The post COVID-19 situation is already looking disastrous for the aeronautical sector as many small airlines which have sprung up over the last decade will not survive the crisis and even the larger, more solid airlines will be forced to rethink their business models.
Without rapid and radical intervention by governments even the biggest “flag carrier” airlines will struggle to deal with this global crisis which is affecting the whole of the tourism industry.
In France, the government has just announced a deferral to the 2021 and 2022 of the payment of air navigation charges (collected by Eurocontrol on behalf of France) as well as the Civil Aviation Tax and the Solidarity Tax, both of which are taxes on ticket sales normally payable in March and December 2019. These measures aim to provide some much needed relief to the French airlines. They are not available to foreign airlines operating in France. Nonetheless, the French airline market was already showing signs of weakness prior to the pandemic with the bankruptcy of two long-standing French airlines, Aigle Azur and XL Airways, at the end of 2019. It therefore seems inevitable that the Government will need to take further measures rapidly to protect its airline industry.
Within the European Union such measures will naturally raise issues of state aid which has long been banished by the European competition rules. This being said, in the face of this exceptional global crisis, it is probable that the member states will come to an agreement to allow Governments to support their national airlines in order to save the industry and a potential social disaster in terms of unemployment. As yet there has not been a collective response from the EU members on this issue. To date, the French Government has obtained the approval of the European Commission to make the concessions described above and Denmark has requested and received approval for an ad hoc state aid package.
In the race against the clock, airlines are looking for all possible commercial and legal means to lighten the burden of their financial obligations in respect of payment of lease rentals and debt repayments.
For reasons of financial optimization and operational flexibility, most airlines organize their fleet according to the model of approximately 1/3 of aircraft owned by them, 1/3 owned by banks under various forms of long term finance leases and 1/3 owned by international leasing companies and leased to the airlines under short term operational leases.
For many years it has been market practice to include the so-called “hell or high water clause” in both finance and operating leases, which obliges the airlines to pay rentals in all circumstances even with the aircraft is not in use.
It is precisely such clauses which are the object of commercial discussions between the airlines and the lessors, as airlines seek to obtain standstill periods for rental payments of 3-5 months.
French airlines will benefit from the protection under the order issued by the French Government on 25 March 2020 which provides that certain contractual sanctions, including acceleration, default interest, and termination which result from a failure to make a payment where the date for payment falls within the period between 12 March 2020 and one month following the end of the state of sanitary emergency declared in France will be automatically delayed for a further period of one month. If no further extensions are made to the current emergency status in France, this means that payment obligations are effectively suspended until 25 July 2020.
Airlines will also be looking at protective regimes under French law such as the force majeure and the hardship regimes to seek to limit or suspend their payment obligations for the duration of the COVID-19 pandemic.
In contrast to English law, article 1218 of the French civil code contains a general principle of force majeure which is applicable to all contacts. This regime provides that, subject to the satisfaction of certain conditions, a party is excused from its obligations for the duration of the force majeure. The conditions are that (i) the event must be outside the control of the party claiming force majeure (ii) the event must not have been reasonably foreseeable at the time the contract was signed and (iii) the effects of the event must not have been reasonably capable of being avoided by the such party. These provisions of the French Civil code are not mandatory and therefore the parties are free to contractually exclude or limit the application of article 1218 or to include negotiated force majeure clauses. However most aircraft leases contains no such clauses.
The satisfaction of the above mentioned tests is determined by the French court on a case by case basis. This not a simple exercise as French courts have in the past set a very high threshold for demonstrating force majeure. By way of example, the H1N1 epidemic, the chikungunya virus and the dengue fever have all been refuted by the French courts as constituting a force majeure event.
In the unique COVID-19 context, the closing of borders and the extensive measures taken by Governments in the wake of a national sanitary emergency, one could imagine that it may be easier for airlines to demonstrate that force majeure has occurred. The fact that the French Government has declared the COVID-19 to constitute a force majeure event under contracts signed with the French State is also likely to influence the French courts approach to private contacts.
Nonetheless, airlines will need to keep in mind that the force measure regime offers them only limited protection in the case of financial obligations. Rentals will remain due and payable even where the force majeure conditions have been met although they may seek a suspension of performance.
Airlines may also look at the legal regime of hardship which is set out in article 1195 of the French civil code and which provides that where a change in circumstances which is unforeseeable at the time the contract was entered into has occurred which renders the execution of the contract excessively onerous for either party, such party may request a renegotiation of the contract terms. The airline would be required to continue to perform its obligations during any period of renegotiation. If the parties fail to reach an agreement then either party may request the court to make necessary adjustments to the contract or otherwise to terminate the contract.
This regime, which was only recently introduced into French law, was seen as a more flexible regime than the existing force majeure regime. However, it does not have mandatory public policy effect and is therefore almost always expressly excluded in aircraft leases governed by French law.
Airlines who are in financial difficulties may also seek pre-insolvency protections offered by the French bankruptcy laws under the safeguard procedure. This procedure allows the airline, under the protection of the court, to negotiate a safeguard plan with its creditors which would its lessors. This and other types of pre-insolvency protections (such as conciliation or ad hoc mandate procedures) facilitate negotiations with creditors in order to find a restructuring solution.
The effects of COVID-19 on bank financing in the aeronautical sector are also already being felt. Banks are seeing credit committee approvals being withdrawn or suspended for financings which have not yet been signed.
Another consequence is that airlines have been asking for payment holidays under their financings from their lenders. To date the banks have reacted favourably to such requests, no doubt in an effort to save the airlines from bankruptcy. In addition, the application of the new Government order will effectively prevent the banks from accelerating loans in the face of a non-payment by the airlines until 25 June 2020 thereby giving the airlines an inherent 3 month payment holiday.
Airlines are also considering the application of force measure in the context of the bank loans. However as noted above this regime provides limited protection in the case of repayment obligations. A 2014 decision of the Court of Cassation held that a debtor may not be exonerated from a financial obligation by reason of force majeure thus underlining the principle that a debt cannot be simply extinguished by the occurrence of an event of force majeure. Although this decision has been criticized by commentators, it remains good law. As we have seen however, it is possible that payment obligations may be suspended for the duration of the force majeure if the conditions are met.
Similar to aircraft leases, it has become the market practice in France for loans made to airlines to include a clause which expressly excludes the application of the hardship regime described above.
Another phenomenon which has arisen out of the crisis is massive demand by airlines to draw down on their revolving credit facilities. Despite the negative effect of the COVID -19 pandemic on the airline industry, the banks have, to date, been very willing to allow these drawdowns to be made as part of what appears to be a global effort to sustain the economy. However the banks will need to consider carefully certain risks that may arise out of this continued funding. Notably, under French law a bank which continues to provide financing to a company whose financial situation is irremediably compromised (and who ultimately goes into insolvency) may be held liable for having abusively supported such company by artificially keeping the company afloat thereby causing harm to other creditors of the company.
Banks are also inevitably starting to consider the question of whether the COVID-19 would constitute a material adverse effect justifying a drawstop under revolving credit facilities and other lines of credit. These clauses (known as MAE clauses) which are almost systematically found in bank loans vary from one contact to another but essentially involve the concept of an event occurring which has a material adverse effect on the ability of the borrower to perform its obligations or on the financial condition, business and sometimes prospects of the company.
The use by the banks of this kind of close to justify drawstops was much discussed during the financial crisis of 2008/2009. Whilst it has been considered on several occasions by the English courts, there appears to be no specific French court decisions on this issue. Nonetheless an analysis of the decisions of the English courts provides an interesting insight into how the French courts may react. The position of the English courts is essentially that the MAE clause may not be triggered by an external event unless the borrower has actually defaulted on its payments or is in demonstratable serious financial difficulties as a consequence of that event. It can be reasonably considered that the French courts would adopt a similar if not more prudent approach and that the existence, in itself, of the COVID-19 pandemic would not be sufficient to trigger an MAE clause in the absence of any actual payment default by the airlines.
In addition, banks are bound by the general principles of French law which require all parties to act in accordance with good faith in the performance of their contractual obligations and in respect of decisions taken under those contracts by the banks in the context of COVID-19.
The banks will also be aware that the airlines may seek protection under article 1343-5 of the French civil code which allows them to ask the French court to re-schedule their debts over a period of up to two years.
Finally we should note that as a result of the confinement rules generally applicable in France due to COVID-19, the French Aviation Authority (DGAC) is currently running a minimum service online and by telephone only and has no physical presence at its registrations office. As such only urgent matters are being dealt with and registration of non-urgent transactions such as lease extensions are likely to be being suspended.
Our Reed Smith Coronavirus team includes multidisciplinary lawyers from Asia, EME and the United States who stand ready to advise you on the issues above or others you may face related to COVID-19.
Client Alert 2020-194