Bruce D. Hickey
Boston +1 617 654 8602
All forms of movement are under serious threat in the current global climate: with an estimated 1/4 of the world’s population in lock down, this unprecedented government intervention has slashed passenger demand and halted the free movement of all but essential goods and key workers. While this is not the first challenge the sector has faced – deregulation, oil shocks, government enforcement actions, September 11, SARS, and the financial crisis – COVID-19 is likely to be its greatest challenge yet. Below we explore recent developments and potential opportunities and strategies for companies operating in this sector to keep the wheels turning.
Transportation firms are fighting a battle – by air, land and sea
In the aviation sector, amid plummeting seat load factors and ticket prices, airlines have slashed capacity and grounded large portions of their fleets. A third of the world’s commercial aircraft are now in storage and Europe’s largest budget carriers have stopped all commercial flights – a dangerous turn of events for an industry known for traditionally high fixed costs and regulation. The drastic knock-on effects for aerospace manufacturers, aircraft lessors and other suppliers are already evident in the hiatus in new and replacement aircraft orders. The world’s major airport owners have also lost value as hub traffic has been decimated. The same has been true for the significant network of duty free retailers and other supporting services (airport facilities, logistics, MROs, cargo) and suppliers that make up the transport ecosystem.
Automotive manufacturers in the U.S., EU and Asia have all applied the brakes with all major manufacturers shutting down production until April and potentially beyond. New order forecasts have already fallen 20% in recent weeks forcing ratings downgrades for major manufacturers.
Shipping operators who were hoping for a smoother ride after a ceasefire in the trade war between China and the U.S. are now navigating unchartered waters as the level of idle container capacity has already eclipsed the height of the 2008 financial crisis. Over the past three weeks, some 30% to 60% of weekly outbound capacity has been withdrawn from the Asia-Europe and Transpacific trade, as well as from intra-regional routes. While the larger shipping players will be better placed to ride out the storm, smaller operators who run crucial secondary routes that feed major porshuts may be challenged by limited cash reserves. This will place further strain on a spluttering supply chain.
The world’s cruise ship and ferry providers have dropped anchor in the hope of riding out the storm, but many are in danger of sinking as governments are reluctant to throw life lines to the largest cruise operators registered in offshore tax havens.
It is impossible to predict with certainty when economic turbines will start to turn again but companies who are able to navigate these challenges and position themselves well in the coming months will be more able to secure the opportunities that will undoubtedly emerge once we are on the road to recovery.
The “10-Point Plan” for surviving COVID-19: considerations for the aviation and transportation industry
1. Understand the recent government assistance measures1
Governments all over the world are drawing up a range of emergency assistance measures to support businesses in key industries, including in the aviation and transportation sectors. The fine print of the industry assistance and bail-out packages is still emerging in the U.S., UK and EU and further measures may be necessary as the pandemic continues. What is already clear is the unprecedented scale and depth of these packages. Some of the most relevant government assistance measures are outlined below:
US government support
The bail out measures prohibit layoffs until September 2020, stock buybacks and dividends. Executive remuneration will also be capped to 2019 levels under the terms of any deal. The government will also take an equity stake in the airlines until the loans are paid back.
UK support measures: The UK government has avoided committing to an industry-wide aviation bail out but has hinted at acquiring equity stakes and partially nationalising some key airlines as a last resort. Struggling UK regional carrier Flybe has already ceased trading and been placed in administration, and Virgin Atlantic has been reported as next airline in line to request an emergency bail out. It is unlikely to be the last and the UK government is under increasing pressure to spell out its approach more clearly as other airlines may follow. Europe’s largest low-cost carriers Ryanair and EasyJet have ceased all commercial flights until June.
Along with other UK businesses, transportation companies will be able to utilise significant UK government support, including £330 billion government-backed loans, including the COVID-19 Corporate Financing Facility (“CCFF”), which is coordinated jointly by HM Treasury and the Bank of England. The scheme will provide funding to large UK businesses by purchasing commercial paper of up to one-year maturity. The facility is intended to provide financing on terms comparable to those prevailing in markets in the period before the economic shock caused by the pandemic, and will be made available to firms able to demonstrate that they were in sound financial condition prior to the COVID-19 shock. The UK government will also fund up to 80% of wages for “furloughed” employees. See further Dechert advice on available employee support below.2
EU subsidies: The European Commission’s antitrust department has confirmed that all exceptions available under state aid rules apply in the circumstances so governments can grant selective subsidies and/or purchase stakes in national businesses. The aviation industry is an obvious beneficiary. These support measures still need to observe certain rules but flexibility is the key word both procedurally and substantively. The speed of the Commission’s approval of COVID-19 State aid schemes (less than 48 hours) has been remarkable.
In the EU nation states:
France has launched an unlimited backstop of at least €300 million for corporate lending and indicated it would “do whatever it takes”. Transport operators in distress can immediately stop paying direct taxes and social charges without penalty for 90 days. The state owned export credit bank BpiFrance has also increased its guarantee from 70% to 90% to secure new credit lines.
Spain announced a €100 billion corporate guarantee to cover working capital and liquidity needs and a 75% discount on social security contributions for temporary lay-offs.
The German federal government agreed to provide an unlimited amount of liquidity via a special loan guarantee and loan facility program to be offered by its state-owned development bank KfW. In addition, the German parliament eased the eligibility requirements for Short-Time Work relief which will partially reimburse employees for reduced hours and match social security contributions for hours lost. On 27 March, Lufthansa announced that it would use this instrument for at least 31,000 of its employees until 31 August. German tax enforcement has also been deferred until December 2020 if failure to pay is linked to COVID-19.3
2. Have a clear strategy for accessing and utilising support
The practical steps required for accessing government assistance vary between jurisdictions and will become clearer in the coming days. The race to access immediate support may be fierce, including for key airlines and key manufacturers, many of whom have already announced temporary or part plant shut downs, including in the U.S. and Europe. It is not entirely clear whether these assistance measures will be made available to the vast network of ancillary services and smaller regional networks that make up the aviation and transport ecosystem. The government may well hope that by protecting only the marquee industry players, sufficient confidence will be restored and the benefit will “trickle down” to the remaining industry stakeholders once normal service is resumed.
While flagship carriers and vital manufacturers have a strong chance of securing government backing, they will obviously do everything possible to avoid accepting taxpayers money as the conditionality that comes with government assistance can be burdensome and may dampen profitability and management control (and share prices) when the world returns to good health. The individual strategy of each firm will vary depending on the cash position and financial strength of each individual company.
Regardless of the final scope of the measures in each jurisdiction, companies must remain vigilant and ensure that they meet the strict criteria for receiving available government assistance. In the absence of clear government guidance, obtaining legal certainty on the fine print of some measures may be difficult, particularly if the government machinery functions slowly during lock-down.
In practical terms this means that senior managers and in-house legal teams in the airline and transport industry should immediately devote resources to ensure that they understand the key eligibility criteria for government support and seek specialist external assistance if they do not have adequate internal government liaison, lobbying or legal capability to determine if the available measures are (i) immediately available to their business; and (ii) strategically beneficial in the medium and long term.
3. Take advantage of new legal protections (or amnesties)
While governments scramble to offer relief to struggling firms in key industries, there will be a period of legal uncertainty around the terms and eligibility criteria for accessing support. This will create opportunities for well-advised firms to position themselves to take full advantage of any support packages available (including indirect beneficiaries such as MROs, spare parts and aviation technology and systems providers who stand to benefit from assistance granted to the larger operators).
Critical infrastructure sectors – make hay while the sun shines: Some operations will be shielded from the full impact of the global downturn by virtue of their strategic importance. In the U.S., Transportation systems has been identified as a critical infrastructure sector by the U.S. Department of Homeland Security that are permitted to remain open at on-site locations, with employees in numerous functions with transportation and logistics identified as essential to continue operations, including the following:
4. Seek new M&A opportunities
In an anxious transport market with patchy and sometimes bipolar consumer demand, the firms that can maintain their market position, economies of scale and secure supply chains will emerge healthiest. The current distressed transport market will undoubtedly create new horizontal and vertical M&A opportunities and threats for carriers, manufacturers and support services (logistic support, MROs, spare parts, components, technology suppliers).
5. Take advantage of volatile oil prices
A surprisingly small number of airlines and transport operators will instantly benefit from the dramatic drop in oil prices. Most airlines will have already hedged their positions by locking in fuel prices that reflect more positive market conditions some months ago. The majority of airline carriers are reported to have already hedged between 30% and 90% of their expected fuel needs in coming months. For those operators who have not hedged a large proportion of their fuel supply, there may be a limited window to lock in the historically low rate and secure a distinct competitive advantage for the recovery period. The prolonged drop in oil prices risks distorting the playing field heavily in favour of operations who have not pursued a widespread fuel hedging strategy and are therefore are not bound by historic high fuel prices. Alternatively, if the supply war between Russia and Saudi continues to create extreme volatility, then a hedged strategy may provide some much needed certainty for operators, even if they miss the fleeting chance to lock in historically low oil prices.
The Chinese and Indian aviation industry does not generally hedge its fuel costs and this could play into their hands as major UK and European competitors may effectively end up trying to compete with double the cost base in coming months unless oil prices return to previous levels or they are able to close out their positions or find credible legal justifications to avoid being tied to hedging contracts. Some potential contractual legal arguments that may be deployed against counterparties to unwind contractual positions in extraordinary circumstances are discussed in more detail below.
6. Re-examine contractual relationships
In times of crisis, parties to an ongoing or committed contractual relationship are likely to seek to avoid proceeding with their contractual obligations pursuant to several legal doctrines. When it comes to the enforcement of contractual terms, transport operators will need to explore both (i) offensive strategies against counterparties (large customers and trade debtors) who owe money to the business and are trying to use the COVID-19-related arguments to avoid payment; and also (ii) defensive strategies against suppliers and creditors who will be aggressively trying to recover cash.
When “forces of nature” are at play, as they are during the current pandemic, parties may seek to avoid those obligations through a force majeure or MAE (material adverse event)/MAC (material adverse change) clause in their governing agreements.
Certain extra-contractual bases also exist for seeking to excuse contractual performance, including, but not limited to the doctrines of (i) frustration of purpose, (ii) impracticability of performance, and (iii) impossibility of performance.
As courts around the world struggle to react to the changing demands of remote working, companies should also factor in delay and the practicalities of modified court filing processes into their enforcement strategy, particularly if urgent injunctive relief is being filed against counterparties in multiple jurisdictions.
7. Manage revenue and cash shortages (up and down the supply chain)
“We have a liquidity crisis coming at full speed – no revenues and costs still on our [books], so we desperately need some cash.” – Alexandre de Junia, CEO, The International Air Transport Association (IATA)
Despite the liquidity squeeze, some major commercial airlines in the U.S. and EU, have been able to tap fairly significant bank credit facilities in March to support their deteriorating cash positions. Major actors in the aerospace and manufacturing sector too have bolstered their cash position by a combination of cost cutting (including suspension of dividends and buybacks) and accessing the bank markets (e.g. Boeing drawing on its $13.8 billion loan facility which loan it obtained in February). As for the aircraft leasing market, lessors are customarily hit later and the impact is not as severe as for the airlines or manufacturers themselves. The lessors’ portfolios traditionally consists of new model aircraft. In a workout or bankruptcy, these aircraft are usually the last to be let go by the airlines, so the impact on lessors may be less immediate.
In light of the almost entire shutdown of transportation services we recommend that providers shift their focus to crisis management, including:
As cash shortages may reach critical levels in coming months, businesses will have to make tough choices about which customers and suppliers they wish to support or prioritise in an extremely distressed market. This will require not just the standard assessment of the financial reserves and balance sheet analysis, but also assessing whether customers and suppliers are eligible for immediate government assistance. By myopically prioritising short term liquidity issues and failing to support vulnerable and dependent suppliers and customers, including smaller regional operators who keep the supply chains robust and diversified, firms risk throwing the baby out with the bath water and losing alternative suppliers and customers that are critical to their long term recovery and continuity. Further practical measures for companies and directors to consider include the following:
9. Maintain compliance and other policies and procedures – protecting against civil litigation and regulatory action
Avoid playing “COVID Roulette” with existing laws: Businesses that flout and circumvent existing laws and regulations, including antitrust, consumer protection, anti-bribery, corruption and trade laws will face a reckoning once the pandemic is controlled.
While it may be tempting to bend rules in extraordinary circumstances, there is no “COVID-19 defence” for misconduct.8 Failure to realize this will expose organisations to liability, class actions, prosecution or potential debarment in the long run when regulators and prosecutors examine conduct in the cold light of day. Significant reputational damage and government penalties await those which play fast and loose with the rules or are shown to have tried to unduly benefit from a global public disaster. The decade of government enforcement actions, individual prosecutions and class actions that followed the 2008 financial crisis should serve as a stark warning.
In order to mitigate these risks the following compliance steps should be applied to a dislocated workforce who may continue to work remotely:
Short-term demands often consume individuals’ and businesses’ attention in times of crisis. Companies nevertheless need to maintain a long term focus by maintaining strong compliance functions and good business practices (including data privacy, document retention and control) in the digital age where business is being conducted remotely.
Companies that do not remain vigilant could face damaging evidence in civil litigation and regulatory actions in the future.
10. Employment issues across jurisdictions
Ensuring employee safety: Employers around the world should follow government guidance to protect employees and comply with applicable worker safety guidelines9 by jurisdiction. Although these vary according to national government, they are likely to include (i) causing all employees who can accomplish their work remotely to work remotely, (ii) non-discriminatory screening of employees for fever or other symptoms of COVID-19, (iii) maintaining at least 6 feet of space between individuals working on-site, with potential staggering and/or reduction of staff as needed to accomplish distancing requirements and (iv) adopting all required sanitization and cleaning measures.
Realizing cost savings: In considering cost saving measures, transportation employers must consider both short term cost controls and long-term needs to be able to resume and ramp-up operations quickly as restrictions ease and/or are revoked. Employers must analyze all governmental aid programs available that encourage employers not to sever employment of employees, including reimbursement programs for paid employee sick leave or family and medical leave. Under the U.S. federal stimulus legislation (CARES), employers can recoup expanded paid sick and leave time through retaining employer payroll tax and employee payroll tax withholdings, as well as employee income tax withholdings, across all employees (not just employees needing leave), with the ability to apply for direct reimbursement if payments exceed tax and tax withholdings eligible to be retained by employers.
Dechert is actively advising companies across industries on how best to utilize the recent government support packages in various jurisdictions including the U.S., UK10 and Europe.
It is clear that these are extraordinary times for all industries, but particularly for aviation and transport. While some operators will fail to rise to the challenge, there will be some agile and well-advised operators11 who take full advantage of the rare opportunities that this period will create. Never has the movement of critical goods and people been so important.
Governments have never been more willing to actively assist commercial transport operators to deliver key goods and people and keep the main arteries of the economic supply chain alive. At the same time, there have rarely been better opportunities for transportation companies to lower their traditionally high cost base (wages, fuel and finance) and secure economies of scale (via expedited M&A opportunities). High costs and regulation have burdened the industry for years and this may be the time for some operators to finally buck that trend. While the current outlook may seem bleak one thing is certain - the world will move again and those who are able to weather this storm may be able to rise to new heights.