Clearing the Air: Australia's High Court Clarifies the Operation of the IATA Clearing House Regulations During Member Airline’s Australian Insolvency Proceeding

If an international airline that is a member of the International Air Transport Association ("IATA") goes into insolvent external administration under the Australian Corporations Act 2001 (Cth) (the "Act"), will the IATA Clearing House Regulations (effective January 1, 2006) (the "CH Regulations") continue to govern the relationship between IATA, the insolvent airline, and the other members of IATA? A recent judgment of Australia’s High Court clarifies these issues.

Ansett Airlines: Background

Prior to appointing external administrators to the company (broadly, the equivalent procedure to that contained in chapter 11 of the U.S. Bankruptcy Code and Schedule B1 of the U.K. Insolvency Act 1986) on September 12, 2001, Ansett Australia Holdings Ltd ("Ansett") had operated as an airline in Australia and abroad for more than 50 years. Ansett had been a member of the IATA Clearing House since 1951.

At its simplest, the IATA Clearing House allows participating international airline operators to sell and issue tickets to passengers for journeys, or parts of journeys, where the carrier of the passenger will be another IATA member. Instead of the airlines making and receiving between themselves numerous payments in respect of these operations, the Clearing House operates so that debits and credits in accounts of the participating airlines are netted out at the end of every month. Airlines with a net credit balance receive a payment from the Clearing House, whereas those with a net debit balance are obliged to pay that balance to the Clearing House.

As part of the external administration process, the creditors resolved that Ansett should execute a deed of company arrangement ("DOCA"), which binds Ansett, its officers, and certain creditors. Creditors bound by the DOCA, which is comparable to a chapter 11 plan under U.S. bankruptcy law, are prevented under the Act from seeking to recover their claims other than pursuant to the DOCA.

The Issues

In International Air Transport Association v. Ansett Australia Holdings Limited [2008] HCA 3 (6 February 2008), Australia’s High Court considered whether or not IATA is a creditor of Ansett with respect to net debit balances and therefore bound by, and entitled to assert a claim under, the DOCA. The High Court also considered whether or not the administrators of Ansett were permitted to sue individual members of the Clearing House (as distinguished from the Clearing House itself) for direct payment of net indebtedness allegedly due and owing to Ansett.

The starting point for answering these questions depended upon interpreting the CH Regulations. The interpretation of the CH Regulations was not, however, the end of the matter. This was because the administrators of Ansett argued that if the CH Regulations, as interpreted by the High Court, produced a result that was different from, or repugnant to, the relevant insolvency provisions of the Act, the court should refuse to apply the CH Regulations.

Similar issues were determined by England’s House of Lords in British Eagle International Airlines Ltd v. Compagnie Nationale Air France [1975] 1 WLR 758. Decisions of the House of Lords are persuasive but not binding on Australia’s High Court. In British Eagle, the House of Lords held that the CH Regulations (as they stood at that time) provided for a distribution of the property of the insolvent company different from that prescribed by the insolvency legislation of the U.K. (In particular, the CH Regulations did not apply the in pari passu (pro rata distribution) principle contained in the Companies Act 1948 (U.K.).) The House of Lords held that this effective contracting-out of the domestic insolvency regime was contrary to public policy and on this basis refused to give effect to the CH Regulations.

The effect of British Eagle was that the IATA Clearing House was rendered ineffective to capture and set off assets of British Eagle, which were required to be available for distribution to the general creditors of British Eagle in accordance with the in pari passu principle contained in the UK Companies Act. The CH Regulations were amended post-British Eagle in an attempt to circumvent the effect of the ruling. Specifically, clause 9(a) of the CH Regulations now provides in substance that direct contractual rights to payment and liabilities shall exist only between each IATA member and the Clearing House, rather than between members.

The Decision

By a majority of 6 to 1, the High Court found that the CH Regulations (most relevantly, clause 9(a)), as they pertain to monthly clearances, operate so that:

The property of Ansett did not include debts owed to it by other airline operators and the liabilities of Ansett did not include debts owed by it to other airline operators. The relevant property of Ansett was the contractual right to have a clearance in respect of all services which had been rendered on the contractual terms and the right to receive payment from IATA if on clearance a credit in favour of the company resulted.

Accordingly, if the CH Regulations were the end of the matter, those regulations operate so that the only debit or credit that arose under the Clearing House was that between IATA and member airlines in relation to the final balance each month. As such, IATA (rather than individual airlines) was bound by the DOCA and was entitled to assert a claim in the insolvency proceeding of Ansett for any shortfall after the monthly setoff, but the administrators of Ansett could not pursue individual airlines for alleged amounts owing to Ansett.

However, as noted above, the administrators of Ansett argued that if the CH Regulations operate in the way found by the majority, the CH Regulations amounted to a contracting-out of the operation of the DOCA and, thereby, the Act. It was further submitted that the High Court should follow British Eagle and find that the CH Regulations were ineffective or void by reason of public policy, at least insofar as they operated to render IATA a creditor of Ansett.

The administrators of Ansett submitted that it is a "fundamental tenet of insolvency law" recognized generally in various common-law jurisdictions that the whole of the debtor’s estate should be available for distribution to all creditors and that no one creditor or group of creditors can lawfully contract in such a manner as to defeat other creditors not parties to the contract. It was further submitted that the CH Regulations, as interpreted by the High Court, were contrary to this policy and, as such, should be rendered ineffective or void. The administrators complained that airlines that had provided services to or on behalf of Ansett did not assert a claim under the DOCA but sought satisfaction under the Clearing House system. Therefore, these airlines, unlike Ansett’s ordinary creditors, received satisfaction in full of their claims against Ansett.

The High Court dismissed the public-policy arguments for the following reasons:

1. There were significant differences between Ansett and British Eagle, including the fact that, unlike in British Eagle, no claim was made between individual members of the Clearing House. Also, as noted above, the CH Regulations were materially different post-British Eagle.
2. The High Court found that the rule of public policy for which the administrators contended was not based on any provisions of the Act, and therefore the CH Regulations were not inconsistent with the Act. Public policy should not be used to supplement or vary an Act of Parliament.
3. Having found that no relationship of debtor and creditor exists between Ansett and other members of the Clearing House, the High Court found that the public-policy argument was an impermissible attempt to use public policy to create for the parties a new agreement different from the agreement made by IATA and its members.

The Ramifications of IATA v Ansett

The factual scenario presented by Ansett will arise in other jurisdictions. While these cases will be determined on their own facts, and by reference to the domestic insolvency laws of those jurisdictions, the reasoning of the majority of the Australian High Court provides clarity to the international aviation community as to how the CH Regulations operate in the event of insolvency. In particular:

1. IATA is a creditor of the insolvent airline, with the ability to assert a claim in the airline’s insolvency proceeding.
2. The insolvent airline has a right to receive from IATA any credit balance arising as a result of the monthly setoff operated by the Clearing House.
3. There is no debtor/creditor relationship between the individual airline members of IATA. Therefore, the insolvent airline may not assert a claim directly against a comember of IATA for any credit balance arising as a result of the monthly setoff operated by the Clearing House, and vice versa.
4. The continued operation of the CH Regulations when a member enters insolvent external administration is not repugnant to the policy that the whole of a debtor’s estate should be available for distribution to all creditors.