Competition. Canada has a moderately robust competition policy, embodied in its Competition Act, R.S.C. 1985. Even in a regulated sec tor like air transport, successive governments have tried to engineer a healthy degree of competition as a means of ensuring efficient service.
With privatization and deregulation, the Minister of Transport was con strained to rely even more heavily on competition to ensure a healthy marketplace. It was the Minister’s unavailing desire to keep at least separate organizations and brands active in the market that prolonged the agonies of CAIL, and subsequently visited on Air Canada a debt load and fractious labour force that were material causes of its eventual in solvency. When Air Canada acted, especially in the difficult 1999–period, in the way textbooks suggest monopolists would, it was the threat (and reality) of regulation under the Competition Act, as well as the threat of allowing cabotage, that acted to moderate the behaviour of the airline.
Airports. A large anti competitive element in air transport is the sys tem of terminals. The availability of gates and landing slots, as well as their cost, can have a material impact on the success or failure of an airline. In Canada, the main airports used to be owned by the federal government. By 1990, however, this model had become unsustainable.
A federal government then running large deficits could not afford the large capital investments required by new terminals and runways and was unwilling to pass the costs directly to passengers. The terminals looked more like utilitarian warehouses than the architecturally imaginative transit and retail establishments that the public had come to prefer. So the federal government turned their management over to a new class of entity, airport authorities, which were responsible to local governments and to airport users. In most cases this worked reasonably well. Montreal, Vancouver, Ottawa and other cities built new well. Montreal, Vancouver, Ottawa and other cities built new facilities that combined ease of use with moderate prices. The Greater Toronto Airport Authority, however, hired a visionary American who embarked on a $4 billion expansion – just as traffic started to slacken at the turn of the century. Air Canada’s central hub went from being a low cost cen ter to one of the highest in the world in three years – at the very time when its own crisis was at its worst259.
Regionalism and the temptation of direct investment. The identifica tion of Air Canada with eastern Canada and CAIL with the west had led the federal government, much against its will, to prop up CAIL with loan guarantees during its struggle in 1992. In 2003–04, with the prospect of the disappearance of a national, not just regional, champion, the temp tation to re nationalize Air Canada was a powerful one, especially as an election was foreseen for the spring of 2004. In the event, market minded ministers won, but not without a struggle behind the closed doors of the Cabinet room. The greatest excursion from established policy turned out to be a relaxation of the 25 percent rule: the govern ment let it be known that going as far as 49 percent would be accept able. Had the government not been firm in its stance, the incentive for the company and its unions to fight to an agreement on wages and work rules would have been impaired, probably fatally.
Liquidation’s externalities. Mention has been made of the external ities consequent on bankruptcy and liquidation. In this case, substantial costs would be borne well beyond the ambit of Air Canada’s managers, employees, and creditors. Airport authorities would be left with large if temporary deficiencies in their cash flow, with consequent impairments in their credit ratings and possible calls on governments for bail out fi nance. The governing federal party, facing an election too close to call, might have found the shock enough to change the result. Consumers would lose frequent flyer points worth hundreds of millions of dollars.
Firms in the supply chain would lose a substantial market, at least until the rise of new carriers to fill the void left by the vanished airline. By that token, of course, enormous business opportunities would have been created for WestJet, CanJet, Jetsgo and the remaining domestic dis count airlines, and for foreign carriers with respect to the lucrative trans oceanic routes.
Eric Reguly, “Terminal turbulence,” Globe & Mail, 30 April 2004.
Stock market regulation. Air Canada’s stock continued to trade on the Toronto Stock Exchange after its CCAA filing, despite explicit warn ings from management that it was worthless under any scenario. Why the stock exchange or its regulator, the Ontario Securities Commission, failed to suspend trading remains a mystery.
Issues under CCAA proceedings The most fundamental issue in an insolvency is whether to liquidate the remaining assets and distribute them among the creditors, or whether to attempt a reorganization. From a public policy point of view, the answer turns on external factors that transcend the concerns of the debtor and creditors in the action. In this sense it is somewhat anoma lous that the decision, at least in the case of CCAA and other debtor friendly regimes, is taken primarily at the instigation of the debtor, who remains in charge of the enterprise. Creditors’ powers are, in the main, those of restraining or moderating the actions of the insolvent. It is in structive to observe the ways in which the embattled management of Air Canada dealt with the issues and parties in their insolvency.
Power of management. Reorganization has a far greater chance of rewarding incumbent management260 than does liquidation. In the latter case, under the BIA or a Court ordered process, a third party is charged with a process that leaves at best only shards of the original business still in existence under new ownership, with the rest of the as sets and workforce idled. Certain of the failed managers may be re tained in the short term by the trustee in order to assist in the process, but at the end of that period they usually become unemployed. Share holders, who may include members of the failed management, typically receive nothing or only a token amount for their shares. Directors lose their emoluments and prestige, and their reputations and hence hopes of future appointments are often diminished. There is thus a powerful inducement to select a process that maintains the power of manage In the Air Canada case, as noted, the president and his chief restructuring officer were promised bonuses worth about $21 million apiece by one bidder if that particular bidder was selected to provide the necessary new equity and thereby gain control of the airline.
This clearly had the appearance of a conflict of interest. It is not surprising that manage ment and the board that supported them persisted in their advocacy of this bidder rather longer than an objective view would have required. Only the collapse of the Li bid kept this issue from assuming more prominence, or possibly attracting the notice of the Court.
ment as long as possible. Overwhelmingly, managements and boards of directors prefer reorganizations. It is thus incumbent on the Courts to intervene to protect the external public interest.
It is no surprise that the perennially optimistic management of Air Canada chose the reorganization route, and therefore filed under the reorganization oriented CCAA, with a parallel filing under the Bank ruptcy Code in the US.
Timing. Management’s first choice has to do with timing. A prema ture application to the courts may be refused, or may be expensively objected to by an aggrieved creditor. This is what happened in the sub sequent case of Stelco, the Hamilton, Ontario steel producer, where the labour union refused to accept the calculations of Stelco management and caused the company to spend time and good will it did not have in proving the point. Leaving it too late, however, exposes the company to pre emptive actions by creditors, such as the seizure of assets for un paid debts or a petition under the BIA. It was the threat of seizure of air craft by unpaid airport authorities that precipitated the bankruptcy and sale of Canada 3000, one of the several discount start ups of the 1990s.
In the case of Air Canada, cash available to pay short term liabilities had been eroding all through the fall and winter of 2002–03, leading the company to sell assets and to negotiate with its labour unions for lower wages and more relaxed work rules. When matters were at their most parlous, SARS struck, and revenues (but not costs) nose dived. Air Canada, having pursued all options in an increasingly public manner, made application to the court only in extremis, and probably not long before pre emption by one creditor or another.
Choice of Court. Air Canada could have applied to the courts of sev eral provinces, though the real choice lay between Ontario, home of its major hub, and Quebec, where its headquarters were. Ontario, how ever, had established a “commercial list” within its Superior Court of judges experienced in bankruptcy and insolvency as well as other busi ness issues. It was to this court that Air Canada applied, where the judge assigned was the highly experienced Mr. Justice James L. Farley.
An important element of Justice Farley’s style is a refusal to let particu lar interests delay an overall solution and a determination to keep par ties moving toward solutions. A frequent tactic is to require parties with opposing interests to negotiate a solution on an urgent basis, under threat of the Court imposing a solution that, almost by definition, will be less than optimal. Distinguished lawyers have often found their nights and weekends commandeered by a judge whose experience tells him that delay is the great enemy of all.
Air Canada would certainly have preferred to file under Chapter 11 in the US, as that statute allows as a fairly automatic provision the setting aside of labour contracts and the “cramming down” of provisions which may be deeply unpalatable to a few creditors in the hope of saving the whole enterprise. In certain international cases a company may have, effectively, some degree of choice regarding the legal regime that is used to regulate a matter. But in this case the locus of activity was so clearly Canadian that no choice was possible. A last ditch attempt to persuade the federal government to amend CCAA so as to make the nullification of labour contracts a normal rather than judicially discre tionary act was rejected, as was a request for a billion dollar loan or loan guarantee.
Defining the creditor classes. Under a CCAA plan of arrangement, each creditor class must approve the proposal. At least half of the creditors, representing at least two thirds of the value of the assets of the class, must vote in favour. The ability to define the classes is thus a powerful tool. Under CCAA, it is the incumbent management, under the general guidance of the Court to group like creditors together, which gets to make the initial proposal. Even when appeals to the Court cause the initial design to be varied, the variances are normally only just enough to satisfy a judge’s sense that a particular creditor has not been treated unjustly. In practice, the management proposal will avoid creat ing any more classes than necessary, since each wields a veto, and may have elements of gerrymandering, in the sense that designing class memberships so as to distribute probable objectors more or less evenly is much to be desired from the point of view of the sitting man agement.
Debtor in possession finance. Under CCAA, by definition the assets of the failing firm, including its shareholders’ equity, are insufficient to satisfy obligations to creditors as they fall due. Under such circum stances the claims of all creditors are impaired, in accordance with the statutory priorities. No rational lender would step forward unless, at the least, his new loans were granted a super priority over all existing claims. It is in the interest of existing creditors to grant that super priority if so doing raises the probability that an injection of new funds will make all creditors better off. It is in the interest of society as a whole to grant super priority if the new funds mean that the sum of creditor losses and external costs are likely to decrease – an important distinc tion. That is why a Court is called on to decide the issue, as the interests of the creditors and those of society at large may diverge. In such a case, the magnitude of the difference and the probability with which it may occur become important considerations, as the Court may be called upon to act against at least the short term interests of the credi tors.
Air Canada, working in necessary secrecy in the days before its fil ing, arranged $954 million in debtor in possession financing from an affiliate of GE Capital Corporation. Later, it sold Aeroplan loyalty points to CIBC, a Canadian bank, for $350 million.
Disclaiming collective agreements. In US practice, filing under Chapter 11 gives management a discretionary right to unilaterally modify or even abandon collective agreements with unions. Wages may be lowered, benefits and pension rights abrogated, and work rules changed to promote efficiency. CCAA contains no such auto matic provision. The presiding judge may, in extreme circumstances, approve a company’s application to set aside a collective agreement, but the matter is contentious and only used with great reluctance and as a last resort.
In the Air Canada case, any of seven unions could, by failing to agree to its share of the pain, bring down the whole house of cards. Mr. Jus tice Farley opted not to repudiate the agreements but rather to appoint a fellow judge, Mr. Justice Warren Winkler, to preside over marathon last minute negotiations, reserving the threat of direct intervention if unions and management failed to find a solution acceptable to the new investors. The combination of threat and suasion – Justice Winkler ap pears to have been at least as tough, behind closed doors, as Justice Farley is in the courtroom – eventually worked, but not until three days after the ‘deadline’ imposed by DB and GECAS, the major new inves tors.
Some lessons Lessons for policy. A workable bankruptcy regime is fundamental to any market economy. Business failures are inevitable, and there needs to be an efficient process for recycling the economic assets involved.
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