Amanda Applegate

For nearly 3 years we have been in a seller’s market. I often think of the aircraft market as a clock’s pendulum. It swings back and forth between being a buyer’s market or a sellers’ market and sometimes for long periods of time rests in or around the middle. However, in recent years, the pendulum has been stuck at the top of the arc on the seller’s side.

In March of 2020 the pandemic started us all on a path we did not understand and could not predict. I recall being on many conference calls with industry experts who were not sure if the private aviation market would go into a downward spiral, stay the same, or boom. As we all know now, the demand for private aviation reached an all-time high during the pandemic. As a result, inventory for pre-owned aircraft became scarce, new aircraft order backlogs grew exponentially, the ability for immediate access in fractional programs evaporated and the charter market exploded. The sum of these factors resulted in increased aircraft prices and limitation on availability.

Consequently, the scarcity created by the pandemic (and an increase in demand as the number of people who could afford to fly privately grew), led to some of the most one-sided aircraft transactions I’ve experienced in my 25-year career. Not only have purchase prices been high but the ability to conduct reasonable pre-acquisition aircraft due diligence and the ability to negotiate reasonable terms has been hampered. In some instances, sellers have simply decided to sell to a different buyer for a higher price, in breach of a signed purchase agreement. Additionally, due to the seller having all the negotiating power, there were often time constraints on the acquisition leading to rash decisions made about ownership structure, aircraft selection and post-closing management of the aircraft. These quick closings have led to an increase in management company changes within the first year or two of aircraft ownership and an increase in sales of aircraft that were acquired in the past few years.

In 2023 we are now seeing some signs of the pendulum swinging back toward the middle. Inventory numbers are starting to increase and there are not as many immediate offers on an aircraft as soon as it is listed. However, quality, low-time aircraft in high demand categories are still selling quickly. Perhaps this too will change as we move forward in 2023.

While we are still in a seller’s market, it is not as one-sided as it once was. As a result, buyers can act more rationally and ensure that they are selecting the right aircraft and take the time needed to properly structure the ownership and operation of the aircraft and select the right aircraft management company.

Regardless of what market we are in now or in the future, when the right aircraft becomes available, a smart buyer will be ready to move so they do not miss out on the best aircraft for them. There are several things a buyer can do in anticipation of finding the right aircraft.

1. Ownership and Operating Structure  A first-time aircraft buyer should engage a skilled aviation attorney to help determine the correct aircraft ownership and operating structure, including review of federal and state tax planning and regulatory compliance. Current aircraft owners should work with their aviation attorney to review the current structure and make sure it still is the best considering any changes that have occurred since the aircraft was acquired.

2. Aircraft  Having an experienced and knowledgeable aircraft broker review usage patterns of the past months or years and/or what future usage may be will help to determine the right aircraft type(s) and the number of hours that will be flown. Then, use this information to determine if charter will be allowed on the aircraft.

3. Management Company  Aircraft buyers should consider where the aircraft will be based, the type of aircraft being purchased and if charter is going to be permitted. (This should not just be based on which management company friends have used.) There is also the X factor in finding a management company that will be the right fit based on the culture of the company.

4. Technical Representation  Select a technical representative to oversee the inspection. This may be an employee of the management company or an outside consultant. The representative should have good knowledge of the aircraft type being purchased and be able to be on-site during the pre-purchase inspection.

5. Lender  The lender can be ready to approve a loan once the aircraft is identified by already having the necessary financials and ownership/operating structure in hand. This will allow the cycle time to close on the loan once the aircraft is selected to be shorter.

As we move towards a more balanced market, it is still important to be a prepared buyer. With the seller’s market waning, a buyer has more time to become a thoughtful buyer, which will hopefully result in less time and money being expended after the aircraft is acquired to correct mistakes that could have been addressed prior to closing.

The most common first step in the acquisition of an aircraft is for one of the parties, usually the buyer, to prepare and submit a letter of intent (“LOI”) to the other party. The main reason for using an LOI is to express each party’s understanding of the key business terms of the transaction and to commit to those terms in writing. The LOI confirms that the parties have reached a meeting of the minds on the key business terms. Generally, unless there are extenuating circumstances, the LOI should not be skipped, otherwise more time and effort may be expended on the negotiation of a full agreement before the parties realize they do not have a deal.

For the purchase and sale of an aircraft, the LOI is usually a short, two or three page document that includes the essential terms (identified below) of the deal. The LOI usually includes a provision requiring that the buyer submit a deposit to a specific escrow company within a certain number of days after the execution of the LOI. Additionally, the LOI usually contains a provision that it will terminate and be of no further effect if the final aircraft purchase and sale agreement (“APSA”) is not executed by a certain date.

Given that the LOI is subject to the completion of an APSA and is usually non-binding, the obligation of the parties under an LOI often may be more of a symbolic commitment than a legal commitment. In almost all aircraft LOIs, the deposit is fully refundable, which means the buyer could change her mind at any time and receive a full refund of the deposit. If the LOI is non-binding or the APSA is not agreed upon by the required date, the seller can sell the aircraft to someone else if a better deal comes along. Since the intent of the parties is not always easy to determine and the cost of litigation can be prohibitive, it is in the parties’ best interests to remove any ambiguity from the LOI and clearly state their intentions. It is paramount that the LOI state which sections of the LOI, if any, are intended to be binding on the parties or that the entire LOI is non-binding.

Is the LOI necessary? Yes, it is the best way to start the aircraft purchase and sale process to make sure the parties agree on the key business terms before spending the time and effort to prepare the full APSA. A list of the key business terms to include in the LOI is as follows:

1. Name of the buyer and seller

2. Purchase price

3. Deposit amount and number of days to remit deposit after LOI is signed

4. Escrow agent

5. Visual inspection requirements (if visual inspection has not already taken place), if any

6. Scope of pre-purchase inspection

7. The facility conducting the pre-purchase inspection and at which location

8. Purchaser’s rights to accept or reject the aircraft after the inspection (for any reason or only if significant findings)

9. Definition of discrepancies and seller’s responsibility regarding same

10. Flight cost allocation for all relevant flights

11. Aircraft delivery conditions

12. Closing process (number of days to close after discrepancies have been remedied)

13. Number of days to agree on the final APSA and which party will draft the initial version of the APSA

14. Non-binding statement except for certain key terms

15. No- Shop provision, if applicable

16. Typical miscellaneous provisions (choice of law, confidentiality, assignment rights, deadline for acceptance, taxes, international registry requirements)

The decision to use a LOI or omit the LOI step is a question that should be evaluated with regard to each deal, the parties involved, and considering all the other variables involved so that a strategic, well-informed determination can be made. Most often the LOI should be the first step in the aircraft purchase and sale process and should not be skipped.

On November 22, 2022, the Federal Aviation Administration (FAA) published the direct final rule in response to the FAA Reauthorization Act of 2018. The final rule modifies (i) the duration that certificates of aircraft registration are valid and (ii) extends the period of effectiveness of aircraft registration applications. The effective date of this final rule was January 23, 2023.

First, the rule increases the validity of certificates of aircraft registration from three years to seven years. The certificates will now expire seven years from the month issued. In addition, the FAA is applying this rule to all aircraft currently registered under the existing regulations. The temporary authorization to operate under registration applications previously expired 90 days after the date filed. Now, registration applications are valid until the earlier of (a) the applicant receiving the certificate of aircraft registration from the FAA, (b) the FAA denies the application or (c) twelve months from the date the application was filed.

Due to the rule changes a new aircraft registration application form has been created by the FAA and published for use. The AC Form 8050-1 (01/23) supersedes previous versions and should be used on a go-forward basis. Not only does the new AC Form 8050-1 (01/23) remove the language regarding the registration expiring in 90 days, but there are also other changes to note. First, on the previous form the aircraft manufacturer and model were in the same box and now they are in separate boxes. Also, there is now a box for the applicant to include an email address.

The FAA has advised that the applicant will not currently be required to include an email address on the registration application and that this box can be considered optional for now. The addition of the email address on the registration application is in connection to the ongoing transition to Civil Aviation Registry Electronic Services (CARES). Eventually as a part of the transition, the email address will become a required field.

These changes will hopefully reduce the workload of the FAA Registry and allow the registry to be able to work on the elimination of the current backlog related processing filed documents. To start, the extension of time that a certificate of aircraft registration is valid from every three years to every seven years will mean less work is needed by the FAA Registry to process aircraft registration renewals. In addition, eliminating the expiration of applications after 90 days means that extension requests for applications no longer have to be filed and processed. Currently, documents filed with the FAA registry are worked in the order they are filed unless they are expediated because it is an import or export transaction or because there is an international trip planned. Documents that are not expediated are currently taking approximately five months to be processed.

What are the practical implications of the current delay in processing and recording documents with the FAA registry?

First, the one noticed most by my clients, is that the FAA website does not accurately reflect who the registered owner of an aircraft is. Almost weekly I receive questions from my clients who recently acquired an aircraft as to why the FAA website does not show them as the owner of their new aircraft. New aircraft owners are immediately concerned that we missed something in the closing process. However, the FAA website is not updated until the filed documents are examined and approved by the FAA registry. As a result, the current FAA website does not reflect changes to ownership, legal name changes, mergers, etc. filed within the last five months.

The second issue that is impacting aircraft owners is the inability to change the aircraft registration number in a reasonable time period. Just as you can personalize the license plate on your car, you can also select the registration number for your aircraft (subject to the guidelines established by the FAA and if the desired registration number is available). However, there is no way to expediate the process. For example, if the registration number you have on the aircraft you are selling is the same number you want to use on the aircraft you are purchasing it can take up to a year to complete that change. It will take approximately five months to receive the authorization to remove the registration number from the aircraft that was sold and reserve it back. It will take an approximate second five months to request the assignment the registration number to the new aircraft.

Next is the impact on international trips. The authorization to operate under the registration application only allows for flights within the continental United States. If an aircraft has an international trip that comes up quickly, it may no longer possible. Without the aircraft registration (not issued until the registration application is processed) the applicant is required to file a declaration of international operations to obtain a fly wire. The declarations of international operations I have filed recently have taken between three to five business days to process. As a result, travel outside of the continental United States on an aircraft that is purchased but where the application for registration has not been processed due to the five month backlog of the FAA registry, is not immediately possible.

Finally, there is an impact to lenders. Until the documents filed and indexed are actually examined it is unknown if the FAA registry will accept or deny the documents. It is also unknown if there are any errors in the filed documents that will cause them to be rejected. As a result, after initially filing it could be five months or more before a security agreement is rejected due to a typographical error or a more substantive error. Additionally, for aircraft that are financed and quickly bought and sold, the lien releases should contain the conveyance number assigned by the FAA registry. However, the conveyance number is not assigned until the documents are examined and recorded. As a result, if an aircraft is bought and sold before the original documents are examined the lien release cannot contain the conveyance number. I believe this will cause issues with title opinions for the aircraft in the future and will generate additional work in order to confirm that clear title can be conveyed.

Thoughtful change to the aircraft registration process is needed. I’m hopeful that these changes are a step in the right direction to get the FAA registry back on track and reduce the processing time for documents filed with the FAA- which would be welcome result for all involved.

Effective immediately the FAA Aircraft Registry announced on December 12, 2022 that it was restricting access to ancillary documents at the Registry to only Federal employees and Federal contractors. As a result, access to ancillary documents by Permit Holders (i.e. aircraft escrow agents and attorneys who specialize in aircraft registry matters) has been terminated. Ancillary documents include statements in support of registration filed for limited liability companies or partnerships, legal name change documents, powers of attorney, corporate merger documents, and trust documents.

The FAA stated this change was being implemented “because of concern about the inadvertent release of proprietary data and personally identifiable information (PII)”, and that “This decision is being made after careful Legal review regarding privacy concerns under the Trade Secrets Act (18 U.S.C. 1905) that prohibits disclosure of proprietary data, and the Privacy Act (5 U.S.C. 552a(b)) that prohibits disclosure of sensitive PII.”

Process change is always difficult, but implementation of this sweeping change during the busiest time of the year is worrisome, particularly with so many parties trying to close transactions prior to the end of the year. The most immediate impact that will be felt with regard to statements in support of registration. Since the statements already on file with the FAA will no longer be accessible to escrow agents and FAA registry attorneys, a new statement in support of registration may be needed, if the previously filed statement is not otherwise available. This is to ensure that the proper signatories and titles are included on the documents filed with the FAA.

We will keep you updated as Permit Holders, industry leaders, and the FAA work through possible solutions to address FAA concerns related to privacy and as new processes are developed.

As we have been rushing through this end of year madness there has been a new sense of urgency due to the scheduled phasedown of bonus depreciation. To be clear, bonus depreciation is not ending on January 1, 2023. There is a scheduled phasedown that was included in the Tax Cuts and Jobs Act of 2017 (“TCJA”). Throughout the history of bonus depreciation we have seen various legislation that has increased, decreased, extended and/or phased-out bonus depreciation.  As it stands now, below is a summary of the scheduled phasedown of bonus depreciation pursuant to the TCJA:

In addition to the percentages shown above, there is a one-year delay in the phasedown percentage for Certain Aircraft and Transportation Property. Certain Aircraft and Transportation Property are both defined in the TCJA. As a result, many aircraft transactions in 2023 will still be eligible for 100% bonus depreciation. In the alternative, the worst-case scenario for 2023, is that if an aircraft does not meet the definition of Certain Aircraft and/or Transportation Property, then the bonus depreciation amount available will be 80%.

As has always been the case, just because an aircraft purchased by a buyer is eligible for bonus depreciation, that does not mean that the buyer automatically qualifies to take the bonus depreciation. The intended use of the aircraft (business vs. personal; within the United States or outside of the United States) and the specific tax situation of the buyer will need to be closely reviewed to determine eligibility to take bonus depreciation.

It is important to always remember that a key step when purchasing an aircraft is the development and implementation of an aircraft ownership and operating structure and tax plan, both at the federal level and state level, which should be in place prior to closing and followed after closing.

 

More often than I would have thought possible, buyers and sellers are motivated by a variety of reasons to close on the purchase and sale of a pre-owned aircraft before the aircraft meets the delivery conditions specified in the aircraft purchase agreement (whether before the inspection has been completed and/or before the inspection discrepancies have been rectified). Sometimes it is because the buyer wants to close to start a major refurbishment to the aircraft and it would be more efficient to fix the discrepancies simultaneously with the refurbishment. Other times the seller wants the aircraft sold by a specific date for financial reasons, to make room for their newly acquired aircraft, or so the seller’s crew can leave for training on a replacement aircraft. Currently the most common reason is because of supply chain issues, such as when a particular part cannot be found, and it is a part that is not required to return the aircraft to service. Regardless of the reason, closing before the aircraft is in the delivery condition is becoming more common.

If the inspection is not complete at the time of closing, the risk to the buyer may be substantial because there could be unknown issues with the aircraft. Additionally, if closing takes place while the discrepancies are in the process of being repaired then additional, significant discrepancies could be found, but the buyer may not have any recourse.

If the parties understand the risks and elect to move forward and close before the aircraft is in the contractually agreed-upon delivery condition, there are two options. The parties can agree on a purchase price reduction based on the estimated cost to repair the discrepancies or the parties can agree on a holdback amount to be held by the escrow agent after closing, with the holdback used to pay for the repair the outstanding discrepancies.

A reduction in purchase price allows the parties to complete the transaction and have no further dealings with one another. The price reduction amount should be the estimated amount to correct the outstanding discrepancies plus an amount that represents the risk that the buyer is assuming by accepting an aircraft before it meets the delivery conditions. A short amendment is needed to document that the buyer is accepting the aircraft even though it does not meet the delivery conditions in exchange for the price reduction. The amount of risk being assumed under this option depends on the status of the inspection and/or the extent of the unrepaired discrepancies. One understated benefit of the price reduction over a holdback is that the transaction is completed, thus the seller has no further responsibilities, and the buyer is free to do whatever they want with the aircraft going forward.

Alternatively, a holdback allows the seller to remain responsible after closing for paying the cost of the repairs necessary for the aircraft to meet the delivery conditions and has less risk for the buyer. In this case, the buyer and seller must continue to interact until the repairs are completed and the holdback is released from escrow. The business terms in the holdback amendment may vary but should include all the following:

1. The amount of the holdback. This can be the estimated repair amount or a greater amount depending on the specific repairs needed.

2. Precisely what the holdback can be used for. Can the holdback only be used for the repair of the specifically identified discrepancies or for any other discrepancies found while the repairs are being completed.

3. A clear understanding of which party is responsible for any shortfall if the holdback is not enough to cover the repairs.

4. The process of how the holdback is released from escrow- irrevocable escrow instructions to release the holdback when the final invoice is submitted for the repairs or by mutual consent of both parties.

5. A deadline for how long the holdback can remain in escrow.

6. The escrow agent should be a party to the holdback amendment, and they should confirm they understand the terms prior to execution.

There can be legitimate business reasons to close on a pre-owned aircraft prior to the aircraft meeting the delivery conditions as originally agreed upon between the parties. When the parties desire an early closing, it is important that the risk allocation is considered in the financial terms and that the agreement of the parties is clearly documented, including, if necessary, the post-closing obligations of the parties and the responsibilities of the escrow agent.