Navigating The Impact of Cape Town Convention: Indian Aviation Sector

The authors are Garv Arora and Ananya Badaya, third year students at Hidayatullah National Law University, Raipur.

This article was originally published with the Law School Policy Review, NLSIU, and has been cross-posted on this blog. The original publication can be found here.

Introduction

Insolvency proceedings in India are governed by the Insolvency and Bankruptcy Code, 2016 (IBC). It was enacted to protect the interests of stakeholders and restructure the enterprise so that it can remain in business. The insolvency proceedings in the aviation sector are also governed by the IBC. However, the highly capital-intensive nature of the aviation industry renders this code incapable of fulfilling its objective due to various reasons as discussed in the subsequent part of this article.

The Ministry of Corporate Affairs (MCA) has recently notified that “the provisions of sub-section (1) of section 14 of the Insolvency and Bankruptcy Code, 2016 shall not apply to transactions, arrangements or agreements, under the Convention and the Protocol, relating to aircraft, aircraft engines, airframes, and helicopters”. This notification is in line with the international standards provided by the Cape Town Convention (CTC) and provides for the smooth functioning of the insolvency process in the Aviation Sector. The provisions of IBC do not align with the CTC.  The convention became relevant after the recent case of Go First’s Insolvency where the NCLT denied GO First’s lessors to sequestrate the assets during the insolvency proceedings.

The aviation sector is considered one of the most capital industries. The costs involved in this sector are comparatively more than other sectors due to reasons like high taxes, fuel charges, and other akin expenses. The COVID-19 crisis affected the world economy, and the aviation sector is no exception. The aviation sector has faced major losses due to the imposition of lockdowns all over the world to curb the spread of coronavirus. As per the Ministry of Civil Aviation (MoCA), the loss incurred by the Aviation sector was about INR 28,907 crore in the last three years from FY 2020 to FY 2022. The effects of the COVID-19 crisis can be felt even today as various airlines struggle to survive. Hence, especially in these times when major aviation companies are becoming insolvent, there arises a need for a comprehensive legal framework to regulate the insolvency process, especially for the aviation sector.

This article highlights the inconsistencies of IBC for the insolvency process of the aviation sector and how the notification provides a much-needed relief to attenuate the problems faced by the lessors. Further, this article applauds the step taken by the government by incorporating the provisions of CTC. In doing so, the article is divided into three limbs. The first part explains the procedure that was followed for the insolvency of the Aviation sector before the notification. The second limb analyses the insolvency process of Go First Airlines and various issues that arose in the process. The third part deals with the Cape Town Convention and its related provisions and how it will impact the Indian aviation sector after its ratification by India.

IBC & Its Inaptness For The Aviation Sector

IBC was introduced in 2016 to make reforms in the ailing insolvency framework of the country. The code provides a comprehensive framework to deal with insolvency, winding up, or liquidation of debt-ridden companies. The IBC provides for a time limit-based insolvency process which is of 180 days, that can further be extended by 90 days to complete the insolvency process. The proceeding of insolvency is adjudicated by the National Company Law Tribunal (“Adjudicating Authority”) and it also established a dedicated regulator Insolvency and Bankruptcy Board of India (IBBI). The process of insolvency of an enterprise which is known as the Corporate Insolvency Resolution Process (CIRP) is divided into four stages: initiation, moratorium, and appointment of an interim resolution professional, control passing to the resolution professional and committee of creditors; and approval of the resolution plan.

CIRP is initiated by the application of the corporate debtor or by its creditor. The insolvency process can be initiated by Financial Creditors, Operational creditors, and by the corporate debtor itself. Once the application for insolvency is accepted by the Adjudicating authority, section 14 is enforced which leads to the initiation of the moratorium period. It provides that on the insolvency commencement date, the adjudicating authority shall by order declare moratorium on various stated things like “recovery of any property by an owner or lessor where such property is occupied by or in the possession of the corporate debtor”. It remains in force till the completion of the insolvency process or 180 days (that can be extended by 90 days in some cases), whichever is earlier. During the moratorium, no claims for recovery, enforcement of security interest, or termination of the lease agreement can take place against the corporate debtor.

In the Aviation sector, it is a general practice that the airlines choose to take aircraft on lease rather than buy them, to save expenses and gain access to new technical breakthroughs. This enables airlines to access a fleet of aircraft without having to make the significant upfront capital commitment necessary for buying new aircraft. The problem arises for the lessor when these airlines fail to pay the rentals or become bankrupt. The IBC does not provide a panacea for the smooth insolvency process in the aviation sector. There are various problems that are faced by the aviation sector while being governed by the provisions of IBC. Firstly, section 36(4)(a) of IBC provides that assets which are owned by the third party will not form part of the liquidation process but in the cases of a lease agreement, a lessee makes instalment payments which leads to the acquisition of equity in the leased asset. However, the recent trend shows that these leased assets are made part of the liquidation process. Secondly, the lessor is unable to take possession of leased aircraft during the moratorium and suffers huge losses. Thirdly, the aviation sector is highly capital intensive, and hence keeping the air fleet stranded for a long time during the moratorium period leads to huge losses and depreciation to the value of assets which subsequently affects the interest of the stakeholders. Fourthly, it is pertinent to note that where the assets involved in the process are stranded in a foreign country where the rights of the stakeholders cannot be enforced, the government of India has to enter into an agreement for the enforcement of the provisions of this code which in itself is a very time taking process.

Therefore, the aviation sector requires a comprehensive framework to protect the interest of the lessors against the provisions of the moratorium. The CTC provides an alternative that attenuates these above-mentioned issues to smoothen the insolvency process of the aviation sector.

Critical Analysis Of GO First Insolvency

There were multiple events that led to the ratification of the CTC and the recent GO First case provided the last hit for the implementation of the same. Go First, has initiated its voluntary insolvency under section 10 of the IBC. It owes over Rs 2600 crore to various aircraft lessors. The airline blames Pratt and White, the engine supplier of the airline for supplying faulty engines due to which it incurred heavy losses and opted for insolvency. It is the second airline to declare bankruptcy in the last four years. The application was allowed by the NCLT and hence the provision of the moratorium was enforced, and all the assets of the airline were freezed. The Airline lessors raised various issues that the application was admitted without giving them an opportunity to put forth their claim. The primary argument of the airline lessors is that they terminated the lease agreement before the admission of insolvency application by the NCLT and are entitled to possess and exporting of the leased aircrafts. The NCLAT affirmed the order of the NCLT and divested the lessors from repossessing planes as the insolvency process was underway.

The impact of the order of the NCLT can be seen as the Aviation Working Group (AWG), a global aviation leasing watchdog, has placed India on a watchlist with a negative outlook as India has failed to fulfill the International Aircraft repossession obligations. The international aircraft repossession norms are governed by the “Convention on International Interest in Mobile Equipment” also known as the Cape Town Convention (CTC). As a result, the AWG reduced India’s score on their Compliance Index to 2 from earlier 3.5 out of 5 points.

Go First case depicts the lacunae in the current insolvency process of the country which does not provide for repossession and deregistration rights to the lessor. Thus, this case became the driving force for the insertion of CTC in the insolvency process of the Indian Aviation Sector.

Need For CTC In The Spectrum Of The Indian Aviation Sector

CTC was introduced with the aim of increasing financing and leasing of aircraft by reducing lessor’s risk. This convention was finalised in Cape Town on 16th November 2001 with the “Protocol on Matters Specific to Aircraft Equipment” under the patronage of the International Civil Aviation Organization (ICAO) and International Institute for the Unification of Private Law (UNDROIT). The treaty came into force on 1st March 2006 with 57 signatories. The primary goal of the convention is to achieve efficient financing of high-value aircraft, engines, and spare parts through the way of lowering the risk of the lessor and thus creating various procedural remedies for the lessor. India became its signatory in the year 2008 but the Indian Parliament is yet to ratify this convention. The question pertaining to the hardships faced by the lessor in cases of insolvency of an airline has come up in various precedents. In DVB Aviation Finance Asia PTE Ltd. v. Directorate General of Civil Aviation, the Kingfisher Airline ceased operations in 2012 due to the continuous impact of the 2006 financial crisis. The lessor demanded the repossession of the aircraft but was denied as they were not deregistered by the DGCA. The lessor filed a writ petition against the Kingfisher and DGCA and the High Court ruled in its favour and directed the DGCA to deregister the aircraft and allow the lessor to take its possession. However, this judgment was not based on the CTC but shows the attitude of the court to safeguard the interest of the lessors. Furthermore, the international lessors had a bite to the dust to take possession of leased assets in the case of Jet Airways’ insolvency case.

Article XI of the CTC protocol provides a much-needed solution for the lessors in case of insolvency proceedings of an airline in the form of Alternative A and Alternative B. Alternative A provides the remedy to the creditors by allowing them to take possession of the leased aircraft upon the expiration of the waiting period, that is, sixty days as per the convention. The creditors are also entitled to speedy relief from the courts if the lessee fails to repay or agrees on some arrangement contrary to the lessor’s interest. Alternative B gives the discretion to the insolvency administrator on whether to give up the leased aircraft or continue to use it and pay the amount as per the agreement. Through this alternative, the airline continues as a going concern, and the rights of the lessors are also protected.

The Indian Parliament tried to implement this convention in India by passing bills on two occasions. Primarily in 2018 and then in 2022, the bill was not passed, and the IBC provisions continued to prevail. There is a quandary between the current Indian laws and the CTC as the IBC provides for the moratorium period which extends to about 180 days, that can be extended by 90 days, and under this period no lessor can claim or take possession of the lease aircraft. On the contrary, in the “Draft Protection and Enforcement of Interests in Aircraft Objects Bill, 2022”, the lessor will get possession of the aircraft after the waiting period, which is two months. The Indian parliament tried to overcome this lacuna by introducing the bills for the enactment of the protocol but the same were never passed in the parliament.

However, the recent notification issued by the MCA is in line with the CTC. It annuls the effect of section 14(1) of IBC pertaining to transactions, arrangements, or agreements relating to aircraft, aircraft engines, airframes, and helicopters. This notification comes as a relief for the lessors that their assets would not get stuck in case of initiation of the insolvency process against the airlines. Considering the need of the hour, the notification provides much-needed relief to the lessors, but this notification will not be applied retrospectively. Hence, the lessors of GO First may not get the relief as per CTC.

If the convention is rightly implemented in India, the lessors would be able to repossess the leased asset after the waiting period which is way less as per the time process in IBC. This notification will help in improving the fallen score of India in the compliance index of AWG which may lead to an increase in premium for the Indian airlines towards the lessors.

Conclusion

The aviation sector is highly volatile due to various factors like high cost, taxation, fuel price, etc., and has its own complexities. Thus, governing such a volatile sector with the same general law seems an arduous task. The IBC has various lacunae associated with it while dealing with insolvency in the aviation sector. The major problem is the moratorium period which works against the lessors’ interest. The recent MCA notification has the potential to provide confidence to asset financing or leasing companies in the aviation sector to invest in the Indian aviation Industry. The implementation of CTC will provide benefits to the lessors as well as to the airlines and to some extent the consumers as well.

In the wake of the GO first case, there may arise some distrust among the international lessors and hence it was high time for India to speed up things to implement the CTC, and this notification was in the right direction. By the implementation of this notification, the conflict between the IBC and the CTC can be resolved and a uniform practice can be established to protect the lessor’s interest and improve the score of India in the AWG’s compliance index.