05 August 2021

The High Court Appeal - Wells Fargo Trust Company, National Association (as owner trustee) & Anor v. VB Leaseco Pty Ltd (administrators appointed) & Ors – Exploration of Virgin Territory

Introduction

In the next month or so the hearing of the appeal in what has become known as the “Willis” Case will be heard before the High Court of Australia. This case relates to the repossession of Aircraft as against the insolvency administrator in the Virgin Australian Airlines administration.

This will be the first case relating to the Convention on International Interests in Mobile Equipment (Cape Town Convention) and the Protocol to the Cape Town Convention (“Cape Town Protocol”) in any of the 80 countries who have acceded to the Cape Town Convention which will consider key repossession matters in the context of an insolvency.

The judgment of the High Court will determine how the Cape Town Convention as adopted in Australia by the International Interest in Mobile Equipment (Cape Town Convention) Act 2013 (Cth) will interplay with the administration provisions of Part 5.3A of the Corporations Act (Cth).

John Canning and Dale Rayner discuss why the outcome of the appeal to the High Court of Australia will be important for the aviation industry across the globe.  

What happened?

Wells Fargo Trust Company and Willis Lease Finance Corporation (together, “Wells Fargo”) are respectively the legal and beneficial owners of four aircraft engines.  The engines were leased to VB Leaseco Pty Ltd and, in turn, subleased to Virgin Australia Airlines Pty Limited (together, “Virgin”).  It was accepted by the parties that Wells Fargo’s rights were “registered international interests” under the Cape Town Convention and the Cape Town Protocol and subject to the provisions of both.

On 20 April 2020, the Virgin Group was placed into administration.  Under Australian insolvency law, an administrator has the power pursuant to section 443B(3) of the Corporations Act 2001 (Cth) (“Corporations Act”) to give, within 5 business days, a notice to the owner or lessor of leased property specifying that the company in administration does not propose to exercise rights in relation to the leased property (“Section 443B Notice”).  If an administrator does not give such a notice, the administrator becomes personally liable for rent and other amounts payable under the lease agreement as are attributable to the period beginning after the 5 business days and during which the company in administration continues to use, occupy or be in possession of the leased property.

The administrators of the Virgin Group previously obtained orders from the Court extending the 5 business day decision period to 16 June 2020.  On 16 June 2020, the administrators of Virgin purported to give notices under section 443B (3) of the Corporations Act.

In response, Wells Fargo brought an application in the Federal Court seeking various declarations and other relief, including a declaration that the section 443B (3) notice did not discharge the administrators’ obligation under Article XI (2) of the Cape Town Protocol to “give possession” of Wells Fargo’s leased engines. Wells Fargo also sought an order that the administrators deliver up the engines in Florida, as required by the redelivery terms in the relevant lease agreements.

Central to the administrators’ arguments in this case is that giving notices under section 443B (3) of the Corporations Act was enough to effect the giving of “possession” under Article XI (2) of the Cape Town Protocol and the administrators did not have to hand back physical possession in Florida, but rather only provide the opportunity to take possession in Australia. They argued this is the manner in which Article (IX) (2)  of the Cape Town Protocol should be read.

What is at stake?

At risk of oversimplifying the legal subject matter being dealt with in this case, the central issue of this case is who pays the costs and expenses in respect of the repossession of the engines – Wells Fargo (or the administrators of Virgin)?

If the courts accept the position of:

  • the administrators of Virgin, then the costs and expenses of repossession would be for Wells Fargo. This is because the administrators say they have done what they have to do to give possession back under Article XI (2) of the Cape Town Protocol. By giving a Section 443B Notice the administrators say that they have given Wells Fargo the opportunity to take possession and therefore no other action including the incurrence of costs and expenses should be incurred by the administrators. In that case, Wells Fargo would then prove in the insolvency as an ordinary unsecured creditor for those costs and expenses.

  • Wells Fargo then the costs and expenses of repossession would be for the administrators of Virgin. Wells Fargo are of the view that to give possession under Article XI (2) of the Cape Town Protocol requires the notion of physical possession and the administrators must take action to give physical possession and also incur the costs and expenses of doing so. The practical effect of this is that the administrators would apply funds from the insolvent estate, which would have otherwise been available for distribution to creditors generally, to meet those costs and expenses.

The decision before Middleton J at first instance and the subsequent appeal to the Full Federal Court

On September 3, 2020, Mr Justice Middleton handed down judgment in favour of Wells Fargo ordered the administrators to redeliver Wells Fargo’s leased engines by transporting them to Florida at the administrators’ cost, as required by the terms of the lease agreements. John and Cameron Mew outline the decision of Justice Middleton here.

The administrators appealed the decision of Mr Justice Middleton and Justices McKerracher, O’Callaghan and Colvin of the Full Federal Court accepted the arguments of the administrators that the giving of a Section 443B Notice was effective to give possession under Article XI (2) of the Cape Town Protocol and upheld the appeal on 7 October 2020. One of the key points in the decision of the Full Federal Court was that the Cape Town Convention and the Cape Town Protocol “were not intended to operate in a way that would result in … a reworking of generally accepted principles of insolvency law” by in effect requiring funds from the insolvent estate, which would otherwise be available for distribution to creditors generally, being used to meet the costs and expenses of effecting redelivery of the engine in priority to any other claim [FN3]. To read about the Full Federal Court decision read the commentary of John and Cameron Mew.

Special leave application to the High Court of Australia

Wells Fargo lodged an application for Special Leave to appeal the decision of the Full Federal Court. In Australia, Special Leave to the High Court is granted in cases if the High Court considers, among other matters, the case is of public interest/importance or will usually raise new points of law.  On 12 April 2021, Chief Justice Kiefel and Justices Gordon and Steward granted Special Leave to Well Fargo to appeal the decision of the Full Federal Court. Whilst not specifically addressing why Special Leave was granted the bench of Chief Justice Kiefel and Justices Gordon and Steward obviously are of the view the case will raise new points of law. If one can take anything from the transcript of the Special Leave Application [FN3] there is no doubt the High Court and its interest in the interplay between the additional remedies provided under application of the Cape Town Convention and the Cape Town Protocol and the interplay with the administration provisions of Part 5.3A of the Corporations Act has led to the application being granted as it does involve new points law to be determined.

Arguments before the High Court

Summary of Wells Fargo’s Submission

The Full Federal Court erred because:

  1. To “give” possession under Article XI (2) of the Cape Town Protocol is to confer a self-help remedy on the part of Wells Fargo to retrieve the engines which requires the giving of physical possession and not just the opportunity to take possession.

  2. It was not necessary to read into Article XI (2) that the words in accordance with the lease agreement for Well Fargo to succeed because Wells Fargo can exercise remedies under its lease as:
    1. The Cape Town Convention as modified by Article XI of the Cape Town Protocol applies to the exercise of remedies under Article XI (13).
    2. Any remedy must be exercised in a commercially reasonable manner
    3. Article XI (3) of the Cape Town Protocol establishes a safe harbour provision by providing that “a remedy shall be deemed to be exercised in a commercially reasonable manner where it is exercised in conformity with a provision of the agreement except where such a provision is manifestly unreasonable.” (There was no suggestion in this case that the redelivery obligations in the lease were unreasonable).
  3. It may be necessary for the administrators to expend funds of the airline to undertake redelivery of the engine in accordance with the lease. This is the very priority provided by the Cape Town Convention and the Cape Town Protocol that reduces risk to the finance industry even if it comes at the cost of other creditors.

Summary of Virgin and Administrator’s Submission

The decision of the Full Federal Court is correct because:

  1. The phrase “give possession” does not entail a physical transfer of possession of the engines to Wells Fargo. Possession may be given by “disclaiming any intention to exercise control over an object in favour of another such that possessory title is being ceded to that person and that person may choose to take up the possessory title” [FN4].

  2. Wells Fargo’s interpretation of Articles XI (3) and XI (13) of the Cape Town Protocol does not assist their case as the technical interpretation should be that Article XI (13) because Article XI (2) is a mandatory obligation on the administrator not a conferral of a remedy.

  3. To say to give possession requires redelivery is not correct as the Cape Town Protocol provides the insolvency administrator is acting in their official capacity under Article XI (4) of the Cape Town Protocol which indicates a strong contextual indication that (a) costs in redelivery if the engines are self-evidently to be significant costs, (b) an insolvent estate may not have the requisite funds, regulatory approvals and technical resources to  process redelivery of the engines and (c) such cost could personally fall on an administrator.

  4. For the administrator to meet the costs of redelivery would be to prioritise creditors holding international interests in aircraft objects, in this case Wells Fargo as the owner of the engines under a lease, and Article XI of the Cape Town Protocol. This is not the correct construction as Article XI (13) applies to Article XI remedies as to priority of rights or interest and not the priority of the creditors to the funds of an insolvent estate.

Observations from a practitioner’s perspective

The matters for decision before the High Court are very technical from a legal standpoint.

There are several matters which are important to discuss from a practical perspective for those in the aviation industry. 

As practitioners and having advised most of the lessors, financiers, and suppliers across the Virgin fleet we note the following matters will need to be considered by the High Court to provide  outcomes that are certain for lessors, financiers, and suppliers seeking to apply the remedies available under the Cape Town Convention and the Cape Town Protocol in Australia.

1. The Policy behind the Cape Town Convention in Australia - It is clear from the second reading speech and the explanatory memorandum that when the Australian Federal Parliament introduced the Cape Town Convention and the Cape Town Protocol were introduced in 2015 it was intended to overcome deficiencies in the insolvency regime which arose from the Ansett administration in 2001 [FN5].

To qualify for export credit discounts under the OECD Aircraft Sector Understanding (ASU) [FN6] Australia had to adopt the Cape Town Convention and the Cape Town Protocol and, Article XI of the Cape Town Protocol (Alternative A) which obliges the insolvency administrator to give possession of aircraft objects within 60 days of the insolvency.

The Parliament in the second reading speech and the explanatory memorandum detailed that any additional remedies  are to include the right to take possession and for a debtor to automatically transfer possession, as the remedies reduce the time it takes for a creditor to take possession and be recompensed.  Whilst the second reading speech and the explanatory memorandum did not refer to the debtor being required to give or transfer physical possession the intent was clearly to provide a better and additional remedies to a creditor for “the expeditious recovery of assets in an event of default”. [FN5 ibid at para 4.4.]

The Full Federal Court considered that the second reading speech of the Parliament has no bearing on the interpretation of the Cape Town Convention and the Cape Town Protocol.  The Full Federal Court concluded that the interpretation lie within the actual words of the Cape Town Convention and the Cape Town Protocol on the basis that “it would follow that any construction of the Convention or Protocol that could be said to make cheaper the provision of credit to airlines would be favoured as a matter of construction, which strikes us as unlikely, and inconsistent with the well-established principles governing the interpretation of treaties.”

The policy and intent of the Cape Town Convention and the Cape Town Protocol is reduction of risk and costs and the aviation industry in Australia. Whilst Australia has taken the step to introduce the Cape Town Convention and the Cape Town Protocol ongoing compliance is critical to the confidence of lessors, financiers, and suppliers. Australia has recorded the highest score out of any country of 94.5/100 with the Aviation Working Group, the international body which monitors compliance with the Cape Town Convention and the Cape Town Protocol. If the High Court find in favour of the administrator’s arguments there is clear risk Australia’s compliance score will be downgraded with the result that lessors, financiers, and suppliers may wish to factor in a repossession analysis which is not as robust as it stands at the moment. Solutions possible to overcome an adverse repossession analysis would be:

  • An increase in pricing after a reassessment of the repossession risk resulting in higher margins and lease rates.
  • The introduction of a liquidity facilities or other third-party support to a financier or lessor like that those used in an asset back securitisation which enhances the underlying corporate credit of an airline by providing an ability to repossess and remarket the leased aircraft within a period during which interest would continue to be paid by a liquidity facility.
  • Increased security deposits in cash or LC backing drawn on in an event of insolvency to cover the costs of repossession.
  • Introduction of ongoing cash collateral or LC’s in certain circumstances, e.g. for breach of LTV ratios (including anticipated repossession costs).

Each of these options which would only serve to increase the overall pricing of any lease rates or financing costs to an airline which will not be in the interest of Australian airlines and which is arguably inconsistent with the intent behind the introduction of the Cape Town Convention and the Cape Town Protocol in Australia

2. Insolvency position before Cape Town – to understand the current arguments and position before the High Court one must understand the remedies open to lessors and financiers before the introduction of the Cape Town Convention and the Cape Town Protocol.  In the case of a lease or a mortgage over an Aircraft prior to the introduction of the Cape Town Convention and the Cape Town Protocol a lessor or mortgagee had limited remedies to repossess an aircraft in a timely manner in an administration. 

As the insolvency law stood before the introduction of the Cape Town Convention and the Cape Town Protocol:

  • A mortgagee who has a mortgage over an Aircraft with an Airline in Australia was subject to a moratorium during an administration and could not enforce their Mortgage and repossess an Aircraft unless mortgagee had security over all or substantially all of the assets of a company. If it did not have such security, the mortgagee could not enforce it security over an Aircraft without the consent of an administrator or without the leave of the court [FN8]. Most operating entity of Airlines do not finance their Aircraft with one financier so, most financers do not hold security over all the assets of an airline and hold separate mortgages over each Aircraft: or

  • in the case of a leased asset, an administrator could elect to use an Aircraft within the 5 business day period from its appointment on the basis that the administrator is personally liable for costs associated with the use of the Aircraft during the period of the administration (rent, insurance storage maintenance) [FN9].  In the case of a large airline enterprise an administrator cannot in most cases, determine in that 5 Business Day period, they wish to use Aircraft. In the case in the Ansett and the Virgin Administrations it is open to the administrator to apply to the court to extend this 5 Business Period. This occurred in both Ansett and Virgin administrations.  Also, in the Virgin. Pre Cape Town, even if an administrator did not elect to use an Aircraft gave a Section 443B Notice and this did not mean that a lessor had right to repossession although the Section 443B Notice would be a relevant factor if a the lessor could apply applied to the court to repossess in certain circumstances the aircraft.

The Ansett administration took place after the introduction of the insolvency administration provisions of the Corporations Act but many of the transactions predated those provisions and just involved a mortgage transaction which was not helpful in a repossession due to the moratorium outline above. 

After Ansett and before Cape Town we developed structures with financing clients which would limit the impact of the administration provisions outlined above by interposing an SPV Asset owning entity which then leased the Aircraft to the airline operating entity. By taking all assets security over the SPV and leasing to the Airline in an insolvency the financiers could at least take control over title to the Aircraft and enforce as against the SPV negotiating return of the Aircraft with the administrator under a lease. Under this structure whist an improvement, creditors still faced uncertain timelines to repossess and have physical transfer of the Aircraft to them. 

3. The meaning of “possession” on appeal – under the Cape Town Convention and the Cape Town Protocol the words “give possession” in Article XI (2) means that any insolvency administrator had an obligation to give possession to the creditor after 60 days of the insolvency event. This change to the law gave lessors and financiers certainty. If the administrators’ argument is successful on appeal in the High Court, it means that the administrators are only under an obligation to give the parties opportunity to take possession after the 60-day waiting period without a physical transfer of the Aircraft.

If this is correct, then in an insolvency scenario the remedy available as to the timing of the physical return of the aircraft is considerably weakened and offers no better protection in a practical sense in terms of physical return of an Aircraft than before the introduction of the Cape Town Convention and the Cape Town Protocol. If in the case of a leased aircraft, an administrator can discharge the obligation for the physical return of the Aircraft by giving a Section 443B notice then there is no real difference in the position prior to Cape Town.  Also, in the case of a mortgage although the remedies are different in the case of all-assets security if a similar approach is adopted then a mortgagee (or a receiver who is appointed) may face the same hurdle in obtaining physical possession of the Aircraft. This outcome in our view is against the policy and the legislative intent of Parliament enacting the International Interest in Mobile Equipment (Cape Town Convention) Act 2013 (Cth)).

Most repossessions are negotiated outcomes and in this Covid - 19 world, repossessions of aircraft do not happen quickly. This fact along with current judicial interpretation as it stands in practice will extend the period that lessors and financiers face getting their “hands on” the aircraft which is important in mitigating their loss if there is a lease or resale opportunity available. Whilst there has been a change in the law to “give possession” after the mandated 60-day period, the interpretation of the law currently as it stands favours any insolvency officer and the debtor to the detriment of any creditor.

4. Does the Cape Town Convention override domestic insolvency law?

One of the findings of the Full Federal Court on appeal was that “the Convention and the Protocol were not intended to operate in a way that would result in such a reworking of generally accepted principles of insolvency law”. Coupled with the finding that the insolvency administrator only needs to offer the opportunity to give possession the Full Federal Court found the obligation to pay for costs of redelivery ceases at that point.  The view that to do otherwise would give holders of international interests of aircraft objects priority over other creditors in addition to priority claims over costs of the administration and statutory claims. It was held if that construction was adopted then it would burden an insolvency administrator with having to satisfy priority claims in relation to international interests under the Cape Town Convention and the Cape Town Protocoin priority to other creditors.  

Section 8 of the International Interest in Mobile Equipment (Cape Town Convention) Act 2013 (Cth) provides that the “The provisions of the Convention and the Protocol prevail over any laws of the Commonwealth (other than this Act), and any law of a State or Territory, to the extent of any inconsistency.”  During the arguments, court proceedings and the judgements given in the matter this Section 8 has not been directly debated raised or addressed. In our minds there is arguably a clear inconsistency. 

The issue of what is meant to “give possession” under Article XI (2) of the Cape Town Protocol should be considered separately from the issue of the priority of the costs of repossession by exercise of remedies as it relates to the recovery of the aircraft objects for a creditor. Costs of repossession and the resultant hand back of possession are separate matters for the High Court to consider in the context of Section 8 of the International Interest in Mobile Equipment (Cape Town Convention) Act 2013 (Cth).

We will be monitoring the High Court hearing and its ultimate bearing on these matters in the coming weeks.

FN1 - https://www.unidroit.org/status-2001capetown-aircraft2 - http://www.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/FCAFC/2020/168.html   

  • at paragraph 104 and 105

FN 3 - http://www.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/HCATrans//2021/63.html

FN4 - https://cdn.hcourt.gov.au/assets/cases/08-Sydney/s60-2021/Wells_Fargo-VB_Leaseco_Res.pdf - see para 26

[FN5] - https://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/Bills_Search_Results/Result?bId=r5085

[FN6] - https://www.oecd.org/trade/topics/export-credits/arrangement-and-sector-understandings/aircraft-specific-rules/

[FN7] - http://awg.aero/project/cape-town-convention/#compliance-with-the-cape-town-convention

[FN8]- Section 440B of the Corporations Act (Cth)

[FN9] - Section 443B of the Corporations Act (Cth)

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