European Union: Code Shares Come Under The Commission's Scrutiny

As intended, the liberalisation of air transport has led to increased competition: national carriers which could once count on a captive domestic market now face fierce challenges from other airlines offering services in their "home territories", while low cost carriers put them under constant pressure to cut prices. Airlines have been forced to become more innovative and offer a better and wider range of services. Above all, the need to cut operational costs has led to a search for economies of scale which only large alliances and enhanced cooperation between airlines can produce. In the past two decades, airlines have adopted several strategies with the fundamental objective of achieving greater efficiency and lower operational costs: mergers, global alliances, code shares and block space agreements, cooperation on ground handling and other airport facilities and links between frequent flyer programmes. The two key strategic benefits of such cooperation are wider network coverage and lower operational unit costs flowing from economies of scale and scope.

This article will concentrate on code share agreements ("CSAs"), as these appear to be receiving particular attention from EU regulators at present.

The traditional concept of a code share agreement

Under a conventional CSA, two airlines establish a reciprocal arrangement for the joint operation of services on specified routes. Flights will be operated by one of the parties, known as the "Operating Carrier", which provides the aircraft and crew, as well as the requisite ground handling services. The other party, known as the "Marketing Carrier" purchases seats or gains access to inventory on the flight operated by the Operating Carrier, and is permitted to apply its own two-character IATA designator code and flight number on the tickets it sells to its customers.

CSAs are a very common form of cooperative joint venture in the airline sector. CSAs allow greater access to cities through a given airline's network without having to offer extra flights, and makes connections simpler by allowing single "on line" bookings across multiple routes. In 2007, the European Commission sponsored a consultancy report regarding such arrangements and the report submitted by its consultants concluded that there were over 4,000 CSAs operated on EU-bound routes. The prevalence of CSAs in the aviation sector has not decreased since 2007. If anything, it is likely to have increased, not least because of the obvious cost saving opportunities CSAs offer to airlines in a period of economic instability.

There are a large number of variations to CSAs, but they can generally be divided into two broad categories:

  1. non-overlapping, or complimentary, CSAs, where the two airlines do not compete on the same routes, but use the CSA to link their respective services into a broader network. For instance, if Carrier A operates New York-London and Carrier B operates London- Frankfurt, a CSA between the two Carriers on those routes will be described as a "non-overlapping" or "complimentary" code share. Since the arrangements are between two market operators that are not in competition, such CSAs are not regarded by the Commission as raising concerns of competition policy and are generally treated as falling outside the prohibition in Article 101(1) of the Treaty on the Functioning of the European Union ("TFEU") and equivalent provisions of national competition laws of EU Member States
  2. overlapping CSAs, where the two airlines compete on the same route; for example if Carriers A and B both operate services between London and Rome, a CSA between them will apply on "overlapping" routes and will be subject to applicable competition rules, including Article 101 TFEU. Such arrangements must satisfy the exemption tests of Article 101(3) TFEU and equivalent provisions of national competition laws of EU Member States

A further relevant classification of CSAs relates to the arrangements between the parties as regards the seats acquired by the Marketing Carrier. There are three basic types of arrangements:

  1. Hard block arrangements, whereby the Marketing Carrier purchases an agreed number of seats on the flight operated by the Operating Carrier and bears the commercial risk of unsold seats
  2. Soft block arrangements, whereby the Marketing Carrier purchases an agreed number of seats on the flight operated by the Operating Carrier but can return unsold seats under arrangements that mitigate or even eliminate the commercial risk of not selling all purchased seats
  3. Free flow arrangements, whereby the Marketing Carrier has access to the Operating Carrier's inventory and is permitted to sell seats according to demand without prior quantities being agreed

In addition to such arrangements, CSAs routinely provide for agreement on various other issues, including safety audits, service quality levels, liability and indemnity.

The reaction of European regulators to code share agreements

It is no surprise that regulators in the EU Commission and in the Member States have taken an interest in CSAs, since these arrangements raise a number of interesting questions of competition policy. How far can code share partners discuss the services the Operating Carrier will provide? Is a marketing carrier limited simply to purchasing a set number of seats and no more? Can the two CSA partners agree on a joint marketing plan, something which would give each other access to information on their passenger bases, their marketing strategies and similar sensitive business information? Can the two parties synchronise their schedules to minimise connecting times? Can this cooperation include agreements or discussions on capacity, particularly how many aircraft to deploy on specific route and with what number of seats?

To date, regulators from the EU Commission or the 27 EU Member States have not given clear guidance. In 2001, a CSA notified to the Commission for clearance by SAS and Maersk Air led to an in-depth investigation during the course of which the EU regulators identified a market sharing infringement that was deemed a serious violation of EU competition rules. Fines of €39.375 million were imposed on the two airlines for this illicit market sharing, but the CSA itself was not condemned.

A general survey of CSAs was published in 2005 by the European Competition Network, a discussion group where the Commission and the competition authorities of the 27 Member States exchange ideas and analyses of the results of cases. This generally takes the view that non-overlapping CSAs do not present competition policy concerns, but that CSAs on overlapping routes must be analysed to determine whether they satisfy the four exemption tests of Article 101(3) TFEU. Encouragingly, the Commission has used hard block CSAs as "remedies" in merger cases, obliging the merging parties to offer such arrangements to competitors so as to mitigate the perceived impact of the proposed merger on the relevant market (for example, in the Air France/KLM, Lufthansa/SN and Lufthansa/Swiss cases). From this one may conclude that the Commission may view CSAs with hard block arrangements as not intrinsically anti-competitive and therefore permissible in appropriate circumstances.

This approach is further supported by two cases involving CSAs on Italian domestic routes, both of which were prohibited by the Italian Competition Authority: in one a CSA party became exclusively a Marketing Carrier and in the other there were reductions in frequencies as a result of the rationalisation of the CSA parties' services. The first decision of the Italian Competition Authority was annulled by the highest Italian competition court in 2002,

a ruling which was subsequently applied by a lower court to quash the second decision in 2004. The Courts held that: "the introduction of one single operator – instead of two – represents the essence of any code-sharing agreement, and it is therefore inappropriate to specifically characterise this economic situation in a negative way" and that "the minimum commercial coordination clauses necessary for a code-sharing agreement cannot be regarded as per se restrictive of competition, namely agreement on frequencies, timetable of flights and sale of seats". These two rulings provide a pragmatic and pro-CSA precedent and remain the only two judicial examinations of these increasingly popular agreements.

By contrast, free flow CSAs appear to be more troublesome to regulators. In February 2011, the EU Commission began two "own initiative" investigations of free flow CSAs between Lufthansa and Turkish Airlines (on the Munich – Istanbul and Frankfurt – Istanbul routes) and between TAP and Brussels Airlines (on the Lisbon – Brussels route). In its press release of 11 February 2011, the Commission indicated that it suspected that co-operation on ticket sales may have anti-competitive effects particularly on parallel, hub-to-hub free flow CSAs where the services of both parties overlap. On 13 December 2011, TAP and Brussels Airlines were "dawn raided" by Commission regulators, indicating that the investigation had become increasingly hostile. In its press release of 19 December 2011, the Commission suggested that it had concerns that the agreements might have gone further than what was necessary to implement the CSA, ie beyond the mere sale of seats in a conventional CSA. The Commission also indicated that it suspected that the cooperation between the parties in the context of the CSA may have infringed the prohibition of cartel activities and other restrictive business practices. The investigation is continuing at the time of writing.

Conclusion

Airlines contemplating CSAs with other carriers must take all reasonable measures to ensure their agreements comply with EU rules, and that involves an objective and detailed assessment of the efficiency gains and consumer benefits generated by their arrangements. The industry needs legal certainty, and this has become even more crucial with the abolition of the notification system in 2004 and its replacement by "self-assessment" together with the recent trend towards high fines for infringements of EU competition rules.

There is a clear need for more guidance concerning CSAs as they are an increasingly important type of airline cooperation. One can only hope that the Commission will respond to this need with appropriate policy pronouncements in the near future.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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