The impact of the Boeing 737 Max grounding

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Boeing is the largest manufacturing exporter in the US, a major US employer and has a supply chain of thousands of US, European and global manufacturers. Before the tragic events described below, the 737 Max had been Boeing's fastest selling aircraft. Economists variously estimate that its grounding and production suspension has taken between 0.24 and 0.4 percentage points per quarter out of US GDP. So, it has been inevitable that this grounding and those production cuts have had far-reaching effects on aircraft lessors, airlines, manufacturers and the wider economy of the US and beyond. We consider some of those effects below.

Global grounding

On 29 October 2018, Lion Air 610 crashed shortly after take-off from Jakarta. On 10 March 2019, Ethiopian Airlines 302 crashed shortly after departure from Addis Ababa. In response, all aviation authorities around the world soon grounded the 737 Max. Boeing hopes the 737 Max will be back in service at some point in Q1 2020, but this looks unlikely, especially given the FAA's recent decision to investigate a second potential risk posed by the aircraft.

Production cuts

After its global grounding, Boeing suspended all 737 Max deliveries and reduced production from 52 to 42 per month. Despite this, orders initially remained buoyant with positive announcements from the 2019 Paris and Dubai air shows. In Paris, for example, International Airlines Group signed a letter of intent to buy 200 737 Max.

However, on 16 December 2019, following the FAA's decision that it would not approve the aircraft's return to service before 2020, Boeing announced an indefinite production halt starting in January 2020. Among other things, this led to an immediate drop in Boeing's share price and falls in the share prices of many of Boeing's suppliers, such as Senior, Spirit Aerosystems, GE and Safran.

Cancelled orders

The first announcement of cancellations came on 14 March 2019, when Garuda Indonesia cancelled 49 orders for the 737 Max. In June 2019, Azerbaijan Airlines announced that it would postpone its order of 10 737 Max. This was followed by Saudi carrier, flyadeal, cancelling its order of 30 737 Max aircraft and switching to a new agreement for the same number of Airbus A320 Neo aircraft.

Airlines and lease rates

The grounding led airlines that were operating or awaiting deliveries of the 737 Max to cancel thousands of flights and these airlines are taking a cautious approach to including the 737 Max back into their flight schedules. American Airlines and Southwest Airlines, for example, have pulled the 737 Max from their operating schedules until 6 April 2020 and 13 April 2020, respectively. Icelandair and United Airlines have pushed this out to May 2020 and early June 2020, respectively. Ryanair has confirmed that it has reduced its expectation of receiving a delivery of 30 737 Max aircraft before the summer of 2020 to 20 aircraft.

In addition, airlines battling lost capacity have extended leases, subleased aircraft on a short-term basis, deferred maintenance and reassigned their other aircraft. However, these measures seem unlikely to head off the upward trend in lease rates for narrowbody aircraft. The costs of flight cancellations and subleasing, which have been enormous, are likely to rise if the 737 Max is unable to fly again soon.

Lessor assistance

It is reported that some lessors have supported their affected airlines with temporary rental holidays or deferrals (reportedly with Boeing providing financial assistance directly to some of these lessors). Usually, this has been on the basis that the airline will share any compensation it receives from Boeing with the lessor or pay higher rentals once the 737 Max is back in service.

Compensation

In March, Norwegian Air became the first airline to publicly demand compensation from Boeing for the costs of the groundings of the 737 Max. India's SpiceJet has also announced it will claim compensation from Boeing. It is reported that compensation claims have also been submitted by China's Shandong Airlines and China Eastern Airlines and, no doubt, other carriers will be privately negotiating compensation packages with Boeing. A number of airlines, such as Southwest Airlines, American Airlines and Groupo Aeromexico have concluded compensation agreements with Boeing for their 2019 losses.

The financial impact of the grounding of the 737 Max has also had a more personal impact in recent months as American Airlines Group's pilots and the Southwest Airlines Pilots Association are currently seeking compensation for lost pay stemming from flights cancelled as a result of the aircraft grounding. American Airlines announced that US$30 million of its compensation from Boeing will be shared with employees.

Litigation

Avia Capital Services, a Russian aircraft leasing company which ordered 35 737 Max, is the first customer of Boeing to bring a lawsuit against the company. Avia is suing for breach of contract and compensation in the form of its cash deposit with interest, as well as a set amount of lost profits. Although the first customer to take this action, Avia may not be the last as companies start to question whether the delay in their delivery order could be considered an inexcusable delay under the terms of their sale agreement. Most such claims are settled out of court, but if any cases go to trial, it will be an interesting test of the enforceability of the extensive exclusion of liability clauses usually contained in purchase agreements.

Capacity alignment and yield improvements

One positive outcome from this situation has been a reduction in overcapacity. Prior to the grounding, airline capacity was growing faster than traffic, with a number of aviation commentators and lessors calling for the major manufacturers to slow the growth on new aircraft deliveries. However, the delivery delays and production cuts to the 737 Max have mitigated some of this overcapacity. This has also improved airline yields, particularly in North America. Whether these improvements will continue will partly depend on how and when the 737 Max is brought back into service.

Fleet planning challenges

Once the 737 Max regains regulatory approval, the shortage of narrowbody aircraft in the market could continue. Boeing currently has approximately 400 aircraft in storage and says it will need six to seven months to deliver those aircraft, based on an optimistic 60-70 aircraft a month delivery target. However, some industry commentators are sceptical about this timetable and have suggested it will take Boeing up to three years to restore the 737 Max to full service. Airlines will need to consider more long-term solutions in their fleet planning.

Fear of flying

The biggest hurdle for the aircraft may be overcoming public fears of flying on it. One plan to counteract these fears is to run many flights without passengers, but carrying senior Boeing airline executives. It has also been announced that Southwest Airlines, United Airlines and American Airlines are planning to hold hundreds of demonstration flights to try to convince passengers that the aircraft is safe. Ryanair has announced that it will be re-branding its 737 Max aircraft. It may not be the only airline to take this approach. Whether any of these approaches will win over the public in significant numbers remains to be seen.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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