Case Study: Aviation

Introduction

In the midst of the pandemic, the Latin American airline industry reached a milestone: the 100th anniversary of the first scheduled airline service in the region. Société des Transports Aériens Guyanais began scheduled flights in early October 1920 from Saint Laurent to Cayenne and Inini in French Guiana with Lévy-Lepen biplanes carrying two passengers. The little airline ceased operations two years later, on 30 October 1922.^[2]

During the following century, the development of the industry in Latin America followed a similar course to its progress in the rest of the world: aircraft grew larger, networks grew denser, operations were professionalised – and there were many failures, as there were in all regions. A group of the region’s oldest and most storied airlines went on separate, mostly unsuccessful, restructuring paths in the difficult years between 11 September 2001 (the 9/11 terrorist attacks in the United States by Al-Qaeda) and the global financial crisis of 2008–2009, which were followed by a period of cross-border consolidation and relative stability.

The covid-19 pandemic caused an unprecedented crisis in the aviation industry globally, and Latin America’s largest airlines were not insulated from its effects. Avianca, LATAM Airlines and Aeroméxico all filed for court protection in the United States in 2020. This chapter discusses the causes of airline restructurings in Latin America and the challenges – and possibilities – inherent in the process.

Latin American airline restructurings in the early 2000s

The 1990s and early 2000s were an extremely challenging time for network carriers in Latin America. Largely because of the competitive pressures of a dynamic industry and internal legacy issues resulting from their long histories, three of the region’s four^[3] oldest carriers liquidated between 2003 and 2010. The fourth, Avianca, successfully emerged from a Chapter 11 proceeding in December 2004.

One source of strain was increasing competition on international routes that historically had been protected from competition. The United States began pursuing Open Skies policies in 1992 to replace bilateral air service agreements that restricted the number of airlines, flights or routes that could be operated between the signatory countries.^[4] The International Civil Aviation Authority and a number of global and regional trade associations began a campaign for international liberalisation around the same time and found some success in Latin America: Brazil and a number of its neighbours signed an agreement in 1996 to open new international routes without restriction, and Brazil progressively liberalised its policies and modified price controls thereafter.^[5]

In addition to increasing capacity and decreasing fares in international markets, incumbent carriers in Latin America were beginning to face new competition in their domestic operations. Mexico began deregulating its domestic industry in 1991, and several start-ups entered the market right away.^[6] Among new entrants that have had staying power in the region, AeroRepública began flying in Colombia in 1993,^[7] GOL in Brazil in 2001, Sky Airline in Chile in 2001, and Volaris and VivaAerobus in 2006 in Mexico.

Compounding the impact of increasing competition, several other events occurred during this period that affected international air travel markets and airline cash flows: 9/11, the SARS epidemic and significant weakening of key Latin American currencies against the US dollar.^[8] Amid all these business challenges, some of the largest airlines in Latin America were forced to pursue in-court restructurings. Ultimately, Mexicana and Varig (and a number of smaller airlines) liquidated during this period.

The Mexicana case illustrates some of the difficulties and risks inherent in airline restructurings.

Mexicana liquidates

Mexicana offered its first service in 1921 and started scheduled service in 1926. The airline was overseen by Pan American for most of its early years. After years of labour actions and financial difficulties, it narrowly avoided liquidation in 1967. The airline was able to reprofile its debts with the assistance of the Mexican courts, restructure its fleet around the Boeing 727 and sell 10 airports that it had built in its early years to the Mexican government. The restructuring was followed by a long period of profitable operations.^[9]

Mexicana was nationalised, along with Aeroméxico, during the 1990s peso crisis, then reprivatised in 2005.^[10] Its cost structure remained elevated – the airline claimed that its pilot pay rates were 49 per cent higher than for US airlines – and the airline was severely affected by the entry of new low-cost competition, the 2007–2008 jet fuel price spike, the financial crisis and the 2009 H1N1 swine flu epidemic.^[11]

Mexicana filed for a voluntary concurso proceeding in Mexico on 2 August 2010, seeking to renegotiate its collective bargaining agreements and US$1 billion of debt. Its labour unions had accepted benefit reductions worth US$35 million annually in 2006, and were unwilling to grant further concessions.^[12] At least three aircraft were seized by creditors immediately after the filing, and two days later it ended ticket sales after it was suspended from the International Air Transport Association (IATA) clearing house.^[13]

Mexicana ceased operations by the end of August 2010. It had filed for Chapter 15 recognition in the United States, but as of the end of operations, it had not been granted protection in its main proceeding in Mexico and was unable to raise financing to reorganise.^[14] Its remaining assets were ultimately ordered to be liquidated in 2014 as ‘no credible new investor had expressed interest in the carrier’.^[15] As recently as 2021, there were Mexicana assets idle at Mexico City International Airport, unable to be sold or used because the estate had been unable to settle on a value-maximising path forward.^[16]

Covid-19 crisis

The sudden onset of the covid-19 crisis was a shock to the entire global aviation system. Industry growth in recent decades had been fuelled in large part by the lowering of barriers to international service and by the accessibility of affordable leisure travel to the growing global middle class – some of the same forces that created so many challenges for legacy carriers. With borders closed and non-essential travel banned in large parts of the world, the aviation industry stepped straight from a year of record passenger traffic and revenues into the worst crisis in its history.^[17]

The sudden halt created intense liquidity pressure, with airlines globally consuming an estimated US$51 billion of cash in the second quarter of 2020.^[19] As passengers stopped booking new flights, cash inflows ceased. As the airlines cancelled future flights, they had to refund fares to the passengers they could no longer carry. Meanwhile, despite reduced flying activity, many cost categories were not immediately flexible: aircraft financing costs, many components of aircraft maintenance, flight crew minimum hourly pay, overhead expenses and interest outflows all continued unabated. Cash burn was reduced thanks to limited demand recovery and cost reduction efforts in the third and fourth quarters of 2020, but remained in excess of US$40 billion and US$30 billion, respectively, in each quarter.^[20]

In some jurisdictions, but not all, government support was made available specifically to the airline industry in the form of loans, grants and reductions in carriers’ obligations to clear refunds and to pay certain taxes, navigation charges, landing fees and other tariffs. IATA estimated that US$162 billion of state aid in various forms had been committed to airlines during the first six months of the crisis.^[21]

In large Latin American markets, however, aid was limited. Brazil changed certain rules to reduce cash outflows but offered no new liquidity,^[22] while Colombia offered modest financing and a reduction in the value-added tax (VAT) on tickets.^[23] Neither Chile nor Mexico offered any state aid.^[24]

Airlines that were not able to raise funds, through state aid or otherwise, or reduce cash burn quickly enough, were subject to substantial insolvency risk. Outside Latin America, Virgin Australia, Malaysian, Garuda, Philippine Airlines, Thai, Air Asia X, Virgin Atlantic, SAS and Norwegian, among others, went through high-profile in-court or out-of-court processes in the wake of covid-19.

Given the experience of the region’s airlines in the prior round of insolvencies, it is perhaps not surprising that when the covid-19 crisis forced Latin America’s three largest airline groups^[25] into bankruptcy protection in May and June 2020, they all chose to reorganise in US Chapter 11 proceedings in the Southern District of New York:

• Avianca filed on 10 May;
• LATAM’s initial debtors filed on 26 May;^[26] and
• Aeroméxico filed on 30 June.

Aeroméxico restructures and modernises its fleet

Founded in 1934, Aeroméxico is a leading full-service carrier in the Americas with its principal hub at Mexico City International Airport. The airline is a founding member of the SkyTeam alliance and maintains a close partnership with Delta Air Lines. The joint cooperation agreement between Delta Air Lines and Aeroméxico was signed in 2015, and joint operations commenced in 2017. Since then, the two airlines have transported more than 22 million passengers on routes between Mexico and the United States.^[27] Prior to the Chapter 11 restructuring, Delta Air Lines held a 51 per cent stake in Aeroméxico.

Aeroméxico’s mainline flights are operated by its subsidiary Aerovias, while all regional flights are operated by Aerolitoral under the brand Aeroméxico Connect. In addition, Aeroméxico provides cargo services under the Aeroméxico Cargo brand and maintains a customer loyalty programme with approximately 6.7 million members under the Club Premier brand.^[28]

Before the pandemic, the Aeroméxico fleet comprised 125 operating aircraft, split across six different types and variants (E170, E190, 737-700, 737-800, 787-8 and 787-9). In addition, Aeroméxico had leases for six 737-8 MAX aircraft that were temporarily grounded in March 2019. As of 31 December 2019, Aeroméxico’s operating fleet had an average age of 9.5 years.^[29] In 2012, the airline entered into a purchase agreement with Boeing to acquire up to 90 737 MAX aircraft, of which six had been delivered by the time the pandemic started. Further, the airline had one 787-9 delivery outstanding.^[30]

Between the onset of the pandemic and the Chapter 11 filing, Aeroméxico had reached substantial deferral agreements with its operating lessors and other vendors. Between vendor and labour concessions, the company temporarily reduced its fixed-cost outlays from approximately US$110 million per month to US$50 million per month by April 2020.^[31] Aeroméxico then used the Chapter 11 process to accelerate the renewal and simplification of its fleet, to reset aircraft rent to the new market reality, to renegotiate aircraft purchase agreements and associated maintenance contracts, to temporarily make rent payments dependent on an individual’s aircraft usage and to lower costs in areas of the operations.

Renewal and simplification of fleet

The fleet renewal and simplification process started with the company’s first rejection motion in July 2020. The airline rejected all leased E170, 737-700 and high-density 737-800 aircraft. A total of 19 aircraft were returned to their lessors.^[32] As further described below, the airline renegotiated all remaining aircraft lease agreements. The renegotiated lease tenors will put Aeroméxico in a position to continue the renewal of its narrow-body fleet by replacing current generation aircraft with the next-generation 737 MAX over the next few years.

Simultaneously, the airline added six 737-800 and 31 737 MAX aircraft to its fleet while operating under Chapter 11 bankruptcy protection.^[33] The company and its advisers^[34] successfully negotiated with Aeroméxico’s unsecured creditors committee to give the company the ability to bring on additional next-generation aircraft while in bankruptcy. This shows that the Chapter 11 process does not stifle an airline’s ability to make significant progress on renewing its fleet if it can demonstrate to its creditors that ongoing fleet renewal adds value to the reorganised airline.

Reset aircraft rent to new market reality

While in Chapter 11, Aeroméxico entered into renegotiated lease agreements for all remaining leased aircraft at improved economic terms. Rent payments were generally adjusted to reflect a pandemic-related decline in market lease rates, and maintenance provisions in the lease agreements were rewritten to lower the airline’s cash outlays.

Shortly after entering Chapter 11, Aeroméxico negotiated stipulations with all its operating lessors to pay for aircraft rent on a ‘power-by-the-hour’ (PBH) basis; that is, the company would only pay for aircraft it was using while demand recovered from the pandemic. The PBH rates were reflective of current market lease rates. In addition to the rent payments, the company also reimbursed lessors for the maintenance impact of continued aircraft usage during the Chapter 11 case. The stipulations also extended all existing operating leases to give the company sufficient time to develop its long-term fleet plan and to reach renegotiated lease agreements.

Renegotiate aircraft purchase agreements and associated maintenance contracts

In 2012, Aeroméxico placed an order with Boeing for up to 90 737 MAX and 10 787 aircraft. In later years, Aeroméxico entered into related financing agreements. Owing to the pandemic, the original pricing exceeded current market rates and the delivery schedule no longer aligned with the company’s capacity needs. The renegotiated agreement between Aeroméxico, Boeing, the engine manufacturers and other financing parties will create total savings exceeding US$800 million and will lower future capital expenditures and related financing charges by almost US$2 billion. Nevertheless, the restructured agreement supports Aeroméxico’s fleet renewal through the delivery of 20 737 MAX aircraft and four new 787-9 aircraft. The negotiated outcome also avoids approximately US$1 billion in unsecured claims.^[35]

In addition to the fleet restructuring, Aeroméxico also transformed its operations and collective bargaining agreements. For example, Aeroméxico successfully expanded its operations at Mexico City International Airport to a second terminal in support of its growth strategy. The company also reached new agreements with all its labour unions, leading to 27 per cent in labour savings.^[36]

Aeroméxico emerged from bankruptcy on 17 March 2022. The equity value of the reorganised company is approximately US$2.56 billion and the airline received approximately US$1.5 billion in new capital as part of the restructuring process.^[37]

The company has received at least 30 new aircraft since filing for Chapter 11 and expects to continue to renew and grow its fleet over the next few years. In summary, the case of Aeroméxico shows that a Chapter 11 filing does not have to put fleet transformation efforts on hold. On the contrary, Aeroméxico managed to accelerate its fleet renewal and simplification during its restructuring.

Like Aeroméxico, Avianca and LATAM used their bankruptcies to their advantage. Avianca filed for its second Chapter 11 case on 10 May 2020, promising to ‘use the tools available to them to optimize their operations in an increasingly challenging market and right-size their network, fleet and related debt and lease obligations, and drive cost efficiencies’.^[38] Its forecasts indicate an expected US$500 million of annualised cost savings and a 41 per cent decrease in unit costs.^[39] After its emergence, Avianca merged with GOL under a holding company structure, creating a new entity called the Abra Group, setting the stage for the next phase of its development.^[40]

LATAM filed on 26 May 2020 planning to ‘reject, renegotiate and/or assume and assign certain aircraft leases in order to revitalize the size and makeup of their fleet . . . [and] maximize the efficiency of their ongoing operations’.^[41] During the case, they recapitalised their Peruvian and Ecuadorian subsidiaries, rejected and renegotiated aircraft leases, reprofiled their aircraft order book and took steps to control operating costs.^[42] LATAM is expected to emerge some time in the second half of 2022.

Conclusion

Airlines facing the possibility of a restructuring process in general have two related goals: ensure the viability of the business and maximise returns to stakeholders. In most cases, those goals also imply minimisation of the risk of liquidation. Restructuring regimes in Latin America and elsewhere have continued to evolve since the liquidations of the early 2000s, but Avianca’s successful emergence from Chapter 11 protection in 2004 also showed that airlines operating to the United States have straightforward access to Chapter 11. The tools provided by the bankruptcy process allow debtors to pursue their plans to maximise the value of the estate for the benefit of all creditors.

In Aeroméxico’s case, the ability to focus on maximising the going-concern value of the airline as a whole underpinned the whole strategy and case approach. The Unsecured Creditors’ Committee’s support for the debtors’ accelerated adoption of 737 MAX aircraft as value accretive for all creditors is one example of how bankruptcy can bring parties together to build consensus.

Every restructuring is disruptive, time-consuming and costly, and no business would elect to go through one except under very unusual circumstances. When a restructuring is required, however, airlines should look for opportunities to use the tools of the process to accelerate progress towards their strategic plan to maximise value.

Notes