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Aircraft repossession: judiciary fails to uphold local law or Cape Town Convention

Introduction

Following developments earlier in 2019 (for further details please see “Recent developments in aircraft repossession“), aircraft repossession has continued to be in the spotlight – yet again with regard to the Oceanair Linhas Aéreas SA(commonly known as ‘Avianca Brazil’) bankruptcy and, in particular, the experience of lessors that sought repossession of leased aircraft therefrom.

In this case, and contrary to Avianca Brazil’s pre-bankruptcy experience, a bankruptcy court failed to uphold the express provisions of the Brazilian Bankruptcy Law 2005 and the Cape Town Convention, which has been a part of Brazilian law since mid-2013.

This failure largely stemmed from the court’s unwillingness to apply clear, objective time periods limiting the protection that should have been provided to Avianca Brazil. As a result, while under bankruptcy court protection, Avianca Brazil was allowed to operate a fleet of aircraft for four months without paying anything for its usage. Thus, lessors that had entered into lease agreements expecting up to a 30-day stay period (as set out under Brazilian law) were forced to suffer a stay period of approximately four months.

Correct stay period

On 10 December 2018 Avianca Brazil filed for bankruptcy restructuring (known as ‘judicial recuperation’ in Brazil). On 13 December 2018 the airline was granted this status and protection. One of the bankruptcy court’s first decisions was to determine the stay period during which lessors would be prohibited from repossessing the leased aircraft. The entirety of Avianca Brazil’s fleet was leased through operating leases (a common practice among Brazilian airlines).

In the first instance, the bankruptcy court set a 30-day stay period for the lessors. The court based this decision on Brazil’s declarations under the Cape Town Convention. This first case is relevant because it clearly acknowledges the application of the Cape Town Convention in Brazil. At no time during the proceedings did the court rule or even imply that the Cape Town Convention was inapplicable in Brazil or that it was subordinate to any particular Brazilian law. The problem with the court’s ruling was that the judge ignored the plain terms of the Cape Town Convention (and the Brazilian Bankruptcy Law).

Countries adopting the Cape Town Convention have several options in insolvency cases (bankruptcy is referred to as ‘insolvency’ in the Cape Town Convention) – specifically:

  • Alternative A;
  • Alternative B; or
  • neither option.

Alternative A, which is modelled on Section 1110 of the US Bankruptcy Code, grants contracting states the power to determine a fixed waiting period during which aircraft lessors and other creditors cannot seek to repossess their aircraft objects (ie, airframes, engines and helicopters).

When adopting the Cape Town Convention, Brazil chose a 30-day waiting period. While a 60-day waiting period is more common, governments can choose the length of this period for insolvency procedures. The aircraft finance community believed that this shorter waiting period was a clear sign that Brazil was serious about recognising and enforcing creditors’ rights in bankruptcy proceedings. In particular, following the 2005 bankruptcy proceedings involving Varig (a major Brazilian airline), which had tarnished Brazil’s image and reputation with the financing community, the 30-day waiting period seemed to signal a conscious effort to improve Brazil’s image.

Thus, on 13 December 2018 the court in Avianca Brazil determined that a 30-day stay period would apply to lessors and scheduled a hearing for 14 January 2019. The judge also correctly determined that the stay period would toll between Christmas and New Year. Under Brazilian civil procedure, the tolling of many stay periods is suspended during Christmas and New Year in recognition of these judicial holidays, as most courts do not hold sessions.

That said, the court’s ruling was flawed in at least two distinct ways. First, the court had granted Avianca Brazil protection on 10 December 2018. Thus, a correctly counted 30-day stay period would have ended on 9 January 2019. That said, the most fatal flaw was that, under a careful reading of the Cape Town Convention, no stay period should have applied. As per Article XI(2) of the Aircraft Protocol:

Upon the occurrence of an insolvency-related event, the insolvency administrator or the debtor, as applicable, shall, subject to paragraph 7, give possession of the aircraft object to the creditor no later than the earlier of

(a) the end of the waiting period; and

(b) the date on which the creditor would be entitled to possession of the aircraft object if this Article did not apply.

In accordance with subpart (a), a 30-day stay period would have applied. However, Article 199 of the Bankruptcy Law states that the rights of lessors under aircraft (and aircraft engine) lease agreements are not subject to suspension under any circumstances. Consequently, the rule in effect before Brazil adopted the Cape Town Convention was that lessors’ rights were not stayed by a judicial recuperation case. This rule had been followed in previous bankruptcy cases (eg, VarigLog and BRA Airlines).

In accordance with subpart (b), the bankruptcy court should have denied Avianca Brazil any stay whatsoever and the lessors should have been allowed to repossess their aircraft immediately. While the 30-day stay period should have applied to other types of creditor (eg, mortgagees), this was not true for lessors following a correct reading of the Cape Town Convention.

Ad hoc extensions to stay period

During the 14 January 2019 hearing, the bankruptcy court determined that the lessors should be stayed for an additional 18 days. The court’s justification was that the airline had not had sufficient time to negotiate with its lessors due to the holidays. This decision was a clear violation of the Cape Town Convention, which expressly prohibits stay periods from being extended in insolvency proceedings. As such, regardless of the applicable stay period, an 18-day extension was a clear violation of the convention.

While there were some suggestions that the lessors had acquiesced to the extended stay, this was untrue; the judge imposed the stay. Further, even if the lessors present at the hearing had agreed, the judge expressly applied the extension to lessors that had been absent. Thus, the court’s violation of the Cape Town Convention was unequivocal.

A parallel dispute emerged after the 14 January hearing between Avianca Brazil and the Brazilian Civil Aviation Agency (ANAC). Several ANAC directors believed that the stay period could not be extended beyond 30 days and were prepared to deregister aircraft by means of irrevocable de-registration and export authorisations. To avoid this from occurring, the bankruptcy court expressly prohibited such de-registrations while the stay period was in effect.

On 1 February 2019 the bankruptcy court further challenged Brazil’s compliance with the Cape Town Convention by issuing a ruling extending the stay until a general creditors meeting could be held. In an effort to recognise the lessors’ interests, the court ordered Avianca Brazil to resume payments to lessors falling due from 1 February 2019. The result of this was that the stay was extended until the middle of April 2019 – a blatant violation of the convention, despite the court’s order that payments to lessors be reinitiated, as the convention expressly prohibits any type of extension.

From 1 February to 28 February 2019, Avianca Brazil made payments under its leases in accordance with the bankruptcy court’s order. However, beginning on 28 February, Avianca Brazil started to default on its payments again. Although the bankruptcy court stay was supposed to terminate after any non-payment, through the combination of a Brazilian holiday in early March and further delay tactics by the airline, Avianca Brazil gained an additional full month of usage of its fleet under court protection, without making any payments.

During this time, several interlocutory appeals were filed, some rising to the Superior Court of Justice, the highest court in Brazil for commercial matters. While there were some decisions in favour of lessors, the decisions ultimately favoured Avianca Brazil. These interim decisions – which included decisions from the president of the Superior Court of Justice and the president of the Sao Paulo Appeals Court – were of limited duration and were not issued on the merits of the Cape Town Convention or any other law. The judges issuing these decisions cited ‘equitable’ considerations. They seemed to think that if Avianca Brazil was given just a little more time, it would be able to successfully restructure.

End of Avianca Brazil’s operations

Finally, on 8 April 2019 a Sao Paulo Appeals Court panel issued a clear ruling correctly interpreting the Cape Town Convention and authorised the lessors to repossess their aircraft. Since that time, nearly all of the aircraft leased to Avianca Brazil have been repossessed either through court orders or by negotiated lease terminations. Avianca Brazil continued to operate with a severely reduced fleet until 24 May 2019, when ANAC suspended its operating licence. The airline is now redelivering the last leased aircraft that remain in its possession.

Comment

The last decision on the merits in relation to Avianca Brazil was the Sao Paulo Appeals Court’s 8 April 2019 decision. As this ruling was correctly decided, it will arguably strengthen the application of the Cape Town Convention in Brazil in future.

However, it would be foolhardy to ignore the extreme reluctance of the Brazilian judiciary to enforce the tight deadlines of Alternative A of the Cape Town Convention. In essence, the judiciary applied Alternative B of the convention, which gives bankruptcy courts more flexibility to determine the rules in each case. Regardless of whether the approach was equitable, and notwithstanding the bankruptcy court’s qualification that Avianca Brazil resume payments to continue the long stay period, the extension violated the plain terms of the Cape Town Convention.

In March 2016 the Organisation for Economic Cooperation and Development found Brazil eligible for export credit agency discounts based on the country’s Cape Town Convention declarations – in particular, its adoption of Alternative A with a fixed 30-day waiting period. This qualification did not sway the courts and Brazil now runs the risk of being removed from the eligibility list due to the violations set out above.

This article focuses on Brazilian compliance with the Cape Town Convention and the Bankruptcy Law in relation to repossession of leased aircraft during an insolvency case. However, Avianca Brazil has raised many other issues, such as the negotiability of and airlines’ ability to monetise slots and the priority of lessor claims in bankruptcy proceedings. Lessor claims, which grew considerably during the first 120 days of 2019 while under court protection, were largely ignored by the bankruptcy court and Avianca Brazil in its proposed restructuring plan.

For further information on this topic please contact Kenneth D Basch at Basch & Rameh by telephone (+55 11 3064 8599) or email (ken.basch@baschrameh.com.br). The Basch & Rameh website can be accessed at www.baschrameh.com.br.

This article was originally written by Kenneth D. Basch and published by International Law Office on June 12, 2019.

http://www.baschrameh.com.br

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