Air Canada (TSX:AC) to Be Sued Over COVID-19 Refunds: Should You Sell the Stock?

Air Canada (TSX:AC)(TSX:AC.B) could fall further if the lawsuit against it goes ahead.

| More on:
question marks written reminders tickets

Image source: Getty Images

The Air Canada (TSX:AC)(TSX:AC.B) saga took another dramatic turn this week, after a group of passengers proposed a lawsuit against the airline and its competitors. The lawsuit is seeking refunds on flights booked prior to March 11.

Until recently, Air Canada had been giving full refunds to customers whose flights had been cancelled due to COVID-19. On March 24, the company’s CEO released a statement saying that customers would instead receive vouchers.

The move got the approval of the Canadian Transportation Agency, which said that vouchers are a valid form of compensation as long as they “do not expire in an unreasonably short period of time.”The agency clarified that 24 months would be a reasonable period for vouchers to remain valid.

The lawsuit stems from customers believing that they are entitled to cash refunds. If the suit goes ahead and succeeds, it would represent a major cost to shareholders. However, as you’re about to see, there’s a much bigger danger beneath the surface.

The legal problem

The lawsuit against Air Canada and its competitors is being overseen by Simon Lin, a Vancouver lawyer with EvoLink Law Group. According to Lin, Air Canada passengers are entitled to monetary refunds. He has argued that the CTA’s statement in support of vouchers is not legally binding, and that Force Majeure does not absolve the airlines of their responsibilities.

Force Majeure is a contract clause that exempts a party from their responsibilities due to unforeseen circumstances. According to an article by the law firm Blakes, Canadian courts generally uphold high standards for Force Majeure — in line with Lin’s argument that it doesn’t let airlines off the hook for refunds.

Business realities

If Lin is correct, and Air Canada owes all of its passengers full refunds, it’s bad news for the company. The proposed class-action suit is seeking not only refunds but additional damages, which will result in staggering costs. In fact, the costs would be greater than if Air Canada had issued refunds immediately. This raises the question of why it and other airlines went with vouchers in the first place. Top management must have known that passengers would get upset and take legal action. Why, then, make this wildly unpopular move?

As it turns out, it may be because the airlines don’t have the cash to pay up.

According to reports, many passengers are hearing that their refunds can’t be processed, because their airline doesn’t have the money. Looking at Air Canada’s financial statements, it appears that could be the case. At the end of last year, AC had about $6 billion in cash and equivalents. That same year, it had $17 billion in operating expenses. This means that the company would not be able to cover operating expenses with cash on hand.

It’s therefore quite possible that much of Air Canada’s 2020 revenue had been sunk back into its business before the voucher program came into effect. If that were the case, then the company may not have the cash needed to give refunds. That would indicate a major liquidity problem — one that’s ultimately a far bigger concern for investors than any potential lawsuit.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned.

More on Coronavirus

Dad and son having fun outdoor. Healthy living concept
Dividend Stocks

1 Growth Stock Down 15.8% to Buy Right Now

A growth stock is well-positioned to resume its upward momentum in 2024 following its strong financial results and business momentum.

Read more »

Double exposure of a businessman and stairs - Business Success Concept
Stocks for Beginners

3 Things About Couche-Tard Stock Every Smart Investor Knows

Couche-tard stock (TSX:ATD) may be up 30% this year, but look at the leadership and history of the stock to…

Read more »

Plane on runway, aircraft
Coronavirus

Can Air Canada Double in 5 Years? Here’s What it Would Take

Air Canada (TSX:AC) stock has gone nowhere since 2020. Can this change?

Read more »

Senior housing
Stocks for Beginners

Home Improvement Stocks Are Set to Fall (When They Do, Buy These Like Crazy!)

Home improvement stocks are due to drop further in the coming months. But with solid underpinnings for the sector, it…

Read more »

An airplane on a runway
Coronavirus

Forget Boeing: Buy This Magnificent Airline Stock Instead

Boeing (NYSE:BA) stock is looking risky right now, but Air Canada (TSX:AC) stock? Much less so.

Read more »

Man considering whether to sell or buy
Stocks for Beginners

Goeasy Stock: Buy, Sell, or Hold?

When it comes to smart buys, goeasy stock (TSX:GSY) is up there as one of the smartest money can buy.…

Read more »

Woman has an idea
Stocks for Beginners

Here’s Why Magna International Is a No-Brainer Value Stock

Magna stock (TSX:MG) has been climbing back once more, but still offers huge value for long-term minded investors.

Read more »

Aircraft wing plane
Coronavirus

1 TSX Stock Down 60% That Could Bounce Back Stronger

Air Canada (TSX:AC) stock got severely beaten down in the March 2020 COVID crash. Here's why it's probably not going…

Read more »