In the recent court decision in AirAsia X Berhad v BOC Aviation Limited & 14 Ors (Originating Summons No.: WA-24NCC-467-10/2020), the Malaysian High Court held that a scheme of arrangement under section 366 of the Malaysian Companies Act 2016 is an "insolvency-related event" for the purposes of the Convention and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment ("the Protocol").
The Convention on International Interests in Mobile Equipment ("the Convention"), commonly referred to as the Cape Town Convention, is an international treaty intended to standardise transactions involving movable property. Malaysia acceded to the Convention and the Protocol on 2 November 2005. The Convention and the Protocol entered into force in Malaysia on 1 March 2006. The International Interests in Mobile Equipment (Aircraft) Act 2006 which was enacted to implement the Convention and the Protocol came into force on 19 October 2006.
The Convention creates international standards for registration of contracts of sale, security interests and leases and provides legal remedies for default in financing agreements, including repossession and the effect of bankruptcy/insolvency laws. The primary aim of the Convention is to resolve the problem of obtaining certain and opposable rights to high-value aviation assets, namely airframes, aircraft engines and helicopters which, by their nature, have no fixed location. This problem arises primarily from the fact that legal systems have different approaches to securities, title retention agreements and lease agreements, which create uncertainty for lending institutions regarding the efficacy of their rights. This hampers the provision of financing for such aviation assets and increases the borrowing cost.
Key points:
- A scheme of arrangement falls within the definition of an 'insolvency-related event' under Article XI(10) of the Protocol (as defined under Article I(1)(m) of the Protocol).
- The Convention applies to both rights in rem and rights in personam.
- 'Security deposits' and 'maintenance reserves' paid by aircraft lessees to the lessors do not constitute 'security'. As such, aircraft lessors holding 'security deposits' and 'maintenance reserves' are not to be regarded as secured creditors.
Brief Facts:
Pursuant to an application under section 366 of the Companies Act 2016, AirAsia X Berhad ("AAX") applied for leave from the High Court to convene a creditors' meeting for the purpose of considering and approving a proposed scheme of arrangement ("Proposed Scheme") ("Leave Application"). Under the Proposed Scheme, AAX's current liabilities of RM64.15 billion will be written down to RM200 million to be shared pari passu with its scheme creditors, hence resulting in a 'cram-down' in the form of 99.7% hair-cut.
15 creditors filed and obtained leave from the High Court to intervene – among others, Malaysia Airports (Sepang) Sdn Bhd (the operator of the Kuala Lumpur International Airport), aircraft lessors and Airbus S.A.S..
The classification of Scheme Creditors changed three times since the filing of the Leave Application. The latest classes of Scheme Creditors at the hearing of AAX's application were Secured Class A creditors (creditors of AAX having security over the assets of AAX) and Unsecured Class B creditors (creditors who have unsecured claims against AAX).
The aircraft lessors were treated by AAX as "creditors of AAX having security over the assets of AAX" and placed in Class A together with the secured lenders. It was argued on behalf of AAX that the aircraft lessors were considered as secured creditors by virtue of the 'security deposits' and 'maintenance reserves' held by the aircraft lessors.
Decision of the High Court
A scheme of arrangement is an "insolvency-related event" for the purpose of Article XI(10) of the Protocol
The Learned Judge agreed with the aircraft lessors that a scheme of arrangement under section 366 of the Companies Act 2016 would fall within the definition of an 'insolvency-related event'1 for the purpose of Article XI(10)2 of the Protocol.
First, the Learned Judge noted that there had been two recent cases (the Irish High Court case of Re Nordic Aviation Capital Designated Activity Company3 and the English High Court case of Virgin Atlantic Airways Limited4) where the courts had come close to determining the question whether a scheme of arrangement or a restructuring plan is an 'insolvency-related event' for the purposes of the Protocol. However, in the end, the question was not necessary for the court's decision as the creditors had approved the scheme of arrangement and the restructuring plan.
The recent case of MAB Leasing Ltd is also not conclusive and not of guidance as the said case did not decide on the issue of the Convention as no objection was raised by any of the creditors.
Second, based on the principles relating to the interpretation of treaties, the issue of whether a scheme of arrangement is an insolvency proceeding is to be considered based on principles underlying the Convention and not on national law5. While the Official Commentary of the Cape Town Convention does not address the issue as to whether a scheme of arrangement is an "insolvency proceedings" under the Convention, the Annotation to the Official Commentary on the Cape Town Convention on 16 June 2020, endorsed by Professor Sir Roy Goode, the author of the definitive guide to the Cape Town Convention, confirms that schemes of arrangement fall within the definition of "insolvency proceedings" under the Convention where they are:
- formulated in an insolvency context, or by reason of actual or anticipated financial difficulties of the debtor company; and
- collective in that they are concluded on behalf of creditors generally or of classes of creditor that collectively represent a substantial part of the indebtedness.
The Annotation also confirms that a reorganisation arrangement, in which a court acts to facilitate a statutory process and where the court's approval is required for its implementation, constitutes insolvency proceedings where the assets and affairs of the debtor are subject to control or supervision by a court for the purposes of reorganisation.
Third, the Learned Judge opined that Professor Payne's expert opinion on the Convention produced and relied on by AAX puts too restrictive a meaning to the words "in which the assets and affairs of the debtor are subject to control or supervision by a court" as provided for under Article 1(I) of the Convention. According to Professor Payne, three elements are required in order for a scheme of arrangement to be an 'insolvency proceedings' for the purpose of Article 1(l) of the Convention, namely (a) the proceeding must be a collective proceeding; (b) the debtor's assets and affairs must be subject to control or supervision by a court; and (c) the purpose must be the reorganisation of the debtor, or immediate liquidation. Professor Payne's view is that in a scheme of arrangement, the debtor's assets and affairs are not subject to control or supervision by the court because outside the terms of the scheme of arrangement, the directors can continue to manage the company without court's approval.
The Learned Judge was of the view that Article 1(l) does not state that the entire assets and affairs of the debtor must be covered under the scheme. Neither does it matter that outside the scheme, possession and management of the company remain with the management. All that is required is that the proceedings being a collective proceedings is such that it involves assets and affairs of the debtor being subject to the control or supervision of the court. The Learned Judge was also of the view that the fact that the Proposed Scheme must be sanctioned by the Court meets the requirement of "control or supervision by a court".
The Gibbs Rule6
The Learned Judge also considered the Gibbs Rule argued by some of the lessors. The Gibbs Rule is an English common law principle which provides that a debt governed by English law cannot be discharged or compromised by foreign insolvency proceedings.
The Learned Judge held that the Gibbs Rule does not operate to restrict the court from entertaining and if thought fit, approving a scheme of arrangement which involves the discharge or modification of any contractual rights between the scheme company and its creditors even where the contracts are governed by English laws or other foreign laws. This was the approach adopted by the Singapore High Court7 and the Australia Supreme Court8, where the Rule has been rejected.
The Cape Town Convention applies to both rights in rem and rights in personam
The Learned Judge disagreed with AAX's submission that the Convention was never intended to regulate rights in personam that a creditor might have against a debtor, for example, lease rentals and termination compensation.
Article XI(10) of the Protocol was found to be unambiguous and thus, the words "obligations under the agreement" in Article XI(10) of the Protocol must be given its literal, ordinary and natural meaning. In this regard, there can be no doubt that the words must include the obligation of the debtor to pay the rentals under the agreement. To restrict the meaning of the words "obligations‟ to only obligations relating to in rem matters is to read into the Article XI(10) of the Protocol, words which are simply not there. There is nothing to suggest that the Convention is to be viewed narrowly to only extend to rights in rem.
The word "obligations" also appears in Article XI(7)9 of the Protocol where there is little doubt that the word must include the in personam obligation to pay rentals under the agreement. The Learned Judge was of the view that it would be "incongruous" that the same word in Article XI(10) of the Protocol bears a different and narrow meaning as suggested by AAX.
The prohibition under Article XI (10) to permit the debtor to modify the obligations under the agreement except with the consent of the creditor was found to be consistent with the purposes of the Convention – to promote and reduce the costs of asset-based financing for airline equipment.
AAX does not require the consent of the aircraft lessors in respect of the 'cram-down' provision under the Proposed Scheme
While the Learned Judge agreed with the lessors that the Convention applies to both in rem and in personam rights and that a scheme of arrangement under section 366 of the Companies Act 2016 falls under the definition of an "insolvency-related event" under the Protocol, the Learned Judge was nevertheless of the view that in the present case, AAX does not require the consent of the aircraft lessors in respect of the 'cram-down' provision under the Proposed Scheme.
Reading Article XI(7), (10) and (11) together, the Learned Judge was of the view that Alternative A of the Protocol only applies in events where the debtor chooses not to terminate the lease agreement when an insolvency-related event occurs or when the creditor does not exercise its right to repossess the aircraft. In such situations, the obligations under the lease agreement, including the obligation to pay the rentals cannot be modified by the debtor unless with the consent of the creditor.
Aircraft lessors are not secured creditors
The aircraft lessors of 27 aircraft leased to AAX's leasing subsidiaries were originally considered by AAX as 'unsecured creditors'. The status was subsequently changed to 'secured creditors' and the ground for holding this position was disclosed to be based on the 'security deposits' and 'maintenance reserves' that are paid over by AAX to the Lessors pursuant to their respective lease agreements.
The Learned Judge held that AAX cannot treat the Lessors who had paid the 'security deposits' and 'maintenance reserves' as secured creditors as they do not come within the definition of 'secured creditors' under section 2 of the Insolvency Act 1967, which defines a 'secured creditor' as a person holding a mortgage, charge or lien on the property of the debtor or any part thereof as a security for a debt due to him from the debtor but shall not include a plaintiff in any action who has attached the property of the debtor before judgment.
Another factor which the Learned Judge opined militated against AAX's position is that AAX has no proprietary rights over these 'security deposits' and 'maintenance reserves' once they are paid to the lessors. It was noted that the lessors had in most cases commingled the cash payments with their own funds as is provided in a typical clause relating to 'security deposits' and 'maintenance reserves' in lease agreements. There is no issue of commingling of any security interests as the lessors never had any security interest in the 'security deposits' and 'maintenance reserves' to begin with. The Learned Judge agreed with the lessors that the right of disposal of the 'security deposits' and 'maintenance reserves' is no longer with AAX. All that AAX has is a contractual right upon the termination of the lease agreements is to be paid an equivalent sums or balance sum in the event that AAX had met all its obligations thereunder. The fact that the lease agreements provide that the 'security deposits' are "security for the performance of the agreement" does not assist AAX's position any further.
Conclusion
This is indeed an interesting case which will no doubt be instructive in many jurisdictions as the number of airline restructurings continue to rise due to the impact of COVID-19 on the aviation industry.
Footnotes
1. "Insolvency-related event" is defined in Article I(2)(m) of the Protocol to mean (a) the commencement of insolvency proceedings; or (b) the declared intention to suspend, or actual suspension of, payments by the debtor where the creditor's right to institute insolvency proceedings against the debtor or to exercise remedies under the Cape Town Convention is prevented or suspended by law or State action.
2. No obligations of the debtor under the agreement may be modified without the consent of the creditor.
3. [2020] IEHC 445; In this case, while arguments were put forward by the company that a scheme of arrangement consists of restructuring of only certain parts of a debtor's assets does not constitute 'insolvency-related event' for the purposes of the Cape Town Convention, the Irish High Court took the view that it was unnecessary to consider or even make a ruling on the potential issues arising under the Cape Town Convention as the scheme in that case was ultimately approved by both classes of creditors unanimously.
4. [2020] EWHC 2191 (Ch); In this case, the question of whether a cram down of non-consenting creditors pursuant to a restructuring plan would be contrary to the provisions of the Convention was again not decided as Virgin had secured the consent of all Convention creditors prior to the hearing.
5. VB Leaseco v Wells Fargo 384 ALR 379, FCA.
6. Anthony Gibbs and Sons v La Société Industrielle et Commerciale des Métaux (1890) 25 QBD 399 (CA) ; recently reinforced by the English Court of Appeal decision of Re OJSC International Bank of Azerbaijan [2018] EWCA Civ 2802 (CA).
7. Pacific Andes Resources Development Ltd [2016] SGHC 210.
8. Bulong Nickel Pty Ltd [2002] WASC 226.
9. "The insolvency administrator or the debtor, as applicable, may retain possession of the aircraft object where, by the time specified in paragraph 2, it has cured all defaults other than a default constituted by the opening of insolvency proceedings and has agreed to perform all future obligations under the agreement. A second waiting period shall not apply in respect of a default in the performance of such future obligations‟
Originally published 08 March 2021
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