How Malaysia Airlines used the UK scheme of arrangement to renegotiate its aircraft leases

In a guest Insight Freshfields partner Craig Montgomery, and Associate Adam Jones, who advised Malaysia Airlines, discuss the airline’s use of a UK scheme of arrangement to renegotiate its aircraft leases.

The UK court approved a restructuring of Malaysia Airlines using a scheme of arrangement in February 2021. It is known as the MABL scheme, as it was proposed by the group leasing company. 

The scheme was innovative in a number of important ways. In particular, it pioneers the use of a UK scheme to reduce lease rents to a market rate.

There has been much debate about the interaction between the Cape Town Convention and UK schemes (in particular, whether they are “insolvency-related events”). The UK court did not have to decide, because (after the vote) all lessors agreed to the scheme. However, the UK court gave a strong indication that the Cape Town Convention would not prevent use of a scheme.
 

What is a UK scheme? 
 

A scheme of arrangement is a UK company law procedure whereby the court approves an arrangement between a company and specified creditors. It only affects the liabilities the company selects, so long as the court considers it fair in the wider context.

The terms must be approved by a majority in number and 75% in value of each class of the affected creditors. Once sanctioned by the court it is then binding on all scheme creditors. Thus, the majority can bind a minority. Schemes are a commonly used tool in the financial context.

The scheme company proposes the voting classes to be approved by the court. The right classes depend on the precise terms of the scheme, but minor differences will not lead to creditors being divided into separate classes. Schemes of lease liabilities have not been common and so the appropriate classes had not been considered before this case.
 

Is use of a scheme “forum shopping”?

Foreign companies can propose a UK scheme if they have a ‘sufficient connection’ with the UK and numerous UK schemes of non-UK companies have been successfully carried out. Assets, employees or operations in the UK are helpful, but not essential to show ‘sufficient connection’. If the relevant liabilities are governed by English law, that is a sufficient connection, even if the company has limited or no physical connection with the UK. 

In fact, a UK scheme is the natural choice for English law leases (which predominate outside the Americas). This is because of the so-called “Gibbs rule”, which says that English law will not recognise a foreign restructuring of English law obligations. So, to be fully effective any restructuring of English law obligations will need to involve some form of UK process.
 

What did the MABL scheme do?

The scheme reduced the rents under certain aircraft operating leases. There was a single voting class, because each lessor was offered the same options:

- reduce the lease rent to a market rent, which varied by type and age of the aircraft; or

- terminate the lease, take back their aircraft and receive a termination payment. The termination payment was calculated to be more than under a Malaysian liquidation, which the company said would be most likely without the scheme.

The wider restructuring includes amendments to other operating leases, finance leases and financial debt, alongside a significant capital injection from the group’s shareholder. These did not have to be in the scheme as they were agreed by all parties.
 

Why is the case significant?

The move to market rent, given the distressed economic environment, meant around a 10% discount for some lessors, and a 40+% discount for others. This could suggest each lease should be in its own class, because each is unique. However, the court said not, because all lessors were being offered a market rent for their aircraft and the option to take it back. The alternative was a liquidation in which all lessors would get back their aircraft and seek a market rent elsewhere.

While you need broad support from lessors to get the votes to support a scheme, the process is useful in setting a time frame for the negotiations and a discipline around the terms that can be agreed. In order to maintain a single class, all lessors need to be offered a broadly similar deal. That is helpful for the airline, as it narrows the scope of the negotiation, but it is also useful for lessors as they can be confident that they are getting a fair deal, relative to other lessors. If, in a different case, a minority of the lessors refused to agree the deal the majority had negotiated, the scheme could be used to make them take the deal or take their aircraft back, rather than force the airline into insolvency.

The scheme now presents a viable alternative to US Chapter 11 or local processes for airline restructurings. A UK ‘restructuring plan’ may also now be viable. This is similar to a scheme, but allows for cross-class cramdown. In an appropriate case, that could be used to reduce the fleet size through rejecting leases, as is commonly seen in Chapter 11. This remains a point which has not been formally decided by the UK court, and there are differing views as to whether this would be compatible with the Cape Town Convention. It would depend on the specific terms of the deal proposed. Safeguards are likely to include shareholders not retaining equity value unless they put in new money to equivalent value.

Why use a UK scheme rather than the alternatives?
 

Many airlines are experiencing financial difficulties. They typically have four restructuring options: (i) bilateral negotiations; (ii) local processes; (iii) US Chapter 11; and (iv) now a UK scheme or restructuring plan. In practice, airlines will often pursue negotiations with one of the other options as a fallback.

The potential advantages of a scheme for the airline, depending on the particular case may include:

- It is not a bankruptcy and the directors of the company (not the court) remain in control. They select which liabilities will be subject to scheme.

- As it is not a bankruptcy, the scheme may allow for continuous operations under the relevant aviation regulatory regime(s). 

- It could be combined with local law processes, if non-English liabilities need to be included. The UK courts are flexible on jurisdiction (particularly where liabilities are English law). A UK scheme gives maximum recognition, given the Gibbs rule.

- In many cases, a scheme will be quicker and more cost-effective than a US Chapter 11 or local process, preserving value for lessors and other creditors. 

- The court process is particularly quick, with time being devoted instead to negotiating with lessors to ensure a fair balance for all.

 

Craig Montgomery is a partner and Adam Jones an associate in the restructuring team of Freshfields Bruckhaus Deringer LLP. They advised Malaysia Airlines.

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