Aircraft Leasing, Scheme of Arrangement, and the Cape Town Convention

In re AirAsiaX, AirAsiaX (“AAX”) filed an originating summons (“OS”) to the High Court to seek an order to convene a meeting of the creditors for the purpose of approving its proposed scheme of arrangement (“Scheme”). A number of creditors, including the airport operator, lessors of aircraft, and a manufacturer of aircraft, intervened in the OS proceedings (“Interveners”) to object to the Scheme. The issue of the Cape Town Convention came to the front because the Scheme involved 14 subsidiaries of AirAsiaX, 11 of which (“Leasing Subsidiaries”) leased aircraft from some of the Interveners.

A number of legal issues relating to the Convention on the International Interests in Mobile Equipment (“Cape Town Convention”) and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment (“Aircraft Protocol”) thereto were canvassed by the court. The issues arose partly because of the question whether the lessors should be placed in a separate class of creditors, separate from Airbus and other creditors.

The Convention on the International Interests in Mobile Equipment, more popularly known as the Cape Town Convention, was made part of the domestic law via the International Interests in Mobile Equipment (Aircraft) Act 2006 (“IIME Act 2006”). Under Article XI of the Protocol, which was in contention, Alternative A is applicable. Under Alternative A, ‘[242]…upon the occurrence of an insolvency-related event…the insolvency administrator or the debtor either (i) cures all defaults (other than the default constituted by the commencement of insolvency proceedings) and agrees to perform all future obligations under the agreement, or (ii) gives possession of the aircraft object to the creditor.’ The insolvency administrator or the debtor must take the action required within the waiting period—in that case, 40 days.

The Convention apparently came into play due to the issues: ‘[240]…(i) whether a scheme of arrangement is an “insolvency-related event” under Article XI(10) of the Protocol; and (ii) whether Article XI(10) operated to prevent the debtor’s obligations to make payments under the lease agreements from being subject to the so-called “cram down” provisions of a scheme of arrangement.’

On the effect of Article XI(10), the court noted that ‘[245]…As a provision that is to apply only upon the occurrence of an insolvency-related event, this provision must be intended to provide protection for creditors in the event of an insolvency-related event. [246] The question before this Court is whether the scheme of arrangement that is filed under s. 366(1) of the Act is an “insolvent-related event” under the Protocol.’

The term “insolvency-related event” is defined in Article I(2)(m) of the Protocol to mean:

the commencement of insolvency proceedings; or
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.

On the facts of the case, it was a common ground that para. b was not applicable.

The term “insolvency proceedings” is in turn defined in Article 1(l) of the Convention to mean ‘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.’

The court noted that neither the Convention nor the Protocol addresses the question whether a scheme of arrangement like that in the case comes within the term “insolvency proceedings”. On the facts, the court concluded that:

‘[272] In the present case, there is no doubt that the scheme of arrangement is formulated in the context of an insolvency. That AAX is currently insolvent is not disputed.

[273] The Scheme is also an arrangement that is collective in that it is “concluded on behalf of creditors generally or such classes of creditors as collectively represent a substantial part of the
indebtedness”.

[274] There can also be no dispute that the Court’s approval is required for its implementation.’

On the interpretation of the term “insolvency proceedings” defined in Article 1(l), the court concluded that ‘[278]…there is no doubt that the Scheme involves “assets and affairs” of AAX,’ and that ‘[279]…the fact that the Scheme must receive the sanction from this Court and AAX and the creditors must also comply with the directions from the court on the implementation of the Scheme…meets the requirement of “control or supervision by a court”.’ Hence, the court held that the Scheme was indeed an “insolvency-related event” under Article XI of the Protocol.

On the interpretation of Article XI(10) of the Protocol, the court held that ‘[283]…the said Article is unambiguous and a literal, ordinary and natural meaning to be given to the words “obligations under the agreement” does not produce an absurd result. There can be no doubt that the phrase must include the obligation of the debtor to pay the rentals under the agreement. To restrict the meaning of the word “obligations” to only obligations relating to in rem matters
is to read into the Articles words which are simply not there. There is nothing to suggest that the Cape Town Convention is to be viewed narrowly, in that it is only to cover in rem rights as asserted by…AAX.’ In arriving at that interpretation, the court noted that ‘[285] There is little doubt that the word “obligations” in this Article XI (7) must include the in personam obligation to pay rentals under the agreement. It will be incongruous that the same word in Article XI
(10) bears a different and indeed a narrow meaning as suggested by…AAX.’ Further, the court took the view that ‘[286]…the prohibition under Article XI (10) to permit the debtor to modify the obligations under the agreement except with the consent of the creditor is consistent with the purposes of the Cape Town Convention – to promote and reduce the costs of asset-based financing for airline equipment,’ and that ‘[288]…the “obligations” that cannot be modified without the consent of the Lessors in this case are “obligations under the agreement”.’

Reading Article XI(7), (10) and (11) together, the court took the view that ‘[290]…Alternative A of the Protocol provides the following protection to the creditor, namely, in the event the debtor chooses not to terminate the agreement when an insolvency-related event has occurred or the creditor does not exercise its right to repossess the aircraft, the obligations under the agreement including the obligation to pay the rentals cannot be modified by the debtor unless with the consent of the creditor.’ However, on the facts of the Scheme, the court noted that:

‘[292] But in this case, the Scheme provides for the termination of the Lease Agreements which under Article XI (11), AAX is entitled to do. With the termination, the Lessors would be left with the remedies of repossession under the Convention as provided under Article XI (7). These remedies are not interfered with under the Scheme at all.

[293] With the termination of the Lease Agreements, apart from the right to repossession under the Cape Town Convention, the Lessors also have the right to claim against AAX for damages which comprises both the accrued rentals that were unpaid and the future rentals under the remaining terms of the Lease Agreements subject to the duty to mitigate.

[294] This claim for damages arises from the termination of the Lease Agreements. This is the same claim that the Lessors would make against AAX in the event of liquidation where the Lessors would have to share pari passu with other unsecured creditors in the assets of AAX. What the Scheme is seeking to do is to compromise this claim for damages. To my mind, this has nothing to do with Article XI (10) of the Alternative A of the Protocol.

[295] For the reasons above, it is my judgment that AAX does not require the consent of the Lessors in respect of the “cram-down” provision under the Scheme in the form of a 99.7% hair-cut of their claims.’

Our Dr. Vince has published a book chapter on the implementation of the Cape Town Convention in Malaysia.

If you have any queries regarding aircraft leasing or financing or enforcement thereof, you may wish to CONTACT ETCoLaw.

30 March 2021

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