Legalflyer

November 2011 Authors: Fabio Miceli, Marianne McMahon, Caroline Thomas

Aircraft/airplane

Contacts

Introduction

Welcome to the latest edition of Legalflyer, in which we once again seek to address a series of topical issues for the aviation industry.

In this edition, Fabio Miceli, a banking associate in the Johannesburg office of Norton Rose South Africa, provides an update on the EU blacklisting regime. One of our new colleagues, Ben Bedard, a litigation partner based in Ottawa, Canada with Norton Rose OR LLP, provides an update on Canadian ownership and control requirements concerning airlines. Richard Skipper, an aviation finance senior associate in London, reports on recent developments on leasing in China. Marianne McMahon, a dispute resolution senior associate specialising in aviation, reports on a recent case which dealt with the meaning of “all reasonable endeavours” phrase, commonly used in aviation (and other) contracts. Finally, Caroline Thomas, a senior associate in our antitrust, competition and regulatory team in London , provides an update on the long-running saga of BAA's dealings with the Competition Commission and, more recently, the Competition Appeal Tribunal in relation to airports divestment.

As always, I hope that you will find our articles to be of interest and we would be delighted if our readers could provide any comments on the content (including editorial), or suggestions for future articles of Legalflyer, by using the feedback email. Likewise feel free to pass on the details of colleagues who may wish to receive Legalflyer.

Finally, for those who may not have seen our press release, I am delighted to announce that with effect from 1 January 2012 the Canadian law firm Macleod Dixon will be merging with Norton Rose OR LLP and becoming a part of Norton Rose Group. As a result of the merger, Norton Rose OR LLP will have close to 700 lawyers in their offices across the country and 60 additional lawyers in Latin America, based in Caracas (Venezuela) and Bogotá (Colombia), a 13 lawyer office in Almaty (Kazakhstan) and a team of lawyers in Moscow to Norton Rose Group.
Best wishes

Editor
Patrick Farrell, Partner
Norton Rose LLP, London

The EU airline blacklist

Author: Fabio Miceli

Deemed to be unsafe, certain airlines are currently banned from landing in the EU due to being blacklisted by the European Aviation safety Agency. This was done in response to a number of fatal airline crashes in Greece, Italy and Egypt, earning certain airlines the title of ‘flying coffins.’ The EU airline blacklist now contains more than 278 airlines.

The 278 airlines on the EU airline blacklist are located in 22 countries, of which 14 are from the African continent, with the Democratic Republic of Congo, Philippines, Indonesia and Kazakhstan having the highest number of banned airline carriers. The other countries affected by the EU Airline Blacklist include Surinam, Ghana, Rwanda, Afghanistan, Angola, Benin, Republic of Congo, Djibouti, Guinea, Kyrgyz Republic, Gabon, Mauritania, Mozambique, Sao Tome and Principe, Sierra Leone, Sudan, Swaziland and Zambia.

The African Airlines Association has reacted strongly against the blacklisting by the EU, making controversial accusations suggesting that the EU had ulterior motives.

The reasoning behind blacklisting certain airlines is to promote airline safety in Europe. Civil aviation authorities are regulated by the International Civil Aviation Organisation and are responsible for monitoring airlines registered in their territories and ensuring that the requisite safety levels are maintained. The EU airline blacklist is currently administered by the EU Regulation Safety Committee and is implemented by the individual aviation authorities. However, this function is due to be migrated to the European Aviation Safety Agency.

An airline will be blacklisted for one of two reasons. The first reason is when an airline does not comply with the common criteria set out in Article 4 of Regulation (EC) No 2111/2005. The second instance is when the airline holds an Air Operator Certificate from a jurisdiction in which the technical and regulatory processes have been deemed deficient in ensuring a satisfactory level of protection for passengers from safety risks.

The procedure for blacklisting airlines is also set out in the regulation of the European Parliament and Council. Airlines have ample opportunity to address problematic areas prior to being added to the EU airline blacklist.

Before being blacklisted the regulatory agencies of member states, the institutions of the European Community, the authorities with responsibility for regulatory oversight of the air carrier concerned, and the air carrier itself are consulted. The airline also has the right to appeal should it be blacklisted.

Furthermore, the EU airline blacklist is reviewed every three or four months, thus giving the airlines the chance to rectify any deficiencies that may have contributed to their blacklisting. The EU airline blacklist is not fixed and airlines can be removed from it should they meet the necessary criteria at a later stage.

If an airline is blacklisted because it holds an AOC from a jurisdiction in which the technical and regulatory processes have been deemed deficient in ensuring a satisfactory level of protection for passengers from safety risks, the airline may need to apply to obtain an AOC from a country that is not blacklisted. The airline may also be able to negotiate an exemption from being included on the EU airline blacklist. Alternatively, the airline may consider entering into an ACMI agreement (Aircraft, Complete-crew, Maintenance, and Insurance Agreement), otherwise known as a wet-lease. The ACMI agreement would allow the airline from the blacklisted jurisdiction to continue operating by wet-leasing an aircraft from a jurisdiction which is not on the EU airline blacklist.

An example of an airline that continued operating, despite being based in a blacklisted jurisdiction, is that of TAAG Angola Airlines. In 2007 TAAG was added to the EU airline blacklist. In order to continue operating its flights to the EU, TAAG entered into a wet lease with South African Airways in terms of which an aircraft was flown with a crew that combined members of TAAG and South African Airways. In 2009 TAAG received an exemption to fly certain specified aircraft to the EU on the basis that these aircraft met the requisite safety standards. In 2010, the EU lifted further restrictions on TAAG effectively allowing the Angolan airline to fly certain of its aircraft to all EU countries. Because these restrictions were lifted, TAAG was able to terminate the wet lease agreement with South African Airways.

The common criteria on which airlines are included in the EU airline blacklist are set out in the Annex to Article 4 of Regulation (EC) No 2111/2005 and include serious deficiencies on the part of an air carrier, such as systemic safety deficiencies, accident-related information, and a lack of ability or willingness of an air carrier to address these deficiencies by not implementing appropriate or insufficient corrective action plans.

The common criteria in the Annex to Article 4 of Regulation (EC) No 2111/2005 also mention the lack of ability or willingness of the authorities responsible to ensure that an air carrier addresses safety deficiencies. This would normally be evidenced by the fact that the competent authorities do not exercise the necessary regulatory oversight to enforce the relevant safety standards.

Although the situation may appear dire for many of the airlines on the EU blacklist, there are many avenues, a few of which are discussed in this article, by which an airline can work to have itself speedily removed from the EU blacklist and to continue operating profitably.

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Canadian ownership and control requirements - Recent developments

Author: Benjamin P Bedard

In Canada, only a “Canadian” air carrier is permitted to operate a domestic air service between points within Canada. Under the Canada Transportation Act (Act), there are three requirements in order for an air carrier to be considered “Canadian”:

  1. it must be incorporated or formed under Canadian federal or provincial laws;
  2. a minimum of 75 per cent of its voting interests must be owned and controlled by Canadians; and 
  3. the entity must be “controlled in fact” by Canadians.

In May 2011, the Canadian Transportation Agency (Agency) released two Interpretation Notes which clarify how the Agency applies the Canadian ownership requirement under the Act. These Interpretation Notes have important implications for businesses which are considering acquiring an interest in a Canadian air carrier as well as for those which currently have a financial stake in Canadian airlines.

The first requirement under the Act that the carrier must be incorporated or formed in Canada is the most straightforward and easily met. The second requirement of 75 per cent equity ownership by Canadian interests is also reasonably clear but there are important points to bear in mind. The voting interests must be both beneficially owned and controlled by Canadians. It is not sufficient for the securities to be simply registered to Canadians. The Interpretation Notes advise that publicly-traded Canadian air carrier companies should have a control system in place to prevent the transfer of securities resulting in less than 75 per cent Canadian ownership of voting interests or an alternative means to achieve the same result, such as securities with a variable voting value.

Of the three requirements, the “control in fact” test, which recognizes that legal control does not always equate to actual control, is the most complex. The Interpretation Notes emphasize that no one factor is determinative and that each case must be assessed on its own facts. The Interpretation Notes provide guidance with respect to a number of factors which may affect an air carrier’s Canadian-controlled status:

  • Risks and benefits: It is presumed that parties which carry a majority of risks and the entitlement to the majority of the benefits in connection with the operation of an air carrier have control in fact.
  • Concentration of voting interests: Voting interest concentration may be relevant where a non-Canadian or non-Canadian group holds a block of voting interests, and where the remaining voting interests controlled by Canadians are spread amongst numerous unrelated persons. The non-Canadian minority interest-holders may have a greater ability to direct the business of the air carrier than the Canadian majority.
  • Directors and officers: It is essential that Canadian shareholders have the right to appoint the majority of the board of directors, and the Agency takes the position that the majority of the board must also be Canadian. However, the officers need not be Canadian, unless there is a reason to believe that the officers are conduits for non-Canadian shareholders’ exercise of control. Quorum provisions should be designed to ensure that a majority of the shareholders or directors present at a meeting are Canadian, and that a majority of the directors present are those appointed by Canadian shareholders.
  • Veto rights: Veto rights over matters such as the payment of dividends are generally not considered by the Agency to affect control in fact. However, the veto rights (especially in conjunction with other factors which permit minority interest holders to affect decision-making outcomes) or the nature of the veto rights in question (for example, veto rights over the selection of officers) can affect control in fact.
  • Security rights, options and warrants: While these rights are not normally significant for the control in fact analysis, they may be important where such rights are not exercisable at market prices and a non-Canadian investor holds an unequal proportion of these rights.
  • Debt, guarantees, lease of assets: Financial arrangements concerning debt transactions, guarantees, the power to wind up a company and the lease of assets do not generally indicate control in fact in the creditor, guarantor or other party, unless the magnitude or nature of the transaction is unusual.
  • Financial strengths and business activity: These factors can indicate those shareholders who have control in fact over the air carrier. For example, where a shareholder is a non-Canadian air carrier, and the Canadian shareholders have minimal experience in the aviation industry, this could be an indicator that the non-Canadian shareholder is exercising control in fact. Further, a non-Canadian shareholder which has significant financial resources and strength may be seen to have control in fact where the Canadian shareholders do not have such financial resources and strength.
  • Management agreements: Where management services are provided by a non-Canadian, the Agency recommends that an independent contractor (as opposed to an employee of another carrier) be used. Payment should be based on services rendered and any incentive bonus should be comparatively small. The Board of Directors should retain authority over major decisions and should have the ability to terminate the management agreement.
  • Operational or service agreements: Such agreements may affect control in fact if the service provider makes major operational decisions or is paid on a contingency fee basis.

In addition to the Interpretation Notes, there are also other changes pending which will impact the issue of foreign ownership. In 2009, Canada introduced a proposed change which would allow for an increase in the amount of voting interests owned and controlled by non-Canadians to a percentage not exceeding 49 per cent. This proposed change was made in response to the Comprehensive Canada-European Union Air Transport Agreement, which came into effect that year. The Agreement provides for phased market opening and increasing degrees of foreign ownership. Ultimately, the Agreement contemplates that EU and Canadian carriers will be granted full rights to operate between, within and beyond both markets, including between points in the territory of the other party (known as cabotage). These rights will be granted once both sides complete the necessary steps to allow the full ownership and control of their carriers by the other’s nationals.

Until such time, and in any event for all non-EU investors, the Interpretation Notes issued by the Agency will provide important guidance to industry about how to structure foreign investment in Canadian air carriers.

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A brief sigh of relief for leasing in China but business still proves to be taxing

Author: Richard Skipper

Circular 48

Made public on 17 June 2011 the “Cai Shui (2011) No. 48” dated 10 June 2011 (Circular 48) grants an exemption for the payment of business tax - which is payable in accordance with the “Provisional Rules on Business Tax of PRC promulgated by State Counsel” (which came into effect on 1 January 2009) (Business Tax) - and has alleviated a number of concerns in respect of the treatment of cross-border equipment leasing agreements entered into prior to 2009.

Confuciusly Confused; Provisional Regulations on Business Tax - 1 January 1994 to 31 December 2008

Under the old regulations issued on 1 January 1994 (Old Regulations) a ‘service’ was taxable by the Chinese tax authorities if it took place in China. However there was uncertainty as to whether the payments under a leasing arrangement (be it loan interest or lease rentals) by a Chinese lessee, constituted a payment for services ‘services’ and was therefore taxable. Helpfully the State Administration of Taxation (SAT) issued, effective from 1 January 1997, circular Guo Shui Fa (1997) No. 35 (Circular 35). Circular 35 clarified that loan interest and lease rentals relating to tangible moveable assets generated from within China, but paid to foreign companies, was exempt from tax.

However, Guo Shui Fa (2006) No. 62 (Circular 62) issued by the SAT in 2006, abolished, amongst other things, Circular 35. Understandably the leasing community was concerned that, with the abolition of the circular that had clarified the tax exemption, the tax exemption itself was abolished. This took the tax position back to the uncertainty that has existed pre 1997. This was only further complicated by local tax authorities issuing different interpretations of the tax position to Chinese lessees within their jurisdictional remit.

The situation only seemed to deteriorate in 2008 when the “new” Provisional Regulations on Business Tax became effective on 1 January 2009. These regulations appeared to confirm that foreign lenders and lessors would be taxed on cross border lending or leasing if the borrower or lessee were located in China.

Due to the understandable response from the business community to the “new regulations”, the Ministry of Finance (MoF) and the SAT quickly issued Cai Shui (2009) No. 112 (Circular 112) in August 2009, which performed a U-turn on the tax position. However it stated that the revenue derived by the lessor from the Chinese lessee would be taxed in accordance with the Old Regulations. It was of course the lack of clarity under the Old Regulations which had started this ‘circular’ process in the first place - Confucius apparently once said “it does not matter how slowly you go, as long as you do not stop” - however going slowly in a big circle of circulars, would appear to be taking this philosophy a bit too literally.

Pre 2009 Lease Agreements

Issued jointly by the MoF and the SAT, Circular 48 states that the Business Tax exemption applies to finance leases and operating leases entered into from 1 January 2010 to the dates of expiry of the agreements, and shall apply retrospectively to the revenues derived by foreign lessors from Chinese lessees under agreements entered into prior to 2009.

For an agreement to benefit from the Business Tax exemption it must fulfil the following criteria:

  1. The lease period must exceed 365 days.
  2. The asset being leased must be an aircraft, ship, aircraft engine, large-scale power generator, machinery, large scale environmental protection equipment, large scale construction project machinery, large scale petrochemical equipment, containers and other equipment.
  3. The annual average lease rentals cannot be less than RMB 500,000 (approximately US$78,000).
  4. Any amendments to the agreement shall not include changes to the asset being leased, the rental amounts received or the term of the leasing. However the identity of the lessor may be changed.
  5. Payments under the lease must have already been remitted by the lessee.

Procedure for Business Tax Exemption

The Chinese lessee must submit the original lease agreement, evidence of the payments under the lease agreement and any other materials required by the relevant tax authority. Such a submission is required to be made by 30 September 2011.

Lessor Novations

Whilst it is always advisable to seek local law and tax advice in respect of the particular details concerning each transaction, Circular 48 appears to confirm that leasing companies purchasing assets currently on lease with Chinese lessees will not be subject to Business Tax provided that the facility arrangements which is the subject of such novation agreement complies with the requirements set out above.

One Step Forward

Whilst Circular 48 has provided a brief window of clarity and respite it remains to be seen whether the next circular takes the Business Tax one step forward or two steps back.

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Jet2.com Limited v Blackpool Airport Limited - the meaning of “all reasonable endeavours”

Author: Marianne McMahon

This case focussed in part on what was meant by Blackpool Airport Limited’s (BAL) obligation to use “all reasonable endeavours” to promote Jet2.com’s (Jet2) low cost service from Blackpool Airport.

The background to the case was as follows: in September 2005, Jet2 entered into a fifteen year agreement with BAL in relation to use of the airport. For four and a half years Jet2 operated some flights outside the airport’s normal operating hours. However, the airport was making a substantial operating loss and as part of the move to increase profitability, BAL wrote to Jet2 on 22 October 2010 stating that from midnight on 29 October 2010 it would not accept departures or arrivals that were scheduled outside normal hours. As a result, two of Jet2 flights had to be diverted from Blackpool to Manchester at considerable expense to the airline. Following successful injunction applications by Jet2, Jet2 was allowed to continue offering the same flight schedule for winter 2010 as it had for winter 2009.

The crux of the dispute centred on the interpretation of the parties’ obligations under clause 1 of the agreement which set out the terms on which the airline’s services to and from the airport would be provided. Clause 1 provided that Jet2 and BAL would cooperate together and would use their “best endeavours” to promote Jet2’s low cost service from Blackpool Airport and that BAL will use “all reasonable endeavours” to provide a low cost base that would facilitate Jet2’s low cost pricing.

Although both parties agreed that there was no difference between “all reasonable endeavours” and “best endeavours”, the parties differed on their interpretation of what this obligation entailed. BAL argued that the obligation did not require it to do anything that would be contrary to its legitimate commercial interests. Jet2, however, argued that BAL could not simply chose to reduce the level of service that it was committed to by the agreement simply because it decided that it was no longer in its commercial interest to do so.

The judge concluded that the meaning of ”all reasonable endeavours” remained a question of construction in each case and was highly fact specific. “All reasonable endeavours” was therefore open to a range of interpretations from a subjective interpretation at one end of the spectrum to an objective one at the other. The upshot of this is that it is not possible to formulate and adopt a general test as to what is meant by “all reasonable endeavours” or “best endeavours”. In this case, it was not possible to determine what BAL’s obligations were simply by ascertaining what an ordinarily competent airport might reasonably be expected to do in the same circumstances.

Factors which the judge took into account when deciding that BAL had been in breach of contract included the fact that BAL’s obligation to use “all reasonable endeavours” related to matters which were within its own control, such as allowing flights to operate outside its normal opening hours. This is different from cases where the party who is under the obligation to provide “all reasonable endeavours” is relying on the actions or decisions of third parties over whom it has no control. In such cases the requirement to use “all reasonable endeavours” does not require that party to sacrifice its own commercial interests.

The judge felt that on the facts of this case, BAL’s obligation to use all reasonable endeavours to provide a cost base to facilitate Jet2’s low cost pricing meant that it had to provide facilities and services that would allow low cost pricing and this included not confining Jet2 to normal operating hours. However, “all reasonable endeavours” did not impose an obligation to make an absolute commitment to provide those specific hours throughout the fifteen year period.

So parties need to be aware that if they include terms like “all reasonable endeavours” or “best endeavours” in relation to a party’s obligations, then whether or not that obligation has been fulfilled may become a matter of debate which may not be easily resolved. It is better, where possible, to use express language when drafting obligations. Here, the airport could not claim that its commercial interest was a good reason for not exercising “all reasonable endeavours”.

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BAA launches fresh appeal of Competition Commission divestment order

Author: Caroline Thomas

In potentially the final chapter of this long running saga, on 16 September BAA filed an appeal with the Competition Appeal Tribunal (CAT) against the Competition Commission’s (CC) decision of 19 July ordering BAA to proceed with the sale of Stansted and one of its Scottish airports (Edinburgh or Glasgow).

The CC had ordered that the divestment process should start on 19 October 2011 at the latest, but while BAA’s appeal is likely to delay this timetable further, the CAT will be under pressure to hear the review promptly given the long delay already since the original CC divestment order following its March 2009 report. Potential bidders will eagerly await the outcome of the appeal, and in particular whether, as BAA has requested, the CAT will order a suspension of the sale timetable while the appeal is heard.

The substance of the appeal relates to BAA’s attempt to convince the CC, prior to its 19 July decision, that there had been material changes of circumstances since the CC’s original March 2009 report meaning that the divestment of Stansted was no longer proportionate and appropriate.

Although the CC rejected all of BAA’s arguments, BAA is now asking the CAT to find that the CC’s assessment was flawed and/or irrational in not recognising a “material change in circumstances” and maintaining the divestment order despite three factors:

  1. the government’s decision not to expand runway capacity at London airports;
  2. the significant fall in the level of Stansted’s profitability; and
  3. the impact of these on the possibility of common ownership of Heathrow and Stansted giving rise to an adverse effect on competition.

In the alternative, BAA is challenging the proportionality of the divestiture remedy and its timing and sequencing given the current economic climate and the potential damage to BAA and its shareholders in ordering the divestment of Stansted within a short specified period.

This latest chapter follows on from the Supreme Court refusing BAA leave to appeal the Court of Appeal’s judgment of last year which restored in full the CC’s 2009 Report. That in turn followed BAA’s initial success before the CAT in having the CC Report overturned on grounds of bias. Please see our previous updates for more details of these previous developments.

Now the CAT will again have to make a decision on whether to endorse the CC’s controversial decision. BAA may have concerns about being forced to sell an asset in the current climate, although given the economic instability it remains to be seen whether further delay will lead to the market improving or in fact deteriorating further.

Considering the delays that appeals have already caused to the implementation of the original CC order, the CAT may have limited appetite for a further appeal, but it will have to consider BAA’s arguments. The CAT has previously recognised that CC decisions involve a significant element of judgement and said that it will allow the CC an appropriate margin of appreciation such that it will not intervene without good reason.

However, unless the BAA appeal is dismissed as vexatious, or the CAT decides not to suspend the sale timetable while the appeal is heard - both of which seem highly unlikely - there will be some further delay to the sale process with pressure for a hearing before the CAT perhaps early next year.

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