Written by Michael McLaren QC
Much has been written on the rights of air passengers resulting from COVID-19. But for many airlines, COVID-19 poses a much more existential threat. It threatens the survival of not just small airlines like Flybe. British Airways warned on 13 March that COVID-19 is “more serious” for aviation than the 2009 SARS or 9/11 (“it’s crisis of global proportions like no other we have known”); and more recently reported that COVID-19 threatens its very survival. Likewise, Korean Air has warned that it might not survive. Cathay Pacific has warned of substantial losses. Many airlines are barely viable; about 40% of passenger flights in Europe are on airlines which trade no better than break even. Others, such as Norwegian, are known to be already heavily shackled by debt.
This article considers COVID-19 from an airline perspective, not a passenger perspective; and offers thoughts as to how airlines might seek to reduce their vulnerability to failure.
The short term problem
The liquidity issue:
The survival of an airline in a fast-moving crisis depends not only on business decisions (present and future) and external factors. The intrinsic resilience of the business, and above all liquidity, are likely to be the key factor. Airlines with weak balance sheets, particularly if heavily geared, will be more vulnerable to failure. So airlines will urgently be looking at how best to reassure lenders or investors that their exposure to claims is limited and manageable – and how to avoid needing to make provisions in their accounts or excessively pessimistic profit warnings.
One obvious vulnerability for airlines is passenger claims for delayed or cancelled flights. But the exceptional nature of COVID-19 might provide a get-out-of-jail-free card. The compensation regime in Europe (EU Regulation 261/2004) does not give passengers a right to compensation if the delay was caused by an “extraordinary circumstance”. COVID-19 might well be thought to be one. But it will be a fact-specific question whether COVID-19 caused a particular flight to be delayed or cancelled. A flight which has effectively been banned by the closure of a country’s borders might well qualify; but another flight cancelled due simply to lack of passengers making it uneconomic might not. Airlines will be looking for excuses not to fly empty flights, but will need to give careful advance consideration to the issue of whether the “extraordinary circumstance” defence will apply. Another factor might be any possible relaxation of EU rules on airlines needing to operate flights in order to avoid losing valuable landing slots. Airlines wishing to reassure nervous investors or lenders as to their viability will pro-actively be considering all their arguments as to how they can robustly defend such claims and, importantly in a cashflow crisis, how far they can legitimately delay paying out on any claims.
A greater pressure point than passenger claims might well be the ongoing running costs of the airline. Staff costs are just one significant expense. But how airlines can reduce staff costs is a business decision, dependent on the jurisdiction, and is outside the scope of this article.
Aircraft leasing costs are another major expense, potentially crippling for an airline if it cannot earn revenue from those aircraft. What recourse have airlines against aircraft lessors? From a legal perspective, in most cases probably not much. Aircraft leases are almost invariably boiler-plated in favour of the lessor. The lessee’s (airline’s) payment obligation is typically “absolute and unconditional irrespective of any contingency whatsoever” (to quote from one aircraft lease currently on my desk). So even if a pandemic such as COVID-19 might fall within a well-drafted force majeure clause, such clauses do not tend to feature in aircraft leases.
However, there might be another option. Particularly if airlines band together to act in concert, they might well have considerable leverage to negotiate payment holidays with aircraft lessors. Aircraft lessors will also be deeply worried by COVID-19; realistically they cannot foreclose on all aircraft leases where the lessees are in default, because that risks making the situation for lessors far worse. If there were to be widespread lease terminations, the lessors’ chances of re-leasing the aircraft during a pandemic or any time soon would be close to nil, even with the continued suspension of the 737 Max. So market forces should give airlines leverage to negotiate payment holidays and other relief with lessors. The earlier an airline raises those issues with lessors, the sooner it will reach a deal and be able to give definitive good news to its investors or lenders.
Certain variable costs (such as fuel costs), by contrast, will be less of a problem for airlines, due to both flight numbers being much reduced and the price of aviation fuel recently falling. But airlines will also need to consider how to cap their liabilities to maintenance providers (MROs), catering companies and the myriad other businesses which depend on the aviation industry. Typically, airlines will have long-term contracts with such other businesses, often at reduced rates because of the airlines’ leverage. How best can airlines mitigate their liabilities to those companies? Early and careful review of all those contracts, including any force majeure clauses which might cover pandemics, might well assist airlines wishing to reassure investors or lenders of their financial resilience in the face of COVID-19.
Longer term opportunities
COVID-19 will pass. After extensive bankruptcies of weaker airlines, surviving airlines might well benefit from a rosier post-COVID landscape with reduced airlines in competition. But what lessons might those surviving airlines take from COVID-19?
This is the first pandemic to cause global economic disruption on anything like this scale. It is certainly possible to draft future force majeure clauses so as include a pandemic (defined as one declared by the WHO). In many fields (not just aviation), there is scope for force majeure clauses to be introduced into in future contracts so as to include pandemics. As regards airlines, they should negotiate into future contracts some mechanism for relief from financial liabilities in the event of future pandemics and other such events (e.g. another 9/11). Surprisingly, even large airlines typically don’t seem to use to maximum effect their considerable leverage when negotiating major contracts with aircraft or engine manufacturers or lessors. COVID-19 should be a wake-up call to them to do so.
Tough contractual bargaining aside, other lessons for the future will surely be able to be learned from the COVID-19 debacle, once the dust has settled. The key point for airlines is perhaps this: once COVID-19 has passed, airlines should not just breathe a sigh of relief and focus on rebuilding their balance sheets on the basis of “business as usual”. The world has changed. “Business as usual” is no longer adequate in whatever will be the post-COVID-19 landscape.