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Courts Override Underlying Contractual Obligations in the Chapter 11 Surrender and Abandon of Aircraft Equipment and Vessels

By: Lisa Strejlau                                            

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

 

            In Chapter 11 airline cases, a court will typically balance the interests of debtors and creditors in determining the method, timing and condition of collateral returns and whether or not the parties must comply with the underlying contractual obligations. In In re Republic Airways Holdings, Inc.,[1] the United States Bankruptcy Court for the Southern District of New York held that a debtor is not required to comply with underlying contractual requirements for the return of aircraft and engines as collateral.[2] After filing for Chapter 11, Republic Airways Holdings, Inc. (“Republic”) sought to surrender or abandon certain aircrafts and engines subject to liens of Citibank, pursuant to an agreement to secure Republic’s obligations with respect to a credit and guaranty agreement.[3] Republic moved for an order authorizing them to (i) transfer title to and abandon certain aircrafts and engines and reject a related aircraft lease, and (ii) to fulfill their obligations under a certain engine purchase agreement and directing Citibank to cooperate with the closing of that agreement.[4]

            Citibank did not object to the surrender and return of the collateral.[5] However, Citibank did object to the surrender and return procedures, stating that the procedures do not satisfy Section 1110(c) of the Bankruptcy Code (the “Code”).[6] Citibank argued that the time period to retrieve the collateral was unreasonable and that Citibank should maintain the right to assert any administrative expense claims.[7] Citibank also requested that Republic remove any third-party engines from the Citibank airframes and replace them with Citibank engines at Republic’s own cost.[8]

            The Court held that Republic is not required to return the aircraft and related equipment in a particular condition for surrender and return.[9] However, this does not “foreclose any claim that Citibank may have for costs associated with the surrender and return.”[10]

            Section 365 of the Code provides that subject to court approval, a debtor in possession may “assume or reject any executory contract or unexpired lease of the debtor.”[11] Generally, courts approve motions to assume, assume and assign, or reject executory contracts upon a showing that the debtor’s decisions are an exercise of sound business judgment.[12] Section 1110 of the Code provides a special form of protection in bankruptcy cases for aircraft lenders and lessors.[13] Under Section 1110, certain secured parties may not be prevented from taking possession of certain types of aircraft equipment in accordance with the terms of an applicable security agreement, lease, or conditional sales agreement, unless the trustee timely agrees to perform the debtor’s obligations under the terms of the relevant agreement and also timely cures certain defaults.[14] This section requires the debtor to choose between performing under the terms of the prebankruptcy agreement or surrender the equipment.[15] The Code does not specify whether a debtor must comply with any conditions of return in the underlying agreement.[16]

            In re Republic Airways highlights a frequent dispute in Section 1110 airline cases, which is whether the debtors should be permitted to abandon or reject collateral without complying with the underlying loan or lease agreements.[17] In determining whether the debtors should be permitted to do so, this Court found a compromise between the debtor and creditor’s competing interests.[18] Rather than placing conditions on the “surrender and return” obligations of the debtor, this Court declined to preclude Citibank from asserting any claim it may have for reimbursement of costs associated with the immediate return of the debtor’s collateral.[19] This result encourages debtors to return the collateral in a cost efficient way, as it is likely the creditor will assert a claim for expenses incurred as a result of the return procedures. In addition, courts can avoid establishing arbitrary monetary awards, as Citibank suggested here, in airline Chapter 11 cases.



[1] In re Republic Airways Holdings, Inc., 547 B.R. 578 (Bankr. S.D.N.Y. 2016).

[2] See id.

[3] See id. at 580.

[4] See id. at 580.

[5] See id. at 581.

[6] See id.; see also 11 U.S.C. §1110.

[7] In re Republic, 547 B.R. at 581.

[8] See id.

[9] See id. at 586.

[10] Id.

[11] 11 U.S.C. §365.

[12] See In re Republic, 547 B.R. at 582 (citing In re MF Glob. Holdings Ltd., 466 B.R. 239, 242 (Bankr. S.D.N.Y. 2012).

[13] See 11 U.S.C. §1110.

[14] See 7-1110 Collier on Bankruptcy ¶ 1110.01 (Alan N. Resnick & Henry J. Sommers eds., 16th ed. 2016).

[15] See id.

[16] See 11 U.S.C. §1110. See also In re US Airways Group, Inc,, 287 B.R. 643, 645 (Bankr.E.D.Va 2002) (rather than requiring compliance with contractual requirement for the return of aircrafts, the court held that lenders were not foreclosed from asserting a claim arising from non-compliance with these requirements) and In re Northwest Airlines Corp., 346 B.R. 307 (Bankr. S.D.N.Y. 2006) (rejecting the argument that debtors must comply with all the return provisions of a given lease, noting that “[t]hat is precisely what Section 1110 does not provide.”).

[17] See In re Republic, 547 B.R. at 584.

[18] See id.

[19] Id. at 586 (noting “a claim filed by Citibank will be a more accurate reflection of the true burdens associated with the surrender and return process than a simple splitting of the costs.”).