The federal government will give Air Canada some relief from its pension woes, allowing the airline more time to fill its $4.2 billion funding shortfall but putting a cap on executive compensation and stock dividends until it does.

Late Tuesday, Ottawa granted Canada's largest airline the lifeline it had sought in its pension problem, but made demands in return. Air Canada now has seven years to come up with at least $1.4 billion to fund the plan, and must put in at least $150 million in any given year until 2020. That's on top of regularly scheduled annual payments.

"By taking this action, we are ensuring that Air Canada remains viable, that thousands of jobs are protected and the service is there when Canadians need it," Finance Minister Jim Flaherty said in a statement.

"Air Canada is the country's largest airline and contributes significantly to the Canadian economy."

Without the move, Air Canada would have been obligated to put in at least $800 million to its underfunded pension next year, a move that surely would have erased the airline's nascent profitability. The company posted a profit of $53 million last year, its first profitable one since 2007.

The airline had been looking for an annual cap of $150 million per year on its annual solvency deficit payments for the next decade, starting in 2014. Ottawa's offer makes that figure the floor, not the ceiling.

Although it throws the airline a lifeline, the strings attached are significant. Executive compensation increases will be capped at the rate of inflation. Special bonuses will be prohibited, and other incentive plans will be severely curtailed.

Air Canada's CEO Calin Rovinescu's total compensation last year was in excess of $4 million, from a base salary of around $1.4 million.

The airline will also be prevented from paying dividends and buying back stock as well as making any pension plan benefit improvements without regulatory approval.

That apparent blow for shareholders didn't seem to register on the stock market, with Air Canada shares gaining five per cent to $2.70 on the TSX on Wednesday.

Critics react

Much like many large companies, Air Canada has been struggling with a pension liability for years, exacerbated by low interest rates that make it harder to make gains to keep up with previous commitments.

Flaherty noted that Air Canada's unions and retirees have been supportive of the company's request for help with its pension deficit.

"This regulatory change is not costing Canadian taxpayers a single dollar, but it is providing Air Canada time to pay off the sizeable pension deficit," the minister said.

Air Canada's largest rival, Calgary-based WestJet, said in a statement Wednesday that it is "disappointed" with Ottawa's decision to give the former Crown corporation special treatment that other companies with struggling pension plans aren't offered.

"We are supportive of a strong and competitive aviation industry in Canada," president Gregg Saretsky said. "To that end, we trust this marks the end of special treatment for Air Canada, as such treatment at the expense of other industry players has become too common.

"We look forward to working with the government to create a level playing field and an environment that supports a healthy industry that benefits the travelling public."

In 2009, Air Canada signed a deal with the federal government that granted the airline a moratorium on special pension contributions to reduce its deficit for that year and 2010. Under that deal, which expires next year, Air Canada was required to make $150 million in special payments in 2011, $175 million in 2012 and $225 million in 2013.

The Air Transport Association of Canada had argued against Ottawa granting Air Canada pension relief, saying it would create an uneven playing field.

The group, which represents small regional carriers and training centres, argued that Ottawa should provide broad pension assistance to all Canadian companies, instead of giving a competitive advantage to the former Crown corporation.

"We don't really have anything to add, but that we respect the government's decision," said John McKenna, president and CEO of ATAC.

McKenna said the group has decided to be more "cautious" after it was falsely accused of being overly critical of the airline.

Last week, it posted a public apology on the front page of its website for the open letter it had written to the federal government to voice its concerns.

Air Canada has said that cost savings from its recent labour agreements, the startup of low-cost carrier Rouge and pension relief will help to lead the airline to sustainable profits.

With files from The Canadian Press