The aviation industry worldwide has been at the forefront of Covid-19 pandemic, and has taken a massive hit due to travel restrictions, lack of demand and high fixed costs. The beleaguered Indian aviation industry has been through troubled waters due to suspension of domestic and international travel from March 2020. This article discusses various strategies which could be or have been adopted by airlines to manage liquidity, mitigate costs and stay afloat.
Recommencement of air travel:
The Ministry of Civil Aviation (“MoCA”) partially lifted domestic air service suspension from 25th May 2020 in a phased manner, and airlines are now allowed to operate domestic passenger flights at 60% of their pre-Covid services. Domestic passengers are subject to guidelines issued by MoCA Order dated 21st May 2020, and MoCA Guidelines and Standard Operating Procedure dated 29th June 2020 (updated from time to time).
Regular international flights to and from India are currently suspended; however Indian government has entered into bilateral air bubble agreements with US, France and Germany, which are reciprocal in nature, meaning airlines from both countries enjoy similar benefits. International passengers are also subject to guidelines issued by the Ministry of Home Affairs dated 30th June 2020.
All MoCA guidelines are to be read with guidelines issued by Ministry of Health and Family Welfare dated 2nd August 2020. Individual States governments have separately issued arrival and quarantine guidelines for passengers.
Liquidity Management & Innovative solutions
With restrictions on air travel during the nationwide lockdown, scheduled airlines had to stop their revenue generation activities. Focus had shifted from profitability and growth to managing cash and liquidity. In order to generate revenue, some airlines converted passenger aircraft into freighters due to demand for transporting essential supplies. The rise in the international cargo rates – from about $1,000 per tonne to $3,000 per tonne – during the lockdown improved the viability of cargo flights. Few scheduled airlines also entered into the realm of non-scheduled charter passenger operations.
Post recommencement of domestic operations, DGCA issued order dated 31st May 2020 prescribing middle seats between passengers to be kept empty. In June 2020, the Bombay High Court allowed airlines to book middle seats during air travel based on expert opinions. It held that safety and health of passengers on board aircraft qua Covid-19 virus is adequately taken care of even if middle seat is not kept vacant on account of passenger load and seat capacity. Few airlines have recently started the practice allowing passengers to book their adjacent seats or pay a discounted rate for the adjacent seat to keep it vacant.
One large airline has sought to raise funds from the public through placement of equity shares by way of qualified institutional placement (“QIP”). QIP allows a company which is listed on the stock exchange for trading to issue equity shares, fully and partly convertible debentures, or any securities other than warrants which are convertible to equity shares to a Qualified Institutional Buyer. The Securities Exchange Board of India has issued guidelines for QIPs which must be adhered. Payment of dividends to shareholders has been deferred and some airlines have increased their borrowing limits. Additionally, promoters of certain airlines have infused additional capital to meet capex requirements.
Liquidity through conversion of owned assets (including aircraft) into sale and leaseback transactions could be explored. Such transactions must comply with the import – export guidelines issued by the Reserve Bank of India (“RBI”). Advances paid to aircraft manufacturers could also re-structured, subject to necessary regulatory approvals.
Employees are pivotal for running an airline since it is a service based industry, and at the same time employee costs without revenue generation activities may be very difficult to manage. Almost all airlines have taken employee cost cutting measures some of which are salary cuts ranging between 10 % – 30 % for senior management and pilots and leave without pay for an average of 1.5 to 5.5 days per month. Some airlines took the decision to lay off a percentage of their employees, which raised questions relating to severance amounts, notice period payments and statutory post-retirement benefits.
Mitigating Fixed Costs
Majority of airline fixed costs result from (i) aircraft lease rentals, (ii) fuel costs (iii) vendor payments for aircraft maintenance, repair and overhaul (“MRO”); airport parking and storage, ground handling and catering.
Aircraft lease agreements were re-negotiated with lessors to obtain ‘rental holidays / moratorium’ and ‘rent deferrals’. Rent deferrals do not increase the lease period, rather higher rentals will have to be paid in future. Supplementary or variable rentals (which are typically collected by lessors on flight hour basis for airframe/ engine / APU maintenance) have been frozen for negotiated periods since a large part of the airlines’ fleet are grounded. Discussions with Export Credit Agencies are being pursued to obtain moratorium on principal repayment for aircraft on finance leases. Some wet leases rentals have been negotiated to be paid on flight hours as opposed to paying a monthly fixed rent. Airlines with aircraft on floating rentals may benefit from lower rent due plunge in LIBOR rates. Most airlines have also quickly phased out older aircraft by redelivery to lessors under respective lease agreements. Lessors have been obliged to renegotiate since the pandemic has put thousands of aircraft out of use in the international leasing market. Several airlines have applied for US Chapter 11 bankruptcy protection which has adversely affected international demand.
Vendor contracts with MROs, caterers and ticket reservation systems have also been renegotiated to secure favourable credit terms. Trade discounts and waivers have also been negotiated with suppliers. Airlines may benefit in the long run from the global oil price crash once operations regularise, but industry experts do not anticipate much short term benefits. Further, airlines are locked into contracts for hedging the jet fuel prices. Therefore, they have to pay the higher hedged amount for jet fuel, leading to hedging losses. Therefore, existing contracts become relevant to leverage legal rights. The airlines have also not received many benefits in airport charges. Costs in some privately operated airports have hiked due to increase in landing charges. The argument raised by airport operators is that increase in landing charges amounts to revenue neutrality since discontinuation of fuel throughput charges i.e. FTC by the government in January 2020 already benefitted the airlines to obtain input tax credit.
Insolvency and Restructuring
The Insolvency and Bankruptcy Code (“IBC”) has been amended to provide that no application for initiation of insolvency resolution of a company can be filed, for any payment default arising on or after 25th March 2020 for a period of six months (extendable upto one year by notification). Further, no application can be filed even after this time period for initiation of any corporate insolvency resolution in respect of a payment default which occurred during this period. This might assist airlines from being taken to insolvency courts for repayment default due to financial stress caused by Covid-19.
RBI has announced a resolution framework for COVID-19 related stress (“Framework”) on August 6, 2020, for addressing borrower defaults pursuant to the stress caused by the pandemic – without necessitating a change of ownership and without asset classification downgrade, modifying the existing framework. Airlines may seek to benefit from invoking the Framework to restructure their debt obligations towards creditors which fall within the ambit of the Framework. On 7th September, 2020, RBI also issued sectoral ratios that lending institutions must consider while finalizing resolution plans under the Framework. Sectoral threshold for aviation are as follows:
|Sector||Total Outside Liabilities/ Adjusted Tangible Net Worth||Total Debt / EBIDTA||Current Ratio||Average Debt Service Coverage Ratio (DSCR)||DSCR|
|Aviation||<=6.00||<=5.00||>=0.40||Not applicable since most airline companies work on refinancing of debt as a financing strategy.||Not applicable since most airline companies work on refinancing of debt as a financing strategy.|
Since IBC has been suspended, lending institutions will be substantially incentivized to explore a resolution plan under the Framework for any accounts that are in stress on account of COVID-19.
Anand Shah, Senior Partner
Rishiraj Baruah, Associate