High Court of Australia decision in the Virgin Australia administration: A world first under Alternative A of the Cape Town Convention and Aircraft Protocol

In a world-first decision of an ultimate appellate Court on the Aircraft Protocol to the Cape Town Convention on International Equipment, the High Court of Australia recently dismissed the appeal of an aircraft engine lessor (Willis Lease Finance Corporation), which was seeking certain lease-based terms for the redelivery of its engines against the administrators of Virgin Australia: see Wells Fargo Trust Company, National Association (as owner trustee) v. VB Leaseco Pty Ltd (administrators appointed) [2022] HCA 8.

This decision will have important ramifications for financing of expensive aviation assets. The Convention on International Interests in Mobile Equipment (Cape Town Convention) and the Aircraft Protocol to the Cape Town Convention (Aircraft Protocol) require uniformity and predictability in their application across the 87 countries that have adopted them.¹ The High Court's judgment will be influential in other jurisdictions applying the Convention and Protocol and currently provides the most authoritative statement as to the effect of Alternative A of Art XI of the Protocol relating to "Remedies in Insolvency".

The issue

At stake was the scope of an insolvency administrator's obligation under Alternative A in Article XI of the Aircraft Protocol to "give possession" of aircraft objects (airframes, engines, records and related equipment) after the expiry of the "waiting period" (moratorium) in an insolvency administration, in this case, the administration of the Virgin Australia companies.

The Convention

The Cape Town Convention and the Aircraft Protocol became law in Australia on 1 September 2015 under the International Interests in Mobile Equipment (Cape Town Convention) Act 2013 (Cth). With respect to insolvency matters, Australia elected to adopt the strong form Alternative A in Article XI of the Protocol, which has similarities to Section 1110 of the US Bankruptcy Code.

The Cape Town Convention and the Aircraft Protocol prevail over any law of the Commonwealth and any law of a State or Territory, to the extent of any inconsistency with them.

At the time of its enactment, the Australian Government identified that the "Cape Town Convention is an international legal system that protects secured lenders of aircraft objects such as aircraft, airframes, engines and helicopters and reduces the risk and cost associated with financing these objects."²

The litigation

In April 2020, following the onset of the COVID pandemic, the Virgin Australia Group of companies, Australia's second major airline, appointed administrators.

In June 2020, at the end of the 60 day "waiting period" specified under Article XI(2) of the Aircraft Protocol (Alternative A as adopted by Australia), Willis sought from the administrators of the Virgin Australia companies the return of its four CFM International (model CFM-56-7B24) aircraft engines, suitable for use in Boeing 737 aircraft in accordance with certain lease-based redelivery terms.

Willis was successful at first instance before the Federal Court of Australia and redelivery was ordered in a manner consistent with the express contractual regime for redelivery. However, that decision was overturned by the Full Federal Court of Australia on an appeal by the administrators.

Willis obtained special leave to appeal to the High Court of Australia in April 2021 and the hearing of the High Court appeal took place in November 2021. Judgment was delivered by the High Court on 16 March 2022.

Willis argued that Article XI(2) of the Aircraft Protocol was the source of a remedy that Willis could call upon to seek to be "given possession". Article XI is entitled "Remedies on Insolvency"; XI(2) is the first substantive sub-article and the reference point for sub-articles (3) through to (7) of Article XI. Of the two alternatives available for adoption by signatories, Australia opted for the so-called "strong form" Alternative A (see [2020] FCA 1269 at [117]), which uses the language of "give possession" and is to be contrasted with the language in Alternative B which uses the language of giving the creditor the "opportunity to take possession" in accordance with local domestic law.

Further, Willis argued that when determining what the obligation to "give possession" means, Article XI(13) supplies the answer by requiring a remedy to be exercised in a commercially reasonable manner and deeming that the exercise of remedy in accordance with the parties' agreement will be taken to be reasonable.

Specifically, Art XI(13) applies Article IX(3) of the Aircraft Protocol to the exercise of remedies under Article XI. Article IX states: "Article IX of this Protocol shall apply to the exercise of any remedies under this Article". Article IX(3) in turn requires all remedies under the Cape Town Convention to be exercised in a commercially reasonable manner, which is deemed to be exercising remedies in accordance with the underlying (lease) agreement unless "manifestly unreasonable."

The administrators argued that the obligation to "give possession" required no more than providing the opportunity for the creditor to take possession of its aircraft objects. That was said to be consistent with the use of those words in Art XI(5), which it was argued had to be read consistently with Art XI(2).

The administrators contended in the High Court that evincing an intention to surrender possession would be sufficient to provide the creditor with the relevant opportunity to take possession. On the facts of the case, the administrators had claimed they had done so by taking steps under Australian law to disclaim the engines by issuing notices under section 443B of the Corporations Act 2001 (Cth).

The High Court's reasoning and conclusions

The High Court held that Article XI(2) (i.e Alternative A) is not a remedy, saying that Article XI(2) "does not in form or in substance give an additional remedy to the creditor" (at [44]).

The High Court held that instead, "Art XI of the Protocol is framed to apply in circumstances where the creditor has a right to take possession of the aircraft object under Art 8 or Art 10 of the Convention" (at [45]).

The High Court concluded that "it is for the debtor or insolvency administrator to take whatever steps may be necessary to provide an opportunity for the exercise of the right to take possession which the creditor has under Art 8 or Art 10 of the Convention."

Finally, the High Court held that that Willis' claim for redelivery pursuant to the terms of the leases remained available as an "additional remedy" under Article XII of the Convention. Article XII operates by picking up "remedies agreed upon by the parties". However, on the High Court's interpretation the right to seek relief pursuant to Article XII remained subject to the stay under local insolvency law (at [57]).

The High Court held that its interpretation of the Cape Town Convention is consistent with the Cape Town Convention's purpose of facilitating capital market financing of aircraft equipment.

The High Court agreed with Willis insofar as it held that Article XI(13) requires a remedy to be exercised in conformity with Article IX(3) in a commercially reasonable manner (that is, in accordance with the lease unless "manifestly unreasonable") (at [45]). But because Art XI(2) (i.e Alternative A) was not characterised as a remedy, the "commercially reasonable" constraint had "no application to the performance of the obligation that Art XI(2) imposes on the debtor or insolvency administrator".

The High Court held that the administrators' "invitation to Willis…to take control of the aircraft engines where they were situated in Australia fulfilled the obligation to 'give possession'" (at [55]).

Practical ramifications

The essential element in the High Court's reasoning was that the obligation to "give possession" in Alternative A is not a remedy.

With that point of departure, it followed that Article XI(2) is to be interpreted without reference to the commercial reasonableness test required by Articles XI(13) and IX(3).

Instead, the Court interpreted Alternative A within the context of the Aircraft Protocol as a provision directed towards limiting the moratorium that might otherwise prevent creditors exercising remedies to take possession of aircraft objects under Article VIII or Article XI of the Cape Town Convention.

Specifically, according to the High Court, Alternative A has the effect, once the 60-day waiting period expires, of overriding the Cape Town Convention's preservation of local insolvency law moratorium on the enforcement of rights to property, enabling the creditor to exercise the right to take possession of its aircraft objects.

In Australia, this in effect means that Article XI(2) overrides, in the context of an administration, the stay on enforcement under section 440B of the Corporations Act, once the 60-day waiting period is over, enabling the lessor or secured creditor to take possession of its aircraft objects.

At that point, the insolvency administrator is to "take whatever steps may be necessary to provide an opportunity for the exercise of the right to take possession."

What remains unclear is the scope of the obligation to take "whatever steps may be necessary".

Unlike the decision of the primary judge, which gave certainty, the "whatever steps may be necessary to give the opportunity to take possession" test is somewhat elusive as to the content of the obligation and tends to beget more questions than it answers. For example,

• Is it sufficient to offer physical collection of the important records (expressly included within the definition of Aircraft Objects in the Aircraft Protocol) from a filing cabinet in disparate foreign airport hangars or must the insolvency administrator do more? What about those records that require certification or sign-off from the airline?
• What happens in the case of engines leased or owned by one lessor, for example on an airframe owned by the airline or another lessor but stuck in a location where the engine cannot be removed? Must the airline assist with a ferry flight to an airport with suitable maintenance facilities?
• What responsibility does the administrator have in removing liens asserted, for example, by airports? Does "whatever steps may be necessary" encompass an obligation to remove or simply facilitating the lessor's efforts in doing so?

The Full Federal Court sought to ameliorate the uncertainty arising from that test by remitting to the primary judge "the factual issues as to what may be required in order to give possession in light of our reasons" (at [110]). However, it was sufficiently clear that the Full Federal Court contemplated the administrators taking some positive facilitative steps to enable the creditor to overcome any barriers to taking possession beyond a mere disclaimer saying: (at [106])

To do so may require the taking of affirmative steps by the insolvency administrator beyond simply disclaiming the property. Merely submitting to the claim by the creditor may not be enough.

While the High Court adopted the "whatever steps may be necessary" test in its reasoning, when it came to applying its reasoning, the High Court held that by the administrators simply disclaiming the aircraft objects on an "as is, where is" basis, they had fulfilled the obligation to "give possession" (at [55]). Further, as noted above, the High Court in making orders, dispensed with the remittal proceeding.

It is unclear whether the High Court intended that the content of the "whatever steps may be necessary" test to be different to that contemplated by the Full Court of the Federal Court. The High Court's application of its reasoning to the facts suggests that simply disclaiming the aircraft objects is enough, but the High Court did not explain whether this is so as a matter of principle. Indeed, where the High Court held that possession means "physical control to the exclusion of others"(at [45]) it is difficult to understand how an obligation to give physical control of aircraft objects can be satisfied by simply inviting the creditor to take control of them on an "as is, where is" basis.

Therefore, it seems likely that important factual and practical issues will need to be resolved in future cases. It remains unclear, however, which, if any, steps would be required in future insolvencies under the "whatever steps may be necessary" test. In the way that the High Court applied the test to the facts, it may be that nothing other than a notice disclaiming possession of aircraft objects would be required.

In the absence of clarity, insolvency administrators would be well advised to take on a coordinative role in redelivery of aircraft objects, with a common sense approach to who may bear which particular costs in the circumstances. The most obvious example is for the insolvency administrator to take positive steps to provide all records (probably in digital form). Practical decisions will need to be taken by insolvency administrators whether they need to deploy the airline's technical staff and contractors to assist in that process.

Absent such a common sense approach being adopted by parties, there remains a risk in the future that the coordinative responsibility, that rests with the airline immediately before the time of an insolvency administrator's appointment, with all its records, resources, and safety responsibility, could be suddenly thrust onto a scrum of creditors with divergent interests after the expiry of the "waiting period" following an insolvency appointment.

Lessors/financiers should be ready, both when drafting agreements and in practical terms, to robustly assert and exercise Article VIII and X rights to take possession as a fall back absent sufficient cooperation and common sense from an insolvency administrator. Article XII might also assist insofar as it preserves redelivery rights subject to local law stays, which may need to be invoked in particular situations.

The value of Alternative A to aircraft financing and airlines

The Aircraft Protocol is "integral to lowering the cost and increasing the availability of financing for aircraft equipment."³ As noted above, a similar observation was made by the Australian Government when legislating the Cape Town Convention and Aircraft Protocol.

Where the obligation to "give possession" is interpreted as merely releasing the creditor from the shackles of a stay under local insolvency law, and otherwise interprets the insolvency administrator's role according to a test with uncertainty as to its scope, "whatever steps may be necessary to provide an opportunity for the exercise of the right to take possession," it seems unlikely that Alternative A will offer a significant contribution to lowering the cost and increasing the availability of financing for aircraft equipment. This is particularly so where the impediments under local insolvency law are limited, as they are in Australia.

As such, it seems that there is very little work for Alternative A to do in Australia, when viewed as simply removing impediments to the creditor taking unilateral action for possession of the aircraft objects.

The High Court's decision will, therefore, be welcome news for insolvency administrators or debtors seeking to effect a restructure of an airline. For them, the operation of Alternative A will be in line with more conventional notions of the rights of any equipment lessor in an insolvency. In that sense, the decision will reflect the observation of the Full Court of the Federal Court, when it came to a similar conclusion to the High Court, in saying that the Cape Town Convention and Aircraft Protocol does not result in a "reworking of generally accepted principles of insolvency law" (at [105]). In particular, the insolvency administrator, for the most part, will not bear the costs of the lessor recovering its property.

It may, however, result in Article XI of the Aircraft Protocol—particularly Alternative A—falling short of its potential to be regarded as "the single most significant provision economically"⁴ and specifically, may fall short of achieving its commercial goal of delivering cheaper finance to airlines. If that were the case, the High Court's decision may turn out not to be such welcome news to airlines seeking to lease or finance aircraft equipment.

This is an abridged version of an article published in International Corporate Rescue, volume 19, issue 4, with permission of Chase Cambria Company (Publishing) Ltd.

The author is a partner of Norton Rose Fulbright Australia and acted for Willis Lease Finance Corporation in the case.