BRAZIL: VARIG'S DEATH THROES

UNCLAS SECTION 01 OF 03 BRASILIA 001302

SIPDIS

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EAIR EIND OPRC BR
SUBJECT: BRAZIL: VARIG'S DEATH THROES

REF: Brasilia 1185 and previous

(U) This cable is business-sensitive. Please protect accordingly.


1. (SBU) Summary. On June 23, Rio Bankruptcy court Judge Luiz
Roberto Ayoub declared the bid by VARIG workers group TGV as failed
since it unsurprisingly was unable to make its first required
payment of USD 75 million. Judge Ayoub also said that he will now
focus on the USD 485 million bid for VARIG by former subsidiary
VarigLog, which is partially owned by MatlinPatterson subsidiary
Volo Brasil. Coincidentally, on the same day, Brazil's civil
aviation administration ANAC ended its investigation of the VarigLog
sale to Volo, saying that it has determined to its satisfaction that
Volo meets Brazilian foreign ownership restrictions, although that
decision will ultimately lie with Brazilian tax authorities. Since
June 10, VARIG's average cancellation rate has been 62.5 percent per
day, and it has cancelled flights to 10 international destinations
and reduced frequencies to another eight until further notice. Wait
times for flights that do take off average 100-240 minutes. The
company is operating an estimated 30 planes of its 65 aircraft
fleet. It has been removed from the IATA clearing house, resulting
in at least 11 companies' non-acceptance of VARIG-endorsed tickets.
Brazilian authorities are planning for the worst, but saying little,
with the military readying five aircraft to transport VARIG
passengers and ANAC encouraging TAM and GOL to free up seats to
VARIG ticket holders. Legal actions threaten to: hold the Rio judge
accountable for his delayed acceptance of TGV's bid, place VARIG
executives in the US in jail, prevent VarigLog from acquiring VARIG,
and open the any potential buyer to further liability from
creditors. End Summary.


SPENDING BEYOND THEIR MEANS
--------------


2. (SBU) The VARIG workers group TGV finally admitted, to the
surprise of no one, that it did not have the required USD 75 million
to effectuate the initial payment for the company. Rio Bankruptcy
judge Luiz Roberto Ayoub then declared TGV's auction bid void. The
announcement came after two days of meetings with Brazil's National
Development Bank (BNDES) to negotiate a loan and a 7-hour extension.
Group representatives, who have still refused to name their
financial backers, hold the Judge responsible for their failure to
raise the funds, blaming his delay in accepting their bid, the short
amount of time given to effectuate payment, and his general handling
of the whole process; they have mentioned litigation more than once.


LESS MONEY, MORE PROBLEMS
--------------


3. (SBU) Oddly enough, the TGV did not blame other factors that may
have played a part in discouraging financial backers. Since June
10, VARIG cancellation rates have hovered between 55-70 percent.
Those flights that take off see a 100-240 minute average delay.
After earlier denials to econoff by a Sao Paulo-based VARIG sales
manager, IATA announced June 20 that it had removed VARIG from its
clearing house, meaning VARIG-endorsed tickets for passengers whose
flights are cancelled have no financial backing. IATA did not
announce how much money it is owed, but said that VARIG has been in
arrears since April. Other airlines are no longer obligated to take
their passengers. On June 21 VARIG announced its suspension of
flight operations to Milan, Munich, Madrid, Paris, New York, Los
Angeles, Mexico City, Monetivideo, Assuncion and Bogota, or 72
percent of its international flights. It is has also further
reduced its frequency to Miami and London to once per day. (Note:
Some London flights have been cancelled.) A company spokesman said
the move was precipitated by its failure to come to amicable terms
with leasing companies. Many of its international flights have been
cancelled through June. Such cancellation rates are understandable
since the company is operating about 30 aircraft.


4. (U) To add injury to insult, one of Boeing's MD-11s leased to
VARIG was involved in a serious incident at Brasilia's international
airport on June 17, in which the middle landing gear failed to

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initialize properly. The ensuing break in the middle wheel well
damaged the fuselage and the BSB landing strip, causing a 2 hour
closure of the runways at the airport. Because of lack of funding,
many VARIG aircraft lay fallow or worse with no available resources
to fix them or fuel them.

MONEY TALKS: VARIGLOG TO THE RESCUE?
--------------


5. (U) During his June 23 announcement to annul the TGV bid, the
judge also stated that he would now turn his attention to VarigLog's
bid for VARIG. VarigLog, which has partial ownership by Volo
Brasil, a MatlinPatterson (U.S. investment fund) subsidiary, offered
to buy its former parent company for USD 485 million. While
VarigLog had made an earlier USD 350 million bid for VARIG in April,
it was rejected outright under ANAC suspicion that Volo was not
fully in compliance with Brazilian laws regarding foreign investment
control. In fact, during meetings with Emboffs in April, ANAC
officials went far as to rule out the sale of VarigLog to Volo.
However, after months of investigating, ANAC leadership conceded,
also on June 23, that such a determination was not within their
purview and that the Brazilian tax authorities would determine
ownership. The ANAC determination coincided with press reports that
VarigLog was prepared to immediately inject US 20 million into the
company to assist it with short term credit problems. Thus far,
VarigLog has given USD 3 million as a sign of good faith of its
intentions. It plans other deposits to keep the airline going until
Judge Ayoub makes a decision about sale or liquidation. Ayoub must
now call a meeting with creditors to determine the viability of the
bid. VARIG will once again go to auction, and one assumes, with
only one buyer. TGV's failed bid automatically disqualifies it from
further participation.


6. (U) However, two issues cast long shadows of doubt over the
auction. First, the Brazilian Treasury (Receita Federal) and the
Brazilian Social Security Administration (INSS) obtained an
injunction against the sale until the issue of whether the money
raised in a new auction would be used to pay taxes and social
security debts, which total USD 1.56 billion. Second, VARIG's
administrator, Deloitte, insists that the "old VARIG" continue to
operate with a guaranteed 5 percent of the new VARIG formed by the
buyers. According to many legal analysts, this would mean that,
legally, VarigLog would assume VARIG's debt (Reftel).

THIS IS THE LAST TIME; I MEAN IT
--------------


7. (U) The reprieves that VARIG has customarily received have been
from GoB entities BR Distribuidora, a Petrobras subsidiary and from
airport administrator INFRAERO. These abeyances will perhaps soon
end. VARIG has renegotiated a payment plan with BR Distribuidora
seven times in 5 weeks, sometimes for just 24-hour periods. This is
after BR spokesmen vehemently proclaimed in April, May and June that
the time to support VARIG out of their own pockets had come to an
end. INFRAERO once again set a firm date of July 1 when VARIG must
pay its airport fees before landing in a Brazilian airport, or not
be allowed to land. The date has slipped four times since April
when INFRAERO first announced that it would resume charging the tax
to all cairlines after a seven-month hiatus, which caused INFRAERO
more than its share of financial pain. Complaints piled as regular
maintenance went undone, some of which was linked to anaccident at
Congonhas Airport, Brazil's busiest (Reftel).


8. (SBU) All the while, ANAC, which has never publicly announced its
contingency plan if VARIG goes under, has pressured local carriers
TAM, GOL and OceanAir to transport stranded VARIG passengers on
their flights and they have accepted. On the non-announcement of a
definitive plan, shares in TAM and GOL which had enjoyed upward
pressure since February, fell due to negative hedging on how much
absorbing VARIG's estimated 28,000 customers will cost them. ANAC
did announce that all Star Alliance partners will ensure that
Brazilians in foreign locations will be accommodated. Star Alliance
leadership, however, corrected ANAC's announcement stating that the
airline partnership is a commercial activity between VARIG and its
alliance partners, not between ANAC and the Star Alliance. The

BRASILIA 00001302 003 OF 003


Brazilian military has made ready five aircraft to transport VARIG
passengers if they are stuck overseas without option. Brazilian
diplomatic posts have notified host-country authorities to be
prepared for a VARIG failure. The Brazilian Embassy in Washington
has notified FAA to expect a diplomatic note petitioning for the
accreditation of Brazilian airline OceanAir, a company currently
with no long-haul capabilities.

AT LEAST NO ONE IS GOING TO JAIL, YET
--------------


9. (U) Numerous current and potential legal battles surrounding
VARIG's bankruptcy promise to erupt into mayhem. VARIG itself has
sued the GoB for damages it believes it is owed for operating under
the strict pricing rules following 9/11. (Note: TAM and other
airlines have also sued; the case has not yet been decided.) ILFC,
the most vociferous foreign player in the VARIG bankruptcy universe,
had asked the New York Bankruptcy court judge to order prison
sentences for the VARIG executives who are in the U.S. until the
company returned their planes. The judge denied the prison sentence
request, but did stipulate that VARIG had to ground ILFC planes and
was not allowed to cannibalize, or dismantle the leased aircraft and
transfer parts. Willis Lease, another aircraft company received a
court injunction to prevent VARIG from using its craft. Econoff
spoke to a Boeing representative who said all but one of Boeing's
ten planes leased to VARIG are grounded, either because of
maintenance issues or by court order. They have not yet taken
possession of their aircraft. The cancellations of Boeing aircraft
covered routes ensured that for now.


10. (U) The National Airlines Association (SNEA in Portuguese)
announced on June 24 that it will now seek an injunction against the
sale of VARIG to VarigLog. The association says that VarigLog has
not proven that it has less than 20 percent foreign participation to
qualify as a Brazilian controlled company. The Public Ministry and
the Superior Court handling the government's accounts may be forced
to sue INFRAERO if it offers yet another reprieve to VARIG to pay
landing taxes. Currently, only VARIG is relieved from paying the
fees. TAM, GOL and other airlines have complained publicly that
they had to pay the reinstituted fees and thus so should VARIG.
They have also threatened legal action. Now that TGV's bid has been
disqualified and the group forbidden to participate in the next
auction, should it happen, the group may pursue a legal case against
Judge Ayoub for what it called an 'unjustified delay' that
endangered its bid.

COMMENT
--------------


11. (SBU) The legal wrangling, delays, cancellations, timed
announcements and misinformation surrounding VARIG's protracted
failure promise to continue through the fall, if not further. Even
if Judge Ayoub allows the VarigLog bid to move forward, the company
has a number of legal hoops to jump through, if it so chooses. Why
a company would choose to buy VARIG, with the assured promise of
legal liability for past debt, is beyond us. The bigger bang for
the buck is obviously to await declared failure of the airline and
then swoop in and acquire assets and airport space. Judge Ayoub's
continued delay in making decisions on the fate of the airline and
NY Bankruptcy judge Drain's unwillingness to allow lessors to
physically re-take their craft, in a sense, is killing VARIG through
kindness. It is increasingly clear that pressure from the Lula
administration during an election year is the only thing that could
be keeping this process dragging on. We consider that the only
plausible explanation for BR Distribuidora and INFRAERO's leniency
on VARIG, and ANAC's consideration of a legally questionable
acquisition of VARIG by Volo via VarigLog. Unfortunately for
everyone, creditors and passengers included, the airline industry
and Brazil's investment climate will be left to deal with the
wreckage.

CHICOLA