Come and get it! The meaning of “give possession” under the Cape Town Convention 

The Full Court of the Federal Court of Australia has become the first appellate court among ratifying countries to look directly at the meaning of “give possession” and “giving possession of the aircraft object to the creditor” under the Protocol to the Convention on International Interests in Mobile Equipment (known as the Cape Town Convention) on matters specific to Aircraft Equipment (the Protocol) in the context of an insolvency (the Virgin Australia insolvency) in Wells Fargo Trust Company, National Association (trustee) v VB Leaseco Pty Ltd (administrators appointed) (Virgin v Wells Fargo).

The ruling (subject to further appeals) in Virgin v Wells Fargo examines the redelivery of leased aircraft objects in accordance with the Protocol where the lessee is subject to an insolvency administration. The Full Court held that “giving possession” under Article XI(2) of the Protocol does not include “a requirement to effect redelivery according to the terms of the agreement with the creditor”. In effect, the ruling means that in Australia (and potentially in other countries that have ratified the Cape Town Convention and adopted the “Alternative A” model in Article XI of the Protocol in respect of insolvency proceedings), whilst an insolvency administrator must take certain steps to ‘give possession’ of an aircraft object to a creditor where such creditor wishes to take up the opportunity to take possession, it is not required to effect redelivery of such aircraft object in accordance with the terms of the lease agreement.

In this briefing we look at the potential impact of this judgment on English law; the protections afforded to lessors and financiers under the Cape Town Convention in an insolvency scenario; and what lessors and financiers should be mindful of when looking at the steps that they can take to strengthen their position in relation to the insolvency of a lessee or borrower.

Background

Wells Fargo (as trustee for Willis) leased to VB Leaseco Pty Ltd (administrators appointed) (VB) who in turn sub-leased to Virgin Australia Airlines Pty Limited (administrators appointed) (VAA), four aircraft engines and the associated equipment and records (the Equipment) on terms governed by four lease agreements which included detailed return and termination conditions, including the requirement to return the Equipment to Florida upon termination of the relevant lease. As lessor, Wells Fargo held an “international interest” within the meaning of Article 2(2)(c) of the Cape Town Convention that was registered on the International Registry, affording it certain rights, privileges and immunities under the Cape Town Convention and the Protocol.

On 20 April 2020 an insolvency related event occurred when administrators were appointed to the Virgin Australia group of companies, including VAA and VB. Article XI(2) of the Protocol provides that upon the occurrence of an “insolvency related event” the insolvency administrator “shall…give possession of the aircraft object to the creditor”. At first instance, it was held that such obligation required VAA’s insolvency administrator to redeliver the Equipment to the lessor in Florida in accordance with the terms of the leases, rather than simply make the Equipment available to the creditor.

At the court of first instance reference was made to Article IX(3) of the Protocol which requires that ‘any remedy given by the Convention in relation to an aircraft object shall be exercised in a commercially reasonable manner’, and that a remedy shall be deemed ‘commercially reasonable’ where it is exercised in conformity with a provision of the agreement except where a provision of the agreement is ‘manifestly unreasonable.’ In this case, the requirement to redeliver the Equipment in accordance with the terms of the leases, was not deemed to be manifestly unreasonable.

VAA appealed to the Full Court on the basis that the obligation to “give possession” in Article XI(2) of the Protocol only requires the insolvency administrator to “make aircraft objects available to a creditor, in the sense of giving such a creditor the opportunity to ‘take possession’ of their aircraft objects, and thereby assume as against the whole world the possessory title which up until that point was held by the administrator”.

On appeal, the decision was overturned and the Full Court held that “Article XI(2) does not provide that possession is to be given in accordance with the terms of the lease or loan agreement between the parties”. In coming to this view, the court relied on the following grounds:

• Article XI(2) of the Protocol contains no reference to the underlying agreement between the parties. In reaching its conclusion the Full Court cited four provisions within Article XI whereby the underlying agreements where expressly mentioned, indicating that if the Protocol intended for the underlying agreement to apply to Article XI(2) it would expressly refer to this;

• the reference in Articles XI(5) to Article XI(2) of the Protocol that “unless and until the creditor is given the opportunity to take possession under paragraph 2” confirms that Article XI(2) does not include redelivery;

• that in both common law and civil law countries possession can be established by “(i) a sufficient degree of physical control, and (ii) a manifested intention to control personally (not on behalf of another) in a manner that excludes unauthorised interference”, and therefore physical redelivery is not required in order to “give possession”; and

• funds available to creditors in the insolvent administration would have to be applied to meet the costs of redelivery in priority to any other claim.

The view of the Australian court is that the Cape Town Convention and the Protocol were not intended to result in a reworking of generally accepted principles of insolvency law.

Protection under Alternative A

The judgment at first instance reflected the previously assumed strong position held by lessors, financiers and mortgagees whose international interests are in relation to an aircraft object situated (or where the lessee/debtor is situated) in a contracting state which has adopted the Alternative A model in Article XI of the Protocol. Alternative A has been adopted into English law and is seen as the preferred model by aircraft owners in an insolvency scenario because it affords additional protections not detailed in the Alternative B model. These protections include (following the end of any waiting period specified by any contracting state) requiring a debtor to either (x) give possession of the aircraft object to the creditor under the security agreement, title and reservation agreement or lease or (y) cure all defaults, other than the default constituted by the opening of insolvency proceedings, and agree to perform all future obligations under the agreement. The Alternative A model also requires the deregistration process and exportation of the aircraft object to be completed in less than five working days. The Alternative B model does not provide such favourable protections to secured creditors, for example, it does not provide strict time periods that a debtor must respect.

Impact of the judgment on English law?

When assessing the impact of this case on other jurisdictions which are contracting states to the Cape Town Convention and Protocol and which have adopted the “Alternative A” model, it is important to note that under English law, the Australian judgment will be persuasive, rather than binding: the English Courts can effectively choose how much they want to treat it as precedent – they are not bound to follow it.

Considerations for Lessors and Financiers

As the impact of Covid-19 continues to take its toll on the airline industry, lessors and financiers will be looking at the steps that they can take to strengthen their position in relation to the insolvency of a lessee or borrower. The judgment in Virgin v Wells Fargo is potentially another hurdle to overcome for lessors and financiers in an uncertain time and they should be mindful of the following:

• Impact on return conditions: As a condition to the continuing stay during the designated waiting period under Alternative A, the debtor or its insolvency administrator, is required, pursuant to Article XI(5)(a) of the Protocol, to ‘preserve the aircraft object and maintain it and its value in accordance with the agreement’. This provision is intended to ensure that the debtor or its insolvency administrator takes active steps to preserve the condition and value of the aircraft object during the period that the creditor cannot have access to it. Therefore until such time as a creditor is given the opportunity to take possession of its aircraft object, it does have the comfort that the debtor or its insolvency administrator is obliged to take care of such aircraft object in accordance with the relevant agreement, albeit that it may not receive the aircraft object back in the required return condition if the judgment in Virgin v Wells Fargo is followed.

• Alternative remedies for breach: If the judgment in Virgin v Wells Fargo is followed and a lessor is only afforded a right to obtain possession of an aircraft object upon an insolvency-related event occurring, in practice, the failure to return the aircraft object in compliance with the redelivery conditions under the lease would be a breach of obligation by lessee, whereby the lessor could still have an action for breach of contract. It should be noted that this would not necessarily leave the lessor in an advantageous position because such claim would be as an unsecured creditor in the insolvency (unless it also had security granted in its favour) and therefore would rank behind fixed charge holders, liquidators’ fees and expenses, preferred creditors and floating charge holders on an insolvency in the United Kingdom.

• Enforcement Expenses: If the judgement in Virgin v Wells Fargo is followed and a creditor is afforded the opportunity take possession of its aircraft object rather than have it redelivered to it in compliance with any contractual redelivery conditions, the underlying agreement is likely to include a provision that the debtor is liable for all costs and expenses (including legal and other costs) incurred by the creditor in connection with the enforcement or preservation of its rights under the agreement, in contemplation of enforcement and in respect of repossession of the aircraft object. This would, in most cases, be an unsecured claim, unless the creditor also had security over other assets (possibly a deposit) granted in its favour, in which case the creditor may have a secured claim to the extent of such security for such expenses.

• Does it make a difference if the international interest arises under a mortgage rather than a lease agreement? Under the Cape Town Convention mortgages and leases are both classed as “International Interests” under the Protocol for the purposes of registration on the International Registry. However, for purposes of “giving possession” there is a distinction between where the airline is the borrower and gives the mortgage security over its aircraft and where the borrower is a lessor who gives security over the aircraft leased to the airline. In the former situation there will be operational covenants in the loan/mortgage documentation (albeit unlikely full return conditions) and the costs of putting the aircraft into the required condition and making it marketable for sale or other disposal will be secured by the mortgage in the event of the insolvency of the airline. Conversely, if the borrower is a lessor then the mortgagee will not be secured in an airline insolvency - in the same way that the lessor would not be secured (unless it has some other security granted in its favour from the airline). Therefore, there is a transaction structure take away from this distinction for lenders - there may be some situations where the structure of a financing at the request of an airline should be a direct loan to the airline rather than a loan to an airline SPV/intermediate lessor that leases the aircraft object onto the airline itself so that the obligation to ‘give possession’ to the creditor is triggered by an insolvency related event relating to the airline itself and the costs of making the aircraft marketable are secured.

What next?

As airlines, lessors and financiers try to work together to find ways forward in the face of the economic impact of the current Covid-19 pandemic, the judgment in Virgin v Wells Fargo could not have arrived at a more difficult time for lessors and financiers needing to repossess aircraft objects in the wake of airline insolvencies. However this is certainly not the end of the story on the meaning of ‘give possession’ under the Cape Town Convention and, it remains to be seen: (i) whether this judgment will be appealed in Australia; (ii) as the first court to ever consider what the meaning of ‘give possession’ under the Cape Town Convention means, how this judgment will be followed or act as a persuasive judgment in other Contracting States; and (iii) how insolvency practitioners and creditors will cooperate in future aircraft repossessions.