Posted by David Manson, Jared Green and Rowan Aspinwall on 18 November 2022
Tagged to Restructuring

There has been no shortage of distressed airlines over the last 2.5 years as the COVID-19 pandemic and its economic reverberations wreaked havoc across the aviation sector and travel industry alike. Virgin Atlantic Airlines, Norwegian Air, Garuda, Malaysia Airlines (its leasing wing MAB Leasing Limited), AirAsia X and SAS are just some of the airlines to have gone through, or are in the process of, debt restructurings or deployment of asset and liability management strategies. Many have relied heavily on the forbearance of critical counterparties, government support and/or fresh equity to survive the prolonged turbulence as well as looking at operational right-sizing and/or down-sizing, cancelling orders, scaling-back on flights and expensive slots and addressing head count. While it is arguable that the pandemic is in the rear-view mirror for many countries, the skies unfortunately still remain grey with further storm clouds building in the shape of geopolitical uncertainty, rising inflation and increases in energy and fuel prices, to name a few. With a global recession on the horizon there will likely be more stress and instability to come as disposable incomes contract and big-ticket purchases on travel and tourism make way for more temperate expenditures.  

Hong Kong Airlines (HKA) has become the latest troubled carrier to seek the help of in-court restructuring techniques which it hopes will help deliver a “strengthened and de-levered balance sheet, with lower overall gross debt” and “rationalized rental payments” reducing its current fleet of 53 aircraft to just 20.

While a number of operational restructuring levers have already been pulled, down-sizing its workforce and introducing other cost-cutting measures, these alone have not been sufficient. HKA is now seeking a more holistic solution by implementing a wider restructuring effort to right-size its capital structure, inject fresh capital and reduce its fleet of jets by promoting a parallel process using the statutory in-court restructuring regimes in both England & Wales and Hong Kong.

The sky does not certainly seem to be the limit for the use of powerful debtor-in-possession processes, and the English restructuring plan under Part 26A of the UK Companies Act 2006 has already been successfully used by a financially distressed airline, Virgin Atlantic Airways. It did so to implement a restructuring in mid-2020 to pass through various compromises to provide longer term runway for those businesses. In that case, the plan company compromised four classes of creditors, namely financial creditors, operating lessor creditors, connected party creditors and trade creditors as part of its solvent recapitalization and was the first restructuring plan following the Chapter 11-style procedure being placed on the legislative books in the UK.

Since that time, the restructuring plan has continued to evolve and we have seen cases exploring the ambit of the game-changing restructuring proceedings. Important milestones have already been reached to provide certainty on key areas of usage, including the significant difference that the new restructuring plan, in contrast to a scheme of arrangement, offers; namely the ability to facilitate “cross-class cramdown” subject to certain safeguards being met. The ability for a debtor to continue its compromise or comprehensive restructuring proposal in the face of a group of dissenting stakeholders is a significant one. Restructuring plan applications and challenges have also clarified the extent to which creditors who are “out of the money” may be excluded, the ability to seek a moratorium to protect the debtor whilst using the process, and its application to small and medium sized businesses.

HKA’s situation continues the evolution as it represents (i) the first time an English restructuring plan is being used inter-conditionally with a Hong Kong scheme of arrangement; (ii) potentially affords a futher opportunity for the English Court to resolve the Cape Town Convention question; and (iii) may pave the way for a novel technique structuring classes by allowing secured creditors to vote in the same class as unsecured creditors for the “unsecured element” of their claims.

Difference between a Hong Kong scheme of arrangement and an English restructuring plan

Cross-class cramdown

One of the key differences between a Hong Kong scheme of arrangement[1] and an English restructuring plan is the ability for the English Court to sanction a plan even where not every stakeholder class has approved it, provided two statutory safeguards are met (cross-class cramdown).

Unlike in Chapter 11[2], the English restructuring plan does not require adherence to the “absolute priority rule” which restricts junior classes from receiving any payment under a plan unless senior classes receive full payment on their claims.

The two statutory safeguards[3] that must be satisfied are:

  • The “no worse off” test: the dissenting class must be no worse off under the plan than they would be under the relevant alternative (i.e. “whatever the court considers would most likely occur in relation to the company if the compromise or arrangement were not sanctioned”[4]); and
  • The genuine economic interest test: the plan must have been approved by at least one class of creditors or members that would receive payment or otherwise have a genuine economic interest in the company in the relevant alternative.

The English Court has yet to consider cramdown in the context of a distressed airline. Whether we see it used in HKA remains to be seen as there is the potential that a court supervised debtor-in-possession process such as this creates a timeline and momentum to help the debtor reach agreement and gain approvals from all its affected stakeholders before the sanction hearing.

Numerosity

The other significant difference between a Hong Kong scheme of arrangement and an English restructuring plan is the “numerosity test”. A Hong Kong scheme requires 75% in value of participating creditors or members in each class and a majority in number of each class to vote in favour of the scheme, whereas an English restructuring plan only requires 75% in value of participating creditors or members in each class to be satisfied. Historically, promoters of schemes of arrangement would seek to compose as few classes as possible not to give disproportionate leverage to hold-out creditors. Conversely, those creditors seeking to avoid being crammed by the consenting majority or seeking leverage to be dealt with outside of the scheme would argue that their rights warranted forming a separate class. As such, the proliferation of classes became a hotly contested topic.

In the context of English restructuring plans the number of classes is less of an obstacle (and if anything, may be deployed to work to plan companies’ advantage) where the numerosity test is not required and cross-class cramdown can be utilized. Therefore, where an English restructuring plan is promoted hold-out creditors have lost a degree of leverage in circumstances where the two statutory safeguards noted above can be met.

For more detailed commentary and analysis of English restructuring plans including comparisons with other international restructuring proceedings, see our previous articles here[5].

Why do we need two flights to the same destination? The Rule in Gibbs…

The Rule in Gibbs[6] is a common law principle which, in effect, provides that, unless a creditor submits to a foreign proceeding (i.e. consents to its jurisdiction by participating in the process), a foreign proceeding seeking to compromise English law governed debt by amending such documentation will not be effective under English law. While the rule is not without its critics, it remains entrenched as a matter of law. Given the prevalence of English law financing arrangements and as a governing law for significant contracts, the rule very often needs to be addressed in the context of overseas/global businesses.

In a restructuring context, if a debtor is seeking to compromise or discharge debt obligations governed by English law it would be prudent to do so using an English law contract or in-court restructuring techniques[7] such as a scheme of arrangement or a restructuring plan to reduce the risk that an international process would not be binding on creditors who may object and attempt to use the Rule in Gibbs as leverage against the debtor. The Hong Kong courts follow the Rule in Gibbs. This was underscored recently by Mr Justice Harris in Rare Earth[8] which reinforced Hong Kong’s position under the common law, albeit in obiter comments he also cast some doubt over whether the application of the Rule in Gibbs went further and meant that a foreign scheme would not be recognized by the Hong Kong courts as an effective compromise of US law governed debt where a creditor did not submit to that foreign proceeding despite the foreign proceeding being recognized in the US under Chapter 15 of the US Bankruptcy Code[9].

For this reason, in parallel with the English restructuring plan, HKA is promoting a Hong Kong scheme of arrangement in order to effectively compromise the Hong Kong law governed and other non-English law governed creditor claims (namely the unsecured creditor claims and the critical lessors claims). It is worth noting that as part of the broader restructuring and outside of these two in-court restructuring techniques, HKA will also enter into a suite of inter-conditional financial arrangements with other creditors and stakeholders, including crucially a new equity injection of HK$3 billion from a new investor[10].

The idea of “twinning” restructuring processes is not a novel one, but in the context of providing certainty of outcome with the enhanced “toolkit” of Chapter-11 style processes in the UK and across Europe (following implementation of the European Directive on preventive restructuring frameworks) is likely to be one where debtors wishing to engage the full power of these processes need to run parallel processes in order to safely “land” the restructuring and achieve that certainty of outcome.

Economy, business… secured, unsecured – a question of class…

HKA has split those stakeholders subject to the English restructuring plan (English RP) and Hong Kong scheme of arrangement (HK Scheme) into the classes and subject to the treatment below:

Class

Amount of debt (HK$)

Comments

Treatment

Unsecured Creditors (including estimated unsecured portion of the secured creditors’ liabilities)

16,797,000,000

Included and treated the same in the HK Scheme and English RP

Intercompany and related party claims excluded and the secured portion of the secured creditors’ liabilities excluded

Pro rata share of an upfront cash payment representing a 5% recovery

Pro rata share of subsequent cash distributions from a new “AssetCo1” if HKA meets certain EBITDA targets starting in FY ending 31 Dec 2027

Critical Lessors

6,710,000,000

Included and treated the same in the HK Scheme and English RP

Intention is to return 26 aircraft leased from third party lessors

Retain 20 “critical aircraft”, of these,  14 will be retained subject to proposed modifications to the operating lease terms

Menu of options:

Option 1 (Cash Option)

(i)             a pro rata share of an upfront cash payment representing a 5% recovery; and

(ii)            Pro rata share of subsequent cash distributions from a new “AssetCo2” if HKA meets certain EBITDA targets starting in FY ending 31 Dec 2027

Option 2 (Equity Option)

(i)             Pari passu, pro rata share of the conversion shares (i.e. HKA’s newly issued shares allotted to the Critical Lessors)

Further, each Critical Lessor has right to continue leases in respect of retained aircraft on modified terms or have their aircraft redesignated as returned and their associated claims treated as unsecured claims.

Perpetual Noteholders

6,562,000,000

USD 683 million 7.125% senior perpetual securities governed by English law (issued by Blue Skyview Company Limited and guaranteed by HKA)

Subject to exclusive jurisdiction of the Hong Kong Court

Included in the English RP only

Pro rata share of an upfront cash payment representing a 2.5% of the outstanding notes

Pro rata share of a new USD 100m perpetual notes (expected to be redeemed in 2036)

Pro rata share of non-discretionary performance-linked distribution amounts based on EBITDA targets being met starting in FY ending 31 Dec 2027

Non-discretionary performance-linked payment

Total

30,069,000,000

The common law test in both Hong Kong and England & Wales for determining class constitution for a Hong Kong scheme of arrangement and an English restructuring plan is the same – namely, stakeholders should vote in the same class where their rights are ‘not so dissimilar as to make it impossible for them to consult together with a view to their common interest[11]’. The authorities provide that by “rights” we mean both “rights in” and “rights out”, i.e. the legal rights (not interests) of the creditors according to their relationship with the debtor as would be preserved in the counterfactual comparator (e.g. liquidation) and their rights pursuant to the proposed scheme or plan. Simply put, if they have dissimilar rights before and it is proposed they will get dissimilar rights after, it would be hard for them to consult with each other and vote together as their interests in the scheme or plan are not shared.

Ordinarily, issues concerning class composition are considered by the Court at the convening hearing. The Perpetual Noteholders (which form a separate class) contested HKA’s composition of classes before Mr Justice Fancourt on 25 October 2022 in the English Courts, as well as raising other concerns about HKA’s proposal. It was submitted that the proposal to bundle the secured creditors and unsecured creditors together is being used to manipulate the voting, that they have been given insufficient time to review the evidence, the proposal is “unfair” because of the favorable treatment being given to the airlines owner and its affiliates, that there are jurisdictional issues and that the creditor class representing 74% of the outstanding principal of the perpetual notes will vote against the proposal at the class meetings.

Mr Justice Fancourt rejected the request to adjourn the convening hearing and instead directed that the issue of class composition be dealt with, together with any other arguments (after the votes at the creditors’ meetings) at the sanction hearing.

The fundamental argument being raised by the Perpetual Noteholders in terms of class composition and fairness is an interesting one and relates to HKA’s unorthodox constitution of the so-called “Unsecured Creditor” class. Counsel for the Perpetual Noteholders raised a number of concerns with the approach, including:

  1. The term “Unsecured Creditors” (as defined in the practice statement letter) is liable to mislead as such a term includes the secured creditors of HKA (in relation to the alleged shortfall between the value of their security and the total quantum of their claims).
  2. The secured creditors of HKA should not vote in the same class as the unsecured creditors of HKA – not even in relation to the alleged shortfall between the value of their security and the total quantum of their claims.
  3. The identity of the secured creditors that make up a portion of the “Unsecured Creditor” class are unknown and HKA has the right to exclude any creditors from the class of “Unsecured Creditors” at any time prior to the class meetings. This makes it very difficult for consultation to occur between the creditors that make up that class.
  4. The secured portion of the secured creditors claims is being dealt with in separate bilateral agreements which fall outside of the English RP and HK Scheme (and such documents have not been shared with the Perpetual Noteholders) and one of the largest creditors of HKA (China Development Bank) may be being treated in a materially different way compared to other creditors.
  5. It is unclear from the evidence provided to date what proportion of the HK$ 16,797,000,000 is represented by the Unsecured Portion of the secured debt.
  6. The “Secured Portion” of the secured creditors claims is being preserved in full and such creditors will continue to be entitled to enforce their security.
  7. While the plan being proposed by HKA purports to exclude the “Secured Portion” of the secured creditors’ claims the fact remains that the secured creditors are subject to the plan as it provides for a partial release of their claims rather than a full release (i.e. their claims are being limited to the value of their security) based on valuation methodologies that are not transparent.
  8. The difference in rights (both “rights in” and “rights out”) between the secured creditors and unsecured creditors in the “Unsecured Creditor” class is too great and as such it is impossible for them to consult together in their common interest.
  9. The approach proposed by HKA is directly contrary to the principles set out in the authorities. Any analogy with a Company Voluntary Arrangement is irrelevant and misconceived not least because there is no concept of class composition, where all creditors of the company are entitled to vote together at a single meeting.

It is worth noting that while there are no English authorities in support of this approach, the High Court of Singapore was faced with something similar by the promoter of a scheme of arrangement in Pacific International Lines[12] (although in this case there was a distinct secured creditor class). In this unreported decision the Judge had to consider whether secured lenders’ “under secured” liabilities could be included in the unsecured creditor class for voting purposes. It is notable that while this case was not contested (and full submissions were therefore not heard), the Singapore Court at the convening hearing directed that the “under-secured” element of the secured creditors’ claims should fall within its own class for voting purposes. Singapore, like England & Wales, has the ability to achieve cross-crass cramdown in the face of dissenting creditors and therefore the insistence on a separate class in such circumstances will not always be fatal to the overall restructuring. Hong Kong, on the other hand, does not have such a powerful statutory tool, which means that the proliferation of classes - potentially damaging to the success of a debtor’s restructuring objectives – still represents fertile ground for disputes.

However, the fight is being had in England & Wales and not Hong Kong. At the convening hearing on 13 October 2022, HKA informed the Hong Kong Court that it had not received any opposition to the HK Scheme. This may indicate that if the votes are passed at the class meetings (and particularly if the percentage voting in favor in each class is well above the statutory thresholds), the Judge at the sanction hearing will find it difficult not to approve the HK Scheme on class composition and/or jurisdiction grounds. While the sanction hearing is not a “rubber-stamping” exercise and it is within the jurisdiction of the Hong Kong Court to decide that the classes have not been correctly constituted at both the convening stage or sanction stage, the impetus for doing so will likely be bolstered if full arguments by dissenting creditors are heard. Those arguments are unlikely to come from the Perpetual Noteholders because they are not being compromised by the HK Scheme. Moreover, the Court typically takes the approach that creditors are themselves best judges of what is in their commercial interests and therefore may be reluctant not to approve a scheme when the overwhelming majority are in support.

It certainly appears to be a bold strategic move by HKA. It is perhaps telling that this approach has not been adopted in England & Wales before, but this does not mean that it is destined to failure.

Is a stop-over in South Africa necessary? The Cape Town Convention Question

Pursuant to Alternative A of Article XI of the Aircraft Protocol[13] and Regulation 37 of the International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015[14] the commencement of “insolvency proceedings” triggers certain insolvency remedies for aircraft lessors, most notably in the context of HKA’s proposed restructuring, "no obligations of the debtor under the agreement may be modified without the consent of the creditor[15]".

An “insolvency proceeding” is defined in the Cape Town Convention as being “bankruptcy, liquidation or other collective judicial or administrative proceedings, including interim proceedings, in which the assets and affairs of the debtor are subject to the control or supervision by a court for the purposes of reorganisation or liquidation.[16]

The definition does not expressly include a scheme of arrangement (or a restructuring plan). This raises two fundamental questions: (i) does a scheme of arrangement and/or an English restructuring plan qualify as an “insolvency proceeding” and (ii) can an aircraft lessor’s rights under a leasing agreement be modified pursuant to a statutory contract without its express consent?

Support for the answer to the first question, at least in the context of an English restructuring plan, can be found in the judgments by Mr Justice Zacaroli in the Gategroup decision[17] and for an English scheme at the convening stage in Malaysia Airlines[18]. In short, while these decisions have yet to definitively answer the question, they are instructive and suggest that a scheme of arrangement would not constitute an “insolvency proceeding” whereas, in what may potentially need to be considered as a fact-specific outcome in Gategroup, an English restructuring plan would. For a more detailed analysis of the Gategroup decision, please see our previous article here[19].

Accordingly, in the HKA case, it is unsurprising that the architects of the restructuring have sought to include a parachute to provide a soft landing in the event that any decision regarding the impact of the Cape Town Convention is made by the Courts. They have done so by seeking to provide a classic “return or reimbursement” structure with lessors of the critical aircraft being offered the right to terminate and recover their aircraft in the menu of options available.  Such a structure is not without its problems, however, given the need for critical mass to support an outcome that will provide the right level of breathing space and financial stability to HKA. This optionality preserves their rights under the lease agreements (including their ability to prove/vote as unsecured creditors vis a vis their claims for losses suffered/early termination) in the event they elect to recover their aicraft. By structuring this option to terminate the leases into the proposed plan, it may be that the answer to the second question will remain “in the air” until further facts and circumstances require it be fully tested by potentially another debtor airline or lessee.

Conclusions

One important trend that cases such as HKA and Malaysia Airlines demonstrate is the viability of European and International restructuring techniques for airlines and the aviation industry. While this will not replace the extent to which the US Bankruptcy Code will remain important for many companies in the sector seeking to right-size their balance sheets and implement operational changes, it demonstrates that there are attractive options for businesses in distress that should be evaluated in the planning stage.

The HKA Scheme sanction hearing is scheduled for 12 December 2022 and the English RP sanction hearing has been scheduled for between 9 and 21 December 2022. It will be interesting to see if the issues concerning class-composition and the Cape Town Convention are resolved between the parties or if a fully contested hearing ensues. How the Courts ultimately rule on these matters (with or without the benefit of full arguments) will be very important for the structuring and success of schemes of arrangements and restructuring plans in the future.

 

 

[1] Under s 673 of the Companies Ordinance (Cap. 622) (which largely follows an English law scheme of arrangement under Part 26 of the UK Companies Act 2006).

[2] US Bankruptcy Code

[3] Set out in Section 901G of Part 26A of the UK Companies Act 2006.

[4] In HKA the relevant alternative / comparator is likely to be compulsory liquidation owing to the extant winding up petition in Hong Kong

[5] https://www.dlapiper.com/en/uk/insights/publications/2020/10/restructuring-global-insight/restructuring-plan/ & https://www.dlapiper.com/en/uk/insights/publications/2021/05/uk-restructuring-plan-update/

[6] Named after the 1890’s case, Antony Gibbs & Sons v La Société Industrielle et Commerciale des Métaux (1890) LR 25 QBD 399).

[7] In so far as obtaining the requisite consents under the various contracts (eg unanimity) proves challenging.

[8] Re Rare Earth Magnesium Technology Group Holdings Limited [2022] HKFCI 1686.

[9] Subsequent to this judgment, the US Bankruptcy Judge Martin Glenn clarified the position, at least under US law, in the Modern Land decision where he held that the Chapter 15 recognition order in that case did constitute a valid and complete discharge of the New York law-governed debt that was compromised pursuant to the Cayman scheme of arrangement.

[10] Related to the existing shareholder (HNA Aviation Group Co., Ltd).

[11] Sovereign Life Assurance v Dodd [1892] 2 QB 573; Re Virgin Atlantic Airways Ltd [2020] EWHC 2191 (Ch); and UDL Argos Engineering & Heavy Industries Co Ltd & Others v Li Oi Lin & Others [2001] 3 HKLRD 634

[12] Order of Court granted on January 28, 2021 by the General Division of the High Court of the Republic of Singapore, HC/ORC 531/2021 (Pacific International Lines (Private) Limited)

[13] Convention on International Interests on Mobile Equipment signed at Cape Town on 16 November 2001.

[14]  SI 2015/912 which transposes the above “Cape Town Convention” into UK domestic law.

[15] Regulation 37(9) International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015/912.

[16] Article 1(1) of the Convention on International Interests on Mobile Equipment.

[17] Re Gategroup Guarantee Limited [2021] EWHC 304 (Ch).

[18] Re MAB Leasing Limited [2021] EWHC 152 (Ch).

[19] https://www.dlapiper.com/en/uk/insights/publications/2021/02/gategroup-planning-and-scheming-are-super-schemes-actually-insolvency-proceedings/

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