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ZNR UUUUU ZZH
P 291000Z JUN 06
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RULSDMK/DEPT OF TRANSPORTATION WASHDC
RUEAYVF/FAA MIAMI
RUEAYVF/FAA MIAMI ARTCC MIAMI FL

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 
 
BRASILIA 00001302  002 OF 003 
 
 
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