What does the Cape Town Convention entail for Airlines’ Insolvency?

By Deepanshi Gupta & Rajat K. Mittal

India has embarked on a significant stride towards harmonising its aviation industry with global benchmarks. The Ministry of Corporate Affairs (“MCA”) issued a notification dated 03 October 2023 (“MCA Notification”), thereby excluding aircraft, aircraft engines, airframes, and helicopters from the scope of the moratorium outlined in section 14(1) of the Insolvency and Bankruptcy Code (“IBC”). This action was taken in accordance with the provisions of the Cape Town Convention and Protocol.

To understand the remedies available to aircraft lessors under the Cape Town Convention (as declared by India) in insolvency proceedings of a corporate debtor (airlines), contextual background and implication of the MCA Notification, read our article ‘Aligning IBC with Cape Town Convention: A Relief for Aircraft Lessors?’. Now, let us elaborate on the Cape Town Convention and Protocol.

INTRODUCTION TO THE CAPE TOWN CONVENTION AND PROTOCOL

In 2001, 53 countries adopted two documents, namely the Convention on International Interests in Mobile Equipment (the “Convention”) and an associated Protocol to the Convention on Matters Specific to Aircraft Equipment (the “Protocol”), collectively referred to as Cape Town Convention (or “CTC”). As per Article 6 of the Convention, this Convention and the Protocol shall be read and interpreted together as a single instrument. It supersedes the Convention on the International Recognition of Rights in Aircraft signed in Geneva on June 19, 1948 (the ‘Geneva Convention’), and regulates transactions related to movable property of companies in the aviation, railways and space equipment sectors (‘i.e., mobile equipments’). As of 04 August 2023, there are 87 parties that have ratified or acceded to the Convention, out of which 3 have not ratified the Aircraft Protocol. India acceded to CTC in 2008.

The CTC is not a treaty imposed as a rigidly uniform regime across the Contracting States. Rather, it functions on the system of declarations allowing a Contracting State either:

WHAT CONSTITUTES INTERNATIONAL INTERESTS UNDER CTC?

Article 7 of the Convention read with Article V of the Protocol sets forth the following specific requirements for creating an international interest or contract of sale—(i) it must be in writing, (ii) must relate to an aircraft object that can be disposed of by an involved charger, conditional seller, lessor or seller, (iii) must specify the aircraft’s details (serial number, manufacturer, model), and (iv) for security agreements, outline the secured obligations. The CTC, and not national laws, determines when an international interest is established. No additional conditions (like situs laws or registration) are needed.

Concerning the aviation sector, the CTC facilitates the acquisition, financing and leasing of airframes, aircraft engines and helicopters (i.e., the “Aircraft Objects”) by way of the creation of an international interest that all contracting states must recognise. The creation of ‘interest’ granted by a chargor under security agreements, vested in a lessor under lease agreements, or vested in a conditional seller under title reservation agreements relating to aircraft objects (hereinafter referred to as “international interests” or “transactions relating to aircraft objects”) is the foundation on which CTC, is applied. Certain provisions of the Convention, as outlined in Article III of the Protocol, have also been extended to apply to a ‘contract of sale’ and ‘prospective sales’ of aircraft objects. The creation of an international interest is determined by the application of CTC’s own rules of interpretation and not by national law.

PRIORITY OF THE REGISTERED INTERNATIONAL INTERESTS

CTC provides for an International Registry, for the registration of prospects, creation, assignment or acquisition of ‘international interests’, etc. The International Registry, set up in Dublin, is supervised by the International Civil Aviation Organization (ICAO”). Although registration is not mandatory, failure or delay to register an international interest renders such ‘unregistered international interest’ or ‘subsequently registered international interest’ below the competing registered interests even if the unregistered interest was known to the holder of any registered interests at the time of such registration.

For instance, the lessor leases an aircraft to the lessee and delivers possession of the aircraft object to the lessee. However, they failed to register the international interest in the lease with the International Registry. Later, the lessee subleases the same aircraft to the sublessee (whether or not such sublease is permitted under the lease) and registers this sublease interest with the International Registry. In this case, the sublease interest (being registered) takes priority over the lessor’s lease interest. This means that the sublessee retains the right to possess and use the aircraft, for the duration of the sublease, even if the lessor-lessee lease is terminated.

In case of insolvency, international interest will be recognized and have priority if it is registered before the commencement of the insolvency proceedings and will not be limited to sharing equally with unsecured creditors. However, it does not protect a registered international interest against rules of law relating to the avoidance of preferences and transfers in fraud of creditors (commonly known as clawback provisions). An unregistered international interest may nevertheless be effective, but would not have priority over the registered one, subject to national law. Hence, if the national law prioritises the unregistered interest in insolvency, then despite the CTC, this would remain secure, potentially taking precedence over sublessee interest.

Therefore, to protect its interest in such cases, it becomes imperative for a creditor to ensure that all potential sales and interests in its favour have been properly registered with the International Registry.

Rights declared to be in priority over registered international rights:

A Contracting State is empowered under the Convention to declare certain national rights or interests (conferred under the national law) that take precedence over the registered international interests. Such rights and interests are declared under Article 39 and are attributed as ‘non-consensual rights or interests’.

Under Alternative A, only those non-consensual rights or interests take precedence over registered interests in insolvency proceedings that are declared under Article 39(1) of the Convention. This would mean that in the absence of such a declaration, other categories of debt, like taxes or unpaid wages, would not override the priority of an international interest. Consequently, India has declared certain rights to be prioritised which include—(a) liens for unpaid wages of airline employees, (b) liens or other rights of Indian authorities for taxes or other unpaid charges related to the aircraft, and (c) liens of repairers for services performed on the aircraft.

Further, India maintains the right to detain an aircraft under its laws for amounts owed to the Government of India for the services provided by it in respect of that object or another aircraft object.

Registrable non-consensual rights or interests:

Unlike Article 39 which allows precedence of non-consensual rights and interests, Article 40 allows Contracting States to declare certain non-consensual rights to be treated and regulated as international interests itself. India has declared the following categories of rights to be registrable as an international interest—(a) liens in favour of airline employees for unpaid wages before a declared default, (b) authority liens for taxes related to the use of an aircraft, and (c) rights of a person who obtains a court order permitting the attachment of an aircraft object to satisfy a legal judgment. This means that these rights will have the same status as internationally registered interests.

It is to be noted that the liens for unpaid wages and of Indian authorities, as covered under Article 39 to take precedence, are those that arose since the time of a declared default under a lease or financing contract for an aircraft object. However, the liens for unpaid wages and of Indian authorities, as covered under Article 40 to be registered, are those that arose prior to the time of a declared default under a lease or financing contract for an aircraft object.

For instance, if unpaid wages (owed under a financing or leasing contract for an aircraft object) have arisen for work done after the declaration of default, those employees have a priority claim over a registered international interest. However, if the unpaid wages (owed under a financing or leasing contract for an aircraft object) pertain to a time period prior to the date of declared default, a lien in favour of such employees can be registered as an international interest. This registered lien then holds a special status, similar to internationally recognized interests.

CONCLUDING REMARKS

As the CTC does not prevail over the conflicting national law (IBC), the effectiveness of the CTC remedies and India’s declarations hinges on the enactment of the ‘Protection and Enforcement of Interests in Aircraft Objects Bill, 2022’, published by the Ministry of Civil Aviation on 16th April 2022 for public consultation, see the light of the day. Despite its proposal in 2018 and publication of the Bill in 2022, the Bill has not been tabled in Parliament yet. It will be critical that such legislation expressly overrides inconsistent provisions in the IBC as well as the latter’s primacy clause, section 238 thereof. Enacting legislation giving CTC primacy over IBC and establishing CTC-compliant practices by the civil aviation authority and other government authorities responsible for the export of aircraft objects would not only bolster the compliance score by AWG but also open doors for the Organization for Economic Cooperation and Development (OECD) discounts.

ABOUT THE AUTHORS:

Deepanshi Gupta is an Advocate and Company Secretary with a focus on IBC, M&A and corporate transactions. She is the recipient of the Former President’s Gold Medal. Explore her published works at https://orcid.org/0000-0001-6598-642X or reach out to her at deepanshigupta228@gmail.com.

Rajat K. Mittal is an Advocate, specialising in corporate and commercial laws and project-finance deals. He can be reached at rajat.m1999@gmail.com.

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