IN THE MATTER OF AN ARBITRATION BY FINAL OFFER SELECTION PURSUANT TO AN ACT TO PROVIDE FOR THE CONTINUATION AND RESUMPTION OF AIR SERVICE OPERATIONS,

BETWEEN:

AIR CANADA and: AIR CANADA PILOTS ASSOCIATION (ACPA)

SOLE ARBITRATOR:

Douglas C. Stanley, Q.C.

Heard in Toronto, ON on July 10, 11, 13 and 18

APPEARANCES FOR EMPLOYER:

APPEARANCES FOR UNION:

Douglas Gilbert, Counsel Maryse Tremblay, Counsel Fred Headon, Counsel Greg McGinnis, Counsel Scott Morey, VP Labour Relations Harlan Clarke, Director LR Ed Doyle, Flying Ops Ian Pollack, LR Advisor Bruce Campbell, Manager Steve Marson, GM Crew Scheduling Steve Duke, GM Crew Manning Dimitrios Tziortzis, Sr. Dir. Finance Rick Allen, Sr. Dir. Flying Operations Marcel Forget, VP Network Planning Amos Kazzaz, VP Financial Analysis Dave Legge, Sr. VP Operations Kevin Howlett, Sr. VP Greg Taylor, ICF SH&E

Steve Waller, Counsel Bill Cole, Co-Counsel Murray Gold, Counsel (Pensions) Jean-Marc Belanger, MEC Chair Darren Francisco, Committee Chair Bill Petrie, Executive Director Phil Aubin, Committee Member Tony Ledsham, Committee Member Mike McKay,Committee Member Sarah Winterhalt, Dir. LR Rob Kokonis, Air Trav Gerry O’Shaughnessy, Dir. Research John Medland, Blair Franklin Rikk Salamat, Case Lab

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INTRODUCTION This is a “final offer selection” arbitration under the terms of the Protecting Air Service Act, S.C. 2012, c. 2. The parties are in agreement that I have been properly appointed and have jurisdiction. The parties are also in agreement that the method of arbitration is “final offer selection” in its purest form. I am required to select one of the two final offers I receive from the parties and I have no discretion to pick and choose on specific issues from one or other of the final offers. The Act is also very specific with regards the matters the arbitrator is to consider in arriving at a decision to select one or other of the offers. This direction is contained in s. 29 (2) of the Act, as follows: (2) In making the selection of a final offer, the arbitrator is to be guided by the need for terms and conditions of employment that are consistent with those in other airlines and that will provide the necessary degree of flexibility to ensure (a) the short- and long-term economic viability and competitiveness of the employer; and (b) the sustainability of the employer’s pension plan, taking into account any short-term funding pressures on the employer.

BACKGROUND The history of collective bargaining between these two parties is so relevant to where they find themselves and to this arbitration that to not include the narrative of it in this Award would be leaving out essential background to the positions taken by the parties and to the Award itself. Pilots at Air Canada have been members of a union for over sixty years. In 1995 they formed a new union, the current bargaining agent, Air Canada Pilots Association (ACPA). They represent approximately 3000 pilots, making them the largest pilot bargaining unit in Canada. It is a matter of considerable pride at ACPA that their union is a “grass roots association”, deliberately established as such in 1995 when ACPA won a representation vote against Canadian Air Line Pilots Association (CALPA), its predecessor bargaining agent. The “grass roots” nature of the organization is definitely a factor in how their recent history has played out. ACPA is governed by a Master Executive Council (MEC) an elected 2

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body of pilots with a Chair chosen by the MEC. There is also an Association President who is elected from the membership of the union. From the time ACPA was certified in 1995 they negotiated collective agreements with Air Canada for the period 1995 to 1998, 1998 to 2000, and 2000 to 2004. That agreement negotiated in 2000, expiring in 2004, was the last freely negotiated collective agreement between these two parties. Air Canada went through its transformational change in 1988 when it was privatized, and in 1995 when the Canadian airline industry was deregulated following the Canada-US Open Skies Agreement. In 1999/2000 Air Canada merged with Canadian Airline International (CAIL) yet another major change to both Air Canada and ACPA as the CAIL pilots were absorbed into the new organization and their seniority lists merged. Almost immediately after the Air Canada - CAIL merger the economy went into recession. Business air travel was depressed followed by the twin crisis of 09/11 and SARS which had a further negative impact on air travel. In 2003 after an unsuccessful attempt to reduce its costs through negotiations outside of the Companies’ Creditors Arrangement Act (CCAA) the company was forced into CCAA protection process. The Ontario Superior Court of Justice appointed Mr. Justice Winkler as a facilitator between Air Canada and all its unions to assist in reaching labour concession agreements. Air Canada attempted, in these negotiations, to migrate employees to a defined contribution (DC) pension plan and away from the existing defined benefit plan (DB). That attempt was unsuccessful with the unions being united in their defence of their DB plans. The agreement with ACPA was concluded in June 2003 and was to be effective to April 2009. In February 2004, Air Canada reached an agreement with all its unions with respect to the funding of Air Canada’s pension deficit. Essentially providing that the deficit could be funded over ten (10) years rather than five (5) as was required by regulatory legislation. In order to achieve this, the unions had to support Air Canada’s application for relief made to the federal regulator of pensions. ACPA signed a further Memorandum of Agreement in June 2004, paving the way for Air Canada to emerge from CCAA. A restructuring plan was signed by Air Canada and all its creditors in August 2004. At the same time, August 2004, the federal government accepted the proposal for funding relief and passed the Air Canada Pension Plan Solvency Deficiency Funding Regulation. 3

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In 2006, pursuant to a wage re-opener in the 2003 collective agreement, the parties started negotiations. These were not successful and I was asked by the parties to arbitrate their dispute, resulting in an Award dated October 20, 2006. In that round of negotiation/arbitration ACPA was seeking to recover the concessions given up in the CCAA process. That effort continued into the present round of bargaining. In 2008, as a result of numerous negative forces, Air Canada experienced a loss of $1.025 billion. The deficit in the Air Canada pension plans escalated significantly because of poor investment returns, losses in market value of investments and persistent low interest rates. Low interest rates have a double negative effect on pension plans—they result in poor returns to the fund and they inflate the cost of the future obligations the fund must meet. From the time it emerged from CCAA in 2004 Air Canada contributed $2.2 billion to its pension plans. The solvency deficit grew from $1.3 billion in 2004 to $2.83 billion on January 1, 2009. As a result of covenants in financial instruments and agreements Air Canada is required to maintain certain liquidity levels. In 2009 the company faced a serious challenge to their liquidity. Without funding relief they would have been required to contribute $430 million into the pension fund to cover 1/5th of the solvency deficit and another $156 million for current year costs for a total of $586 million. In its first quarter of 2009 Air Canada reported a loss of $400 million. Thus, the company began another round of negotiations on pension relief with all its unions. The Honourable James Farley, Q.C. was appointed by the Federal Minister of Finance to mediate discussions between the parties. That exercise resulted in an MOU providing for fixed payments to the pension plans by Air Canada and extending the collective agreement until March 31, 2011. In July 2009, the Government adopted the Air Canada Pension Regulations, 2009 to relieve and cap past service contributions the company would have to make to its pension plans from April 1, 2009 until December 31, 2013. This allowed Air Canada to raise additional funding for its operations. This was the second regulatory relief granted within five years. These events of 2009 overtook the first steps that had been taken in 2008 towards negotiating a whole new collective agreement. The parties had an understanding going into these discussions that this was not “collective bargaining”, but work towards an agreement with a new structure and new language and identifying areas of differing interpretation, all of which would be negotiated with the expiry of the 4

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agreement approaching in July 2009. This review process resulted in the drafting of the “Clarity Document” which incorporated these potential improvements. As stated above, these preliminary steps towards a new agreement to be negotiated in 2009 were overtaken by events. Among these were the global recession, the credit crisis and Air Canada’s $1.025 billion dollar loss in 2008. With the assistance of Mr. Justice Farley, ACPA, Air Canada and every other union agreed to extend their collective agreements for 21 months, expiring on March 31, 2011. They also agreed to join in submissions to OFSI for the pension deficit relief that was obtained by the Regulations passed in July and the Clarity Document was essentially set aside. In the summer of 2010, the parties met to discuss the approaching end to the agreement. Both parties agreed that, if possible, an early settlement would be mutually beneficial and they worked to that end. They agreed to use the “Clarity Document” as the basis for negotiations and they started meeting in October 2010. The parties adopted what is referred to as “interest based bargaining”. They made progress. They agreed to extend the first 30 day period of negotiation and ended up meeting over a period of six months. During that time both parties made use of subject matter experts on topics such as short and long term scheduling, equipment and vacation bidding and general operations. These experts met separately as subcommittees and fed their results into the main bargaining committee work. On March 17, 2011 the negotiating committees reached an agreement on terms of settlement and had completed drafting language in the form of a new collective agreement. Before ratification the committees met together to conduct a final review of the contractual language of the settlement. This joint effort at drafting language was intended to minimize future disagreement and to develop language that would assist pilots and managers in understanding the new concepts in the Tentative Agreement (TA). Air Canada submitted that at no time during negotiations leading to the TA did any representative of ACPA indicate to them that either the method or direction of bargaining was not supported by the Association. Air Canada advised this arbitration board, in their brief, that their understanding was that the ACPA negotiating committee met numerous times throughout this process with the MEC to update them on the bargaining process and to receive direction. In this period of time Air Canada management met twice with the MEC to discuss specific issues such as the company’s financial performance and Air Canada’s intentions to establish a Low Cost Carrier (LCC). 5

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The ACPA negotiating committee that arrived at the TA recommended its acceptance. The MEC endorsed sending the TA to the membership for a vote but they did not make a recommendation. On May 11, 2011 ACPA started meetings across the country to explain the TA to their membership. On May 19, 2011 ACPA advised Air Canada that the membership rejected the TA by a vote of 66%. All the members of the ACPA negotiating committee resigned. On learning that the TA had been rejected by the membership, Air Canada attempted to have ACPA return to the bargaining table. A new ACPA negotiating committee was not appointed until August and in October that committee agreed to meet with Air Canada to resume negotiations on November 23, 2011. When they met ACPA advised Air Canada that they would not be using the rejected TA as the basis for negotiation but would be starting fresh and using the language of the expired collective agreement as the basis for negotiations. In February 2012 ACPA conducted a strike vote in which 97% of the members voted in favour of strike action. The next day the Minister of Labour appointed two mediators to work with the parties. Mediation was shortly abandoned and on March 7, 2012 Air Canada tabled a third and final comprehensive offer. On March 8 Air Canada served ACPA with a notice of lockout and on March 12, 2012 the legislation under which this arbitration is taking place was introduced and subsequently passed by Parliament on March 15, 2012. These events were all playing out concurrently with Air Canada negotiating with its other unions. The legislation mandating this arbitration process mandated a similar process for the settlement of a dispute between Air Canada and the IAMAW (Machinists). That arbitration has taken place and Arbitrator Picher has delivered his Award (unreported at this time). As was the case in all its union negotiations the issue of pension plan solvency deficit funding relief was on the table. In referring to that issue Arbitrator Picher said, at page 11, “Should that relief not be obtained, grave existential questions will arise with respect to the future of both the pension plan and of the company itself.” I am satisfied that both Air Canada and ACPA share that view, and although ACPA attaches existential importance to a second issue— scope of the bargaining unit—the parties recognize that it is the pension issue that weighs heavily on the outcome of this arbitration.

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EXPERT REPORTS The parties submitted extensive briefs supporting their comprehensive offers. They were assisted by experts they engaged to advise on various issues both general and specific. Those reports that were filed with me were very helpful in understanding the issues and the positions taken by the parties in their final offers. Taylor Report: Air Canada engaged an expert in the aviation business to review Air Canada’s final offer. Gregory T. Taylor is Senior Advisor with ICF SH&E. Mr. Taylor spent 35 years in the industry at United Airlines and US Air. He held the position of Senior Vice President of Corporate Planning and Strategy at United Airlines. He joined ICF SH&E, the worlds largest consulting firm specializing in the airline business, in 2011. He was asked by Counsel for Air Canada to review provisions in Article I of the Tentative Agreement as revised in Air Canada’s final offer related to Code Sharing, Joint Ventures, Capacity Purchase Agreements, and a Low Cost Carrier. He was asked to explain the purpose of each of these types of commercial arrangements and to provide his opinion on the contribution of each one to an airlines economic viability and competitiveness. Mr. Taylor was also asked to compare the flexibility and the restrictions contemplated in the Tentative Agreement for each of these types of commercial arrangements with those under which other Canadian, U.S. and International airlines operate and comment on the significance of any relevant differences. His report, dated July 5, 2012, was presented by Air Canada in support of their final offer. At the beginning of his report Mr. Taylor makes some very interesting observations about the profitability of Air Canada and the nature of the airline industry. Air Canada has been largely unprofitable over the last 20 years. During this period, there have only been six profitable years and only one (2007) in the last 10 years. And the magnitudes of the losses were substantially greater in absolute terms than the profit years. In total, over the entire 20-year period, Air Canada and its preceding corporate entities lost a total of $5.858 CAD1 billion on $157.80 CAD billion in revenue – a net margin of -3.7% over the 20 year period. While the cumulative historical loss is very large ($5.858 billion CAD), as a percentage of revenue the loss amounts to only 3.7%. This demonstrates that in such a low margin business, a few percentage points of cost are hugely significant and are often the difference between success and failure. Importance of Pilot Cost At Air Canada, as at other airlines, a high proportion of costs are outside of management’s day-to-day control. Fuel, Airport Cost, Navigation and Landing

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Fees, all of which are generally uncontrollable in the short term, typically make-up approximately 40% of an airline’s operating cost. Labour, which is generally seen by airlines as a more-controllable element of the total expenses is one of the largest categories. In 2011, Wages, Salaries and Benefits accounted for 17% of total operating cost at Air Canada of which the pilot work group is a large contributor. This is why a competitive pilot agreement is so important to the company and the industry in general. Industry Volatility and the Need for Flexibility In addition to long-term low margins, Air Canada and the airline industry are highly susceptible to external shocks that all too frequently send the industry into economic nosedives. During the last 20 years, the global airline industry experienced some of the most damaging events in its history – including the 9/11 terrorist attack, the SARS epidemic, the fuel price spike during 2008 and the current global economic downturn. In order to survive shocks like these and the volatility inherent in the industry, Air Canada needs strong earnings in the good times, a solid balance sheet, access to credit and most importantly, the business model flexibility required to quickly adjust to demand shocks and the rapidly changing market.

In general we accept the thrust of Mr. Taylor’s comments on the nexus between flexibility competitiveness and profitability. Although ACPA disputes in several areas Air Canada’s need for specific flexibility they do not really dispute the fundamental relationship of these business factors. It does however lead them to conjure up their worst fears which they describe as the “virtual airline” a business that does not fly its own planes but flies all its passengers on the lowest cost carrier available. ACPA maintains that in order to ensure that would not happen various protections were negotiated into the scope language of the agreement. ACPA argues that their final offer continues the pattern of protection established by the parties in the past. They say yes to new commercial relationships provided they do no harm to and potentially benefit the pilot group. The short and long-term economic viability and competitiveness of Air Canada is something I am directed by the statute to consider. The Taylor Report analyses Air Canada’s markets in terms of where it competes and who it competes with. The report concludes that the aggregate level of competition Air Canada faces from other carriers is extremely high. WestJet competes with Air Canada in more city pairs (referred to as Origin & Destination markets or O&D) than any other carrier. Fully 37% of Air Canada revenue is derived from O&D markets where it competes directly with WestJet. Air Canada derives 23% of its revenue from O&D markets where it competes head to head with United. Although small, Air Transat competes in many of Air Canada’s international O&D markets, markets which account for

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5% of Air Canada’s revenue. All told, Taylor calculates that 87% of Air Canada’s revenues are derived from contested markets. At page 10 of his report Taylor looks at the near future: Going forward, the number of markets without direct competition stands to decrease due to the expansion plans of Air Canada’s competitors. WestJet recently announced plans to introduce 45 regional aircraft over the next six years—aircraft that will likely be used to bring WestJet service to smaller Canadian cities. … The competitive landscape is getting more intense every year as cost and Canadian competitors WestJet, Air Transat, and Porter grow rapidly. And, because each of these three carriers has a distinctly different market focus, the increase in competition facing Air Canada is coming from multiple directions. WestJet predominantly operates flights domestically, to the US, and to sun destinations; Air Transat flies to Europe and sun destinations; and, Porter serves the major business centres of Eastern Canada and the Northeast US from its hub at Billy Bishop Toronto City Airport. These carriers are growing rapidly. In the year ending July 2008, the three carriers combined produced just over one-thrid as many available seat miles (ASMs) as Air Canada produced. But over the next four years, Air Canada grew by only 4.9% while Porter, Air Transat, and WestJet expanded rapidly, growing by 53.9%. For the year ending July 2012, these airlines are scheduled to produce ASMs totaling more than half of Air Canada’s capacity.

If long term viability and competitiveness in the airline industry depends on flexibility, it behooves me, in looking at the two final offers to consider what sort of flexibility is necessary. Which of the two proposals on scope language gives the enterprise the tools to meet the competitive challenge. I refer here to the enterprise —pilots and management together. ACPA’s greater challenge is not protecting pilot jobs from management decisions, it is protecting them from this competitive challenge. Taylor does include in his report a section on a Salary Rate Comparison and Pilot Hourly Rates. ACPA has serious issues with this part of the Taylor Report (see ACPA Reply Brief para 31-32). R.W. Mann & Company Report ACPA has filed a Report by R. W. Mann who is a leading airline consultant with extensive experience analyzing Air Canada and the Canadian industry as well as the American airline industry. Mr. Mann has excellent credentials to advise and consult in the North American airline industry. His report filed with ACPA July 13,

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2012 is largely a rebuttal to the Taylor Report. Mr. Mann expresses his opinion on the scope-related parts of the Taylor Report as follows: Scope Most claimed deficiencies in current Air Canada scope are self-inflicted. •

As previously noted, Air Canada feeders operate more than 60% of SYSTEM departures, though more modest shares of block hours and ASMs, due to the relatively short hauls and small gauge of the feeder fleets (appropriate to the size of most Canadian markets)

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Air Canada is saddled with what is arguably the highest cost, “Take or Pay” capacity purchase agreement in North America – the Jazz/ Chorus trust spin-out engineered by ACE Holdings

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The Jazz/Chorus fleet is outdated and fuel-inefficient, which we noted on several occasions in reports shared with the Company, done almost a decade ago

Air Canada scope is no more restrictive than US network carrier agreements. As noted, any apparent deficits are collateral damage of ACE Holdings’ business fragmentation initiatives.

The summary of his opinion is found at page 23 of his report: Summary Opinion Mr. Taylor’s report and its opinions should not be relied on because: • Mr. Taylor compares single clauses (bare pay rates, scope) out of what are comprehensively bargained agreements, and • Mr. Taylor omits actual and impending changes to agreements (Delta, “Delta plus $1” at United, TA or LCC CLA at American) in the metrics used for comparison • Mr. Taylor recommends that Air Canada place more aircraft into CPA service, while placing more aircraft at Jazz/Chorus now would burden Air Canada more than it is already • The window of opportunity to diversify shut almost a decade ago, when the Company implemented Eclat’s similar recommendation to place the CRJ200 at Jazz, the highest cost CPA contract in North American industry • Mr. Taylor’s rationale for LCC and joint venture initiatives is counter-factual to industry experience, including the multi-fold LCC experiences of his former employers, along with more recent industry LCC and offshore joint venture experience • Air Canada has adequate flexibility to accommodate seasonality and business cycle variation

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Blair Franklin: ACPA has also engaged experts to advise on the viability of the company and on the impact of ACPA’s offer on the company’s future performance. ACPA engaged the firm of Blair Franklin in 2008. Blair Franklin is an independent investment bank that provides a full range of financial advisory services. What they provide ACPA with, and what they have provided in the report submitted to me, is a review of the historical performance of the company. They make certain assumptions and based on those assumptions they created a financial model of the company that they use to make projections of future performance. They present a five-year forecast of AC operating and financial results as well as a specific analysis of the company’s financial performance since the failure of the tentative agreement in 2011. Blair Franklin projects the profitability of Air Canada to the end of 2012 from s. 2.3 page 10 of their report: EBITDAR is the standard performance metric used in analyzing airlines. It is a measure of profitability once differences in capital structure are eliminated. Air Canada’s EBITDAR has recovered significantly since 2009 due to increases in revenue, renegotiation of key contracts and the successful implementation by management of other revenue and cost initiatives. The recovery slowed in the latter half of 2011 as high jet fuel prices persisted despite higher revenues and lower non-fuel costs. EBITDAR declines in Q4 2011 and Q1 2012 (year over year) directly relate to higher fuel costs during these periods. WTI averaged $94 per barrel and $103 per barrel, respectively in these periods or 11% and 22% above the current $84 per barrel. While the recent declines in EBITDAR are concerning, it is important to bear in mind that they are directly related to fuel costs. Traffic, Pricing and Revenue are all increasing and other non-fuel costs are constant or declining on a per mile basis. Given current market forward prices for WTI and Jet Fuel, Q2 – Q4 EBITDAR results for 2012 should be very strong.

Blair Franklin applied their financial model of Air Canada to the five years 2006 to 2011. At section 3.1 of their report, page 13 they review those results and comment: Two key takeaways from the figure are: 1) Without labour providing liquidity relief, Air Canada would not have had sufficient liquidity to manage through 2009 and likely would have been forced to seek creditor protection. The Company’s avoidance of creditor protection was a benefit to the equity holders courtesy of the pension plans; and

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2) Blair Franklin’s analytical and detailed model has been an accurate predictor of actual results at Air Canada.

At page 16 of their report: Air Canada has provided ACPA and Blair Franklin with a forecast that they prepared in July 2011 (more recent forecasts were not disclosed). The largest difference between Blair Franklin’s forecast (June, 2012) and Air Canada’s (July, 2011) is the fuel price assumed. As seen in Figures 6 and 11, fuel prices and the fuel outlook has changed dramatically since July 2011. Were Air Canada to update its fuel forecast, it would likely look quite similar to Blair Franklin’s. While the fuel costs in Q2 and Q3 are forecast, the fuel price is observable on a daily basis and we are confident that the short-term forecast is relatively accurate. The table below demonstrates that the change in the fuel price assumption has a dramatic effect on the remainder of 2012. Throughout Q1 and Q2 2012, as fuel prices have declined, Air Canada has been able to maintain yield and RPM consistent with the forecast.

ACPA asked Blair Franklin to review its final pension offer. At page 18 of their report they state: ACPA’s final proposal to the Arbitrator provides approximately $317 million of funding relief to the total Air Canada pension solvency deficit. This relief is comprised of $273 million from general pension concessions (bridge benefit, early retirement and Normal Date of retirement) as well as $44 million from the provision relating to flying past the age of 60. ACPA’s concessions represent a pro rata share of the Company’s target solvency reduction of $1.1 billion and is in excess of what was asked for from ACPA by the Company. Given the Company’s disclosed solvency deficit of ~$4.4 billion as of January 2012 and the expected aggregate savings generated from concessions by ACPA and other labour groups, the current solvency deficit as at January 2012 is estimated to be ~$3.3 billion. As agreed to by the labour groups and adopted by the Government of Canada under the Air Canada 2009 Pension Regulations, Air Canada’s solvency deficit contributions are defined for the remainder of 2012 and 2013. On a simplified basis, post-2013, the Company’s solvency deficit contribution is determined based on the 3-year average of the trailing solvency deficit valuations. Air Canada is obligated to pay down a fifth of the 3-year average balance in any given year.

Based on the pension deficit concessions made in this round of bargaining and on an assumption that interest rates will return to normal and that the current low rate will not persist, Blair Franklin estimates that the pension deficit will shrink to under $1 billion by 2016. Their assumptions include Air Canada making capital

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expenditures for the purchase of Boeing 787 planes and refinancing 70% of their debt. From this base they created a liquidity profile looking into the future. They provide that at pages 23-24 of their report: The key assumptions behind Air Canada’s liquidity forecast, which have been discussed in more detail above are: 1) Conservative growth in Traffic, Pricing and Revenues; 2) Stable fuel costs consistent with the general economic assumptions underlying assumption 1 above; 3) Non-fuel costs per mile flown halt their declining trend and begin to grow; 4) Interest rates gradually rise and lower the pension solvency deficit; 5) Capital expenditures increase significantly as the Company purchases Boeing 787s; and 6) 70% of debt that matures is refinanced. The key assumptions listed above result in the following liquidity profile: Cash levels fall through 2015 as the Company replaces its fleet, begins to pay off the solvency deficit and refinances only 70% of its maturing debt. This decline is an investment in the future of Air Canada and has been made by Management on the basis that it will increase the financial strength of Air Canada and provide a positive return in the coming years. Liquidity begins to return in 2016 as the solvency deficit shrinks through moderate increases in the Government interest rates (2016 assumed 10 Year bond rate of 2.9%) and continued payments by the Company. The “liquidity low point” occurs in 2015 where cash and equivalents reach ~ $1.6 billion. For context, before the 2009 restructuring, liquidity was at ~ $900 million. While in 2014 and 2015 cash balances will be below the optimal level, forecast cash and equivalents remains at nearly twice the level of the low point in 2009. The Company, should it desire more liquidity over this period, may also enter into Sale / Leaseback transactions on its newly acquired Boeing 787s, which as discussed above, could represent approximately $1.5 billion of liquidity in addition to the committed financing for these aircraft.

This report is largely the basis of ACPA’s argument that the financial future of the company is not as gloomy as presented by the company. Case Lab ACPA also engaged Case Lab, a consulting firm that provides economic and financial analysis services for clients. The Case Lab Report was authored by Rikk

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Salamat who specializes in the analysis of economic and financial data. Most of his work has been with airline pilots, including most major US carriers. Since 2008 he has been the costing consultant to US Airways Pilots Association, analyzing their proposed contract changes and doing cost comparisons with WestJet pilots. At page 1 of his report Mr. Salamat sets out what he was engaged to do and a concise summary of his analysis: I have been asked by the Air Canada Pilots Association (ACPA) to conduct an analysis of the impact the proposed wage rates set out in Appendix 1 would have on their employer and how their compensation under those rates would compare to the pilots of other carriers. A particular concern was how Air Canada's competitiveness, particularly in relation to its major competitor, WestJet, would be affected. A summary of the results from my analysis is as follows: 1.

Under ACPA's proposed mainline rates, the average compensation of an Air Canada pilot would be 10% less than those of WestJet.

2.

The average pay of an Air Canada pilot would be 16% less than an average of Air Canada's major domestic and international competitors, placing them towards the bottom of their peers.

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Air Canada will have a 10% pilot cost advantage relative to WestJet, its major competitor, and will have comparable costs to its international competitors.

Air Canada, in their reply (Tab 15, Appendices to Reply Brief) set out a very detailed account of its analysis of WestJet pilot compensation against that of Mr. Salamat, detailing the assumptions made by each and the variance arrived at. Mercer Air Canada provided a report on pensions which will be considered in a later section on pensions.

Mr. Kazzaz Air Canada presented financial information through a slide presentation and oral testimony from Mr. Kazzaz, Vice President of Financial Planning and Analysis. Some of the financial information he presented was that:

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Air Canada has incurred a net loss of close to $1 billion since 2006. In 2011 Air Canada had record revenues but lost $249 million. Mr. Kazzaz stated that the Blair Franklin model was $100 million off on 2011 profit. US carriers have been able to raise fares but Air Canada cnnot because when they tried WestJet did not match them. WestJet has had a 12% increase in market capacity share of transborder flying while Air Canada’s share has declined by 1.9%. Air Canada has lost 6% of its International Market Capacity Share. WestJet has increased its ASM by 69.2% over 5 years while AC has increased only 8.8%. WestJet is now larger that Canadian Airlines was in 2000 when it merged with AC. Historically, AC’s CASM ex-fuel has been between 30%-50% higher than WestJet. Compared to WestJet AC’s RASM-CASM spread remains too low putting AC at a huge competitive disadvantage. Air Canada has the lowest EBITDAR margin of all major North American carriers. WestJet has built up impressive cash levels compared to AC and therefor benefits from a much more favourable credit rating. Air Canada has growing cash needs over the next few years, fixed pension funding ends in 2013, new 787’s arrive in 2014, and $1.1 billion in debt maturities in 2015 have to be refinanced. Mr. Kazzaz points out that the Blair Franklin Report assumes refinancing 70% of this debt, he states that either 100% or 0% gets refinanced. Mr. Kazzaz states that the Blair Franklin Report over states cash by $200 M. Mr. Kazzaz states that if Air Canada is not successful in having their final offer accepted the company will have a cash shortfall of $350 M to $500 M over the next four years based on his projections of the company’s contractual obligations. In January 1, 2011 the pension deficit was $2.2 B and the enterprise value of Air Canada was $6 B, on Jan. 1, 2012 it was $4.4 B against an enterprise value of $4.9 B. Mr. Kazzaz pointed out that the Blair Fraser Report suggests Air Canada’s second quarter will benefit from lower fuel costs when in reality fuel costs did not go down until May and because Air Canada buys its fuel a month in advance the lower fuel costs will not benefit them until June. 15

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Blair Fraser suggests Air Canada could benefit from hedging all their fuel costs, Mr. Kazzaz explained that Air Canada hedges 75% of their fuel costs and the cost of premiums to do that is $50 M and Air Canada simply does not have the cash to be able to hedge 100%. Mr. Kazzaz pointed out that from an IPO price of $20.00 in 2006 Air Canada’s stock now trades below $1.00.

ACPA disputes the general tone of Mr. Kazzaz’s financial picture as well as some of the specific information. Again Blair Franklin were asked to review it. ACPA filed a second report from Blair Franklin, dated July 17, 2012, with their Reply Brief. In that report Blair Franklin addresses the liquidity crunch described by Mr. Kazzaz, at p.10, as follows: Air Canada’s witness, Amos Kazzaz, arrived at an opinion that Air Canada does not have sufficient liquidity to operate through 2014 and 2015 unless the Air Canada final offer proposal is selected. Mr. Kazzaz arrives at this opinion based on a review of future contractual obligations and not a comprehensive approach which includes a review of future revenues estimates and future cost estimates. Blair Franklin’s financial forecast illustrates that Air Canada can manage its liquidity through 2016 and beyond if the ACPA final offer submission is selected. The Blair Franklin model looks at a fulsome picture of revenue expectations, cost expectations and future contractual obligations. The Blair Franklin approach is standard financial practice in analyzing the future performance and outlook of a company. Blair Franklin strongly believes the comprehensive approach to forecasting allows for more informed analysis than the Air Canada approach of looking solely at contractual obligations. The Blair Franklin model considers a range of factors. In determining the assumptions underlying the model we have used a common outlook on the global economy, the Canadian economy and the airline industry. In determining assumptions, we review both historic information and forward looking indicators. We test all assumptions back against the common macro outlook. Our assumptions are a set that all work together and are interrelated. We consider these inter-relations in determining the set of assumptions. Selecting portions of the analysis or singular assumptions, without considering all related assumptions together, could create a misleading view of the financial analysis as a whole.

These various reports and opinions inform the positions taken by the parties on the issues in dispute. Clearly the way the parties use this information highlights why they have not been able to conclude an agreement. The parties cannot agree on the financial health of the company, what the competitive environment is, or what the 16

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comparable pilot wages are at WestJet. Being unable to agree on these facts it is not surprising they cannot agree on whether/how the existing collective agreement restricts Air Canada’s ability to compete, whether their pension plan is sustainable by the enterprise, and how Air Canada should position itself in the marketplace in the future. In the end this Award turns on three critical issues pensions, scope and LCC; and term, a fourth issue, less critical, but important enough to be commented on. It is the nature of final offer selection, where so many issues remain outstanding, as they do in this case, that many issues will be simply swept up in the award. I will not cover the complete offer of either party in a comprehensive way. I have reviewed the offers in their entirety, nothing in either offer, outside of the three critical issues I identified above, would be persuasive enough to displace my conclusions based on these three issues. With respect to how I ought to approach the final offer selection on those three issues, I have been provided with a comprehensive survey of the law by Counsel for both parties.

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THE LEGAL FRAMEWORK ACPA Argument Mr. Waller, Counsel for ACPA submitted that their offer has been crafted to address the needs of both parties with regard to the statutory criteria. He maintained that they have responded vigorously to Air Canada’s concerns and the need for terms and conditions of employment consistent with other airlines. ACPA maintained that the concessions they have made will greatly improve Air Canada’s short and longterm economic viability and competitiveness and ensure the sustainability of the pilots pension plan. He referred specifically to the following concessions: •

$316.5 million in solvency funding relief, which is $42.5 million more than the original target set for ACPA in this round of bargaining, other employee group and is a greater proportionate give than has been achieved with any other employee group

•

Changed normal retirement age from 60 to 65

•

Numerous provisions for flexibility including the ability to launch a Low Cost Carrier that can operate both domestically and internationally with WestJet pilot compensation levels, WestJet schedule bidding system and many WestJet work rules

•

Increased productivity and flexibility through expanded overtime

•

Reduced training costs by limiting the number of courses to which pilots are entitled in their careers

•

Wholesale adoption of the company’s stated needs in training, checking and supervisory flying

ACPA stressed in their brief that this was the first time a tentative agreement was not approved by their Master Executive Council (MEC) and that it was overwhelmingly rejected by their membership. They argued that under replication theory a return to the TA is arguably the “least likely destination of continued free collective bargaining” and that the parties based their post 2009 bargaining on the expired agreement. ACPA submitted that this final offer selection arbitration process is not an appropriate vehicle for imposing the clarity document. One of the themes that runs through ACPA’s argument is that to impose the TA on the union at this point is an affront to their fundamental rights of free bargaining. ACPA cites Paul Weiler, Reconcilable Differences; New Directions in Canadian Labour Law (Toronto; Carswell, 1980) at page 64:

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The basic assumption of our industrial relations systems is the notion of freedom of contract between the union and the employer. There are powerful arguments in favour of that policy of freedom of contract. We are dealing with the terms and conditions under which labour will be purchased by employers and will be provided by employees. The immediate parties know best what are the economic circumstances of their relationship, what are their non-economic priorities and concerns: what trade-offs area likely to be most satisfactory to their respective constituencies. General legal standards formulated by government bureaucrats are likely to fit like a procrustean bed across the variety and nuances of individual employment situations. Just as is true of other decisions in our economy – for example the price of capital investment or of consumer goods and services – so also unions and employers should be free to fix the price of labour at the level which they find mutually acceptable, free of intrusive legal controls.

ACPA does recognize that the right to free collective bargaining is essentially foreclosed by the Protecting Air Services Act. They note that although the Act sets criteria for the selection of the final offers it does not preclude the use of the standard criteria developed by arbitrators and they rely on the principles of “replication, gradualism and demonstrated need” as enunciated by Arbitrator Burkett in Air Canada and CAW (unreported) Sept. 16, 2011, where Arbitrator Burkett made the following observations: We are, therefore, a board of interest arbitration called upon to adjudicate this issue and as such the principles that have guided boards of interest arbitration for many years are applicable here. The terms replication, gradualism and demonstrated need are used to describe the guiding principles of board of interest arbitration. Replication refers to the objective of fashioning an award that, to the extent possible, replicates the settlement the parties would have reached had the dispute been allowed to run its full course. In this regard, interest arbitrators look to benchmarks in the community (in our case in other major Canadian corporations and in the airline industry) and to the bargaining history between the parties. [emphasis added] ... Further, the bargaining history shows, on the one hand, a Union that has steadfastly held to a DB plan for all (existing employees and new hires alike) while making other pension-related compromissory concessions and, on the other hand, and Employer intent on extricating itself, to the maximum extent possible, from the financial dilemma caused by unfunded pension liabilities and who has agreed to these compromissory concessions. Having obtained two major concessions from the Union in this regard in 2011 bargaining (reduced early retirement entitlements for existing employees and a lower wage schedule for new hires) that represent a compromise from the bargaining positions of the parties, the 19

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application of the replication principle in all the circumstances that prevail here suggests to us that if left to their own devices, these parties, in the face of a very competitive business environment, would have fashioned a meaningful compromise. This is not a bargaining situation in which the bargaining strength of one or other of the parties would have allowed it, within the context of this industry, to force a prolonged work stoppage in order to bring about the capitulation of the other side, as for example, at Vale/Inco in 2010. As between two offers that meet the sustainability threshold, the union final offer represents such a compromise while the Employer’s final offer does not. The principle of gradualism reflects the reality that collective bargaining between mature bargaining parties, as these are, is a continuum that most often accomplishes gradual change as distinct from drastic change. It follows that absent compelling evidence, an interest arbitrator will be loath to award “breakthrough” items. ... The principle of demonstrated need, as applied to a major economic item, provides a counterbalance to the principle of gradualism. It does so by establishing the basis upon which a board of interest arbitration will award a “breakthrough” item. A party seeking a major or even a radical change must convincingly establish the need for such change; hence the term demonstrated need. In this case, where both of the final proposals meet the sustainability threshold, the Employer is at a disadvantage in convincing us that the move to a pure DC plan for new hires (a radical departure from the status quo) is to be preferred to the alternative of a hybrid DB/DC arrangement (a less radical departure from the status quo). This is especially so in the context of the concessions already made by the union in 2011 collective bargaining assessed against the Employer’s own measure of sustainability. Final offer interest mediation/arbitration constitutes, in effect, a two-edged sword. On the one hand, because of the all-or-nothing final result, it forces the parties to mediate their difference. On the other hand, if the difference cannot be mediated, the Board is forced to choose one of the two final proposals in its entirety.

ACPA relied on comments I made in 1999, in an unreported case, Mount Allison University and Mount Allison University Faculty Association. These comments were cited by Arbitrator Ashley in Nova Scotia Government and General Employees’ Union vs. Nova Scotia (unreported) Aug. 13, 2001. In the Mount Allison case I had been appointed as a mediator to settle a strike. The strike was settled on the principal issues and the parties gave me the authority to settle, by final offer selection, any issues they could not agree on in a back to work protocol. In the course of a very brief decision I said: 20

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My understanding of the theory of final offer selection is that it compels both parties to compromise. It requires both parties to evaluate the other’s position and to modify their own proposals in such a way as to incorporate the concerns and recognize the legitimate interests of the other party. I was pleased that in the mediation that preceded this final offer selection both parties recognized this feature of the process. Throughout the mediation process, and in the preparation of their final positions, both parties addressed the concerns and legitimate interests of their opposite party. Both proposals put to me were “fair and reasonable”. In selecting one of two “fair and reasonable proposals” it is my view that the process ought to favour the proposal which goes furthest in addressing the legitimate concerns and interests of the party opposite. In other words, the proposal which is the best blend of the legitimate interests of both parties.

ACPA refers to a FOS Award of Arbitrator Fagan in Newfoundland and Labrador (Public Service Secretariat) and Royal Newfoundland Constabulary Assn., 89 CLAS 281, 2007 CLB 12432 as follows: It is because of the significant difference in the final offer selection process, that arbitrators have grappled with the application of the principle of replication. Arbitrators in interest arbitrations strive to fashion an award that mirrors what the parties would have agreed to through collective bargaining and negotiations. The principle of replication is the essential objective for arbitrators when they have the jurisdiction to craft a settlement. But the principle obviously cannot be applied with precision when there are only two choices available to chose from. Arbitrator William Kaplan arbitrated a July 2006 final offer selection arbitration between Canadian Niagara Hotels Inc and UNITE HERE Local 75, 2006 CanLII 25535 (ON. LA). He commented at page 6 that neither of the selections which he was faced with, looked like a negotiated settlement: To be sure, neither final offer in this case, experience indicates, looks like the product of a negotiated agreement, an unfortunate circumstance given that the parties are in what otherwise would be described as a mature collective bargaining relationship. Both proposals contain provisions that, because of drafting, will cause future difficulties. Neither final offer would ever emerge as the outcome of normative interest arbitration. This process, however, is final offer selection with its self-evident limitations. That means, after reviewing the submissions, studying the two final offers, selection the one that comes closest to conforming with the criteria. Those criteria, however, cannot be viewed in isolation. They must be seen in context, and that context is our legal system for resolving industrial disputes.

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ACPA cites several authorities on the principal of replication in interest arbitration and returns to the Nova Scotia Government Award of Arbitrator Ashley, who deals with replication in the context of referral to final offer selection in the shadow of back to work legislation. The principle of “replication” has been widely accepted by interest arbitrators in Nova Scotia and Canada as the appropriate criteria for considering the issues raised in that forum. What that means is that the arbitrator is to “replicate” as closely as possible the agreement that would have been reached if the parties had engaged in free collective bargaining with the right to resort to a work stoppage. (Re: Yarrow Lodge Ltd( 1993), 21 CLRBR (2d) 1; Re: Western Pacific Security Group, [1998] BCCA No. 396: Re: Department of Transportation and Communications, [2001] Venoit (unreported); Re: EMC Medical Care Inc. [2000] Clarke (unreported). In the EMC Medical Care case the Board was dealing with a labour impasse where the government had, as here, introduced back to work legislation. The Board said, as follows: In our opinion, the obligation upon this Board is to fashion a decision that will replicate the results the parties would have achieved had Bill 19 not been enacted and we had not entered upon the process. That is, to frame an award that the parties would have arrived at had they been successful in reaching a collective agreement in an atmosphere where free and unfettered collective bargaining had continued. ... Accepting that the replication test is the one to be applied, one must also accept that applying it in this context is not an exact science. It is difficult to speculate about what the parties would have achieved in free collective bargaining had things not come to this point. The strike option was not really available to the Unions once Bill 68 passed. Even though the Unions appeared to have had a great deal of popular support, the Employer (as Government) had the upper hand, in that they could unilaterally end the Union’s job action. The fact that the Government elected not to impose Bill 68 and agreed to this FOS process instead, amounts to a recognition that an imposed contract would not have brought labour peace. The “replication” test comes from the jurisprudence on interest arbitration and other FOC [sic] cases. My own subjective evaluation of what the parties would have agreed to through free collective bargaining would involve too much speculation to be useful. If one cannot, then, predict with any confidence what might have come from negotiation, one must try to determine which position is the most reasonable in the circumstances. As Arbitrator Beck stated in University of Waterloo [2000] unreported, perhaps 22

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the role of the Selector is to find against the party that advocates the less reasonable offer.

Several times in argument Counsel for ACPA suggested that the Air Canada final offer was not reasonable and would not be replicated in free bargaining. ACPA closes their written argument with the following observation: ACPA members play crucial roles in the workplace, indeed they are irreplaceable. Unlike some workplaces where work continues to be performed by management personnel, in the instant case continued service by management would be ineffective. Pilots can, therefore, bring the business to a halt. In negotiation terms, the pilots possess considerable collective bargaining strength. An arbitrator should make the final offer selection with ACPA’s considerable bargaining strength in mind.

Air Canada Argument Mr. Gilbert, Counsel for Air Canada, agrees with Counsel for ACPA, that the arbitral principle of replication is not ousted by the statutory criteria set for this arbitration. He argued strenuously that the sub-set of cases involving arbitration after a failed TA also apply in this case and compel the selection of Air Canada’s final offer. Counsel for Air Canada submitted that arbitrators have overwhelmingly concluded that a tentative agreement, even one rejected by union members in a ratification vote, is the best evidence of what the parties would have agreed to in free collective bargaining. Air Canada relies on Arbitrator Picher, who dealt with the issue in, Re Salvation Army Windsor Community and Rehabilitation Centre and Recycling Unit and SEIU, Local 2, (2009), 183 L.A.C. (4th) 127, at page 135: I turn to consider the merits of the dispute. In doing so I must acknowledge that the Union bears a heavy onus of persuasion in this arbitration. A review of the Canadian jurisprudence reflects that it is extremely rare for boards of interest arbitration to depart from the terms of a tentative memorandum of agreement which has not been ratified by the rank and file employees. The obvious reasoning of this line of cases is that if a board of arbitration is to engage in the analytic process of replication, to determine what the parties would have agreed to if they had reached a collective agreement through 23

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free collective bargaining. The evidence of a tentative agreement reached between the two bargaining committees selected by them to negotiate their terms and conditions of employment is, absent extraordinary evidence, in all likelihood the best indication of what they would have agreed to. While the fact that employees within the bargaining unit may have voiced some discontent with that agreement, to the point of non-ratification, is obviously admissible in evidence, that is not an uncommon phenomena even in the area of agreements which are not made by interest arbitration. That element alone cannot of itself be seen as sufficient to necessarily displace the presumptive persuasiveness of the terms of settlement reached by the parties’ respective committees at the bargaining table, particularly where both parties expressly recommend ratification to their principals, as occurred in the case at hand. One of the earliest expressions of the approach adopted by arbitrators, almost unanimously in Ontario, is reflected in the decision of Arbitrator Weiler in Mount Sinai Hospital and Building Services Union. At pp. 1-2 of that award the following passage appears: The fact that the negotiators on behalf of the parties have, in good faith, reached agreement, furnishes a strong prima facie basis for the validity of the terms of settlement. If they reasonably direct their minds to the relevant issues and principles, negotiators must be supported in arbitration, in order that the system of free collective bargaining be maintained. This principle was established in a decision of the same board in Peel Memorial Hospital (1969) (unreported) (Weiler). Such a prima facie case is not absolutely binding though, because negotiators are, after all, only the agents of the parties, not the principals to the dispute, they may agree on a clearly erroneous or irrational basis. The arbitrator should not be absolutely bound by their agreement, any more than he would be by O.H.S.C. guidelines, where they conflict with relevant standards established in the process of arbitration. However, a very substantial onus rests on the principal which has repudiated the memorandum of agreement to demonstrate why it should not be followed.

Counsel argued that non-ratification of a TA is not a factor sufficient in itself to displace the presumptive persuasiveness of the terms of settlement reached by the parties’ respective bargaining committees in bargaining, particularly where those committees have recommended the settlement.

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Counsel for Air Canada described the negotiations that began in October 2010 as “distinctly different” from previous negotiations. He submitted that both parties quickly recognized the need for a more candid process if the complex problems of scope, scheduling, pensions and pay were to be addressed. The parties adopted an interest based approach and involved subject matter experts from both sides who formed sub-committees to the negotiating table. Counsel for Air Canada submitted that the TA provided ACPA with improvements that were based on early conclusion of the contract. Air Canada saw a competitive advantage in moving early into the Low Cost Carrier market which the TA facilitated. Air Canada also recognized the value of ACPA’s leadership in bargaining by having ACPA start and complete the bargaining process first and by having ACPA tackle some of the challenges that the airline and all its bargaining employees faced collectively, like pensions. Counsel maintained that the TA remains the best evidence of a reasonable settlement between the parties. Air Canada’s final offer varies in some areas from the TA and Counsel for Air Canada cites authorities on that subject. Professor Weiler dealt with this issue in Re Toronto Transit Commission and Amalgamated Transit Union, (1985), 17 LAC (3d) 385 where he said at page 389: There is a broad consensus among labour arbitrators that a settlement voluntarily arrived at by competent negotiatiors is a much better index of the appropriate award than the opinion of an outside arbitrator whose involvement in the dispute is inherently limited. I had occasion to consider this issue in my Sixty-five Participating Hospitals Award, 1981 (Weiler) [unreported]. There I did say that the preference for the agreed-to settlement should only be a general presumption, not an automatic, unyeilding rule: otherwise, the democratic participation of union members in the ratification or rejection of their contracts would be eroded. However, I went on to state that: “If seasoned representatives produce a comprehensive package out of the give and take at the bargaining table … the product of their work must be treated as strong prima facie evidence of an economically sound bargain … The arbitrator … should treat the settlement as fixing the ball park figures for the new contract.” While being “prepared to scrutinize the terms of the tentative agreement, perhaps to find that certain items are misguided, or at least that others have been overtaken by changing economic conditions … he should begin that inquiry from the premise that the terms actually agreed to by the representatives of the parties are a sound and workable basis for the new contract, to be revised only if and when this is clearly shown to be warranted” (emphasis added)

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Counsel for Air Canada submitted that arbitrators depart from the terms of a tentative agreement where, “intervening forces and events justify the modifications of its terms. The party seeking to displace a tentative agreement bears the onus. The burden on the party seeking to displace a tentative agreement requires the party to establish that the agreement has been, for example, overtaken by changing economic conditions or other events”. Counsel argued where this has happened arbitrators may turn from the tentative agreement to a variety of industry benchmarks to determine if the parties can be reasonably expected to have made an agreement comparable to others in the same industry and geographic area. (see Re Canada Building Materials Co. and Teamsters, Local 880 (9190), 9 CLRBR (2d) 71 as cited in Air Canada and CUPE (unreported) Nov. 7, 2011 (Arbitrator E. MacPherson). Counsel for Air Canada referred to Arbitrator Sims, Canadian National Railway Co. and Teamsters Canada Rail Conference, (2010) 101 CLAS 145 at page 3: The interest arbitration process, with its goal of replication, is unlikely to produce “breakthrough” provisions the parties themselves would have been unlikely to agree to. It is not a scientific process capable of being reduced to a formula, but neither is it arbitrary. There are well established indicia of what would influence parties negotiating freely. Many of those indicia can be found in the objective evidence of existing internal and external comparators, economic trends, the economic viability of the enterprise and so on. Such factors are in a state of constant flux. The arbitrator’s task is to try to replicate what the parties could have been expected to do in the prevailing environment. Arbitrator Korbin expressed the task as follows: Put another way, an interest arbitration board must put itself in the positions of the respective parties, and seek to arrive at the bargain the parties would have reached on their own. Necessarily, this includes due consideration to matters such as the parties’ historical bargaining pattern, the use of comparators, the prevailing economic context, etcetera. At different times in a collective bargaining relationship, different factors will be prominent in shaping an outcome. It remains the task of an interest arbitrator to be sensitive to the prevailing bargaining reality of the parties, and make a decision consistent with what they themselves would have bargained.

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Skidegate Band Council (2002), [2002] C.L.A.D. No. 642 (QL), 70 C.L.A.S. 335 (Korbin) at para. 45 (emphasis added)

Counsel submitted we should be looking at external factors such as rising competition and adverse economic conditions as well as internal benchmarks such as collective agreements entered into by the employer with other unions. He argued that the underlined passage above should be a guide where the parties have found it necessary to depart from the tentative agreement. Counsel for Air Canada argued that in the private sector, the financial well being of the employer and in particular its economic viability, may be relevant to what an employer can be expected to have agreed to in the circumstances of any case. Counsel relied on what Arbitrator Picher said in Air Canada and National Automobile, Aerospace, Transportation and General Workers Union of Canada (CAW), (2006) 86 CLAS 293 at paragraphs 66-68: 66 What principles should guide the Arbitrator in resolving this dispute? I am satisfied that, in the case of an interest arbitration which involves a private sector employer, rather than a public sector employer which may be differently situated with respect to its ability to pay, the decision of Arbitrator Burkett in Bruce Power LP and Society of Energy Professionals (2004), 126 L.A.C. (4th) 144 provides important guidance. At pp. 151-52 Arbitrator Burkett commented on the importance of carefully evaluating an employer's financial situation for the purposes of a private sector interest arbitration: I start by addressing the issue between the parties as to whether the Employer's financial situation is a relevant consideration in respect of the debate concerning an appropriate salary increase. Collective bargaining is an exercise that has as a necessary and critical backdrop the financial well-being of the employer. While it may be that in public sector interest arbitration (where tax dollars underwrite labour costs) it has long been held that an employer's asserted inability to pay is not a relevant consideration, that rationale has no application to a private sector dispute. The issue arises in the public sector where an employer argues that it lacks the financial resources to provide its employees with a normative salary increase. Arbitrators have rejected this argument on the basis that public sector employees ought not to subsidize the public purse by receiving substandard wage increases. In other words, public sector interest arbitrators have ruled that tax revenues must be tapped (whether directly or indirectly) to the extent 27

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of providing normative salary increases to public sector employees. A whole different set of considerations applies in the private sector. Firstly, the normal dispute resolution mechanism is strike/lockout. It is only in rare cases, such as this, that private sector collective agreement renewal disputes are subject to interest arbitration. Secondly, the wage bill is paid not from the public purse but from the financial resources of the employer, which are determined by the employer's success or lack thereof in the marketplace. It is not surprising, given the foregoing, that when faced with a strike or lockout in circumstances where the economic well-being of the employer (and by necessary implication that of its employees) hangs in the balance, concessions and/or below market value increases are sometimes negotiated. The bargaining in connection with the recent spate of private sector bankruptcies illustrates the difficult choices that must be made. 67 Arbitrator Burkett was clear that in his view, a view which this Arbitrator shares, it will be the role of an interest arbitrator to determine whether increases either above or below an identified normative standard will be justified, with close regard to the employer's economic viability. At p. 152 of the Bruce Power award he stated: One of the guiding principles of interest arbitration, whether public or private sector, is replication. It is accepted that an interest arbitrator ought to attempt to replicate the result that would most likely flow from free collective bargaining. It follows from all of the foregoing that when the subject matter of an interest arbitration is a private sector dispute, as here, the financial well-being and economic viability of the employer are relevant considerations. This is not to say that normative increases are to be ignored. Rather, normative increases form a baseline from which deliberations commence. The decision as to whether or not to adopt or to deviate from the baseline is thus made, in part, on the basis of the economic viability of the enterprise, both real and projected. See also Re All-Way Transportation Corp. Wheel-Trans Division and A.T.U., Local 113, (1986), 25 L.A.C. (3rd) 321 (Brown).

Counsel for Air Canada pointed out that the short and long-term economic viability and competitiveness of the employer, and the employer’s ability to meet its shortterm funding obligations are factors that influence an employer’s ability to pay. These criteria are emphasized in the Protecting Air Service Act. Counsel stressed that while it may be necessary to “modify” elements of a tentative agreement, the tentative agreement is the starting point for the discussion. In this 28

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regard Counsel relies on Arbitrator Burkett in, Re Thames Emergency Medical Services Inc. and O.P.S.E.U. (2004), 129 L.A.C. (4th) 192 (Burkett), where the Board reasoned as follows: It is also important to remember that interest arbitration is a substitute for free collective bargaining in the limited circumstances where the services sup- plied by the affected employees are too critical to society at large to risk interruption by strike or lockout. In these limited circumstances, interest arbitration is a substitute for economic sanctions as the final method of dispute resolution. Not surprisingly, it has long been accepted that the overriding objective of interest arbitration must be to replicate, to the greatest extent possible, the result that would otherwise have obtained had the right to strike or lockout not been removed. The issue before us, therefore, ought not to be decided on the basis of abstract statements of legal principle, but rather reference must be had to the manner in which rejected memoranda are dealt with by the parties to free collective bargaining as regulated by the statutory duty to bargain in good faith. As will be seen, under free collective bargaining a rejected memorandum establishes the framework within which post-rejection bargaining takes place. One of the primary arguments advanced in support of the inadmissibility of a rejected memorandum is that the bargaining committee or agent cannot bind the principal. This is correct in a technical sense; however, as we have emphasized, collective bargaining is regulated by a statutory duty that establishes narrowing parameters as the bargaining progresses. The principal must be presumed to understand that a position once tabled by its bargaining committee and responded to becomes interwoven into the fabric of the bargaining. It is not surprising, therefore, that the rejection of a memorandum of settlement under free collective bargaining is not viewed as a signal to recommence bargaining afresh. Rather, the bargaining that follows a rejection of a memorandum of settlement is in the nature of a problem-solving exercise designed to “tweak” the terms of settlement in a manner that preserves the essential bargain while at the same time facilitating a reconsideration by the principals. Indeed, a party that sought to commence bargaining afresh following the rejection of a memorandum of settlement would leave itself open to a bad faith bargaining complaint. Conversely, a party that had put its best position forward in order to achieve a tentative settlement, only to have that settlement rejected by the other side, would, absent more, be immune from a finding of bad faith if it adopted the terms of the rejected memorandum as its firm and final position. The reality is that in free collective bargaining, the rejected memorandum remains front and centre. A party is not free to adopt any bargaining position it chooses following the rejection of a memorandum of settlement. Although it does not constitute a legally binding document, the memorandum establishes the parameters for the bargaining that follows the rejection, notwithstanding the 29

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fact that it was entered into by the bargaining committees acting as agents for the principals. Accordingly, if the primary objective of interest arbitration is to replicate free collective bargaining, as it is, a rejected memorandum of settlement must be admitted as the product of the prior good faith efforts of the parties to reach agreement without resort to arbitration. (emphasis added)

Counsel for Air Canada submitted that the tentative agreement was arrived at with both parties acting in good faith and that it is the foundation for a new collective agreement. At paragraphs 532-33 of their brief Counsel submits: Accordingly, while 15 months have passed, there have been few developments at the bargaining table that would displace the TA as a foundation for the next collective agreement. Clearly however, there have been significant financial and competitive developments in the interval. Parliament has enacted legislation that includes criteria which must be considered in the selection of the final offer. The changes Air Canada proposes to the TA are modest, necessary, supported by the legislation and justified by developments occurring since it was concluded. However, despite the time that has passed, the overwhelming majority of the solutions incorporated in the TA remain highly relevant and the TA remains a solid foundation on which not only to build the next collective agreement but also the parties’ relationship.

Turning to the statutory criteria, Counsel for Air Canada submitted that the question now is not only “how does the party’s offer compare to what the two parties would likely have negotiated?”, but also “does the party’s offer meet the standards set by the statute?”. Section 29 (2) sets out the guiding criteria under the Act: 29.(2) In making the selection of a final offer, the arbitrator is to be guided by the need for terms and conditions of employment that are consistent with those in other airlines and that will provide for the necessary degree of flexibility to ensure (a)  The short and long-term economic viability and competitiveness of the employer; and (b)  The sustainability of the employer's pension plan, taking into account any short-term funding pressures on the employer. (emphasis added)

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Counsel relies on comments by Arbitrator Picher in the IAMAW arbitration under the same statutory direction, where he comments on the weight given to the pension issue by the statute: As a matter of general practice, Canadian arbitrators called upon to resolve interest arbitration disputes have effectively given little or no weight to “ability to pay” arguments submitted to them by employers. While I consider that approach to be valid and appropriate generally in interest arbitrations in both the public and private sector, I am compelled to recognize that the legislation which defines this process, and my corresponding jurisdiction, is clearly more constraining. That is particularly so as relates to my obligation to take cognizance of the Company’s pension plan burden, a factor of such magnitude that it goes indisputably to the long term sustainability of the Company. Most significantly, the Company faces a critical deadline in 2014. In the interests of protecting the Company’s survival following its emergence from CCAA protection, federal pension authorities granted it a moratorium on the payment of its pension deficit until 2014. It was hoped initially that the period of the moratorium would be sufficient to allow the Company to reduce its pension deficit. However, economic events of the last few years, including the recession of 2008 and a fiscal policy that has consistently favored low interest rates, have in fact led to a significant growth in the pension deficit. It is now clear to all concerned that an extension of the Company’s pension moratorium beyond 2014 will be essential to the Company’s continued viability. It is against that background that I now turn to consider the issues in dispute, the final offers and supporting submissions of the respective parties.

Counsel for Air Canada submitted that the financial, commercial and competitive challenges facing Air Canada are clearly set out in their submission and in the reports of the experts on which they rely. Counsel maintained that their final offer is the one that will enable Air Canada to progress towards a more competitive industry standard. In summary, Counsel for Air Canada argued that their offer should be accepted on the following basis: i)

The final offer is based on the TA. The TA is the best source of guidance as to what these parties have found to be acceptable solutions to difficult problems.

ii)

The changes that Air Canada proposes be made to the TA are limited in number. Each change is justified by the lapse of time or the significant developments that have occurred since the TA was concluded in May

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2011, are proportionate to those changes, and are designed to mitigate any adverse effects the pilots may experience because of the changes. More specifically, Air Canada's competitive prospects and financial condition have seriously deteriorated. Its primary domestic competitor has announced a major expansion and its pension liability has soared to $4.2 billion. A decisive response is necessary and justifies a certain adjustment to the TA provisions. iii)

Air Canada’s final offer satisfies the statutory criteria by ensuring economic viability, competitiveness and pension sustainability and addressing the consistency of the parties’ agreement with those in force at other airlines. More specifically, provisions in the final offer afford Air Canada a degree of greater commercial flexibility in code sharing, Joint Ventures, a low cost carrier and capacity purchase arrangements – all developments that are firmly and increasingly part of the competitive landscape in the industry, but still, less flexibility than is enjoyed by many of its competitors . Provisions in the final offer affording Air Canada a measure of greater commercial flexibility will enable Air Canada to make reasonable competitive progress within the industry. Air Canada’s offer also provides for modest but reasonable progress, but essential in addressing the enormity of the pension funding challenge.

iv)

Wherever discussions since the TA have identified areas of possible compromise, Air Canada has endeavoured in its final offer to move towards this direction. 8

Conclusions on the Legal Framework The arbitral law of replication, strongly influenced by the existence of a tentative agreement, is not displaced by the statutory criteria. Those statutory criteria are a measure I am directed to take into account when selecting the final offer. I would note that these statutory criteria are not different in tone from the direction taken by Arbitrator Picher in in Air Canada and National Automobile, Aerospace, Transportation and General Workers Union of Canada (CAW), (2006) (see above), where he cites Arbitrator Burkett, in discussing the significant difference between arbitration in the public sector and arbitration in the private sector regarding the issue of the employer’s financial health and the “ability to pay”. I stand by what I said in the Mount Allison Award, but note that context is important. Here we have the overlay of arbitral jurisprudence on the issue of rejected Tentative Agreements. Where you have that Tentative Agreement it is

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strong evidence of what is a “proposal which is the best blend of the legitimate interests of both parties”. I am very much influenced by what Arbitrator Sims said in Canadian National Railway Co. and Teamsters Canada Rail Conference, (2010), at p.3: Arbitrators have often spoken of achieving fair and reasonable terms and conditions. At times, this is linked to the need to ensure that the arbitration award is not simply a reflection of a power imbalance between the parties, a power imbalance which I note can apply either way. Cases offering this caution “... that interest arbitrators should not simply mirror any great imbalances of power between the parties” include: British Columbia Automobile Association v. Office of Professional Employees Union, Local 378, 2000 B.C.C.A.A. No. 7, Award No. A-007/00 (Thompson), Star of Fortune Gaming Management (BC) Corp. v. Teamsters, Local 31 (2001), 2001 Carswell BC 3270, [2001] B.C.C.A.A.A. No. 293 (B.C. Arb. Bd.) (Blassina) While I accept the caution, I am not convinced such a power imbalance exists between this large and well established Union and this Employer. What amounts to “fair and reasonable terms” is itself a relative concept and, like beauty, lies in the eye of the beholder. I agree with the observations of Professor Swan when he wrote: Fairness remains an essentially relative concept, and therefore depends directly upon the identification of fair comparisons if it is to be meaningful; indeed, all of the generally stated pleas for fairness inevitably come around to a comparability study. It appears to me that all attempts to identify a doctrine of fairness must follow this circle and come back eventually to the doctrine of comparability if any meaningful results are to be achieved ... K.P. Swan, “The Search for Meaningful Criteria in Interest Arbitration,” Kingston: Queen’s University Industrial Relations Centre, 1978 Collective bargaining is not simply a process of brokering of interests between parties. It also involves a brokering of interests internally within each party. Particularly within trade unions, which often represent geographically diverse groups or diverse skill sets, priorities may differ among its constituent elements. Impasses in 33

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collective bargaining sometimes, involve difficulties balancing priorities within the bargaining unit or (albeit less often) within the Employer’s various components. This too has to be factored into the replication approach.

The caution Arbitrator Sims accepts as valid, “... that interest arbitrators should not simply mirror any great imbalances of power between the parties” is a warning against doing what the union would have me do when they argue: In negotiation terms, the pilots possess considerable collective bargaining strength. An arbitrator should make the final offer selection with ACPA’s considerable bargaining strength in mind.

I also note in this same vein as Arbitrator Sims, comments by Arbitrator Laing in Re Regina (City) and Regina Professional Firefighters Assn. (1991) (unreported), where the following comments are found at page 6: An interest arbitration board’s impression of what the parties might have eventually settled for, must of necessity depend in large part on the evidence presented in the hearing. With respect to that evidence, the Board must take into account not only the “power” position of the parties and attempt to determine who might prevail if a [sic] unrestricted economic warfare was permitted, but must be guided in large part by the “reasonableness” of the respective positions of the parties.

This comment is cited with approval at paragraph 24 by Arbitrator Kuttner in Halifax (Regional Municipality) and IAFF Local 268, [1998] N.S.L.A.A. No. 12; 71 LAC (4th) 129. It is cited with approval by Arbitrator Christie in Northumberland Ferries Ltd and CMSG (2004) 76 C.L.A.S. 227 at page 9. (Arbitrator Christie attributes the comments to Arbitrator Kuttner). I take these arbitrators as warning against relying on the ability to wage a powerful sanction in free bargaining as the basis to take an unreasonable position to arbitration. I am persuaded that my responsibility is to apply the arbitral jurisprudence, on replication, mindful of the impact of a tentative agreement and mindful of the fact that in private sector interest dispute resolution arbitrators have accepted that the financial well-being and economic viability of the employer are relevant considerations. My responsibility under this particular statute is to select the offer which best satisfies the need for terms and conditions of employment that are consistent with those in other airlines and that will: provide the necessary degree of flexibility to 34

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ensure the short and long-term economic viability and competitiveness of the employer; and the sustainability of the employer’s pension plan, taking into account any short-term funding pressures on the employer.

Turning then to those critical issues on which this Award turns.

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Critical Issues PENSIONS: Air Canada’s Offer: Mr. McGinnis, Air Canada Counsel on the pension issue, submitted that the pension solvency issue is the most critical issue facing the viability of the company. Further, that the sustainability and volatility of the pension plan have a serious impact on the viability, competitiveness and risk profile of the company. Counsel submitted that the plans are simply too big to be supported by the company in its present situation. Mr. McGinnis referred to the history of interventions in 2004 and 2009, the 2009 schedule of relief expiring in 2014. Counsel argued that Air Canada now needs relief until 2024. That by itself, Counsel argued, should demonstrate the problem is not just a short term interest rate problem. Without the current relief Air Canada’s pension liability in 2012 would have been $1B or 60% of its payroll. Counsel pointed out that Air Canada is the only carrier in North America, except for Jazz and American Airlines, that has a defined benefit pension plan. American Airlines is in Chapter 11, and in the process of converting its plan to a defined contribution plan. Counsel submitted that the regulatory rules are what they are and that all the parties can do is ask for relief from the application of those rules. Counsel referred us to the DBRS rating sheet on Air Canada where the following comment is made: The Company has a weak financial profile. The Company’s balance-sheet leverage is very aggressive for a highly cyclical company. In addition, the Company’s pension plans are in a large underfunded position (its solvency deficit was $2.1 billion as of January 1, 2011). Although relief from the Air Canada 2009 Pension Regulations (ACPR; adopted by the government of Canada in July 2009) moderates the cash contributions through 2013, the overhang of such a large financial liability puts the Company under significant financial risk. The Company’s operations in the last decade have mostly been loss making. The Company has a high- cost structure. Most of the Company’s employees are unionized and the usual restrictive work practices hinder productivity improvement. The combination of a high debt load and weak operating results has led to very weak debt coverage ratios. The Company’s source of liquidity is its cash on hand, short-term investments ($2.2 billion at September 30, 2011) and internal cash flow. DBRS believes the Company has adequate liquidity to meet its regular funding needs. However, the Company could face liquidity problems if operations are disrupted for an extended period.

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In summary, the Company’s business risk profile is close to the average of the airline industry, but its overall rating is weighed down by its weak financial profile burdened by its high debt load, weak operating performance and debt coverage ratios, and large underfunded position in its pension plans. Therefore, DBRS has concluded that an Issuer Rating of B is appropriate.

Counsel stressed that what is at stake here is not just risk as between the company and the pilots, but risk to the company in the market place for the debt and equity it needs to fund its operations and explore new ventures critical to its survival. Counsel for Air Canada asked we accept that, without funding relief and benefit cost reductions, Air Canada cannot return to viability and the company faces the risk of insolvency with devastating consequences to employees and retirees. Counsel pointted out that ACPA is the last union group to deal with Air Canada on pensions so there is a history to look to. There are two themes that run through settlements with all those other groups: first, benefit cost reductions of 20% to 27% of active member solvency liability with an average of 22%; second, new arrangements for new hires. Air Canada’s belief is that the best way to approach a funding relief request to the regulator is to take a clear and consistent approach—consistent between unions, consistent with market trends and an approach which minimize the impact on present members. The company’s proposal will generate benefit plan reductions of $319M or $267M depending on whether funding relief is obtained (see p. 51 Mercer Report). This represents 17% of active member solvency liability. Savings from the Air Canada’s offer come from changing early retirement and changing the retirement age to 65. Air Canada also proposed changes in cost allocation, increases in pilot contributions that will not impact benefits. This change does not address the liability but saves cash in the short run. Finally, Air Canada proposed that ACPA support the company approach to funding relief to the level of $150M/ year for ten years with contributions proportionate to their plan’s unfunded liability. Counsel submitted this is consistent with the approach taken by all the other unions at Air Canada. The actual language in the offer reflecting the commitment to support funding relief is found in Appendix 1 to the Pension LOU, as follows:

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The Company and ACPA shall vigorously support regulations under the Pension Benefits Standards Act, 1985 (the “Special Regulation”) that provide for the funding relief set out below. The Company and ACPA shall cooperate, act diligently, and take all actions required to implement this agreement and obtain enactment of the Special Regulation, including, without limitation, the making of representations to any governmental authority in support of implementation of the agreement and enactment of the Special Regulations.

Mr. McGinnis also addressed Air Canada’s concerns with ACPA’s offer, which he argues is, “fundamentally flawed and unresponsive to the statutory criteria and principles of replication used in interest arbitration”. The only benefit cost reductions on a solvency basis result from their proposed change in the retirement date which ACPA costs at $94M or 6% of the active solvency liability. Counsel pointed out that ACPA asserted that the only issue is funding relief. He argued that the funding relief they proposed is “irregular and opaque process of shifting liability to the SERP from the RPP”. Counsel argued that this scheme is problematic from the point of view of transparency and fairness with the other unions and may raise legal issues. In addition, ACPA’s offer on MPU’s will, according to Air Canada, add $137M to Air Canada’s liability on its balance sheet and a $10M/year service cost Mercer Canada Limited are recognized expert consultants in the field of pensions, Air Canada engaged them to: •

to provide actuarial insight on the sustainability issues affecting the Air Canada pension plans, taking into account short-term funding pressures; and

•

to analyze Air Canada’s Final Offer for the pension arrangements.

In addition to receiving the report we heard oral opinion testimony from Mr. Robert Dumas, Senior Partner, an actuary and Fellow of the Institute of Canadian Actuaries. He has worked at Mercer for 28 years and has worked on the Air Canada file since 1985. Mr. Dumas is the Senior Retirement Consultant and head of the Retirement Business Section at Mercer. In the Summary, Mercer Report states: A sustainable pension arrangement should consider the employer’s ability to pay without compromising the viability of the employer. There are three fundamental problems affecting the sustainability of the Air Canada pension plans: 38

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1.

The plans have significant deficits relative to the financial capacity of the Company. These deficits have been exacerbated over 2011, with no abatement to date in 2012. The reduction of past service benefits in respect of other unions, in addition to any modifications for pilots, if approved by OSFI, will assist the plans in returning to the break even point but do not resolve the problem;

2.

Even if the plans do return to the break even point, due to the relative size of the plans to Air Canada and the inherent volatility in defined benefit plans, there will be significant, unpredictable changes in the solvency deficits and employer contribution requirements. It is unlikely that the plans can consistently maintain the break even point in equilibrium at a reasonable cost without further crippling lows from time to time, jeopardizing Air Canada’s and the plans’ sustainability; and

3.

The terms and conditions of the benefits themselves are inconsistent with pension plans offered by their domestic and international competitors in both generosity and risk exposure.

At page 3 of the report the consultant makes the following point: Impact of Volatility on Sustainability The volatility in the deficit of Air Canada’s pension plans is typical for DB plans. However, its impact on the Company is unique, due to the size of the pension plans relative to the size of the Company. Air Canada’s pension liabilities have reached around 160% of corporate liabilities whereas the median is about 10% and the 90th percentile is 75%. In another measure, the annual variation in the amount of deficit over the past five years represents approximately 60% of the Company’s cash, cash equivalents and short-term investments and 100% of the average EBITDAR over the same period. Such risk exposure is unmanageable.

Also on page 3 of the report Mr. Dumas commented on the changes in the pension environment since March 17, 2011 (the date of the TA): Since the Air Canada and ACPA reached the Tentative Agreement on March 17, 2011, there have been several significant developments from a pension perspective: •

The financial situation of pension plans in Canada and Air Canada’s pension plans in particular has deteriorated significantly, fuelled primarily by low interest rates. The annuity rate reduced from 4.5% on January 1, 2011 to 3.3% on January 1, 2012. As a result, the solvency deficit in respect of all Air Canada registered pension plans

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has increased from $2.2B as at January 1, 2011 to $4.2B as at January 1, 2012 before benefit reductions. •

On December 15, 2011, the federal government passed legislation abolishing mandatory retirement except where a bona fide occupational requirement exists. This change allows and indeed requires additional alternatives to be considered in terms of pension benefits.

•

Over the past year, all of Air Canada’s other main unions have agreed to implement pension design changes as a result of collective bargaining or interest arbitration. These changes are two-fold: – Benefit reductions for current employees to reduce the generosity of the current pension arrangement, primarily on early retirement provisions; and – Implementation of a new pension arrangement for new hires.

Starting at page 33 of his report Mr. Dumas charts the growth in the plan’s liabilities relative to its assets, and comments on the volatility of the plan. Mr. Dumas explained that it is not just the deficit that is a problem for Air Canada, it is the size of the deficit and its volatility relative to the size of the company. At page 36 the report relates the solvency deficit to Air Canada’s EBITDAR, another way of looking at the relative size of the deficit to the company’s ability to earn the money to pay it down. The report contains a chart that sets out the funding relief granted in 2004 and 2009 and the impact these measures had on the required past service payments and on the solvency deficit. (see page 26) At page 42 of the report Mercer lists the companies that moved from a DB to a DC plan in the last several years. These include Bell Canada, Brewers Retail, Bell Aliant, Telus Communications, Molsons, Ivaco, The Globe & Mail, and Cara Operations, all unionized companies. At page 43 the Report details the US carriers where DB plans have been terminated or frozen. These conversions and freezes have had significant negative impact on employees at those carriers. At page 44 of his report Mr. Dumas looks at the Air Canada proposal on pensions. He states that: Air Canada’s Final Offer is articulated around four main objectives: •

Design for new hires: over the medium to long term, reduce the weight of the Company’s defined benefit responsibilities

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•

Benefit reductions: measures taken to reduce the generosity of pension arrangement for current active members

•

Cost allocation: measures taken to reallocate on-going cost of the plan between employees and the Company

•

Funding relief: provide breathing room to the Company in terms of certain and reduced funding requirements over next 10 years

In addition to these four main areas of changes, a series of administrative changes with little or no cost implications are part of Air Canada’s offer.

The details of Air Canada’s final offer to ACPA on pensions and mandatory retirement are as follows: Pension formula: The TA would have scaled back the pension formula. Because of the agreements subsequently struck with all the other unions, Air Canada is not seeking this change which was a part of the TA. This is a concession to ACPA from the TA position. Normal form of Pension: The TA would have made changes in the form of a surviving spouses pension. Because of the agreements subsequently struck with all the other unions, Air Canada is not seeking this change which was a part of the TA. Maximum Pension Units (MPUs) The TA did allow for an increase in MPUs. Air Canada’s final offer does not contain that improvement. Again Air Canada explains this change as a result of the agreements struck with all the other unions and the deteriorating funding level of the plan. Cost Allocation/Employee Contributions: Air Canada’s proportionate share of the pension plan funding has risen since 2000/2001. In that year pilots were contributing 40% of the total current service cost in the RPP. In 2011 this contribution has dropped to 22%. Air Canada’s final offer includes an increase of 1.5% in the pilots contribution to the RPP. (these contributions are tax deductible by the pilots) Air Canada’s final offer also reallocates pilot’s contributions between the RPP and the SERP, depending on the solvency in the pilots plan. This is intended to enable

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pension benefits to be financed in a manner that is much more cost effective for Air Canada. Retirement Eligibility: Both pension plans have a mandatory retirement age of sixty, on that date the pilot is entitled to a full pension without reduction. Under the current plan pilots are also entitled to a subsidized reduced pension on reaching 25 years pensionable service or attaining age-plus-service of 80 points. The TA included two changes to subsidized reduced early retirement. It changed the years service to 30 and changed the age-plus-service 80 point requirement to 90 points. It also eliminated early retirement subsidies for retirement before age 60 by providing for early retirement reduction on an actuarial equivalent basis before age 60. As a result of mandatory retirement being abolished Air Canada’s final offer eliminates age 60 as being the mandatory retirement age. Retirement “eligibility” will occur at age 60 or the completion of 30 years service. The “pensionable age”, the age to receive an unreduced pension, is age 65, or, for a pilot who has completed 30 years of service, age 60. Early retirement reductions are actuarial reductions from age 65. If solvency is achieved the rules revert to the present and a pilot can receive an unreduced pension at age 60 with 25 years service. At page 145 of their brief Air Canada states: Modifying the retirement eligibility and the early retirement reduction is the approach Air Canada followed in 2011-2012 bargaining for benefit reductions for all other unions. Recognizing that different groups have different employment patterns, different plan rules before reductions and that the exact nature of the reductions may vary, the overall approach has common characteristics and impact: •

The majority of members still qualify for an unreduced pension at the same age as before i.e. upon attainment of age 55 (with 85 points for majority of other unions) or upon attainment of age 60 (with 25 or 30 years of service for pilots);

•

Some members, being shorter service employees, see their first age deferred to a later age; members retiring early or terminating employment before retirement eligibility have larger reductions; and

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•

Under-utilized benefits are reduced, thereby maximizing the impact on solvency liabilities; there is little purpose in funding retirement benefits which are rarely used.

The reduction in solvency liabilities resulting from this change in retirement eligibility and early retirement conditions for the two registered pension plans equals $319 million based on the 30 year condition and $267 million based on the 25 year condition. These reductions represent 20% or 17% of pilots’ active members’ solvency liabilities respectively. In comparison, the reduction in solvency liabilities obtained from other groups range from 20% to 25% with an average of 22% to 23% depending on final reductions for the IAMAW.

At page 141 of their brief Air Canada described its final offer on pensions, and put it in context with what the other unions achieved as follows: Air Canada’s final offer respects the general principles of the TA. The integrity of the DB plans and SERPs would be preserved for current members. Air Canada’s offer is balanced and gradual, notwithstanding the doubling of the pension plans’ solvency liabilities from January 1, 2011 to January 1, 2012. Air Canada’s offer is also equitable relative to the changes agreed to in respect of the CAW, CUPE, CALDA and IAMAW. The changes agreed to for those groups, and the resulting reductions in solvency liabilities, valued as at January 1, 2011, are summarized in the chart below: group

nature of reduction

$ reduction in solvency

As % of active member’s solvency liability

CAW

Change to early retirement provisions; unreduced pension at 55 and 85; otherwise deferred to 65

$153M

25%

CUPE

Change to early retirement provisions; unreduced pension at 55 and 85; otherwise deferred to 65

$194M

20%

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group

nature of reduction

$ reduction in solvency

As % of active member’s solvency liability

CALDA

Change to early retirement provisions; unreduced pension at 55 and 85; otherwise deferred to 65

$6M

24%

IAMAW

Change to early retirement provisions; unreduced pension at 55 and 85; otherwise deferred to 65, plus change in normal form of pension.

$345M

25%

IAMAW

change in early retirement provision only as per above

$316M

23%

total

with change in normal form for IAMAW

$699M

23%

total

without change in normal form for IAMAW

$670M

22%

ACPA’s Offer: Mr. Gold, ACPA Counsel on Pension matters, submitted that it is the arbitral principal of replication that should be followed in this case. Notwithstanding the statute, he argued, I have no power to ensure things that are not ensurable. He pointed out that s. 29 says the arbitrator is to be “guided by” the need for terms and conditions etc”. Mr. Gold further argued that the only aspect of pensions specifically referred to in the statute is, “sustainability in relation to the shortterm”. Although, as we know, pensions and pension liability is a long-term issue. Counsel for ACPA argued that, notwithstanding the evidence of the size of the deficit in relation to the size of the firm, it is a struggle to connect that macro set of 44

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circumstances to this arbitration. He submitted, even if Air Canada’s offer is accepted in its entirety, the problem is not solved by going from a deficit of $4.2 B to $3.2 B. He submitted that does not change the size of the plan relative to the business or create an instantly fundable plan. Counsel argued that many elements of the employer’s presentation on pensions do not relate to the choice that has to be made. Counsel submitted that ACPA is very aware of the horror that insolvency would bring for pilots. He maintained that these considerations weighed heavily on ACPA’s offer. Mr. Gold maintained that the paradigm put forward by ACPA was to look for a solution to the solvency crisis that had a minimal effect on employees. He argued that ACPA did a better job of that than did Air Canada. Counsel compared the numbers and the volatility of solvency funding versus going concern funding. In questioning, Mr. Dumas agreed with Mr. Gold that funding current service costs for the present plan on a going concern basis is not a problem for Air Canada. This leads ACPA to argue that the plan itself is otherwise “affordable” in a competitive market place. Counsel submitted there were two ways to deal with the solvency problem. First, he suggested you can cap the contributions to the plan, regardless of the funding rules, and, if that cap is affordable, then there is no issue. That has been the regime the parties operated under during the last 3 years when the contribution was $225M, $175M, and $150M. Mr. Gold suggested that both parties are proposing that this cap continue for another decade and that this might be a complete solution to the problem. The second way to reduce the solvency deficit is to reduce the benefit. Neither party’s proposal reduces benefits enough to make the plan affordable in the short term. Counsel for ACPA suggested that both parties have proposed a mix of these two solutions and that ACPA has tried to address the company’s problem while minimally affecting employee benefits. Counsel argued that the biggest difference in the two proposals was in the short term, the next five years. ACPA’s proposed cap on contributions is $86M, a figure that AC has said they could afford as opposed to Air Canada’s proposed cap of $150M, which Mr. Gold argues, has no rationale behind it. Counsel pointed out that ACPA’s proposal shifts a significant risk to employees and in return they should reap the advantage of any surplus that develops. Consequently, their proposal is, in the event of a surplus, to keep a buffer of 10% in the plan and use any surplus to reduce the “normal retirement age” to 60, before 45

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Air Canada takes any contribution holiday. Counsel pointed out that this is what the parties did in the TA. Counsel submitted that ACPA’s offer provides $274M in relief, more than what was requested of them. Counsel submitted that based on a percentage of negotiating targets reached ACPA’s share of the solvency funding relief would have been $165M. ACPA, however is willing to accept the mope aggressive target based on a percentage of the solvency shortfall. By this measure the pilots’ plan deficit of $702M represents 26% of the $2.696B total solvency shortfall in 2010. In turn 26% of the total of $1.04B in solvency relief would make ACPA’s share $774M. Counsel submitted that ACPA has not only adopted this target as a minimum, they have exceeded that target by a large margin in their offer. Counsel explained that the most significant difference in the two offers occurs in the first five years 2014 to 2018 and that the first five year period is governed by what Air Canada told ACPA the “could afford”. (ACPA relies on a presentation to the Union by Air Canada October 6, 2010, ACPA Supporting Documents Tab 34) They argue that based on the target they were assigned and the remainder being the company responsibility, they divide that by 5 to get the cap of $86M/year to ACPA plans. For the 5 years 2018 to 2024 Counsel maintained the the cap in the two proposals are identical. Pilots have a Bridge Benefit in their pension plan which increases the portion of their total pension that comes from the RRP as opposed to coming from the SERP. Counsel maintained that ACPA was willing to shoulder the risk of transferring funding for the bridge benefit from the RPP to the SERP. He points out that this is simply the reverse of what the parties agreed to in 1998 when they provided that more benefits would be funded through the RRP as opposed to the SERP. Counsel argued that this meets both tests of meeting the target and minimally affecting pilot benefits. Similarly ACPA proposed that the “early retirement subsidy” pilots enjoy would be transferred from the RPP to the SERP. ACPA proposes an “early retirement incentive plan” for pilots who complete 25 years service or whose age and service equals 80 to be eligible for a pension that is reduced to the actuarial equivalent of a pension starting at the Pilot’s normal Date of Retirement. Few pilots retire early. This proposal to transfer coverage for this benefit to the SERP has no effect on pilots but provides funding relief to the RPP because the solvency funding rules for the registered plan require that this benefit be funded. 46

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ACPA’s costing is that this change provides $120M in solvency relief as well as a reduction in current year service costs. Counsel pointed out that ACPA’s proposal on “normal retirement date” saves $94M in solvency funding but affects only 198 pilots. This compared to Air Canada’s offer of 30 years service or age 65 which adversely affects 1480 pilots. The TA, counsel points out, retained unreduced pensions at age 60. No other unit, he argued was asked for or gave 30/90. Counsel Pointed out that there were real savings in the ACPA proposal on flying past age 60. Under ACPA’s offer the majority of pilots who reach age 60 will be able to retire with an unreduced pension. Pilots are no longer required to retire at age 60 and if they choose not to there are savings to AC and the RPP. Counsel also asked that we compare the TA provisions on MPU and the Air Canada offer and also consider the increase in pilot contributions proposed by Air Canada. Counsel argued that neither of these are related to the affordability or viability of the plan. Counsel argued that the ACPA offer is less expensive than US mainline carriers and that ACPA has made considerable concessions to Air Canada in their offer. ACPA Offer on Pensions Their costing of their proposal is as follow: Bridge Benefit Early Retirement Normal Retirement Date Flying Past Age 60 total relief

56.2 million 122.3 94.5 43.5 $316.5 million

ACPA Proposal Bridge Benefit: Pilots who retire after 25 years of service whose age and service totals 80 are entitled to a bridge benefit payable from the Registered Pension Plan. Because it is a benefit payable from the RPP it creates an actuarial liability in that plan which must be funded. ACPA’s proposal is to move this liability from the RPP (which is regulated) to the SERP (which is not regulated and which is not required to be funded). This reduces both the going concern and solvency liabilities of the RRP’s.

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ACPA’s calculations result in this saving the RRP $56.2 million in funding requirements. ACPA Proposal on Early Retirement: If a pilot reaches 25 years of qualifying service or if age and service totals 80 he is eligible to retire early with a penalty of approximately 3% for every year short of age 60. ACPA submits that changing the early retirement to a “consent provision” provides solvency relief of $120M and a current service cost of $6.5M, over the period 2014-2018. ACPA submitted that their proposal costs $4.2M over the same period resulting in a savings 0f $122.3M ACPA Proposal on Normal Date of Retirement: The “normal date of retirement” is the earliest date on which the pilot can retire with an unreduced pension. The existing collective agreement provides for a mandatory date of retirement at age 60. The “normal date of retirement” is the same date as the mandatory date of retirement. ACPA has maintained the trigger date for “normal retirement” as the same date as the trigger for “early retirement— 25 years service or if age and service totals 80”. The result of this is the Pilot’s RPP will not be required to fund for a normal retirement age at age 60 but only for when the pilot reaches the trigger. ACPA points out that the company proposal selects a trigger of 30 years service and that Air Canada relied on this change to achieve almost all their solvency liabilities savings. ACPA claimed their approach was more “balanced” achieving only 30% of their total saving from this change. Flying Past 60 ACPA submits that there is another way to address the solvency problem and that is by preserving the plan assets. A pilot who continues to fly past age 60 does not draw a pension and thus reduces the plan costs. Another aspect of ACPA’s proposal is that the pilot who flies past age 60 occupies the second seat but continues to receive captains pay. When they offset this cost they arrive at a net saving to the pension plan of $43.5 million in the years 2013-2018. ACPA has used an average age of retirement of 61.5, which they maintain is a conservative estimate.

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Additional Features of ACPA’s Offer The Snap Back ACPA’s offer includes a provision that declares the any agreement reached by them to reduce the pension plan’s unfunded liability would be nul and void in the event of a plan wind-up due to insolvency (referred to as a snap back). ACPA reasons that by asking for relief from their pension plan now without corresponding relief from other unsecured creditors puts those unsecured creditors at an advantage in the event of a bankruptcy and that it is only fair and equitable that, in that event, their relative positions should be re-established. ACPA submitted that this provision is of no cost to the Company. Surplus and Minimum Funding ACPA proposed that AC maintain up to 10% of the greater of solvency or going concern liability as a cushion against future economic downturns. In effect that the plan’s agreed funding level is 110% and no contribution holidays may be taken by the company until the plan reaches that level. Further, that when AC is in a position to take a contribution holiday they shall first restore the normal date of retirement to age 60. There is no current cost to AC or the plan as a result, there is a potential future cost when the plans are in a surplus position. Maximum Pension Unit (MPU) Increases Pilots accrue pension per year of service based on a formula that determines Maximum Pension Unit for that year. That amount is in excess of the RPP maximum benefit limit and the amount of that excess is covered by the Supplemental Employee Retirement Plan (SERP). SERP benefits are paid out of general revenues and are only minimally secured by payments into a Retirement Compensation Arrangement (RCA). MPUs have been fixed since 2006. ACPA’s final offer provides for increases in MPUs effective on April 2, 2014. There are no costs to this proposal within the term of the agreement proposed by ACPA. DC Pension Plan For New Hires ACPA has proposed a modified version of the last AC proposal on a DC plan for new hires. Those changes are:

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d. e. f. g.

Both the pilot’s and company’s contribution will be set at the maximum amounts. AC will pay the employee contribution when the employee is on GDIP. AC will create an RCA for contributions that exceed the contribution cap for a DC plan. AC will invest the assets of the DC plans and RCAs alongside other pension assets managed by AC.

ACPA considers this to be a major concession to AC. They see the AC proposal as lacking as contribution levels proposed by them would not produce an adequate pension. They cost their proposal as a saving to AC of $2.2 million over the life of the agreement. Company Targets and Funding Moratorium

ACPA maintained in their brief that Air Canada represented to the Association that if the unions met their targets, the company could provide the rest (expressed as $1 to $1.5 billion). ACPA contends that the unions were targeted with $1,541 million in concessions (ACPA’s share being $274M) leaving $1,164 million for the company to pay over 5 years (or $259 million annually). ACPA now argues that none of the other unions met their targets. Consequently, ACPA argued, the company’s proposal to freeze their contribution at $150M/year will reward those unions who did not meet their targets, at ACPA’s expense. Their proposal is to cap the employer’s funding for past service contributions to the ACPA plan at $86M/year. The following is from the ACPA brief at p. 261: In our pension proposals, ACPA has provided meaningful funding solvency relief that, at $316.5 million, is $42.5 million above our original (and proportionate) target of $274 million. In turn, all we expect is that Company fulfill its part of the bargain. Specifically, in that when the Company negotiates a funding moratorium, they will provide the remaining funding envisioned in the 2010 solvency valuation for the next five years. Because ACPA has overshot its target, the Company’s total solvency funding obligation has been reduced from $428 million to only $385 million or $86 million dollars per year in past service contributions. At 89% of ACPA’s planned PBSA payments it is comparable to the average of 81.3% of planned PBSA payments that the other plans will receive. While it is slightly higher, it must be reiterated that ACPA exceeded its target whereas others fell far short.

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Working Past Age 60 ACPA’s final offer contains a recognition of the fact that mandatory retirement at age 60 is no longer a requirement. Their proposal (at page 215 of their brief) is as follows: Our proposal accomplishes five goals: it (1) accommodates pilots flying past age 60; (2) addresses the career expectations of junior pilots; (3) prevents the uncertainty of senior pilot retirement from affecting Air Canada`s manning requirements; (4) maintains the current cost structure of the Air Canada pilot group; and (5) provides additional solvency funding relief to the pilots pension plan. The proposal modifies the terms and conditions of employment for a Captain who has reached age 60. For First Officers who fly past the age of 60 the changes are restricted to a freeze for bidding different equipment types, or Captain up-grades. In brief, pilots flying past age 60 will be restricted to operating aircraft from the right seat, unless trained as a Relief Pilot (RP). In the case of Captains reaching the age of 60, they would operate flights with other Captains and be paid as Captains. These “Co-Captains” would be second-in-command of the aircraft, senior in authority to other Augment First Officers and RPs. They will bid schedules and vacation on a blended seniority basis with the First Officers on the same equipment and base. Upon reaching the age of 65, they will revert to First Officer status and pay. Our proposal includes a bonus designed to encourage pilots to give at least 12 months notice of retirement which will further improve the Company`s ability to plan staffing and training requirements. Accommodating pilots working past age 60 will have an adverse impact on the careers of younger pilots. In order to mitigate this impact during the transition period, ACPA proposes a phased in change in the vacation policy from a trailing year to a current year method. Other labour groups at Air Canada have already transitioned to a current year method for vacation entitlements. Although this process would result in a temporary increase in manning levels, it will benefit Air Canada in manning the airline ahead of the introduction of the B787 and help taper off the staffing level thereafter. The combination of the change in vacation and pilots flying past age 60 will make the training impact of the B787 implementation much easier for the company to manage.

ACPA has costed the savings from this proposal and included those in the overall costing of their proposal as well as in their costing of relief to the pension deficit.

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Conclusions on Pension In accordance with the statute I am to be guided by the need for terms and conditions of employment that are consistent with those in other airlines and that will provide for the necessary degree of flexibility to ensure the sustainability of the employer's pension plan, taking into account any short-term funding pressures on the employer. At p. 228 of their brief Air Canada cite Arbitrator Picher, who said in the recent IAMAW arbitration award (conducted under the same legislation as this process): Most significantly, the company faces a critical deadline in 2014. In the interests of protecting the Company’s survival following its emergence from CCAA protection, federal pension authorities granted it a moratorium on the payment of its pension deficit until 2014. It was hoped initially that the period of the moratorium would be sufficient to allow the company to reduce its pension deficit. However, economic events of the last few years, including the recession of 2008 and a fiscal policy that has consistently favoured low interest rates, have in fact led to a significant growth in the pension deficit. It is now clear to all concerned that an extension of the Company’s pension moratorium beyond 2014 will be essential to the Company’s continued viability. It is against that background that I now turn to consider the issue in dispute, the final offers and supporting submissions of the respective parties. (emphasis added)

Later in the Award, at page 8, Arbitrator Picher said: Simply put, the viability of the Company and to a substantial extent, the viability of the pension plan, essentially depend on the granting of an extension of that pension fund relief, hopefully for a period of not less than 10 years beyond 2014. The likelihood of the Company achieving success in its efforts with federal authorities is obviously substantially enhanced to the extent that the Union representing the largest group of employees and retirees in the Plan lends its active support to the effort to obtain an extension of the pension fund relief. It is of critical interest for the Company to gain that relief now, thereby assuring its long term solvency, consolidating its ability to finance the capital expenditures which are now necessary to maintain and upgrade its fleet in both the near and long term. Conversely, the issue of pension relief remaining unresolved places a cloud over the very viability of the Company, going forward.

I agree with Arbitrator Picher that an extension of the moratorium is essential to Air Canada’s viability and the viability of the pension plan.

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The pension fund deficit poses a grave threat, not just to Air Canada, but to retired pilots and their surviving spouses. In 2003, when Air Canada was threatened with bankruptcy, there were $2 billion in unsecured assets and the pension deficit was $1.3 billion. Today, if Air Canada were to find itself in CCAA there would be $200 million in unsecured assets and a $4.2 billion pension deficit. The pension “promises” could not possibly be kept. That is the reality. That reality is what makes it critical that the company not just survive but thrive in the future. There is an important element of this issue that gets lost when it is framed as a labour/management point of contention. Although Mercer couches the language in terms of the impact on Air Canada by saying that “such risk exposure is unmanageable”, this translates into a situation that is equally unmanageable for employees and pensioners. It says to those people—In the future you cannot rely on Air Canada’s ability to provide the pension benefit you are looking forward to, or to continue to pay the pension benefit you are receiving. It is not just a question of providing some relief to Air Canada from a pension burden, it is a question of restoring some security to the employees who are relying on this pension plan to secure their future. This consideration has weighed heavily in my deliberation, notwithstanding ACPA’s assertion that they are willing to assume more of that risk through transferring liability to their SERP from the RRP. At para 66 of their Reply Brief ACPA states: Air Canada’s submission attempts to paint the picture of Air Canada as a business at “death’s door” with the following attributes:  Financial performance heading for a liquidity crunch or “cliff” in 2014 or 2015  Strong competitors in the market against whom Air Canada cannot compete  A business in which the revenue inputs are just too volatile to forecast – so the forward-looking business plan consists of a schedule of Contractual Obligations

Air Canada, in their brief and their submissions, set out the magnitude of the pension deficit issue. The 2004 and 2009 measures that were taken to buy time and to allow Air Canada and its unions to find a long term solution were not successful and the plans funding over that time has deteriorated, as follows:

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All Plans

Pilots’ Plan

January 1, 2004

$1.3 billion

$136 million

January 1, 2009

$2.83 billion

$727 million

January 1, 2011

$217 billion

$550 million

January 1, 2012

$4.2 billion

$1,110 million

It is not being alarmist to draw attention to these numbers. These are the numbers that inform the credit rating agencies, the aircraft lessors and suppliers and all the commercial partners Air Canada relies on to do its business. I cannot conclude that Air Canada is overstating the case. They are not in a sound position. Blair Franklin recognizes that in 2009, without the union’s agreeing to the scheme of solvency relief Air Canada would likely have had to seek CCAA protection. I understand Blair Franklin’s projections and how they arrive at them. Notwithstanding those projections, I am not persuaded that the situation in 2014 will be much improved or that Air Canada could not return to that 2009 position if ACPA’s offer were accepted. The Blair Franklin opinion that Air Canada will have no liquidity issues in the future if ACPA’s offer is accepted depends on the company being able to absorb the ACPA pension proposals. That means depending on the proposed funding deficit reductions in ACPA’s offer passing regulatory scrutiny and scrutiny by Air Canada’s creditors and on creditors and analysts finding the “snap-back” provisions to be benign. It depends on the offer being accepted by the other unions as ACPA’s contribution to their joint problem. It also depends on the Federal Regulator accepting a plea for funding relief with one of the major players being potentially off-side. If all that works and if the other assumptions—such as the assumption that interest rates will rise and fuel will stay low—then the Blair Franklin projections will prove to be accurate. In their presentation, ACPA has attempted to downplay the seriousness of Air Canada’s pension issues by suggesting that the current service costs of the pension plan are “affordable” for Air Canada and that on a “going concern basis” the plan is manageable. The notion that the plan is “affordable” on a going concern basis is the foundation for their position that there is no need in the deficit reduction exercise to cut plan benefits. It leads them to criticize the Air Canada offer as not 54

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being “balanced” because of the extent of saving that comes from changes to the early retirement benefit, whereas all the other unions have contributed to the deficit reduction by reducing benefits in their plan. ACPA’s approach to pension funding relief starts with an analysis of what they determine their “fair share” of solvency funding relief should be. They conclude they have a target of $274 million. ACPA submit that their offer exceeds this target by $42.5 million. Other than a change to the pensionable age date their proposal does not include any substantial plan benefit reductions to address the funding deficit. It does not include supporting the company, with the other unions, in asking the regulatory body for relief from the funding regulations with plan and a funding cap that is consistent with those of the other unions. ACPA only meet their “target” if their proposal to shift pension liability from the RPP to the SERP passes regulatory scrutiny and if the “snap back” prove to be benign. In Air Canada’s offer the company’s contribution to the plans for funding past service is capped at $150M/year for ten years, paid into all the union plans, prorated on the basis of their funded deficit. Under ACPA’s proposal for the first five years 2014 - 2018, Air Canada would contribute $86M/year to the pilots plan. At paragraph 435 of their brief Air Canada states: Funding relief can alleviate the symptoms and address the short-term economic viability and competitiveness of Air Canada. But as Air Canada has raised repeatedly with its unions, measures that address the nature and magnitude of the liabilities are required to address the root causes and provide for long-term viability and competitiveness and accordingly provide sustainability to the pension plan through the sustainability of its sponsor. It is for this reason that Air Canada’s offer includes a requirement for union support in seeking an extension of funding relief regulations, as well as calibrated changes to benefits that reflect changes to the law since the TA was concluded and reductions that have a meaningful and certain impact on costs without undermining or even changing the expectations of the vast majority of pension plan members. These changes are equitable toward the pilots and consistent with changes to be applied to other employee groups within Air Canada. They are also consistent with Air Canada’s competitors and the TA. (emphasis added)

I can understand ACPA asking, in relation to the requirement for union support, “How can you include this kind of a provision in this kind of final offer arbitration?”. It is a troubling aspect of the proposal. It is equally fair to ask how could you leave it out when you believe that the success of the proposal (to approach the regulator for relief) depends on the support of all the unions. At this stage, how could Air Canada leave it out and maintain good faith dealing with their other unions?

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Aspects of the TA on pensions have not been followed in Air Canada’s final offer. Air Canada refers to several events that have taken place since the TA was developed. Most significant are the abolition of mandatory retirement for pilots at age sixty and the agreements reached by all the other unions and the arbitrated settlements. It is essential to the success of the solvency funding relief that the unions are united in their support of the request. In my view their approaches must be consistent. The one approach that has been successful twice in the past is the approach proposed by Air Canada. ACPA’s offer on solvency relief is untried and uncertain. It puts at risk, the company, their own pension plan and the plans of the other unions. Removing mandatory retirement creates a major problem for ACPA. It pits the interests of younger pilots with career income aspirations against the interests of older pilots who would like to be free from age discrimination in their continued employment. In their reply brief ACPA identifies, “the most harmful features of the Air Canada final offer from a pilot point of view”. Second only to scope changes is Air Canada’s proposal on mandatory retirement. At page 231 of their Brief they state: Mandatory retirement at age 60 has long been the policy of the Association, one that was for many years supported by both legislation with respect to the normal age of retirement for occupational groups, and by the jurisprudence recognizing the right of unions to negotiate the terms and conditions of their employment. However in recent years there has been a growing acceptance that because people are healthier and living longer, they should have the option to remain employed longer. This has resulted in an increasing pressure to accommodate the wishes of those pilots who wish to fly at Air Canada beyond 60 years of age. Most recently, the government has removed one of the legislative supports for mandatory retirement provisions formerly section 15(1)c of the Canadian Human Rights Act.11 In contrast to the right of older pilots to continue to work past age 60 are the legitimate career expectations of the pilot group. Our system has been designed for over 70 years with a back-end loaded pay structure; a seniority provision that provides optimum work schedule and vacation for senior pilots; and, a pension system that is based on the “best 60 months”. Most pilots have planned their entire career to be in position to maximize schedule, pay and preferred aircraft type for their final five years. Unless carefully implemented, allowing pilots to work past the age of 60 could be devastating to the remainder of the pilot group and effectively force all pilots to work beyond the age they would have otherwise expected. In addition to pay, lifestyle and pension considerations, insurance and disability benefits are similarly laddered and have been negotiated and costed with retirement at age 60 in mind. In

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addition to pilot concerns, the predictability of the mandatory retirement age policy also allowed the Company to effectively forecast their training requirements.

However, ACPA’s proposal on flying past 60 is untried and uncertain. If mandatory retirement at age 60 has been struck down on the basis of its being “age discrimination”, the same principals are going to apply when someone decides to challenge any change in the terms and conditions of their employment based on age 60, notwithstanding maintenance of their pay. I understand ACPA’s dilemma— they need to move pilots off the top of seniority list at age 60 to accommodate their younger pilot members. The difficulty is that this is what the Human Rights Act, as interpreted, is just as likely not going to allow. I conclude that ACPA’s offer on flying past age 60 is flawed by the uncertainty that surrounds its implementation. The “savings” attributed to that aspect of the offer are to the same extent “uncertain”. I cannot accept ACPA’s premise on this issue—that they were given a funding deficit reduction “target” by Air Canada and that whatever means ACPA can come up with to arrive at that target should be satisfactory to the company. If that was the case at the time of the TA, events have superceded that situation. Since that time all the other unions have settled on a deficit reduction plan that involves supporting a common request for funding relief—a process that is familiar to the parties and one which requires uniform union support. In effect ACPA lost the opportunity to lead on this issue when the TA failed and they did not get back to the bargaining table quickly. The arbitral authorities are clear, events can sometimes supercede the effect of a tentative agreement in subsequent arbitration. When that happens other criteria have to be looked at. Here we have the precedent established by all the other bargaining units, something that replication theory holds in high regard as a reliable benchmark of a “reasonable settlement”. The agreements with the other Unions included “real” cuts to pension benefits. In my view that is an essential part of maintaining the defined benefit pension plan while addressing the funding deficit problem. ACPA’s offer, on the other hand, increases pension benefits through the MPU formula. Improving pension benefits at the same time that the parties are seeking funding relief is inconsistent and puts ACPA in a favourable position viv-a-vis the other unions that is not justified by the circumstances. The “reasonable settlement” envisioned by the theory of replication has to account for the position the company is in given its settlements with all the other unions. Applying the test of replication and the arbitral jurisprudence cited above, which deals with the impact of a tentative agreement: I conclude that Air Canada’s offer 57

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on Pensions and mandatory retirement is the proposal that most closely represents what the parties would achieve in free collective bargaining. Applying the statutory test: I conclude that Air Canada’s offer on Pensions and mandatory retirement satisfies the need for terms and conditions of employment that are consistent with those in other airlines and that will provide the necessary degree of flexibility to ensure the short and long-term economic viability and competitiveness of the employer; and the sustainability of the employer’s pension plan, taking into account any short-term funding pressures on the employer.

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SCOPE and LOW COST CARRIER (LCC) I have already said, in the Introduction, that for ACPA the scope language of the collective agreement is also an existential issue. The scope language of the agreement defines and protects the work of the bargaining unit. Scope is also a key driver of compensation since pilots are paid depending on the aircraft they are flying. To the extent that the scope language reserves certain aircraft types to the Air Canada mainline fleet, it is key to the pilots ability to maximize their earnings. Progression from the entry level pilot position (which pays less than $40,000/year) to a wide body captain position earning $237,000/year, and the opportunity of five years in that senior position is why pilots come to Air Canada. ACPA generally has a fair degree of frustration with Air Canada’s approach to scope issues. ACPA maintain that Air Canada is looking for flexibility in the collective agreement but is never able, or willing, to share with them how that flexibility will be exercised. That is why ACPA finds much more comforting what they describe as the past practice of the parties dealing with these scope issues as they arise in the context of a specific problem or issue. For Air Canada the ability to establish a Low Cost Carrier to compete head to head with WestJet and Air Transat is key to their competitive strategy and, in their opinion, to their survival. At page 26 of his report Taylor makes the following observation: The provisions allowing Air Canada to create a new LCC subsidiary with pilot rates competitive with the WestJet and Air Transat will give the company a valuable tool to compete with its major Canadian competitors. And given WestJet’s rapid expansion, this is a strategically critical capability. However, the block-hour minimum included in the LCC provisions is material restriction. This hard floor under total company block-hours could limit Air Canada’s ability to respond to poor market conditions. And this is most likely to happen during periods when the company is under severe economic pressure.

ACPA details in their brief what they refer to as their on-going frustration with Air Canada’s lack of transparency on the issue of a Low Cost Carrier. They claim that in their final offer they have made substantial moves towards meeting the company’s express concern about their ability to compete with WestJet. ACPA has 59

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tabled a comprehensive offer on the establishment of a LCC. They assert that their offer will allow the company to address its short and long-term viability and competitiveness. ACPA submit that their proposal provides the company with a completely restructured set of working conditions which adopt nearly all of the WestJet Pilot Agreement terms while maintaining ACPA’s interest in maintaining this new work within their bargaining unit. ACPA deals with their proposal on scope at pages 46 to 72 of theirs brief. They maintain that they have addressed a number of areas in article 1.03 of the agreement, what they refer to as the “core scope clause”: 1.

Two new definitions (“entity” and “competitor”) introduced here as they are general in nature but support parts of the core language.

2.

A provision that all flying will be classified into one of the categories defined in the Collective Agreement. This will promote labour peace by forestalling any argument that certain flying for Air Canada can, by default, be performed by other airlines because it does not fall within any category covered by the scope language.

3.

As a matter of housekeeping, there is deletion of outdated language from the article, together with the addition of two terms (“scheduled charter” and “sports charter”) to the list.

4.

Finally the list of exclusions (under which other airlines can fly on Air Canada's behalf) is expanded to clearly specify the kind of flying excluded from the core definition and the articles within which the terms of that exclusion are found.

The collective agreement in effect from 2000 to 2004 was the last freely negotiated collective agreement between these parties. Thus, ACPA contends, the history to the scope language in that agreement is significant. ACPA says that prior to 2000 the scope language in the agreement focused on limiting the type of aircraft Air Canada’s “feeders” could use to fly under Air Canada’s code. In 2000 the scope language was expanded and revamped to cover not only “feeder” flying but also code sharing. These are commercial arrangements under which mainline carriers sell seats on each others flights. With some exceptions the agreement on scope reached in 2000 remains the same. One of those exceptions is referred to as the Teplitsky small jet allocation. In 2003 ACPA agreed to allow Jazz to expand its fleet of small jets through an arbitral process that allowed the arbitrator to allocate 105 new aircraft between the

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mainline and Jazz. That process resulted in the Jazz fleet expanding from 39 to 60 aircraft. This included the following : • •

All existing and new 50-seat Bombardier CRJ aircraft were allocated to Jazz. All new 75-seat Bombardier CRJ 705’s were allocated to Jazz.

The Teplitsky process also saw 15 new 75-seat Embraer EMJ 175’s and 45 new 90seat Embraer EMJ 190’s added to the mainline. ACPA contends that the net effect of the “Teplitsky allocations”, combined with Air Canada’s decision to remove large jets from the mainline fleet following CCAA, was to alter the balance of jets and growth in pilot jobs at Jazz. ACPA maintained that in the current round of bargaining and in their final offer they have made proposals aimed at adjusting the scope language so as to protect bargaining unit work while at the same time accommodating the changing commercial arrangements being made between airlines. ACPA contended that Air Canada’s proposals would eviscerate the job protections found in the agreement. ACPA made the point that they have agreed in the past to allow other airlines to fly on behalf of Air Canada. However, they have done that only at the bottom of the equipment ladder, or to accommodate commercial arrangements like code sharing on international routes where those arrangements result in net increases in the flying that is equitably shared with the pilots of those other airlines. For example, mid-contract 2002 ACPA agreed in LOU 51 to allow Air Canada to create ZIP, a low cost carrier based in Calgary to compete with WestJet. ZIP operated no-frills 737’s the same plane flown by WestJet and replaced AC domestic flights mostly in western Canada. Air Canada pilots flew the planes under relaxed work rules and reduced pay rates. ZIP was subsequently shut down in 2004. From Air Canada’s perspective it is the scope language of the agreement that limits its ability to enter into commercial arrangements with other airlines and to create a Low Cost Carrier (LCC) which would allow them to compete on a more level playing field with WestJet, their most significant competitor. Air Canada maintains that: ... any provision in a collective agreement that restricts commercial activity in a dynamic and transforming industry, like the airline industry currently is, must also keep pace with developments in the industry or the provision will ultimately become self-destructive of the interests of all parties. This reality was evident to the parties when the TA was negotiated and was the motivation for the substantial change in the scope language reflected in the TA.

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Air Canada described their final offer as the TA with some changes necessitated by changing circumstances. Low Cost Carrier: In the TA the parties agreed to a Letter of Understanding which would allow Air Canada to establish a Low Cost Carrier to compete with WestJet. Air Canada’s final offer on LCC is to adopt the TA provisions with a small change advantageous to ACPA. The essential features of the proposal, as described in the Air Canada brief, are as follows: i) The LCC would be a separate entity. ii) Pilots employed by the LCC would be represented by ACPA working under terms and conditions specific to the LCC but which form part of the Air Canada collective agreement. iii) The LCC would be focussed on leisure markets where low cost competition has intensified. iv) The LCC would be permitted to operate a fleet of 50 aircraft composed of 30 319's, 20 of which may be transferred from the mainline fleet without being replaced and 20 B767's, all of which may be transferred from the mainline fleet but must be replaced with equivalent or larger aircraft (ie. Boeing 787's aircraft). v) Different pay and work rules would apply to pilots employed with the LCC that are competitive with WestJet and Air Transat rates and rules, as applicable. vi) The only change Air Canada proposes to the LCC provisions of the TA relate to the probationary period for captains. Air Canada understands that during the ratification process, some pilots expressed views about the addition of a probation period when transitioning to the Captain’s role, unlike the transition at Air Canada. As a gesture to improve the TA for the benefit of the pilots, Air Canada proposes that the probation period be that of pilots at Air Canada.

ACPA’s offer on LCC is found at pages 74-75 of their brief:

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ACPA’s proposal on LCC is based on providing the Company the flexibility to compete with other ‘Low Cost Carriers’ and to enter new International markets. ACPA submits that the proposals set out below satisfy the interests of both the Company and the Association. They provide the Company with a restructured set of working conditions –adopting nearly all of the West Jet Pilot Agreement terms and maintain ACPA’s interests as the provider of pilots to perform this new work. The ACPA proposal is encompassed in LOU VV as part of its main Collective Agreement proposal. In many cases the language was extracted without modification from the WJA to ensure the competitive nature of the provisions. Proposed Collective Agreement Language – LCC LOU VV The following passages highlight the key components of the LCC proposal and their rationale. Collaboration and Concept: Lvv.01 Preamble Lvv.01.01 In the context of Air Canada’s announced intention to launch a new Specialty Company (hereinafter called the Low Cost Carrier or “LCC”), Air Canada and ACPA have agreed to amendments to the collective agreement that will be applicable to only the LCC. The provisions of the collective agreement are amended only to give effect to the provisions contained in this LOU, otherwise, all other provisions of the collective agreement apply. Lvv.01.02 A LCC Joint Committee (LCCJC) will be established to review and recommend resolution to issues that arise concerning the terms and conditions, including transition, governing the LCC. Any recommendation from the LCCJC requires approval by the Company and the Association

ACPA maintains that their proposal on LCC is in fact more reasonable than the Air Canada offer and that, according to the Case Lab report, the hourly rates proposed by ACPA offer a significant advantage in pilot costs to the company. Air Canada rebuts this. They disagree with the analysis of ACPA’s proposal done by Rick Salamat, Case Lab, and provide their own analysis. They claim ACPA’s proposal would cost Air Canada $16.6M/year over the Air Canada proposal to operate a LCC. 63

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Code Share: Code sharing is a way for an airline to offer its customers access to a much larger network of destinations and a greater frequency of flights. The Taylor Report, at pages 11-12 makes the following point. Due largely to the power of frequent flyer programs and corporate discount agreements, customers strongly favor carriers that can meet most or all of their travel needs. This allows them to concentrate their travel with a single carrier and maximize the benefits they receive from these programs. The business and premium traveler passenger segments, which are the largest and highest value sources of revenue, are especially sensitive to those factors. Since no carrier can provide the kind of global coverage and service demanded by travelers today, marketing agreements and alliances have become critically important for the airline industry. To implement these joint marketing agreements, almost all carriers in the world today, including Air Canada, employ a practice known as code sharing.

At paragraph 213-214 of their brief Air Canada provided an example of how code sharing with United Airlines on flights between Toronto and Chicago benefits both carriers. On Saturday April 28 Air Canada operated 2 flights between Chicago and Toronto and carried 169 United passengers. United, on the other hand, carried 85 Air Canada passengers on the same route that day. Both airlines were able to offer their customers greater frequency of flights and both were able to maximize their load factors through this code-sharing agreement. In 2009, Air Canada derived 14% of its passengers and $1.3 billion in revenue through code sharing agreements with other airlines. Air Canada pointed out that in the July 2012 flight schedule United Airlines, US Airways, American Airlines and Delta all have more code share ASMs per week than Air Canada. Air Canada perceives the current collective agreement provisions on code sharing to be defensive. Air Canada contended that ACPA views code sharing as an encroachment on their work as opposed to an opportunity to create more flying for Air Canada pilots. The existing agreement sets limits on domestic, transborder and international code sharing arrangements. Air Canada finds that the existing agreement limits mutually beneficial growth of code sharing. The transborder and international code share formula fixes the ratio of code-share ASMs at the January 28, 2000 level. For example, if Air Canada operates 10 ASMs and its code-share partner operates 1 ASM, if the code share partner were to double 64

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its available code share ASMs to 2, Air Canada would also have to double its ASMs to 20 or the code share partner would have to reduce its flying in and out of Canada. Neither of these outcomes makes sense according to Air Canada and neither enhances the growth and competitiveness of Air Canada. Air Canada cited a similar problem with domestic code sharing. Air Canada contended that in order to compete against WestJet’s Regional carrier, Air Canada needs to reduce costs at the regional carriers it uses. To achieve greater competitiveness Air Canada wants to allow those carriers to operate outside the CPA. Air Canada wants to be able to code share on those non CPA flights to enhance their revenue growth and spread costs over more flying. At paragraph 225 of their brief Air Canada states: In negotiating the TA, the parties recognized the inherent advantage of reciprocal code sharing arrangements and found solutions to enable Air Canada to expand these opportunities for growth, while at the same time, assuring pilots that their interests were respected.

And at para 230 of their brief: TA code share provisions have been modified to address changing circumstances, most notably the arrival of WestJet’s regional airline which will push the Tier 2 carriers contracted by Air Canada to become more competitive. Code share arrangements with Tier 2 carriers is one response to WestJet’s expansion. Tier 2 carriers outside the scope of CPAs will however, apply against the 29:100 ASM ratio controlling the ultimate extent of this flying. The changes are also responsive, in the case of transborder code share, to circumstances beyond Air Canada’s control, namely the Competition Bureau’s position regarding the proposed Joint Venture between Air Canada and United, and include the key protection in the United Joint Venture in an updated provision to accommodate the continuation of the Air Canada – United transborder code share.

Domestic Code Share: changes from TA The change from the TA being proposed by Air Canada with respect to domestic flights is in response to WestJet’s announcement that they are creating a regional airline. Air Canada has the ability to enter into Capacity Purchase Agreements (CPA) with tier 2 domestic carriers. Air Canada has changed their offer from the TA to allow them to enter code share agreements with these same carriers outside the scope of their CPA. Pilots are protected by the ASM ratios set in the TA at 29:100. Air Canada maintained that the ASM ratios provide the protection ACPA seeks while providing flexibility to deploy the most efficient aircraft for the flight.

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Transborder Code share: changes from TA: Air Canada submitted that in the TA the parties were focused on the company’s right to enter into new transborder code share agreements because it was expected the existing agreement with United would become a joint venture. This has not happened as a result of opposition from the Canadian Competition Bureau and the matter is before the Competition Tribunal. Consequently Air Canada has proposed a revision to the TA language to accommodate continuation of the existing code share with United. Air Canada’s offer proposes a specific formula for the existing United code share under which Air Canada would maintain the difference in transborder flying ASMs into and out of Canada between Air Canada’s operation and United’s operations carrying the Air Canada Code. As in the case of domestic code sharing, Air Canada would have the flexibility to code share with Tier 2 CPA partners in respect of flying by the tier 2 carrier outside the scope of its CPA with Air Canada. According to Air Canada this modification of the TA is intended to maximize the flow of passengers to Air Canada from the Tier 2 carrier’s entire network. This modification is also coupled with the inclusion of this code-share flying within the CPA ASM limits, placing a limit on the extent of this flying. Air Canada maintained this change is in keeping with the rationale of the TA. Air Canada’s final offer on International code sharing is the same position as the TA. Air Canada would have the flexibility to enter international code share arrangements provided they maintain as a minimum, the difference in international flying ASM’s into and out of Canada between Air Canada’s operations and the operations of the other airlines. ACPA on Code Sharing ACPA’s offer on Code Sharing is to included language that would see “joint ventures” as a type of revenue sharing arrangement that falls under the agreement code share provisions. Under ACPA’s offer some existing provisions continue to apply to all code share operations regardless of form. In the current Collective Agreement, these provisions were also intermingled with other provisions, such as Tier 3 and Arctic flying. Under ACPA’s final offer, outsourcing to Tier 3 carriers is still limited to a 100:2 ASM ratio (Air Canada must fly 100 ASMs for every 2 ASMs flown by Tier 3 carriers), and is still limited to SP aircraft (small propellor aircraft up to 23 seats).

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At page 56 of the brief, ACPA states: In our final offer, ACPA retains the general code share language and adds a prohibition against Tier 2 code sharing. Instead, it sanctions and allows for further Tier 2 growth under the Capacity Purchase Agreements that Air Canada now uses to define its commercial relationships with Tier carriers. The ‘Within Canada’ provisions have been updated and enhanced. The structure of this section is improved by moving the ‘sub-committee’ provisions to the information section of scope, and by introducing separate sub-articles for Arctic and Tier 3 operators. For code sharing that is not revenue sharing, ACPA has included a new code sharing provision for a single Arctic Operator with a 100:2 ASM ratio, and has updated the restriction on Tier 3 Operators (including capacity purchase agreements for Tier 3 in a later section).

Transborder and International Code Sharing: The current formula requires Air Canada to have Air Canada pilots operate a fixed percentage of the total traffic carrying the Air Canada code in that market. That baseline percentage was established in 2000. In their brief ACPA describe their offer as follows: The Company has expressed a concern that the current formula for protecting the amount of Transborder and International Flying is difficult to manage as it includes both code share flights and non-code share flights in the formula. Additionally, the Company has suggested that the code share formulae for international and transborder flying should not include flights within revenue sharing agreements (such as joint ventures). ACPA has developed the following formula to meet the stated needs of the Company, while continuing to provide protection for the work of Air Canada Pilots in these markets. The formulae in ACPA's final offer substantially reduce the proportion of flying required to be done by Air Canada pilots. They accomplish this result by adjusting the ratio of flying that can be done by other airlines (OALs) vs. Air Canada. First, the proposed new ratio will “grandfather” Air Canada's potential outsourcing at current levels, which significantly exceed the more restrictive ratio baseline in the current Collective Agreement. Second, the proposed new formula relaxes current restrictions even further, by allowing Air Canada a further 5% buffer, using a three year trailing average, in order to allow for normal fluctuations in the flying within these markets.

Joint Ventures: 67

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At page 13, Taylor describes “Star Alliance”, formed in 1997 between Air Canada United - Lufthansa, as the first multi carrier alliance designed to create a global offering for frequent fliers. (Star Alliance now includes 27 airlines world wide.) Taylor describes two competing alliances that subsequently developed between North American, European and Asian legacy carriers. Taylor continues to describe more recent developments, as follows: More recently, the major alliances have evolved further to create extensive, antitrust immunized joint ventures within these alliances. United and Lufthansa created a JV covering transatlantic flying and subsequently added Air Canada, Swiss Airlines and Austrian Airlines. Delta has formed a competing JV with Air France and KLM and oneworld followed suit with American, British Airways and Iberia. The airline JV concept continues to grow globally as each of the alliances are forming similar JVs covering transpacific and Latin American flying. Airline JVs are proving to be highly valuable for the carriers involved. Anti- trust immunity allows the JV partners to coordinate fares, corporate discount agreements, promotions and capacity and has allowed the JV partners to materially improve their economic results. Of the existing JVs, the one that is probably the most successful is the transatlantic JV created by Delta, KLM and Air France. This is because this JV includes true profits sharing, as opposed to just revenue sharing, which is the norm in other JVs. True profit sharing allows Delta, KLM and Air France to optimize the aircraft used in the JV without regard to which carrier flies any given city-pair. This results in a level of revenue and cost efficiency that is unachievable by JVs that don’t fully share profits.

The expired collective agreement had no provisions with respect to joint ventures. At the time the TA was negotiated, Air Canada anticipated a joint venture with United on transborder flying. (currently before the Competition Tribunal). In the negotiations leading to the TA, ACPA requested that there be language in the agreement to address this subject. Air Canada considered this to be a major concession in bargaining. The language in Air Canada’s final offer on Joint Ventures is the language from the TA. ACPA Offer on Joint Ventures: ACPA describes its proposal on Joint Ventures, at p. 60 of its brief, as follows: Joint Ventures fall under the definition of code sharing as they are one example of the larger category of revenue sharing agreements. In the current Collective Agreement joint venture flying would be captured and combined with all code share flying under the code share provisions and restrictions.

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Joint Ventures are contractual relationships formed between two or more air carriers that are reviewed by governments and are generally granted multilateral immunity from anti-trust prosecution. This permits the carriers to jointly plan flying, capacity, scheduling and pricing. The revenues and costs of the flights operated by the joint venture are divided up between the member airlines according to their commercial contract. Air Canada currently operates as part of only one joint venture, that of the Atlantic ++ agreement. Joint Ventures do not necessarily link revenue with capacity, so there is no natural incentive for a joint venture partner to ensure that their pilots operate a ‘fair’ share of the joint venture flights (as would exist in a traditional code share agreement). To ensure that fair share, pilot unions negotiate ‘baselines’ to establish their share of flying going forward, thus ensuring that all pilot groups in the Joint Venture benefit from the flying. The baseline used by pilot unions to measure such flying is based on the percentage of ASMs that a carrier performs within the entire Joint Venture. Under ACPA's proposal, Air Canada’s baseline percentage for the Atlantic + + Joint Venture is substantially lower than the current percentage of Air Canada’s flying within that joint venture. ACPA’s proposal will not in any way limit Air Canada for the foreseeable future. To the contrary, the baseline comes with a 5% buffer and a trailing three year calculation in order to allow for fluctuations in traffic volumes. In order to update our Collective Agreement and address the specific concerns of Joint Venture code share, ACPA has included a number of provisions such as when and how new partners are included, and restrictions against wet leasing by the Joint Venture itself. For the purpose of calculating flying ratios, the ASMs within a joint venture are separate from the ASMs used to calculate the ratios in the Transborder and International markets.

Capacity Purchase Agreements (CPA): Prior to 2000 Air Canada had acquired an ownership interest in a number of regional airlines referred to as “connectors”. (These included Air Nova, Air Ontario, Air BC.) Through these acquisitions Air Canada was able to serve regional markets and provide feed to the mainline from areas where Air Canada could not operate profitably. Through 2000 to 2003 and the merger with Canadian these feeder airlines were rolled up into one entity which became Jazz. Through the CCAA process ACE Aviation Holdings became the parent company of Jazz and Air 69

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Canada ceased to have any ownership interest in that company. Jazz was sold off from ACE through an IPO in 2006. Although Air Canada has no ownership interest in Jazz, it has what is referred to as a capacity purchase agreement (CPA) with that airline. Under that agreement Air Canada determines the routes flown by Jazz on Air Canada’s behalf and agrees to purchase (for a negotiated fee) almost the entire capacity of the airline on those routes. Under the terms of the expired collective agreement this feeder arrangement with Jazz is the only feeder arrangement in which Air Canada is permitted to participate. Through the 1980’s the scope language of the agreement permitted the various feeder regional airlines to fly up to 85 seats, with no distinction between jets and propeller aircraft. In 1993 and 1995 collective agreements the restriction became “propeller aircraft of 70 seats or less”. The regional jets such as the Bombardier CL65 were to be flown at the mainline. By 2000 the relationship between the mainline and regional carriers was changing. Small jets were migrating to the regional carriers from the mainline. Consequently, Air Canada sought accommodation from ACPA to allow the Bombardier CL65 to be flown by the regional airline. There were major changes to the scope language with respect to regional flying including: i)

Air Canada was limited to a single “feeder” arrangement with he airline that would become Jazz. ii) Air Canada was afforded the means to transition 25 Bombardier CL65 aircraft from the mainline to Jazz, provided provided there was corresponding growth in narrow or wide body jets at the mainline fleet. iii) There was agreement on a formula for “growth or shrinkage” in the mainline fleet relative to the acquisition or disposition of any additional small jets at Jazz. iv) Air Canada agreed to maintain 100 ASMs at the mainline for every 12 ASMs flown by Jazz v) Jazz was to be allowed to operate larger propeller aircraft of up to 80 seats. In less than three years Air Canada was under CCAA protection and a recovery plan was developed that changed this arrangement. Small jet aircraft would transition to Jazz and Air Canada would acquire a new fleet of jet aircraft in the 76

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to 110 seat range. This was accomplished through the purchase by Air Canada of the Embraer 175 and 190 aircraft. This transition could not be accomplished under the terms of the 2000 ACPA scope language. Air Canada/ACPA and Jazz and ALPA, the union representing Jazz pilots, agreed to an arbitration process to determine their respective rights regarding equipment acquisition and scope. This resulted in Arbitrator Teplitsky assisting the parties to arrive at an agreement that provided as follows: i) a fleet of 50 CRJ 100’s/200’s at Jazz, including the transition of 25 CRJ 100's from the mainline to Jazz. ii) a fleet of 15 Bombardier CRJ 705's configured to a maximum of 74 seats would form part of the Jazz fleet. iii) 15 Embraer 170's/175's would be added to the mainline fleet. iv) 45 Embraer 190's would form part of the mainline fleet. v) Air Canada would maintain a minimum of 100 ASMs at the mainline for every 12 ASMs flown by Jazz. The Air Canada/ACPA collective agreement was then amended to reflect this settlement. This was all concluded at a time when Jazz was wholly owned by either Air Canada or ACE. The current language of the collective agreement is a composite of the 2000 scope language as amended by this agreement. At page 15 of his report, Taylor makes the following observation about mainline carriers and CPAs with regional feeders: In most cases, major network carriers enter into contractual capacity purchase relationships with regional airlines to provide connections from small and mid-sized cities using regional aircraft. This is because these carriers can operate smaller regional aircraft much more efficiently than large, network carriers. For large carriers with well integrated “hub-and-spoke” networks, typically 15 to 20% of the passengers carried on mainline aircraft connect to or from regional partners – incremental passenger traffic that is a direct result of these regional capacity purchase agreements.

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Given the relatively low population density of Canada, one would expect Air Canada to have a more developed regional network than the US carriers. But Air Canada actually has a smaller regional operation.

Taylor’s conclusion is based on the number of aircraft flown by Jazz, Air Canada’s regional feeder, compared to the number of aircraft in the feeder fleets of other airlines. (See table at p. 15 of the Taylor Report.) ACPA’s expert came to a different conclusion based on a different measure. The report prepared by RW Mann & Company, (Tab 2 ACPA supporting documents to Reply Brief) at page 7, in a chart that appears to use ASMs as a measure, Mr. Mann shows that Air Canada’s ratio of feeder to mainline fleet actually exceeds that of US network carriers as a whole. Mr. Mann writes, “While Mr. Taylor states a 29% ratio of ASM to be a limitation, Air Canada has only briefly exceeded this cap, and only on a comparison to network narrow-body ASMs”. Mann states as follows: “On a system basis, the manner in which most US PWA measure, Air Canada has only briefly reached 9%”. Notwithstanding these comments, the observation from the Taylor Report that, “Given the relatively low population density of Canada, one would expect Air Canada to have a more developed regional network than US carriers” rings true. Presently Air Canada’s relationship with Jazz is a purely arms length commercial agreement under which Air Canada purchases seat capacity. The CRJ 100/200 fleet operated by Jazz is obsolete. Jazz has already reduced the number in its fleet from 56 to 25. According to Air Canada, in the negotiations leading up to the TA the parties recognized the competitive advantage of allowing Air Canada to enter into more than one CPA with regional airline provided there were safeguards in place. Counsel for Air Canada maintained that their final offer on scope and the changes made from the TA are not vehicles to outsource flying to the cheapest participant and that Air Canada has no interest in the “virtual airline” scenario described by ACPA’s counsel. Air Canada described their final offer on CPA arrangements in relation to the TA at pages 76 to 79, as follows: … Commercial and competitiveness challenges require modification of the TA to ensure Air Canada’s viability. In pursuit of these goals of viability and competitiveness, it is vital to enable Air Canada to work with several regional carriers, without handcuffs relating to the identity of those carriers or the number of aircraft they operate. The seat and ASM restrictions in Air Canada’s final offer provide the necessary protection while supporting the transformation required for Air Canada to be viable and to compete. 72

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c. Air Canada's Final Offer on the Capacity Purchase Agreement 264. Air Canada adopts the approach of the TA with respect to CPAs with Tier 2 and Tier 3 Carriers, with the changes described below. The primary features of Air Canada's offer with respect to CPA are as follows: i) As in the TA, a CPA would be defined to mean a commercial agreement whereby a Tier 2 or Tier 3 Carrier performs flight operations for and on behalf of Air Canada and where the other airline's entire capacity (or a specified blocked space) on specified aircraft is operated using Air Canada's trade name and designator code, operating on routes and according to schedules and terms of carriage specified by Air Canada on routes that do not support the deployment of Air Canada mainline aircraft. ii) Also as included in the TA, Air Canada would gain the ability to enter into CPAs with any Tier 2 and Tier 3 carriers (Jazz would come within the definition of a Tier 2 carrier). iii) The final offer varies from the TA by affording Air Canada the flexibility to have up to 60 76 seat jet aircraft operating at Tier 2 carriers. The CRJ-100 and CRJ- 200 that have been the mainstay of the Jazz fleet are aged aircraft and cannot be replaced on a commercially viable basis. Of the 58 CRJ-100s and CRJ-200s once in service, only 33 remain. The 76 seat aircraft is the appropriate alternative. Jet aircraft of this size are common at regional airlines in North America. 60 is the approximate number of CRJ-705 aircraft that were anticipated to be available to Tier 2 carriers under the TA in its original form, although pursuant to a formula requiring specific aircraft acquisitions at the mainline. iv) In the TA, the operation of additional CRJ-705s or CRJ-900s (there are presently 16 CRJ-705s at Jazz) was conditional on Air Canada maintaining its current fleet of 60 Embraer 170/175/190/195 aircraft and its current fleet of 86 Airbus 319/320/321 aircraft. In order for a Capacity Purchase partner to add additional CRJ-705s or CRJ-900s, then additional aircraft would have had to have been added at the mainline. v) In the 15 months since the TA was negotiated, triggered, in no small part, by WestJet’s announcement of the creation of its regional carrier, Air Canada’s plans were being revisited. While no final decision has been made, Air Canada is currently reviewing exiting the Embraer aircraft during the term of the next collective agreement. It may be determined that the Embraer is not an aircraft that meets Air Canada’s business needs or may not be the optimal aircraft for the future. The operating costs of the Embraer 175, in particular, make it less competitive, save on routes where Air Canada faces little competition. With WestJet’s continued expansion, for example into the New York market, and with the arrival of WestJet’s regional carrier, the opportunities to operate this aircraft in any

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viable manner are likely to be significantly further reduced. Accordingly, maintaining a fleet guarantee based on the Embraer is not feasible. vi) Air Canada’s final offer provides a job guarantee not found in the TA. This guarantee is designed to protect the pilots whose employment would be at risk if the Embraer aircraft left the fleet (that is, the number of pilots with the least seniority on the day after the award under this process which is equal to the number of pilots holding an Awarded Position (“APOS”) or Qualified Position (“QPOS”) on the Embraer fleet on that day). These pilots will be protected against furlough as a direct result of the removal of any or all of the Embraer fleet from Air Canada for reasons unrelated to airworthiness. vii) Since the negotiation of the TA, Air Canada is that much closer to needing to re- fleet its next largest planes: the Airbus 319/320/321 fleet. Like any equipment used in business, these aircraft have a limited life span. It can be anticipated that replacing them with identical aircraft would make little business sense in an environment where more fuel efficient aircraft are now available. The aircraft which will replace them may be more densely configured, meaning fewer planes can provide the same number of ASMs as today. In anticipation of these changes, maintaining a fleet commitment relating to the Airbus 319/320/321 fleet in the form expressed in the TA is not feasible. A modified form of protection as described in this paragraph vii will be provided. Air Canada’s final offer contemplates that the 86 Airbus 319/320/321 aircraft, referenced in the relevant TA provisions, be maintained unless they are replaced by other equivalent aircraft on a 1:1 basis or replaced by wide-body aircraft on a 2 (319/320/321): 1 (wide-body) ratio. viii) In addition, Air Canada’s agreement in the TA protects mainline flying by providing a ratio under which 100 ASMs must be flown at the mainline for every 29 ASMs flown by Capacity Purchase partners. ASMs for this formula exclude international flying. This represents a significant new level of restriction when compared to the expired Collective Agreement and must be borne in mind when considering the changes to the TA which provide some additional flexibility to the airline, without adversely affecting the flying opportunities for mainline pilots at all, and are contained in Air Canada’s final offer. ix) As in the TA, Air Canada would agree that CPA carriers would not operate international flying or transborder flying, other than flights between Canada and the United States though excluding Hawaii.

ACPA offer on CPA’s: Tier 2 and Tier 3 CPA’s

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At page 64-65 of its brief ACPA deals with the relationship of Air Canada to Jazz and the Robert Mann analysis of that arrangement, which Air Canada does not seem to dispute. At page 65 they describe their final offer as follows: … As was made clear in the 15 May LCC briefing to the ACPA Negotiating Committee by Ben Smith, the Jazz CPA is a millstone around Air Canada’s neck. This has motivated Air Canada to seek permission from ACPA for additional Tier 2 carriers to fly on Air Canada's behalf, in competition with Jazz. In its final offer, ACPA agrees to permit Air Canada to source its Tier 2 flying from any number of air carriers, but only through Capacity Purchase Agreements. To this end we have added a definition of Capacity Purchase Agreement (CPA) to the Collective Agreement. ACPA's final offer will also permit Air Canada to sign CPAs with Tier 3 carriers. In both cases the ASM limits within each Tier are for all such carriers combined (100:12 for all Tier 2, 100:2 for all Tier 3). In the case of Tier 3 carriers this ratio includes Tier 3 ASMs under both CPA and code share arrangements. The ASM ratios continue to be based on the total ASMs flown by Air Canada Pilots. Since any required growth in feed into the Air Canada system is proportionate to mainline growth, including growth in the international market, this metric provides the best balance between required feed for Air Canada and required protection for Air Canada Pilot jobs. ACPA's final offer gives the Company further flexibility by substantially changing the jet ratio for Tier 2 to permit more and larger jets to be operated by Tier 2 carriers than in the past, all within the ASM ratio. More specifically: •

The company’s request for 90 seats on the CRJ 705 has been accommodated.

•

Tier 2 may fly an unrestricted number of SJ aircraft.

•

Additional CRJ 700/705/900 aircraft are permitted in accordance with a ratio when the total jet fleet at Air Canada exceeds 204 aircraft including: •

At least 60 EMJ 170/175/190/195 or equivalent (e.g. Bombardier C series) or larger NJ aircraft; plus

•

At least 144 319/320/321 aircraft or equivalent (e.g. B737s) or larger aircraft (e.g. B757 or any WJ aircraft).

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•

A provision for removing Tier 2 CRJ 700/705/900 aircraft is included in the event that mainline jet numbers shrink.

ACPA described the elements of Air Canada’s final offer which vary from the TA as being a “Trojan Horse”. They argue that the company has downplayed the significance of those changes. In particular ACPA emphasizes: • •

The ability to eliminate the 643 pilot positions derived from the 60 Embraer jets now in the mainline fleet. The ability to eliminate up to 473 pilot positions derived from the 40 narrowbody A319/320/321’s that may be removed from the mainline fleet.

ACPA refer to these proposals as changes that would never have been negotiated in a collective agreement and an example of the company over-reaching. They maintain the proposals are illogical and unrelated to their stated goals. Still they maintain, their proposal for Tier 2 (as detailed at Tab 6, and 7, of the Supporting Documents to ACPA Reply Brief) are the only ones which will allow the Company to achieve their stated optimal fleet. Counsel for Air Canada points out that they have removed the the promise to maintain 60 Embraer planes but have put a job guarantee in its place which protects the 643 Embraer pilots and gives them the opportunity to move up to another plane. Counsel stresses that there are thirty-seven 787’s due to arrive in 2013 and there are twenty 767’s that will stay in service, making a total of 57 wide body planes. Counsel argued that this proposal is not a trick to eliminate pilots but that the company has to avoid making a promise to keep planes in the fleet which are a drag on the company’s competitiveness. Merger / Change of Control In ACPA’s offer the provisions for Merger, Change of Control, and ASM ratios in the event of a merger are combined into a single set of articles. In addition ACPA has proposed a single definition of 30% of securities and flying as the metric for both the merger and change of control provisions. Wet Leasing: Wet Leasing is an arrangement whereby an airline leases an aircraft from another airline with its crew, maintenance and insurance included in the lease. Under the expired collective agreement Air Canada could wet lease from another airline only 76

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where there is a need for service to the public of a temporary nature and where the company is unable to provide service with its own aircraft and crew. When wet leasing was necessary Air Canada was required to notify ACPA prior to the lease and both parties were required to determine the method for compensation for the wet lease. That might take the form of placing wet lease credit in open time or placing wet lease credit in each pilot’s bank. In negotiations leading up to the TA the parties arrived at new language on wet leasing and Air Canada’s final offer incorporates that language. ACPA submitted that their final offer addressed the company’s expressed concern that wet lease credits not be used to limit a pilot’s allowable flight time.

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Conclusions on Scope and LCC I accept that Air Canada needs to establish an LCC to ensure its competitive future. Both parties presented an offer on an LCC. Air Canada’s offer matches the TA in all material respects. ACPA’s offer is new, never discussed by the parties at the bargaining table and ACPA provided no persuasive explanation for why the TA was not acceptable on this issue. At paragraph 76 of Air Canada’s Reply Brief, Counsel makes the following point: ACPA’s proposal suffers the further weakness of not having benefited from the experience, scrutiny and knowledge of subject matter experts from both parties reviewing the proposed contractual language. This shortcoming is reflected in problems, some of which are highlighted above, and as well as others, such as the lack of a definition of what “flying” will be, covered by the Joint Venture rules and the incongruity of the definition of “flying” and the operative scope provisions (while “flying” is defined, that defined term is not used, except in the one place it arguably matters most to Air Canada pilots – the clause that says flying by or on behalf of Air Canada is to be done by its pilots). By flaws such as this, ACPA would have the parties forego the benefits the subject matter experts brought to the TA and create new, likely sometimes unpredictable, and in many cases predictable points of friction between the parties. While no contract is ever perfectly drafted, the likelihood that ACP A ’ s proposed language will lead to unpredictable application of the agreement, disagreement between the parties leading to litigation, and unintended consequences is significantly greater when compared to the use of the TA language jointly drafted and agreed to by subject matter experts.

This observation is particularly pertinent to these scope and LCC provisions. These are very complex issues that have interrelationships with many aspects of the collective agreement. Applying the test of replication and the arbitral jurisprudence cited above which deals with the impact of a tentative agreement: I conclude that Air Canada’s offer on LCC and Joint Venture, being the language from the TA, is the proposal that most closely represents what the parties would achieve in free collective bargaining.

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Applying the statutory test: I conclude that Air Canada’s offer on LCC and Joint Venture best satisfies the need for terms and conditions of employment that are consistent with those in other airlines and that will provide the necessary degree of flexibility to ensure the short and long-term economic viability and competitiveness of the employer; and the sustainability of the employer’s pension plan, taking into account any short-term funding pressures on the employer. I accept the conclusion by management that to meet the competitive challenge of WestJet, Air Canada needs a more developed regional network to feed their mainline operations. I accept that in the time that passed between the TA and this arbitration, circumstances have changed which necessitated Air Canada’s departure from the TA. In particular, WestJets’ announcement of a LCC is a game changing event. I am not able to conclude that Air Canada is “over-reaching”, as Counsel for ACPA suggested. Applying the test of replication and the arbitral jurisprudence cited above which deals with the impact of a tentative agreement: I conclude that Air Canada’s offer on scope is the proposal that most closely represents what the parties would achieve in free collective bargaining. Applying the statutory test: I conclude that Air Canada’s offer on scope best satisfies the need for terms and conditions of employment that are consistent with those in other airlines and that will provide the necessary degree of flexibility to ensure the short and long-term economic viability and competitiveness of the employer; and the sustainability of the employer’s pension plan, taking into account any short-term funding pressures on the employer. Similarly I conclude that Air Canada’s offer on CPA’s best satisfies the need for terms and conditions of employment that are consistent with those in other airlines and that will provide the necessary degree of flexibility to ensure the short and long-term economic viability and competitiveness of the employer; and the sustainability of the employer’s pension plan, taking into account any short-term funding pressures on the employer.

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WAGES AND TERM Air Canada’s wage offer and term are as follows: April 1, 2011 August 1, 2012 April 1, 2013 April 1, 2014 April 1, 2015

2% 5% 3% 2% 2%

to expire on March 31, 2016

At paragraphs 320 and 321 of their brief Air Canada explains their proposal as follows: The TA contemplated a four year term, which would have provided Air Canada with four years of labour stability with ACPA. In the time that has passed since March 2011, it has become clearer that the challenges facing Air Canada have intensified. For that reason, and consistent with the Act which requires that the sustainability of the pension plan be considered, a foundation of stability is important to support the beginning of Air Canada’s continued transformation. Stability will assist Air Canada, for example, in improving its credit rating, making the imminent financings which are needed more feasible, and will help restore Air Canada’s reputation in light of the labour-related disruptions it has suffered this year. That stability is crucial to Air Canada’s viability and hence, its ability to continue to support the pension plans’ sustainably as required by the Act. For these reasons, Air Canada’s final offer adds an additional year to the life of the TA. The final offer is thus a five year agreement, with the first year having already elapsed from April 1, 2011 to March 31, 2012. In essence, it preserves four years of labour stability with ACPA from the time of conclusion of the Collective Agreement. In the TA, the parties contemplated wage increases of 5%, 3%, 2% and 2% for a collective agreement of a four-year term. The TA included a higher percentage increase in year 1 and 2 because it incorporated provisions to improve productivity, through for example, more flexibility in scheduling, or the use of pay groupings to reduce training time and expense. Those productivity improvements were to be rolled into the collective agreement in the form of the additional 3% wage increase in year 1, and the additional 1% increase in year 2. With the demise of the TA after the vote, those productivity improvements have obviously not been obtained and cannot be obtained in its first year. However, Air Canada recognises that the productivity improvements will materialize should its final offer be selected, and those productivity increases will come into effect as of August, 2012. To be fair and to respect the rationale of the TA, Air Canada is proposing a 2% increase in Year 1, being retroactively applied to the period from April 1, 2011 to July 31, 2012 (when no productivity gains were realized), a 5% increase effective August 1, 2012, a 3% increase effective April 1, 2013, and a 2% increase effective on each of April 1, 2014 and April 1, 2015. While this represents a change from the TA, Air Canada submits that it is, in fact, a necessary change to reflect faithfully in 2012 what the parties intended when they negotiated the TA in 2011. 80

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ACPA’s offer April 1, 2011 April 1, 2012 August 31, 2012 April 1, 2013 April 1, 2014

2% 2% 3% 2% 3%

to expire on March 31, 2015

Both parties have based their wage offer on what was in the failed TA. Arbitrator Picher, in the IAMAW arbitration added a year to the term that had been agreed in the TA between Air Canada and IAMAW. What the TA did was provide 4 years of labour stability from the time it came into effect. In light of the time that elapsed from the rejection of the TA to the resumption of negotiations and this arbitration I find that it is reasonable and desirable to add a year to the term of the agreement so that it continues to guarantee that 4 years of stability which these parties clearly need. ACPA’s proposed term would see the collective agreement expiring 2 years and 8 months from the date of this Award. Therefor I prefer the Air Canada offer on this point. Applying the test of replication and the arbitral jurisprudence cited above which deals with the impact of a tentative agreement: I conclude that Air Canada’s offer on term is the proposal that most closely represents what the parties would achieve in free collective bargaining.

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FINAL CONCLUSIONS AND AWARD On the basis of my conclusions on the above issues: pensions, scope, LCC, and term, and for all of the foregoing reasons, I find and declare that the offer of the Company is hereby selected, and shall constitute the terms of the parties’ collective agreement. That offer is attached and herby incorporated into this Award as Appendix “A”. I retain jurisdiction in the event of any dispute between the parties concerning the interpretation or implementation of this final offer selection, or its ultimate drafting into the terms of the parties’ collective agreement.

Dated this 30th day of July 2012

___________________________________ Douglas C. Stanley, Q.C.

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