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How oil prices and the credit crunch affect aviation law
Law Society Gazette – 16 October 2008

Airlines have gone to the wall as the price of oil rockets. How can lawyers help the industry weather the turbulence? By Mark Smulian

Airlines are, metaphorically, falling out of the skies. A lethal combination of the credit crisis, the accompanying downturn in customer demand and recent high oil prices has taken a heavy toll on the industry.

Budget airlines XL and Zoom have ceased flying, following the collapses of Silverjet and Eos, which had pioneered business class-only flights to the US. Irish airline Aer Lingus is to shed 1,500 jobs as part of a cost-saving programme. Among major airlines, Alitalia spent the early autumn teetering on the brink of oblivion, and few would bet on it being the last.

These problems keep aviation law specialists busy. This is a relatively small world, in which lawyers act for airlines and those who deal with them. The work can range from financing the purchase of new aircraft to sorting out the consequences of an airline collapse.

UK airlines have also had to contend with the publication by the Competition Commission of its provisional finding in the case of airport operator BAA. The company, owned by Spain's Ferrovial, could be forced to sell two airports around London and one in Scotland (see case study below). BAA has already put Gatwick up for sale, but disputes the commission's case elsewhere.

To cite the ancient, apocryphal Chinese curse, aviation lawyers live in interesting times.

Aviation and travel specialist Ian Skuse, a partner at London firm Piper Smith Watton, says the industry's recent financial problems have led to 'a big debate on the level of protection offered to airline passengers'.

He says: 'Those who buy a ticket on a credit card have protection for non-supply of goods, and those who buy a package holiday are also protected, but those who buy a scheduled airline seat by any other means are not.'

Passengers who end up trying to take legal action have sometimes thought that an airline which claims to be a member of the International Air Transport Association means they are in some way protected. But, as Skuse points out, this body is simply a trade association that runs a system to remit money from travel agents to airlines. 'There is quite a lot of feeling that there has to be a change so that everyone gets protection,' he says. 'It's confusion all round when an airline like XL fails and you find some people are repatriated by other airlines while others have no protection at all.'

Holiday operators also face difficult issues when airlines collapse, since their business is to sell customers packages of flights, accommodation and, sometimes, activities. If they have booked with an airline that ceases to fly they must rebook their customers on an alternative. Skuse, who has been talking to a dive company with a programme in Sharm el-Sheikh, Egypt, and used XL for its flights, says the company has had to try to find replacement flights for its customers when there is no spare capacity in the market, 'and if flights are available they may be at a higher price'.

These sorts of problems have prompted the sector's regulator, the Civil Aviation Authority, to call for a new financial strength test with higher bond costs for new or weaker companies. This move came after the authority had to use a 40m bond lodged by XL to rescue its stranded passengers.

'If that happens it could be difficult for the smaller airlines to get the insurance cover required by the CAA,' Skuse says.

The downturn in the aviation market is sorting out the soundly based airlines from those in less robust condition, though the banks' reluctance to lend is hampering the ability of all but the best-established carriers.

Jeremy Edwards, a partner at City firm Norton Rose, says: 'At the moment, the aviation law market is still surprisingly robust, but the impact of the banking crisis is significant in that the airlines' ability to raise capital and borrow has been reduced, so we are not seeing so much new activity in aircraft leasing.' He says the impact of these pressures on aviation law has been 'less than I might have feared, although a lot of the work is the tail-off from deals done last year for aircraft purchase and leasing'. Japanese and German airline leases are still being negotiated and 'work for the better-credit airlines is still there, and at a good margin, because good airlines like BA, EasyJet and Air France KLM still find it perfectly easy to borrow'.

Even so, the effects of the credit crisis have hit the industry further and faster than Edwards had anticipated, coming before the end of the airlines' summer season, the normal point at which a fall-off in demand would reveal problems. 'The general expectation is that there will be difficulties in the winter months because of the downturn in the market and high cost of fuel, even though it has come down in price a little, as there are too many airlines in Europe,' he says. This factor may hamper tour operators who need to find alternatives to a collapsed carrier, Edwards says, since 'it's not so much a matter of capacity, but of which airline would you decide to use in the present climate'.

There is still aviation market activity. Norton Rose worked on the sale earlier this year of Belfast's George Best (City) airport by Ferrovial to ABN AMRO Global Infrastructure Fund for 132.5m.

'My colleagues were involved in that, and there is also work in recovering aircraft for lessors and in chasing fees owed to airports when an airline collapses - it is always messy,' he says.

Skuse says the industry's problems 'obviously mean there is work for lawyers and it is keeping people busy, for example in advising airlines on potential insolvencies and the need to have additional commercial security in place'. Sean Gates, a senior partner at London-based aerospace specialist Gates & Partners, expects that the commercial pressures on airlines will lead to more pressure for consolidation in the industry through mergers and acquisitions 'in ways that may not necessarily be commercially sensible', and that failures will inevitably rise.

This need not mean any great fall-off in legal work. 'People still fly, get killed, get injured, lose their bags, and as lawyers we are pretty much doing the same as ever,' Gates says.

His firm helps to guide clients through the thickets of the industry's regulatory system. 'One of the problems continues to be the regulators, especially at European level, where they are tightening the screw at exactly the wrong time,' he says. 'I don't think this is an appropriate time to make it more difficult by tightening regulation, but they seem to be doing so.'

Bad times can be good for the bold, and Gates thinks the airline industry is no exception for any business with deep pockets and strong nerves.

When an airline collapses, its aircraft become available to be leased or, less usually, bought - and plenty are on the market or soon will be because, as he points out, 'more of the less competent budget carriers will go'.

This could create an opportunity. 'I have no doubt that people are going to be a lot more careful when the economy is in an appalling state,' says Gates, 'but anyone with the nerve to do it could buy themselves a whole fleet of modern, fuel-efficient, aircraft very cheaply and without historic debt right now, and they would be in a strong position when things recover. It's a very good time for anyone with the balls and bank balance to be buying.' The aviation law sector will hope to take advantage of both the down and upsides of the industry.

Flying blind: airport wrangles

The instability that has afflicted the airline industry this year has been exacerbated by no one knowing who will end up with control of most of the country's main airports, or what they will do with them. BAA faces a break-up following a Competition Commission investigation into complaints by airlines of anti-competitive practices. The watchdog argues that BAA had an effective monopoly in London and Scotland. The former British Airports Authority was privatised intact in 1987, which left BAA owning London's Heathrow, Gatwick and Stansted airports, and Glasgow and Edinburgh in Scotland. It also owns Aberdeen and Southampton. BAA has put Gatwick on the market, perhaps seeing the writing on the wall, but is fighting any forced sale of its other sites. Elizabeth McKnight, head of competition at City firm Herbert Smith, is advising BAA on the commission's inquiry but declined to comment on this work.

While Herbert Smith is, presumably, helping BAA to fend off any commission direction to sell Stansted or any airport in Scotland, another solicitor is working to make the operator's position even worse. Richard Venables, senior European counsel at Bird & Bird, with which his former firm Lane & Partners merged on 1 October, is acting for the budget carrier Flybe. Flybe hardly uses London airports, serving mainly continental Europe from UK regional airports. It wants the commission to force BAA to sell Southampton, something not previously considered since it is not normally seen as a London airport.

'Flybe is pressing the commission to direct BAA to sell Southampton,' Venables explains. 'It argues that Southampton is in competition with Heathrow and Gatwick and has been very poorly developed by BAA, in contrast to regional airports like Liverpool John Lennon, which are in separate ownership, because BAA has an interest in defending Heathrow and Gatwick. We feel it is not reasonable for them to keep it and that it should be sold.' Venables is providing legal advice to support this argument but admits that in such cases it can be 'difficult to draw a line between that and lobbying'.

A BAA spokesman responds in a manner that suggests Venables has a fight on his hands: 'BAA has no intention of selling Southampton. It is not a significant issue which has been brought up in the recent provisional findings by the Competition Commission.'

The commission's review of BAA is a matter of UK competition law and so is also an issue in Scotland. Neil Amner, a partner at Glasgow law firm Biggart Baillie, is helping businesses in central Scotland put together submissions to the commission on whether BAA should sell either Glasgow or Edinburgh. 'In Scotland people generally feel BAA has been a competent operator,' he says. 'The speculation has been that BAA will sell Glasgow and keep Edinburgh, since Edinburgh has been busier.' He wonders though how the anticipated takeover of HBOS bank, with its Edinburgh headquarters, might affect the demand for business flights to Scotland's capital.

'Edinburgh is largely a business market while Glasgow is more mixed,' Amner says. Glasgow acts as a feeder for connections to intercontinental flights from Heathrow and Amsterdam's Schipol, but also has successful direct links to Dubai and Australia. 'At the moment people are saying they would prefer the status quo and are concerned about whether a new operator, or BAA in more straitened circumstances, would put in the investment planned,' says Amner. 'It's a big issue in business circles here'.