Latest airline restructuring news – Avianca Brazil – What happens in Cape Town stays in Cape Town

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Chapter 15 of the United States Bankruptcy Code promotes cooperation between the United States courts and parties involved in international insolvency proceedings. A recent chapter 15 case in the United States Bankruptcy Court for the Southern District of New York has caused some turbulence in the aviation finance world concerning the precise role that the US Bankruptcy Court plays in such a case. Before we turn to the specifics of the case, we’ll take a quick jaunt to Cape Town.

The Cape Town Convention and aircraft protocol

In late 2001, 68 countries and 14 international organizations attended the Diplomatic Conference to Adopt a Mobile Equipment Convention and an Aircraft Protocol in Cape Town, South Africa. At the closing of the Diplomatic Conference, 53 states signed a treaty and aircraft protocol (together, the “Cape Town Convention”), which extended modern commercial finance laws to international transactions involving aircraft and aircraft engines and provided a range of basic default and insolvency-related creditor remedies for airline insolvency proceedings. The Cape Town Convention was strongly supported by the aircraft manufacturing industry, financiers, and the key government agencies involved, and by the Aviation Working Group, a nonprofit entity comprised of the world’s major aviation manufacturers, leasing companies, and financial institutions, which was formed to contribute to the development of the Cape Town Convention. As of 2018, the aircraft protocol had 73 contracting parties, including the United States (ratified October 2004) and Brazil (ratified November 2011). 

The Cape Town Convention included provisions related to the rights of aircraft lessors and financiers in insolvency cases, including an alternative akin to Section 1110 of the US Bankruptcy Code. Under the Cape Town Convention, a contracting state may choose between one of two alternatives by making a declaration of which alternative would apply upon occurrence of an insolvency-related event. See Article XI of the Aircraft Protocol. As relevant here, Brazil declared that it would apply Alternative A in all insolvency proceedings and require that, within 30 days of initiating a proceeding, a debtor must either (a) give possession of an aircraft to the creditor or (b) cure all defaults regarding that creditor and agree to perform all future obligations under the applicable agreement. Under Alternative A, if the debtor fails to take either action by the expiration of the 30 days, the creditor may exercise any and all available remedies, and local insolvency law may not prevent or delay the creditor from exercising its remedies beyond the 30-day period.¹ 

To ensure cooperation between contracting states, the Cape Town Convention requires that the courts of other contracting states apply the declared alternative of a contracting state with primary insolvency jurisdiction. Thus, where a debtor files an insolvency-related proceeding in Brazil, other contracting states must apply also Alternative A in related proceedings. With this background, we turn to the recent insolvency filing of one of Brazil’s largest airlines.

Avianca Brazil files for judicial restructuring in Brazil

Avianca Brazil, officially known as Oceanair Linhas Aéreas S/A, is Brazil’s fourth-largest airline by both domestic and international traffic in Brazil. As is customary with most large airlines, Avianca Brazil’s aircraft and engines are subject to lease and sublease agreements. Facing an economic crisis, increased fuel costs, and foreclosure actions, in December 2018, Avianca Brazil filed a petition for judicial restructuring in the Brazilian Bankruptcy Court. This filing initiated the first Brazilian airline bankruptcy proceeding since the Cape Town Convention became effective in Brazil in May 2013. Avianca Brazil asked the Brazilian court for emergency relief to stay actions filed by three of its lessors seeking to repossess fourteen of its aircraft. The following day, the Brazilian court granted the request for emergency relief, suspending the foreclosure
actions as well as “future actions that aim the seizure or practice of other acts for constriction of aircrafts and/or engines.”

Several days later, on December 13, 2018, the Brazilian court reconsidered its suspension of the foreclosure actions upon request of one of the lessors. Referencing the Cape Town Convention, the lessor argued that the foreclosure actions could only be stayed during an initial period of 30 days. The Brazilian court agreed, finding that the Cape Town Convention was “undeniabl[y] applicable to the case” and holding that the “suspension of the repossession orders will be valid for the period of 30 days, [which is the] waiting period defined by the Brazilian government by adhering to the referred convention.” The Brazilian court set January 14, 2019 as the expiration of the 30-day period, and ordered that for the next 30 days, the lessors of aircraft were prohibited from exercising their rights and remedies under the Cape Town Convention and under their lease agreements.

The foreign representative requests US recognition and extension of the stay 

As an international airline, Avianca Brazil holds licenses at various US airports and is party to US lawgoverned fuel contracts, operational leases, and other service contracts with US counterparties. To deal with these U.S.-related issues, Avianca Brazil initiated a chapter 15 filing in the United States Bankruptcy Court for the Southern District of New York. During the initial 30-day waiting period, the foreign representative requested that the US Bankruptcy Court recognize the foreign proceeding through the Chapter 15 process and grant provisional relief to Avianca Brazil under Chapter 15, including a request to apply the automatic stay of the US Bankruptcy Code to Avianca Brazil’s property within the territorial jurisdiction of the United States. After holding a hearing on January 3, 2019, the US Bankruptcy Court entered an order (the “Provisional Order”) granting provisional recognition and relief, and imposed a stay within the territorial jurisdiction of the United States through the date of the hearing on recognition of the Brazilian insolvency proceeding, which was scheduled for January 22, 2019. 

The US Bankruptcy Court’s entry of the Provisional Order without reference to the January 14, 2019 termination date of the stay in Brazil threw the lessors into a tailspin. Several lessors wrote to the US Bankruptcy Court (and later followed up with a formal objection to recognition), informing  the judge that the lessors believed the Provisional Order was in direct conflict with the Cape Town Convention, as it improperly extended the stay beyond the initial 30-day waiting period. Arguing that the Cape Town Convention requires the US Bankruptcy Court to apply the Cape Town Convention in accordance with Brazil’s declaration of Alternative A, the lessors requested that the US Bankruptcy Court incorporate additional language into the Provisional Order that would clarify the lessors’ abilities to exercise their rights and remedies in the US following expiration of the 30-day period, as set forth in the Cape Town Convention. The Aviation Working Group submitted its own letter to the US Bankruptcy Court, expressing its agreement with the lessors’ letter and informing the US Bankruptcy Court that “the expiry of the waiting period is a fundamental provision of the treaty and that no extension of the waiting period is permitted.”

Not surprisingly, the foreign representative opposed the lessors’ requests, arguing that the lessors waived their right to object to the Provisional Order at the January 3 hearing and that the purpose of Chapter 15 is for the US Bankruptcy Court, acting in its ancillary capacity, to aid the foreign insolvency proceeding, rather than to second guess the Brazilian court or impose a contrary rule that might undermine Avianca Brazil’s ongoing restructuring efforts in Brazil. 

Following a status conference, the  US Bankruptcy Court agreed with the foreign representative and declined to modify the Provisional Order, but commented that the issues remained up in the air and could be raised at the January 22 hearing on recognition of the foreign proceeding.

The Brazilian court extends the 30-day deadline

While the Chapter 15 proceeding was pending in the U.S., the Brazilian court held a hearing on January 14. Avianca Brazil and the lessors reported to the Brazilian court that they had been unable to reach an agreement on a restructuring. Rather than allow the stay to terminate, the Brazilian court instead extended the stay to February 1, 2019, conditioned upon Avianca Brazil (a) submitting proposals by February 1 for making payments of past-due amounts to the lessors or making arrangements for the return of the aircraft or engines, and (b) making payments due as from February 1 on the dates laid out in the originally signed contracts. The Brazilian court expressly ordered that if Avianca Brazil failed to fulfill either obligation, the lessors could immediately exercise their rights to repossess the aircraft or engines.²

The US Bankruptcy Court grants recognition

Prior to the Brazilian court’s January 14th ruling, the question before the US Bankruptcy Court was relatively simple: should the court limit the stay under the US Bankruptcy Code to the 30-day period provided for both in the Brazilian court’s December 13th order and in the Cape Town Convention? But once the Brazilian court extended the 30-day period, the US Bankruptcy Court now had to decide whether it would act solely as an ancillary arm to the Brazilian court, rubber-stamping the extension to February 1, 2019, as urged by the foreign representative, or whether the court was independently bound to apply the Cape Town Convention, which expressly prohibited a further extension of the stay past January 14. Ultimately, the US Bankruptcy Court ruled that its role was not to second-guess the decisions of the Brazilian court, but merely to facilitate cooperation and maximize assistance to the Brazilian restructuring proceedings. The US Bankruptcy Court granted recognition of the Brazilian proceedings and ordered that the lessors could not take any action within the United States inconsistent with any orders issued by the Brazilian court.

What is left of the Cape Town Convention?

These rulings in Brazil and the US seem to fly in the face of the protections afforded by the Cape Town Convention. In essence, the foreign representative was allowed to use Chapter 15 to circumvent an international treaty, due to the Brazilian court’s apparent contravention of Brazilian  law providing for a 30-day waiting period without extension. Had the US Bankruptcy Court applied Alternative A in conformity with the Brazilian declaration strictly as a matter of compliance with a US treaty, Avianca Brazil and the lessors certainly would have been subject to inconsistent rulings, but the spirit of the Cape Town Convention would have been preserved. In the event of future airline insolvency proceedings, it will be interesting to see whether other signatory countries follow the Brazilian court’s rulings in this case or strictly apply the waiting period without extension.

Postscript: In recent weeks, Azul, S.A. (another Brazilian airline) has come forward offering to acquire certain of Avianca Brazil’s assets in a plan for approximately US$105 million in cash. Avianca Brazil also secured debtor-in-possession financing from funds controlled by Elliot Management, which would end up with a substantial minority stake in the “new” Avianca Brazil acquired by Azul, S.A.