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10 March 2021
This article examines the High Court's decision in AirAsia X Berhad v BOC Aviation Limited (Originating Summons WA-24NCC-467-10/2020).
On 19 February 2021 Judicial Commissioner Ong Chee Kwan allowed AirAsia X (AAX) Berhad's application under Section 366 of the Companies Act 2016 for leave to convene creditors' meetings to consider and approve an arrangement scheme. However, the judge disagreed with AAX's division of the scheme creditors into two classes:
The judge agreed with the submissions from the counsel for Malaysia Airports and the counsel for the lessors and held that:
The judge stated as follows:
What is clear is that the selection of creditors for the class composition cannot be arbitrary or capricious. If there is evidence of a calculated and dishonest move to remove or to place certain creditors in [a] certain class with the purpose of ensuring that the class is constituted in such a way that certain creditors would not be able to vote or that their votes would be rendered ineffective, this will be considered as class manipulation or gerrymandering.
The principal question for the court was the identification of the classes. It had to ensure that each class was properly constituted so that meetings for each class could be properly convened.
AAX still bore a duty of absolute transparency. It had to unreservedly disclose all material information to assist the court to:
The court had to be mindful of the possibility of class manipulation. It is incumbent on a company to propose a scheme fairly and not to manipulate the constitution of classes to satisfy the statutory requirements.
In its scheme application, AAX proposed that its debts – which amounted to approximately RM64 billion – be reconstituted into an acknowledgement of indebtedness for a principal amount of up to RM200 million, to be shared equally between secured creditors (Class A) and unsecured creditors (Class B).
As part of this restructuring exercise, AAX also intended to carry out a share capital reduction and a share consolidation and thereafter undertake a fundraising exercise to seek a fresh injection of funds for its operations.
AAX had originally placed all scheme creditors into one unsecured creditors class. After Malaysia Airports objected to its classification as an unsecured creditor, AAX filed an application to amend its classification by dividing the unsecured class into two classes – namely:
Three weeks later – while these amendment proceedings were ongoing – AAX further changed the definition of Class A to:
creditors who are critical or essential to the business of AAX and are considered to have a common or unified interest in the continuation of AAX as a going concern, some of whom may be able to assert secured rights. (Emphasis added.)
After leave to amend the classes was granted, AAX proposed to change the classification again to:
Scheme creditor classification
First, to answer the question of whether the matter of the class constituents should be determined by the court at the convening stage, or whether it was better left until after the proof of debts exercise or even the sanction stage (hereinafter the 'approval stage'), the court held in the affirmative for the convening stage. The judge found that:
the principal jurisdiction question for the Court is the identification of the classes and to ensure that each class is properly constituted so that the meetings for each of the classes can be properly convened. To me, this can only be achieved if the issue pertaining to the constituent or composition of the classes is taken at the Convening stage.
Second, the court found that AAX had been wrong in its classification of the lessors and Airbus as
secured creditors within Class A. The court held that they must be treated as unsecured creditors and that AAX could not:
treat the Lessors who had paid the 'security deposits' and 'maintenance reserves' as secured creditors and classif[y] them under Class A creditors. They do not come within the definition of 'secured creditors' under s.2 of the Insolvency Act 1967.
With respect to Airbus, the contingent debt of which formed three-quarters of the total scheme debt, the High Court held that the 'cash deposits' that had consisted of pre-delivery payments and been treated as a part-payment towards the purchase price did not make Airbus a secured creditor. Further, any contingent liability towards Airbus was claimable only upon the scheme's approval and the subsequent termination of the purchase agreements. As such, there was no basis for AAX to treat Airbus as a secured creditor.
The judge also specifically concluded that it did not dispute that Malaysia Airports was a secured creditor given that it had had a contractual lien over AAX's assets. Thus, Malaysia Airports and the lessors must be placed in Class A and Class B respectively.
Finally, the court considered whether the lessors should be placed in a separate class altogether due to their dissimilar rights with the other creditors. On this issue, the lessors contended that the debt owed by AAX to the lessors could be restructured under the scheme without their consent pursuant to the Cape Town Convention and its Aircraft Protocol and the common law principle known as 'the rule in Gibbs', which provides that a debt obligation can be changed or discharged only in accordance with the law governing that obligation.
After considering the submissions and expert reports that were submitted by the parties, while it agreed with the lessors that the Cape Town Convention and its Aircraft Protocol applied to arrangement schemes, the court decided that AAX did not require the lessors' consent in respect of the cram-down provision under the scheme in the form of a 99.7% cut of their claims. The judge's reason for this was that the scheme had provided for the termination of the lease agreements.
The court agreed with the Singaporean and Australian courts that the Gibbs rule did not prevent it from entertaining and approving an arrangement scheme which involved the discharge or modification of any contractual rights between the scheme company and its creditors, even where the contracts were governed by English law or other foreign laws.
The lessors also contended that even if they could not be excluded from the scheme, they should at least be placed in a separate class from Airbus. Since Airbus's debt value would have exceeded more than 75% of the total scheme debt, its vote alone would have effectively carried the resolution, depriving the lessors' votes on the scheme of any meaningful weight.
While the court did not agree that Airbus should be placed in a separate class just because its claim alone exceeded 75% of the total claims in Class A, the judge held that the difference in the rights between Airbus and the lessors under the scheme was significant and warranted that the lessors be placed in a separate class from Airbus. The court took into consideration the effect of the commercial evaluation of the fresh contracts into which Airbus was likely to enter with AAX. These could have significantly mitigated the losses that had arisen from the termination of the agreements. The lessors, on the other hand, would have borne a 99.7% loss of their accrued debts even if they had entered into fresh contracts with AAX to mitigate its rental losses in respect of the unexpired terms of the lease agreements.
Compromise or arrangement
The High Court held that the scheme was a 'compromise or arrangement' under Section 366(1) of the act. While it found that the scheme came across as "audacious" and "non-bona fide" in that it had proposed to pay its creditors only 0.3% of their claims, the marginally better position it had provided for, compared to liquidation, was sufficient to constitute a compromise or arrangement under the act.
While the court acknowledged that AAX's past performance records and financial position indicated that it was hopelessly insolvent, the judge ultimately held that the court "ought not make any commercial judgment on the viability or otherwise of the company post Scheme at this stage without the benefit of any independent or expert report". Similarly, it was not for the court to speculate as to whether AAX would be able to raise the necessary funding.
Bona fide or abuse of process
The court found that since there was no evidence of actual dishonesty shown by AAX, it was not prepared to hold that the scheme application was not genuine, even though AAX had failed to satisfactorily explain its earlier changes in classification.
That said, the judge also found that the multiple changes in the classification of creditors throughout the proceedings suggested:
a determined effort to place certain creditors together into a single group regardless of the true legal position of the creditors as secured creditors or otherwise. The formulation of the classes appears to be no more than a matter of form than substance.
This decision extensively examined the court's jurisdiction and duties when considering an application under Section 366(1) of the Companies Act 2016 for an order that a meeting of the relevant creditor classes be convened, also known as the 'convening stage'. This jurisdiction and duty are distinct from the 'meeting stage' of the creditor classes and the 'approval stage' of the proposed arrangement scheme.
In this landmark ruling, the court ruled that AAX's proposed arrangement scheme was an 'insolvency-related event' for the purposes of the Cape Town Convention's Aircraft Protocol.
For further information on this topic please contact Wai Hong Leong, Claudia Cheah Pek Yee, Shannon Rajan or Sharon Chong at SKRINE by telephone (+603 2081 3999) or email (firstname.lastname@example.org, email@example.com, firstname.lastname@example.org or email@example.com). The SKRINE website can be accessed at www.skrine.com.
Janice Ooi, senior associate, and Laarnia Rajandran, associate, assisted in the preparation of this article.
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