Not long ago, aircraft fractional ownership was promoted as an attractive alternative for individuals and businesses seeking the benefits of private aircraft travel, but whose annual flight time requirements did not justify the substantial capital and operating costs of owning a full airplane or undertaking the burden of maintaining a flight department. While charter and jet card programs do not require long term commitments or initial capital investment, the lure of fractional programs was in providing the owner with access to a managed fleet of aircraft, and the ability to depreciate his or her capital investment while maintaining and, perhaps, increasing the value of the investment in a market in which private aircraft travel was in demand.
In the current economic climate, however, luxury and business travel has significantly declined, and pre-owned aircraft values have dramatically fallen due to a glut of private aircraft on the market with few buyers. Many fractional owners are making an early exit from their programs to eliminate monthly fixed costs and fees, even if it means taking a loss on their capital investment and paying brokerage or remarketing fees to the fractional operators. At the same time, however, fractional operators are offering incentives and discounts to attract new customers and maintain existing customers. Given this environment, there are significant buying opportunities for those who still favor fractional programs over full aircraft ownership, as well as opportunities for current fractional owners to renegotiate their deals if they are willing to retain their capital investment in a declining market, rather than exercise repurchase rights when aircraft values are at their lowest in years.
A fractional interest in an aircraft is an undivided capital interest in a private aircraft. Fractional owners agree not only to share their own aircraft with others having a shared interest in the same aircraft, but also to "lease" their aircraft to other owners in the fractional program (an "interchange"). All of the owner participants use a common management company to provide a turnkey operation of the aircraft, including for crews, scheduling and maintenance.
There are multiple benefits of fractional ownership. Participants avoid the hassle of repeated airport searches and the need to arrive at the airport two hours before take-off. Business jets can land at more than 5,500 US airports compared to 500 airports for commercial service, reducing overall travel time and expense. Unlike commercial air travel, fractional owners are assured of privacy during their flights, so flight time can be productively utilized for business meetings and the like. In most programs, there is guaranteed on demand availability: with a minimum of only six hours of advance notice, a jet will be made available to the owner. Unlike many charter arrangements, the fractional owner is not charged for "deadhead" or ferrying time before the start time of the flight or after the owner has reached his or her destination.
Upon joining a fractional program, the customer purchases the undivided interest in a specific aircraft. The capital cost is proportionate to the size of the interest purchased, and most programs offer a one-sixteenth share or greater. The larger the share, the greater the number of hours allocated annually to the owner during the program's term. In addition to the up front capital cost, the owner pays an hourly fee for each hour of flight time used (an "occupied hour"), a monthly management fee (which will also be proportionate to the size of the purchased share), and other selected fees depending upon the program, including, for example, a fuel surcharge to account for fluctuations in fuel prices and "ferry" fees for traveling outside of the program's standard geographic service area. Generally, there is no economy of scale in purchasing a larger percentage interest, although some programs are offering incentives along with larger shares, such as guaranteed availability for upgrades to a larger cabin aircraft, simultaneous use of more than one aircraft without a premium charge, and limited flights outside of designated geographic service areas without a surcharge.
The cost of the fractional interest is tied to the cost of the aircraft's purchase by the fractional operator, but it is typically not equal to that cost. For example, larger fractional operators can often purchase aircraft from manufacturers at discounts without passing along the total savings to the fractional customer. Operators that offer fractional pre-owned aircraft often add hard to verify costs for refurbishment and other charges associated with purchasing the aircraft. The true value of the aircraft relative to the purchase price paid by the owner for a fractional share is particularly relevant when it comes time to resell the interest back to the operator at the end of or during the term of the program. Since the repurchase price for the aircraft is generally based upon its fair market value as of the date of sale, any premium paid at inception over the true cost of the aircraft will not be recovered on resale, and the residual value of the fractional interest will likely be less than the owner anticipated, even taking into account normal depreciation and market fluctuation. This becomes an even more critical issue if the purchase price was financed and the proceeds on resale of the aircraft are less than the outstanding balance of the loan. Moreover, establishing fair market value is a challenge in the current market since there are so few sales for comparable aircraft to establish a real market price.
In this current environment, purchasers of fractional interests will find plenty of negotiating room for the price of their interest. Some owners of newer aircraft have been forced by financial considerations to sell their aircraft at current market value, notwithstanding the depressed market, meaning that fractional owners who resell shares in an aircraft are selling them at prices which are substantially less than they were able to command for the very same aircraft just months ago. In fact, pre-owned aircraft prices represent the biggest decline in the industry, with discounts as high as 25% to 30% in some cases, making fractional programs more attractive than ever.
Similarly, to maintain market share in a declining market, fractional operators are more than ever inclined to negotiate the other terms, fees and charges associated with fractional programs. These incentives include reducing monthly management fees, or waiving the annual increase in those fees, and in occupied hourly rates; guaranteeing upgrades to larger cabin aircraft for smaller cabin fractional owners that might only occasionally need larger aircraft; increasing or waiving the minimum flight time (short-leg) requirements; waiving fuel surcharge requirements; and waiving ferry surcharges on a set number flights outside the program's standard coverage area. Depending upon the usage patterns of an owner, these concessions can represent real value and may help to offset the cost of holding on to the fractional interest in a declining market.
While savings abound in the fractional market, fractional programs are not for everyone. Depending upon the specific needs and objectives of the user, card programs, charters, and in some cases, full aircraft ownership may make more sense, and in this market, there are savings to be had in each. Due diligence, careful planning and proper guidance from consultants, counsel, and accountants with aircraft experience will help to ensure that the owner's objectives are met and that the savings are well worth the commitment to private aircraft travel.
Cozen O'Connor's business attorneys regularly counsel clients in legal issues relating to private aircraft purchase and ownership, and aircraft fractional programs. For more information, please contact Steven N. Haas (West Conshohocken, 610.832.7441, shaas@cozen.com).
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