7 redemption. Aero also granted Air Canada the ... - assets.kpmg

7

redemption. Aero also granted Air Canada the right to set off the Bills of Exchange against Aero

payables if Aero failed to remedy its defaults.

23. On May 8, 2009, with Aero's consent, two Bills of Exchange were released from escrow

and delivered to Air Canada to enable Air Canada to set-off the amounts payable under the Bills

of Exchange against Air Canada's outstanding receivables from Aero.

24. In June of 2009, based on the declining volumes of consumption from the January

Inventory Pool, Air Canada undertook an audit of the CAT 3 Inventory in the January Inventory

Pool. Based on the results of the audit, Air Canada estimated that as much as US $40,000,000 of

the CAT 3 Inventory in the January Purchase Pool would not be used by Air Canada within the

period agreed to between the parties under the January Purchase Agreement and that the

remaining January Inventory Pool was comprised of many spare parts that could not be used by

Air Canada at all or would not be used for 24 months or so. Air Canada notified Aero of Aero's

breach and demanded that the breach of warranty be remedied.

25. Aero acknowledged the breach and agreed to remedy the breach by replacing the non-

conforming inventory with conforming inventory that Aero said it had on site in Canada. Aero

agreed to pay Air Canada the difference between actual consumption and the average monthly

consumption that would be necessary to meet the warranty requirements, namely US$8,500,000,

if the new inventory was not delivered.

26. This became the basis for a Warranty Performance Agreement executed between the

parties in October, 2009 (the "Warranty Performance Agreement"). Procedures were

implemented immediately to begin to correct the composition of the January Inventory Pool.

27. As Aero's indebtedness to Air Canada increased throughout the summer of 2009,

including indebtedness arising from its warranty performance obligations, Aero agreed, in

August of 2009, to deliver three more Bills of Exchange into escrow and authorized Air Canada

to set off the Bills of Exchange against its outstanding receivables from Aero.

28. Throughout the summer of 2009, negotiations continued between Air Canada and Aero

with a view to settling their disputes and, in particular, agreeing on the terms and conditions

8

under which Aero would exchange the Bills of Exchange that it held for the CAT 3 Inventory it

was purchasing from Air Canada or in payment of its warranty obligations.

29. Air Canada learned during this period that Aero PLC was showing a markedly improving

share price and, in October 2009, Aero PLC advised Air Canada that it was negotiating a major

equity issue and had applied for a listing on the senior board at the London Stock Exchange.

30. On October 9, 2009, a term sheet is agreed to between Air Canada and Aero providing

for the settlement of their disputes.

31. The settlement of the dispute between Air Canada and the Aero Companies involved

several key concessions by each of the parties:

(a) Air Canada would be bound to buy two Bills of Exchange and, except for

US$2,000,000 which would be used to set-off against Aero payables, the purchase

price would be paid to Aero; the discount rate in respect of the Bills of Exchange

to be purchased was fixed at 15%, generating proceeds of US$17,000,000 for

Aero;

(b) Aero would deliver to Air Canada the remaining Bills of Exchange in its

possession, except Bill of Exchange No. 10 which Aero would sell in a private

placement, generating additional cash proceeds;

(c) the discount rate for the five Bills of Exchange that had previously been delivered

to Air Canada, and which Air Canada had the right to set off against outstanding

Aero payables, would be fixed at 5%;

(d) to compensate Air Canada for the cost of capital relating to the foregone cash

payments under the January Purchase Agreement, the Holdback would be reduced

by US$4,000,000;

(e)

Air Canada agreed to purchase new CAT 3 Inventory from Aero, representing

new receivables for Aero in an aggregate amount of US$25,500,000 plus

applicable taxes, provided that the sales would be in instalments and that Air

9

Canada would have no obligation to pay for any instalment for at least 60 days;

and

(f)

the parties would memorialize and give effect to their agreement relating to

warranty performance in the Warranty Purchase Agreement.

32. The purpose of converting the Bills of Exchange maturing on February 8, 2010, into

obligations payable on demand was to accelerate Air Canada's indebtedness and to evidence the

discount rate negotiated and fixed by mutual agreement.

33. As part of the settlement transactions, the January Purchase Agreement, as amended, was

further amended by a Second Amending Agreement (the "Second January Agreement

Amendment"). The Second January Agreement Amendment reduced the Holdback under the

January 2009 Agreement from US$10,000,000 to US$6,000,000. This transaction compensated

Air Canada for the damages it suffered due to the loss of the cash flows that should have been

generated under the January Purchase Agreement.

34. The settlement transactions were concluded on October 23, 2009. Air Canada paid to or

to the order of Aero US$17,000,000 under the Demand Promissory Notes exchanged for Bills of

Exchange Nos. 8 and 9. Air Canada then set off the amounts owing under the Demand

Promissory Notes exchanged for Bills of Exchange Nos. 3-7 against amounts due and owing to

Air Canada as at September 30, 2009. After the conclusion of these transactions, the Aero

Companies continued to be net debtors to Air Canada for ongoing purchases of CAT 3 Inventory

from the January Purchase Pool and for warranty performance under the January Purchase

Agreement.

35. On October 23, 2009, the parties also entered into the Warranty Performance Agreement.

This agreement confirmed and extended the agreement already made and in force for the purpose

of remedying Aero's breach of warranty under the January Purchase Agreement.

36. Aero has defaulted in the performance of its obligations under the Line Maintenance

Agreement, the Warranty Performance Agreement and the October Purchase Agreement. Air

Canada has informed the Administrators that no payment would be made under the Line

Maintenance Agreement, the October Purchase Agreement or any other agreement between the

- 10 -

parties until the obligations owed by the Aero Companies to Air Canada have been discharged.

The Administrators have dismissed Aero's employees in Canada and refused to perform their

obligations, disrupting Air Canada's operations and causing it extensive damages.

37. Following the Recognition Order, the Administrators wrote to Air Canada, to inform Air

Canada that Aero did not consider itself to be bound by the Line Maintenance Agreement and

dictating new commercial terms for all transactions. Since the date of the Recognition Order,

Aero has failed to provide any of the services or support required under the Line Maintenance

Agreement, disrupting Air Canada's operations and causing it extensive damages.

38. Because Air Canada holds CAT 3 . Inventory purchased under the January Purchase

Agreement and the October Purchase Agreement, it has not needed to and has not purchased any

CAT 3 Inventory from Aero under the Line Maintenance Agreement since the date of the

Recognition Order. Air Canada has taken over the inventory procurement and management

functions that it had outsourced to Aero. The disruption of Air Canada's operations and the

increased costs are substantial, including a profound change in the implementation of Air

Canada's long-term strategic objectives to outsource the procurement and management of CAT 3

Inventory.

With respect to the relief sought in paragraph (c):

39. All material agreements between Air Canada and the Respondents are governed by the

law of Quebec. The January 2009 Purchase Agreement and the October 2009 Purchase

Agreement contain the following provisions:

"This Agreement shall be governed by and construed in accordance with the

laws of the Province of Quebec ahd the laws of Canada applicable therein. The

parties consent to the exclusive jurisdiction of the courts of the Province of

Quebec in connection with any civil action concerning any controversy, dispute

or claim arising out of or relating to this Agreement or the Transaction

Documents."

40. Section 40.19 of the Line Maintenance Agreement provides the parties choice regarding

both the law governing their relationship and the appropriate forum for resolving disputes:

9 z "Governing Law. This Agreement shall be governed by and construed in

accordance with the laws of the Province of Quebec and the federal laws of

Canada applicable therein, without regard to its choice of law principles. Subject

to the provisions for arbitration in Section 32.3, the courts of the province of

Quebec, judicial district of Montreal shall have exclusive jurisdiction in relation

to all Disputes."

General Provisions

41. Sections 9, 11, 21, 48 and 50 of the CCAA;

42. Section 97(3) of the BIA;

43. Rules 2.03 and 37 of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194; and

44. Such further and other grounds as counsel may advise and this Flonourable Court may

permit.

THE FOLLOWING DOCUMENTARY EVIDENCE will be used at the hearing of

this motion:

1. The Affidavit of Alan Butterfield, solemnly declared and affirmed January 27 , 2010, and

the exhibits thereto ; and

2. Such further and other materials as counsel may advise and this Honourable Court may

permit.

- 12 -

January 27, 2010 HEENAN BLAIKIE LLP

2900 Bay Adelaide Centre 333 Bay Street Toronto, Ontario M5H 2T4

Kenneth D. Kraft, LSUC #31919P John Salmas, LSUC# 42336B Tel: 416.643.6822 / 416.360.3570 kkrafaheenan.ca / [email protected]

Fax: 416.360.8425

Montréal Office:

1250, boul. René-Levesque Ouest bureau 2500 Montréal, Québec H3B 4Y1

Keith D. Wilson, LSUC #37420A Tel: 514.846.2325 Fax: 514 846.3427 [email protected]

Solicitors for Air Canada

- 13 -

TO: OGILVY RENAULT LLP Suite 3800 Royal Bank Plaza, South Tower 270 Bay Street, P.O. Box 84 Toronto, Ontario M5J 2Z4

Orestes Pasparakis Tel: 416.216.4815 Fax: 416.216.3930 Email: [email protected]

Susan Rothfels Tel: 416.216.4033 Email: [email protected]

Fax: 416.216.3930

Canadian Counsel to the Applicants

AND TO: OSLER, HOSKIN & HARCOURT LLP P.O. Box 50 1 First Canadian Place Toronto, Ontario M5X 1B8

John A. MacDonald Tel:: 416 862-5672 Fax: 416 862-6666 Email: [email protected]

Canadian Counsel to Aveos Fleet Performance Services Inc.

AND TO : AERO INVENTORY (UK) LIMITED and AERO INVENTORY PLC 30 Lancaster Road New Barnet, Hertfordshire ENA 8AP United Kingdom

Paul Docker Tel: +44 (208)447.3372 - Fax: +44 (208) 447.3362 Email: [email protected]

Collin Trupp Tel: +61 4 0662.6670 Email: [email protected]

Respondents

- 14 - 9 5

AND TO :

AND TO :

KPMG INC. Suite 3300, 199 Bay Street Commerce Court West Toronto, Ontario M5L 1B2

Nicholas Brearton Tel: 1.416.777.3768 Fax: 1.416.777.3364 Email [email protected]

Information Officer

LLOYDS TSB COMMERCIAL FINANCE LIMITED Boston House, The Little Green Richmond, Surrey TW9 1QE United Kingdom

Jon Fenton-Jones Tel: +44 208 727 2023 Fax: 01295 702124 Fax: +44 208 332.7761 Email: j on. fenton-j ones@ltsbcf. co . uk

Commercial List No. 09-8456-00CL

IN THE MATTER OF THE COMPANIES' CREDITORS ARRANGEMENT ACT, R.S.C. 1985, c. C-36, AS AMENDED

AND IN THE MATTER OF JAMES ROBERT TUCKER, RICHARD MIS AND ALLAN WATSON GRAHAM OF ICPMG LLP, AS JOINT ADMINISTRATORS

AND IN THE MATTER OF AERO INVENTORY (UK) LIMITED and AERO INVENTORY PLC

ONTARIO SUPERIOR COURT OF JUSTICE

(COMMERCIAL LIST) Proceeding commenced at Toronto

NOTICE OF MOTION

HEENAN BLAIKIE LLP 2900 Bay Adelaide Centre, 333 Bay Street Toronto, Ontario M5H 2T4

Kenneth D. Kraft, LSUC #31919P John Salmas, LSUC# 42336B

Tel: 416.643.6822 / 416.360.3570

[email protected] / [email protected]

Fax: 416.360.8425

Montréal Office:

1250, boul. René-Lévesque Ouest, bureau 2500 Montréal, Québec H3B 4Y1

Keith D. Wilson, LSUC #37420A Tel: 514.846.2325 Fax: 514 846.3427

[email protected]

Lawyers for Air Canada

1-IBdocs - 7594253v6

TAB 10

Court File No. 09-CL-8456-00CL

ONTARIO SUPERIOR COURT OF JUSTICE - COMMERCIAL LIST


AND IN THE MATTER OF JAMES ROBERT TUCKER, RICHARD HEIS AND ALLAN WATSON GRAHAM OF KYMG LLP, AS JOINT ADMINISTRATORS

Applicants


Respondents

APPLICATION UNDER SECTIONS 46 AND FOLLOWING OF THE COMPANIES' CREDITORS ARRANGEMENT ACT, R.S.C. 1985, C. C-36, AS AMENDED

SUPPLEMENTAL REPORT TO THE

REPORT OF THE INFORMATION OFFICER AND TRUSTEE IN BANKRUPTCY DATED FEBRUARY 4, 2010

FEBRUARY 9, 2010

cg

1. KPMG Inc. is the Information Officer and trustee in bankruptcy ("Trustee") of Aero

Inventory (UK) Limited and Aero Inventory plc (the "Foreign Debtors") and the

receiver and manager of their Canadian affiliate, Aero Inventory Canada Inc./Aero

Inventaire (Canada) Inc. ("Aero Canada").

2. James Robert Tucker, Richard Heis and Allan Watson Graham of KPMG LLP are the

Joint Administrators of the Foreign Debtors (collectively, the "Foreign

Representatives").

3. The Trustee files this Supplement to its February 4, 2010 Report in order to address

issues raised by Air Canada regarding the insurance coverage of the Foreign Debtors.

4. Based on a review of records provided by the Foreign Debtors, their insurance policy is

in effect from the period June 1, 2009 to May 31, 2010 with coverage, as it relates to the

stock they own and the potential liability associated with the sale of same, which

includes:

(a) Employers' Liability/Public and Products Liability

Insurer: ACE European Group Ltd.

Policy Number: UKCANC31027

Period of Cover: 01 June 2009 to 31 May 2010

Limit of Liability: USD 20,000,000 any one occurrence and in the aggregate in respect of Products

(b) First Excess Public and Products Liability

Insurer: QBE Casualty Syndicate 386

Policy Number: B060903804A09


Limit of Liability: USD 30,000,000 in excess of USD 20,000,000 any one occurrence and in the aggregate in respect of Produr

(c) Aviation Products Liability

Insurer: AIG UK Ltd.

Policy Number:

B0370J50902629000

oc s


Limit of Liability: USD 250,000,000 any one occurrence and in the aggregate annually

(d) Marine Stockthroughput including Stock in Storage and Stock in Transit

Insurer: Various Underwriters at Lloyd's and Company markets

Policy Number: PC0902996000


Limit of Liability: USD 100,000,000 any one Vessel, Aircraft, Postal Sending, Conveyance, or any one loss any one Location throughout the World

(e) Excess Marine Stockthroughput incorporating Stock in Storage and Stock in Transit

Insurer: Various Underwriters at Lloyd's

Policy Number: PC0902997000


Limit of Liability: USD 75,000,000 any one Vessel, Aircraft, Postal Sending, Conveyance, or any one loss any one Location in excess of USD 100,000,000 any one Vessel, Aircraft, Postal Sending, Conveyance, or any one loss any one Location throughout the World

5. A former manager of the Foreign Debtors, subsequently retained by the Foreign

Representatives, has advised that the above outlined coverage was put in place to comply

with the Foreign Debtors' customer contract requirements.

6. The Foreign Representatives have confirmed that they have instructed the Foreign

Debtors' insurance broker to maintain this insurance coverage.

7. KPMG Inc. also understands that Air Canada has raised a concern about the Trustee's

duties to report. KPMG Inc. notes that, as Information Officer, it is obliged to report to

the Court as to the affairs of the Foreign Debtors and will continue to do so.

8. KPMG Inc. has prepared this Supplemental Report to assist the Court in its deliberations

and in doing so understands the role of an officer of the Court and its obligation to act

impartially and objectively.

2

All of which is respectfully submitted this 9 th day of February, 2010.

KPMG INC. INFORMATION OFFICER AND TRUSTEE OF THE ESTATES OF AERO INVENTORY (UK) LIMITED AND AERO INVENTORY PLC

Per: Nicholas Brearton Senior Vice President

1

TAB 11

[Transcribed]

10 Feb 2010

0. Pasparakis for U.K. Administrator

K.D. Kraft for Air Canada

J. MacDonald for Aveos

In the circumstances of this case, the requested relief represents, in my view, a practical proposal to deal with ongoing issues without incurring the added expense of having KPMG Inc. duplicate the work of the foreign representatives. It is also noted that KPMG Inc. is Information Officer and through this role will ensure that required information will come to the attention of the affected parties.

The Trustee will be reporting back to Air Canada on the insurance issue identified in submissions of Air Canada. In addition, KPMG Inc. has undertaken t. provide periodic reports to the Court on the Estates. It is expected that the Trustee will report on issues on a quarterly basis with more frequent reporting, if the Trustee is of the view, that additional reporting is required. It is noted that with the exception of the insurance issue and the reporting obligations of KPMG Inc., counsel to Air Canada took no position in the motion.

"Morawetz J."

Av' •

7&Pu/t.".'

MOTION RECORD (Motion returnable February 10, 2010)

AL:

Ogilvy Renault \ FED 0 4 2010) ; Suite 3800-

Royal Bank PI VSouth Tower i d i

200 Bay Street, ‘g.CIA: oxi8/4k Toronto, Ontario

Orestes Pasparakis LSUC #: 36851T Tel: (416) 216-4815

Susan Rothfels LSUC#: 39638K Tel: (416) 2164033 Fax: (416) 216-3930

•

0 -re:40 o IN THE MATTER OF THE COMPANIES' CREDITORS ARRANGEMENT ACT, RS.C. 1985, C. C-36, AS AMENDED Court File No: 09-CL-8456-00CL

AND- IN THE MATTER OF , JAMES ROBERT TUCKER, RICHARD HEIS AND ALLAN WATSON GRAHAM OF - KPNIG-AS JOINT'ADMINISTRATORS

AND1N THE MATTER'OF AERO INVENTORY (UK): LIMITED AND AERO INVENTORY PLC

o • P (K) tA 4 / 0 2,0 / 0 • ONTARIO SUPERIOR COURT OF JUSTICE -

COMMERCIAL LIST

Proceeding commenced at Toronto a f ,

.Av.„ -744

„(70, /e_ •-7

e

6-4----"Z 1(yt

2444j- .

,6';3t

./27je-

Lawyers for the Applicants

.tv-fret, ‘,4 jet,

DOCSTOR: 1859135 \1

TAB 12

JUGDES ADMIX IX4- 170 .4.15 41 7 P,002A10.7. OLt

CITATION: Tucker v, Acts InVeritory (14K) Limited, 2010 ,ONSC 1196 COURT rat NO.: 09-CL-8456-00CL .

DATE: 20100224

SUPERIOR COURT OF "JUSTICE —

(COMMERC*LIJST)

IN 'PMMAuiiR OF TO iiRgr Tata:TORS litkiNOE ;€47 ACT, R.S.C. A* 0. ,c::30; ,AS AMENDED.

THE MAER OP JAMES- ROBERT TUCKER, tleflA0 - 11EIS - AND ALAN W.4003,1 ORAtiAbil Ok K1)..MG AS: ItiiNT APMJNI$TRATOR&I,A011OWs

AND ix mE• MATTER OF AEROINVENTORY ) LIMITED AERO INVENTORY FILC„ Respondents

11EPORE: MORAWETZ

COUNSEL: Dena:ck Tay ena Susan RI:Alders, Tor:the Applicants

Kenneth"). Xraft and John Salmas, fer.Air Can,acla

John MacDonald, fzsr Avcos Fleet Performance Inc.

mwsi.

kEttAgED:. JANow 2z zoo

ENDORSEMENT

At the conclusion cf. opulent on January 22,•2010, I endorsed the recond 4 follows:

The Applicant tikes the poSition Slat it is necessary to determine the issue todaSt.. Counsel tq Air Canada takes a different View, based on existing "deeining language"in previousordem

I do not have tp determine this preliminary point as I haVe determined that the motion.shonlabe granted. The 'reasons will follow.. An order shall issue in the fvrm prtserted, asamendcd.

[21

The following are my reasons "

44- 6 327 47 \ P 303'007 5 FEB-2-2010 .15 It3 queDEs =ITN .RM 170

[3] The APPlicantsbrouglit this motion for an order lifting the stay granted in the initial order dated November j I, 2009 in these -proceedings and granting leave to John Robit. T Richard Heis and' Allan Watson -Graham of KPMG LLP (the "Foreign Represcniativess) -to an Assignment-in Banlcruptcy in Toronto for Aero Inventory (UK) Limited and Aero Inventory plc (both in Administration and, collectively, the "Foreign Debtors"), and restoring the stay thereafter.

[4] •The motion was opposed by Air Canada.

M. On NoVenibef I I* 20091 this PZnitt T .ecognited '.the Appointment of the- 1Apolitaho as Foreign R sentatjves of Acre! IPventgrilIptIlithitod vA11-40d.Aero Inventóry.plc (be*in-administration, and toilectively, the "fOrtign DebtO01, Under Part IV of the Cthiglithiee Creditef&All - ketOpitAct("cCAA"),(thellecognitiOn:C ,rderu):

In order tO fadilitate a preferenee attion under the .1J'enzretyptc-;,' and kz. 7.61-vCncl Act (131.A")? the Foreign Representatives teguire (a) &date br an initial bankl-optcy eye* and .:(17). a trnstee in bankruptcy.

[71 The Foreign Representatives bring this. motion for an order to temparari& lift the stay granted in the Recogfiltion Order and Zrleaveto assign thaToreign Debtort into'h,anicTIAPteY-

[8] The 'Foreign DebtOtS and tipitinterna,tiOnifi affiliates i,ineludinz Aero Invittory Canada 41cAeeq ,TA*0):144P- (canada)-.Ine;„.0ieso Cariadal; fOrny an intogi*ii4 and intcr,deperident group)SfeoMpanieS thatttipplY,parls*IbqArlit4.i44144S,

[9) ''The Fotago potoEs. , hnve a.ssets, Cana.* and then, canadfan 4e -rations tte . . , adininlitered by Agii Canada_ They itav61-00 key'Canadian,.4407ners: Air Canadarand Aveos Fleet PerformanceInc. eAyocin pn. October23, 2009 , Ai ana Air Canada entet4intoa.series of cOntracts inehiding;ngreeMents providingfetthe exeliange of n.teriek of bills of 40.1:awe; .40t-off agreements and a purchase ;64-saie.agreement *ithrespeetto ix•rtain inventory .

ROI On NpircalbOr 11, griOst, administration prodeeding§ (the "FAreiga _za") were eplquicnced:bythetbreign kireseOtatiVesJil r4gitti4a0.)4..OrtheToreign-Do3bbsktilb High C,eurt. of Jp$tioi-q',..,,tagle0d And Wales (Chancery - Divis. ION ck.anparadt Co*t) 'the "'grtgli§h C0147'att.d. the FOreiga ktpreSetitaiiVesr ;werela000#4* i0i4i,,a0initisirator$. Of the- affairs i business .and property -Of the .FOreign Debtors (Sometimes referred to the; "IJK Court Administrafere.),

1111 OnNovenbeill2 200g,'Ne*I7olial. gratitcd a Recognition Order, inter

(a) recOglilingOrderamade onNovember 14 2009 bythe Engush.rcont

(h) recognizing thc Foreign Pmceedings as "foreign mait. prt)ceediage• putsuant to s. 47 of the CCAA;

(c) recognizing-the Foreign Representatives as "foreign remsentatives" as defined in s. 45 of the CCAA;

Ytui--2472010 ZUGDE$ ADKOT-RN 170

41g 501 P;004/007 (0

- Page 3 -

(d) staying all prOcepdings,ip respect of the Foreign Debtors, the Foreign Represent2itives or theirbusiness or property; and

fej noobiting KPMG 1nc as Information.Officer in these prOceedings.

[1Z1 On December 1,-2009i..This court...Made an older appointing gaiNid inc:t.t.*;;ivet and managct;Ovet Aeros, Canada purstient.th-s.. 49 of the C-CAA and s 101 .,-of the rpzirts cf.hgtice, Ada.

1133 icemc 1n orted,that is.sues e arisen with Air Canadgs copcierning the status 01 it§ relationship vyith the Foreign Debtors inehiding the effect of the October 23, 2009 tranSadionS.

[14] Qn Janua#1,.201A -Cunmaing,1 made Mi Order:

_(a) op the consent of Air Canada, al It re, ates to Air Canada, deeming -the date of the FOreign Debtora'"ipithil bankruptcy eVentyilit liappered after3anuary, 2010 to have occurred ortianuary g;„2910 •

(h) se4et_laliAg a-00341:.a4e1,1dane9 for February 1„, 2010 and providing that the Foreign Representatives. Coulct attend earlier ta .file a banlcuptcy apPlicatio%i if 'teen to be neeeSSary,

' 05] The 'Foreign: Representatives viiskto -ascign the Foreign pebtors into bankruptcy:for the pwpose of preserving- theAr Yight to poriue any reviewable AranSactioni; ,Settlenients and prefetenet§ Ortridervaluetransiction which May taken place-dtring the statutory review' peried pres.P.ibed toy tc BIA •

[IQ Counsel . ..thó:i è tbde±eda§ whether it i§ appropriate for the court to Ii the stay io4 spitt woo to, tho Fereign Representativ0 tO 0 -§itt • t4e..Foreigo -Obbtoit intobanlcasptey„

1 1 71TheForeigu Rep .resentatives arc officers -appointed by the Ctç:inaiiage th -managd . _ ForeigoDebtorst affairs, butiness and property.

E13:1 lalthiS:eites,:tlierc-1.$11910,ing concenilantinets-and it appears that the seoored will suffer a shortfall!. 'Conniel to ow Fereign Representatives submits that the Statutory obligation of theUK Pk* AdMinistrators. in these ciretanstandeS is to MaxiMiZelecoveries ler the secured. Creditors and that the UK Court Administrators have the statutbry'role lof Managing the :Foreign Debtors for the purpOse of realizing property in Order to Make diStributions to secured Creditors. Further, counsel ..subtnits that ss 1 of the UK insotyen97 Act, vvhichissexptessly incorporated into the Etigii§h court ,-,tat4cr. recognized by this Court, set.S. oot _ . _ specre pOWers'including;the poWer to bring legal prinecedingS:in.the 4dministratOr's name:and op behalf Of-the Foreign Dtbtotsi : inehgling the ..power to wind,up debtor companies ina otaot relief

1191 The UK Court Administrators have been 'recognized as Foreign Representatives in. the Recognition Order: 'This court has already recoplized the UK Court Administrators' authority in

FEB-24-2010 15:34 aiGDES MI 170

416 5417 P.P.0611;e07\

P4e4

Canada and as offleers of the court to act as agent of the Fcreiga Debtors and/or brmg legal proceedings on -their behalf

[20) Coupsel to tile foreign:Representatives firtheriOrnits that:the IIKtourtAdminiStrators, vagent7 ofthe Pordivy'DebtorS, have the. autherity to bring proceedinp ,on their behal.f nnd sgs

'agent" Of the lereign Debtors have the ability:Undeie* 49 of 0413410 it*ke-na. assigrageniin bankruptcy.

Dij POPTIsel als0-zeferenceg' parar0 Of AO git-P0117.0.11: , w41:41 .410 satiits specifically contemplateS bankrnp patOci be initiated by The.; Coirt_Adininistratem

"Nothing in tlus order ishail. prevent the Foreign Representatives or the, Information bfficer Tim:4 icting as a trustee lit: haniUlipiey of -thegFordign :Mt*"

[22) Part IV (Idle CCAA addrestiesissna5,telating to pross=bordcr insolvendei and the eoUrt is given broad statutory discre6on in PartW and,in parikular, 4,49(1 ).:

If an order recogaizin' g a foreip Proceedift is lua4e, the allot maY, on applicati= by the foreign rvresentative who . applied for the order, ifthe aourt is satisfiedThat it is necessary foLthe protect:len 'of ihe dOloes c,oPipaniCs' PioPertY or the intereSts of -a creditor , or creditor, make any order that . it Considers aPPTPPtiate-..

[23] Tho purpose of Part IV Of the CCAA is fp promote cooperation between -41M dourta-anill other tompetent authoritieiinCanada with these of foreigajutiidictionaig et* of cross-hOrder insolvencies..:". See s. ,44-(a) CCAA.

1241 Counsel th theToreignilepresentatives submits that Part IV of the CCAA proVides naPchanism bY which the, tanadian court coordinates with forcizn CoUrts and,. fdrther, that the CCAA expressly conteraplatcs that Ishkrre cakbe;gowigxent :Canadian and foreigrriproccedings. Further, counsel to the Foreign Titoresentatives -submits that Tarfly is arSo cleat in that those Canadian insolvency proccedinp cnn inch* a BIA filing. S action 48 addresses recegnition of

-

a foreign main prnececling. Section. 48(4),reads:

"Iqo ' g in subsection -(1) precludes the,dehtor cornpany frora commenting or continuing:proceedings under thts 4c4 the Baida720,01: aildinoolvency Act or the Winding-up ipzd RestructuritigActin respect-of a debtor -tompany2i'

125] Since Part IV of the CCAA specifically contemplates a bankruptcy preceeding continuing during a Part Wproceedinz, counsel submits there cEuLbe noinconsiateneyin hayin both proceedings concurrently.

'26] Further, counSel submits that the coordination of Canadian insolvency proceedings with Foreign Proceedings was recoyi-led by Newbould J. at paragraph 15 of-the Recognition Order referred at [21] above

FEB-24-2010 i5 :26 JUGDES ADM I II RM AIS• 221 ,5417 P. Op 5/.0t717 aa

- Page 5—

[77] JustiCe turtmaingalS6 acknoWledged that a fl g Of•a -liankiliptey , iibation -could be Made before ,February 24.)11) If seen tO be nteess , as .re.fereneed fl4iAbdve:

[28] Counsel to 4ip canada,S‘Mitsthat the order of ',the 'English Court, which i the subjecx of .the Redognition, Opcier,-; shotild not be 'interpret -0d to include the ability of the- Petelko kepresehtatiske to 'fliiikelhe ass4mient. in the circulated= of thicise.,,i diSagreefat reasons sotOlit below.

fp] CCtunselJO ,Airtanada alSO:taiSed the;:ettreStibn.as :toliow bankruptcY isnSiitcgt with the-Nit IV stOte"Obn, lt%Se.ems: to me that Part N. conterriP14$4110 pogsibilitST-of 'Concurrent prOceedings inyolifing the 111A. E#rtheii, 41,0, *bititiity of moth:tent /3IK ptoCer;ding$ Was ctmttmplated,hytheprties*ltis reffeeted the ofitlefe:alitA .NokoVj.,:ard"....Commiagi,

_circunts.tanccs of this ease, tbe 104 of the SIAm ooncutrett :pkidetalgslo patt w is tonsistat with Con4oviiiiiikpoRcy. The preposed actionsofthc1JK Court*dininistratorS inkingtelinyoke Canadian iiankruptCy prOCccclings.10 t4e-ailitantaggettn**Piettft#00; proviSions ate fOz= the purpose of i/ix6rni4in& the b6bto-te proposed *di:0PS of the UK Administrators Ore 40:00 *bat a uedifor reptts4ittitip, *oula undertake it tina4k.

pn counSel to Air Canada were try bc succes,sfurin Opposing theJelief so theffci may-very well be that a transaction that Triay be prefurential in nature may escag review by a ereclitox rVreSentative. Snell an outcome ivould,belleonSistentivith Canadian' rilblie Policy , It seems to me that, in the circumstances Of thit - caSe, the &reign tepresentaave AO:0d, have the abliity tochallenge the traasaCtion under Canadian bankruptcy Iei*:;

[32] In my view, theitaerpretation urged by counsei.to Air Cana6 is =dilly reStdctive mth circumstance& The language of gip Q.C.AA is permissive. There is -rio going cor*En operatiOn. The stated purpose of the assignment is o engage in a ;'emiew .of a potential preference transaction and the only objection is being raised by ilk _party that is ;likely the sbjet of the -review,

P3] l am in.agreein.exit with ap submissions made by-connsei to Foreign Representative.

(341 the UK Conn AdmiriStritors see 1.5 to set aside-contracts gOvelrnOl by C,.44dian law and affecting assets in Canada. It is not necessary to deterMina tbe.appropriatenag or tlio remedy today nor to assess the various defences that May be available to:the responding party.. Rather, this court needs only to ensure that the UK Court Administrators ad consistently' with ?art IV and theirstatntory obligation to maximize the debtors* estate&

[35) in my view, in -the furtherance of these objectives,, it is appropriate fbr ,this court to exercise its discretion to -lift the stay to permit the bankruptcy Min&

MOMWETZ

FEB-24-20,10 15:15 MODES ADmuf RN 17.0 416 5417 P . 007/001 CCk

Pagefi

An._o_id0 -has bi* giv:e1T7d6k. to the foregov-rezigolik.

itatv-febttiag24_4_20,19 .

TOTAL P . Q07

TAB 13

Court of Appeal No. M38515

Superior Court of Justice (Commercial List) Court File No. 09-8456-00CL

COURT OF APPEAL FOR ONTARIO


AND IN THE MATTER OF JAMES ROBERT TUCKER, RICHARD HEIS AND ALLAN WATSON GRAHAM OF KPMG LLP, AS JOINT ADMINISTRATORS

Applicants


Respondents

APPLICATION UNDER SECTION 46 AND FOLLOWING OF THE COMPANIES' CREDITORS ARRANGEMENT ACT, R.S.C. 1985, c. C-36, AS AMENDED

CONSENT TO EXTEND TIME TO PERFECT

AIR CANADA (the "Appellant"), on behalf of itself and all. other parties participating in

this appeal hereby advises that all such parties have consented, without prejudice to any party's

position that the appeal was commenced out of time, to extend the time for the Appellant to serve

its Motion Record in connection with the motion for leave to appeal to August 31, 2010.

June 30, 2010 HEENAN BLAIKIE LLP 2900 Bay Adelaide Centre 333 Bay Street Toronto, Ontario M5H 2T4

Kenneth D. Kraft, LSUC #31919P John Salmas, LSUC# 42336B

Tel: 416.643.6822 / 416.360.3570 Fax: 416.360.8425 [email protected] / [email protected]


TO: OGILVY RENAULT LLP Suite 3800 Royal Bank Plaza, South Tower 270 Bay Street, P.O. Box 84 Toronto, Ontario M5.1 2Z4

Orestes Pasparakis Tel: 416.216.4815 Email: opasparakisRogilvyrenault.com

Virginie Gauthier Tel: 416.216.4853 Email: [email protected]

Fax: 416.216.3930

Canadian Counsel to the Applicants and KPMG Inc.

AND TO: OSLER, HOSKIN & HARCOURT LLP P.O. Box 50 1 First Canadian Place Toronto, Ontario M5X 1B8

John A. MacDonald Tel:: 416 862-5672 Fax: 416 862-6666 Email: j m acdonaldQosler.com

Canadian Counsel to Aveos Fleet Performance Services Inc.

I ea - 3 -

THE UNDERSIGNED PARTIES, by their solicitors hereby consent, without prejudice

to any party's position that the appeal was commenced out of time, to an extension of time for

Air Canada to tile a Motion Record in connection with the motion for leave to appeal in this

matter to August 31,2010, or such further date as the parties may agree.

June , 2010 APPLICANTS and KPMG INC., by its solicitors, Ogilvy Renault LLP

/Per: ,;; 7 ,

Name: Orestes Pasparakis / Virginie Gauthier

June 0 , 2010 AVEOS FLEET PERFORMANCE SERVICES INC., by its solicitors, Osler, Hoskin & Harcourt LLP

Per: I) P.- 95; Name: John. A. MacDonald

Court of Appeal File No. M38515

Commercial List No. 09-8456-00CL




COURT OF APPEAL FOR ONTARIO Proceeding commenced at Toronto

CONSENT TO EXTEND TIME TO PERFECT

HEENAN BLAIKIE LLP 2900 Bay Adelaide Centre 333 Bay Street Toronto, Ontario M5H 2T4

Kenneth D. Kraft, LSUC #31919P John Sattnas, LSUC# 42336B

Tel: 416.643.6822 / 416.360.3570

[email protected] / jsalmasheenan.ea

Fax: 416.360.8425


HBdocs - 8221127v6

TAB 14

C VS/ Cameron MeKenna

All Parties on the Service List

Your Ref. Our Ref NEJA/M1T2.62a

CMS Cameron mcKenna LIP

Mitre House 160 Aldersgate Street London EC1A 4DD

Tel +44(0)20 7367 3000 Fax+44(0)20 7367 2000 www.cms-cmck.com DX 135316 BARBICAN 2

Tel +44(0) 207 3667 3118 [email protected]

30 September 2010

Dear Sirs/Mesdames

Ontario Superior Court, File No. 09-CL-8456-00CL

' We write to you as counsel for Lloyds TSB Commercial Finance Limited ("Lloyds TSB").

Lloyds TSB, in its capacity as agent, security trustee and debt purchaser of Aero Inventory (UK) Limited and Aero Inventory plc (collectively, "Aero"), has instructed us to write to you.

On February 6, 2009, Aero, Lloyds TSB and Air Canada entered into an intercreditor agreement (the "Intercreditor Agreement"), whereby Air Canada expressly acknowledged Lloyds TSB's security over Aero's assets, including the bills of exchange (the "Bills of Exchange") that Acro received from Air Canada pursuant to a Bulk Inventory Purchase Agreement, dated January 28, 2009. It appears from the materials now filed with the Ontario Superior Court of Justice that, after entering the Intercreditor Agreement, Air Canada: i) sought and accepted a pledge of five of the Bills of Exchange; ii) converted certain Bills of Exchange into promissory notes; and iii) was transferred inventory in bulk. Lloyds TSB believes that by entering into these transactions Air Canada breached its obligations under the Intercreditor Agreement.

We are aware that KPMG Inc., in its capacity as Trustee-in-Bankruptcy (the "Trustee") of Aero, is pursuing a preference claim against Air Canada in connection with the above-mentioned transactions. We understand the Trustee's position to be that Lloyds TSB will have priority to the proceeds of a successful claim by the Trustee. We also understand Air Canada's position to be that the proceeds ought to go to the unsecured creditors.

On behalf of Lloyds TSB, we write to advise that Lloyds TSB intends to pursue its remedies against Air Canada in the event that the claims for breach of the Intercreditor Agreement are not fully satisfied by the recoveries from the preference claim.

(23107637.01) CMS Cameron McKenna LLP Is a limited liability partnership registered In England and Wales with registration number 0C310335. It is a body corporate which uses the word "partner to refer to a member or an employee or consultant with equivalent standing and qualifications. A list of members and their professional qualificabons is open to inspection at the registered office, Mitre House, 160 Aldersgate Street, London EC1A 400. Members are either solicitors or registered foreign lawyers. Regulated by the Sdicitors Regulation Authority.

CMS Cameron McKenna LLP is a member of the CMS alliance of independent European law firms.

CMS offices end associated offices: Amsterdam, Berlin. Brussels. London, Madrid, Paris, Rome, Vienna, Zurich. Aberdeen, Algiers, Antwerp, Arnhem, Beijing, Belgrade. Bratislava. Bristol, Bucharest, Budapest, Buenos Aires. Casablanca, Cologne. Dresden, Dusseldorf. Edinburgh, Frankfurt, Hamburg, Kyiv. Leipirg, Ljubljana, Lyon. Marbella, Milan. Montevideo, Moscow, Munich. New York. Prague, Sao Paulo, Sarajevo, Seville, Shanghai, Sofia, Strasbourg, Stuttgart, Utrecht, Wasaw and Zagreb. ,,wow.cmslegaicom

Notice: the rum does not accept service by e-mail of court proceedings, other processes or formal notices of any kinl without specific prlorwrittenagreemert

H 5

C /M /S / Cameron iVicKenna

This letter is without prejudice to or waiver of any rights or remedies of Lloyds TSB against Air Canada.

Yours faithfully

cms cetAkeltr Nr\cKpAr\lkc

CMS Cameron'UcKenna LLP

2 (23107637.01)

TAB 15

Court File No. 09-8456-00CL

ONTARIO SUPERIOR COURT OF JUSTICE

(COMMERCIAL LIST)

IN THE MATTER OF THE COMPANIES' CREDITORS ARRANGEMENT ACT, R.S.C. 1985, c. C-36, AS AMENDED AND IN THE MATTER OF JAMES ROBERT TUCKER, RICHARD HEIS AND ALLAN WATSON GRAHAM OF KPMG LLP, AS JOINT ADMINISTRATORS

Applicants


Respondents

APPLICATION UNDER SECTION 46 AND FOLLOWING OF THE COMPANIES' CREDITORS ARRANGEMENT ACT, R.S.C. 1985, c. C-36, AS AMENDED

AFFIDAVIT OF ALAN BUTTERFIELD ON BEHALF OF AIR CANADA (Solemnly Affirmed and Declared January 28, 2010)

I, Alan Butterfield, of the City of Beaconsfield, in the Province of Quebec,

SOLEMNLY AFFIRM AND DECLARE:

1. I am the Vice President, Maintenance and Engineering, of Air Canada. My

responsibilities include all aspects of the maintenance, repair and overhaul of Air Canada's fleet

of aircraft including Air Canada's relationship with suppliers of spare parts and equipment such

as Aero Inventory (UK) Limited ("Aero"). As such I have knowledge of the matters declared in

this Affidavit or, if I do not, I have relied on my information and belief and believe my

statements to be true.

2. In the report they filed with this Court in support of their motion for an order seeking to

recognize in Canada the November I I, 2009 administration order in respect of Aero and its

holding company, Aero Inventory PLC ("Aero PLC" and, together with Aero, the "Aero

- 2 -

Companies") which motion was granted by the Ontario Superior Court of Justice that same day

(the "Recognition Order"), the UK administrators (the "Administrators") made numerous errors

of fact, many of which are detailed in this Affidavit, respecting the relationship between Air

Canada and the Aero Companies and the obligations and balances of account owing between

them.

3. Although it is possible the Administrators did not possess all information that was needed

to understand the relationship between Air Canada and the Aero Companies at the time the

Recognition Order was made, Air Canada has since given the Administrators all of the relevant

contracts, which, in any event, were in the possession of the Aero Companies, as well as the

financial information compiled by Air Canada, the responsibility for much of which was to be

borne by Acro under the agreements between Aero and Air Canada. Air Canada has also made

available to the Administrators, members of Air Canada's management and its maintenance

personnel to assist the Administrators in understanding the logistics, procurement and

management of the consumable and expendable spare parts and services supplied by Aero to Air

Canada and financial arrangements between the parties. Despite these efforts by Air Canada, the

Administrators continue to mischaracterize the agreements and relationship between Air Canada

and the Acro Companies and the steps taken by Air Canada since the Recognition Order,

including the extraordinary efforts required of Air Canada to mitigate the extensive damages

sustained by Air Canada as a result of the breach of the Aero Companies' obligations to Air

Canada, the interruption of all services provided to Air Canada and the dismissal of Aero's

employees assigned to service Air Canada.

4. The main focus of this Affidavit is the relief sought by Air Canada from the limitation

under the Recognition Order against the exercise of set-off rights. However, this Affidavit also

seeks to correct inaccuracies that Air Canada believes exist in the current Court record. Most

importantly, Air Canada was, at the date of the Recognition Order and throughout most of its

relationship with the Acro Companies, and Air Canada continues to be a net creditor of the Aero

Companies, not a net debtor.

5. As the Administrators acknowledge in the Report submitted with the motion for the

Recognition Order (par. 13):

- 3 -

"[the) principal activity of the Aero Group [is the] provision of a comprehensive procurement and inventory management service to companies in the aerospace industry. Specifically, [Aero] sources, distributes and sells consumable and expendable parts (e.g., bearings, fasteners and gaskets) required in the maintenance of aircraft, its customers being airlines and aerospace maintenance and repair companies around the world."

6. As between Air Canada and Aero, the expendable spare parts that Aero sold are known as

Category 3 Inventory ("CAT 3 Inventory"). Spare parts are classified as CAT 3 Inventory

because they are either single-use items that arc not capable of repair or items which, after the

performance of certain procedures, are re-certifiable for limited periods. Consumable spare

parts, such as machinc oils or fluid and other materials that breakdown with use, are entirely

consumed during the maintcnance or operation of aircraft. Expendable spare parts must be

traceable, warranted and certifiable. Tracking systems must record the entire life-cycle of each

expendable part from the time of manufacturing of the part until it is destroyed. Air Canada

requires tens of thousands of different types of CAT 3 Inventory to maintain its aircraft. Very

substantial stocks of CAT 3 Inventory must be maintaincd at all times and must be accessible at

each site where maintenance is performed. Thc efficient procurement and management of CAT

3 Inventory is a crucial and complex task, indispensable to Air Canada's operations and the

delivery of its services to customers.

7. In December, 2008, Air Canada and Aero entered into an Agreement for the Supply and

Management of Consumable and Expendable Spares (the "Line Maintenance Agreement"). Line

maintenance is generally considered to be minor or scheduled maintenance carried out on

aircrafts that are in service (such as overnight maintenance and maintenance between flights).

Under the Line Maintenance Agreement, Aero became Air Canada's exclusive supplier for

approximately 98% of CAT 3 Inventory used by Air Canada for line maintenance on its mainline

aircraft Acro also assumed responsibility for managing all aspects of the procurement and

delivery of CAT 3 Inventory for line maintenance, including monitoring and planning for Air

Canada's consumption and use of the inventory. A copy of the Line Maintenance Agreement is

attached as Exhibit "A".

8. The implementation of the Line Maintenance Agreement was part of Air Canada's long-

term strategy to focus on customer service and reduce operating expenses by outsourcing certain

- 4 -

supply and logistics functions, including the procurement and management of CAT 3 Inventory

for line maintenance. A key element of this strategy, implemented after Air Canada's successful

restructuring under the Companies' Creditors Arrangement Act in 2004, was to appoint Aveos

Fleet Performance Inc. ("Aveos") as Air Canada's sole supplier of certain maintenance services.

The Line Maintenance Agreement enabled Air Canada to pursue this strategy further, by

outsourcing the procurement and management of thc CAT 3 Inventory used in line maintenance

while nevertheless retaining responsibility itself for the maintenance performed.

9. Having concluded the Line Maintenance Agreement with Aero and previously

outsourced most procurement and maintenance functions to Aveos, Air Canada did not intend,

and until the default of the Aero Companies following the Recognition Order, was not required

to takc on any responsibility for the logistics, procurement or management of CAT 3 Inventory.

However, for the reasons explained in this Affidavit, and, specifically, what appeared to be Air

Canada's relatively lower cost of capital, it was beneficial for the Aero Companies and Air

Canada that Air Canada bear a portion of the capital cost of the CAT 3 Inventory required by

Aero to perform its services for Air Canada.

10. Air Canada financed a portion of the capital cost of the CAT 3 Inventory required by

Aero under two principal agreements. In February, 2009, Air Canada purchased

US$100,000,000 of Aero's then current stock of CAT 3 Inventory under a Bulk Inventory

Purchase Agreement dated January 28, 2009 between Air Canada and the Aero Companies

(the "January Purchase Agreement"). A copy of the January Purchase Agreement is attached as

Exhibit "B". In October, 2009, Air Canada agreed to purchase additional CAT 3 Inventory from

Aero's then current stock but in three equal instalments, each valued at USS8,500,000,

deliverable on October 23, 2009, November 1, 2009 and December 1, 2009, and each payable

approximately 60 days after delivery (the "October Purchase Agreement"). A copy of the

October Purchase Agreement is attachcd as Exhibit "C".

11 The January Purchase Agreement was proposed by the Aero Companies. The Acro

Companies informed Air Canada that under their proposal, Air Canada could procure a

guaranteed supply of CAT 3 Inventory matching Air Canada's requirements for I year and that

Air Canada could defer making any payment for thc inventory until the end of the year.

- 5 -

12. Thc Aero Companies were expanding aggressively and appeared to require massive

capital investments. By the fall of 2008, the Acro Companies' access to capital markets

appeared to be limited due to the collapse of credit and financial markets generally. The Aero

Companies advised Air Canada that Aero had the opportunity to become the exclusive supplier

of another major airline, a transaction that would reduce its overall operating costs and would

indirectly benefit Air Canada. The transaction with another major airline would be predicated on

the purchase of the airline's existing stock of CAT 3 Inventory and would require a significant

capital investment. Market conditions at the time seemed to preclude the Aero Companies from

raising sufficient funds independently for this purpose. Acro's proposal to Air Canada involved

the leveraging or monetization of a portion of Aero's stock of CAT 3 Inventory in Canada by

selling it to Air Canada. Air Canada concluded that, if it could purchase the CAT 3 Inventory in

bulk, pay the purchase price under negotiable bills or notes maturing in the future — after Air

Canada had consumed the inventory — the transaction would be strongly cash flow positive for

Air Canada. A purchase transaction bascd on payment instruments that the Aero Companies

could discount and sell on the London commercial paper market would achieve the parties'

objectives and creatc a source of new capital for the Aero Companies based on Air Canada's

credit rating.

13. More specifically, the January Purchase Agreement provided three advantages to Air

Canada. First, Air Canada would acquire CAT 3 Inventory necessary to meet its forecast

consumption for a year but would pay for that inventory only at the end of the year. Second,

because Aero would be buying back the inventory in order to supply Air Canada under the Line

Maintenance Agreement and to supply Aveos under its exclusive supply agreement with Aveos,

Air Canada would receive monthly payments from Aero before making any cash outlay itself on

account of the Purchase Price. Third, Air Canada could obtain certain discounts and volume

rebates under thc Line Maintcnance Agreement. For the Aero Companies, the January Purchase

Agreement held out the prospect of raising new capital undcr then prevailing market conditions

that limited the Aero Companies' access to the capital markets.

14. Under the January Purchase Agreement, Aero sold to Air Canada the CAT 3 Inventory

described in Schedule 2.1(c) to the agreement (the "January Inventory Pool"). Air Canada paid

an aggregate purchase price of US$100,000,000 plus applicable goods and services tax and

1 Z

- 6 -

provincial sales taxes, representing an aggregate purchase price of US$110,740,027 (the

"January Purchase Price"). The January Purchase Price, less a holdback (as provided for in the

January Purchase Agreement) in the amount of US$10,000,000 (the "Holdback"), was paid in

full at the time of the transaction closed on February 9, 2009.

15. The January Purchase Price, less the Holdback, was paid at closing by way of thc

acceptance by Air Canada and delivery to Aero of the following bills of exchange drawn by Aero

on Air Canada and payable on February 8, 2010 (the "Bills of Exchange"):

Principal Amount Number Maturity

US$10,000,000 1 February 8, 2010 US$10,000,000 2 February 8, 2010 US$10,000,000 3 February 8, 2010 US$10,000,000 4 February 8, 2010 US$10,000,000 5 February 8, 2010 US$10,000,000 6 February 8, 2010 US$10,000,000 7 February 8, 2010 US$10,000,000 8 February 8, 2010 US$10,000,000 9 February 8, 2010 US$10,740,026.72 10 February 8, 2010

Copies of the Bills of Exchange are attached as Exhibit "D".

16. The delivery of the Bills of Exchange by Air Canada to Aero at the closing of the

purchase and sale transaction under the January Purchase Agreement discharged and constituted

full and final payment by Air Canada of the January Purchase Price except the Holdback.

17. The January Purchase Agreement was amended as of February 6, 2009, in order to

specify the conditions for the closing of the transactions contemplated by the agreement. A copy

of the First Amending Agreement is attached as Exhibit "E".

18. As further consideration for the purchase of the CAT 3 Inventory under the January

Purchase Agreement, the Line Maintenance Agreement was amended in order to guarantee Air

Canada a monthly rebate of US$100,000. This amendment also provided for three additional

- 7 -

rebates to Air Canada of US$833,333.33 each, payable on July 1, 2009, and on July 1 of each

year thereafter until July 1, 2011. A copy of the relevant First Amending Agreement (the "LMA

First Amending Agreement") is attached as Exhibit "F".

19. Air Canada insisted on receiving extensive representations and warranties under the

January Purchase Agreement. Part of the benefit to it under the transaction accrued because it

would use the spare parts from the January Inventory Pool before being required to make any

payments under the Bills of Exchange. For this to occur, it was essential that the CAT 3

Inventory in the January Inventory Pool be of a nature and kind, and purchased in quantities, that

would meet Air Canada's requirements over the ensuing twelve (12) months. Thc Acre

Companies madc the following specific representation and warranty to Air Canada in section

3.6(e) of the January Purchase Agreement:

"(e) Supply Management. The Seller is a specialist in inventory management and planning for the aerospace industry. The Seller has made investigations of historical relevant data and has made enquiries necessary and has the data and software required to forecast the Buyer's consumption of Parts and other inventory of the same nature or kind as the Purchased Inventory in the ordinary course of business during the twelve (12) months following the Closing Date. Based on historical data and the forecast derived from the Seller's investigations, enquiries and expertise, the Purchased Inventory does not exceed the requirements of Air Canada for such period. Only "high usage" C&E and Parts form part of the Purchased Inventory and none of the Purchased Inventory is or will become obsolete or unusable during the twelve (I 2) months following the Closing Date".

20. In planning for the purchase and sale transaction under the January Purchase Agreement,

Air Canada took the steps necessary to verify and protect its interests in the January Inventory

Pool, including obtaining the consent of the Aero Companies' senior lenders and the discharge of

thcir security interests in the January Inventory Pool, taking its own security in the January

Inventory Pool, obtaining confirmation from Air Canada's auditors and the Aero Companies'

auditors that the transaction would be recorded as a sale and insisting on receiving the benefit of

the following representations, set out in section 3.5, 3.6 and 3.7 of the January Purchase

Agreement.

"3.5 Transfer of Title

- 8 -

At the Closing, the Buyer will acquire good, valid and marketable title to all the Purchased Assets, free and clear of any Lien, except any Lien in favour of the Buyer".

"16 Purchased Assets

(a) Description of Purchased Inventory. Schedule 2.1 contains an accurate and complete description of the Purchased Inventory.

(b) Related Assets. Schedule 3.6(b) contains an accurate and complete description of any material Related Assets.

(c) Location of Purchased Assets. All Purchased Assets are located at the premises identified in Schedule 3.6(e). The owner and any other person having any interest in or access to such premises, other than the Seller and the Buyer, is also identified in Schedule 3.6(c)".

"3.7 Financial Information and Accounting Treatment

(a) Financial Statements. The financial statements of each AI Party described in the Closing Agenda have been prepared from the books and records of each such Al Party in accordance with International GAAP and present fairly in all material respects the financial condition of such AI Party as at the date thereof.

(b) No Material Adverse Change. Since the date of the financial statements of each AI Party described in the Closing Agenda, there has been no Material Adverse Change.

(c) Solvency. Thc Aero Inventory Group is able to pay its liabilities as such liabilities become due. The fair market value of the assets of the Aero Inventory Group cxceed the liabilities of the Aero Inventory Group.

(d) Accounting Recognition. The Purchase Transaction will be recognized on the balance sheet and income statement of the Seller as a sale of the Purchased Assets."

- 9 -

21. Aero PLC made these representations and warranties jointly and severally (solidarily)

with Aero and agreed to indemnify Air Canada in connection with Aero's obligations under the

January Purchase Agreement.

22. For Aero, the commercial value in the transaction arose only if it succeeded in

discounting and selling the Bills of Exchange, raising thc capital it required. Air Canada learned

after the closing of the transaction that Aero had not taken any steps to pre-sell the Bills of

Exchange or obtain firm commitments to purchase them or a put option. It appears that the Aero

Companies entered into the January Purchase Agreement without any assurance that they would

be able to sell the Bills of Exchange.

23. After the closing of the transaction under the January Purchase Agreement, Acro

informed Air Canada that it was having difficult) , selling the Bills of Exchange.

24. Only weeks after the closing of the transaction under the January Purchase Agreement,

Acro sought to sell a number of Bills of Exchange to Air Canada. Because Air Canada was

concerned when it learned of the difficulty in selling the Bills of Exchange and had concluded

the January Purchase Agreement to conserve cash, it was reluctant to buy any Bills of Exchange.

Instead, it proposed that thc parties take the steps necessary to reverse the transaction. The Aero

Companies refused to consider unwinding the purchasc and sale. Air Canada agreed to purchase

two Bills of Exchange but subject to a discount of 50%. Bills of Exchange Nos. 1 and 2 were

thus acquired by Air Canada. Air Canada understands that the proceeds from the transaction

were used to make an interest payment to the Aero Companies' senior lenders. A copy of the

BofE Purchase Agreement dated February 23, 2009 is attached as Exhibit "G".

25. The first sales under the Line Maintenance Agreement occurred in Spring of 2009. All

sales of CAT 3 Inventory that occurred under the Line Maintenance Agreement and the purchase

price and other amounts payable by AC on account of the agreement are summarized in the

fo I I owing table:

a 3

- 10 -

Description Amount Taxes Total

May 2009 Consumption US$1,774,954.69 US$131,206.88 US$1,876,161.57

Jun. 2009 Consumption US$1,916,261.45 US$136,537.00 USS2,052,798.45

Jul. 2009 ConsAption US$1,658,397.13 US$100,405.58 US$1,758,802.71

Aug. 2009 Consumption US$1,792,465.66 US$132,544.29 US$1,925,009.95

Sept. 2009 Consumption US$1,874,126.24 US$152,694,69 US$2,027,090.93

Oct. 2009 Consumption* US$2,301,479.06 US$155,509.92 US$2,456,988.98

Nov. 1-10, 2009 Consumption* US$456,196.74 US$30,825.01 US$487,021.75

Total US$11,743,880.97 US$839,993.37 US$12,583,874.34

* It was the responsibility of Aero to generate and deliver invoices under the Line Maintenance Agreement. No invoices were given to Air Canada for October or November. These figures are based on Air Canada's own audit.

26. The cumulative rcbates payable to Air Canada based on the LMA First Amending

Agreement and the achievement of annual spend targets, are summarized in the following table:

Description Amount

May 2009 Line Mtce. Rebatc US$100,000.00

Jun. 2009 Line Mtce. Rebate US$100,000.00

Jul. 2009 Line Mtce. Rebate US$100,000.00

Aug. 2009 Line Mtce. Rebate US$100,000.00

Sep. 2009 Line Mtce. Rebate US$100,000.00

Oct. 2009 Line Mtce. Rebate US$100,000.00

Nov. 2009 Line Mtce. Rebate US$33,333.33

Line Maintenance Conditional Rebate US$833,333.33

Total US$1,466,666.66

27. The Line Maintenance Agreement, as amended by the LMA First Amending Agreement,

was in full force and effect as of the date of the Recognition Order. As at that date, Air Canada

was indebted to Aero in the amount of US$11,050,541.01, representing the difference between

the sales under the Line Maintenance Agreement and the cumulative rebates owing as at that

12,6

date. These balances do not include expenses which Air Canada is entitled to deduct from the

amount payable to Aero nor the damages caused by Acro's breach and disclaimer of the Line

Maintenance Agreement.

28. Contrary eo the evidence presented in the report of the Information Officer to this Court

at the time of the Recognition Order, Air Canada was entitled to approximately US$1,500,000 in

rebates under the Line Maintenance Agreement. More importantly, the Information Officer's

report omitted any reference to the obligations of Aero to Air Canada under the January Purchase

Agreement, the October Purchase Agreement and the other transactions that occurred in the

period until the end of October, 2009. The net effect of these transactions is that Aero was

indebted to Air Canada, not the other way around.

29. As explained, it is important to appreciate that in order to supply CAT 3 Inventory to Air

Canada under the Line Maintenance Agreement and to supply CAT 3 Inventory to Aveos, Acro

was buying CAT 3 Inventory from the January Inventory Pool throughout the period preceding

thc Recognition Order. In fact, Aero purchased CAT 3 Inventory from Air Canada daily until

the Administrators ceased making any such purchases.

30. The following is a summary of the purchases made by Aero from the CAT 3 Inventory

Pool, based on the monthly invoices issued and approved by the parties:

- 12 -

Month Aero Purchases Taxes Total

February 2009 US$6,806,468.00 US$706,886.30 US$7,513,354.30

March 2009 US$7,909,346.00 US$775,146.80 US$8,684,492.80

April 2009 US$5,139,597.16 US$533,435.40 US$5,672,992.56

May 2009 US$5,072,642.40 US$536,805.02 USS5,609,447.42

Junc 2009 US$2,122,210.13 US$233,496.46 US$2,355,706.59

July 2009 US$1,671,345.93 US$179,678.74 US$1,851,024.67

August 2009 US$1,721,126.06 US$174,481.92 US$1,895,607.98

September 2009 US$2,598,706.15 US$237,493.56 US$2,836,199.56

October 2009* US$1,054,859.56 US$107,944.11 US$1,162,803.67

November 2009* US$389,192.95 US$41,419.62 US$430,612.57

Total US$34,485,454.19 US$3,526,787.93 US$38,012,242.12

* Air Canada calculations. Not approved by Aero.

31. None of the invoices for the sales described in the foregoing table were paid by Aero. As

early as March, it became clear that Aero believed that because it had failed to sell the Bills of

Exchange or raise the capital it had hoped for from the January Purchase Agreement, it was

entitled to postpone the payment of its mounting debt to Air Canada. There was no basis for this

belief.

, 32. The foregoing table also demonstrates that the Acro Companies had breached the

representation and warranty made in section 3.6(e) of the January Purchase Agreement to the

effect that all the CAT 3 Inventory from the January Inventory Pool would be used or consumed

by Air Canada within twelve months. Because the January Purchase Agreement providing for

aggregate consumption of US$100,000,000 within 12 months, compliance with this

representation and warranty would require average monthly purchases by Aero of US$8,500,000.

33, Around April 7, 2009, to induce Air Canada to refrain from exercising its remedies, Acro

delivered two Bills of Exchange to Air Canada but in escrow and subject to a right of

redemption. Aero also granted Air Canada the right to set off the Bills of Exchange against Aero

Z

12g

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payables if Aero failed to remedy its defaults. A copy of the interim pledge and escrow is

attached as Exhibit "H".

34. On May 1, 2009, Air Canada sent a demand for payment to Aero, including a demand

that Acro make arrangements to pay for future purchases of CAT 3 Inventory by delivering

additional Bills of Exchange. A copy of the Air Canada demand is attached as Exhibit "I".

35. On May 8, 2009, with Aero's consent, two Bills of Exchange were released from escrow

and delivered to Air Canada to enable Air Canada to set-off the amounts payable under the Bills

of Exchange against Air Canada's outstanding receivables from Aero.

36. In March and May of 2009, based on the declining volumes of consumption from the

January Inventory Pool for the period from March 2009 through to May 2009, Air Canada

undertook an audit of the CAT 3 Inventory in the January Inventory Pool. Based on the results

of the audit, Air Canada estimated that as much as US$40,000,000 or more of the spare parts

remaining in the January Purchase Pool would not be used by Air Canada within the period

agreed to between the parties under the January Purchase Agreement and that the remaining

January Inventory Pool was comprised of many spare parts that could not be used by Air Canada

at all or would not be used for 24 months or more. Air Canada notified Aero of Aero's breach

and demanded that the breach of warranty be remedied. Aero acknowledged thc breach and

agreed to remedy the breach by replacing the non-conforming inventory with conforming

inventory that it said it had on site in Canada. It agreed to pay Air Canada any difference

between actual consumption and the average monthly consumption that would be necessary to

meet the warranty requirements, namely US$8,500,000, if the new inventory was not delivered.

This agreement was later memorialized in the Warranty Performance Agreement executed

between the parties in October, 2009 (the "Warranty Performance Agreement"). Based on the

agreement, procedures were implemented immediately to begin to correct the composition of the

January Inventory Pool. Beginning in June 2009, invoices included both the amount owed for

CAT 3 Inventory actually consumed and the amount owed for warranty performance. In

addition, a special invoice was issued for the aggregate difference between actual consumption

during the months of February through to May and the agreed monthly minimum consumption of

1Zei

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US$8,500,000 necessary to comply with the warranty requirements. A copy of the Warranty

Performance Agreement is attached as Exhibit "J".

37. As Aero's indebtedness to Air Canada increased throughout the summer of 2009,

including indebtedness arising from its warranty performance obligations, Aero agreed, in

August of 2009, to deliver three more Bills of Exchange into escrow and authorized Air Canada

to set off the Bills of Exchange against its outstanding receivables from Aero. A copy of the

second interim escrow and set-off agreement is attachcd as Exhibit "K".

38. Throughout thc summer of 2009, negotiations continued between Air Canada and Aero

with a view to settling their disputes and, in particular, agreeing on the terms and conditions

under which Aero would exchange the Bills of Exchange that it held for the CAT 3 Inventory it

was purchasing from Air Canada or in payment of its warranty obligations. However, Aero and

Air Canada could not agree on the discount rate to be used to establish the fair market value of

the Bills of Exchange. During this period, Aero appeared to be seeking buyers for the Bills of

Exchange in the commercial paper market, relying on improvements in Air Canada's financial

condition.

39. Air Canada learned during this period that Aero PLC was showing a markedly improving

share price and, in October 2009, Aero PLC advised Air Canada that it was negotiating a major

equity issue and had applied for a listing on the senior board at the London Stock Exchange.

40. On October 9, 2009, a term sheet was agreed to between Air Canada and Aero providing

for the settlement of their disputes. A copy of the term sheet is attached as Exhibit "L".

41. The settlement of the dispute between Air Canada and the Acro Companies involved

several key concessions by each of the parties:

(a) Air Canada would be bound to buy two Bills of Exchange and, except for

US/$2,000,000 which would be used to set-off against AI payables; the purchase

- 15 -

pricc would be paid to Al; the discount rate in respect of the Bills of Exchange to

be purchased was fixed at 15%, generating proceeds of US$17,000,000 for Aero;

(b) Aero would deliver to Air Canada the remaining Bills of Exchange in its

possession, except Bill of Exchange No. 10 which Aero would sell in a private

placement, generating additional cash proceeds;

(c) the discount rate for the five Bills of Exchange that had previously been delivered

to Air Canada, and which Air Canada had the right to set off against outstanding AI

payables, would he fixed at 5%;

(d) to compensate Air Canada for the cost of capital relating to the foregone cash

payments under the January Purchase Agreement, the Holdback would be reduced

by US$4,000,000;

(e) Air Canada agreed to purchase new CAT 3 Inventory from Aero, representing new

receivables fbr Aero in an aggregate amount of US$25,500,000 plus applicable

taxes, provided that the sales would be in instalments and that Air Canada would

have no obligation to pay for any instalment for at least 60 days; and

(f) the parties would memorialize and give effect to their agreement relating to

warranty performance in the Warranty Purchase Agreement.

42. In certain pleadings, the Administrators suggest that Air Canada received a preference

under thc settlement transactions entered into in October, 2009 or that these transactions were

otherwise prejudicial to the Aero Companies or their creditors. As demonstrated in the table in

paragraph 48, if the settlement transactions had not been concluded, Air Canada would be a net

creditor of the Aero Companies at the time of the Recognition Order. If the financial impact of

these transactions is disregarded, the Aero Companies would be indebted to Air Canada at the

date of the Recognition Order, and excluding the damages suffered by Air Canada as a result of

the Acro Companies' breach of their agreement with Air Canada, in the amount of

VD-

- 16 -

US$23,949,829.95. As part of the settlement transactions, the Bills of Exchange delivered to Air

Canada were exchanged for Demand Promissory Notes. There should be no confusion regarding

the purpose of these exchanges, which was twofold: to convert thc Bills of Exchange which

matured on February 8, 2010 into obligations payable on demand, that is, to accelerate Air

Canada's indebtedness; and, to evidence the discount rate negotiated and fixed by mutual

agreement.

43. As previously stated, as part of the settlement transactions, the January Purchase

Agreement, as amended, was further amendcd by a Second Amending Agreement (thc "Second

January Agreement Amendment"). Thc Second January Agreement Amendment reduced the

Holdback under the January 2009 Agreement from US$10,000,000 to US$6,000,000. This

transaction compensated Air Canada for the damages it suffered due to the loss of the cash flows

that should have been generated under the January Purchase Agreement. A copy of the Second

January Agreement Amendment is attached as Exhibit "M".

44. The settlement transactions were concluded on October 23, 2009. Air Canada paid to or

to the order of Acro US$15,000,000 under the Demand Promissory Notes exchanged for Bills of

Exchangc Nos. 8 and 9. Air Canada then sct off US$2,000,000 and the amounts owing under the

Demand Promissory Notes exchanged for Bills of Exchange Nos. 3-7 against amounts due and

owing to Air Canada as at September 30, 2009. After the conclusion of these transactions, the

Aero Companies continued to be net debtors to Air Canada for ongoing purchases of CAT 3

Inventory from the January Purchase Pool and for warranty performance under the January

Purchase Agreement.

45. In summary, for the period beginning in February, 2009 and ending in October, 2009, Air

Canada purchased Bills of Exchange from Aero at thc dates and subject to discounting at or

above market rates, as set out below.

\r32

- 17 -

Discounted Date of Delivery Date of Purchase Principal Purchase to Air Canada by Air Canada Bill No. Amount Price

February 23, 2009 February 23, 2009 I US$10,000,000 US$5,000,000 February 23, 2009 February 23, 2009 2 US$ 1 0,000,000 US$5,000,000 May 8, 2009 October 23, 2009 3 US$10,000,000 US$9,500,000 May 8, 2009 October 23, 2009 4 US$10,000,000 US$9,500,000 August 19, 2009 October 23, 2009 5 US$10,000,000 US$9,500,000 August 19, 2009 October 23, 2009 6 US$10,000,000 US$9,500,000 August 19, 2009 October 23, 2009 7 US$10,000,000 US$9,500,000 October 23, 2009 October 23, 2009 8 US$10,000,000 US$8,500,000 October 23, 2009 October 23, 2009 9 US$10,000,000 US$8,500,000

Total US$90,000,000 US$74,500,00

46. As a result of the settlement transactions, including the Second January Agreement

Amendment, the balance of the Purchase Price payable by Air Canada under the January

Purchase Agreement, as at October 24, 2009, was as follows:

Description Amount

Original Purchase Price List: US$110,740,026.72

Amounts Prepaid by Air Canada by Discounting Bills of Exchange: US$90,000,000

Capital-cost of Non-payment US$4,000,000

Cash Proceeds for Aero US$27,000,000

Payment of Acro's Arrears on AC's Receivables US$47,500,000

Balance of Purchase Price: US$16,740,026.72

Amount Payable to Holder of Bill of Exchange No. 10: US$10,740,026.72

Amount Payable to Aero: US$6,000,000

47. As explained, on October 23, 2009 the parties also entered into the Warranty

Performance Agreement. This agreement confirmed and extended the agreement already made

- 18 -

and in force for the purpose of remedying Aero's breach of warranty under the January Purchase

Agreement. The Warranty Performance Agreement was advantageous to Aero because it gave

Aero a three-month time frame in order to satisfy outstanding warranty obligations instead of Air

Canada holding it liable for the full breach of warranty immediately.

48. The following table summarizes the respective balances owing between Air Canada and

the Aero Companies on the assumption that none of the October settlement transactions had been

concluded.

V64 - 19 -

Receivables Balances Assuming No October Settlement Transactions

(Pre-Tax Amounts as at November 10, 2009)

Agreement Obligation Air Canada Receivable Aero Receivable

Line Maintenance Agreement

Inventory Purchases

Monthly

N/A US$11,743,880.97

Rebates US$633,333.33 N/A

Conditional Rebate US$833,333.33 N/A

Total US$1,466,666.66 US$11,743,880.97

January Purchase Inventory Agreement Purchases US$34,485,454.19 N/A

Holdback N/A US$10,000,000.00

Warranty Performance US$65,514,545.81 N/A

Eligible Expenses US$859,498.76 N/A

Capital Cost of Non-payment* US$2,867,545.50 N/A

Total US$103,727,044.26 USS I 0,000,000.00

Bills of Exchange Principal Nos 3 -- 9** Amount N/A US$70,000,000.00

Market Discount*** US$10,500,000.00 N/A

Total US$10,500,000.00 US$70,000,000.00

Grand Total US$115,693,710.92 US$91,743,880.97

Air Canada's historical annual capital cost is 10% annually (0.03% daily). Aero was obliged to compensate Air Canada for the delay in payment. This is the minimum rate discussed.

** Bills Nos. 1, 2 and 10 were sold by Aero for cash *** Based on third-party market purchase of Bill 10

49. Air Canada understands that, in the course of an audit conducted as a condition of the

new listing sought by Aero PLC and its proposed equity issue, serious accounting irregularities

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were discovered in the books and records of the Aero Companies. Although Air Canada had

reason to be concerned about Aero's failure to pay for the CAT 3 Inventory it was purchasing

from Air Canada, Air Canada had no reliable knowledge of any accounting irregularities and was

given representations and warrantics by the Aero Companies under the October Purchase

Agreement respecting among other things, their solvency and their financial condition generally.

In October 2009, when the settlement transactions were concluded, the price of Aero PLC's

stock had been rising for several months. Air Canada had no reason to believe the trend was not

a reliable indicator of the Aero Companies' financial condition and prospects.

50. Aero has defaulted in the performance of its obligations undcr the Line Maintenance

Agreement, the Warranty Performance Agreement and the October Purchase Agreement. Air

Canada has informed the Administrators that no payment would be made under the Line

Maintenance Agreement, the October Purchase Agreement or any other agreement between the

parties until the obligations owed by the Aero Companies to Air Canada have been discharged.

The Administrators have dismissed Aero's employees in Canada and refused to perform their

obligations, disrupting Air Canada's operations and causing it extensive damages.

51. Following the Recognition Order, the Administrators wrote to Air Canada, to inform Air

Canada that Aero did not consider itself to be bound by the Line Maintenance Agreement and

dictating new commercial terms for all transactions. Since the date of the Recognition Order,

Aero has failed to provide any of the services or support required under the Line Maintenance

Agreement, disrupting Air Canada's operations and causing it extensive damages. A copy of the

Administrators' letter to Air Canada is attached as Exhibit "N".

52. Because Air Canada holds CAT 3 Inventory purchased under the January Purchase

Agreement and the October Purchase Agreement, it has not needed to purchase any CAT 3

Inventory from Aero under the Line Maintenance Agreement since the date of the Recognition

Order, except certain parts in limited quantities. Air Canada has taken over the inventory

procurement and management functions that it had outsoureed to Aero, The disruption of Air

Canada's operations and the increased costs are substantial, including a profound change in the

implementation of Air Canada's long-term strategic objectives to outsource the procurement and

management of CAT 3 Inventory.

Alan Butterfiel

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53. Finally, I understand that Aero assigned itself into bankruptcy by way of assignment on

January 22, 2010, with KPMG Inc. appointed as bankruptcy trustee. A copy of thc notice from

the Official Receiver confirming the assignment is attached as Exhibit "0".

54. 1 make this Affidavit in support of Air Canada's motion that the set-off provisions in the

Recognition Order are improper or, in the alternative, Air Canada should be entitled to set-off all

amounts owed to it by Aero and that any determination of the validity of such set-off rights arc

more properly determined by the Courts in the Province of Quebec and for no other or improper

purpose.

SOLEMNLY AFFIRMED AND

DECLARED BEFORE ME at the City

of Montreal, in the Province of Quebec

this 211 Jan , 2010

A Commissioner For Taking Oaths

;

;

I

TAB 16


ONTARIO

SUPERIOR COURT OF JUSTICE

(COMMERCIAL LIST)

IN THE MATTER OF THE CO.MPANIES' CREDITORS ARRANGEMENT ACT, R.S.C. 1985, c. C-36, AS AMENDED


Applicants


Respondents

APPLICATION UNDER SECTION 46 AND FOLLOWING OF THE COMPANIES' CREDITORS ARRANGEMENT ACT, R.S.C. 1985, c. 0-36, AS AMENDED

AFFIDAVIT OF ALAN BUTTERFIELD (sworn August 13, 2010)

I, Alan Butterfield, of the City of Montreal in the Province of Quebec MAKE

OATH AND SAY:

INTRODUCTION

1. I am the Vice President, Maintenance and Engineering, of Air Canada, a

position that I have held since February 2007. I am responsible for all aspects of the

maintenance, repair and overhaul of Air Canada's fleet of aircraft, including Air

5714141 v1

3 s - 2 -

Canada's relationship with suppliers of spare parts and equipment such as Aero

Inventory (UK) Limited ("Aero"). Prior to becoming the Vice President,

Maintenance and Engineering, I was the Vice President, Airframe and Line

Maintenance, at United Airlines. As such, I have knowledge of the matters herein

deposed, except where stated to be based on information and belief and, where so

stated, I verily believe same to be true.

2. I previously swore an affidavit in this proceeding on January 27, 2010 (my

"First Affidavit"). Capitalized terms used herein but not otherwise defined have the

meanings ascribed to them in my First Affidavit.

QvFAY' EW

3. In late 2008, Rupert Lewin, Aero's Chief Executive Officer, approached Air

Canada with a proposal. Aero •as a company specializing in consumable and

expendable parts (CAT 3 Inventory) procurement and inventory management

services for the aerospace industry; indeed, it owned and managed almost all of the

consumable and expendable CAT 3 Inventory being used by Air Canada's primary

maintenance services to Air Canada's aircraft. Mr. Lewin told me that Aero needed

financing in order to buy its way into a similar business with United Airlines. To

raise money, Mr. Lewin proposed that Aero would sell Air Canada a significant

portion of the CAT 3 Inventory that Air Canada would need for a year in a single

bulk transaction. In return, Air Canada would issue ten bills of exchange that would

not mature for a year. Aero would then sell those bills of exchange and use the cash

5714441 ‘, 1

I 3c1 -

to finance its new business opportunity. During the course of the year, when Aero

needed parts, it would buy them back from Air Canada.

4. The essence of the transaction was Air Canada's ability to defer payment for

parts and thereby conserve cash. As long as the parts sold to Air Canada were of a

type that would be consumed within twelve months (i.e. prior to the maturity of the

bills of exchange) and Aero paid for the parts it purchased, Air Canada would

effectively delay paying for most of its CAT 3 Inventory needs for a year. However,

Air Canada was reliant on Aero's representations as to the nature of the parts and

Aero's expertise in inventory management to ensure that the parts would be

consumed within twelve months.

5_ Within weeks of closing the trarcsaction, Aero's plan began to unravel. Mr.

Lewin admitted that he had taken no advance steps to sell the bills of exchange and

ultimately had not been able to do so. Moreover, over the following months, Aero

failed to pay for any of the parts it purchased from Air Canada. Furthermore, as

discussed below, it became clear that Aero had substantially misrepresented the

nature of the parts sold to Air Canada. Even though Aero specialized in inventory

management and procurement - and had owned the inventory in question,

approximately 40% or more of the parts it sold Air Canada could not be used within

twelve months or were non-existent. I can only conclude that Aero made its

representations recklessly and without any real consideration as to whether or not

they were true.

$714441 vl

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6. Air Canada spent most of the year trying to undo the effects of Aero's

misrepresentation and its failure to pay. As significant portions of the inventory

would not be used within twelve months, Air Canada and Aero agreed to have non-

conforming parts substituted for conforming parts. As Aero accrued tens of

millions of dollars in debt to Air Canada from failing or refusing to pay for CAT 3

Irwentory purchased or substituted, it also agreed to give back five of the bills of

exchange in April and August to set them off against amounts owing.

7. KPMG Inc., as trustee in bankruptcy for the Aero Companies, now seeks a

declaration that various transactions used to effectively unwind the Aero transaction

were preferences and are void against the trustee. I swear this affidavit in opposition

to the trustee's motion and in response to the affidavit of Martin Webster filed in

support of it, sworn April 23, 2010 (the "Webster Affidavit").

BACKGROUND TO THE LINE MAINTENANCE AGREEMENT: AVEOS' DEAL WITH AERO

COMPELS AIR CANADA TO ENTER ITS OWN AGREEMENT

Air Canada's Maintenance and Repair

Air Canada and Air Canada Technical Services

8. Air Canada is Canada's largest domestic and international airline and the

largest provider of scheduled passenger services in the Canadian market, the

Canada-US trans-border market and in the international market to and from Canada.

A copy of Air Canada's 2009 Annual Information Form dated March 26, 2010 is

appended to this my affidavit as Exhibit "A".

LI

5711e4I

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9. Until September 2004, maintenance, .repair and overhaul ("MRO") services

were provided to Air Canada by its in-house maintenance division, Air Canada

Technical Services ("ACTS"). ACTS provided "nose-to-tail" maintenance and repair

for Air Canada as well as other airlines, including airframe, engine and component

maintenance and line maintenance (line maintenance generally being considered to

be minor maintenance performed on an aircraft that is in-service but between

flights).

10. ACTS also provided Air Canada with supply chain management services

(including inventory management, procurement, and logistics) relating to parts and

materials to be used in the provision of MRO services. These parts and materials

included the "CAT 3 Inventory" referenced in my First Affidavit that are either

single-use items that are not capable of repair or items which, after the performance

of certain procedures, are re-certifiable for limited periods.

Air Canada Outsources Inventory Management to Aveos; Disposes of Inventory

11. In 2003, Air Canada applied for and was granted protection from its creditors

in widely publicized proceedings under the Companies' Creditors Arrangement Act,

R.S.C. 1985, c. C-36 (the "CCAA"). Air Canada emerged from CCAA protection on

September 30, 2004 and ACE Aviation Holdings Inc. ("ACE") became the new parent

company under which the reorganized Air Canada was held. As part of the

implementation of the CCAA plan, ACAS' MRO business was transferred to ACTS

Limited Partnership - except for the line maintenance business (and very minimal

5714441

\(4 - 6 -

CAT 3 Inventory parts and materials needed for that business) and spare parts

already designated for Air Canada's aircraft. ACTS Limited Partnership became a

full-service MR0 stand-alone entity under ACE. ACTS Limited Partnership's assets

were later sold, on a going concern basis, to ACTS LP, also directly held by ACE.

12. On 'June 22, 2007, .ACE announced that it had agreed to sell a 70% interest in

the business of ACTS LP to a consortium consisting of Sageview Capital LLC, a

private investment firm, and KKR Private Equity Investors, L.P., the publicly traded

fund of Kohlberg Kravis Roberts & Co. The transaction was completed on October

16, 2007. ACTS Aero Technical Support & Services Inc., which would be renamed

"Aveos Fleet Performance Inc." in September 2008, conducted the business

previously operated by ACTS LP. The entity that carried on the business after the

sale - ACTS Aero Technical Support & Services Inc. / Aveos Fleet Performance Inc. -

is hereafter referred to as "Aveos".

13. Aveos was, and is, a MR0 service provider to the airline industry, offering,

amongst other .things, airframe services, engine and auxiliary power unit services,

component services, supply chain management and technical records management.

Aveos represents that it serviced more than a hundred global customers, although I

believe that Air Canada remained its largest customer. Copies of Aveos' website

material, "Key Facts" and brochure are appended to this my affidavit as Exhibit "B".

14. Prior to, and following, the disposition of Aveos by ACE, Air Canada relied

upon Aveos for heavy maintenance (including lhe management and procurement of

5714441 vl

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the necessary inventory), but continued to perform its own line maintenance.

Although Air Canada retained some parts required to support line maintenance,

practically all CAT 3 Inventory was transferred as part of the disposition of the ACTS

business, together with the infrastructure supporting the inventory management and

procurement functions. CAT 3 inventory used in line. maintenance was thereafter

procured and managed by Aveos.

Aveos Outsources CAT 3 Inventory Management to Aero; Disposes of Inventory

15. As described in the Webster Affidavit, Aero provides comprehensive

procurement and inventory management service to companies in the aerospace

industry. Specifically, Aero sources, distributes and sells consumable and

expendable CAT 3 Inventory parts (e.g., bearings, fasteners and gaskets) required in

the maintenance of aircraft. As Aero describes it, Aero "is responsible for ensuring

that the right parts are available at the right time..."

16. On October 25, 2007, without consulting Air Canada, a letter of intent was

entered into between ACTS and Aero. On November 16, 2007, Aero announced that

it had entered into a ten-year exclusive supply contract and strategic partnership

arrangement with ACTS (with two further five-year extension options). Pursuant to

the agreement (the "Aveos Agreement"), ACTS would outsource the supply and

management of consumable and expendable aircraft parts inventory to Aero. Copies

of the October and November press releases are appended to this my affidavit as

Exhibits "C" and "D".

5%14441 rl

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17. Aero states that its business model involves buying a customer's existing stock

of consumable and expendable parts at the outset of a long-term contract and then

selling it back over the term of the agreement. I understand from Aero's press

release that ACTS sold Aero its existing stock of consumable and expendable parts,

together with ACTS' database relating to the parts to be supplied, for US$95. million.

As far as I am aware, those parts remained at ACTS' facility. A copy of the Aero

Inventory plc 2008 Annual Report and Accounts is appended to this my affidavit as

Exhibit "E".

Air Canada Is Left Without Structured Management and Procurement for CAT 3 Inventory

18. With respect to airframe, engine and component maintenance, Air Canada

continued to rely on Aveos. In turn, I understood from Aveos that it relied upon

Aero to supply it with the necessary parts and then incorporated the cost of those

parts into a particular invoice for services performed for Air Canada.

19. With respect to line maintenance, the Aveos Agreement created a significant

concern for Air Canada. Air Canada scrambled to find a secure replacement solution

as it had no material stock of CAT 3 Inventory, had no relationship with Aero and

could no longer rely on Aveos to manage and procure CAT 3 Inventory (as Aveos

had exited that business). Accordingly, Air Canada was faced with either having to

buy its own CAT 3 Inventory and establish a system to manage it, or entering into its

own arrangement with Aero.

5714441v.!

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Air Canada Enters into an Agreement with Aero for CAT 3 Inventory

Line Maintenance Agreement

20. Following the execution of the Aveos Agreement, Air Canada and Aero began

discussions relating to the procurement and supply chain management of CAT 3

Inventory required by Air Canada for its line maintenance operations. However, it

was not until December 2008 that Air Canada and Aero finally executed the

Agreement for the Supply and Management of Consumable and Expendable Spares

(the "Line Maintenance Agreement") designed to formalize the arrangement for the

procurement of CAT 3 Inventory for line maintenance. Like the Aveos Agreement,

the term of the agreement was ten years, subject to two five-year extension options.

A copy of the Line Maintenance Agreement is appended to my First Affidavit as

Exhibit A.

21. As I mentioned in the First Affidavit, under the terms of the Line Maintenance

Agreement, Aero became Air Canada's exclusive supplier for practically all of its

CAT 3 Inventory used for line maintenance on its aircraft. Aero also assumed

responsibility for managing all aspects of the procurement and delivery of CAT 3

Inventory for line maintenance, including monitoring and planning for Air Canada's

consumption and use of the inventory. Accordingly, the parties acknowledge in the

Line Maintenance Agreement that Aero's services are critical to Air Canada's

operations and that it is critical for Air Canada to have continuity of services and the

supply of parts.

5714441 I

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22. Following the execution of the Line Maintenance Agreement, it was my

understanding that Aero would provide CAT 3 Inventory to Aveos for use in

airframe, engine and component maintenance on Air Canada's aircraft pursuant to

the Aveos Agreement, and that Aero would provide CAT 3 Inventory to Air Canada

directly for use in line maintenance pursuant to the Line Maintenance Agreement.

Therefore, I understood that:

(a) If a part was used for maintenance services provided by Aveos on Air

Canada aircraft, Aveos would "pick" the necessary part from Aero's

inventory. Aero would invoice Aveos for the part and Aveos, in turn,

would invoice Air Canada (with its own mark-up).

(b) If the part was used for line maintenance, Air Canada maintenance staff

would "pick" the part required and Aero would invoice Air Canada

directly.

Aero Confirms Its Expertise

23. As stated in my First Affidavit, the effective management of CAT 3 Inventory

is complex. Not only does it require accurate forecasting and obsolescence

management, but expendable spare parts must be traceable, warranted and certified.

Tracking systems must record the entire life-cycle of every expendable part from the

time of manufacturing of the part up until it is destroyed.

2=1. Aero confirmed in the preamble to the Line Maintenance Agreement that it "is

an experienced, world-class designer, implementer and manager, with a solid track

5714441 vl

record for judicious application, of the Services to be provided under this

Agreement..." and that it "has all the experience, skills, qualifications, license,

permits and authorizations (including those required by applicable law) necessary to

perform and manage those Services requested by [Air Canada] in an efficient, cost-

effective and controlled manner, with a high degree of quality and responsiveness."

Mr. Lewin gave me similar assurances on a number of occasions during the course of

the negotiations leading up to the execution of the Line Maintenance Agreement,

including in relation to Aero's experience with other airlines.

BACKGROUND TO THE TANUARY PURCHASE AGREEMENT

Aero Approaches Air Canada About the Purchase of Its Inventory

In late 2008, I was contacted by Daniel Bunyan, who is a consultant that had

been retained by Air Canada in connection with the negotiation of the Line

Maintenance Agreement. Mr. Bunyan was trying to set up a meeting with me on

behalf of Mr. Lewin about a new proposal. I met with Mr. Lewin at Air Canada's

offices in Montreal and Mr. Lewin pitched his idea. Mr. Lewin said that he could

arrange for .Air Canada to defer payment on CAT 3 Inventory for a year.

26. As I stated in my First Affidavit, Mr. Lewin told me that Aero had the

opportunity to become the exclusive supplier to United Airlines. That transaction

would be predicated on the purchase of United Airlines' existing stock of CAT 3

Inventory and would require a significant capital investment.

571-1441 vl

- 12 -

27. Accordingly, Aero proposed to sell $100 million of Aero's stock of CAT 3

Inventory to Air Canada in return for negotiable bills of exchange maturing in twelve

months - after which time Air Canada would have consumed the inventory. It was

Mr. I .ewin's idea to use bills of exchange as the mechanism to allow Air Canada to

defer payment on the parts. Up until that point, I had no familiarity with bills of

exchange and Mr. Lewin took pains to explain the concept to me so that I could

understand it.

28. To give effect to his plan, Mr. Lewin repeatedly advised Air Canada that he

would be selling the bills of exchange. I understand from the January Purchase

Agreement ultimately entered into that the purchaser would be DF Deutsche Forfait

AG ("Deutsche Forfait").

Aero Presses the Advantages of the Transaction

29. Mr. Lewin had to walk me through his proposal a number of times. Not only

was the Aero proposal complex (and, as described above, I was unfamiliar with bills

of exchange), but Air Canada was uninterested in assuming the risks associated with

owning a significant volume of parts, including the risks of damage, loss and

obsolescence that had in part motivated the disposition of ACTS years earlier. As I

stated in my First Affidavit, having concluded the Line Maintenance Agreement with

Aero and previously outsourced most procurement and maintenance functions, Air

Canada did not want to, and was currently unable to, take on any responsibility for

the logistics, procurement or management of CAT 3 Inventory.

5714441 vl

- 13 -

30. Mr. Lewin stressed that the basic premise of the transaction was to allow Air

Canada to delay payment on CAT 3 Inventory for a year, which was a real incentive

for Air Canada given the associated cost savings and its liquidity pTessures at the

time. Mr. f .ewin assured me that the inventory that would be sold to Air Canada

was inventory of a nature, kind and quantity that would be consumed by Air

Canada, either directly or through Aveos, within a year. In fact, because Air

Canada's CAT 3 Inventory consumption at the time was approximately US$10 to 11

million per month, given Mr. Lewin's assurances, it was expected that the purchased

inventory would be consumed well in advance - within nine or ten months.

31. From Air Canada's perspective, that was the essence of the transaction. If the

purchased parts were used before the bills of exchange came due and Aero paid for

the inventory on time, Air Canada would defer payment on the inventory. Because

Aero would be buying back the parts in order to supply Air Canada under the Line

Maintenance Agreement and to supply Aveos under the Aveos Agreement, Air

Canada would receive monthly payments from Aero before making any cash outlay

itself on account of the purchase price.

32. Mr. Lewin knew from our discussions relating to the Line Maintenance

Agreement, some of the parts proposed to be sold to Air Canada had been under the

independent control of Aveos and Aero since june 2007. Air Canada had no way to

independently ensure that the purchased parts would be consumed within twelve

5714411 "I

1 5 - 14 -

months. Air Canada would be reliant upon Aero's expertise in CAT 3 Inventory

supply chain management and its representations to ensure that this was the case.

33. As Mr. Webster acknowledges at paragraph 24 of the Webster Affidavit, Air

Canada sought assurance that the purchased parts would be consumed before the

bills of exchange fell due. Based upon what Mr. Lewin told me and the fact that Aero

held itself out as a specialist in inventory planning and management, I received that

assurance. I also took for granted that Aero was intimately familiar with the stock of

parts being sold, having bought the vast majority of its inventory from ACTS in late

2007 and managed the inventory thereafter.

34. Paragraphs 25-28 of the Webster Affidavit are simply inaccurate. There were

never any discussions around "swapping" inventory in connection with entering

into the January Purchase Agreement. Air Canada did not agree to buy US$100

million (before tax) in parts that might be non-conforming in reliance on an informal

and undocumented "understanding" to replace the non-conforming inventory

through "some form of swapping arrangement". The e-mail from Keith Wilson, a

partner at Heenan Blaikie LLP, counsel to Air Canada, referred to in paragraph 27 of

the Webster Affidavit has been presented out of context. Air Canada simply wanted

to ensure that the transaction under the January Purchase Agreement would be a

true sale, that the agreement contain full and adequate representations and

warranties and that Air Canada would be protected if there were issues with the

inventory.

5714441 vl

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Mr. Lewin Offers An Inducement

35. Mr. Lewin pressed the transaction's advantages to Air Canada during a

number of conversations over the next few weeks. Aero pushed the deal to move

forward, as it wanted thc cash to enter into an arrangement with United Airlines.

Finally, to induce Air Canada to enter into the arrangement, Mr. Lewin offered Air

Canada certain discounts and volume rebates under the Line Ma intenance

Agreement.

36. To be clear, it was Aero's representation about the nature of the inventory

being purchased - and the corresponding ability to delay payment until after the

inventory was used -- that was the reason that Air Canada was willing to enter into

the transaction. We simply would not have considered entering into the transaction

without those assurances. The discounts and rebates were offered as an incentive for

Air Canada to enter into an agreement - and to do so quickly - but Air Canada

would not have entertained the discussion if it had not been given solid assurances

that the purchased inventory would be used within a year and paid for by Aero.

Air Canada and Aero Enter into the January Purchase Agreement

Air Canada Enters the Agreement Based on Aero's Representations

37. Ultimately, Air Canada agreed to Mr. Lewin's proposal and entered into the

Bulk inventory Purchase Agreement dated January 28, 2009 (the "January Purchase

Agreement") with Aero, which is appended to my First Affidavit as Exhibit B. A

5714441 vl

\L3a - 16 -

copy of Aero's February 10, 2009 press release announcing the transaction is

appended to this my affidavit as Exhibit "P.

38. Consistent with the assurances described above, the following representation

and warranty is included in section 3.6(e) of the January Purchase Agreement:

(e) Supply Management. The Seller is a specialist in inventory management and planning for the aerospace industry. The Seller has made investigations of historical relevant data and has made enquiries necessary and has the data and software required to forecast the Buyer's consumption of Parts and other inventory of the same nature or kind as the Purchased Inventory in the ordinary course of business during the twelve (12) months following the Closing Date. Based on historical data and the forecast derived from the Seller's investigations, enquiries and expertise, the Purchased Inventory does not exceed the requirements of Air Canada for such period. Only "high usage" C&E and Parts form part of the Purchased Inventory and none of the Purchased Inventory is or will become obsolete or unusable during the twelve (12) months following the Closing Date.

Operation

39. As discussed with Mr. Lewin, Aero's buy-back of the purchased inventory

was intended to work as described in the Webster Affidavit:

(a) Aveos would continue to "pick" inventory as needed to service Air

Canada. If the part belonged to Air Canada, then:

(i) Aero would buy back the part from Air Canada;

(ii) Aero would sell the part to Aveos; and

5714441 wl

1 53 - 17 -

(iii) Aveos would then use the part to service Air Canada and

invoice Air Canada.

(b) Air Canada would "pick" inventory as needed for line maintenance. If

the part belonged to Air Canada, then:

(i)

Aero would buy back the part from Air Canada; and

(ii) Aero would then supply the part to Air Canada under the Line

Maintenance Agreement.

Purchase Price; Air Canada Assumes No Responsibility for Bills of Exchange

40. As described in my First Affidavit, under the January Purchase Agreement,

Aero sold Air Canada the CAT 3 Inventory described in Schedule 2.1(c) to the

agreement (the "January Inventory Pool"). The purchase price of US$110,740,026.72

(US$100 million in CAT 3 Inventory plus taxes), less a US$10,000,000 holdback, was

to be paid by delivery to Aero of nine US$10 million principal bills of exchange (Nos.

1 to 9) drawn by Aero on Air Canada and one similar bill of exchange (No. 10) in the

principal amount of US$10,740,026.72 (together, the "Bills of Exchange"). The last

US$10 million of the purchase price would be paid in cash a year after the closing

date. Copies of the Bills of Exchange are appended to my First Affidavit as Exhibit

D.

41. Furthermore, as described above and in my First Affidavit, the Line

Maintenance Agreement was amended in order to provide Air Canada with a

monthly cash rebate of US$100,000. Air Canada was also provided with three

57H411 v

- 18 -

additional cash rebates of $833,333.33, payable on July 1st of each of 2009, 2010 and

2011. A copy of the First Amending Agreement to the Line Maintenance Agreement

is appended to my First Affidavit as Exhibit F.

42. Each of the Bills of Exchange was scheduled to mature on February 8, 2010,

after the twelve month period during which the CAT 3 Inventory was to be

consumed. Air Canada assumed no responsibility for the sale of the Bills and, as far

as I am aware, neither Mr. Lewin nor anyone else at Aero ever asked Air Canada to

take on that responsibility. In any event, there didn't seem to be any need to do so,

as Mr. Lewin led me to believe that he had already made his own arrangements for

their sale.

Consent of Aero's Lenders

43. At the time of the January Purchase Agreement, Aero's significant secured

lender, Lloyds TSB Commercial Finance Limited, for itself and as agent of the

secured lenders ("Lloyds"), consented to the transaction and agreed to release its

security on the purchased assets. Contrary to the suggestion in the Webster

Affidavit, Air Canada did not know that any transactions between it and the Aero

Companies conflicted with any obligations owed by the Aero Companies to their

secured lenders, if in fact that is the case.

5711411

\55 -19 -

Representations as to Financial Condition

44. In the January Purchase Agreemeni, Aero provided representations and

warranties as to the compliance of its financial statements with GAAP and to the

solvency of the Aero Companies:

3.7(a). Financial Statements. The financial statements of each AI Party described in the Closing Agenda have been prepared from the books and records of each such AI' Party in accordance with International GAAP and present fairly in all material respects the financial condition of such AI Party as at the date thereof....

3.7(b) Solvency. The Aero Inventory Group is able to pay its liabilities as such liabilities become due. The fair market value of the assets of the Aero Inventory Group exceed the liabilities of the Aero Inventory Group.

Closing; No Immediate Sale of the Rills of Exchange

45. The purchase and sale transaction under the January Purchase Agreement

closed on February 9, 2009 and Aero took delivery of the Bills of Exchange at that

time. Mr. Lewin advised me that, immediately after the closing, he left Montreal,

taking the Bills of Exchange with him. I learned later from Diane Mazuroski that he

went to Chicago for meetings with United Airlines and did not return to London,

England with the Bills of Exchange until some time thereafter.

5714.I4 I v I

15G - 20 -

AERO'S ARRANGEMENT IMMEDIATELY BEGINS TO UNRAVEL

Aero Asks Air Canada to Buy Back Some of the Bills of Exchange

46. Within ten days of closing, on or about Wednesday, February 18, 2009, Mr.

Lewin called me to say that the Aero Companies needed US$20 million by the

following Monday, February 23, 2009 at 5:00 p.m. UK time in order to make an

interest payment to their lenders. If they could not make payment, Mr. Lewin told

me, Aero would likely fail. However, if Air Canada could help the Aero Companies

make payment, they would be on sure footing as they would not need to make

another substantial interest payment for some time.

47. Mr. Lewin's call took me completely by surprise. I recall asking Mr. Lewin if

he was kidding, as I clearly had neither the authority nor the ability to cause Air

Canada to give Mr. Lewin US$20 million by Monday. I told Mr. Lewin that, in any

event, Air Canada did not have the free cash available to advance US$20 million to

the Aero Companies, particularly on such short notice and that he should try and

seek an extension of time to make the payment to Aero's lenders.

48. Mr. Lewin replied that things didn't work that way in the UK and that, if the

interest payment were not made, the Aero Companies could be placed into

administration. He made clear that, if the Aero Companies were placed into

administration, it would have significant negative consequences for Air Canada. It

would profoundly disrupt Air Canada's own operations and its parts procurement

process. At the same time, Mr. Lewin made clear that this was just a temporary

S711441 v 1

1 5 - 21 -

liquidity issue and that, as described above, Aero had no other imminent interest

payments and would be in a position to carry on business in the ordinary course.

Mr. Lewin then asked me to try and arrange a meeting between him and Michael

Rousseau, Air Canada's Chief Financial Officer.

49. I readily acknowledged to Mr. Lewin that Aero's services and its business

model were important to Air Canada and that terminating services could create

significant problems. However, Air Canada faced its own liquidity concerns; indeed,

as Mr. Lewin was well-aware, Air Canada had entered into the January Purchase

Agreement in an effort to conserve cash.

50. I had been unaware that Aero was facing any liquidity issues and I did not

know that the Aero Companies had been unable to monetize the Bills of Exchange,

which Mr. Lewin gave as the reason for the liquidity problem. Mr. Lewin attributed

the failure to sell the Bills of Exchange to the market's reaction to the release of Air

Canada's quarterly results on February 13, 2009. A copy of the February 13, 2009

News Release is appended to the Webster Affidavit as Exhibit G. Copies of Air

Canada's 2008 Consolidated Financial Statements and Notes dated February 13, 2009

and Air Canada's 2008 Management's Discussion and Analysis are appended to this

my affidavit as Exhibit "G".

51. Based upon Mr. Lewin's statements and his representations as to the

importance of the sale of the Bills to Aero, I had assumed that Aero had already

secured a binding purchase commitment for them. However, Mr. Lewin now

5714441 vl

1 5 - 22 -

indicated that Aero had not taken any steps to pre-sell the Bills of Exchange or obtain

firm commitments to purchase them.

52. In any event, the fact that Air Canada was releasing its fourth quarter results

should not have been unexpected. Prior to the closing of the January Purchase

Agreement transaction, on February 6, 2009, Air Canada issued a press release

announcing- that it would be presenting its fourth quarter and full year 2008 results

on February 13, 2009. A copy of the press release is appended to this my affidavit as

Exhibit "H". In fact, when I spoke with Mr. Lewin about Air Canada's results, he

indicated to me that he understood the numbers and was taken aback by what he

considered to be the market's unduly negative reaction to the release of the results.

am advised by Mr. Wilson that Aero never sought any representations or warranties

in this respect.

Air Canada's Offer to Unwind the Transactions Is Rejected; Air Canada Buys Back Two Bills of Exchange

53. I arranged. a meeting between Mr. Rousseau and Mr. Lewin, which took place

in Toronto, on or about Friday, February 20, 2009 and lasted about half an hour. I

undersiand from Mr. Rousseau that Mr. Lewin basically reiterated what I had

discussed with him on the telephone, and Mr. Rousseau told him that he would see

what he could do. Mr. Rousseau then asked me to do what we could for Aero, in the

interests of being a good business partner.

5714441 v

- 23

54. The next day, Saturday, February 21, Mr. Lewin flew to Montreal and met

with Ms. Mazuroski and myself. We met over lunch to review Mr. Lewin's

conversation with Mr. Rousseau and Aero's situation. Mr. Lewin asked Air Canada

to purchase three Bills of Exchange, in an aggregate principal amount of US$30

million, for US$20 million in cash. Mr. Lewin told me that he believed that Aero

could sell the remaining Bills of Exchange if Air Canada funded its short term

liquidity requirements by buying three Bills of Exchange at a one third discount.

55. Mr. Lewin attended both meetings by himself. As far as I am aware, neither

Mr. Webster nor Mr. Bevan met with Mr. Rousseau or came to Montreal. In fact, I

only ever recall meeting Mr. Webster once briefly, and that was not relating to the

matters described in this affidavit.

56. I told Mr. Lewin that I would recommend that Air Canada buy two Bills of

Exchange for US$10 million, and said that Aero should keep the third and raise the

rest of the funds it needed from another source.

57. At that time, I proposed to Mr. Lewin that we should simply unwind the

transaction under the January Purchase Agreement. If there was any suggestion that

the Bills of Exchange concept was not working, Air Canada was prepared to return

the inventory in exchange for the Bills of Exchange and unwind everything.

However, Mr. Lewin said that reversing the transactions could not help the Aero

Companies, which needed an immediate infusion of cash to meet their obligations to

its lenders, and could not be done as a practical matter. Mr. Lewin also remained

V14441 vl

- 24 -

confident that, given more time, he could sell the Bills of Exchange in the market to

generate cash. In fact, he asked me not to raise the subject of unwinding the

transactions again.

58. Air Canada wanted to act as a good business partner and, at the time, the

transaction still made sense for Air Canada. It still appeared that Air Canada would

be able to defer payment on CAT 3 Inventory purchases based on the representations

and warranties given as to the January Inventory Pool.

59. At a special meeting of the board of directors held on Sunday, held specifically

for this purpose, Air Canada was authorized to buy back two Bills of Exchange for

US$10 million in cash and Air Canada did so the next day.

60. Section 2.3 of the Bilis of Exchange Purchase Agreement allowed Aero to

repurchase the Bills within sixty days, but that right was never exercised. A copy of

the Bills of Exchange Purchase Agreement is attached to my First Affidavit as Exhibit

G.

AERO'S REPORTS ON ITS FINANCIAL CONDITION

61. On or about March 16, 2009, Aero released its Interim Report and Accounts for

2008 - 2009, reporting on the first half of the financial year, a copy of which is

appended to this my affidavit as Exhibit "I" (the "Aero Interim Report"). The Aero

Interim Report did not represent that Aero was in financial distress of any kind. The

Aero Interim Report states that revenues had increased 55% over the prior

5714441 v 1

- 25 -

corresponding period and pre-tax profits had increased 46%. In light of its results

and "the satisfactory outlook for profits", Aero elected to maintain its interim

dividend at the prior year's level of 6.0 pence per share.

62. At the same time, Aeru announced that its Board had apparently decided to

withdraw from negotiations for the United Airlines contract "as satisfactory

commercial terms could not be agreed." Aero stated in the Aero Interim Report:

On 10 February 2009, Aero Inventory announced that it had completed the sale of a significant quantity of consumable aircraft parts to Air Canada, the principal customer of Aveos. The consideration received by Aero Inventory for this material is in the form of Bills of Exchange with a face value of approximately US$100 million, maturing in early February 2010. Aero Inventory had intended to discount the bills for cash to raise part of the funds necessary to finance its prospective substantial new contract. In light of the decision to terminate the contract negotiations referred to earlier the Company is now considering whether to hold some or all of the bills until maturity. This sale of material which will largely not need to be restocked represents a significant step towards achieving the Company's twin objectives of

improving stock turn and releasing cash from inventory.

AERO MISREPRESENTS THE JANUARY INVENTORY POOL AND FAILS TO COMPLY WITH

THE JANUARY PURCHASE AGREEMENT

63. Despite Aero's representations and the agreement between the parties, Aero

ultimately failed to comply with the most significant provisions of the January

Purchase Agreement. As described below, a significant portion of the January

Purchase Pool was not consumable within twelve months (if at all) and Aero never

3714441 1

- 26 -

paid Air Canada for any parts purchased from Air Canada in accordance with the

January Purchase Agreement.

Aero Pays None of the Invoices under the January Purchase Agreement

64. As described at paragraphs 29 and following of my First Affidavit, Aero was

buying CAT 3 Inventory from the January Inventory Pool in order to both supply Air

Canada pursuant to the Line Maintenance Agreement and to supply Aveos with the

inventory needed to perform heavy maintenance. Aero's purchases from the January

Inventory Pool are shown at paragraph 30 of my First Affidavit.

65. By April 2009, Aero had yet to make payment on any of the invoices for parts

purchased from the January Inventory Pool.

66. The parties began to discuss settling accounts by delivering two Bills of

Exchange to Air Canada for purposes of set-off, which, as I discussed with Mr.

Lewin, appeared to both parties to be the simplest manner of proceeding. On or

about April 17, 2010, Aero delivered two Bills of Exchange (Nos. 3 and 4) to Heenan

Blaikie LLP, in escrow pursuant to the letter agreement appended to my First

Affidavit as Exhibit H (the "Interim Pledge and Escrow Agreement"), subject to a

right of redemption in favour of Aero. Under the terms of the Interim Pledge and

Escrow Agreement, Aero delivered the Bills as security for payment, not later than

April 30, 2009, of Air Canada's invoice for consumable and expendable spare parts

5714411

lGj3 - 27 -

for the period ended February 29, 2009 and as security for parts used or consumed

during March 2009 from the January Inventory Pool.

67. Aero agreed that Air Canada could set off the Bills of Exchange against

obligations that were past due under an invoice payable on the last day of the second

month after use or consumption (consistent with existing invoice payment terms)

and that the indebtedness under the Bills of Exchange would be accelerated for this

pu rpose.

68. Aero had still not made payment by the end of April. On May 1, 2009, Air

Canada sent a demand for payment to Aero, stating that it was exercising its rights

under the Interim Pledge and Escrow Agreement. A copy of my letter of that date

was attached as Exhibit I to my First Affidavit.

69. As I stated in my First Affidavit, Aero consented, on or about May 8, 2009, to

the release from escrow and delivery to Air Canada of the two Bills of Exchange held

in escrow by Heenan Blaikie (Bill Nos. 3 and 4). Air Canada took possession of the

Bills and, as Mr. Lewin acknowledged to me, became entitled to exercise its rights of

set-off against Aero's indebtedness to Air Canada.

70. Although Air Canada took possession of Bills of Exchange Nos. 3 and 4, it

refrained from exercising the right of set-off until it could reach an agreement with

Aero concerning the appropriate discount rate to be applied to the Bills, which the

571 444111

- 28 -

parties acknowledged must reflect the fair value of the Bills of Exchange before

maturity.

Aero Significantly Misrepresented the fanuary Inventory Pool; Aero Admits the Breach

71. By April 2009, Air Canada had observed that the monthly consumption of

CAT 3 Inventory purchased under the January Purchase Agreement was too low. To

consume the USS100 million in parts in the January Inventory Pool within a year

would require average monthly purchases before tax of US$8.5 million. Actual

consumption from the January Inventory Pool was falling well below that amount -

and significantly below Air Canada's average monthly consumption. It became clear

that a significant amount of the January Inventory Pool did not conform to Air

Canada's requirements and the representations and warranties in the January

Purchase Agreement.

72. Due to the declining volumes of consumption from the January Inventory

Pool, Air Canada asked Bunyan Aero Consultants to review the parts comprising the

January Inventory Pool that I described in my First Affidavit. Based on the results of

that review, Air Canada estimated that approximately $40 million or more of the

parts remaining in the January Inventory Pool would not be used by Air Canada

during the period fixed by the January Purchase Agreement, including parts that

could not be used by Air Canada at all or would not be used for 24 months or more.

571444 1v1

- 29 -

73. I was disturbed by the results of the review that confirmed the trend in

consumption and the clear disparity between the representations that had been made

to Air Canada prior to entering into the january Purchase Agreement and the actual

composition of the January Inventory Pool. While I understood that the forecasting

of Air Canada's usage may not be exact, I did not expect that Aero would have

misrepresented its inventory so significantly, particularly given its expertise in the

area. Neither I, nor to my knowledge, anyone else at Air Canada expected the nature

of the January Inventory Pool to have been so misstated.

74. It was clear from the results of the review that Aero's prior statements and the

representation and warranty at section 3.6(e) of the January Purchase Agreement

were untrue. Aero had represented in the January Purchase Agreement that "based

on historical data and the forecast derived from the Seller's investigations, enquiries

and expertise, the Purchased Inventory does not exceed the requirements of Air

Canada for such [twelve-month] period. Only 'high usage' CcSrE and Parts form part

of the Purchased Inventory..."

75. In addition, Bunyan Aero Consultants' review revealed that some of the

inventory listed in the scheduled description of the January Inventory Pool did not

exist.

76. Had Aero accurately portrayed the actual composition of the January

Inventory Pool, Air Canada would not have entered into the January Purchase

Agreement.

5714441 v 1

- 30 -

Aero Agrees to Remedy the Breach through Substitution and Warranty

77. Air Canada confronte.d Aero with the results of the audit and demanded that

the breach of the Ja:nuary Purchase Agreement be remedied. As I mentioned in my

First Affidavit, Aero acknowledged the breach and we discussed how to make the

relationship continue to work. Aero agreed to remedy the breach by deeming

contract-conforming parts from its own stock that had been used and provided to Air

Canada or Aveos to have been substituted for the non-conforming parts in the

January inventory Pool. In other words, when Aero used parts during the month,

Air Canada would get paid regardless of their source.

78. To give effect to the substitution, Air Canada calculated the difference

between actual consumption from the January Inventory Pool and the average

monthly consumption necessary to meet the requirements of the January Purchase

Agreement (US$8.5 million). The difference represented the amount of non-

conforming parts being replaced by substituted conforming parts. Accordingly,

every month, Aero would owe Air Canada for the parts actually taken from the

January Inventory Pool, and the parts deemed to have been substituted (U5$8..5

million less the value of the parts actually consumed).

79. In effect, Aero took the opportunity to remedy its default by replacing non-

conforming parts in the ordinary course of business without disrupting the parties'

operations. As Mr. Lewin and I discussed, any substitution of inventory in bulk

would have to be predicated on extensive audits and renewed forecasts, while the

5714141

- 31 -

monthly adjustment allowed Air Canada and Aero to simply verify and compare

actual consumption of CAT 3 Inventory with the forecast consumption.

80. While the agreement was not memorialized until the Warranty Performance

Agreement was entered into in October 2009, it came into effect immediately. An

invoice was issued that included the parts from the January Inventory Pool actually

consumed in June 2009 and the difference between actual consumption and US$8.5

million. In addition, a special invoice was issued for the aggregate difference

between actual monthly consumption and US$8.5 million for February, March, April

and May 2009.

81. Paragraphs 44 to 51 of the Webster Affidavit purport to provide the

background to what Mr. Webster calls "the Inventory Swap." However, until it - was

discovered in the spring of 2009 that Aero had breached its representations and

warranties under the January Purchase Agreement, there was never any "swapping"

mechanism or discussion of such a mechanism.

Aero Continues to Fail to Pay Any Invoices

82. Despite the parties' agreement described above, neither the invoices issued in

the ordinary course, nor the special invoice were paid. However, the question of

Aero's solvency never crossed my mind, as discussed below. Aero Inventory plc's

stock price had rebounded by July, as shown in the London Stock Exchange report

5714441 vl

- 32 -

appended to this my affidavit as Exhibit 1", and Mr. Lewin had spoken to me a

number of times about Aero's plans for expansion.

83. That having been said, there were other issues with Aero's performance.

Although Aero was charged with procuring and managing CAT 3 Inventory, it was

often late or unable to produce necessary parts, which interfered with Air Canada's

ability to perform line maintenance. At the same time, Air Canada was contacted by

certain of Aero's suppliers, including Embraer and Hamilton Sundstrand, about

difficulties that they were having in getting paid by Aero in a timely manner.

Accordingly, I began to discuss with Diane Mazuroski, Senior Director Supply

Chain, Air Canada Maintenance, whether Aero was a viable long-term n -tanager of

CAT 3 Inventory.

84. On July 20, 2009, Ms. Mazuroski wrote to Mr. Lewin, asking him to come to

Montreal to address these performance issues. That was the context in which Ms.

Mazuroski sent her e-mail that is referenced at paragraph 60 of the Webster

Affidavit. Ms. Mazuroski advises me that the intent of her words around "the

viability of Aero Inventory" was essentially operational and related to Aero's ability

to perform its obligations to Air Canada under the Line Maintenance Agreement.

85. In response to Ms. Mazuroski's request, Mr. Lewin came to Montreal and met

with both of us. Mr. Lewin advised us that Aero would be able to perform its

obligations and persuaded us that Air Canada should not terminate the January

Purchase Agreement and the Line Maintenance Agreement. He assured us that

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arrangements were being made to satisfy both Embraer and Hamilton Sundstrand

and that he was working towards a resolution of the disputes with Aveos that had

prevented payment to date, as described below. Ms. Mazuroski advises me that she

followed up after the meeting with both Ernbraer and Hamilton Sundstrand and that

they both confirmed that the Aeru Companies had made payments to them and that

they were willing to continue dealing with the Aero Companies going forward.

AERO'S CONTINUED FAILURE TO MAKE PAYMENT IS REMEDIED 13Y DELIVERY OF THREE B ILLS OF EXCHANGE

86. By August, Aero had still failed to pay its invoices. As can be seen by the

emails attached as Exhibit Q to the Webster Affidavit, Air Canada was growing

increasingly frustrated. Accordingly, in August 2009, the parties agreed that Aero

would deliver three more Bills of Exchange into escrow and authorized Air Canada

to immediately set off the Bills of Exchange against its outstanding receivables.

87. The three Bills of Exchange (Nos. 5-7) were delivered to Heenan Blaikie in

escrow. The Second Interim Escrow and Set-Off Agreement, a copy of which is

appended to my First Affidavit as Exhibit K, states that Aero delivered the Bills of

Exchange for the express purpose of making payment when due of Air Canada's

invoices for the period from April 1, 2009 until the end of May 2009 and for parts

consumed by Air Canada after May 31, 2009. This was consistent with the

discussions in May to use the Bills of Exchange to set off against amounts owing by

Aero and to induce Air Canada to forbear in exercising its rights under the January

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Purchase Agreement. However, the Bills of Exchange were not released from

escrow. Once again, the outstanding issue was the discount rate to be applied in

effecting the set-off.

88. Contrary to the statement made by Mr. Webster in paragraph 67 of the

Webster Affidavit, the letter agreements under which Aero delivered Bills of

Exchange were given effect before October, 2009. The two Bills of Exchange (Nos. 3

and 4) delivered into escrow in April were released to Air Canada in May in

accordance with the Interim Pledge and Escrow Agreement as described above. The

Bills of Exchange delivered to Air Canada in August (Nos. 5 to 7) became eligible for

set-off immediately in accordance with the terms of the Second Interim Escrow and

Set-Off Agreement.

OCTOBER 2009 AGREEMENTS DOCUMENT AND SUPPLEMENT THE PRIOR ARRANGEMENT

89. As noted at paragraph 85 of the Webster Affidavit, by October 2009, Aero

owed Air Canada USS66 million before tax in respect of inventory purchased by

Aero pursuant to the January Purchase Agreement and in respect of warranty

obligations. At the time, five Bills of Exchange with a face value of USS50 million

were held by Air Canada or in escrow and able to be immediately set off.

90. As described in my First Affidavit, a term sheet was agreed to between Air

Canada and Aero providing for the settlement of all outstanding issues relating to

the January Purchase Agreement. The term sheet represented the culmination of

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discussions through May and July as to settlement, including the written proposal to

resolve the outstanding issues in July, which is referenced in the Webster Affidavit.

The term sheet was executed on October 9, 2009, and a copy is appended to my First

Affidavit as Exhibit L. Contrary to the suggestion at paragraph 76 of the Webster

Affidavit, it was Mr. Lewin who conducted the negotiations relating to the October

transaction on his own. As far as I am aware, Mr. Webster did not participate in the

discussions between the parties.

91. Under the terms of the settlement:

(a) The discount rate for the Bills of Exchange previously delivered to

allow for set-off against amounts owing to Air Canada (Nos. 3-7) would

be fixed at 5%;

(b) Air Canada would buy two Bills of Exchange (Nos. 8 and 9) at a

discount of 15% (for a total of US$17 million). US$2 million of that

amount would be set-off from the purchase price against Aero

payables;

(c) Bill of Exchange No. 10 would be sold by Aero to a third party;

(d) The Holdback under the January Purchase Agreement would be

reduced by USS4 million; and

(e) Air Canada would purchase new, conforming CAT 3 Inventory in three

instalments for a total purchase price of USS25.5M.

99. To give effect to the settlement,

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(a) Bills of Exchange Nos. 3-7, previously delivered to Air Canada or held

in escrow were exchanged for Demand Promissory Notes, each with a

face value of US$9.5 million (totalling US$47.5 million). The exchange

evidenced the discount rate that had taken a considerable period of

time to negotiate.

(b) Bills of Exchange 8 and 9 were exchanged for Demand Promissory

Notes, each with a face value of USS8.5 million (totalling US$17

million).

(c) The January Purchase Agreement was further amended by the Second

Amending Agreement, reducing the Holdback under the January 2009

Agreement to USS6 million. Again, Mr. Wilson advises me that the

rationale for the reduction was made clear to Mr. Lewin, notably to

compensate Air Canada for the damages it suffered due to the loss of

the cash flows that should have been generated under the January

Purchase Agreement.

(d) Air Canada set off the amounts owing under the Demand Promissory

Notes exchanged for Bills of Exchange Nos. 3-7 against amounts due

and owing to Air Canada as at September 30, 2009.

(e) On October 23, 2009, Air Canada paid Aero US$15 million by wire

transfer pursuant to the Demand Promissory Notes exchanged for Bills

of Exchange Nos. 8 and 9, having set off US$2 million of the amount

owing on those notes against amounts due and owing to Air Canada as

at September 30, 2009.

(0 The parties entered into the Warranty Performance Agreement, which

confirmed and extended the agreement already in place for remedying

Acro's breach of warranty under the January Purchase Agreement. A

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copy of the Warranty Purchase Agreement is appended to my First

Affidavit as Exhibit J.

93. From his comments to me, Mr. Lewin appears to have understood, as did Air

Canada, that the agreements and instruments entered into in relation to the set-off of

Bills of Exchange Nos. 3 to 7 in October merely formalized agreements relating to set-

off reached months before. From his discussion with Air Canada, it was clear that

Mr. Lewin considered a significant portion of the amounts owing to Air Canada to

have already been dealt with by way of set-off against Bills of Exchange No. 3-7. It is

clear from the Interim Pledge and Escrow Agreement and the Second Interim Escrow

and Set-Off Agreement that the Aero Companies always knew that Bills of Exchange

would be set-off against amounts owed by the Aero Companies to Air Canada as

long as either the Aero Companies or Air Canada were in possession of the Bills of

Exchange. The conversion of the Bills of Exchange into Demand Promissory Notes

and then setting them off had also been discussed for some time and was specifically

included in the July 28, 2009 proposal to unwind and settle the January transactions.

94. The only live issue between the parties related to the discount rate to apply to

the Bills of Exchange. It was Mr. Lewin's view that a discount rate not exceeding

15% was appropriate; Air Canada maintained that the discounl rate should be 20-

25%.

95. It is simply wrong to suggest, as the Webster Affidavit does, that Air Canada

procured any new or additional set-off rights in October, 2009 with respect to the

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previously delivered Bills of Exchange. The agreements giving effect to the Bills of

Exchange set-off in October, 2009 were intended solely as evidence of the discount

rate fixed between the parties and to avoid valuation and characterization issues for

income tax and accounting purposes.

96. Set-off was also an integral part of a transaction under which Air Canada

agreed to acquire the two Bills of Exchange (Nos. 8 and 9) in October 2009. This

transaction netted Aero US$15 million in cash after the deduction of US$2 million in

payment of outstanding accounts receivable from Aero. The US $2 million Payment

Set-Off was a condition to the payment of US$15 million in cash to Aero.

OCTOBER PURCHASE AGREEMENT

97. In the context of negotiating the settlement described above, Air Canada

agreed to acquire additional inventory from Aero. Under the terms of the October

23, 2009 Consumable and Expendable Spare Parts Purchase and Sale Agreement

(US$25.5 million New CAT 3 Inventory) (the "October Purchase Agreement"), Air

Canada agreed to acquire one-third of the purchased assets (having an OEM

Catalogue Price of not less than US$8.5 million) on each of October 23, 2009,

November 1, 2009 and December 1, 2009 and pay USS8.5 million on each of

December 31, 2009, January 30, 2010 and February 28, 2010, consistent with the

prevailing payment terms between Air Canada and Aero. A copy of the October

Purchase Agreement is appended to my First Affidavit as Exhibit C.

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98. Mr. Webster states, in paragraphs 94 and 95 of the Webster Affidavit, that the

October Purchase Transaction was created for the purpose of off-setting the last three

obligations under the Warranty Performance Agreement - in other words, it was

solely intended to create security for the future obligations of Aero under the

Warranty Performance Agreement. However, that is not true. From my perspective,

the October Purchase Agreement was, first and foremost, an inventory purchase

agreement. Air Canada was prepared, and intended, to pay the full cash amount for

the parts acquired under the October Purchase Agreement.

99. Buying the parts provided Air Canada with several advantages including, but

not limited to, a certain discount and a ready amount of inventory that would allow

Air Canada to ensure transition in case Air Canada elected to change supplier down

the line should Aero fail to improve its level of service to Air Canada.

100. In order to ensure that Air Canada's objectives were met, the October

Purchase Agreement provides a representation and warranty almost identical to that

found in the January Purchase Agreement:

(e) Supply Management. The Seller is a specialist in inventory management and planning for the aerospace industry. The Seller has made investigations of historical relevant data and has made enquiries necessary and has the data and software required to forecast the Buyer's consumption of Parts and other inventory of the same nature or kind as the Purchased Inventory in the ordinary

course of business during the six (6) months following the First Instalment Purchase Datc. Based on historical data and the forecast derived from the Seller's investigations, enquiries and expertise, the Purchased Inventory does not

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exceed the requirements of [Air Canada] for such period. Only "high usage" C&E and Parts form part of the Purchased Inventory and none of the Purchased Inventory is or will become obsolete or unusable during the six (6) months following the Closing Date.

101. The correspondence referred to in paragraph 96 of the Webster Affidavit has

no bearing whatsoever on the purpose of the October Purchase Agreement. In that

correspondence, Mr. Wilson states what the parties already knew and had agreed,

specifically that Aero was in default of its warranty obligation's and that Air Canada

had accepted that Aero could remedy its breach over a period of time either by

supplying new inventory that conformed with the January Purchase Agreement or

by buying back non-conforming inventory under a forward purchase commitment.

102. In connection with entering into the October Purchase Agreement, the parties

agreed to a reduction in the balance of the purchase price under the January

Purchase Agreement. A copy of the Second Amending Agreement to the January

Purchase Agreement is appended to my First Affidavit as Exhibit M. Air Canada

sought, as part of its ordinary purchase practices, a discount below OEM price for the

purchase of new CAT 3 Inventory under the October Purchase Agreement. It was

Aero's preference to allocate the value of the discount to another agreement, as was

the case with the rebates under the Line Maintenance Agreement, thereby allowing

Aero to adhere to its policy of not selling inventory at less than the current OEM

price. It is not correct, as stated in paragraph 90 of the Webster Affidavit, to suggest

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that the reduction of the balance of the purchase price under the January Purchase

Agreement was a gratuitous additional benefit to Air Canada.

A ERO'S FINANCIAL SITUATION BY THE FALL OF 2009

103. Despite the short term liquidity crunch that Aero faced in early February 2009,

I never had any concerns about Aero's solvency from that point onward. In fact, the

question of Aero's solvency never occurred to me. Mr. Lewin readily shared

information about Aero's performance (as he did in February) and no one at Aero

raised any cash-flow or financial concerns after February. Instead, on March 16,

2009, Aero released positive results and elected to continue its dividend, as described

above.

104. Mr. Lewin and I spoke a number of times about Aero's failure to pay Air

Canada's invoices under the January Purchase Agreement, which Mr. Lewin

attributed throughout the period to difficulties he was having in getting his own

invoices paid by Aveos. Furthermore, Mr. Lewin advised me that, after February,

Aero did not have to face significant interest payments for some time and it was only

a matter of time before Aveos paid Aero or Aero obtained cash from other parts of its

business, which included relationships with Qantas Airways, SR Technics and Heico.

105. By the fall of 2009, it was apparent that Aero was doing well. As discussed

above, Mr. Lewin had spoken a number of times about new partnerships with

prospective clients. The price of Aero stock had doubled from April. On September

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30, 2009, Aero Inventory plc announced that it had commenced preparation for a

move from the AIM, the more junior board of the London Stock Exchange, to the

main market of the London Stock Exchange. A copy of the press release is appended

to this my affidavit as Exhibit "K". In October, I was made aware that Aero had

received an offer from a leading investment bank to underwrite an issue of new

equity once Aero Inventory plc had been listed on the main market. I believed that

Aero's resolution of its issues with Air Canada, described above at paragraphs 89

and following, was part of the ordinary course of Aero's business and would assist

the completion of the transition of Aero Inventory plc to the London Stock

Exchange's senior board. At that time, Aero Inventory and Air Canada were also

continuing to implement the Line Maintenance Agreement.

106. On October 23, 2009, the Aero Inventory Group gave another representation

and warranty as to solvency in both the October Purchase Agreement and the

Warranty Performance Agreement. Aero again represented as to its solvency

substantially as follows:

Both before and after giving effect to the Purchase Transaction, the Aero Inventory Group is able to pay its liabilities as such liabilities become due and the fair market value of the assets of the Aero Inventory Group exceeds the liabilities of the Aero Inventory Group.

107. As I mentioned in my First Affidavit at paragraph 49, I understand that, in the

course of an audit conducted as a condition of the new listing sought by Aero plc and

its proposed equity issue, serious accounting irregularities were discovered in the

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Aero Companies' books and records. Neither I nor, to my knowledge, anyone else at

- Air Canada had knowledge of any such irregularities and I was very surprised and

concerned when they were revealed.

108. I had no reason to believe that Acro's increasing stock price was not a reliable

indicator of the Aero Companies' financial condition and prospects. I don't believe

that I was alone in that regard. After Aero Inventory plc announced the financial

review that led to the appointment of the Administrators, the Sunday Times reported

in a November 15t article, a copy of which is appended to this my affidavit as Exhibit

Investors knew it had been suffering from growing pains, but nobody expected the company, which had a market value of £140m at suspension, to drop such a bombshell.

Administrators Actions Subsequent to Recognition Order

109. Once the Administrators were appointed, we met to discuss the obligations

that existed between the Aero Companies and Air Canada. I explained to them that

so long as Aero continued to abide by its obligations to Air Canada then Air Canada

would make the three required USS8.5 million payments (for an aggregate

consideration of US$25.5 million) under the October Purchase Agreement plus the $6

million payment due on February 28, 2010, under the January Purchase Agreement.

110. I explained that Air Canada did not want to take over the inventory

procurement and management functions that had been outsourced to Aero and that

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it was in both parties' economic interest to continue the arrangements at least until

the end of February 2010. However, the Administrators repudiated the Line

Maintenance Agreement which caused significant damages to Air Canada as I

previously stated in the First Affidavit.

111. Since the date of the Recognition Order, Aero has failed to provide any of the

services or support required under the Line Maintenance Agreement, which has

disrupted Air Canada's operations. Instead, it appears to have effectively abandoned

the remaining CAT 3 Inventory housed at Aveos' and Air Canada's facilities. Air

Canada has been compelled to assume the inventory procurement and management

functions previously outsourced to Aero. As 1 mentioned in my First Affidavit, that

has led to a profound change in the implementation of Air Canada's long-term

strategic objectives to outsource the procurement and management of CAT 3

Inventory and considerable economic loss.

112. As Air Canada advised the trustee in bankruptcy for Aero and Aero Inventory

plc, Air Canada is attempting to segregate its parts, which are held by Aveos, from

those of Aero. Because of the logistical complexity relating to the warehousing of

parts and Aero's cessation (without notice) of inventory management and support, it

is possible that Air Canada has used some of Aero's parts inadvertently after the

bankruptcy filing (although the amount, if any, has not yet been. finally determined).

Air Canada is reviewing whether any such use occurred and is prepared to pay for

any such parts used during the post-filing period.

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Fair Market Value of Inventory Accepted Is Well Below OEM Pricing

113. Pursuant to the October Purchase Agreement, Air Canada acquired the first

third of the CAT 3 Inventory on October 23, 2009, and the second third of the CAT 3

Inventory on November 1, 2009 and the last third on December 1, 2009.

114. The fair market value of the inventory that Air Canada acquired pursuant to

the October Purchase Agreement was significantly less than US$25.5 million.

US$25.5 million represents the OEM pricing for the inventory, not iN fair market

value.

115. As I mentioned in my First Affidavit, spare parts must be traceable, warranted

and certified. Tracking systems must record the entire life-cycle of every expendable

part from the time of manufacturing of the part up until it is destroyed or re-certified.

If an expendable part's history cannot be tracked, it must be destroyed. For that

reason, the parts that Aero sold to Air Canada were physically located at facilities in

Canada that were operated either by Aveos or Air Canada. They were, in effect,

within a closed system so that Air Canada could be assured that the parts were

accurately certified even if accurate records were unavailable.

116. These assurances no longer exist for parts without accurate records if they are

removed from the closed system. Therefore, no airline will acquire such parts from

outside its procurement system at OEM pricing. Rather, if an airline is willing to buy

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such parts at all, -it will do so at almost scrap prices as they will have to go through

the certification process with the product manufacturer before they can use the part.

SWORN BEFORE ME at the City of Montreal, Province of Quebec on August 13, 2010.

•

" •• • • 4' , 4 • , •

Commissioner for Taking AffidavA

. „

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ONTARIO SUPERIOR COURT OF JUSTICE -

COMMERCIAL LIST

Proceeding commenced at Toronto

MOTION RECORD OF AIR CANADA (MOTION RETURNABLE JANUARY 6, 2011)

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