High Court of Australia decision in the Virgin Australia administration

The issue

At stake was the scope of an insolvency administrator’s obligation under Article XI(2) 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). 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

Central to the case are three provisions of the Cape Town Convention and Aircraft Protocol:

1. Articles 8 and 10 of the Cape Town Convention which provides (in summary) that upon the occurrence of a default (as agreed by the parties) a secured creditor under a financing agreement or lessor under a leasing agreement can "terminate the agreement and take possession or control of any object to which the agreement relates”.
2. A secured creditor’s or lessor’s rights arising from Articles 8 and 10 are however subject to Article 30.3(b) of the Aircraft Protocol. That Article preserves "rules of insolvency procedure designed to limit the enforcement of security or other property rights in the interests of the general body of creditors, for example, by imposing an automatic stay on the enforcement of security and other in rem rights in order to facilitate a reorganisation".³
3. However, for secured creditors or lessees in Contracting States which have selected Alternative A of Article XI to the Aircraft Protocol (which include Australia and the majority of Contracting States), Article 30.3 (b) is displaced by the provisions of that Article.⁴

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, 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.

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,⁵ 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) is not a remedy, saying that Article XI(2) “does not in form or in substance give an additional remedy to the creditor”.⁶

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.” ⁷

The High Court concluded (emphasis added):⁸

For the debtor or insolvency administrator to “give possession” to the creditor within the meaning of Art XI(2) of the Protocol is for the creditor to be “given the opportunity to take possession” within the meaning of Art XI(5) of the Protocol: 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. If the creditor then chooses to take up the opportunity to exercise that right to take possession, the rules of insolvency procedure preserved by Art 30(3)(b) of the Convention will not stand in the way.

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 12 of the Convention. Article 12 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 12 remained subject to the stay under local insolvency law.⁹

The High Court held that its interpretation of the Cape Town Convention is consistent with and will facilitate its purpose:¹⁰

To so construe the obligation, also attributes to Art XI(2) of the Protocol an operation consistent with the “underlying purpose” of Art XI as identified in the Official Commentary, being “to reflect the realities of modern structured finance, in particular to facilitate capital market financing, by ensuring as far as possible that, within a specified and binding time-limit, the creditor either (a) secures recovery of the object or (b) obtains from the debtor or the insolvency administrator, as the case may be, the curing of all past defaults and a commitment to perform the debtor’s future obligations.

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”).¹¹ But because Art XI(2) 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’.”¹²

The High Court’s orders

In dismissing the appeal, the High Court dispensed with the remittal of the proceedings ordered by the Full Court of the Federal Court of Australia. The Court otherwise ordered the release to the administrators of funds paid into Court by Willis representing the value of the charter flight of Willis’ four engines from Australia to the USA, thus reimbursing the cost paid by the administrators.

Commentary

The essential element in the High Court’s reasoning was that the obligation to “give possession” in Article XI(2) 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 Article XI(2) 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 8 or Article 10 of the Cape Town Convention.

Specifically, according to the High Court, Article XI(2) of the Aircraft Protocol 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.”

Practical ramifications

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 (albeit on terms unpalatable to the insolvency administrator), 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 sign-off from the airline?
• What happens in the case of engines leased or owned by one company, for example on an airframe owned by the airline 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.”¹³ However, it was sufficiently clear that the Full Federal Court contemplated the administrators taking positive facilitative steps to enable the creditor to overcome any barriers to taking possession beyond a mere disclaimer. It said (emphasis added):¹⁴

[T]he insolvency administrator must do that which is necessary to pass to the creditor the form of possession that the creditor could have taken in the exercise of the self-help right to take possession. 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. However, the extent of those affirmative obligations is confined by what is needed to overcome any barrier to taking possession that is a consequence of the insolvent administration.

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.”¹⁵ 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 does 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”¹⁶ 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. Because Willis had been successful at first instance, the administrators undertook all return steps and bore the cost of all steps up to the point of the charter flight of Willis’ engines from Australia to the USA before the case reached the High Court. Importantly, the administrators provided all historical records and, despite an initial refusal,¹⁷ they also provided “end of lease operator records” (being records requiring sign-off by the airline) to Willis.¹⁸ They also retrieved two engine stands from Delta Airlines in Atlanta USA, readied the engines for their charter flight¹⁹ and arranged for removal of a lien asserted by Adelaide Airport.²⁰ It remains unclear, however, which, if any, of these 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 none of those steps are required.

In the absence of clarity, insolvency administrators would be well advised to take on a coordinative role in positively facilitating recovery 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 Art 8 and 10 rights to take possession as a fall back absent sufficient cooperation and common sense from an insolvency administrator. Article 12 might also assist insofar as it preserves redelivery rights subject to local laws stays, which may need to be invoked in particular situations.

The risk of such a situation arising does not seem to promote certainty or reduce risk and appears, to that extent, to be contrary to the underlying purpose of the Cape Town Convention and Aircraft Protocol.

Persuasiveness of the reasoning in other jurisdictions

Being the ultimate appellate Court in Australia, the High Court’s decision represents a definitive settling of the interpretation of the meaning and operation of Article XI(2) of the Aircraft Protocol in Australia.

The decision is likely to remain highly influential in other jurisdictions considering the scope of Art XI Remedies on Insolvency. The decision is cogently expressed and aligns with certain statements in the Official Commentary, in particular that Article XI acts to modify or override Article 30(3)(b) of the Cape Town Convention.²¹

However, those approaching the question in other jurisdictions may seek to view the reasons through a more critical lens.

First, as noted above, the essential element in the High Court’s reasoning was that the obligation to “give possession” in Article XI(2) is not a remedy. This was a decisive blow to Willis’ argument which relied on it being a remedy and, in turn, to the operation of Article XI(13) as to the exercise of that remedy.

Beyond the brief statement that Article XI(2) “is not in form or in substance” a remedy, the High Court’s judgment does not explain how that is so.

That conclusion was a departure from both the decision of the primary judge who agreed that it was a remedy (and who adhered to the requirements in Article XI(13) for its exercise) and that of the Full Federal Court which also proceeded on the basis that Article XI(2) was a remedy but came to a different conclusion about the content of the remedy (in which Article XI(13) played no role). The High Court did not address Willis’ arguments as to why indeed there is a textual basis for concluding that Article XI(2) is a remedy.²²

Article XI is entitled “Remedies on Insolvency”, Article XI(2) is the first substantive paragraph and the reference point for paragraphs (3) through to (7). Those sub-paragraphs (3) to (7) establish a regime for what should occur until possession is given (to maintain and preserve the value of the aircraft objects in accordance with “the agreement”) and how to avoid the obligation to give possession (by remedying all defaults and agreeing to comply with “the agreement”). Those two alternatives – to give possession or cure defaults and perform the agreement – reflect the core of Aircraft Protocol’s underlying purpose²³ and are deferential to the parties’ “agreement.” Those provisions in Article XI, which have their starting point as the insolvency administrator’s obligation to give possession, are the centre-piece of “Remedies on Insolvency.”

The Official Commentary, notes that a creditor can enforce the insolvency administrator’s obligation to “give possession” (emphasis added):²⁴

If the insolvency administrator or the debtor fails to give up possession after the creditor has become entitled to it under the above provisions or in any other way fails to fulfil its obligations under Alternative A the creditor can apply for and is entitled to obtain speedily a court order requiring the insolvency administrator or the debtor to give possession of the aircraft object.

The High Court elsewhere stated that the Cape Town Convention and Aircraft Protocol “are best understood by having regard to the Official Commentary”²⁵ but did not address this important statement in the Official Commentary.

Secondly, the High Court did not account for the differences in the terms of Alternative A and Alternative B of Article XI.

As noted above, Australia opted for the so-called “strong form” Alternative A of Article XI, which imposes the obligation to “give possession” and related requirements in Arts XI(2)-(7). That is to be contrasted with the requirements in Alternative B under which the insolvency administrator is required give the creditor “the opportunity to take possession of the aircraft object” in accordance with local insolvency law.

It is apparent from the text and the Official Commentary that Alternative A represents a more onerous and stringent regime, but despite this, following the High Court’s decision, the Alternative A obligation carries a meaning which equates with the less stringent obligation found in Alternative B, to “give the opportunity to take possession”.

The High Court did not address Alternative B or otherwise explain how its interpretation reconciles with the clear textual differences indicated by Alternative B.

Thirdly, the High Court held that its interpretation of Article XI(2) aligned with the operation of section 1110 of the United States Bankruptcy Code, “on which Alternative A of Art XI of the Protocol was substantially based.”²⁶

The Court cited Gray, Gerber and Wool’s article published in the Cape Town Convention Journal: The Cape Town Convention aircraft protocol's substantive insolvency regime: a case study of Alternative A (Gray, Gerber & Wool).²⁷ In that article, the authors go into extensive detail to explain that Alternative A was intended to be a new and improved version of 11 USC §1110(c)(1), saying:

Alternative A was specifically drafted with view to preserving all of the best parts of Section 1110, while simplifying it and amending the problematic provisions…The intent was to develop an efficient and enhanced version of Section 1110.

Critically, Gray, Gerber & Wool contrast Alternative A’s requirements with those of 11 USC §1110(c)(1):²⁸

Section 1110 merely releases the creditor from the shackles of the automatic stay and allows it to exercise whatever remedies it is entitled to under the applicable financing documentation, which includes any action to exercise control over the property of the debtor’s estate, including repossessing property leased to the debtor. Alternative A adopts a more assertive approach. Should the applicable debtor fail to cure all defaults and agree to perform all future obligations under the applicable covered agreement, the debtor then becomes affirmatively obligated to give possession of the applicable aircraft object to the creditor by no later than the end of the waiting period.

Should Gray, Gerber & Wool be correct, then it would seem to follow that the operation of Alternative A should not align with the operation of section 1110 of the US Bankruptcy Code in merely releasing creditors from the ‘shackles’ of the insolvency moratorium but rather should reflect the “more assertive approach” that involves affirmative obligations.

Finally, the High Court concluded its reasoning by stating that its interpretation accords with the “underlying purpose” of the Cape Town Convention and Aircraft Protocol.²⁹ It repeats the Official Commentary’s statement of that purpose, namely to “facilitate capital market financing” ensuring the creditor “secures recovery of the object” or cures all defaults and commits to performance of the agreement. It is to be interpolated the High Court considered that goal could be achieved by a reading of Art XI(2) as primarily directed to overcoming local law stays on enforcement at the expiration of the waiting period. But the High Court does not explain how that may be the case and in view of the practical issues identified above and the parties’ respective arguments, such an explanation was warranted.

The value of Article XI(2) of the Aircraft Protocol to aircraft financing and airlines

Gray, Gerber & Wool note that the Aircraft Protocol is “integral to lowering the cost and increasing the availability of financing for aircraft equipment.”³⁰ 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 the Aircraft Protocol 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.

The High Court proceeded on the basis that there was a procedural impediment to Willis’ exercise of its right to take possession: “without the consent of the Administrators or the leave of the court, [Willis] was constrained by the operation of s 440B of the Corporations Act”³¹ from taking possession of its aircraft objects.

However, the trigger for the commencement of the proceedings between Willis and the administrators was the receipt of a notice issued by the administrators under the local insolvency law, section 443B of the Corporations Act 2001 (Cth). A section 443B notice evinces an intention to permit creditors to collect their property. Upon receipt of a notice under section 443B, therefore, the statutory stay under section 440B was irrelevant and Willis’ ability to take possession of its leased property was unaffected by the section. More generally, under section 443B, the administrator becomes personally liable after the first five days³² of the administration for rent and other amounts payable under the lease unless a section 443B notice is given (or Court relief is obtained to extend the five days or relieving the administrator of the obligation to pay rent). This legislative mechanism creates a situation in which the lessor is either receiving payment from the insolvency administrator for continued use and possession of the leased property, or is entitled to collect its leased property.

Similarly, in the case of a liquidation or a creditors’ scheme of arrangement (both “insolvency proceedings” under the Aircraft Protocol³³), there is no equivalent moratorium on exercising third party property rights of the kind that is set out in section 440B of the Corporations Act.

It seems that there is very little work for Article XI(2) 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 Article XI of the Aircraft Protocol will be in line with more conventional notions of the rights of a 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.”³⁴ In particular, the insolvency administrator, for the most part, will not bear the costs burden of the lessor recovering its property.

It may, however, result in Article XI of the Aircraft Protocol falling short of its potential to be regarded as “the single most significant provision economically”³⁵ 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 in a restructuring scenario.