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In re Delta Air Lines

June 22, 2010; as amended July 13, 2010

IN RE: DELTA AIR LINES, INC., DEBTOR.
THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY, APPELLANT,
v.
DELTA AIR LINES, INC., BANK OF NEW YORK, AS INDENTURE TRUSTEE AND PASS THROUGH TRUSTEE, AND BANK OF AMERICA, N.A.,*FN2 APPELLEES.
DFO PARTNERSHIP, APPELLANT,
v.
DELTA AIR LINES, INC., AND STRATEGIC VALUE PARTNERS, LLC, APPELLEES,
WILMINGTON TRUST COMPANY, AS OWNER TRUSTEE, AND CARGILL FINANCIAL SERVICES INTERNATIONAL, INC., INTERESTED-PARTIES APPELLEES.
AT&T CREDIT HOLDINGS, INC., APPELLANT,
v.
DELTA AIR LINES, INC., AND BANK OF AMERICA, N.A., APPELLEES,
BANK OF NEW YORK, AS INDENTURE TRUSTEE, INTERESTED-PARTY APPELLEE.



SYLLABUS BY THE COURT

Claimants in the bankruptcy proceedings of debtor Delta Air Lines, Inc., who are Owner Participants in leveraged leases of aircraft to Delta, appeal from the judgment of the United States District Court for the Southern District of New York (Berman, J.), affirming final orders of the United States Bankruptcy Court for the Southern District of New York (Hardin, J.), which upheld Delta's objections to their claims under tax indemnification agreements. The Court of Appeals (Leval, J.) vacates the ruling of the district court, and remands with instructions to overrule Delta's objections.

The opinion of the court was delivered by: Leval, Circuit Judge.

Argued: September 21, 2009

Before: LEVAL, RAGGI, and LIVINGSTON, Circuit Judges.

Northwestern Mutual Life Insurance Company, Inc. ("Northwestern"), DFO Partnership ("DFO"), and AT&T Credit Holdings ("AT&T") (collectively, the "Appellants" or "Claimants"), who are claimants in the bankruptcy proceedings of Delta Air Lines, Inc. ("Delta"), appeal from a ruling of the United States District Court for the Southern District of New York (Berman, J.) affirming final orders of the United States Bankruptcy Court for the Southern District of New York (Hardin, J.) (the "Bankruptcy Court Orders"). The bankruptcy court upheld Delta's objections to Appellants' claims for approximately $1 billion under tax indemnity agreements. For the reasons discussed herein, the judgment is VACATED, and the cases are REMANDED with instructions to reject Delta's objections.

BACKGROUND

I. Underlying Agreements

Each of these three appeals requires that we construe a set of agreements governing a leveraged lease, a financing structure commonly employed by airlines to fund the acquisition of aircraft. Because of its chronic unprofitability, Delta was unable to benefit from the right to take accelerated depreciation deductions accorded by the Internal Revenue Code to the owner of equipment used in business. See 26 U.S.C. §§ 167(a), 168. The purpose of the leveraged lease was to place ownership of the aircraft in a profitable entity -- the Owner Participant -- which would put up a portion of the acquisition cost and take accelerated depreciation against its own profits; the aircraft would be leased to Delta. The Owner Participant's bearing of a portion of the purchase price of the aircraft as an equity investor (in order to obtain the benefits of accelerated depreciation) reduced the percentage of acquisition cost that needed to be financed by debt, thus reducing the interest cost of the acquisition.

A. The Leveraged Leases

In each of these leveraged lease transactions, the parties entered into a master agreement (the "Participation Agreement"), which specified the roles of the parties and identified the various constituent agreements. An "Owner Trust" was established to purchase aircraft with funds provided by (i) an equity contribution (of approximately 20%) from the Owner Trust's beneficiary (the "Owner Participant") and (ii) non-recourse borrowings (of approximately 80%) from lenders (the "Lenders"). Each Claimant was the Owner Participant and beneficiary of such an Owner Trust.

In each transaction, the Owner Trust leased the aircraft to Delta pursuant to a "net" lease (the "Lease") that required Delta to pay all operating expenses. Basic rent payments were calculated to amortize the debt due to the Lenders and in some cases to provide a cash return to the Owner Participant. In each case, in order to provide security for the borrowed funds, the Owner Trust granted a security interest in the aircraft and assigned its interest in the Lease (subject to certain exceptions) to an "Indenture Trustee" acting for the Lenders, pursuant to an indenture agreement (the "Indenture"). The Indenture Trustee was charged with making debt payments from the Lease rentals and distributing the excess, if any, to the Owner Trust. As assignee of the lessor's interest, the Indenture Trustee was entitled to control the exercise of remedies if Delta defaulted under the Lease.

B. Tax Indemnity Agreements and Stipulated Loss Value

The primary incentive of the Owner Participant in advancing 20% of the purchase price of the aircraft was to obtain the benefits of accelerated depreciation. That interest, or in any event its economic value to the Owner Participant, was protected by two mechanisms against events that would prevent the Owner Participant from taking full advantage of the deductions, including Delta's default under the Lease (which might result in the Indenture Trustees' foreclosing on the aircraft). The first form of protection for the Owner Participant was a Tax Indemnity Agreement ("TIA"), which required Delta to compensate the Owner Participant in the event that, upon a foreclosure on the aircraft, the Internal Revenue Service required the Owner Participant to "recapture" deductions it had taken for accelerated depreciation. The second was a provision of each Lease that permitted the lessor (or the Indenture Trustee, as assignee) to demand that Delta pay "stipulated loss value" ("SLV") if Delta defaulted under the Lease. SLV (the precise amount of which was fixed by an appendix to the Lease and was tied to the date of the default) was calculated to provide for (i) the payment of the remaining debt with all interest due and (ii) the agreed-upon return to the Owner Participant through the date of termination, taking into account all adverse tax consequences that would result from the default.

In each case, the rights assigned to the Indenture Trustee as security for the loan to the Owner Trust included the right to demand payment of SLV. The terms of the Indenture provided that, upon the Indenture Trustee's collection of SLV, the funds would first be applied to the parties' expenses, and then to any outstanding balance on the loan. Remaining funds would be paid over to the Owner Trust, and ultimately to the Owner Participant. This sequence of payments was known as the "Indenture waterfall."

Because SLV was calculated to be sufficient to compensate the Owner Participant for all adverse tax consequences of a Lease default, if Delta were to make a full payment of SLV and a full payment under the TIA, the Owner Participant would receive double compensation, at least to the extent of the tax losses indemnified by the TIA. Accordingly, each TIA contained an exclusionary provision, which stipulated in some form that, in the event that Delta paid SLV under the Lease, the Owner Participant was not entitled to collect under the TIA. (For the same reason -- i.e., to protect against the Owner Participant's receipt of double payment -- the Participation Agreements contained provisions requiring reduction of the SLV to account for any amount paid by Delta to the Owner Participant under a TIA.)

The precise language employed in the exclusionary provisions of the TIAs is not standardized, but varies slightly as among the three sets of leveraged lease transactions involved in these appeals. DFO's TIAs provide that no amount is due under the TIAs where Delta is "required to pay" SLV. AT&T's agreements provide that it is not entitled to anything under the TIAs where Delta "pays an amount equal to" SLV. Northwestern's TIAs provide that it is not entitled to "any payment . . . in respect of any Loss . . . arising as a result of . . . [a]ny event whereby [Delta] pays Stipulated Loss Value . . . or an amount determined by reference thereto." DFO TIA § 7c; AT&T TIA §6c; Northwestern TIA § 6c.

II. Procedural History

A. Bankruptcy Filing and Exercise of Remedies by ...


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