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The Treatment of Aircraft in Canadian Insolvency Proceedings

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Editor's Note: The Supreme Court of Canada recently reversed decisions by the Ontario Court of Appeal and the Quebec Court of Appeal by ruling that airport and navigation authorities can potentially obtain court orders that (1) authorize the detention of aircraft until outstanding service charges and fees are paid and (2) rank in priority to the proprietary/secured party rights of aircraft lessors.1

The past 20 years have brought significant changes to the Canadian airline industry. The story is not significantly different from other countries, especially the United States. Factors such as deregulation, increased competition, political turmoil (such as regional wars and Sept. 11) and pandemic health occurrences (such as SARS) have played a large role in instigating the insolvency of established airlines such as Air Canada, Canadian Airlines and Canada 3000.

An issue that has frequently surfaced in Canadian airline insolvencies is the clash between airport and navigation authorities (the authorities) and aircraft lessors concerning priority claims over the aircraft of the insolvent airline. The authorities have argued that upon receipt of a judicial order under applicable Canadian aviation statutes, they may seize and detain the insolvent airline's aircraft until outstanding charges and fees are paid (the detention remedy), and that such statutory detention remedy rights stand in priority to the ownership or perfected security rights of third parties. Conversely, aircraft lessors have vigorously argued that upon default of an aircraft lease, a lessor is entitled to repossess the aircraft free of the charges and fees that the defaulting airline incurred to the authorities, and that the detention remedy is ineffective against a lessor's proprietary right of repossession.

Until recently, this "clash of the titans" has generally resulted in victories for the aircraft lessors, since courts have ruled that the aircraft lessors' right to repossess their aircraft had priority over the detention remedy. However, in Canada 3000, the Supreme Court of Canada reversed the lower court decisions and ruled that under the detention remedy, any aircraft could be detained by the authorities in priority over the interests of the aircraft lessors.

Background

In the 1990s, the Canadian government established a new national airports policy whereby private nonprofit corporations known as airport authorities2 were established to manage, operate and maintain federally owned airports, and NAV Canada, also a nonprofit corporation, was established to manage and control the civil air and navigation system. The authorities operate independently from and without the financial assistance of the federal government and are required to finance the operations, management and expansion of the airports and air traffic system from fees and charges primarily received from air carriers. Unlike other business enterprises dealing with air carriers, the authorities are mandated to provide equitable access to all air carriers and cannot attempt to restrict access to an air carrier based on perceived financial instability. Consequently, at the commencement of airline insolvency proceedings, the authorities are often owed significant airport charges and fees.3 As a result, the authorities have attempted to utilize the detention remedy in a number of instances to recover such unpaid charges and fees. These attempts at recovery were generally unsuccessful until the decision of the Supreme Court of Canada in Canada 3000.

Facts of the Case

In 2000, following the merger between Canadian Airlines and Air Canada, Canada 3000 quickly expanded its charter operations to become Canada's second-largest airline. However, its new stature did not last long, as it became the first Canadian airline economic casualty of Sept. 11. With a sudden drop in passengers, dwindling cash reserves and unsuccessful negotiations with its unionized employees, Canada 3000 applied to the court in Toronto for protection under the Companies' Creditors Arrangement Act4 and was granted an initial order on Nov. 8, 2001.5 Canada 3000 operated a fleet of 39 aircraft, and although all of the aircraft were registered in the name of Canada 3000, the airline did not own the aircraft. The aircraft were leased from various third parties, and the aircraft lessors, who were the legal owners, included many of the major international aircraft leasing institutions.

Following the granting of the initial order, which included a stay prohibiting the initiation of enforcement measures against Canada 3000, the authorities sought to lift the stay to allow for detention of the aircraft. At this time, Canada 3000 owed approximately CAD$28.75 million to the authorities for past airport charges and fees.

Assertion of the detention remedy was opposed by the aircraft lessors on the basis that the remedy did not have priority over the rights of the aircraft owners. In reviewing the detention remedy, the Ontario Superior Court of Justice (court of first instance) concluded that the detention remedy did not create a lien or security interest ranking in priority to the ownership or statutory perfected security rights of third parties. The Court determined that the statutory detention remedy had to specifically state that the remedy was to have priority over third parties to be implemented, analogizing the detention remedy to a Mareva injunction (whereby assets are frozen while various parties work out their respective entitlements) rather than to a statutory lien.

The decision was appealed to the Ontario Court of Appeal, where, in a 2-to-1 decision, the majority of the Court of Appeal agreed with the lower court that the detention remedy did not give the authorities priority over the rights of the titleholders to repossess the aircraft. Further, the Court of Appeal was of the view that the detention remedy was not a statutory lien, and at best could only be used to pressure an airline to pay the outstanding fees.

Decision of the Supreme Court of Canada

The Supreme Court of Canada granted leave to the authorities to appeal the decision of the Ontario Court of Appeal. It also granted leave for an appeal of a decision of the Quebec Court of Appeal in the Inter-Canadian insolvency proceedings.6 In a unanimous decision that reversed both the decisions of the Ontario Court of Appeal and the Quebec Court of Appeal, the Court stated that the authorities are entitled to obtain judicially authorized detention orders to be exercised against the aircraft. The Court ruled that the detention remedy is a remedy against aircraft, irrespective of who is the ultimate owner of the aircraft, and that it has to be an effective and meaningful remedy, not a mere pressure tactic. The Court held that the detention remedy was to be interpreted in the commercial reality of the marketplace where the applicable statute is intended to function, and in the context of a turbulent airline industry where financial failure is commonplace. Since the authorities are not entitled to withhold services from failing airlines and are required by law to provide services on a cost-based tariff, the Court held that the only effective collection scheme for the authorities was to render the aircraft available for seizure. Thereafter, those interested in the aircraft, including legal titleholders, lessors, secured creditors and operators, would have to resolve their dispute as to where the money would come from to pay the amounts due to the authorities.

Basic Principles of the Detention Remedy

In reviewing the detention remedy, the Court defined its essential principles, which can be summarized as follows:

The detention remedy is national in scope. The authorities can bring an application anywhere in Canada to detain aircraft located in Canada. In Canada 3000, a motion was brought in Toronto to detain aircraft located not only in Toronto but also in Vancouver, Halifax, Montréal, Calgary, Ottawa and St. John's.
The detention remedy is federal law and is not limited by provincial laws. The courts should strive to interpret the remedy in the same manner across the country without regard to local laws. Analogies to Mareva injunctions or liens are not necessary, and references to provincial laws are inappropriate.
The detention remedy is available against aircraft irrespective of the ultimate owner of the aircraft or of any security interests in same.
The detention remedy extends not only to the aircraft body but also to the aircraft's engines and equipment such as onboard computers. One cannot cannibalize an aircraft to defeat the remedy.
The authorities are not bound to seize all aircraft and allocate their charges on a "per aircraft" basis. They may seek to seize only one aircraft if they so choose. The authorities are entitled to be paid in full before they release any aircraft.
The claims of the authorities include accruals of interest at their standard rates up to the first to occur of the date of payment, the posting of security or the bankruptcy of the airline.
The detention remedy is only a right of detention, without a right to sell or dispose of the aircraft.
The detention remedy is not automatic. The authorities must obtain a court order. A judge has wide discretion to grant the remedy and to alleviate the burden and potential unfairness of a detention among various owners of aircraft, subject only to the right of the authorities to be paid in full.

Effect on Aircraft Lessors

The Supreme Court was not overly sympathetic to the plight of aircraft lessors in Canada 3000, noting that aircraft lessors that have done their due diligence will recognize that detention remedies have deep roots in the transport business. In the Court's view, airport lessors are in a better position to protect themselves against this type of loss than are the authorities. The Court further noted that aircraft lessors have the ability to select which airlines they are prepared to deal with and negotiate appropriate security arrangements as part of their lease transactions with such airlines. In the case of the aircraft at issue in Canada 3000, many if not all of the leases required Canada 3000 to post security deposits for airport fees and charges. Such deposits, according to the Court, demonstrate the aircraft lessors' ability to negotiate protection at a time when an airline is solvent to cover the amounts in overdue charges that the airline may eventually be required to pay to the authorities.

The International Impact

In Canada 3000, the Supreme Court noted that aircraft lessors are able to manage the risk of seizure in Europe and that there was no reason why they should not be able to manage this risk in Canada. In its remarks, the Court referred to similar English detention remedies in favor of the U.K. airport authorities.

As a result of the Supreme Court's decision in Canada 3000 and Inter-Canadian, the authorities will become major players in airline insolvency proceedings, their role increasing in future bankruptcies and restructurings.

For international carriers filing for insolvency protection, it has been the practice in Canada and the United States to obtain an order from the court overseeing the restructuring, to allow the carrier to pay the fees of foreign airports and navigation authorities that are incurred before the filing. Foreign airports and other authorities are viewed as critical suppliers. This prevents the seizure of aircraft during the insolvency proceeding and preserves the airline's international routes. For example, such an order was obtained from the U.S. bankruptcy court in the Delta and Northwest chapter 11 proceedings. A similar court order was obtained in Canada in the Air Canada restructuring. Surprisingly the Canadian order in Air Canada treated the authorities differently by staying their rights and remedies and treating them as critical suppliers. This created an unfair and unequal result. The detention remedy may now create a level playing field between foreign and Canadian authorities. An international carrier restructuring in Canada may now determine that the payment of fees and charges to airports and navigation authorities, wherever located, should be made so as to avoid dealing with seizures in Canada as well.

Conclusion

As a result of the Supreme Court's decision in Canada 3000 and Inter-Canadian, the authorities will become major players in airline insolvency proceedings, their role increasing in future bankruptcies and restructurings. The authorities will now regularly apply for the detention remedy to recover outstanding fees and charges in future insolvency proceedings, and as a result, courts will need to allocate the burden of those fees and charges on owners of aircraft that are no longer required as part of the restructured fleet. In an international carrier's restructuring, the detention remedy may lead the insolvent airline to pay all of the pre-filing fees and charges to the authorities as well as to their foreign counterparts on the basis that they are all critical suppliers. Aircraft lessors accordingly must remain mindful of the newfound ability of the authorities in Canada to detain aircraft in priority to their right of repossession, and that they may be required to post bonds or security in excess of the claims of the authorities so that the aircraft may be released as an interim measure during the initial stages of the proceedings. Additionally, in negotiating lease agreements, aircraft lessors should ensure that the airlines post sufficient deposits so that any overdue charges can be expeditiously remedied and detained aircraft released.

 

Footnotes

1 Re Canada 3000 et al, 2006 SCC 24 [Canada 3000].

2 Such as the Greater Toronto Airports Authority.

3 For instance, at the commencement of the Air Canada insolvency proceedings in April 2003, the authorities were owed in the aggregate approximately CAD$80 million for past airport charges and fees.

4 R.S.C. 1985, c. C-36 [CCAA].

5 A CCAA initial order is similar to a "first day" order in a chapter 11 proceeding.

6 The Supreme Court heard the Inter-Canadian appeal in conjunction with the Canada 3000 appeal, since both appeals raised similar issues concerning the enforceability of the detention remedy in airline insolvency proceedings.

Journal Date: 
Friday, September 1, 2006

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