Dispute Over Unique Collateral Creates Uncertainty Around Value of American Airline Bonds in Bankruptcy


By: MD

As is common in bankruptcy proceedings, the recent Chapter 11 bankruptcy of AMR Corp., the parent company of American Airlines, has created uncertainty as to the value creditors can hope to collect from the restructured entity in the future.  Secured and unsecured creditors alike are wondering what type of value they will be able to recover if and when the entity reemerges from bankruptcy as a going concern.  However, certain secured creditors of American Airlines, in particular, face an interesting new legal challenge to recovery as the legitimacy of certain collateral is being called into question.

In order to operate at various airports and fly routes from any given location, the FAA grants airlines the right to use the gate space at airports, the right to fly specific routes (“route authorities”), and the right to take-off and landing slots (“slots”) at a given airport.  In addition to the tangible property,  like airplanes, that one would expect to be used as collateral for loans, airlines often use the rights to fly routes, take-off and land, and use gate space at various airports as collateral for their debt obligations as well.  In the event of default by the debtor, the creditor could then seize the rights to these routes, gates and slots and sell them to other airlines, thereby recouping the value of the collateral.  One problem with such rights being used as collateral is that they are subject to regulation by the Federal Aviation Administration (FAA) and can be altered by the FAA when it is deemed appropriate.  For instance, the FAA has stated in the Code of Federal Regulations that the FAA may withdraw or temporarily suspend Arrival Authorizations at any time as a result of reduced airport capacity or to fulfill operational needs.”  Because these rights are not under the full control of the airlines that are using them as collateral, their value can be difficult to determine.  Furthermore, part of that value can completely disappear in the event that the FAA decides it is necessary to revoke or alter an airline’s privileges.

However, some are questioning whether rights to these various routes, gates or slots may be used as security interests at all.  A security interest in property, commonly known as a lien, is a contingent property right that allows the creditor to seize the property if the debtor violates the terms of the debt agreement.  In order to place a valid lien (commonly understood simply as a claim on property) on collateral that is recognized by courts, a given creditor must “perfect” that lien.  “Perfecting” a lien is the process by which creditors officially record their interest in the property being used to secure the loan.  For instance, when a bank provides a home loan to a buyer, backed by a lien on the house, that lien is “perfected” by recording it in the registry of deeds for the county in which the house is located.  This process functions to put the world on notice that the property is subject to a claim by a creditor, and also serves to validate the claim for legal purposes.  Liens on different types of collateral require different procedures and locations for recording such property rights, but all claims to property of this sort must be “perfected” to be recognized in court.  If this process of “perfecting” is defective for some reason (such as filing the lien in the wrong place or failing to correctly fill out the requisite paperwork) then that claim will not be recognized by the court and the creditor will have no right to the collateral.

In the case of the creditors whose claims are backed by a lien on route authorities, gate leaseholds, and take-off and landing slots, the issue is whether these privileges constitute true property rights that can be even used as collateral.  The FAA has stated that, “slots do not represent a property right but represent an operating privilege subject to absolute FAA control…slots may be withdrawn at any time to fulfill the Department’s operational needs.” Courts could take this language to support the view that these, and similar FAA-controlled privileges are not true property rights, but merely operating privileges.  This in turn could lead to a finding that the liens are defective, because the airlines owned no actual property rights that could be perfected, and are therefore invalid.  Such a ruling would have a drastic impact on the level of recovery for secured creditors, as the value of the collateral backing their claims would likely be decreased to the extent that such liens in collateral are defective.

The bankruptcy court will hear motions on various issues concerning these bonds and issues pertaining to their collateral this week.  The eventual outcome of such hearings could have significant effects on the ability of airlines to raise debt against such collateral in the future.




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Fordham Journal of Corporate & Financial Law