Background

Once again the insolvency of Australia’s second largest airline has served to highlight the deficiencies with our voluntary administration process and reopened debate as to the adoption of US Chapter 11 style debtor in possession rescue funding options. As in the Ansett Australia Group administration, the inability of the Virgin administrators to secure the urgent capital injection necessary to avoid personal liability for the significant ongoing trading costs limited the viable options to avoid a grounding. To add to the complexity this time around the Virgin administrators were exposed to personal liability for excess COVID Job Keeper payments and to the cost of maintaining and redelivering the aircraft equipment under the overriding international Capetown Convention and Aircraft Protocol.[1] Now that the Virgin restructuring has been completed, it is timely to once again consider the complex voluntary administration priority and funding regime, associated policy considerations and areas for reform. King & Wood Mallesons acted for over 40 clients with 98 aircraft out of the 118 Virgin financed or leased aircraft as well as numerous suppliers of spare engines and parts.

Priority Overview

At the heart of our insolvency system are the technical rules which for policy and other reasons confer priority on various stakeholders and which are exceptions to the general rule that all unsecured creditors rank equally.[2] The most important priority class of creditors are the employees whose claims in any liquidation are in effect underwritten by the federal government.[3] Such employee claims have priority over not only other unsecured creditors but also secured creditors in respect of debtors, stock and other circulating assets given that such assets are usually generated by the efforts of the employees.[4] The same technical and critical distinction between fixed and circulating assets applies in respect to a voluntary administrator’s lien for payment of post-appointment fees, costs, borrowings and other liabilities.[5] The personal liability for borrowings was introduced as a light touch to partially fill the funding gap identified by the Ansett administration.[6] However, it is still necessary to obtain the consent of the existing circulating security holder to maintain “super priority” status.[7]

Given that any attempt to contract out of the administrator’s personal liability is ineffective[8], an administrator needs to apply to the Court for relief usually on the basis any such liability is limited recourse to the available circulating assets to satisfy the lien. This personal liability for borrowings was entrenched with a view to ensuring that administrators would exercise appropriate caution in using this funding option.[9] In effect, any such post-appointment loan or other liabilities are at the risk of the preferential employee entitlements. However, there is no specific provision for such a “super priority” position for post-appointment funding and liabilities over fixed charge assets. A narrow exception is to place reliance upon the general discretionary equitable salvage and fairness principles which are always difficult to apply in an insolvency scenario where all parties have lost their money.[10]

Virgin Funding

For the above reasons, the Virgin administrators conducted an expedited marketing campaign which in effect limited potential purchasers to those who had immediately available funding they were prepared to risk upfront pending implementation of the complex restructuring. The existing priority regime really left all stakeholders with little realistic option but to entrench the successful party without the mandate of creditors at the second meeting or face a value destructive liquidation. Some of the more specific issues were:

(a) Despite the abolition by the Personal Property Securities Act 2009 (Cth) of the concept of title or ownership for priority purposes, in an administration there is no personal liability on an administrator for post-appointment loan payments on aircraft and other specific assets used by the administrator despite the intention to otherwise treat such aircraft financiers on the same basis as aircraft lessors. It is submitted that this irregularity should be rectified.

(b) As the administrators were successful in obtaining orders extending the five business day decision period[11] before assuming personal liability for post-appointment periodic lease payments, they were in effect able to use the aircraft equipment (with the associated depreciation of the life of those assets) without any rights of recourse by lessors to the income or circulating assets. It is submitted that any such extension should be on a limited recourse liability basis rather than leaving it to a more uncertain manipulation of the priority waterfall post-administration.[12]

(c) Although there was equity in the owned aircraft equipment, the administrators were unable to unlock this value to secure critical post-appointment funding. It is submitted that an amendment to enable administrators to borrow money without a court order on a limited recourse basis upon the security of their lien would facilitate such rescue funding. Further, consideration should be given to extending the administrator’s lien for this purpose to fixed charge assets with the consent of the existing secured creditors (with pre-emptive further funding rights) or by order of the Court. As is currently the case[13], the Court would need to be satisfied that arrangements are in place to adequately protect the existing secured creditors. Like in Singapore, consideration should be given to conferring on the Court the power to grant “super priority” for rescue finance on a graduating scale with the same or higher priority than existing secured creditors. A proposal for a special majority of creditors to confer “super priority” has previously been rejected as being unduly expensive and impractical.[14]

(d) The administrators needed to exercise caution in agreeing to post-appointment liabilities being secured on their lien to ensure that there were sufficient available assets to pay their fees.[15] Practically, this offers no better incentive for caution.

Conclusion

Given the complex web of statutory, legal and equitable rules of priority and the associated costs of multiple court applications for directions, the time has come for greater certainty for all stakeholders. It is submitted that with a few relatively minor changes and minimal policy shifts our administration procedure can once again be fit for purpose prior to the pending post COVID uplift in restructuring and insolvencies. This will serve to avoid the need for stakeholders to resort to the much criticised prepack or phoenix arrangements to overcome the trade on funding risk during an administration. This will also buy time for an overhaul of our corporate, individual, trust, partnership and not for profit insolvency laws on a holistic basis taking into account international best practice and reforms adjusted for our local community and stakeholder expectations. It is submitted that the time has come to finally abolish the commercially and legally outdated distinction between fixed and circulating assets for priority purposes. It is also interesting to see that the United Kingdom has recently reintroduced priority for tax debts[16] and proposed an independent expert report as a prerequisite to pre-packaged phoenix sales.[17]