State aid for Lufthansa vs. protective shield?

Lufthansa CEO Carsten Spohr sees the initiation of protective shield proceedings under insolvency law as a possible restructuring alternative.

The coronavirus crisis is shaking the German aviation giant. One million euros, that is how much Lufthansa is losing per hour due to the current standstill. About 700 of the approximately 760 aircraft are currently on the ground and only about 3,000 instead of the usual 350,000 passengers a day fly with Lufthansa and its subsidiaries. Of the total of 130,000 employees, more than 80,000 are working short-time.

In order to get through this crisis, Lufthansa is negotiating with the German Federal Government for state aid in the billions. In total, he said, there was talk of around ten billion (10,000 million) euros. In addition, Switzerland, Austria and Belgium are also to provide financial support for Lufthansa and its subsidiaries Swiss, Austrian and Brussels Airlines.

But the politicians are attaching conditions to the granting of loans. According to sources familiar with the discussions, the Federal Government entered the negotiations demanding high interest rates for any emergency funding together with a guaranteed dividend of 9%, and voting rights in return for the use of taxpayers' money and, further, a firm commitment that the company does not move its  business elsewhere. Most recently, in addition to loans and a silent partnership without voting rights, a share package for the State of 25% of shares in the company was said to be discussed. This would give the Federal Government a blocking minority and access to membership in the Lufthansa Supervisory Board.

Lufthansa CEO Carsten Spohr is fiercely defending the company against these demands  and paints an altogether darker picture of an overbearing debt burden and possible overindebtedness of the company, and on the other hand against too much interference from politics. Lufthansa needs state support, but not state management.

There is also debate within the political arena about how much say the state should have in the event of participation.

The Social Democrats and the Left Party were against the possibility of a silent participation. However, if a company receives state aid from taxpayers' money in this amount, the Federal Government must be guaranteed a say in the matter, according to them. Environmentalists are also calling for state aid to be linked to requirements and only granted in return for commitments in the field of climate protection.

On the other hand, the Christian Democrats and the Liberals warn against too much state influence. State aid is intended to help the company through the crisis, not to give the state a say in the company. Most recently, the flight attendants' union UFO also expressed criticism of a state representative on the Lufthansa Supervisory Board, as such a representative would not offer any added value in the operational business.

In this difficult situation, Lufthansa CEO Spohr brought into play the possibility of stabilising the company and guiding it through the crisis not by way of state intervention but by following in the footsteps of Condor and putting Lufthansa into protective shield proceedings [Schutzschirmverfahren] under German insolvency law.

Protective shield proceedings are restructuring proceedings under the protection of German insolvency law, roughly similar to the Chapter 11 procedure in the U.S.: upon presentation of a petition for the commencement of insolvency proceedings, the corporate debtor is protected from due and payable claims of its creditors which are no longer immediately enforceable. The process gives the corporate debtor the necessary breathing-space and time to draw up a viable restructuring concept, which is reflected in a so-called insolvency plan.

The insolvency plan will typically set out comprehensive provisions for the restructuring and preservation of the corporate debtor. It is a particularly important restructuring instrument for airlines, as this is the only way to preserve the so-called airport and airspace slots for the restructured company. These are licences or time slots granted by national or European authorities for a season for the use of airports or airspace, without which an airline cannot operate (the EU regulation is currently suspended due to the effects of the coronavirus but will apply again from 24 October onwards).

As in any insolvency, the state (usually pre-financed by banks) pays the salary for all employees for up to three months preceding the commencement of the insolvency proceedings. Social plans can be agreed on terms more favourable to the employer than those outside insolvency, thus reducing personnel costs.  Current contracts that are disadvantageous to the company may be terminated or renegotiated and better conditions agreed. As a rule, the Pension protection Fund (Pensionssicherungsverein, which is financed by levies on all businesses, guarantees the fulfilment of pension obligations to employees and only enters the proceedings as an insolvency creditor. This can ease the strain on a corporate debtor’s balance sheet considerably, especially for groups with high pension obligations.

Protective shield proceedings are also particularly attractive for the management, as it retains responsibility for the operative business and does not, as in other insolvency proceedings, have a (provisional) insolvency administrator take over the management of the business. However, the management is assisted by a court appointed supervisor [Sachwalter], whose role is to protect the interests of creditors. On the management side, it has to bring on board one or more restructuring experts with recognised insolvency law expertise (either appointed to the board as CRO or, alternatively, operating under a general power of representation [Generalbevollmächtigter]) so that debtor-in-possession management [Eigenverwaltung] can be successful.

However, the procedure is quite complex for airlines: the aircraft are often owned by external leasing companies (Lufthansa, however, owns the majority of its aircraft), with whom agreement must be reached on the future use of the aircraft. Moreover, the proceedings must not result in disadvantages for creditors compared with ordinary insolvency proceedings, so that the business may only be continued as a going concern if this does not result in a current loss (and thus a reduction in the insolvency assets) without corresponding compensation. It is therefore crucial that the restructuring is successful and that air traffic can continue without restrictions, at least at the current low level. However, if the necessary liquidity is no longer generated by the operational business and/or is no longer available in the company, it will still be the State that has to provide support, as did the state-owned KfW in the case of Air Berlin or Condor. Therefore, even in protective shield proceedings, Lufthansa are unlikely to continue without any state aid. However, KfW will not make loans available without imposing the necessary conditions and covenants.