Commercial aviation has been one of the sectors most heavily impacted by COVID-19, but thanks to the strong controlling measures to weather the impact of the pandemic, the People’s Republic of China (the “PRC”) has been a market in which some form of aviation recovery is happening. Unfortunately, the recovery has not come soon enough for the Chinese conglomerate HNA.
On 29 January 2021, HNA Group, parent company of Hainan Airlines, posted a statement on its website that it had been served a notice by the Hainan High People’s Court that relevant creditors had filed a petition in the court for bankruptcy restructuring of HNA Group based on its incapability to pay off the debts due.
On 10 February, the Hainan High People’s Court announced acceptance of the restructuring cases in respect of 64 HNA-affiliated companies, including Hainan Airlines Holdings. The court appointed a liquidation team as the administrator for all those companies requiring creditors to declare claims no later than 31 March or 15 April 2021.
On 2 March, the Hainan High People’s Court issued a notice stating that the administrator of HNA Group had found the close connection between the 7 debtors under restructuring and 318 other companies. In order to take opinions from and protect the interests of all right-holders, the administrator applied to take all the companies under bankruptcy restructuring but withdrew its application against 4 companies. On 13 March, the Hainan High People’s Court issued another notice stating that the court had ruled a substantive consolidation of the 314 companies linked to the 7 debtors.
HNA Group is an important player in the airline industry in PRC with Hainan Airlines undoubtably being the jewel of the crown. The group also holds stakes in multiple other carriers, including but not limited to Beijing Capital Airlines, Tianjin Airlines, Lucky Air, Suparna Airlines, West Air, Air Guilin, Grand China Air, Air Chang’an, Shanxi Airlines, Fuzhou Airlines, Urumqi Air and GX Airlines. Although executives of HNA Group have indicated that the bankruptcy restructuring would not affect HNA's aviation business (which operates about 700 commercial aircraft), clearly there is some concern among the HNA aviation creditor community.
While bankruptcies and other formal restructuring proceedings have unfortunately impacted airlines elsewhere, this is the first big airline group restructuring in PRC. This note provides a brief introduction of the PRC bankruptcy restructuring regime applicable to HNA and deals with some relevant questions for HNA’s aviation creditors.
Q: What does the HNA bankruptcy restructuring mean in practice?
Under PRC law, bankruptcy procedures include restructuring, settlement or liquidation. Bankruptcy restructuring, as is the case here, refers to the reorganization of the business of a company that may already be in a bankruptcy but has the potential to recover through restructuring.
In many ways, a PRC bankruptcy restructuring is similar to U.S. Chapter 11. It is focused on recovery and future profitability.
A successful restructuring permits the debtor to restructure its debts, sell off selected assets, trim costs and obtain new financings.
In most restructuring cases, pre-petition equity holders are diluted or even wiped out in the restructuring plan.
Q: What does the substantive consolidation mean in the bankruptcy restructuring?
The substantive consolidation in a bankruptcy restructuring is the combination of assets and liabilities of two or more entities into a single pool for restructuring purpose. Under PRC law, such substantive consolidation is applicable to consolidation of affiliated entities which probably will be regarded as one single entity while independent corporate personalities no longer exist among those entities. The assets and debts of each enterprise will be combined as a whole bankruptcy restructuring property which will be arranged as a whole in the restructuring to achieve fair compensation to all creditors.
Q: How could the HNA bankruptcy restructuring play out?
Within six months from entry into restructuring, the debtor or the administrator, as the case may be, shall propose a draft restructuring plan to the court and the creditor’s meeting. Such period could be extended for another three months with the approval of the court.
The restructuring plan must designate classes of creditors and claims. Each class of creditors shall vote on the draft plan separately but only the impaired creditors are permitted to vote. If more than two-thirds in amount and one half in number of the creditor class vote in favour of the plan, such plan shall be deemed accepted by such class. If all classes accept the draft plan, it shall be deemed adopted by the creditor’s meeting and the court will further confirm the plan if it complies with the PRC Enterprise Bankruptcy Law.
If more than one class (but not all) of the creditors vote to object, the plan can still be confirmed by the court through a “cram down”, as long as certain requirements are met.
A confirmed plan shall be binding on the debtor and all creditors. Essentially, the confirmed plan creates new contractual rights, replacing the pre-bankruptcy contracts.
If (i) the administrator or the debtor fails to submit the draft restructuring plan within the specified period; or (ii) the plan is not adopted by the creditor’s meeting or confirmed by the court, or (iii) the debtor fails to implement the confirmed plan and at the request of the administrator or the interested parties, the court will terminate the restructuring, declaring the debtor bankrupt and then proceed to liquidate all assets and distribute proceeds in accordance with a statutory priorities scheme.
The restructuring may also be terminated by the court upon request of the administrator or the interested parties in circumstances where the management and financial position of the debtor continue to deteriorate and there is little possibility of rescuing it.
Q: How does the HNA restructuring impact aircraft lessors?
Under Article 18 of the PRC Enterprise Bankruptcy Law, upon acceptance by the court of the application for bankruptcy, the administrator is entitled to rescind or continue the performance of the contracts that have been concluded before the acceptance of the case, and the administrator shall notify the counterparty concerned. If the administrator fails to give such notice within two months of the acceptance of the case or fails to reply to the counterparty concerned within thirty days of its demand, it shall be deemed to have rescinded the relevant contract.
Where the administrator decides to continue the performance of a contract, the counterparty is entitled to request a guarantee or other security.
In other words, the PRC lessee in such circumstances may terminate its aircraft lease agreement on a selective basis.
The lessors may also be concerned about their ability to repossess their aircraft should it come to that. Pursuant to Article 76 of the PRC Enterprise Bankruptcy Law, where the right-holder whose property is occupied by the debtor on legitimate grounds requests to repossess its property during the restructuring, agreed requirements shall be met. With the above said, if the relevant aircraft lease agreement contains provisions according to which an event of default is trigged (very likely here), the lessor shall be entitled to repossess its asset, however it is worth noting that restrictions may be added to the lessor’s repossession right.
Q: How does the PRC bankruptcy restructuring proceeding interact with the Cape Town Convention?
PRC ratified the Cape Town Convention on International Interests on Mobile Equipment and the related Protocol on Matters Specific to Aircraft Equipment (collectively, the “Convention”) in 2009 and relevant declarations were made.
Alternative A of Article XI of the Protocol applies, and the ‘waiting period’ is sixty days. Accordingly, with respect to an aircraft lease agreement covered by the Convention, where a PRC debtor enters into bankruptcy restructuring, the debtor or the administrator, as applicable, shall release possession of the aircraft where a lessor requests within sixty days - unless all defaults (other than the default constituted by the insolvency proceeding itself) are cured before the expiry of such period, and the debtor or the administrator has agreed to perform all future obligations under the agreement.
NB, the Convention does not apply to domestic leases in PRC – where both the lessor and the lessee are incorporated in PRC.
Q: Will DPoAs / IDERAs be upheld to allow lessors to repossess if needs be?
PRC maintains an operator-based aircraft registry. In order for a PRC lessee to operate an aircraft in PRC, the aircraft must be registered with the Civil Aviation Administration of China (“CAAC”).
With respect to the Deregistration Power of Attorney ("DPoA"), according to its rules, normally CAAC only accepts the deregistration application filed by the PRC lessee of the aircraft in the capacity of "operator". In common with most other aviation authorities, CAAC's rules do not expressly permit a lessor being owner of the aircraft to deregister an aircraft by virtue of a deregistration power of attorney, however they may be of some assistance “on the ground”. It helps if they are written in Chinese.
For those leases where the Convention applies, the lessor may rely on an Irrevocable De-Registration and Export Request Authorisation ("IDERA") recorded with CAAC to deregister the aircraft.
However, it should be noted that a declaration was made by PRC under Article 54(2) of the Convention – “Any remedy available to the creditor under any provision of the Convention which is not there expressed to require application to the court may be exercised only with leave of the court of PRC.” As a result, even if a lessor has a duly recorded IDERA, it still needs to present "a document issued by a PRC court confirming that the Authorized Party is entitled to possession of the aircraft under the Convention" to CAAC in the deregistration application.
For lessors with IDERAs in place, it would be worth checking that these have been properly recorded.
Q: Can airports with unpaid landing charges take a lien over aircraft owned by lessors?
Generally yes. Although the law in this regard is not entirely clear, we take the view that a specific lessor is entitled to the return of its aircraft, unless the relevant unpaid dues are attributable to the aircraft subject to the lessor’s repossession.
Although an airport lien is not expressly recognized under the PRC Civil Aviation Law, a general principal under the PRC Civil Code allows a creditor to impose a lien on the debtor’s movable assets where they are lawfully possessed by the creditor, unless otherwise stipulated by the PRC law or agreed by the parties. Further, for a lien imposed between enterprises (other than between natural persons or between natural person and enterprise), which is very likely the case for an airport’s lien, on the face of it, a lien can be taken over an asset which is not the subject of the claim. In other words, it appears that a fleet lien is permitted.
Moreover, in GECAS vs. Guangzhou Baiyun Airport, the Guangzhou Middle People’s Court indicated in the first instance judgment that the airport should not be responsible to examine the ownership of the aircraft when a lien was imposed on the same. However, the case was settled during the appealing proceeding without judgment on this specific issue.
More positively for lessors perhaps, further guidance was provided recently by the Supreme People’s Court of PRC, which suggests that if the debtor (i.e. the PRC lessee) failed to perform an obligation which was due, the creditor (i.e. the airport) could take a lien over the debtor’s moveable assets (e.g. an aircraft) where such asset was lawfully possessed by the creditor but owned by a third party (i.e. a lessor), as long as the asset is “in the same legal relationship” of the creditor’s claim - i.e. the debt owed to the airport by the lessee arises in connection with the same aircraft detained by the airport. Otherwise, the third party owner is entitled to ask for return of the asset.
Q: Is there a moratorium on enforcing for unpaid debts due to the insolvency?
Pursuant to PRC law, upon acceptance by the court of the bankruptcy restructuring petition, the PRC lessee is not allowed to pay rent or other amounts to an individual lessor. Further, any existing preservation measures taken against the debtor’s property must be lifted, any execution procedures initiated prior to the commencement of the bankruptcy case are suspended, and the PRC lessee’s creditors are prohibited from enforcing rights against the property of the PRC lessee. In addition, interest on matured and unmatured debts (including default interest on unpaid rent) stops accruing as of the date of acceptance of the case by the court.
It is also notable that if the debtor is insolvent during the six months period prior to the entry into the bankruptcy proceedings but still makes payment for the benefit of specific creditors, the administrator may request the return of such payments, unless they benefitted the debtor’s assets as a whole - which means the court may scrutinize all payments made by the PRC Lessee to lessor(s) within such period.
Q: Risks of clawback of any security deposits or maintenance reserves drawn down (in case) or under LCs.
This will depend on whether the security deposits or maintenance reserves are regarded as part of the debtor’s property. Well-drafted aircraft lease agreements will provide that such monies shall irrevocably and unconditionally become the property of the lessor when paid and may be commingled with the general funds of lessor. If the drafting meets the criteria, it is unlikely that any claw-back will apply.
Q: What should the HNA lessors or other types of creditors do now?
Creditors are required to declare claims within the time limits specified by the Hainan High People’s Court, namely 31 March or 20 May (depending on the identity of the respective debtors). Such declarations shall be made in writing with details including the amounts of the claims, whether the relevant debts are secured or not and any evidence or proof in relation thereto. The earliest creditor’s meeting has been scheduled on 12 April, 2021.
For further information, please don’t hesitate to contact Jordan Yang (email@example.com) or Aubrey Tao (Aubrey.firstname.lastname@example.org).