INDUSTRY STRENGTH

Who’s Who Legal: Aviation has proven itself to be a resilient sector in the past. How has the recent financial crisis impacted the level of work in your jurisdiction? How will the industry perform in the coming year?

Robin Springthorpe: The economic climate still dominates the market and the fortunes and activity of airlines, aircraft lessors and lenders. For the airlines, passenger numbers and yields are down; there is a surplus of capacity; airlines do not wish to take new aircraft; and many airlines continue to be at risk of insolvency, and are likely to be at even greater risk during 2010. Aircraft lessors are finding it difficult to place aircraft, particularly older ones; aircraft values have fallen off a cliff; and there remains enormous uncertainty, with major aircraft leasing companies such as ILFC, RBS Aviation, Babcock & Brown and Allco up for sale, further depressing aircraft values. Added to this is the difficulty of obtaining financing, or at least affordable financing, which is affecting all of the players. Consolidation seems likely in all parts of the industry, in part to reduce costs to achieve economies of scale but also in some cases as a last-ditch survival strategy.

In terms of legal work, there has been strong Ex-Im and ECA activity but a sharp reduction in traditional debt financing work. Routine leasing and commercial work continues, although many leasing companies and, where possible, airlines are trying to keep costs low by performing transactional work in-house. There has been a marked increase in dispute work, particularly leasing issues, claims on lease guarantees and aircraft repossession. We have been particularly active advising on defaults and repossessions in India, South-East Asia, Eastern, Central and Western Europe, the Middle East and in both North and sub-Saharan Africa.

Ronald Scheinberg: If I may respond to this from the aircraft finance perspective (as opposed to the airline industry generally speaking) – the aircraft finance industry really took it on the chin with the global financial crisis starting in the Fall of 2008. This crisis, as compared to other crises such as 9/11, took its toll on this sector. The capital markets froze up, numerous banks long-active in this sector permanently exited from participating in financing, credit terms became much more rigorous and pricing requirements exploded. Nevertheless, the resiliency alluded to in the above statement has largely proved to be true. Evidence of that largely rests in the fact that the feared “funding gap” never quite materialised. US Eximbank and the European ECAs stepped-up big time to fill the gap, the remaining banks continued to commit to financings and the capital markets did open now and then at which time US airline issuers made significant aircraft-secured offerings. While work levels did suffer for a bit, aircraft finance lawyers fortunate to be involved in export-credit financings and capital markets financings, as well as able to work with the remaining banks, have managed to keep fairly busy.

Lalit Bhasin: Undoubtedly the financial crisis has severely hit the Indian aviation sector as the passenger traffic has recorded a negative growth rate of about 8 per cent in the first six months of 2009. As per newspaper reports, close to 26 airlines went under or suspended operations in the course of the year. Huge governmental taxes, airport charges, surcharges, and a price rise in aviation turbine fuel (ATF) have aggravated the high debts and losses of airlines.

The recent financial crisis has severely impacted the level of work in India. Airlines are in the process of cutting costs by reducing their staff strength and laying off employees in phases. Personnel including flight attendant probationers, cockpit crew and managerial staff have been terminated recently, although assurances have been made that they would get priority in recruitment whenever the situation improves.

Airline employees have resorted to strikes causing suspension of services. Recently more than half of Jet Airways pilots took mass sick leave forcing cancellation of about 200 flights. To counter these strikes, airlines have been approaching the courts seeking orders restraining the employees’ associations and their members from going on any form of strike. Further, a large number of employment issues between management of airlines and their employees have come before the Labour Commissioner.

Further, due to economic slowdown, some prominent airlines have defaulted on lease payments prompting their foreign lessors to terminate the lease agreements and initiate proceedings for deregistration before the Directorate General of Civil Aviation and for repossession of their aircraft before the courts.

Shawn Rafferty: In the US, at least, we’ve witnessed a significant downturn in transactional work on the aircraft trading and finance side throughout the industry. The decrease in leveraged lease work was palpable well before the 2008 financial crisis, and with the current paucity of capital (except from export credit sources) and with current interest rates, I’m not expecting this work to return to historic levels any time soon. For all of that, we’ve seen increased deal flow in the past few months that gives us cause for optimism moving forward.

One area that seems active – although this is cold comfort for most in the industry – is distressed aircraft debt trading. While new debt deals may be significantly slower than in recent years, debt is still changing hands, and that provides workflow to qualified lawyers.

Predicting how aviation will fare in the next year is particularly difficult. We seem to be in an economic trough, and much of the success of the aviation industry depends on consumer confidence and the state of the economy in general. Until the economy as a whole picks up, we can expect the industry to remain in a holding pattern.

Finally, the drumbeat of consolidation seems to be sounding in the distance again, at least for US carriers. While that may bode well for the long-term health of the industry, consolidation often disrupts the plans of the airlines concerned. Consolidation, or the potential for it, will remain a factor in aircraft transactions over the next year and beyond.

EMERGING MARKETS

Who’s Who Legal: Which developing countries are emerging as markets to watch for aviation? Have any formerly viable markets become more or less promising over the past year?

Ronald Scheinberg: We have seen increased activity in Brazil and much of the rest of Central and South America. I think those markets will continue to expand in the area of aircraft finance. India has seemed to have taken a breather. Russia still looks difficult from a risk-management perspective.

Lalit Bhasin: Despite the global recession, India and China are prominent developing countries emerging as markets to watch for aviation. As per aircraft manufacturer Airbus, these two countries would account for nearly 35 per cent of the total aircraft in the near future. India is also fast growing as an MRO destination and manufacturing base. Even Brazil is a fast emerging market.

Shawn Rafferty: I agree with Ron and Lalit that India and China will be fascinating to watch over the coming years. It will be very interesting to see whether the substantial aircraft order books in India result in deliveries, deferrals, or outright order cancellations. Vietnam also strikes me as a market that is showing signs of growth. I think Ron is correct to note that Russia has become a less attractive market for investors than it was a few years ago.

The rapid growth in the Middle East over the past years has been striking, and it will be interesting to see if that region can maintain its growth over the coming years. Finally, sub-Saharan Africa still seems somewhat underserved, and notwithstanding some political and humanitarian strife in certain African countries, it seems that there are growth opportunities in Africa.

Robin Springthorpe: There is no doubt that the Chinese market looks huge. India has lost a little of its sparkle at the moment, not helped by some high-profile defaults (a number of surviving airlines remain on lessors’ watchlists) and while capacity will no doubt increase again, lessors may well be more cautious in the future given the enforcement issues they have experienced. The Middle East is generally booming and I agree with Shawn that Africa has enormous potential going forward. By contrast, a number of lessors are regretting at their leisure their flirtations with the Russian market, which has left them with defaults and enforcement issues.

COMPETITION

Who’s Who Legal: Many of the lawyers we spoke to noted an increase in anti-cartel regulation in the sector in recent years. Have there been any significant developments in antitrust regulation in your jurisdiction? How are clients responding to these changes?

Lalit Bhasin: The code-sharing agreement signed in October 2008 between Jet Airways and Kingfisher has come under the scrutiny of the recently-established Competition Commission of India (CCI), as a complaint was filed with CCI saying that the pact could lead to formation of cartel and thus notices were issued against Kingfisher and Jet asking them to justify the agreement. As a recent development, Kingfisher had petitioned the Bombay High Court in September 2009 challenging the jurisdiction of the CCI on two grounds: namely the Monopolies and Restrictive Trade Practices Commission had already looked into the agreement and secondly, the agreement predates the setting up of the CCI. In the said matter, the High Court has issued a notice to the CCI and the matter is sub judice.

Though the CCI is authorised to review cases pertaining to anti-competitive agreements and abuse of dominance no substantial development has taken place to date. Further, the search for a new director general for the investigative arm of the CCI has not been concluded. Notwithstanding the above, airlines are now on their guard.

Shawn Rafferty: We really don’t have any data yet as to how the Obama administration is going to treat the next proposed merger of major US airlines. Antitrust matters in the US are a matter, primarily, for the Antitrust Division of the US Department of Justice.

While the previous administration’s DoJ was reluctant to interfere with proposed corporate mergers, the DoJ did express serious concerns regarding UAL’s proposed acquisition of US Airways. Those concerns included the prospect of limiting carrier options in certain cities, overlapping city pairs, regional concentration (in that case in the north-eastern part of the US), and the effect of the proposed merger on transatlantic markets. These are still the factors I’d expect to be at the forefront of the DoJ’s analysis, regardless of the recent redecoration of the Oval Office.

In spite of its concerns regarding the proposed UAL/US Airways merger, the Bush DoJ was not overly troubled by the subsequent America West/US Airways and Delta/NWA mergers. While the DoJ announced it would sue to prevent the UAL/US Airways merger (and thus effectively killed the prospect of that merger), the other two major mergers saw very little DoJ resistance.

With this backdrop, it will be very interesting to see how the Obama administration views the next proposed merger. My sense is that the Obama DoJ will take a pragmatic look at mergers, and for all of the pre-election handwringing over this issue, carriers will still pursue mergers that they think have a sound business justification.

Robin Springthorpe: Cartel and antitrust issues are of course slightly different, their regulation being narrower and wider respectively. In both areas, regulation has been highly active: one can think of many high-profile cases over the last few years including the British Airways fuel surcharge cartel, yet another cargo cartel, the British Airways rebates case, the Ryanair/Aer Lingus merger control, Air France/KLM merger, the Oneworld and Star Alliance cases. The UK Competition Commission recently completed its inquiry into the BAA airports monopoly. With consolidation likely, including the proposed British Airways and Iberia tie-up, I forecast the regulators are going to continue to be busy.

Clients are responding to these changes by introducing ever more stringent internal controls. This often involves them seeking legal advice to make sure that the controls they put in place are effective and that there are no other steps that they can take to avoid the attention of the regulatory authorities.

CLIMATE CHANGE

Who’s Who Legal: How do you predict that aviation lawyers and their clients will be affected as the UN focuses more closely on climate change prevention in coming years?

Shawn Rafferty: Climate change has been a huge political issue for the past several years, and it’s hard to imagine that the issue is going away any time soon. As Bob Dylan noted (although not with respect to greenhouse gases), the times they are a-changin’.

The closest parallel I can think of in the US was the implementation of Stage 2 and then Stage 3 noise limits on aircraft. As those noise limits took effect, older noncompliant aircraft lost value, and any party having a stake in the residual value or collateral value of non-Stage 3 aircraft suffered. The industry responded creatively to the challenges imposed by noise restrictions, and ended up complying with the US requirements, however grudgingly.

As with the noise restrictions implemented two decades ago, it seems as though climate change concerns will almost certainly drive equipment changes at airlines over the long haul. Alternative fuel, improvements in emissions technology, and carbon trading will likely all play a role in this, although the UN seems like it will not be the real driver of those changes. Instead, I expect the EC, the US and other governmental entities (whether by treaty or on an individual basis) to lead those changes.

Lalit Bhasin: According to a recent report published in Mail Today in India, international commercial airlines are worried about the EU’s move to impose a carbon emission tax on all flights to and from Europe. The tax is proposed to be imposed on the total emissions of a flight. Therefore, an Air India flight from Mumbai to Paris would entail that the airline shells out money in France to buy “carbon credits” for excess emissions which have taken place in Indian skies as well as other countries en route. Therefore, in such event, although only a small fraction of this fuel would be burnt in European skies, the discriminatory tax these 27 European countries propose to impose would cover emissions that are made outside their territory.

Recently, India’s central government through the DGCA sought information on carbon dioxide emissions of all airlines flying in Indian skies and the combined carbon footprint of the fliers.

Robin Springthorpe: The EU Emissions Trading Scheme has begun and, as Lalit says, has application even to non-European airlines which fly into Europe. Whilst the implementation of the scheme has not been without its problems, and there remain a number of aspects which are uncertain, we can be sure that it is not a passing fad but is here to stay. Indeed, the regulation will only become more stringent and the cost to airlines greater. A number of other jurisdictions round the world are likely to follow suit. Unfortunately the aviation industry is an easy and politically popular target, out of proportion to the carbon emissions it actually produces.

In some respects the ETS is complicated and its effect uncertain. Since it has a substantial cost attached so it is probably unsurprising that airlines – and other major producers of CO2 – have sought and are likely to carry on seeking expert legal advice.

FIRM ISSUES

Who’s Who Legal: Many of our sources noted a contraction in the demand for legal services among aviation clients over the past year; in such a climate are full service firms or aviation boutiques better suited to meeting clients’ needs?

Shawn Rafferty: The old maxim that “clients hire lawyers, not law firms” still seems to hold true. Aviation clients are best served by having specialist lawyers who have an understanding of the industry and the ability to discuss aviation matters without a steep learning curve. Aviation clients can get this expertise either from trusted lawyers at boutiques or from trusted lawyers at full-service firms.

For all of that, the full-service firm with aviation specialists has an advantage over a boutique, because in a larger firm aviation lawyers can readily draw on tax, corporate, litigation, and regulatory resources. I’ve worked in both an aviation boutique and a full-service firm, and have come to believe that this advantage is significant.

Ronald Scheinberg: While I generally agree with Shawn’s statement, a distinction might be made between a full-service firm like the one Shawn is (and I am) affiliated with, and the mega full-service firms. The smaller full-service firms can be significantly less pricey than those larger firms and provide the same (or better!) level of service.

Lalit Bhasin: Due to the economic slowdown there is no surge for aviation clients in India to buy or lease new aircraft and related activities; however, there has been more demand for ancillary legal services to respond to the issues of employment, commercial and contractual disputes. In the present climate, instead of aviation boutiques, full-service law firms are better suited to meet the needs of the aviation clients and I am in agreement with the views expressed by Shawn and Ronald.

Robin Springthorpe: The seamless advice which a full-service firm can provide should result in more efficient performance both in terms of cost and response time – if not, clients are going to the wrong firm! Such service should be joined up not only as between the different disciplines such as tax, finance, commercial, regulation, competition, employment and dispute resolution – ideally by having a genuine sector focus comprising lawyers who truly understand the industry – but, in relation to the multi-jurisdictional issues which regularly affect the aviation industry, as between the firm’s offices around the world.

I agree that a distinction should be drawn between full-service firms and the mega-firms. In fact, over the last couple of years most of the very big firms in London have largely exited from aviation. It is fair to say that those which remain in the sector are hard to beat for, say, highly complex banking work where cost is not a concern. However, too many clients, even those whom I regard as prime industry players, have become disillusioned with their treatment as a lower priority to the mega-firm’s key clients, despite paying the eye-watering costs demanded of them for comparatively routine transactional work and for dispute work. Worse still, clients rightly tire of educating – at the clients’ considerable expense – one junior associate after another who, while undoubtedly bright, are inexperienced and sometimes do not have even basic industry knowledge or understanding.