft engine. Please do not hesitate to contact us if you would like a detailed discussion in this regard.

Default and Asset Repossession Checklist

  1. Establishing a framework
    • Conduct a review of all contractual documentation (including security documents, letters of credit (“LCs”) and warranty agreements) to identify clearly:
      • your rights under the documents;
      • the agreed procedures following a default by the operator;
      • the scope of any retention of title provisions;
      • the insurance provisions;
      • any notice requirements;
      • any grace periods.
    • Are there any existing defaults that have not been addressed by waiver or deferral arrangements?
      • If so, prepare and serve a reservation of rights letter on operator in respect of these defaults.
      • In any case, check if the contractual documentation require a notice of termination to be served on the operator.
    • Can you apply any cash deposits or reserves you hold or draw down on any LCs to mitigate your losses?
      • Review the terms of the lease agreement to check rights and obligations in respect of drawing of any LC and how such amounts should be allocated.
      • Review the terms of any LC and prepare a drawdown request complying with its conditions.
      • Check if physical presentation of the LC at the bank’s counter is required or if drawing by authenticated SWIFT is permitted, and liaise with your personnel at the relevant location or your advising bank (as applicable).
    • Where the Cape Town Convention (“CTC”) is applicable:
      • check that all International Interests have been registered;
      • locate the original IDERA and any deregistration/export POAs; and
      • check which CTC remedies are available in the relevant jurisdiction(s).
  1. Insurances
    • Enquire as to whether:
      • all premiums have been fully paid up (whether the asset is in operation or in storage); and
      • any outstanding unpaid claims exist in respect of insurance proceeds resulting from damage to the asset if you have a contractual right to such proceeds.
    • Get in touch with the insurer to ensure any due insurance proceeds are paid to you or your financiers (who are named as loss payee) and kept out of a potentially insolvent estate.
  2. Location of asset (aircraft)
    • Where is the habitual base or storage location of the aircraft?
    • If the aircraft is still being flown, do any of the jurisdictions it is flying to allow for a quick creditor-friendly repossession?
  3. Location of asset (engine)
    • Is the engine installed on an airframe, in storage or with a workshop for maintenance?
    • If the engine is installed, locate the relevant aircraft and determine if it is being flown:
      • If the aircraft is still being flown, do any of the jurisdictions it is flying to allow for a quick creditor-friendly repossession?
      • If the engine is not on the creditors’ aircraft, establish who owns the aircraft and if there is a recognition of rights agreement (“RORA”) in place or if an existing RORA is still valid and applicable.
  1. Parts and Technical documents
    • Have any parts been removed from the aircraft or engine?
      • If so, what condition are these in and where are they being kept?
      • If parts have been removed and installed on other aircraft or engines, there may be certain retention of title challenges to these as title to the parts may have passed to the owner of such aircraft or engine.
    • What condition are the technical documents in and where are these being kept?
  2. Maintenance and Current Use
    • Are the maintenance reserve payments up-to-date, if payable under the lease, and are current balances sufficient to cover any anticipated qualifying work?
    • If end of lease maintenance payment adjustments are payable under the lease, what alternative arrangements are feasible if the operator is unable to cover these in full if the asset is repossessed?
    • Is the operator able to provide an accurate update on the current status of the maintenance on the aircraft or engine?
    • Are monthly use reports, if these are a requirement under the lease, up-to-date, complete and provided in a timely manner?
  3. Storage arrangements
    • Are the asset(s), any part(s) or any documents stored with a third party storage provider?
      • What would be required to access this storage facility?
      • Are any storage fees owed which may have given rise to liens in favour of the storage provider?
    • If the asset is in storage or with a workshop for maintenance:
      • Gather information on the level of maintenance required and the condition of the asset.
      • Establish if any money is owed for maintenance work already completed.
      • Establish if any liens exist over the asset as a result of work already completed on it.
  1. Appoint counsel and local counsel
    • Have any jurisdictional questionnaires that were obtained at the time of the original transaction refreshed to take into account any recent change of law?
    • If a jurisdiction questionnaire was not obtained, request updates on any relevant changes of law since the legal opinions on the original transaction were issued, including any changes to the local insolvency laws as a result of Covid 19 or otherwise which would impact de-registration/repossession/export.
    • Can you unilaterally export and/or deregister the asset without the operator’s cooperation and/or a court order?
    • If a court order is required, what is the applicable procedure, how long would it take and what are the associated legal risks?
    • What export permits and licences are required, if any?
    • What fees and taxes are payable to export the asset?