Special Features of German Law in Case of Airline Insolvencies
In the past two years, there seem to be many insolvency cases among European airlines. Current examples can be found in both smaller and larger companies. At the time, Air Berlin filed for insolvency in August 2017 Air Berlin was the second-largest airline in Germany and the seventh-largest in the European Union. In September 2018 the German air carriers Azur Air GmbH as well as Small Planet Airlines GmbH and in December 2018 the German airline PrivatAir GmbH together with its Swiss affiliate PrivatAir S.A. filed for insolvency too. Due to such an increased number of insolvencies of German airlines in the last 1 1/2 years an overview of the German law on insolvency proceedings in general and the particulars that need to be considered in the aviation business are set out below.
- German Insolvency Law in general
- Regulation (EU) 2015/848
As EU Regulations are directly applicable law in Germany, first of all, the Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (recast) – hereinafter “Regulation (EU) 2015/848” has to be considered. Pursuant to Article 3 (1) of the Regulation (EU) 2015/848 the courts of the Member State within the territory of which the center of the debtor’s main interests is situated shall have jurisdiction to open insolvency proceedings (“main insolvency proceedings”). The center of the main interests is the place where the debtor conducts the administration of its interests on a regular basis and which is ascertainable by third parties. In the case of a company or a legal person, the place of its registered office shall be presumed to be the center of its main interests in the absence of evidence to the contrary. However, this presumption shall apply only if the registered office has not been moved to another Member State within a period of three months preceding the request to open insolvency proceedings. Save as otherwise provided in the Regulation (EU) 2015/848 the law applicable to insolvency proceedings and their effects shall be that of the Member State within the territory of which such proceedings are opened (the “State of the opening of proceedings” – Art. 7).
Under certain conditions also secondary insolvency proceedings may be opened in another Member State (Art. 3 (2) and Art. 34 -52).
During the insolvency proceedings regarding the Austrian airline NIKI there was a controversy as to whether only insolvency proceedings in Berlin, Germany (where the insolvency court of NIKI’s affiliate – Air Berlin – was situated) or at NIKI’s registered seat in Austria shall be opened, respectively whether the proceedings in Austria shall be regarded as main or secondary insolvency proceedings according to the Regulation (EU) 2015/848.
- German Insolvency Code (“Insolvenzordnung” or abbreviated “ InsO”)
- 1 InsO determines the objectives of German insolvency proceedings. Accordingly, such proceedings have the purpose of “collective satisfaction of a debtor’s creditors by liquidation of the debtor’s assets and by distribution of the proceeds, or by reaching an arrangement in an insolvency plan, particularly in order to maintain the enterprise“.
Insolvency proceedings are judicial proceedings which are opened only upon a written request that has been filed by either the debtor or a creditor (§ 13, 14 InsO). The insolvency court in whose district the debtor has its general jurisdiction shall have exclusive local jurisdiction, however, if the center of the debtor’s business activity is located elsewhere, the insolvency court in whose district such place is located shall have exclusive jurisdiction (§ 3 (1) InsO). If several courts have jurisdiction, the court first requested to open the insolvency proceedings shall exclude any other jurisdiction (§ 3 (2) InsO).
The opening of insolvency proceedings requires the existence of a reason to open such proceedings which needs to be substantiated already in the request to open insolvency proceedings. Such a reason could be (i) illiquidity – the debtor shall be deemed illiquid if it is unable to meet its mature obligations to pay (§ 17 InsO); (ii) imminent insolvency – the debtor shall be deemed to be faced with imminent insolvency if it is likely to be unable to meet its existing obligations to pay on the date of their maturity (§ 18 InsO); or (iii) overindebtedness – which shall exist if the debtor’s assets no longer cover its existing obligations to pay, unless it is highly likely, considering the circumstances, that the enterprise will continue to exist (§ 19 InsO).
If a legal person becomes illiquid or overindebted, the members of the board of directors have to file a request for the opening of insolvency proceedings without undue delay, at the latest, within three weeks after the company has become illiquid or overdebted (§ 15a (1) InsO). If the responsible persons do not file such request within that time period they may be punished with imprisonment for not more than three years or a fine if they acted willfully or with imprisonment of not more than one year or a fine if they acted negligently (§ 15a (3) and (4) InsO).
If the court considers the application for insolvency to be admissible, an examination is made as to whether there is a reason for opening the insolvency proceedings (§ 16 InsO) and whether the debtor’s assets are likely to be sufficient to cover the costs of the insolvency proceedings. If the assets are not sufficient, the application shall be rejected for lack of assets unless an advance on costs is paid (§ 26 InsO). The phase during which the court has to decide whether to either (i) open insolvency proceedings; or (ii) reject the request due to lack of assets to cover the costs of the insolvency proceedings, is called the preliminary insolvency proceeding. Such preliminary insolvency proceeding usually has a duration of one to three months.
The insolvency court shall take all measures appearing necessary in order to avoid any detriment to the financial status of the debtor for the creditors until the insolvency court decides on the request to open insolvency proceedings (§ 21 (1) InsO), in particular the court may order any of the following:
- designate a provisional insolvency administrator to whom § 8 subsection (3), as well as §§ 56, 56a and 58 to 66 shall apply mutatis mutandis;
1a. appoint a provisional creditors’ committee, to which § 67 subsection (2) and §§ 69 to 73 shall apply mutatis mutandis; persons who become creditors only upon the opening of insolvency proceedings may also be appointed as members of the creditors’ committee;
- impose a general prohibition on making dispositions on the debtor or order that the debtor’s dispositions shall require the consent of the provisional insolvency administrator in order to become effective;
- order a prohibition or provisional restriction on measures of execution/enforcement against the debtor unless immovables are involved;
- order provisional interception of the debtor’s mail, in respect of which §§ 99 and 101 subsection (1), first sentence, shall apply mutatis mutandis.
- order that objects which would be covered by § 166 (disposition of movables) or their separate satisfaction could be requested if proceedings were to be opened may not be used or collected by the creditors and that such objects may be used to continue the enterprise insofar as they are of considerable significance therefor; § 169, second and third sentences, shall apply mutatis mutandis; the creditor shall be compensated by current payments for any loss in value on account of such use. Such obligation to make compensating payments shall only exist to the extent to which the loss in value accruing from such use impairs the security of the creditor with a right to separate satisfaction.
If the debtor is subject to a court ordered general prohibition on making dispositions (§ 21 Nr. 2, 1. Alt. InsO), the provisional insolvency administrator is a so-called “strong” insolvency administrator, i.e. the administrative power and power of disposal over the debtor’s assets passes already at that stage to the (provisional) insolvency administrator. If, on the other hand, the court appoints a provisional insolvency administrator without imposing a general prohibition of making dispositions on the debtor, the provisional insolvency administrator is a so-called “weak” insolvency administrator as the debtor may still administer, and dispose of, its assets (subject to the provisional administrator consenting thereto). The provisional insolvency administrator is appointed by the court in order to (i) secure the debtor’s assets, (ii) analyze the debtor’s economic situation and continuing viability and (iii) make a recommendation to the court as to whether the insolvency proceeding shall be opened. The (provisional) insolvency administrator will usually be a lawyer from a law firm specialized in insolvency proceedings.
If the insolvency court decides to open the insolvency proceedings it will issue an order which shall specify, inter alia, the name and address of the insolvency administrator (which is usually the same person as the provisional insolvency administrator) as well as the hour the insolvency proceedings are opened (§ 27 InsO). At the latest upon the opening of the insolvency proceedings the debtor’s right to manage and transfer the insolvency estate is vested in the insolvency administrator (§ 80 InsO). In addition, upon the opening of the insolvency proceedings, any pending court actions against or on behalf of the debtor are interrupted by operation of law to the extent they concern the insolvent estate; the same applies already during the preliminary insolvency proceeding, if the authority to manage the debtor’s assets and the power to dispose over them devolves already upon a provisional insolvency administrator (§ 240 of the German Code of Civil Procedure).
In the court order that opens the insolvency proceedings it is also stated within which period of time the creditors have to file their claims with the insolvency administrator. Such time period shall be fixed to extend over not less than two weeks and not more than three months after the opening of the insolvency proceedings (§ 28 (1) InsO).
Such filing has to be done in writing and all respective documents which prove the existence of the claims have to be provided. Thus, in such filing the amount and basis of such claims have to be substantiated (§ 174 InsO). If neither the insolvency administrator nor another creditor objects to such claims, the insolvency court registers such claims in a table and such registration in the table has the same effect as a non-appealable judgement. However, it depends on the value of the assets of the debtor and whole amount of the outstanding debts whether a creditor will finally obtain a satisfying amount for its claims/damages (if any). If an objection to the filed claim is raised by the insolvency administrator or any other creditor, the creditor may commence a court action in order to determine whether its claim is valid or not. If such court action is not commenced within 2 weeks after the objection to the claims was published, such claim will not be considered in the insolvency proceedings.
The insolvency creditors are permitted to enforce their claims only under the provisions governing the insolvency proceedings (§ 87 InsO). However, although there is such a continuing general moratorium on creditors action during the pendency of an opened insolvency proceeding, there are certain exceptions, for example, creditors with security in immovables can foreclose on their collateral because creditors with a right to satisfaction from immovable objects are pursuant to § 49 InsO entitled to separate satisfaction under the provisions of the German Act Governing Auctions and Sequestrations of Immovables (“Gesetz über die Zwangsversteigerung und die Zwangsverwaltung”).
In addition, anyone entitled to claim the separation of an object from the insolvency estate under a right in rem (in particular a third party owner) or in personam shall not form part of the insolvency proceedings, i.e. such creditors are entitled to have “their” objects separated and returned to them – such process is governed by the legal provisions applying outside the insolvency proceedings (§ 47 InsO).
If a mutual contract was not or not completely performed by the debtor and the other contractual party at the date when the insolvency proceedings were opened, the insolvency administrator may perform such contract replacing the debtor and claim the other party’s consideration (§ 103 (1) InsO). If the administrator refuses to perform such contract, the other party shall be entitled to its claims for non-performance only as an insolvency creditor. If the other party requires the administrator to opt for performance or non-performance, the administrator shall state without undue delay whether it will claim performance or not. If the administrator does not provide such a statement within such time frame, the administrator may no longer insist on performance (§ 103 (2) InsO). However, contracts concluded by the debtor for the lease or tenancy of immovables or premises and employment relationships of the debtor shall continue to exist (but to the credit of the insolvency estate (§ 108 InsO)), unless the administrator has expressly terminated such lease or tenancy in accordance with § 109 InsO.
Moreover, according to § 112 InsO tenancy or lease contracts concluded by the debtor as tenant or lessee may not be terminated by the other party after the opening of the insolvency proceedings was requested due to any of the following reasons:
- default in the payment of tenancy or lease fees arising before the opening of the insolvency proceedings was requested,
- degradation of the debtor’s financial situation.
Contractual provisions that exclude or limit the application of §§ 103 to 118 InsO are considered to be invalid (§ 119 InsO). Thus, any outstanding lease rentals from the period prior to the filing for insolvency may be pursued by the lessor only as insolvency creditor in the insolvency proceeding.
- § 129 – 147 InsO as well as the German Creditors’ Avoidance of Transfers Act (“Anfechtungsgesetz”) regulate the contest of certain debtor’s transactions that disadvantage other creditors, however, the “Anfechtungsgesetz” is applicable only outside the insolvency proceedings.
Finally, the debtor-in-possession management insolvency proceeding (§§ 270 – 285) shall be mentioned as it was the requested and court ordered proceeding during the preliminary insolvency phase of Air Berlin due to the fact that Air Berlin received a government loan to continue its airline business during the 3 months of that first phase of the insolvency proceedings. Such proceeding means that the debtor is entitled to manage and dispose of assets involved in the insolvency proceedings under the supervision of an insolvency monitor/trustee (“Sachwalter”) if the court – upon the request of the debtor – orders so. However, in most airline insolvency cases, it will most probably not be possible for the airline to continue to provide air transportation services (and therefore debtor-in-possession could not be justified) because already about the date when the opening of insolvency proceedings was requested the German Civil Aviation Authority (“Luftfahrt-Bundesamt” or abbreviated “LBA”) will have withdrawn or at least suspended the airline’s operating license pursuant to Regulation (EC) 1008/2008 due to the financial situation of the airline (see in more detail under B. 4. below).
- Special features of an airline insolvency
Due to the peculiarities of the aviation industry, there are some special features in an airline insolvency which are stated below.
- Aircraft owned by another person than the debtor
As aircraft are often not owned by the insolvent debtor airline, the aircraft owner may request the debtor/(provisional) insolvency administrator to release/surrender the aircraft to the owner pursuant to § 47 InsO provided the leasing has been terminated. Thus, if the leasing of an aircraft is terminated due to a termination by either the insolvency administrator or the lessor, the leased aircraft must be separated from the insolvency estate and returned to the lessor. At the latest after the opening of the insolvency proceedings, the separation obligation falls within the scope of duties of the insolvency administrator. If the preliminary insolvency administrator is already a strong one, such obligation rests with the provisional insolvency administrator already in the preliminary insolvency phase. Otherwise it is the debtor who has to return the aircraft to the owner (with the consent of the provisional insolvency administrator) during the preliminary insolvency proceedings if the leasing has been terminated by the lessor already prior to the filing of the request to open insolvency proceedings.
Hence, due to the prohibition for a lessor to terminate an aircraft lease agreement pursuant to the reasons stated in § 112 InsO (which cannot be circumvented by any contractual provision – see § 119 InsO), it may be advisable for a lessor to terminate any aircraft leasing prior to the filing of the request to open insolvency proceedings. However, if such termination has not occurred prior to that date and the debtor airline uses the aircraft after the request to open insolvency proceedings has been filed and does not pay rent during that period, the lessor may terminate for a payment default that occurred (after the filing for insolvency) in accordance with the termination rights set forth in the lease agreement.
In the case of a commercial aircraft, a technically complex acceptance procedure must generally be carried out in case of the return of the aircraft and extensive technical documentation handed over. Moreover, if the engines of an aircraft have been detached from the airframe at any time, they must be returned separately. Hence, even if the insolvency administrator is cooperative, he may lack the necessary technically trained personnel as a result of a cessation of operations in order to return the leased aircraft with the documentation in correct and up-to-date from and this can lead to a delay in redelivery. An additional challenge arises when the transfer of the aircraft together with its documentation (in paper and/or electronic form) still requires certain statements and stamps from the Continuing Airworthiness Management Organization (CAMO) of the insolvent airline. Thus, it is important whether the CAMO license of the insolvent airline is still valid in order to obtain such certification of the documentation if needed.
All these elements may ultimately result in the lessor being able to enforce its rights effectively only at its own expense. This requires short-term liquidity, and the long-term reimbursement of expenses by the lessee is largely unlikely in view of the insolvency proceedings.
In the case of large and complex leased assets like commercial aircraft, however, the daily costs incurred (e.g. for maintenance as well as liability and hull insurance) and the potential liability risk arising from aircraft will often be an incentive for the insolvency administrator at least not to prevent or complicate the return of the leased aircraft.
With regard to the financing of the aircraft by the lessor, obstacles and delays in the return of the leased aircraft could mean that the lessor may only avoid a breach under the loan agreement if the loan agreement provides sufficient leeway for such situations or if the lessor has sufficient liquidity reserves.
- Mortgage registered on an aircraft
As aircraft are considered to be immovables according to the German insolvency law, § 49 InsO applies to a mortgagee who has the benefit of a mortgage registered on an aircraft. Thus, such mortgagee may request the enforcement of the registered mortgage by public auction of the aircraft pursuant to the German Act Governing Auctions and Sequestrations of Immovables. Pursuant to § 165 InsO also the insolvency administrator may initiate with the competent court an auction of an immovable asset (e.g. an aircraft) forming part of the insolvency estate even if such aircraft is subject to a right to separate satisfaction by a mortgagee. However, in such case the mortgagee’s interest in the aircraft will be considered when the proceeds obtained after the sale by auction will be distributed.
As mentioned above, in order to secure the insolvent company’s assets during the preliminary insolvency proceedings, the insolvency court usually implements a temporary stay of debt enforcement with respect to the insolvent company’s movables. The temporary stay also covers the enforcement of security interests. However, regarding the insolvent debtor’s immovable assets (as mentioned before, aircraft are regarded as immovable assets under German insolvency law), a temporary stay may not be ordered by the insolvency court. However, the court in charge of the enforcement proceedings (“Vollstreckungsgericht”) in connection with the public auction of the aircraft may order a temporary stay if the insolvency administrator expressly requested that in order prevent any detrimental changes in the debtor’s assets (§ 30d of the German Act Governing Auctions and Sequestrations of Immovables).
- Aircraft Engines
Aircraft engines have a high economic value in itself and as they are replaced regularly and with not much effort, an independent market has developed. Nowadays, aircraft engines are often purchased, financed and leased separately. Moreover, in order to avoid aircraft downtime, engines are swapped for the necessary maintenance on a regular basis. Due to such practice, aircraft engines are regarded in Germany as simple components (“einfache Bestandteile”) or accessories (“Zubehör”) of an aircraft, and therefore, may be subject to different rights than the rights in rem regarding the airframe to which they are attached.
Under German law, this allows engines to be separated from the aircraft without any change in the allocation of ownership and the owner’s right to have the engine surrendered to it in an insolvency proceeding, continues even after the engine has been detached from the airframe. In addition, the ownership of an aircraft does not have to extend to the engines, so that another person may claim a right of separation from the insolvency estate in relation to the engines than the person claiming a right of separation in relation to the airframe to which the engines are attached. However, the legal position of the person entitled to have an aircraft engine separated differs from the position of a person entitled to separation of an aircraft/airframe, because an engine not owned by the aircraft owner is subject to enforcement procedures for movable assets, i.e. an aircraft engine is considered a movable and not an immovable object (as an aircraft) under German insolvency law. As a result, an engine may, for example, be covered by the provisional measures under § 21 (2) No. 3 and No. 5 InsO during the preliminary insolvency proceedings. Furthermore, a separate on-going leasing contract for an engine does not fall within the scope of § 108 I InsO (which applies only to the leasing of immovables), but within that of § 103 InsO (see above the distinction between the two Sections). German insolvency law thus leads to a differentiation between leasing contracts for aircraft on the one hand and leasing contracts solely for aircraft engines on the other.
However, if the engines are owned by the owner of the aircraft and such aircraft is encumbered with a registered mortgage, the mortgage extends to the engines (§ 865 ZPO (Zivilprozessordnung = German Civil Procedure Law) in conjunction with § 99 I 1 LuftFzRG (Gesetz über Rechte an Luftfahrzeugen = German Act on Rights on Aircraft)). However, a release of any engine from liability under the mortgage is possible pursuant to § 31 (3) and (4) LuftFzgRG provided the engine is sold and separated from the airframe (not only on a temporary basis) before a bailiff has taken the aircraft into custody for enforcement purposes. In the case of detaching an engine from the airframe solely on a temporary basis, e.g. for maintenance purposes only, the release from liability for an aircraft mortgage is normally denied.
- Operating License and AOC
Since a commercial airline is dependent on the existence of a valid operating license and air operator certificate (AOC) for providing air transportation services to the public, the question arises as to what effect an insolvency filing and the opening of insolvency proceedings has on the existence and use of the operating license and AOC.
Although neither the filing of a request to open insolvency proceedings, nor the actual opening of, the insolvency proceedings leads to an automatic expiry of the operating license and AOC, such license/certificate may be suspended or revoked by the LBA (as the competent licensing authority for German airlines) considering the financial situation of the airline debtor.
Pursuant to Art. 4 (b) and (g) of Regulation (EC) 1008/2008 of the European Parliament and of the Council of 24 September 2008 on common rules for the operation of air services in the Community (Recast) as amended from time to time (hereafter the “Regulation (EC) 1008/2008”), requirements for an operating license of a German air carrier are, inter alia, a valid AOC as well as meeting the financial conditions specified in Article 5 of the Regulation (EC) 1008/2008. Moreover, according to Art. 9 (1) 1. and 2. sentence of Regulation (EC) 1008/2008, the LBA may at any time assess the financial situation of a German air carrier and based upon its assessment, the LBA shall suspend or revoke the operating license (it has issued) if the LBA is no longer satisfied that the German air carrier is, will be, able to meet its actual and potential obligations for a 12-month period. Nevertheless, the LBA may grant a temporary license not exceeding twelve months pending financial reorganization of the German air carrier provided (i) safety is not at risk, (ii) such temporary license reflects, when appropriate, any changes to the AOC and (iii) there is a realistic prospect of a satisfactory financial restructuring within that time period (Art. 9 (1) 3. sentence of Regulation (EC) 1008/2008).
Thus, only if each, the operating license and the AOC, is still valid, it is generally possible for an airline that is subject to insolvency proceedings, to continue the business as an airline (i.e. providing air transportation services on a commercial basis) during the insolvency proceedings.
- Eurocontrol charges
In case of a dry or wet lease of an aircraft, the lessor has to bear in mind that the insolvent lessee may have not paid the Eurocontrol charges it occurred in the last month(s) prior to the filing of the request to open insolvency proceedings (although the lessee is obligated under the respective dry or wet lease agreement to pay such Eurocontrol charges).
Under the respective contracts, the (wet) lessee usually has to pay Eurocontrol charges in connection with the flights performed by it, respectively by the wet lessor for the wet lessee under the designator of the wet lessee. However, if those have not been paid, Eurocontrol may “claim” payment of such outstanding Eurocontrol charges from the (wet) lessor/owner by Eurocontrol “threatening” that if the aircraft ever flies to the United Kingdom it could be detained and sold under UK law (Transport Act 2000) for such outstanding Eurocontrol charges although according to the “Eurocontrol Agreement“ Eurocontrol may demand payment only from the respective operator that incurred the debt if that operator is known to Eurocontrol. Hence, although German law does not provide such right of detention and sale for unpaid Eurocontrol charges (as it is available in the UK) it has to be considered even by a German (wet) lessor if it intends to ever operate the Aircraft to the UK.
As in particular the Air Berlin insolvency has shown, sometimes the only valuable assets of an airline (that is subject to insolvency proceedings) are the airport slots, i.e. the time window within which permission is given by a coordinator to an airline in accordance with the “EU Slot Regulation” to use the full range of airport infrastructure necessary to operate an air service at a coordinated airport on a specific date and time for the purpose of landing or take-off. However, only under particular conditions airport slots may be transferred, see Article 8a of the “EU Slot Regulation” (Council Regulation (EEC) No. 95/93 as amended from time to time in particular by Regulation (EC) 793/2004).
The separate treatment of engines and the (security) rights often enjoyed by third parties on aircraft raise a number of highly complex legal and factual issues. Moreover, the mandatory operating license required for the provision of commercial air transport services may be suspended or even withdrawn. Hence, if the airline (subject to insolvency proceedings) shall be continued, a number of tasks must be undertaken as early as possible (even before the request to open insolvency proceedings is filed with the court), in order to set the course for a successful restructuring during insolvency proceedings (if that is at all possible).
It is always advisable for the lessor to demand from the lessee a security deposit (either in cash or as a bank guarantee/letter of credit) in order to be covered for a certain period of time. Moreover, the lessor is well advised to analyze the options available in the lessee’s financial crisis, in particular termination of the leasing prior to the lessee or a creditor filing a request to open insolvency proceedings.
Written by Christine Kranich, Counsel with Arneck Sibeth Dabelstein