Wells Fargo v Virgin Australia

• Introduction
• Facts
• The Cape Town Convention
• Additional remedies
• The decision of the High Court
• Conclusion

Introduction

The High Court of Australia, the highest appellate court in that jurisdiction, recently addressed the meaning of the words "give possession" in Article XI.2 of the Aircraft Protocol to the Cape Town Convention (CTC)¹. It is a case which impacts considerably on the competing interests of aircraft and engine lessors and the general body of creditors of an airline subject to insolvency proceedings in a CTC Contracting State. Although the issue had previously been addressed by the High Court in Ireland in a judgment relating to the examinership of Norwegian Air Shuttle (the NAS Case)², this is the first time that the issue has been considered in detail by a senior appellate court. Given the requirement, in Article 5.1 of the CTC, that, in its interpretation, "regard is to be had to the need to promote uniformity and predictability in its application", the decision is one that could have strong persuasive authority before the courts of other Contracting States. However, the judgment leaves many questions unanswered and its reasoning is open to challenge.

Facts

Wells Fargo Trust Company (Lessor) had leased four aircraft engines to VB Leaseco (Lessee), part of the Virgin Australia group, under operating leases, the terms of which were substantially documented in a General Terms Agreement (GTA). The Lessor was the legal owner of the engines, holding them on trust for Willis Lease Finance Corporation (Willis). The Lessee appointed administrators on April 20, 2020. This constituted an event of default under the leases as specified in the GTA.

The GTA provided for the redelivery of the engines upon the termination of the leases to a location in Florida, alongside various other redelivery conditions. Sixty days after the appointment of the administrators, Willis made a demand for redelivery of the engines to the location specified in the GTA, which the administrators rejected. The administrators on the same day proffered to Willis an opportunity to take control of the engines where they happened then to be located, in Australia, which was in turn rejected by the Lessor.

The case therefore addresses whether, following the occurrence of an event of default occasioned by the commencement of insolvency proceedings in respect of a lessee in a Contracting State, the expenses incurred in returning the engines to the contractually-required redelivery location are primarily to be borne by the lessor or by the general body of creditors of the lessee. That question needs to be considered in the light of the stated objective of the CTC to give intending creditors greater confidence in the decision to grant credit and so to reduce borrowing (and leasing) costs.

Part of that confidence is intended to be engendered by the improvement of CTC creditors' rights on their debtors' insolvency. That is in contrast to the traditional approach of a court seised of an issue in the course of insolvency proceedings, which will be protective of the interests of the general body of creditors. The extent to which that approach can be maintained depends on the correct interpretation of the CTC, which must prevail.

The High Court of Australia ruled in favour of the Lessee and its administrators. The Lessor's rights against the Lessee for breach of contract would be limited to a claim for damages, ranking pari passu with the Lessee's other unsecured creditors. This briefing analyses the reasoning behind that decision and considers exactly what obligations Article XI.2 imposes on CTC debtors (or their insolvency administrators).

The Cape Town Convention

The CTC, and its associated Aircraft Protocol, has been in force since 2006 and now has over 80 Contracting States, including Australia. It provides amongst other things for certain remedies to be made available to creditors in respect of international interests relating to aircraft objects - which category of creditors includes lessors of engines such as the Lessor.

The case related expressly to the rights of lessors under leases and this briefing assumes that the debtor/creditor relationship under the CTC will be that of lessee and lessor. However, similar arguments arise in the context of creditors in respect of other types of international interests, such as security agreements. Central to the case were three provisions of the CTC:

a.Article 10 of the CTC provides (in summary) that upon the occurrence of a default (as agreed by the parties) a lessor under a leasing agreement can "terminate the agreement and take possession or control of any object to which the agreement relates". The appointment by the Lessee of administrators constituted a default.

b.A lessor's rights arising from Article 10 are, however, subject to Article 30.3(b) of the CTC. 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 Those rules include the restrictions imposed by s440B of the Corporations Act of Australia which, in the circumstances of the case, operated to prevent a lessor to the Lessee from exercising any right to take possession of or otherwise recover leased property without the consent of the Administrators or the leave of the court.

c.However, for 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 proper interpretation of Article XI, and particularly Articles XI.2 and XI.7, of the Aircraft Protocol is therefore the crux of the case. Those Articles provide:

"XI.2 Upon the occurrence of an insolvency-related event, the insolvency administrator or the debtor, as applicable, shall, subject to paragraph 7, give possession of the aircraft
object to the creditor no later than the earlier of:

a.the end of the waiting period [which for Australia, is sixty days]; and

b.the date on which the creditor would be entitled to possession of the aircraft object if this Article did not apply".

XI.7. The insolvency administrator or the debtor, as applicable, may retain possession of the aircraft object where, by the time specified in paragraph 2, it has cured all defaults other than a default constituted by the opening of insolvency proceedings and has agreed to perform all future obligations under the agreement. A second waiting period shall not apply in respect of a default in the performance of such future obligations".

Thus, the stay provided for s440B of the Corporations Act of Australia is limited to a maximum of 60 days for aircraft objects. In the event, the Lessee did not wish to retain the engines so Article XI.7 was not relevant and the Lessee agreed that it would give possession of the engines to the Lessor at the end of the sixty day period.

The dispute reflects the differences in the language used, on the one hand, in Article 10 CTC (which refers to the lessor/creditor taking possession) and, on the other hand, in Articles XI.2 and XI.7 of the Aircraft Protocol (which refer to the lessee/debtor giving, or retaining, possession). Other provisions use yet a different formulation: for example, Article XI.5 of the Aircraft Protocol refers to the creditor being "given the opportunity to take possession under paragraph 2". Article 10 CTC portrays the creditor as the active party; Articles XI.2 and XI.7 of the Aircraft Protocol give this active role to the debtor.

The question is therefore whether Article XI.2 broadens the remedies set out in Article 10 by imposing an active duty on the lessee/debtor (and, if so, what that duty entails), or whether it leaves the remedy unchanged but curtails the provisions of Article 30.3(b) by reference to the sixty day waiting period.

Additional remedies

Article 12 CTC provides that any additional remedies permitted by the applicable law, including any remedies agreed upon by the parties, may be exercised to the extent that they are not inconsistent with the mandatory provisions of the Convention. Invariably aircraft and engine leases will provide for such additional remedies, including:

a.the recovery of damages;

b.the redelivery of the leased equipment in a specified condition, particularly with all constituent parts installed and accompanied by the required technical records, and with the requisite maintenance status;

c.the export and physical transfer of the equipment by the lessee from the territory in which it is located to an agreed location; and

d.in the case of an aircraft, its deregistration by the lessee (if, under the relevant regulations, it is the lessee who has the power to deregister).

These remedies are contractual in nature and not subject to the rules of the CTC. However, in the cases of deregistration, export and physical transfers, Article IX(1) of the Aircraft Protocol provides lessors with additional remedies, exercisable at a Contracting State level, in the event that the lessee fails to perform its corresponding obligations.

The decision of the High Court

The High Court unanimously held that:

a."Unlike Art IX(1) of the Protocol, Art XI(2) of the Protocol does not in form or in substance give an additional remedy to the creditor".⁵

b."There is no reason to attribute to the term "possession" in Art XI(2) of the Protocol anything other than the constant meaning that the term has in Art XI(5) and Art XI(7) of the Protocol, in Art 8 and Art 10 of the Convention and elsewhere in the Convention and the Protocol. Throughout the Convention and the Protocol, the reference to "possession" is to physical control to the exclusion of others";⁶ and

c."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".⁷

Although the decision of the High Court is clear, the logic behind it lends itself to further examination:

a.There is a great deal of discussion in the judgment as to what is meant by "possession". The administrators had argued that "the "ordinary meaning" of the phrase "give possession" does not entail a physical transfer of the object in question"⁸ but the High Court rejected that argument, holding that it was necessary for the Lessor to have "physical control [of the engines] to the exclusion of others".⁹ The key question was how possession should be transferred from Lessee to Lessor and whether the verbs used to qualify possession - "take", "give", "retain" - are capable of being reconciled or must be interpreted cumulatively.

b.To say that to give possession is the same as to give the opportunity to take possession does not accord with common usage. For example, "give" is variously defined as:

(i)"to grant or bestow by formal action" or "to put into the possession of another for his or her use" (Merriam-Webster Dictionary); and

(ii) "[T]o make another the recipient of (something that is in the possession, or at the disposal, of the subject)" (Oxford English Dictionary).

Both definitions require positive acts by the donor.

c.The High Court further argued that Article IX of the Aircraft Protocol makes it is clear that having taken possession of the aircraft object, "it is the creditor who is to undertake, and be responsible for, the burden of the effort and expense of the physical transfer of aircraft objects from the Contracting State to the location nominated by the creditor".¹⁰ That is based on a fundamental misunderstanding as to how the GTA and the Aircraft Protocol interact. The GTA imposes an obligation on the Lessee to effect the transfer of the engines to the agreed redelivery location: Article IX requires Contracting States to assist creditors in the event that their debtor fails to perform that obligation.

d.The High Court further argued that "telling strongly against [the Lessor's] argument is also that no right to procure the expeditious de-registration of the aircraft or the export and physical transfer of the aircraft object is available to the debtor or the insolvency administrator during the waiting period of 60 days from the insolvency-related event or at all".¹¹ This is a puzzling statement: it is not clear why the Lessee would want the right to deregister or export the aircraft during the waiting period, otherwise than for the purposes of fulfilling its contractual obligations. In any event, the power to export the aircraft object and (in Australia) to deregister the aircraft lies with the debtor, as operator. As mentioned previously, Article IX of the Aircraft Protocol is intended to assist the creditor with remedial action in the event that its debtor does not exercise its powers in the manner contractually agreed.

e.In the same paragraph, the High Court goes on to say: "For Art XI(2) to impose an obligation to deliver or redeliver the aircraft object to the creditor by the end of the waiting period would effectively negate the opportunity afforded to the debtor or insolvency administrator by Art XI(6) and Art XI(7) to use the aircraft object to attempt to trade out of default during that same period". That is also puzzling. Article XI.7 of the Aircraft Protocol allows the debtor or the insolvency administrator to "trade out of default" by curing all defaults during the waiting period. It is only if it fails to do so that the debtor becomes obliged to give possession of the aircraft object to the creditor. It may be that the High Court intended to say that the sixty day period is insufficient to allow the Lessee to trade out defaults and plan for the redelivery of the engines, but that assertion is unsupported by any evidence and is clearly negated by the treaty obligations Australia assumed when it ratified the CTC.

f.The High Court further considered Section 1110 of the US Bankruptcy Code on which Alternative A was substantially based. "The obligation imposed by that provision to "surrender and return" equipment to a secured party, lessor or conditional vendor has been construed to mean no more than that "you get [the equipment] immediately and you get it as is, where it is".¹²¹³ The High Court did not consider, however, why, having decided to base Alternative A on Section 1110 of the US Bankruptcy Code, the draftsmen of the CTC declined to use the "surrender and return" formulation of the remedy, preferring instead the language of "giving possession". The difference in the wording must be given relevance.

Even if the High Court was right in deciding that the debtor or insolvency administrator "giving possession" to the creditor is the same as the lessor being "given the opportunity to take possession", that leaves many questions open.

a.What is meant by "opportunity"? How accessible must the aircraft object and its constituent parts be? What happens if the lessor is unable to access the aircraft object, for example by virtue of a travel ban during a pandemic or because of governmental action following the imposition of sanctions?

b.Must the aircraft object be in one place? Often, when an airline is insolvent, the constituent parts of an aircraft object are difficult to find and may be in various different locations. At what point can the lessor argue that it has not had the opportunity of taking possession of the entire object?

c.The technical records for an aircraft object form an particularly valuable part of it (and are expressly included within the definition of "airframe" and "aircraft engine" in the Aircraft Protocol). If (as is often the case) the technical records are incomplete or missing, does Article XI.2 give the lessor a prior claim for the costs of their reconstitution?

d.If, at the end of the waiting period, another creditor of the debtor has a lien over the aircraft object which, under the rules of the CTC, ranks above the international interest of the lessor, what remedies does the lessor have? The lessee will have a contractual obligation to remove the lien but may fail to do so. Does the obligation to give the lessor the opportunity to take possession mean that the lessee (or its insolvency officer) has a treaty obligation to discharge the lien? Or does the lessor have to discharge the lien and seek reimbursement, and if so what priority does it have in respect of that right of reimbursement? This question was addressed in the NAS Case and decided against the lessor, but with no supporting reasoning from the court.

e.Generally, the judgment of the High Court is silent as to what "giving a creditor the opportunity to take possession" entails. Perhaps that is unsurprising as none of the fact patterns recited above existed in the case: but it illustrates the limitations of the judgment in terms of its application to the facts of any particular case in future. The parameters of the obligations that expression imposes on debtors will need to be developed in case law, whether in Australia or other Contracting States.

Conclusion

Article 5.1 of the CTC requires uniformity and predictability in its application to Contracting States and the decision of the highest appellate court of a jurisdiction such as Australia should have great persuasive authority in other Contracting States. However, Article 5.1 also requires regard to be had to the CTC's purpose as set forth in the Preamble, which include providing economic benefits to all parties and the promotion of party autonomy. The Official Commentary contains extensive provision as to how this should be interpreted but courts should be wary of reducing the impact of the Convention. In the case in question, where the Lessee did not wish to retain the leased engines, Article XI.2 of the Aircraft Protocol provided no benefit to the Lessor.

It goes without saying that the decision is not binding precedent outside of Australia. The judgment of the High Court needs to be considered on its particular facts and gives little guidance as to how the phrase "give possession" in Article XI.2 of the Aircraft Protocol should be interpreted in practice. That Article does impose an obligation on debtors, the exact scope of which needs to be decided in future cases.

Footnotes