Garuda Indonesia restructuring proceedings

Garuda's history

Garuda's first restructuring took place between 1998–2001 and resulted in a compromise of approximately US$2.4bn of Garuda's financial liabilities. Multiple implementation tools were used, including schemes of arrangement in England and Singapore, a voluntary agreement with certain creditors to term-out their debt, a conversion of state-owned enterprise debt into mandatory convertible bonds and a conversion of existing government debt into equity. There was no parallel Indonesian suspension of debt payment obligation (PKPU) proceeding at that time.

Global events were not kind to the airline industry in the years that followed. Garuda subsequently defaulted on scheduled loan repayments in 2005, and announced its need to restructure as a result. This time around, the Indonesian Government made it clear that bailouts were not on the cards. Ultimately, Garuda's second restructuring was delivered by way of a debt-buyback programme. Garuda was then listed on the Indonesia Stock Exchange in 2011.

Unfortunately (but not surprisingly) the coronavirus (COVID-19) pandemic has had a devastating impact on the airline industry. Several airlines have been through some form of restructuring process in the last two years. Notably, many of these restructurings have featured the use of foreign restructuring processes, with Malaysia Airlines and Philippines Airlines being two prominent regional examples.

In July 2021, a trade creditor of Garuda filed an application to commence PKPU proceedings before the Central Jakarta Commercial Court. This petition was ultimately thrown out in October 2021, however another trade creditor shortly filed another petition and Garuda was declared to enter into PKPU in December 2021. A key point of interest is that Garuda has expressed its intention to file an English scheme of arrangement in parallel to the ongoing PKPU proceedings in order to restructure certain liabilities under English law-governed leasing arrangements.

The PKPU process in brief

PKPU is an Indonesian law governed restructuring process conducted under the auspices of the Indonesian commercial courts. Either the debtor or a creditor can commence an application to place a debtor into PKPU. Once the Indonesian commercial court grants a decision declaring the debtor to enter into PKPU status, a stay on (among other things) actions to compel the debtor to repay its debts takes effect. The court also appoints an administrator/team of administrators who jointly manages the debtor's assets for the duration of the PKPU.

By law, the Court will grant a temporary PKPU for 45 days in the first instance. This may be followed by an extension into a permanent PKPU, which can last up to 270 days from the date of the original decision. Failure to obtain approval from the requisite majorities of creditors and subsequent court sanction within 270 days from the date of the original PKPU decision will result in the debtor subsequently being placed into bankruptcy.

As of the time of writing, Garuda has obtained an extension of its PKPU process by the commercial court for 60 days until 21 March 2022, with the following agenda:

• claim and tax verification on 24 February 2022
• discussion of the composition plan on 1 March 2022
• discussion and voting towards the composition plan on 15 March 2022, and
• panel of judges deliberation meeting on 21 March 2022

Whether further extensions will be obtained remains to be seen. There is a possibility that Garuda may receive further extension of PKPU process up to 270 days or until September 2022.

Parallel scheme process

Garuda has publicly stated that it intends to restructure its English law lease liabilities by way of an English scheme of arrangement. An English scheme of arrangement is a company law (rather than insolvency law) procedure that allows a debtor to reach a compromise or arrangement with its creditors (or any class of creditors). The approval thresholds are a majority in number and 75% in value of those creditors present and voting in each class, and each class of creditors must approve the scheme for it to be sanctioned. As with the PKPU, the English scheme process obviates the need to deal with each lessor individually, and allows for the debtor's operations to continue under management's purview.

The reason a parallel restructuring process is required is primarily down to an old English common law principle known as the ‘rule in Gibbs’. This is the rule that a discharge of debt under the insolvency law of a foreign country can be only recognised in England if it is a discharge under the law applicable to the contract in question. From this follows the general proposition that a debt governed by English law cannot be discharged or compromised by a foreign insolvency proceeding, unless the creditor in question has submitted to the jurisdiction of the foreign court.

What this means in a restructuring context is that the English courts will not recognise the compromise of an English law debt pursuant to a foreign restructuring process. For example, a scheme of arrangement under Singapore law would not, as matter of English law, result in a valid compromise of English law debt.

This does not mean the debt would not have been validly compromised as a matter of the foreign law in question—indeed, the Singapore court held in Pacific Andes Resources Development Ltd [2016] SGHC 210 that such a compromise is valid as matter of Singapore law. This can leave creditors in a difficult position: they may be able to take action in the English courts to enforce the debt as if it had not been compromised, but may not be able to enforce that judgment in the jurisdiction where the compromise took place.

Unsurprisingly, the rule in Gibbs has faced much criticism recently, particularly from outside the UK. However, recent cases from the UK demonstrate that the rule in Gibbs remains good law. (See, for example, coverage of the decisions in Bakhshiyeva v Sberbank of Russia [2018] EWCA Civ 2802, Chang Chin Fen v Cosco Shipping (Qidong) Offshore Ltd [2021] CSOH 94.)

What this makes clear is that Garuda's English law lease liabilities cannot, as a matter of English law, be compromised under Garuda's ongoing PKPU proceedings without leaving the door open for creditors to bring proceedings in England to enforce their rights as if they had not been compromised by the PKPU. Any restructuring of such debts will therefore instead need to be effected under an English process.

Tying the PKPU and an English scheme together

Any holistic restructuring of Garuda's liabilities will, therefore, need to consider how to effectively implement both a PKPU and an English scheme.

One approach would be to make each element of the restructuring inter-conditional, such that Garuda's overall restructuring can only become effective if each distinct element is approved. The typical approach taken in cross-border restructurings is to ensure the relevant processes are also aligned so that, for example, the relevant court sanction hearings take place as close together as practicable in the circumstances.

The alternative would be sequential approval: either the scheme or the PKPU being approved (and becoming effective) first, with the other to follow. However, this approach is generally not preferred and can cause uncertainty. For example, if the PKPU process were concluded and purported to compromise any claims that were also subject to the scheme, this could have an impact on class composition, especially if any of the creditors in question have agreed to be bound by the PKPU. The effect could be that only creditors who did not submit to the PKPU process would be included in the relevant class, potentially giving those creditors a veto right in the scheme.

From an English law perspective, the inter-conditional, simultaneous approach for Garuda's restructuring is therefore likely to be preferable.

Recognition

One potential catch with multi-jurisdictional restructurings with an Indonesian nexus is that Indonesia does not have a legal framework to recognise and enforce foreign judgements. A foreign matter generally needs to be re-tried before the Indonesian court, with the Indonesian court subsequently issuing a new Indonesian judgement.

This could pose a potential problem because from an English law perspective, the international effectiveness of the scheme is a key issue. If it is clear that the scheme would not be recognised or otherwise be effective in Indonesia, this may present a barrier to sanction. The other element the court will look for is widespread creditor support, either by way of evidence of votes in favour of the scheme or of creditors' entering into a lock-up agreement ahead of the scheme. This can, of itself, be enough to convince the court that it will not be acting in vain in sanctioning the scheme.

The Malaysia Airlines restructuring—an illustrative example

The recent English scheme of arrangement of Malaysia Airlines serves as a useful comparator to Garuda's ongoing restructuring efforts. Malaysia Airlines' scheme was sanctioned in February 2021 and restructured 52 English law governed aircraft operating leases. The scheme also formed part of a wider restructuring of the company's liabilities, and the overall restructuring was inter-conditional such that all elements had to be implemented or none would.

The Malaysia Airlines decision is helpful in clearly confirming that foreign airlines can utilise an English scheme of arrangement to comprise claims under English-law governed lease agreements. Although not the first time this has been done, it is a helpful clarification that the governing law of a leasing arrangement is, of itself, a sufficient connection to the jurisdiction.

The approach taken by Malaysia Airlines was to offer lessors a 'menu' of options. Broadly, these options were to either:

• continue to lease the aircraft to the Company at a revised market rent, or
• terminate the lease, take back the aircraft and receive a one-off payment

It may be that Garuda elects to offer lessors a similar menu of options, but that remains to be seen.

Helpfully, the English court found that the lessors constituted a single class of creditors. This was despite each lease being on independent terms. The court found that, even though lessors may have different outcomes (depending on which of the options they chose), the fact they were all offered the same range of options was sufficient to place them in the same class. This is particularly relevant as no cross-class cram down is available in a scheme of arrangement, unlike in a restructuring plan as introduced in Part 26A of the Companies Act 2006 under the UK Corporate Insolvency and Governance Act 2020.

The Cape Town Convention, and its relevance to Garuda's English scheme

Given the nature of Garuda's business, the Cape Town Convention and associated Aircraft Protocol (the ‘Convention’ and ‘Protocol’ respectively) (which provide a system to create, perfect and enforce security rights over aircraft objects) are key to consider in any English scheme of arrangement Garuda undertakes.

The Convention and Protocol are international treaties that need to be adopted by individual states to be enforceable in those jurisdictions. Both the UK and Indonesia have done so. The Convention and Protocol also prescribe a standardised set of rights and remedies that arise on a debtor's default. It is worth noting that, in relation to insolvency, both Indonesia and the UK have adopted 'Alternative A', which is the more 'lessor-friendly' of the insolvency options available. Essentially, lessors are given certain rights upon the occurrence of an ‘insolvency-related event’ in respect of a relevant debtor.

From an English law perspective, a key issue for lessors is likely to be whether Garuda's intended scheme constitutes an ‘insolvency-related event’ for the purposes of the Protocol. If a scheme does constitute an insolvency-related event, this would prevent the terms of the lease from being amended without the consent of the lessor. This would effectively prevent a scheme from operating to compromise the terms of any lease governed by English law.

A number of factors would need to be considered to ascertain whether or not an English scheme of arrangement would be considered as an ‘insolvency-related event’ and the English court recently provided helpful guidance on this in the context of a restructuring plan (see In the matter of gategroup Guarantee limited and in the matter of the Companies Act 2006 [2021] EWHC 304 (Ch)). In that case, the court considered whether an English restructuring plan would constitute an insolvency proceeding for the purposes of the Lugano convention. The court found that the necessary hallmarks were present—specifically that a restructuring plan (i) was a collective proceeding, (ii) was formed under law relating to insolvency, and (iii) was subject to the supervision of the court. Although not directly relevant to the test under the Convention, it is likely that a similar approach would be taken in any further analysis of this issue by the English Court, though it is important to bear in mind the differences between a restrcturing plan and a scheme.

The issue of whether schemes are ‘insolvency related events’ for the purposes of the Convention was raised in Malaysia Airlines' scheme proceedings. The court in that case did, at the convening stage, find favour with the argument that a scheme would not constitute an ‘insolvency-related event’, albeit without ruling on the point. However, as the scheme ultimately received the support of all affected creditors, the court did not need to make a decision on whether schemes are ‘insolvency related events’ for the purposes of the Cape Town Convention.

On the other hand, in a decision relating to another Malaysian airline (this time AirAsia X), the Malaysian High Court found that a scheme of arrangement was an ‘insolvency-related event’ for the purposes of the Convention. However, on the facts of that case, the claims being compromised were not those to which the Convention applied, so creditors did not have recourse to the rights under Article A of the Convention in any event.

Next steps

Of course, the above is not an exhaustive discussion of the options available to Garuda. The airline may decide on an about-turn and follow Philippine Airlines down the route of Chapter 11 filing. Whatever happens, uncertainty remains the watchword as Garuda continues to discuss the terms of its restructuring with creditors and interested parties will have to wait to see how this national flag carrier resolves its ongoing financial issues. However, what is certain is that any deal will be closely watched by restructuring professionals in the region and around the world.

This article first appeared on LexisPSL R&I and is reproduced with permission.