Jonathan Epstein is a Partner in our Washington, D.C. office
The management, operation and maintenance of a business aircraft is a complex and expensive undertaking. Although some aircraft owners may be able to hire experienced pilots and mechanics, a good charter-manager brings additional resources in connection with maintenance oversight, logistics and flight planning. As a charter-manager customer, an owner often may take advantage of the charter-manager's buying power associated with costs for overhead such as fuel and insurance. FAA certificated charter-managers may generate additional income for the owner by chartering the aircraft to third parties, and often will allow an owner to charter other fleet aircraft at a discount.
The Charter-Management Arrangement
Charter-management agreements range from "turn-key" management of an owner's entire aircraft operation, including providing pilots, hangarage and insurance, to more limited arrangements. In a typical arrangement, the owner pays all the costs of owning and operating the aircraft, including the pilots' salaries and benefits (even if employed by the manager). If the manager is certificated as an air-taxi operator under Federal Aviation Regulations (FAR) Part 135, then in addition to managing the aircraft, the manager may lease the aircraft and use it to generate revenue from third parties. A common arrangement is for the charter-manager to pay/credit 85 percent of the revenue generated from third-party charters to the owner as lease payments.
Choosing a Charter-Management Company
Charter-managers range from single aircraft operations to large international companies operating hundreds of aircraft. It is advisable to meet with and obtain quotes from more than one charter-manager before making any commitments. Among the recommended issues of inquiry are the following:
- Is the charter-manager certified under FAR 135?
- Is the charter-manager rated by any third-party services, such as WYVERN or ARGUS?
- Has the charter-manager gone through the voluntary process to obtain IS-BAO certification?
- Does the charter-manager have experience in the relevant category of aircraft?
- Does the charter-manager have facilities near where the aircraft is based?
- What is the charter-manager's safety record?
Specific FAA Regulatory Issues Play a Role in Structuring the Charter-Management Arrangement
Regulatory concepts are important when structuring aircraft ownership, including who will be in "operational control" of the aircraft for particular flights. In a pure management arrangement, the owner may hire the manager to provide pilots but the owner remains in operational control of the aircraft for the private flights of the owner (to be operated under FAR 91). In a pure charter-management arrangement, the charter-manager (which must be a certificated air-taxi operator) will lease or otherwise have contractual possession and operational control of the aircraft for all flights (operated as commercial flights under FAR 135). Most common is a combined arrangement where flights for the owner are conducted under the "operational control" of the owner under FAR Part 91, and flights for third parties are conducted by the charter-manager as commercial flights under FAR Part 135. There are tax, operational restrictions and other factors that go into determining the best structure, which include the following:
- The "Flight Department Company Trap" – An owner may operate an aircraft under FAR Part 91 for is own business purposes (e.g., incidental to the main business of the company). However, if the company's primary purpose is to provide air transportation for compensation (even if the compensation comes from a member or parent company), then that entity is required to obtain an air-taxi certificate. Hence, while a special purpose entity may own the aircraft, that entity will generally have to lease the aircraft to the parent or true operating subsidiary if it wants to fly the aircraft under FAR Part 91.
- The "134½ Operator" – If the manager does not hold a FAR Part 135 certificate, be wary of scenarios that involve (i) the owner leasing the aircraft to a number of entities with the manager providing pilots; (ii) the manager making use of another operator's FAR Part 135 certificate; or (iii) "franchising" type arrangements where the owner is independently marketing the aircraft for charter. While there are scenarios for joint ownership and leasing that are legitimate, the FAA has punished operators that are viewed as trying to skirt the air-taxi certification process.
State and Federal Tax Considerations
Depending on the specifics of the arrangement, a charter-management arrangement may have tax implications and your accountant or tax advisor needs to be part of the planning. For example, in some states predominant use in charter may qualify the aircraft for an exemption from state sales and use tax. However, the federal income tax issues associated with charter-management arrangements are complex and uncertain. For example, the IRS may take the position that a charter-management arrangement should be characterized as a rental of the aircraft to the manager, rather than services provided by the manager to the owner. Charter use may affect the applicable depreciation method, but third-party charter may be useful if there is considerable personal use of aircraft. If the owner or its related entities charter the aircraft, this will trigger, among other things, a 7.5 percent federal excise tax (FET) on air transportation on the charter payments that is not generally applicable to most FAR Part 91 flights. In recent years, the IRS has pushed to collect FET on virtually all payments made to a charter-manager in certain common charter-management scenarios. (The IRS takes the position that regardless of how the FAA views "operational control," an entity providing an aircraft and crew for compensation to another entity is providing taxable air transportation). Although this IRS policy currently is in abeyance and being opposed by industry groups, owners should be mindful of these potential tax ramifications.
Understanding the Cost Structure of the Agreement and Avoiding Conflicts of Interest
Many disputes between owners and charter-managers arise from misunderstandings about costs/markups that were either not disclosed or not understood by the owners, particularly where they create a potential conflict of interest. For example, charter-managers typically charge a handling fee/surcharge on parts and material that is often a percentage of the cost of the parts/material. This surcharge creates a disincentive to find the lowest price solution for repairs/repair parts. Charter-managers may charge labor rates for maintenance oversight in addition to actual time spent conducting maintenance and repair. In addition, charter-managers often keep their management fees low but make a profit on fuel, hangar rental and other ancillary services. None of these fees are necessarily "red flags," but they should be discussed up-front and addressed in the management agreement so there is no misunderstanding.
Liability and the Charter-Manager's Insurance Policy
An owner often benefits from placing its aircraft on a charter-manager's fleet insurance policy. The manager may have higher liability limits and lower premiums than the owner could obtain on its own. However, it is critical that the management agreement and the actual insurance endorsements adding the owner to the policy fully cover the owner and any affiliates that will operate the aircraft, and meet the requirements of any financer holding a security interest in the aircraft. As discussed above, often the owner or an affiliated company under a lease will be in "operational control" of private flights for the company operated under FAR Part 91. However, it is not uncommon to see the owner and/or affiliated company listed as an "additional insured," and covered for liability solely for the operation of the aircraft by the "named insured" (i.e., the charter-manager). Hence, the owner may not be covered for its own operation of the aircraft. There are other protections that an insurance broker may add — at no cost — to the policy endorsement and certificate to ensure that the company is fully covered by this policy.
Conduct a Thorough Analysis Prior to Any Charter-Management Arrangement
When considering a charter-management arrangement, aircraft owners must carefully analyze both the nature of the charter-management arrangement and the specific charter-manager who will operate the aircraft. FAA regulatory compliance, income generation, tax implications and insurance coverage are some of the very important components of the analysis. Particularly important is identifying surcharges or markups to be imposed by the charter-manager that may not be readily apparent. The aircraft owner should educate itself as to these issues with appropriate legal and accounting advice in order to have productive discussions and negotiations with charter-manager candidates.
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.