Schemes of Arrangement and the Cape Town Convention

Introduction

Schemes of arrangement in England come in two forms – under either Part 26 of the Companies Act or Part 26A of the Companies Act 2006 (which was introduced by the Corporate Insolvency and Governance Act 2020). Although Part 26A Schemes are a recent introduction, Part 26 Schemes have been available since the middle of the nineteenth century.  Both schemes allow companies to propose an arrangement or compromise with their members and/or creditors.  If sanctioned by the court, both types of scheme may result in certain creditors being forced to accept, against their will, revised terms for the debts owing to them (a so-called “cram-down”) because they form part of a dissenting minority or (in the case of a Part 26A Scheme) because that particular class of creditor has been subjected to a cross-class cram-down.

There are significant differences between the two schemes.  In particular, Part 26A Schemes only apply if two conditions (the Threshold Conditions) are met: (a) that the company has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern and (b) the purpose of the compromise or arrangement is to eliminate, reduce or prevent, or mitigate the effect of, any of those financial difficulties. Part 26 Schemes can apply irrespective of the financial condition of the company.

In July 2020, we issued a briefing (The Corporate Insolvency and Governance Act 2020 of the United Kingdom and the Cape Town Convention) in which we explained why we believed that the Part 26A Schemes constitute “insolvency proceedings” for the purposes of the Cape Town Convention¹. That characterisation is important because, if correct, Article XI.10 of the Aircraft Protocol provides that no obligations of the debtor may be modified without the consent of the creditor.  In particular, a lessor would not be obliged to accept a cram-down under a court-sanctioned scheme if it is part of a dissenting minority or on a cross-class basis.

Since we issued that briefing, there has been considerable debate amongst lawyers, both in private practice and in academia, as to whether that characterisation is correct. That debate extends also to the proper characterisation of Part 26 Schemes and, indeed similar schemes proposed under the laws of other jurisdictions.

The cases

Since July 2020, there have been five schemes proposed, in England, Ireland and Malaysia, in which the question of whether or not they constitute “insolvency proceedings” has arisen.  Those proceedings were proposed by Nordic Aviation Capital (NAC), Virgin Atlantic Airways Limited (VAA), gategroup Guarantee Limited (gategroup), AirAsia X Berhad (AirAsia X) and MAB Leasing Limited (MAB). 

The debtor company was able to obtain, effectively, the unanimous consent of relevant creditor classes in three of these proceedings: NAC (before the High Court in Ireland) and VAA and MAB (both before the High Court in England).  Although all three companies asserted in prior communications with affected creditors and/or their pleadings that the schemes did not amount to insolvency proceedings for the purposes of the Cape Town Convention, the fact that they managed to obtain the relevant levels of creditor consent means that the arguments in favour of and against that proposition were not rehearsed before the relevant courts, which were not then required to pronounce on the issue.   

However, the Malaysian and English courts were required to consider the question in the AirAsia X and gateway cases respectively and their decisions merit greater analysis.

AirAsia X

AirAsia X made an application to the Malaysian High Court under s. 366(1) of the Companies Act 2016  of Malaysia for an order to hold meetings of the company’s creditors to approve a scheme of arrangement proposed by the company in order to avoid the prospect of a liquidation. On 19th February, 2021, the Malaysian High Court granted that application.  The creditors’ meetings will now be held and, assuming the requisite majorities are obtained, the court will be asked to sanction the scheme.

Schemes brought under s366.1 of the Companies Act 2016 share many similarities with Part 26 Schemes.  Indeed, in a long and carefully reasoned judgment, the Malaysian High Court relied extensively on English precedent.

One of the questions the court was asked to address was whether these were “insolvency proceedings” for the purposes of the Cape Town Convention and so subject to the provisions of Article XI.10 of the Aircraft Protocol. Insofar as relevant, “insolvency proceedings” are defined in the Cape Town Convention as including “bankruptcy, liquidation or other collective judicial or administrative proceedings, including interim proceedings, in which the assets and affairs of the debtor are subject to control or supervision by a court for the purposes of reorganisation or liquidation”. There are, accordingly, three conditions that need to be met for this definition to apply:

• the proceeding must be a collective proceeding;
• the debtor’s assets and affairs must be subject to control or supervision by a court; and
• the purpose must be the reorganisation of the debtor, or immediate liquidation.

In seeking to contend that a scheme does not constitute insolvency proceedings, AirAsia X relied primarily on the proposition the court does not have sufficient control over the affairs of the company for a scheme to constitute insolvency proceedings. But the court, after considering rival opinions placed before it, disagreed, holding that the facts that the scheme must receive its sanction and that AirAsia X and the creditors must also comply with its directions on the implementation of the scheme, were sufficient to meet the requirement of “control or supervision by a court‟.

gategroup

The question of whether a Part 26A scheme is an insolvency proceeding came before the English High Court in the gategroup case², in a different context: the question here was whether the court had jurisdiction under the Convention on Jurisdiction and Enforcement of Judgments in Civil and Commercial matters, signed in Lugano on 30 October 2007 (the Lugano Convention) to sanction a scheme in respect of certain bonds, governed by Swiss Law and with an exclusive jurisdiction clause in favour of the courts of Zurich.  It was common ground that, if the Lugano Convention applied to Part 26A schemes, that clause would be effective and the English court would be denied jurisdiction.  The Lugano Convention applies to civil and commercial matters but has an exception for “bankruptcy, proceedings relating to the winding-up of insolvent companies or other legal persons, judicial arrangements, compositions and analogous proceedings” (the Bankruptcy Exception).  The applicant argued that Part 26A Schemes fall within that exception.

It is a complex case, framed in part by the interaction between the Lugano Convention, the Recast Brussels Regulation and the recast EU Insolvency Regulation (the European Legislation).  The wording of the Bankruptcy Exception is different from the “insolvency proceedings” definition in the Cape Town Convention. The case was further complicated by the timing of the introduction of the Part 26A Schemes and the end of the Brexit implementation period.

However, analysing the Bankruptcy Exception and the European Legislation, the court held that, to fall within the exception, proceedings must contain the following elements:

• The proceedings must be collective proceedings;
• They must be based on laws relating to insolvency and have as their purpose rescue, adjustment of debt, reorganisation or liquidation; and
• They must encompass at least one of the following:
  • The debtor is partially or totally divested of its assets;
  • The assets and affairs of the debtor are subject to control or supervision by a court; or
  • A temporary stay is imposed, by a court or by operation of law, on individual enforcement proceedings to enable negotiations to take place between the debtor and its creditors.

The court held that a Part 26A Scheme satisfied all three requirements and therefore falls within the Bankruptcy Exception.  It is true there are significant differences as to how the European Legislation and the Cape Town Convention should be interpreted but the conclusions reached by the court as to what is meant by “collective proceedings” and as to the requisite degree of supervision by the court are equally compelling in both cases.  It is difficult to see, following the gategroup judgment, how a Part 26A Scheme could fall outside the definition of “insolvency proceedings” in the Cape Town Convention.

One of the conditions required for the Bankruptcy Exception to apply is that proceedings must be based on laws relating to insolvency - but insolvency is given an extended meaning, including proceedings which provide for restructuring of a debtor at a stage where there is only a likelihood of insolvency.  The court had no difficulty in holding that the Threshold Conditions were sufficient to satisfy this requirement for Part 26A Schemes.

However, the court went on to note that the Bankruptcy Exception applies to “proceedings which are based on laws relating to insolvency. However, proceedings that are based on general company law not designed exclusively for insolvency situations should not be considered to be based on laws relating to insolvency”.  On that basis, Part 26 Schemes (to which the Threshold Conditions do not apply) would appear to fall outside the Bankruptcy Exception.

Part 26 Schemes and the Cape Town Convention

The English courts have yet to decide whether either a Part 26 or a Part 26A Scheme is an insolvency proceeding for the purposes of the Cape Town Convention.  It is important that that question is decided in accordance with the principle of autonomy set out in Article 5 of the Convention:  “questions concerning matters governed by this Convention which are not expressly settled in it are to be settled in conformity with the general principles on which it is based”.  Unlike the European Legislation, the Cape Town Convention does not refer back to the domestic laws under which the schemes are introduced: that is a natural consequence of the European Legislation being primarily concerned with the recognition of foreign proceedings whilst the Cape Town Convention requires substantive changes to insolvency procedures in contracting states.  Those substantive changes need to be consistently applied.

The Cape Town Convention Academic Project has (with the agreement of Professor Sir Roy Goode and Unidroit) issued an Annotation to the Official Commentary on the Cape Town Convention³ which helps answer this question.  That Annotation confirms that arrangements fall within the definition of “insolvency proceedings” in the Cape Town Convention “where they are formulated in an insolvency context, or by reason of actual or anticipated financial difficulties of the debtor company”.  There has been some discussion as to the precise legal status of the Annotation.  However, given its provenance and the need to promote uniformity and predictability in the application  of the Cape Town as required by Article 5.1, it is appropriate to give the Annotation considerable weight as an interpretive tool. The Malaysian High Court took note of it in the AirAsia X case.  The logic behind it is also compelling. What matters is not the nature of the laws under which schemes are proposed but rather the context in which they arise.   In view of the rules of interpretation required by Article 5 of the Cape Town Convention, it cannot be right that a company which is effectively insolvent may seek to achieve identical results with affected stakeholders in commercially identical circumstances by proposing a scheme under either Part 26 or Part 26A of the Companies Act, but that one type of scheme should be an ‘insolvency proceeding’ for the purposes of the Cape Town Convention and the other not. 

Article XI.10 Compliant Schemes

It has been suggested that including Part 26A and (potentially) Part 26 schemes within the definition of “insolvency proceedings” would give individual creditors a right of veto.   That is not correct. A scheme which gives the creditors the genuine option to terminate their leases, take possession of their aircraft assets and recover damages (as an alternative to accepting a contractual modification of the lease)  is permissible as it does not impose a modification of terms upon the creditor without consent, and is therefore compliant with Article XI.10 of the Aircraft Protocol. Such an option needs to be carefully crafted to ensure compliance with Article XI.10 and to avoid any suggestion of abuse.

Conclusion

Many English commentators have expressed doubts as to the proper categorisation of schemes, whether proposed under Part 26 or Part 26A of the Companies Act, as insolvency proceedings. Those reservations arise from an analysis of the  English laws under which they arise.  However, the Cape Town Convention requires their categorisation to be based on the autonomous principles underlying it and not on the domestic laws of one contracting state.  Although the question of whether either type of scheme constitutes an “insolvency proceeding” for the purposes of the Cape Town Convention has yet to be decided by an English court, the gategroup and AirAsia X decisions give a welcome indication of the direction of travel of the debate.