Proceedings of the Standing Senate Committee on
Transport and Communications
Issue 10 - Evidence for February 8, 2005
OTTAWA, Tuesday, February 8, 2005
The Standing Senate Committee on Transport and Communications, to which was referred Bill C-4, to implement the Convention on International Interests in Mobile Equipment and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment, met this day at 9:34 a.m. to give consideration to the bill.
Senator David Tkachuk (Deputy Chairman) in the Chair.
[English]
The Deputy Chairman: Welcome senators. Welcome, Mr. McArdle. I ask our witness to please make his presentation to the committee and then respond to questions.
[Translation]
Mr. Jim McArdle, General Counsel, Export Development Canada: I would like to thank the committee for extending an invitation to EDC to appear as a witness this morning and provide its views on Bill C-4.
[English]
Before I begin, I would like to point out that Export Development Canada is interested in Bill C-4, as we believe the corporation will be a beneficiary of Canada's implementation of the convention in so far as Canada's implementation acts as a catalyst for other countries to implement the convention since EDC would benefit from adoption by these other countries when we provide aircraft financing in those countries.
In light of this, my remarks will draw on EDC's experiences as an institution with a significant aircraft loan and lease financing portfolio in many countries, rather than on the specifics of the bill, as we believe the EDC's experience in these countries could provide some insight to you as to how non-Canadian financers will view Canada when they finance aircraft in Canada.
I would like to start by offering to provide you with a very brief overview of EDC and the role we play in supporting Canadian exporters and investors in completing in today's global economy.
[Translation]
EDC is a parent Crown corporation incorporated pursuant to an Act of Parliament — the Export Development Act — and is Canada's official export credit agency. As such, it operates as a financial institution dedicated to providing a wide range of trade finance and risk management services to Canadian exporters and investors, often in partnership with the private sector, to help them compete and succeed internationally.
[English]
EDC's products and services, for the most part, fall into the following broad categories of products: Accounts receivable insurance, contract insurance and bonding, political risk insurance, equity and financing, which includes project financing, and aircraft financing.
EDC conducts its operations on a self-sustaining basis, generating sufficient income to protect its assets and to support future business. EDC does not rely on tax revenues or taxpayer dollars to operate, nor does it receive annual appropriations. Rather, it uses the interest and fees it charges borrowers, the premiums it charges on its insurance products, and the interest it earns on its investments to cover operating costs and grow its financial capacity, which in turn enables EDC to support more Canadian exporters and investors.
EDC has recorded a profit in all but one year of its existence. In 2003 EDC extended Can. $51.9 billion in trade finance and risk management services in 173 countries and territories to finance or insure export sales and investments by over 7,000 Canadian exporter companies. The numbers for 2004 are just being tallied now, but are expected to be similar.
EDC has considerable experience in the aerospace sector in a number of countries, ranging from the United States to Argentina to the Maldives. This experience perhaps gives us a fairly unique perspective in Canada as to the merits of the convention and the impact its ratification in Canada and elsewhere would have on lenders in this sector. As mentioned, the corporation is hopeful that Canada's ratification will encourage other countries to do the same.
Ratification by other countries, particularly those whose bankruptcy laws are not sophisticated and whose airlines seek financing from EDC to support the purchase of Canadian aerospace products, will clearly benefit EDC.
[Translation]
At present, EDC's aircraft loan and lease financing portfolio is predominantly concentrated in the United States, with certificated carriers in that jurisdiction who are subject to the US Bankruptcy Code. Given the current state of that industry, EDC has gained first-hand experience with the effectiveness of the applicable provisions of that Code, the key provision for aircraft lenders being section 1110.
[English]
Fairly similar to that which would happen in Canada, should an airline find itself in an insolvency position, it can seek protection from creditors during a stay period pursuant to chapter 11 of the U.S. Bankruptcy Code. In the absence of a provision such as section 1110, the airline would be entitled to retain possession and use the aircraft, and any other assets it has, without any obligation to make payment to the lenders during the stay period while the airline develops a restructuring proposal.
As a result, the security value of the aircraft is likely to decline during this period of use without payment to the lenders. Unfortunately this means that lenders cannot rely as heavily on the fact that they have good security over the aircraft which can be realized upon in an insolvency situation.
Section 1110 alters all of this for certificated airlines in the U.S. and puts a lender who can rely on this provision in a preferential position. Even during the stay period, if demanded by a creditor, the insolvent airline is required to make an election, after the prescribed 60-day period, to cure the existing defaults and agree to perform all obligations under the applicable agreement going forward, or surrender possession of the aircraft to the lender immediately.
Section 1110 provides clarity, protection and a predictable regime for the creditors of insolvent U.S. airlines and enables lenders to place greater reliance on the fact that they have real security on the aircraft. The provisions of the convention would extend similar benefits to creditors of airlines in those jurisdictions which adopt it. This will be of significant benefit to airline lenders, as many of these countries currently do not have sophisticated bankruptcy regimes, nor does the application of their bankruptcy laws and legal systems offer the same degree of predictability as would come from the convention.
The provisions of the convention will benefit EDC even for aircraft based in the United States, as it will permit the filing of international interests, thereby protecting our position during periods when the subject aircraft are operated outside the United States in another jurisdiction which is covered by the convention. The current Geneva Convention does not provide adequate protection in this matter and also has not been adopted by many jurisdictions.
In addition, the convention deals not only with repossession rights, which is significant, but also with a number of other issues, including the establishment of an international registry, allowing for the registration of ownership interests in aircraft, not just liens, thereby addressing security protection issues and deregistration rights, allowing for powers of attorney to permit the financier to deregister the aircraft without any consent or help from the borrower.
As mentioned, we believe that the adoption of Bill C-4 will serve as a catalyst for other countries that are considering or are in the process of adopting the convention. For the convention to be effective, article 28 requires that eight countries must ratify it. I understand that five have done so, and consequently Canada's implementation through Bill C-4 will reduce the number of other countries required for the treaty to be effective.
The manner of enacting Bill C-4, following alternative A of the convention, will further serve as a benchmark for other countries to refer to and reinforce the approach of adopting alternative A, which is consistent with that of the practice in the United States in that it provides for a fixed 60-day period and provides for less judicial discretion in setting the terms under which the creditor may take repossession of the aircraft, which is critical in countries where the laws are not stable.
Although it is difficult to quantify the extent of the benefit derived from a country's adoption of the convention, as a practical matter it will bring a consistency to repossession requirements in various jurisdictions, which will enhance the predictability and reliability of the process. This improvement will vary, however, from country to country, depending on the present state of judicial remedies and legal systems.
The adoption of the convention in some of these other jurisdictions may also impact credit decisions themselves; whether or not to participate in an aircraft loan or lease financing in any specific jurisdiction. For example, at the present time EDC is considering a transaction where the airline is based in Pakistan, which has acceded to the convention. Consequently the security position of EDC would be enhanced, thereby mitigating some of the risk associated with a transaction in a country such as this, once the convention becomes effective.
While I do not have any substantive comments on the specific wording of the proposed amendments contained in Bill C-4, I would be pleased to respond to any questions you may have. Thank you.
Senator Phalen: Why are changes in the Bankruptcy and Insolvency Act necessary?
Mr. McArdle: Currently the act allows a stay to occur, as would happen in the U.S. without section 1110, and that stay prevents lenders from actually being able to access their aircraft during that stay period, thereby reducing the value of the security.
The proposed amendment to the Bankruptcy and Insolvency Act will allow the election by the debtor as to whether they will keep the aircraft and maintain it and service the debt payments or immediately hand it back. The stay provision would not apply to a debtor in that situation. It gives us a preferential position.
Senator Phalen: Why was it necessary to change Canada's bankruptcy protection legislation to bring it in line with the United States?
Mr. McArdle: Financiers who have done aircraft financing and other security-related deals in the U.S. that can rely on section 1110 have found it very stable and predictable and of value to them, such that they would actually be able to lend to an aircraft company, an airline, that does not have as good a credit rating as would normally be required. If you can rely on the asset and know you can get the asset back and resell it or re-lease it to another operator, you can feel much more comfortable in entering into the transaction. If you just had to rely on the credit of the airline, it is a much different story; it is basically unsecured lending.
Many of the airlines today would not be able to get any financing in the U.S.
Senator Phalen: How would the convention assist Third World countries and Canadian companies doing business in these countries?
Mr. McArdle: It would assist the Third World countries mainly because their bankruptcy laws now are unsophisticated and unstable. When you are lending into that country, trying to take security on an asset is very unpredictable and very little reliance is placed on the value of that security. In effect you are lending unsecured, so it often takes a government guarantee from that developing country to actually entice a lender to enter into that market. If this convention is adopted by that country, lenders would feel more comfortable that their asset is protected and accessible.
As for exporters, right now it is very difficult for exporters to find a buyer who can actually afford to buy aircraft, unless they are government related or have some other parent company that is out of that country and can support them, and a guarantee would be required.
For example, in the Pakistan situation right now, the only way to do it would be to have a government guarantee in that deal. If there was actual security over the aircraft, we may be able to support Bombardier's sale through security and accept the operator's risk, knowing we can get the aircraft out.
Senator Forrestall: I do not know why we are dealing with something like this. This belongs with a bunch of lawyers.
I am curious about the impact. As someone who has used aircraft to secure loans, I know some of the problems. I am curious as to whether or not the universality of the complete coverage of this process, whether or not it has the approbation of the Province of Quebec, for example. Would Quebec willingly give up jurisdiction?
Mr. McArdle: The way that I understand the convention, each country which adopts it then has to deal with whether or not the federal entity or provincial or state entity has the right to pass legislation on security interests. In Canada, for the most part, that is delegated to the provinces.
While Canada would adopt it and create an international registry, the provinces would have to, in effect, also pass the necessary laws to put into place the proper statutes and provisions that would mirror the convention. In Ontario we have the Personal Property Security Act, which does not have any type of protection or preferential treatment of lenders that would happen if this convention was adopted by Canada, and Ontario altered its laws to enable it to be put into place for that province.
There has to be a matching between the provinces and the federal laws to really make this work in Canada, throughout Canada.
Senator Forrestall: Can we explore a little further just where we stand with the various provinces?
Mr. McArdle: I am not aware of the situation, other than just a small amount. I believe that Ontario and Nova Scotia have indicated they are in the process of passing the necessary changes, but the other provinces are not yet at that stage. I understand there has been a significant amount of consultation with them and their support is apparently behind this change.
Senator Nolin: I have a correction. I am sure as a lawyer you would like to correct your information that the province does not have a delegated authority to legislate on securities, but it is an autonomous and fundamental jurisdiction that they have.
Mr. McArdle: Yes, thank you for allowing me to correct that error. It was evenly split at Confederation.
Senator Nolin: The federal authority also has the power to legislate in the purview of their jurisdiction.
Mr. McArdle: Yes, thank you.
Senator Forrestall: It seems the direction that we are going is that the government does not need to get too deeply involved in this process. What makes that a good thing?
I am thinking specifically of Air Canada or should we ever get back into the airplane business again, closing a door, for example, might make life difficult down the road.
Mr. McArdle: I understand there will be a representative from Air Canada appearing later in the session. From our perspective, as a financier looking at Canada, we do not do much in Canada obviously being Export Development Canada, but if I were a U.S. lender and wanted to lend to Air Canada, the adoption of this convention and the necessary laws with it would allow the lenders to feel much more comfortable that they have valuable security in the assets in the aircraft that Air Canada has. If Air Canada or any other airline in Canada were to be in an insolvency position again, the lenders would be much more comfortable dealing with the airline.
This time, when Air Canada went into CCAA, the court has much discretion as to how to proceed through that restructuring. Lenders were subject to the stay that the court was able to impose on them and so had to work differently than they would have in, say, the United States.
Senator Forrestall: Will this have a tendency to open up the national markets? Will this make it easier for foreign lenders to involve themselves? Is there any suggestion of impairment of ownership?
Mr. McArdle: In terms of ownership of the aircraft or ownership of the airlines themselves?
Senator Forrestall: Let us speak to the debt.
Mr. McArdle: The real benefits to airlines out of Canada are that they will find lenders more willing to lend money in countries that right now it is very difficult to get financing in. In countries that do not have a very strong regime, the only airlines that can actually borrow without the support of the government are very strong airlines. Cathay Pacific and Lufthansa are two very strong airlines that are weathering the storm.
In smaller markets and smaller countries, it is difficult to start competition and to lower the costs to users, as well as encourage the purchase of Canadian and other aircraft unless the buyers can actually access financing.
This will, I believe, provide more opportunities for financing to them so they will be able to acquire newer aircraft, less pollution associated with them, and be more cost efficient, and so forth.
Senator Forrestall: I wish to return to my first question. Is there somebody here from the government?
Will someone make absolutely certain that we have the consent of the provinces in this respect? Otherwise, I could see people requiring funding caught with unnecessary or undue delay. As you know, like everything else, time is of the essence when we are talking about this kind of financing.
Mr. McArdle: That is correct. If we can merge the laws of the provinces with the changes that are being proposed to the federal statutes here that would make it a lot easier.
Senator Forrestall: Is anybody working on it?
Mr. McArdle: I understand that is happening. EDC is not involved in that process.
Senator Forrestall: Who is driving that bus?
Mr. McArdle: I am not sure who is sponsoring this proposed bill through Parliament, but in reading some of the debates it is clear that there are several discussions occurring with the provinces and that is an absolute critical need, a necessity.
The Deputy Chairman: We will have the minister and the departmental officials here tomorrow.
Senator Forrestall: Is the Export Development Corporation fully satisfied that this is a step in the right direction, that we are going where we should have gone 15 or 20 years ago?
Mr. McArdle: Yes, I can fully support that statement. It is a step in the right direction and will enable financing in Canada to be much easier in regard to aircraft. As we have mentioned for EDC, this will encourage other countries who look to Canada and the United States as sophisticated security regimes and bankruptcy regimes as a step in the right direction and a model for them to adopt.
Senator Massicotte: The fact of the international agreement makes it more comfortable for many of us, given it represents all of the stakeholders' interests.
How does it work? My impression of the airline industries in North America is that they are extremely heavily leveraged already. That is why the bankruptcy rate is so high. I did not realize there was any problem with financing. How do we finance aircraft today and why do we need to change it?
Mr. McArdle: Traditionally, in the United States and Canada, financing is done on a tax-efficient basis. They do it through what is called ``leveraged leases.'' A company that has a significant amount of profit puts some money into a special purpose vehicle, maybe 25 per cent of the purchase price. Often a group of lenders will provide the remaining part of the cost of the aircraft. That special purpose entity will actually acquire the aircraft from the manufacturer, if it is an RJ from Bombardier, and pay 100 per cent of the purchase price. The special purpose entity will then lease the aircraft on a full net-net-net lease to Air Canada, for example, or in the U.S. to United Airlines or Delta. That airline will operate, maintain, insure and do everything on a net-net basis with money flowing to the lenders and the equity receiving capital cost allowance depreciation and also some cash at the end of the lease.
It is done on the basis that the operator, Air Canada, gets to claim it as an expense and the equity gets to claim it as a capital asset and depreciate it. The lenders put their money into the structure and receive security over the aircraft and the lease payments.
That is the typical fashion. It can also be done in the standard outright purchase with a mortgage over the aircraft, just like if you were buying your house and mortgaging your house. The lender would then have a mortgage on the house that if you defaulted on your payment they could seize the mortgage.
Senator Massicotte: You say it is a tax shelter. Where is the tax shelter element in it?
Mr. McArdle: The tax efficient basis arises from the profitable entity that is the equity. It can write off the capital cost allowance from its profits and not pay as much tax. That is usually done in the U.S. The operator gets to claim it as an expense.
Senator Massicotte: This is pretty standard, why is it considered tax efficient?
Mr. McArdle: It lowers the ultimate cost to the operator because the equity can depreciate the aircraft and thereby save tax. They will allow their money to be used in the structure without requiring interest on that amount of money versus if the airline had to borrow all 100 per cent of the price, they would end up paying interest on all of it.
Senator Massicotte: They could get CCAA.
Mr. McArdle: Yes they would, but generally airlines are not profitable enough to actually benefit much from the depreciation.
Senator Massicotte: In both cases they are highly levered. In other words, there is a lender which provides for 75 per cent to 85 per cent of the aircraft purchase price. What is the security?
Mr. McArdle: It is security over the aircraft itself and the engines, the type of equipment that is covered by the convention as well as the lease receivables and the lease itself. You can then feel comfortable that you can actually receive the cash directly from the operator and it does not have to flow through any other entity.
Senator Massicotte: The reason for these proposed amendments is that the security conditions today are not adequate. If they are not adequate they are getting a lot of money for security that is not very good.
Mr. McArdle: The convention, if adopted in Canada, would change two things. For an aircraft to be secured in Canada, you have to actually register it in every province in which the aircraft will arrive. This situation is unlike the procedure in the U.S. where a central registry is used. The second change is the preferential treatment if the operator ends up in an insolvent position.
As was seen in Air Canada and the same in the U.S., the airline wants to restructure. Currently, the Bankruptcy Act is set up to allow a restructuring period and all the lenders and all the secured parties are held at bay. They are forced into a stay position where they cannot seize their assets and cannot recover and realize on them, release them to someone else, or sell them.
During those periods the airlines are cash strapped so they do not maintain the aircraft as well. They do not pay any debt service at all, so you are unable to access your asset that you have looked at as your piece of cake that you can take back, and you are not getting paid for it. Often, especially in third world countries, the maintenance is not as strict as in Canada and the U.S., and therefore the sort of quality of your asset depreciates through time.
Lenders in those situations want to have the right to either get the aircraft back right away because that is what they have lent on the basis of, or force the operator to say, ``I will maintain it and pay and not be able to benefit from the stay period.'' That is the situation in the U.S. now, and it has allowed a lot more airlines to receive financing even though they are in an insolvent position. There are many airlines in Chapter 11 protection and still acquiring aircraft and receiving financing.
Senator Massicotte: These amendments make it such that even if there is a stay under CCAA, they will have to meet the rental payments in a typical situation and maintain the aircraft.
Mr. McArdle: Yes, or hand it back to the creditor.
Senator Massicotte: Does it give special favour to the airline creditors as compared to many other assets?
Mr. McArdle: Yes, it actually does put them ahead, not in terms of payment so much as in terms of being able to access the aircraft. Let us assume we have an aircraft that United Airlines has leased and we have security over it. They go into Chapter 11. We say to them, ``Either pay us or hand it back.'' Somebody who has security over the trucks they own or other equipment they have, does not have the same benefit of being able to say, ``Pay me or hand it back.'' They would be subject to the stay.
Senator Massicotte: Say they have 15 aircraft, can they say, ``Take back five and I will keep on paying ten,'' or is it all or nothing?
Mr. McArdle: Yes, they can do that.
Senator Massicotte: This is a lot like real estate, which I have a bit of experience on from a creditor sense. I am surprised that in the real estate sector if you do CCAA, if you want to occupy X square feet you have to make rental payments on what you occupy. Precedents are set; you are not allowed to give it back. Why would we need a special provision in this act to treat it differently?
Mr. McArdle: Aircraft are so expensive that they are treated as a separate asset in and of themselves. They have a long life so people want to be able to feel that their security can be accessed if necessary. The aircraft can be taken back. Also, the maintenance aspect is very critical. If you do not maintain the aircraft, it can be incredibly expensive to bring back up to a level that you can sell or lease the aircraft to someone else. This happens very quickly; there is a lot of maintenance on aircraft that we do not see, we just get on and they work. There is a very regular cycle of repair.
Senator Massicotte: The same concern applies if your building is destroyed; manufacturers have the same CCAA issues.
Mr. McArdle: I agree with that. Aircraft are seen as a unique asset and in order to finance them you want to be able to stay with them and feel that if necessary, you have the leverage to say, ``Pay me, or give me the aircraft back and I will get my money from it that way.'' This is partially because the aircraft industry is very cyclical and throughout the 15-20 years life of a loan on an aircraft, the airline will often go through two troughs and two peaks.
Senator Massicotte: What you are saying is we will now have one international registry system and we will not have to register for each province and because of the fact that the right of possession upon default is much more severe than it is currently, you think that will allow greater certainty, therefore allowing greater financing, more competition and the consumer will benefit. Is that the theory?
Mr. McArdle: Yes, in Canada, and other places in the world.
Senator Massicotte: When you finance an aircraft that is Canadian based and it lands in another country which law applies, the law of the country which did the financing on it or where the aircraft is currently situated
Mr. McArdle: EDC would not be looking to finance aircraft based in Canada, but we would let us say in France or the U.S. Pick the U.S. for example, where predominantly we have most of our loans right now. If that aircraft was to land in another country, if it had adopted the convention we would be very comfortable allowing it to land.
Senator Massicotte: If it does not?
Mr. McArdle: If it did not, we may limit the right of the operator taking it to that country. We may prevent them from doing that.
The Deputy Chairman: You cannot fly your building to another country either.
Senator Nolin: In Quebec it is called le registre de la publicité des droits, for a very specific reason. It is to advertise the rights of whoever has the rights to an asset.
How is it going to work if there is only one registry and how will creditors have access to that information?
What about reregistration; the various assets that are already registered?
I would like you to walk us through a seizure. How will it work? Who will do it? How will the money be distributed? Who will have access to the distribution, and all the other legalities?
Mr. McArdle: As I say, we rarely finance in Canada. However, I was a lawyer in Toronto for a number of years before and did do financing that way. So I will try to help.
In connection with the first question, the searching capacity, the international registry would be accessible to anyone who wants to pay the small fee. It is computer based, and probably on-line. People would be able to access the search capacity and pay the fee. You would basically put in various parameters. If you knew the name of the owner, you would put the name of the owner; you would put the serial number of the aircraft; you could put the operator's name. That would show you whether or not this aircraft has any liens on it, and confirm the ownership of the aircraft. This is a new aspect that is not possible at the present time.
The international registry is set up such that if a mistake was made, if they were negligent in providing the advice and somebody relied on it, the creditor who did the search could actually claim compensation back from the international registry; there is an assurance fund. People can rely on the fact that this search is truthful and accurate, and if it turns out to have been wrong, they are not the ones who suffer. The fund actually will pay them.
It is a system of great certainty, and it is set up to be easily accessible. Similar to the central registry that we have in Ontario for personal property, you can do that either online or in several government offices no matter where it is registered. If somebody is in Sudbury, they can search it in Ontario. It is the same thing, only more global.
In connection with the re-registration, in the past it required the owner or operator to participate in both de- registration and re-registration of an aircraft. So, out of their certificate, if you want to call it that, and then into your own or into a body that can actually fly the aircraft for the lender.
With the new system there can be powers of attorney that are signed up ahead of time by the owner and operator that tells the world that you have given your power of attorney to deregister this aircraft to the lenders. The lenders will be able to take this step, if they repossess the aircraft, without needing any help from the borrowers.
That is one of the real difficulties that occurred in the past. We had a situation in Argentina where we participated in a purchase and lease of an RJ. The laws and court system were such that we were concerned we would not be able to repossess it, because if the borrower wanted to fight, they would continue fighting. The only way we did that deal is we had two and one-half years of repossession insurance and a six-month back-up from the manufacturer. We anticipated it would take three years to repossess this because we could not deregister on our own. We had to get help from the borrower or the courts forcing them. This would make it easier to deregister if you had a borrower/operator that was reluctant to assist.
Senator Nolin: The rights would be registered all over the world, but let us narrow that down to Canada and the 10 provinces. If it is deregistered will it be sent to Ireland because that will be the only place in the world where it will be registered?
Mr. McArdle: I have not checked it as well in Canada because, as I say, we do not do a lot here. I understand that there can be a mirror of it in the country. I am not certain of that, but if I was searching I would go to the Irish company, as you say, that has won the bid and search at that place.
Senator Nolin: We can ask that question of Air Canada, but you can see the problem in court if there are two registrations.
Mr. McArdle: Yes and there would have to be a mirror. It is not intended to be overlapping or different. The way it is set up, the international registry would set up an override.
Senator Nolin: We can say that in the treaty, but there will need to be a law, for instance, in the province of Ontario, to ratify that law. If there is no such tool, no matter the length and volume of the treaty, the law in the Ontario will say the Ontario registry will be the registry.
Mr. McArdle: That is my understanding. Each province that has the right to regulate and legislate on personal property, which an aircraft is, would have to make their laws consistent with it, for priority.
Senator Nolin: My third question deals with the process of redistribution when a seizure occurs.
Mr. McArdle: Typically the aircraft would be mortgaged or secured by the lender and the lender would have prevented any other party from also having a security interest in that aircraft. If there is a group of lenders who have lent with respect to one aircraft, they would be a pool. Generally, all other creditors of the airline could not have secured any interest in that particular aircraft. If they tried, it would be a default in the loan agreement or in the asset.
Senator Nolin: So there is no distribution.
Mr. McArdle: There is no distribution. I understand that there is the possibility in the convention that countries are permitted to specify certain super priority rights, such as landing rights in the airports. Right now they can seize an aircraft and demand payment and refuse to release the aircraft until their landing fees have been paid.
The theory of the convention is that the registration of a security interest would override all of those other lien rights except airport landing rights or whatever.
Senator Nolin: I assume that would include taxes?
Mr. McArdle: Taxes, exactly.
Senator Nolin: We already have that in the civil code in Ontario. If you do not pay your taxes, the ranking is affected.
Mr. McArdle: Exactly. It is possible for Canada to continue to keep that super priority for certain items if they want to. The convention encourages the fact that those would be eliminated as well so that lenders can feel truly comfortable. Lenders already take that into account and monitor very closely the tax payments of the operators and owners, as well as the landing fees, insurance payments, things like that, to make sure there are no super priorities.
The Deputy Chairman: If you were lending to companies of equal risk in two countries, one which had ratified the protocol, and one which had not, how much of a difference would it make in interest rates and other fees to the country that had ratified the protocol?
Mr. McArdle: We have not yet faced that situation so we have not had to make that determination. The availability of security is a factor that is taken into account in both the credit decision and the pricing. As of yet, we have not determined whether or not we would be able to make any kind of broad statement in that regard.
We look at each deal on an one-of basis and take all factors into account in determining the pricing, unlike EX-Im Bank which has offered an across-the-board rate reduction and exposure fee reduction if a country has adopted the convention. We look at each deal on a particular basis.
I see it enabling lenders to actually make a loan into a country, not so much reduce the fees, but opening up the availability of the financing into the countries. Right now, there are many countries that no one would finance into without a government guarantee.
The Deputy Chairman: This has been a big selling point to the government. This would be of benefit and would be cheaper for countries that had ratified the agreement. It would be cheaper for countries with equal standing to other countries. There would be some kind of financial benefit. Where would they be getting this information from? It is obviously not from you.
Mr. McArdle: Not from us that I understand. Possibly they looked at what EX-IM has done. It makes some intuitive sense in the scenario that you have indicated. If all else was equal and you were able to get security over the aircraft in a country that was subject to the convention versus everything else being equal in a country that had not adopted the convention, I would be surprised if it did not impact the pricing. I cannot say how much. It is difficult to have a situation where it is identical to all other factors. The airlines are unequal, at best, in terms of their strength and financial viability. It would be difficult to assess it in that situation, but it makes complete intuitive sense if you were to have everything else equal.
The Deputy Chairman: Alberta and Quebec are the two provinces, one would think, especially Quebec which would have self-interest in passing equivalent or parallel legislation. Yet, there does not seem to be a lot of movement by the provinces that we have heard of today. What is holding it up?
Mr. McArdle: This convention has taken a long time to come to fruition, not totally unlike other conventions of this type. It has lost a little momentum from the initial euphoria that we can put a convention in place that will have an international registry and make life a lot easier because it has taken some time to come to a point where it is now being ratified by countries.
There is a significant impact to manufacturers such as Bombardier particularly, because basically their market is exports, and for each country that would adopt this, it would be more likely that financing could be obtained for those sales.
This is less of a concern for Alberta and Quebec with Air Canada and WestJet, et cetera. As you mentioned earlier, in Canada there really has not been a large problem for financing because our bankruptcy laws are not horrible. There is a stay provision and people had to live with that through the Air Canada situation, but it ended up working out. In other countries, it is much less certain and much less predictable. The introduction of this convention in those countries would be a huge step forward.
The Deputy Chairman: On the briefing we received, there is only the United States, Canada, Ethiopia, Nigeria, Pakistan and Panama, in the process. Is this normal? Great Britain, France, Japan, Spain, the rest of the civilized world, so to speak, is not involved. Will this take a long time?
Mr. McArdle: Unfortunately, traditionally they have taken a long time to get widespread adoption, and in some instances, the interest has fallen away before there has been widespread adoption. That has been an unfortunate circumstance for financing in this area in particular. Sometimes the benefits are marginal.
In Britain, let us say, British Airways can get financing partially on its financial strength but also because the security regime and the bankruptcy regime in Britain is pretty stable and it is relatively predictable. It is not as predictable and not as favourable for lenders as the U.S., but it is okay.
In addition, in France, Airbus gets a lot of financing support, so it is not really impacting sales of Airbus aircraft because they get a lot of government support in any event.
The real benefits to those countries are not as critical as for some of the Third World countries that have adopted it already and are hoping that this will open the doors to some financing in their countries.
We are hoping Canada does it to show, as the U.S. did, that this is a good move, something countries should do to encourage others and act as a catalyst.
Senator Nolin: Is it the intent of the committee to hear from provincial representatives to understand their analysis of this subject?
The Deputy Chairman: We have not been approached by them.
Senator Nolin: Maybe it would be a good idea to hear from them. The federal step is an important one but it is not the only one. I think provincial representatives should at least be asked if they want to express their understanding and the way they see their responsibilities in this matter.
Senator Massicotte: It is noted in here that the government will not implement this act until a certain number of provinces approve.
The Deputy Chairman: That is correct.
Mr. David Shapiro, Vice-President and General Counsel, Air Canada: I am grateful for the opportunity to express the support for this admittedly low profile initiative, but an extremely critical one to the aviation community in general.
I will limit my objective to describing why, from an airline perspective; an airline would strongly support the initiative and explain what is most innovative and valuable and the benefits we expect to be derived from the convention.
The implementation of the proposed Convention on International Interests in Mobile Equipment, and I will refer to that as the convention, and the protocol to the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment, which I will call the protocol, as provided in Bill C-4 represents what I would think is a very rare if not a unique occasion. I cannot imagine that one would often deal with a legislative initiative that has only winners and no identifiable losers. There is virtually stakeholder unanimity in its support for this initiative among financiers, lessors, manufacturers, and airlines themselves, and ultimately the flying public would stand to benefit.
The proposed initiative is comprised of meaningful but virtually cost-free measures that can be taken by government to assist an industry. There are virtually no costs involved in implementing this to the governments and it assists, as I said, the entire industry as a whole.
At the same time, this very initiative redresses a structural imbalance in the international sphere by promoting a level playing field. The convention could accomplish all those things simply by implementation of proposed Bill C-4.
Some of the benefits expected to be derived by the proposed convention would benefit airlines in other jurisdictions more than those in Canada only because certain of the principles implemented by the convention already exist in Canadian law, relating to certain remedies, including enforceability of security interest remedies and registry systems.
There are, however, still major objectives and values to be achieved by implementing the proposed convention in Canada, even from the airline perspective. One is the simplification of transaction management and reduction in transaction costs relating to aircraft leasing and financing. The core and principal objective is to expand opportunities for expanded access to new sources of financing, ultimately reducing financing costs for every airline. Therefore, they would reduce costs directly and indirectly, which is obviously a core focus of airlines in this extremely competitive environment.
To elaborate, we know that aircraft are high-value objects. Therefore, they are often acquired through complex leasing and financing transactions. At the core they involve the same basic requirement as security of a home; a mortgage, and the lenders obviously need protection from a failure to pay.
Unlike a house transaction, where it is clear where the house is and what law governs the mortgage, an aircraft can move, and that fact has raised a great many concerns to lawyers. An inordinate amount of time and money has been spent debating the jurisdiction in which the mortgage should be registered; the implications for the validity of that mortgage; how the mortgage should be recognized in other jurisdictions; the enforceability of that mortgage, and the remedies. I can attest to the amount of time and money that goes into what for a house transaction is a very basic consideration, and taken for granted.
The transactions often involve elaborate legal opinions that have to be developed by lawyers. They are legitimately needed but they add no value to the transaction. The regime envisaged by the convention and the protocol would ultimately simplify this important element of the transaction by creating one single international registry and would clarify many of these questions that are often debated. It would create a context within which certain documents could be moved to a common platform, ultimately reducing uncertainty, and much of the academic debate that surrounds these issues. It would further reduce the costs associated with the issue.
These factors alone may not have been sufficient to garner the support of some of the airlines and perhaps not Air Canada, but that is an important objective that will be achieved. The core objective to be achieved is really the expanded opportunities for access to debt capital markets.
The passage of proposed Bill C-4, without more in any other jurisdiction within Canada, would assist in expanding the access to new sources of financing. It would do that by facilitating access to debt capital markets, where funding is provided by institutional and individual investors rather than banks, and where the cost of borrowing is markedly lower.
I do we not want to go into the technicalities about how this is achieved unless anyone requests an explanation, but for these purposes the proposed legislation would remove from the discretion of the court the ability to determine whether and within what time frame creditors may repossess their aircraft. That very fact itself, in the event of a default under whatever financing arrangements there are, is what allows for this benefit of accessing debt capital markets.
The creditors' rights, therefore, become very predictable and allow certain types of public market transactions, for example, something called ``enhanced equipment trust certificates'' in the United States or in other jurisdictions, because it provides this degree of certainty required to assure the creditors, the ultimate holders who are collecting the interest payments, how long it will take them to get their security back and how much is required to fund that in the event of a default.
Without this second benefit, it is unlikely that the convention would have garnered the same degree of support. It provides an extremely important alternative to bank debt, which has become more scarce in this environment and more expensive over the last number of years during this instability that has plagued the industry. It also deals with the shortfall between internal funds and external financing. Debt capital markets open up a large pool of investors and enhances liquidity, which favourably affects pricing.
That type of access to debt capital markets would allow Canadian airlines to compete with U.S. airlines that have access to this most efficient, least expensive source of funding. This of course would ultimately reduce costs and contribute to the stability and the profitability of airlines.
I would not suggest that this is a panacea to all of the ills and challenges confronting the industry, but the proposed Bill C-4 will unquestionably address an element and assist in making additional sources of financing available, and reducing the pressure on governments to provide government funds as a source of funding.
Senator Mercer: You mentioned that a debt capital market with a large pool of investors enhances liquidity which favourably affects pricing. That leads to the obvious question: Can consumers expect to see lower airfares as a result?
Mr. Shapiro: That is a viable possibility. As the cost structure is reduced, and as a market dictates lower and lower costs for the flying public lower prices certainly become possible. I certainly am not involved in the pricing and yield management side of airlines, but given that the pricing and costs go down with the competitive forces driving prices down, one would expect that that could ultimately be a result.
Senator Mercer: I should remind you, some of us will be here for a long time and those comments have been recorded. We may read them back to you in the future.
Senator Nolin: We like the formula.
Senator Mercer: I am here for the next 18 years. I will remember.
Do you have any examples of where this legislation would have been of help to Air Canada in the past situations that could have been avoided, or opportunities that were missed because the legislation was not in place?
Mr. Shapiro: Prior to the last couple of years, Air Canada has made some of the most innovative financing transactions, one might say. There was too much financing leverage going on. We have not had any secured asset public market transactions. The price that we had to pay and the margins that had to be paid to banks and the tightening of that market were certainly felt over the last number of years. Whether we would have been in a position to rectify that by accessing them is probably beyond the area of my expertise and would require an investment banker's expert opinion. However, the avenue would exist which might help reduce the cost, which I expect our CFO and others would have had a serious look at.
Senator Nolin: In regard to provincial influence or position on that treaty, what is your reading of what will happen in the various provincial capitals legislatively speaking?
Mr. Shapiro: I am probably not the best placed person to give the most accurate status update, but I should mention again that the core benefit of this convention is not dependent on implementation at the provincial level. Provincial participation in this is ultimately important, but not for the core benefit that I was ascribing in terms of access to public markets.
Senator Nolin: I understand that, but my question is more of a technical question. We want that treaty to be implemented properly. I think the word ``properly'' is the key word. If we want it to be done properly, we need the cooperation of provincial legislators. The previous witness was not competent or competent enough to answer that question. That is why I am asking you.
Mr. Shapiro: I am probably not much more competent. I have heard of advances made in two important provinces. I am not familiar with the current status.
Senator Nolin: Which provinces?
Mr. Shapiro: I believe it is Ontario and British Columbia, but I do not know of any progress made in Quebec. Again, this is only speculation. I am not probably much better placed than your previous witness.
Senator Nolin: The previous witness said that they would probably have a mirror registry. Actually, in Canada we have at least 11 registries. What will happen in court if there are two registries applicable to one piece of equipment? Who will win? What are the laws that will govern?
Mr. Shapiro: You are absolutely correct. It is no different than saying we currently have 10, which one governs. There are rules that determine which of the ten govern. For any province that signs on to this, those same rules would apply to dictate which one of the 10 govern, but this one will replace the one in that provincial jurisdiction which has adopted this convention.
Senator Nolin: We agree that a provincial law is needed to say that?
Mr. Shapiro: Ultimately, that would be agreed, that is clear.
Senator Massicotte: We all have the same objective; how do we benefit the consumer with the increased competition? I would have thought Air Canada would have said there is enough competition, given your experience in the last couple of years. How will it help?
I gather from my understanding of the proposed legislation it will allow easier registration and interest and it will clarify the application of CCAA upon this hold period that the judge may impose. Explain to me from that point.
How do you see more competitive financing? I understand it is been developed internationally, the way aircraft has been financed by way of basically task-efficient corporate structures and whereby the aircraft is leased. It is my understanding that the financing in North America, excluding maybe Mexico, is extremely competitive and highly leveraged already.
Please take me to the point where the financing will become more competitive and less expensive and become of benefit to the consumer.
Mr. Shapiro: The U.S. airlines have not taken an active part in supporting the convention because they already benefit from the lowest source of financing. That would work to make this same source of financing available to their competitors so they have no interest in forcefully pushing this convention. Other interest groups in the United States have pushed for the convention.
Here in Canada we have had to rely on international banking syndicates to provide virtually all of the funding. In order for Air Canada or any domestic airline to acquire an aircraft through one of these transactions, they need to turn to an international banking syndicate, or one of the lessors that have huge pools of aircraft available for leasing. Over the last number of years the pricing has gotten tighter; as the risk of default increases, so does the instability in the industry.
This proposed legislation will open up a whole new source of funding, and the public, the investors, the institutional investors, the pension funds, and individuals will see an increase in liquidity and a whole other source of capital become available to them. That capital is currently just simply either unavailable or available on very complicated terms that virtually price it almost back to where it would be if it would be from a banking syndicate.
Senator Massicotte: What is the current form of legislation that prohibits that form of financing?
Why do not you go to the United States and get the financing?
Mr. Shapiro: The situation that any airline in Canada would face in the event of default, or ultimately on a CCAA- like filing or a bankruptcy filing, is that under the CCAA the presiding judge has the ability to determine when the stay ends. The judge has the right to say, ``Even though the airline is not paying, you cannot have your aircraft back now.'' There is a lot of history to show that he would not say that if you do not continue paying during the CCAA. Ultimately it comes down to a legal opinion that needs to be rendered by a Canadian lawyer to a credit-rating agency, to assure that credit-rating agency, who rates these public-market transactions, that within X number of days you are entitled to get your aircraft back. That allows the economics to be structured in such a way as to provide a liquid facility.
Senator Massicotte: Did Justice Farley preside in your case?
Mr. Shapiro: Correct.
Senator Massicotte: As I understand it, it is the practice in Canada that during CCAA rental payments are continued to be made. You are obligated to make rental payments during that period of time. Given it is not a law but rather in practice, it lacks certainty which impedes or prejudices creditors, and therefore it affects the competitiveness of your financing.
Mr. Shapiro: I think that is a very good summary of what I am saying. The only modification being that it is hard to determine precisely the practice and the number of days as well. If there were clear practice to say, in every case it has been roughly 90 days, then that might serve as a similar purpose, but the practice differs from case to case and judge to judge.
Senator Massicotte: There is precedent in Canada that rent payments must continue to be made during that period.
Mr. Shapiro: Again, it depends on the type of transaction. For operating leases the answer is yes, for capital leases the answer is more likely no. That has not been fully decided by the courts in the situation of Canadian Airlines when it was under CCAA, or in the situation of Air Canada when it was under CCAA.
Senator Massicotte: Which one is more common; capital leases or operating leases?
Mr. Shapiro: The capital lease is the one which one would more arguably say does not have to be paid, it does not have to be brought whole to continue holding on to the aircraft.
Senator Massicotte: Let me give this observation from the real estate side. We have the problem in the real estate sector whereby the issue of paying rent during a period of stay is present only by judge, there is no law, yet it has not inhibited it at all in the last several years. They have mortgage pools, mortgage-backed securities in a very liquid international sense. I hope you are right that this will help, but I am not sure this is the issue that will change why you are not doing security-backed financing in Canada.
Mr. Shapiro: We are probably beyond my expertise. I am not in a position to be critical from a professional perspective, but there have been numerous studies done by economists and investment analysts to point to this very factor as to what has prevented the ability for airlines and jurisdictions without this sort of provision from accessing those funds.
Senator Massicotte: Why do you not get financing in the United States if that is the case?
Mr. Shapiro: The bankruptcy of a Canadian airline would still be governed primarily by the primary jurisdiction, so they would look to the Canadian laws.
The Deputy Chairman: Would other airlines also benefit, no matter where they are in the world? Would they be putting pressure on their government or lobbying in some way to have this protocol passed by their own legislature or enlightened despot or whoever it may be?
Mr. Shapiro: I would expect that to be the case. Again, I cannot report on the actual status. Others are better placed to do that. I would expect, from what I have seen throughout the development of the convention that was a case.
I must be frank; there was a concern among the airlines that instituting a provision that said that you get your aircraft back unless the fault has been remedied within 60 days has been a concern to some airlines and other jurisdictions, labelling that provision as ``to pro-creditor.'' Frankly, that is folly. That is planning for reorganization and restructuring rather than planning to stay out of reorganization and restructuring. Some airlines have been concerned by that. Yet, there has been a ground swell of support and other airlines stand to benefit more than Canadian airlines where the legal regime is quite developed. Aside from this one point, there are certainly other countries where the principles of asset-backed financing generally have not been recognized and this convention would achieve that for them. They stand to benefit even more.
Senator Mercer: Six countries have signed this convention and protocol. Some of them are airline giants such as Kenya, Panama, Ethiopia and Nigeria. I am concerned that we are passing legislation, signing conventions and protocols and we will find ourselves off in a corner where the United States and Canada have said this is a good thing to do. The important players in the international airline industry are not at the table: The Germans, French, Dutch, Israelis, Brazil and Australia. These are countries that have larger airlines that do a lot of business with aircraft manufacturers.
I wonder why we do some of these things when you look at the list of countries that have signed. Of the six, only three, the United States, Canada and perhaps Pakistan, have airlines of any consequence.
Mr. Shapiro: I am not sure if the honourable senator is saying there are six countries that have implemented or six countries that have ratified the convention.
Senator Mercer: There are six that have ratified the convention. What happens if nobody else ratifies the convention?
Have we just wasted the time of the House of Commons and the Senate; your time, our time?
The Deputy Chairman: Just so it is clear, 28 countries have signed.
Senator Mercer: Ratification is different, I understand that.
Senator Massicotte: How many countries are required to sign on in order for the convention to become effective?
The Deputy Chairman: Eight.
Senator Mercer: If two more do not sign it, we have wasted all our time.
The Deputy Chairman: That is right. The European countries have promised to sign.
Mr. Shapiro: The expectation is that there will be a number of others who sign on. Like the previous question in terms of status within the provincial capitals, I am probably not the best placed witness to report on international developments.
The murmurings I have heard are that there is a high degree of expectation that this will go ahead and the requisite number of countries will ratify. As that happens, my projection would be that there will be a slight snowball effect.
As soon as the convention does come into effect, while the benefits of the single registry would not be achieved, what I call the core benefit of access to capital markets would become available.
Senator Forrestall: Did Canada or any Canadian interest bid on this piece of business?
Mr. Shapiro: My understanding is that we certainly would have.
Senator Forrestall: Did they?
Mr. Shapiro: We would have, yes.
Senator Forrestall: What a business. There are billions and billions of dollars and all you have to do is find some way to let 1 per cent stick to your fingers. Those Irish are on top of us all the time, are they not?
The Deputy Chairman: I asked the EDC whether there would be a saving that they would charge less of an interest rate or fewer fees if they were lending to two airline companies of equal or close to equal credit rating and one country had implemented the legislation apart from one that had not. The witness was not able to say that there would be fewer charges.
From a purchaser's point of view, you being the consumer, will it make a difference with Boeing in the United States and Airbus in Europe and if their countries had signed on to their financial institutions, do you think you will pick up a point or two on the interest rate or save money on certain fees?
Will that be helpful to you when you are purchasing or leasing?
Mr. Shapiro: Who will ultimately derive the benefit? Will it be the flying public? Will it get held at the airline level? Will it not get passed on to the airline level? Part of the answer to that question depends on airline's country of origin. The greater degree the difference is between the existing legal regime and the legal regime that would be implemented by the convention, the greater the pricing difference.
In Canada, we have the benefit of a very developed legal regime. I expect the pricing increment to be much less for the benefit of Canadian airlines. That is for like transactions, putting aside what I again consider the core benefit, which is access to a whole different type of transaction. There would be some scraping over that benefit.
I would expect that the legal certainty increased by this convention would benefit the financier-provider, the guarantors in the case of an EDC or an EX-Im Bank. Much depends on where the airline is situated and it would be less in the case of a Canadian domestic airline than some others. However, the core benefit would still be there which allows access to these debt capital markets.
The Deputy Chairman: The Canadian Bar Association sent a couple of amendments. They always send amendments. I will forward those to you and if you could please respond to the committee by letter, we will be asking them questions on these amendments and it would be nice to have your perspective.
Mr. Shapiro: Thank you, Mr. Chair, I will certainly do that.
The committee adjourned.