Legalflyer

April 2011 Authors: Charlotte Winter, Andrew Wood, Marc Waha, David Ward, Emma Humphries, Caroline Thomas

Aircraft/airplane

Contacts

Introduction

Welcome to the April edition of Legalflyer where we once again review a series of topical issues for the aviation industry.

We start this edition with an article on liens written by Charlotte Winter, a dispute resolution of counsel based in London. The article looks at the English law approach to liens against the backdrop of more difficult financial times, when aircraft repossessions and disputes over liens become more prevalent.

You can also view a video of Charlotte Winter presenting this article.

In our second article, Andrew Wood, an associate in our London banking team, takes a look at the new Aircraft Sector Understanding on Export Credits for Civil Aircraft and how the new rules may affect the price differential between export credits and commercial lending.

In our third article, Marc Waha, a partner in the antitrust, competition and regulatory team based in Hong Kong and Clémence Perrin, a consultant in the antitrust, competition and regulatory team based in Brussels, examine two recent antitrust investigations by the European Commission into whether a particular form of codeshare agreement entered into by two groups of airlines could infringe EU antitrust laws.

For our fourth article, following the March 2011 UK budget, David Ward, a tax associate based in London, gives an update on the UK government's proposals for changes to air passenger duty.

Our fifth article looks at the topical issue of the UK Bribery Act 2010 which will impact on aviation companies operating their business (or part of their business) in the UK. Emma Humphries, a dispute resolution associate based in London, sets out the main features of the Bribery Act 2010 and the steps that aviation companies should be taking to meet its requirements.

Finally, Caroline Thomas, a senior associate in the London antitrust, competition and regulatory team, looks at the latest from the BAA inquiry, following the Competition Commission's provisional decision that BAA should proceed with the sale of Stansted and either Edinburgh or Glasgow airport.

As always, I hope that you will find our articles to be of interest and I would be delighted if readers could provide any comments on the content, or suggestions for future editions of Legalflyer, by using the comments box which can be accessed through this hyperlink. Likewise please feel free to pass on the details of colleagues who may wish to receive Legalflyer.

Editor

Patrick Farrell, Partner
Norton Rose LLP, London

Liens - Is possession nine tenths of the law?

A lien is the right to retain possession of a thing until a claim is satisfied.1

Aviation, like many other industries, is affected by economic highs and lows. During times of financial crisis some of the less financially secure airlines will collapse. In those cases, lessors look to repossess their aircraft from the defaulting airline.

A collapsing airline will, however, also inevitably owe money to other creditors as well as the lessor. Where the leased aircraft, engine or part is undergoing maintenance or repair, the maintenance or repair providers (MRO) may also be a creditor.

If the airline collapses when the asset is in the MRO’s possession, can the MRO assert a lien and refuse to release the asset to the owner until paid?

What law applies?

It is important first to identify which law determines this question because the MRO’s rights can be different depending upon the applicable law.

As against the owner (as opposed to the lessee airline) with whom the MRO has no contractual relationship, the applicable law is likely to be the law of the place where the asset is located. However, different jurisdictions take different approaches to this question.

The English law approach to liens

There are two primary requirements for the maintenance provider to assert a lien.

The first is that the lien will only arise, at all, if a person has expended labour and skill to improve or repair (as opposed to maintain) the asset bailed to him. So in other words, mere maintenance is not enough. Where the line is drawn between maintenance, and repair or improvement, will depend on the facts of the case. However, as aircraft maintenance often involves an element of repair or improvement, it is likely that this first hurdle will be overcome.

The second is that there has to be express, implied or apparent authority on the part of the owner for the work to be done.

In Green v All Motors, Limited [1917] 1 KB 625, a hirer sent a car to a mechanic for repair and then defaulted. It was held that the owner’s authority for the car to be repaired was implied as the hire purchase agreement required the hirer to “keep the car in good repair and working condition”. It was implicit therefore that the hirer would have to send the car to the garage and had authority to do so. Such clauses are invariably found in an aircraft operating lease between the owner and lessee.

In Tappendem (t/a English and American Autos) v Artus [1964] 2 QB 185, it was held that the bailee of goods is deemed to have the implied authority of the owner to do all things reasonably incidental to the use of such goods. Here, the court found that giving possession of a motor vehicle to a mechanic for the purpose of effecting repairs was an act reasonably incidental to the bailee’s reasonable use of the vehicle and if the owner wished to exclude the bailee’s authority he must do so expressly.

Exclusion from creating a lien and apparent authority

Operating leases will invariably exclude the lessee’s right to allow a lien to be created.

This however conflicts with the situation where the lessee has been given apparent (or ostensible) authority to allow a lien for work done to be created over the aircraft or part. An example of this situation arose in the case of Albemarle Supply Company v Hind and Company [1928] 1 KB 307. Here, despite the express agreement providing that the lessee could not create liens without the owner’s consent, it was held that the owner had held out the lessee as having sufficient authority to create liens. As the express limit on that authority to create liens had not been communicated to the third party, that third party was not, therefore, bound by it. The fact that the third party knew that the lessee was not the owner of the chattels in question did not matter.

It may be argued that in the aviation market the MRO will know (or should know) the market practice to exclude expressly the right of the lessee to allow the creation of a lien and that this knowledge should prevent the lessee from having the authority to allow a lien for work done to be created.

However, this has not been tested in this jurisdiction and so, as the law stands, it is not clear whether the owner’s or the MRO’s rights will override the other.

Other jurisdictions have had different approaches to the problem and in some there is more certainty as to the outcome. In France for example, we understand that a lien for work done will usually override ownership rights, whereas in Scotland, where there is a specific prohibition on creation of a lien in the lease, this will override the MRO’s rights to create a lien, even it if was not aware of the prohibition.

Enforcement

If the circumstances result in the rights of an MRO overriding those of an owner then the lien for work done only provides the MRO with the right to detain the aircraft or parts until the debt is paid. The benefits of the MRO that derive from a lien are therefore limited to this passive right of retention. It may provide some incentive on the owner to make a payment, but does not necessarily provide the MRO with the opportunity to actively pursue payment from the owner.

Charlotte Winter is an of counsel in dispute resolution, Norton Rose LLP, London.


Note:

Stroud’s Judicial Dictionary of Words and Phrases.

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New Aircraft Sector Understanding in relation to Export Credits

The new Aircraft Sector Understanding on Export Credits for Civil Aircraft (the ASU) came into effect on 1 February 2011 as a measure by the OECD to foster a level playing field for export credits in the aviation finance sector.

The ASU seeks to achieve its aim by setting out the most favourable (i.e. minimum) terms on which officially supported export credits (in the form of guarantees or direct lending) may be approved and - crucially - by prescribing mechanics by which such terms can be adjusted so that they remain aligned with the commercial lending environment.

The new rules appear to add complexity to the process of calculating minimum premia and have the effect of approximately doubling the costs of ECA support. Whether or not this will result in more commercial lending returning to the sector may ultimately be determined by factors beyond the scope of the ASU.

The need for change

The 2007 Aircraft Sector Understanding (2007 ASU) preceded the ASU and was negotiated prior to the global financial crisis. That crisis severely hampered the ability of banks to stay competitive: the commercial lending market was significantly scaled back (with some banks ceasing their aircraft finance activities altogether), making export credit financing more attractive than ever before.

Whilst being an issue outside the scope of the new ASU, at the same time the major airlines in the UK, France, Germany, Spain and the US were finding themselves at a major competitive disadvantage in relation to their overseas (particularly Middle Eastern) competitors who were not restricted in pursuing these attractive export credits by the so-called “home country rule” (an informal arrangement between the US Eximbank on the one hand and the European ECAs on the other to the effect that neither will provide export credit support for aircraft being delivered to airlines in the other’s jurisdiction).

The ASU

The new ASU differs from the 2007 ASU in several key respects, including by establishing arrangement, commitment and administration fees which are payable in respect of export credit support. New minimum interest levels are set for direct lending and (subject to exceptions where additional surcharges are payable) the maximum term and frequency of repayments are now fixed at 12 years and quarterly respectively for all aircraft. Minimum premium rates are established in respect of export credit guarantee cover, with rates reflecting an annually-reviewed price risk plus a quarterly-reviewed surcharge to reflect movements in the commercial lending market at the relevant time. Export credit premia will therefore fluctuate with the commercial market.

The ASU provisions simplify matters in some respects (for example, by introducing a single system applicable to all aircraft models) but not in others. There is now a greater number of risk mitigants which must be structured into an export credit transaction depending on the airline’s credit rating. Similarly, the procedure for aligning minimum premia with market pricing is (understandably) complex. There are now two levels of advance ratios: the existing maximum support level of 85% still applies to most carriers but those with a credit rating of AAA to BBB- now can receive only up to 80% support.

The immediate impact of the ASU is significantly limited by extensive grandfathering (and great-grandfathering in respect of a small number of pre-2007 ASU aircraft financings) provisions contained in the ASU itself (eligibility for grandfathering is determined by factors such as the date of the specific financing contracts and the delivery date of the particular aircraft). Even grandfathered transactions, however, will become the subject of newly introduced commitment fees.

The intention is that the gap between export credit and commercial pricing will diminish and that the new regime will have the flexibility to withstand severe market fluctuations and consequently succeed where its short-lived predecessor failed.

Effects

Once the impact of the grandfathering rules subsides in early 2013, the new rules will almost certainly reduce the price gap between export credits and commercial lending (which, despite falling outside the ASU, will have the knock-on effect of reducing the impact of the “home country rule”). If Russia (Sukhoi) and China (COMAC) respond to calls to join the agreement this will further serve to level the global playing field.

Whether this will lead to an increase in commercial lending in the sector however remains to be seen. The majority of banks are in the process of reviewing the sectors in which they propose to remain active in light of Basel III and the results of these analyses, coupled with ongoing liquidity issues, are likely to have an equally significant bearing on the market in the short-to-medium term. It is possible that manufacturers may be asked to reduce the price of aircraft to compensate the airlines for the higher ECA premia (or direct loan pricing), a consequence which could inadvertently negate the benefits afforded to the commercial lending market by the ASU. The new ASU is clearly a forward step, but its impact will be influenced by additional factors such as those referred to above on which we can only speculate at present.

Andrew Wood is an associate in the banking team, Norton Rose LLP, London.

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A step too far? European Commission investigates airline collaboration on hub-to-hub routes

Introduction

On 8 February 2011, the European Commission decided to initiate two separate antitrust investigations with a view to ascertaining whether a particular form of codeshare agreement entered into by two groups of airlines could infringe EU antitrust laws.

The first investigation concerns a codeshare agreement on routes between Belgium and Portugal implemented by Brussels Airlines and Transportes Aéreos Portugueses S.A (TAP Portugal). The second investigation relates to an agreement with similar features entered into between Deutsche Lufthansa and Turkish Airlines on routes between Germany and Turkey.

In both investigations, the Commission will assess whether the particular agreements entered into by the relevant airlines infringe Article 101 of the Treaty on the Functioning of the European Union (TFEU), which prohibits anti-competitive agreements and concerted practices, and, if so, whether such agreements can be exempted under Article 101(3) TFEU.

Codeshare agreements are a common form of cooperation between airlines. What was originally aimed at a mere sharing of the airlines’ designator codes has slowly become more sophisticated, integrating an increasing number of additional features. Interestingly, these two investigations will focus on a type of codeshare agreement which, from an antitrust perspective, is most likely to give rise to concerns because of the degree of integration and cooperation between the parties.

Assessment of the agreements under antitrust rules

As with any antitrust investigation, the Commission is likely to undertake a legal and economic analysis of the restrictive effects of the arrangements on the relevant markets (here the routes covered by the codeshare agreements) and will consider whether the potentially redeeming benefits resulting from the arrangements outweigh their anti-competitive effects.

The relevant markets

As in most air transport cases, the Commission will probably ascertain the relevant markets by reference to the “point of origin/point of destination” system. In the Deutsche Lufthansa/Turkish Airline investigation the segments covered by the agreement are Munich - Istanbul and Frankfurt - Istanbul. The relevant segment in the investigation concerning TAP Portugal and Brussels Airlines is Brussels - Lisbon. For many passengers, the relevant markets will therefore be the segments covered by the agreements. However, passengers flying on the codeshared routes may well continue their travel by transferring to another flight and other markets may therefore be affected.

Restrictive effects of the arrangements

The Commission will most likely focus on three characteristics of the codeshare agreements, which, if combined together as is the case here, are most likely to raise antitrust concerns.

The first point is the fact that the airlines both operate on the relevant segments and are therefore actual competitors. Cooperation among competing airlines is subject to close scrutiny, in particular with regard to the degree to which they remain independent in terms of scheduling, pricing and determining capacity.

In addition, the segments under investigation link the airlines’ respective hubs. These routes are particularly important for airlines, as they feed traffic to the rest of their networks. The competitive dynamics on these routes are likely to influence competition in other parts of the airline networks.

Second, the codeshare agreements are “free flow”, which means that each party has direct and real-time access to the other carrier’s seat inventory. Antitrust authorities usually consider this form of codeshare agreement as lessening the incentive for companies to compete against each other. For example, each company has the opportunity to monitor through the booking reservation system information on capacity utilisation of the other carrier, potentially favouring tacit collusion between the companies to allocate capacity amongst them.

In addition, the Commission will also take into account in its assessment other factors such as the market power of the parties in the relevant markets. In the case of the TAP Portugal/Brussels Airlines investigation, the parties are the only airlines operating on the Brussels - Lisbon segment, leaving them subject to limited if not complete absence of competitive constraint from other airlines on this segment.

It is therefore not surprising that the Commission has concerns that this form of parallel, free-flow, hub-to-hub codeshare agreement may distort competition, leading to higher prices and less service quality for customers.

Potential exemption

However, if the airlines can persuade the Commission that the codeshare agreements bring about substantial quantitative and qualitative efficiencies and award a fair share of the resulting benefit to the flight passengers, then the agreements could be held to be pro-competitive. The parties would furthermore have to demonstrate that these benefits could not have been obtained by less restrictive alternatives and that competition is not eliminated.

There is no doubt this will be a challenge in relation to non-transferring passengers: providing evidence that a codeshare agreement concluded between direct competitors on a route operated solely by them can lead to pro-competitive effects is not an easy task. Airlines have been successful in the past in demonstrating benefits where traffic volumes were low, or where one of the airlines was a new entrant. However, the most likely arguments for the routes under review relate to the airlines’ respective networks. They are all members of Star Alliance, and their codeshare agreements are useful tools to generate traffic for the rest of their respective networks. There may be significant benefits on the other, multi-segment, markets, where passengers may obtain better prices, easier booking, and seamless transfer. The question will be whether parties could have brought these benefits to their passengers without agreeing to mutual, free flow codeshare agreements on these hub-to-hub routes.

Marc Waha is a partner in the antitrust, competition and regulatory team, Norton Rose Hong Kong and Clémence Perrin is a consultant in the antitrust, competition and regulatory team, Norton Rose LLP, Brussels.

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Reform of Air Passenger Duty

On 23 March 2011, the Conservative and Liberal Democrat coalition Government published a consultation containing proposals for the reform of air passenger duty (APD). This follows the announcement in 2010 that the Government was considering the replacement of the existing regime with a tax charged on a per-aircraft rather than a per-passenger basis. The stated aim of this change was to encourage airlines to operate aircraft efficiently whilst minimising their environmental impact. However, the Government has decided not to proceed with a per-aircraft duty as it is considered that this may be in contravention of current international obligations (including the 1944 ICAO Chicago Convention).
The Government has stated that it wishes to proceed with the international “consensus in this area” but will work with other countries to consider this approach in the future. Similarly, in the absence of international coordinated action, the Government believes that it would not be appropriate to extend APD to transfer-and-transit passengers or to freight transport services as this would affect the competitiveness of the UK as a hub.

The Government is, however, proposing an extension of APD to business jets; this would be a per passenger charge on all qualifying flights on aircraft with a take-off weight of more than 5.7 tonnes, and would apply irrespective of the distance travelled at an amount equivalent to the highest standard rate of APD. The Government is also seeking to explore whether changes to APD could result in a simpler and more efficient system, acknowledging that there are anomalies in the current four band system under which a flight to the west coast of the United States is charged at a lower rate than a flight to Barbados. It also questions the effectiveness of APD as an environmental tool given that aviation is due to enter the EU Emission Trading System from January 2012. Two alternative models are proposed for the simplification of APD based on a short-haul/long-haul delineation at 2000 miles (this is based broadly on the boundary of the EU/EEA/European Common Aviation Area). The first has two bands with only the short-haul/long-haul delineation at 2000 miles and the second has three bands delineated at 2000 miles and 4000 miles (i.e. with greater differentiation in long-haul flights). The Government also asks for comments on the impact on the market of the current class distinction in APD between the reduced rate (for the lowest class of travel) and the standard rate (for other classes).

This is very much a case of “here we go again” as this appears to be the same process that was undertaken in 2008-09. The difference this time is the looming impact of the EU Emissions Trading Scheme which will need to be factored into any thinking.

David Ward is an associate in the tax team, Norton Rose LLP, London.

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The Bribery Act 2010 - what you need to know

The Bribery Act (the Act) will come into force on 1 July 2011 and will bring wide-ranging changes of which aviation companies that operate their business (or part of their business) in the UK need to be aware.

1    The offences

The Act clarifies the law on the existing offences of active bribery (bribing someone) and passive bribery (being bribed).
A key element of the bribery offence is that the person attempting to bribe another intends that the person being bribed improperly performs his/her duties.

Bribery of private persons remains illegal under the Act and the Act also introduces a separate offence of bribery of a Foreign Public Official (FPO). To commit this offence, a person does not need an intention that the FPO will improperly perform his duties, nor does the payment need to be made “corruptly”. All that is required is an intention to influence the FPO in his official capacity; an intention to obtain/retain business, or an advantage in the conduct of business; and that the act is not permitted by local written law.

Most significantly, the Act creates a new strict liability offence for corporates of failing to prevent bribery within the organisation. The only defence to such a charge is to show that the corporate entity had “adequate procedures” in place designed to stop such conduct.

2    Adequate procedures

“Adequate procedures” is not defined in the Act, but on 30 March the UK Ministry of Justice published its final guidance on the “adequate procedures” that must be in place if a commercial organisation is to successfully defend a prosecution for failing to prevent bribery (the Guidance).

The Guidance emphasises that an organisation’s procedures to prevent bribery should be “proportionate” to the particular bribery risks faced by that organisation and to the “nature, scale and complexity” of its activities. There is no “one-size-fits-all” approach for the procedures to be adopted, but all businesses should start by conducting an assessment of the risk of bribery being committed by the organisation or by persons associated with it (associated persons) worldwide.

It will be vitally important that adequate procedures are carefully designed and implemented.

3    Associated persons

Corporates can be guilty of failing to prevent bribery if an “associated person” carries out an act of bribery on their behalf.

The Guidance confirms that a subsidiary will not always be an “associated person” and an organisation is only liable for the actions of its associated person if the bribe was intended to benefit the organisation directly. A bribe paid by an employee of a subsidiary is normally intended to benefit the subsidiary and not the parent company, even though the parent may benefit indirectly. Thus a parent will not always be caught by bribes paid by or on behalf of a subsidiary. In addition, contractors/suppliers will generally be deemed to perform services only for the entity with which they have a direct contractual relationship.

The question of whether a bribe can be said to have been paid by an associated person on behalf of the commercial organisation will ultimately depend on the particular circumstances of each case. It is therefore important to ensure that the associated person is aware of and commits itself to the anti-bribery policies of the principal; that it is made aware of a zero tolerance culture within the organisation; and that it is subject to appropriate due diligence and ongoing monitoring.

4    Hospitality

Reasonable and proportionate business hospitality will fall outside the scope of the Act and will constitute bribery only if the provision of the hospitality is intended to induce someone to breach a relevant duty defined in the Act or to influence an FPO. The Guidance provides examples of acceptable hospitality, such as taking a client to a sporting event. Commercial organisations must continue to exercise their good judgment and common sense as to what is proportionate in the circumstances.

5    Facilitation payments

The Act provides no exemption for facilitation payments which, in common with the vast majority of international legal systems, will amount to bribery (with the exception of legally required payments). The elimination of facilitation payments remains a UK Government objective because of the corrosive effect on the countries in which they are paid. The Director of the SFO has said publicly that some companies have not yet eradicated facilitation payments and he is prepared to be sympathetic, provided that the company is “genuinely committed to achieving zero tolerance” of facilitation payments and “there is meaningful commitment within a reasonable timeframe.”

6    Jurisdiction

The “failure to prevent bribery” offence can be committed by a corporate entity, whether or not incorporated in the UK, which carries on business or part of a business in the UK, even if the act of bribery was committed outside the UK, and even if the UK-based part of the business was not in any way involved in the bribery.

The Guidance states that a foreign company with a subsidiary in the UK is not necessarily “carrying on a business or part of a business” in the UK and so may not, by that mere fact alone, be subject to the jurisdiction of the Act. The Guidance also suggests that a company will probably not be carrying on business in the UK merely because it is listed on a UK stock exchange.

However, the Director of the SFO has indicated on a number of occasions that the SFO intends to take a wide view of the extra-territorial jurisdiction of the Act.

7    Consequences

If found guilty, companies can face unlimited fines. Directors found guilty of the substantive offences of active or passive bribery, or bribery of FPOs, can face a prison sentence of up to 10 years. Corporates could face having turnover generated by deals procured by corruption confiscated.

8    What companies need to do

Aviation companies must seek to adopt a “tone from the top” culture of zero tolerance to bribery and corruption at all levels within the organisation and implement business-wide policies. Agents and subsidiaries must positively sign up to such procedures and must be monitored to ensure this is done. Further, thorough due diligence should be carried out on third party agents and subsidiaries, which should be repeated on a regular basis. Training should be provided to all staff on how to comply with the company’s policies on corruption, with particular focus on those employees who operate in high risk areas.

It is important that companies address the procedures and businesses adopted in their day-to-day business as soon as possible.

Emma Humphries is an associate in the dispute resolution team, Norton Rose LLP, London.

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Competition Commission indicates sales of BAA airports to go ahead

In a previous update (October 2010) we reported on the Court of Appeal’s judgment overturning the Competition Appeal Tribunal (CAT) finding of apparent bias in the Competition Commission’s (CC’s) BAA inquiry. Following this judgment, the CC has now published its provisional decision that BAA should press ahead with the sale of Stansted and one of Edinburgh or Glasgow airports, in line with the CC’s original findings.

The CC’s original decision was placed in doubt by the CAT’s ruling that the CC inquiry had been affected by “apparent bias” because of possible links between one of the CC members and a potential purchaser of the airports. However, on appeal the Court of Appeal found that the CAT had been wrong to identify any apparent bias for most of the CC inquiry process. The Court of Appeal did agree with the CAT’s finding of apparent bias for a short period towards the end of the inquiry, but given the timing, found it was very unlikely that this could have tainted the CC’s final decision in any way. As a result, the Court of Appeal’s judgment effectively restored the CC’s original decision that BAA should sell Stansted and one of Edinburgh or Glasgow airports. (The original CC decision also required the sale of Gatwick - this has now been completed anyway.) However, the Court of Appeal ruling was subject to a possible further appeal and questions remained over the timetable for the disposals.

These two questions have now been resolved. First, BAA’s application for permission to appeal the Court of Appeal’s judgment to the Supreme Court was refused by the Supreme Court in February 2011. Second, since the Court of Appeal judgment, the CC has been considering whether any material changes in the market mean it should update or alter its original decision. On 30 March 2011 the CC announced that it had provisionally concluded that there had been no material changes of circumstances in the market, thus confirming that its original decision will stand, including its original timescale for the sales of the airports. The airports are to be sold in sequence, with Stansted first and then the Scottish airport - although there may be a small overlap between the two processes. All the sales (including that of Gatwick, which has now been completed) were originally intended to be completed within two years of the CC’s decision and it appears a similar timescale can be expected to apply now.

The CC’s decision is provisional and is open for consultation until 19 April 2011. The CC is expected to confirm its final decision in May or June of this year, following which it can be expected that the two year sale period will commence.

Caroline Thomas is a senior associate in the antitrust, competition and regulatory team, Norton Rose LLP, London.

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