ANALYSIS: The significance of AirAsia X's recent court judgement

Written by my colleague Michael Allen

A "seminal" judgement from a Malaysian court about AirAsia X's restructuring under a scheme of arrangement has significant implications for the aircraft leasing industry, both for lessors with exposure to the carrier and those unexposed.

"Not only is this intellectually interesting, but also it is going to be very important down the road with potentially some more airline restructurings going on in the next couple of years or so," says Simon Wong, a partner at Stephenson Harwood in Hong Kong who is involved with the restructuring.

"It's both complicated but at the same time very interesting for us lawyers. We have been discussing this issue within our firm with different offices where we have aviation partners and people in other firms are very interested."

Published on 19 February, the judgement from the High Court of Malaya in Kuala Lumpur gives AirAsia X the go-ahead to convene a creditors' meeting to vote on its restructuring under a scheme of arrangement.

Further to that, a Malaysian court will decide on 19 March AirAsia X's application for a restraining order that prevents creditors from bringing legal actions against it during its restructuring. Cirium understands that some creditors are objecting to that application.

AirAsia X has declined to comment for this article.

SUMMARY OF THE KEY RULINGS

Some of the key rulings include, firstly (1), that both lessors' security deposits and maintenance reserves, as well as pre-delivery payments (PDPs) made to OEMs, do not constitute security interests. Both lessors and OEMs are therefore unsecured creditors, but the court put them into different classes of creditors for reasons explained below.

Secondly (2), a scheme of arrangement (a type of debt restructuring process) in the eyes of Malaysia's judicial system does come under the ambit of the Cape Town Convention (CTC), a treaty that protects the rights of lessors.

Thirdly (3), that protection under the CTC extends not only to lessors' aircraft assets themselves, but also the lease rental payments.

Fourthly (4), an airline can use a cramdown mechanism – whereby the minority creditors are essentially forced to consent to a restructuring, especially in relation to the haircut on damages recoverable by creditors â€“ in the Malaysian scheme of arrangement, as long as it terminates current leases and invites lessors to enter new leases on a voluntary basis. If it modifies existing leases without lessors' consent, those lessors cannot be crammed down.

(1) CLASSIFICATION OF CREDITORS

In a scheme of arrangement, a court places creditors into different classes, with each class being able to vote on the scheme.

The 19 February judgement finalised the classes each AirAsia X creditor would be placed in.

Fifteen parties – including lessors, a bank, Malaysia Airports and Airbus – opined that the classification of creditors in AirAsia X's scheme of arrangement was "wrong", the judgement states. They said that "in particular" the lessors are wrongly classified as "secured creditors".

Classification of creditors has also been a contentious issue in other restructurings in the region, such as that of Malaysia Airlines, during which lessors were concerned about being placed into a single class and subjected to a cramdown mechanism which would have forced them to consent to that airline's restructuring.

The classification of creditors is important because if at least 75% in worth in each class of creditors approve the scheme, objecting creditors who are in the minority may still be bound by its terms. That is to say, even if you disagree with the restructuring, you may still have to comply under law.

Stephenson Harwood's Wong says the reason why lessors objected to the classification was because one single creditor, aircraft manufacturer Airbus, is according to AirAsia X's calculation already owed more than 75% of all debts by way of compensation for uncompleted aircraft ordered by the airline.

Airbus had originally been placed in 'Class A' – along with lessors, Malaysian Airports and some other creditors – as a secured creditor. The other category was 'Class B' for unsecured creditors. This would mean that Airbus alone could approve the scheme of arrangement, regardless of the opinion of other creditors in its class. Essentially, lessors within the same class would have been forced into consenting to the scheme of arrangement.

Whether lessors are secured or unsecured creditors boiled down to whether deposits AirAsia X paid as part of lease agreements are considered to be the lessors' "absolute property" or whether they are regarded as lessors having security over an asset of AirAsia X.

When leasing aircraft to airlines, lessors require a security deposit payment or payments, calculated based on the risk associated with leasing to a particular carrier.

Maintenance reserves, meanwhile, are payments that protect lessors if a lessee defaults ahead of a scheduled maintenance event. Airlines are responsible for maintenance under operating lease agreements.

Wong says the lease agreement makes it "very clear" that security deposits are lessors' "absolute property", rather than being securities.

"That is to say, you [the airline] no longer have any proprietary interest in the security deposits or MR [maintenance reserves] that have been given to us [the lessors]. It is only upon the satisfaction of the terms and conditions on the lease agreement that you will be given back the remaining sum," Wong says.

Judicial Commissioner Ong Chee Kwan, who made the 19 February ruling, determined that AirAsia X has "really no legal basis to treat [lessors] as secured creditors" and therefore put lessors into 'Class B' along with other unsecured creditors.

PDP PAYMENTS

In addition, AirAsia X had argued that its pre-delivery payments (PDPs) made to Airbus represented security interests and therefore Airbus should be considered a secured creditor.

Ong also ruled against AirAsia X on this point, saying that the PDPs "clearly do not make Airbus a secured creditor at all", because the PDPs are considered part payment for the aircraft, are not required to be held separately as security by Airbus, and that Airbus is the "absolute owner" of the PDPs.

However, while Ong considered Airbus to be an unsecured creditor, he decided not to put Airbus into the unsecured 'Class B' with the lessors but instead created a special class containing Airbus only. This is because he believes Airbus to be in a more favourable position than the lessors.

"[Ong] effectively said in his judgement that Airbus's commercial position is entirely different from that of the lessors as Airbus has been receiving progress payments during the manufacture process and Airbus could either resell the aircraft or reach fresh agreement with AAX," Stephenson Harwood's Wong says.

"In contrast, lessors are going to suffer significant actual loss [in the event of a default], having invested a lot in acquiring the aircraft leased to AAX."

That means, then, that Airbus will be able to control the vote in its class, but since no other creditors are in the same class, there is no risk for other creditors to have their voting power quashed by Airbus's outsized debt claims.

(2) THE CAPE TOWN CONVENTION

The Aviation Working Group (AWG) – which includes aircraft manufacturers, lessors and aviation finance institutions – has called the 19 February judgement "seminal".

This, it says, is because the judgement endorsed the concept that a scheme of arrangement is indeed an "insolvency proceeding" for the purposes of the CTC.

The CTC, concluded on 16 November 2001, is an important treaty for lessors as it helps them get aircraft back from tricky jurisdictions when there is a dispute in the lease contract.

Countries that sign up for the CTC can choose between two versions. Malaysia chose to adopt 'Alternative A', the version that gives more protection to creditors.

'Alternative A' is "specifically designed to meet the requirements of advanced structured financing and to give certainty as to the right of a secured creditor to repossess a qualifying aircraft asset after a specified waiting period," according to law firm Walkers. 'Alternative B' is often referred to as a "soft" version of the CTC, according to law firm Gowling WLG, and offers "much less" protection to secured creditors, such as not specifying time periods that the debtor must respect.

Part of 'Alternative A' stipulates that "upon the occurrence of an insolvency-related event... no obligation of the debtor under the agreement may be modified without the consent of the creditor". This arguably prevents lessors from being subject to a cramdown, since cramming them down to make lease modifications would not be consensual.

AirAsia X argued, however, that that part of 'Alternative A' does not apply here because a scheme of arrangement (unlike an outright liquidation) is not an "insolvency-related event" as defined in the CTC.

The CTC defines an insolvency-related event as involving a court taking over control over the business and assets of the airline, Stephenson Harwood's Wong explains. Under a Malaysian scheme of arrangement, AirAsia X's directors would retain control, although the court would supervise the scheme.

Judicial Commissioner Ong accepted lessors' argument that the overall supervision exercised by the court over the scheme of arrangement process is enough control to bring a Malaysian scheme of arrangement under the ambit of the CTC, even if AirAsia X's directors still retain control of the company.

"This is the first time any court anywhere has actually passed a judgement on this issue, and this is why this is a landmark case," says Wong.

Ong's judgement here could be favourable to lessors subject to schemes of arrangement in other countries and jurisdictions, but it depends on how much significance overseas judges ultimately decide to attach to Ong's judgement.

Wong adds: "It remains to be seen whether courts elsewhere would give weight to this Malaysian judgement in future cases."

(3) A GUN TO THE HEAD

AirAsia X further argued that the protection offered under this part of 'Alternative A' extends only to lessors' interests in their tangible aircraft assets, but that they do not extend to claims against things like lease rentals and lease termination compensation.

Therefore, the airline added, the scheme of arrangement does not alter any of the lessors' rights relating to their aircraft and so they cannot be excluded from the scheme. This is because AirAsia X is not stopping lessors from repossessing their aircraft if they want to.

Lessors disagreed with AirAsia X on this point. Ong noted that it is important to consider the "practical and real effect" if those lessors' position were taken to be correct.

According to AirAsia X as relayed by Ong, the lessors' opinion that things like lease rentals are covered by the protections of Alternative A would mean that "one lessor with a small debt can effectively put a halt to any schemes of arrangement worldwide by withholding consent. It would therefore allow a lessor with even a small debt to put a gun to the head of not just the debtor, but to that of every other creditor."

Despite AirAsia X's argument and the "gun to the head" effect such an interpretation could cause, Ong sided with the lessors, ruling that "there can be no doubt that the phrase ['obligation of the debtor under the agreement'] must include the obligation of the debtor to pay the rentals under the agreement".

To restrict the meaning of the word "obligations" to only those relating to the aircraft asset itself would be to "read into the articles words which are simply not there", he said.

(4) LESSORS NOT SPARED FROM PARTICIPATION

Despite the interpretation of lessors' interests under Alternative A, Ong ruled that it does not necessarily mean that lessors can be excluded from AirAsia X's scheme of arrangement.

Those protections mean the airline cannot vary its obligations under its lease agreements. However, AirAsia X is not proposing under the scheme of arrangement to modify existing lease agreements. Rather, it wants to terminate everyone's lease agreements, then invite lessors to enter into brand new lease agreements on new terms on a voluntary basis.

Ong ruled that this approach would not violate the protection afforded by Alternative A, and therefore lessors could still be crammed down.

"This part of the ruling puts lessors in a tricky position", Stephenson Harwood's Wong says, noting that the amount of compensation or damages lessors could get if they decline to enter into new leases with AAX after having their leases terminated will be controlled by the scheme of arrangement and could be very low.

"As to how much damages you are going to get, whether it's 0.03% as AAX proposed or some other percentage, it all depends on the result of the creditors' meeting and the court sanction," he says.

It is, nonetheless, some comfort that lessors can get their aircraft back if they need to – the weakness of the A330ceo market notwithstanding.

"It is common ground between lessors and AirAsia X that AirAsia X will not, and cannot, retain an aircraft unless the relevant lessor agrees to renew the lease," Wong says.

"It is of comfort to note that the Cape Town Convention is, by and large, honoured in Malaysia, although there could be continuing debate regarding its interpretation, depending on which side you are on."

WHAT HAPPENS NEXT?

By mid-May, there will be a creditors' meeting – approved in the 19 February judgement – for creditors to approve or reject the scheme of arrangement. If they approve it in that meeting, the court is expected to approve the scheme of arrangement by the end of May.

That sanctioning stage would be the final of three stages of the scheme, the first two being the convening stage and the meeting stage. There is also an intermediate stage called the "negotiating phase" in between the convening stage and the meeting stage, during which AirAsia X and the creditors would negotiate with the goal of reaching agreements to ensure enough creditors vote in favour of the scheme.

"In the sanctioning stage, there could be further challenges – theoretically – in case minority creditors do not agree with the plan approved by the majority of the creditors," says Wong.

"If everything goes smoothly, hopefully when the creditors' meeting is convened actually everything is already agreed and there will be a smooth approval of the plan, so hopefully that will be what happens."

The section titled 'SUMMARY OF THE KEY RULINGS' has been amended to correct a misrendered court ruling (PDPs paid to OEMs do not, in fact, constitute a security interest); to remove a reference to a scheme of arrangement in Malaysia being 'court-led'; and to clarify that it is minority creditors who are forced to consent to a restructuring under a cramdown mechanism, especially in relation to the haircut on damages recoverable.