Although domestic flights have resumed faster than initially anticipated, the fact that many international borders remain closed (both from the perspective of restricting residents and citizens from exiting a country; and the restriction on the entry of non-citizens / non-residents into a country), has meant that international flights have a long way to go, to hit their pre-COVID-19 levels.

Latest International Civil Aviation Organisation (ICAO) estimates indicate that the possible COVID-19 impact on world scheduled passenger traffic (compared to business as usual) would be (i) an overall reduction of 1,815 to 3,213 million passengers; and (ii) approximately USD236 to USD419 billion of potential loss in the gross operating revenues of airlines.

Many airlines have already announced rationalisations of their fleet – including retiring entire aircraft types, and streamlining or harmonising their existing fleets. These rationalisations have been effected in various forms – delayed or cancelled deliveries for new aircraft; early termination and return of aircraft in existing leases and in extreme cases, pure default in leases – all in an attempt to cut costs and capacity, in order to better cope with some of the economic fallout of the COVID-19 pandemic. With most airlines having a fleet that consists of both owned, albeit financed aircraft, as well as leased aircraft, both finance lessors and operating lessors are already seeing the negative impact of COVID-19 on their businesses.

With a few airlines having already announced insolvency and/or restructuring of some sort (for eg. Flybe (the United Kingdom) having gone into administration in March 2020; Virgin Australia having entered voluntary administration in April; Avianca (Colombo) filed for chapter 11 bankruptcy protection in May), and many other operators showing serious signs of distress around the world, the industry faces the prospect of many aircraft coming into the market over the immediate and short-term.

Lenders and lessors are facing similar scenarios across multiple markets. A forcible repossession is not the preferred option, with lessors preferring to work with and support their airline lessees, particularly if the airlines are being reasonable. Also, depending on the jurisdiction concerned, the cost of a forcible repossession, usually predicated by some sort of injunctive order, could end up being substantive. Hence what is most likely to happen is a mutual termination whereby certain provisions are made for the benefit of both lessor and airline. However sometimes a mutual position may not be possible, for example in the event of a liquidation event on the part of the airline. In either event - the lessor is then faced with a dilemma – how to deal with the aircraft once it has been returned or repossessed?

Labuan is already host to several entities in the business of aircraft leasing. The current structures mostly reflect that the Labuan company (who is the aircraft owner) is a wholly-owned subsidiary of a parent company who is an airline operator in Malaysia. A plus point is the relative speed (24 hours) and low cost (USD300-USD1500) of incorporating a Labuan company.

In accordance with the provisions of the Labuan Business Activity Tax Act (“LBATA”), Labuan companies who own aircraft and/or leased aircraft for the purpose of sub-leasing those aircraft, are required to comply with certain conditions pertaining to economic substance. Prior to these provisions coming into effect (circa 2019), the preferred structure was for the Labuan entity (that owned the aircraft) to be a Special Purpose Vehicle (“SPV”) whose sole shareholder was a trust controlled by a corporate trustee, and for the lenders to hold a charge over the shares in that SPV. In the event the airline were to default on its performance of the sub-lease, the Secured Party (typically the Lender) could then call in the charge and gain ownership of the subject aircraft with minimal fuss and minimal time.

A similar structure, of an SPV owned by a trust, may well come in use today, for the purpose of holding aircraft assets that no longer have homes, whether due to mutual termination or due to repossession from airline operators. Having a Labuan trust hold an aircraft during the interim period while that aircraft is not being leased out and/or operated by the next operator, could be a more efficient process, and provides an alternative to the lessor holding the aircraft directly.

These kinds of structures therefore see a Labuan trust owning aircraft, through the ownership of all the shares in an SPV that is the legal owner of the aircraft. So long as the Aircraft is not physically situated in Malaysia, the Aircraft may be the property of the Trust. In addition, utilising the Trust as the ultimate beneficial owner of the SPV protects the SPV structure from any insolvency risk on the part of the lessor / owner. Such a Trust is usually set up as a Labuan purpose trust - controlled by a corporate trustee, and the directors of the SPV are often independent professional directors provided by a dedicated corporate services provider (who would be the corporate trustee). The constitutional documents and trust documents governing the SPV or to which the SPV is subject, provide an effective means of limiting the roles of the directors. The deed settling the purpose trust (Trust Deed) can be drafted to clearly set out the purpose of the Trust and the duties of the Trustee, and any restrictions or obligations on the exercise of shareholder powers in relation to the SPV.