11 Decemmber 2020
This article first appeared in Insurance Day, December 2020
As airlines continue to weather the pandemic storm, lessors are bracing themselves for an increasingly difficult landscape. In an appeal decision emanating from Australia last month, the Federal Court in New South Wales, handed down a decision that will weigh heavily on global decision-makers at banks and lessors.
Facts
The case arises out of the administration of Virgin Australia. The security trustee and lessor of four aircraft engines, sought their return (including all technical records) together with related accessories, from the administrators of Virgin Australia. The lessor asked the administrators to comply with their obligations under the Cape Town Convention to re-deliver the engines and ancillary equipment to Florida, in accordance with the terms of the lease.
However, the administrators took the view that the lessor will have to recover possession of the engines at their own cost on an “as is, where is” basis. The administrators then issued notice to inform the lessor that the engines were “on the wing of” four separate aircraft (all B737-800s), three of which were in Melbourne and one, in Adelaide.
The lessor made an application to the Federal Court in New South Wales seeking an order that its engines, engine stands, Quick Engine Change (QEC) units and accessories together with all relevant technical records be delivered up to the lessor’s facility in Florida, USA in accordance with lease terms.
First instance decision
Central to the dispute is the interpretation of the administrators’ obligations under the Cape Town Convention, and more specifically, under Article XI(2) of the Aircraft Equipment Protocol to “give possession” of the engines and accessories.
On 3 September 2020, Middleton J of the Federal Court of Australia ordered the administrators to deliver up the engines and related accessories (termed as “aircraft objects”) to the lessor’s facility in Florida. He also directed that until such time as the administrators give possession in accordance with the court’s order, the administrators preserve the aircraft objects by maintaining the engines in a prescribed manner and also maintain insurance cover over the aircraft objects.
The Cape Town Convention is intended to create an international legal framework that protects and prioritises lenders/lessors of aircraft, airframe and engines. As Middleton J puts it: “The adoption of the Convention and Aircraft Protocol was to assist local Australian airlines to have access to cheaper finance.”
Appeal
The administrators appealed. In an expedited appeal heard by the Full Federal Court of Australia, the appellate court of three justices overturned the first instance decision.
The appeal court held that “the terms of the Convention do not expressly confer on creditors (which are defined in Art 1 to include lessors under a leasing agreement) the right to enforce provisions of their agreement to require redelivery on default or termination. Rather, they confer remedies that include the self-help remedy of being able to take possession”. The Federal Court seemingly took the view that to “give possession” in Article XI(2) means the same as “to give the opportunity to take possession”. In other words, the administrators’ decision to abandon the engines “on wing” to the lessors was justified.
The Federal Court accepted the administrators’ argument that “possession” in Article XI(2) does not mean giving possession in accordance with the underlying lease because there is no reference in Article XI(2) to any underlying agreement between the parties.
This conclusion is difficult to reconcile with Article IX(3) which requires any remedy exercisable under the Convention be exercised in a “commercially reasonable manner” and 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.” On the face of it, it could hardly be said to be “commercially reasonable” to expect a lessor to exercise its remedy of repossession in a manner which requires it to incur significant expense and is contrary to the terms of the bargain that had been struck between the parties.
In observing that “…, if there is an insolvency administration, then under the Convention, the creditor must conform to the requirements of the domestic law as to the procedures by which it may enforce its rights to the property”, the Federal Court seems to have disregarded the general rule of interpretation set out in the Vienna Convention on the Law of Treaties which calls for a treaty to be interpreted “in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in light of its object and purpose” rather than subjected to requirements of domestic law. The Court also seems to have departed from the purposive approach to construction of international treaties advocated by the Australian High Court in Povey.
Far-reaching implications
This case will have far-reaching implications beyond the aviation finance industry. For now, the decision is confined to Australia and there are signs that the decision may yet be appealed. Any appeal will be to the Australian High Court. However, until a different outcome is determined, and given that the decision, as it stands, relates to an international treaty, courts of other treaty jurisdictions may well follow suit.
The economic benefits of the Cape Town Convention and the Aircraft Equipment Protocol will be eroded if banks and lessors are faced with the daunting prospect of having to repossess their assets in locations where those assets are being deployed. This will have a knock-on effect on the cost of doing business. Prudent lessors with comprehensive contingent aviation coverage should be able to call upon their policies to help defray certain repossession expenses. That said, the scope of coverage for repossession expenses is often limited. Typically, coverage would not extend to assist lessors with airports or repairers’ liens or legal costs for repossession proceedings.
Nevertheless, in the midst of every crisis, lies opportunity. It would be opportune for banks and lessors to engage with their insurers on the scope of coverage and for insurers to assess exposure following this decision.
For further information, please contact:
Peng Lim, Partner, Kennedys
Peng.Lim@kennedyslaw.com
