Amanda Applegate

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.

For nearly two years we have been in the most significant seller’s pre-owned aircraft market in recent memory and the consequences are beginning to surface in various ways.

First, during this unprecedented seller’s market, some buyers, in order to be selected as the winning bidder for a particular aircraft, have skipped full pre-purchase inspections and complete aircraft records reviews the consequences of which are now surfacing.

One consequence we are seeing is that some aircraft which were thought to be charter ready, are not able to be added to Part 135 certificates unless major modifications are done. Not only are these modifications expensive, but supply chain issues and limited openings at maintenance facilities are causing extensive delays. Additionally, when the new aircraft owners take their aircraft into the shop for the first scheduled inspections since closing, the findings are overwhelming. Major corrosion on the aircraft and undisclosed deferred maintenance are just a few of the issues that have come up.

An additional consequence of this seller’s market is that buyers expediated the purchase process, prior to developing an accurate operating budget for the aircraft. As such, buyers did not plan or budget for upcoming major inspections and/or unknown discrepancies. As a result, the cost to own and operate the aircraft exceeds the estimated costs put together during the quick purchase process.

Next, there has been an increase in management company changes during the initial year of aircraft ownership. New buyers who purchased aircraft quickly selected management companies before fully vetting the company to make sure it was a good fit. As a result, aircraft owners are changing management companies at levels I have not seen before. The increase in management company changes is costly to the industry due to the time and money that are necessary to onboard the new aircraft and owner and then to quicky have to offboard them. These costs include legal documenting costs, internal hours, and most important personnel issues. If pilots, flight attendants and/or maintenance technicians were hired by the management company during the on-boarding process, then the crew will need to determine (with the help of the aircraft owner and management company) if they should stay with the current management company or move to the new management company.

Finally, in some instances the charter revenue expected is not being realized. The reasons for such charter revenue shortfalls range from overestimated revenue, increased maintenance costs, or aircraft availability issues due to more owner flights than predicted. Additionally, there have been long delays in getting the approvals necessary to add aircraft onto Part 135 certificates, thus delaying the generation of charter revenue with the aircraft.

On a brighter note, since we continue to be in Seller’s market, buyers who purchased their aircraft at the start of the pandemic can now become sellers and realize tremendous gain. I have seen several previous buyers become sellers and earn enough profit on the sale to cover the operating costs of the aircraft for the two years the aircraft was owned. However, once the aircraft is sold, the aircraft owner will have difficulty finding a replacement aircraft. In addition, there continues to be long lines to join membership programs or fractional programs. Another trap to be aware of for the buyer turned seller- the sale of the aircraft may also cause tax issues, if the aircraft was used for business and depreciated more than the sales price.

Going forward, what can be done if we continue to stay in an imbalanced sellers’ market? If a full pre-purchase inspection is not possible, hire technical experts to spend a day or two with the aircraft and records for a detailed visual inspection and records review prior to the closing. With the right technical team some, but not all, issues can be discovered without a full pre-purchase inspection. This should help with the development of an accurate operating budget. Additionally, before an aircraft is even found, management companies can be interviewed. This way the right management company will be ready to engage when the aircraft is purchased.

In an ideal world full pre-purchase inspections would become the norm again and deals would progress a bit slower as a result of the longer inspection timeline. However, until that happens, hiring the best available technical representatives for a limited scope of inspection is the next best thing, along with working in advance to select a management company to manage the aircraft.

Over the past two years, the charter market has grown, and more people are flying privately than before the pandemic. One challenge facing charter operators is how to add more aircraft onto their Part 135 certificate in order to accept more charter flights and grow their charter revenue. To overcome this challenge, some charter operators have purchased their own aircraft, started to guarantee or increased the guarantee of charter revenue to aircraft owners and entered into exclusive leases with guaranteed fixed lease rates for multiple years with aircraft owners.

When an aircraft owner is considering allowing their aircraft to be chartered, it is important to realize that the charter operator is responsible for the scheduled and unscheduled maintenance on the aircraft and the appearance of the interior and exterior of the aircraft. This responsibility, however, may cause the charter operator to face competing interests. Specifically, seeking to maximize charter revenue to satisfy and meet the demands of the charter customers while maintaining the aircraft to the highest necessary safety standards.

This conflict can be more pronounced when the charter operator is also responsible for the costs associated with maintenance and/or appearance of the aircraft. If the charter operator has the obligation to pay for all maintenance while the aircraft is being operated by the charter operator, then an unscrupulous charter operator may try to defer certain maintenance obligations to maximize charter revenue. While such deferments are sometimes permissible under the regulations, such deferrals can impact the future condition of the Aircraft and increase the cost and duration of the maintenance events.

Aircraft owners must mitigate the associated risks with the exclusive charter lease by having certain terms in the agreement with the charter operator.

First, the agreement between the aircraft owner and the charter operator should clearly set forth the obligations of the charter operator about maintaining the aircraft. Specifically pertaining to what standards the aircraft must be maintained and if deferred maintenance is allowed. It may also be helpful to require that the aircraft return to the same maintenance facility on a regular basis so that the same technicians can service the aircraft and monitor any reoccurring issues.

For example, an undiscovered water leak or a water leak that is not immediately remedied properly could cause additional damage to the aircraft. As a result, it is important for the charter operator and aircraft owner agree in writing on the amount of time that the aircraft can be operated while deferred maintenance remains open.

Additionally, the owner of the aircraft should have a right to inspect the aircraft and the aircraft documents with reasonable notice on a regular basis. This will allow the owner to hire a technical expert to make sure the aircraft is being maintained in accordance with the terms of the agreement, government regulations and the manufacturer’s guidelines. It is important that the aircraft owner not only has the right to inspect the aircraft but also exercises the right at least annually to avoid any significant surprises related to the condition of the Aircraft.

The aircraft owner must have an expressed right to repossess the aircraft and terminate the agreement if material conditions are breached, including but not limited to, failure by the charter operator to (i) maintain the aircraft, (ii) insure the aircraft, (iii) pay for items required under the agreement or (iv) maintain clear title by allowing liens to attach to the Aircraft.

Most importantly, the aircraft owner should have the right to conduct a return inspection during the last month of the agreement and a corresponding requirement for the charter operator to be responsible to fix any necessary repairs (allowing for any normal wear and tear). At the end of the lease, the aircraft must meet a list of well-defined return conditions that are set forth in the agreement at the expense of the charter operator. The aircraft owner should be able to select the inspection facility at which the return inspection is conducted to ensure the inspection is completed by an independent third party.

With the new charter customers that started flying privately during the pandemic, it is predicted that charter activity is going to remain higher than it was pre-pandemic. As a result, charter operators will continue to create new ways to meet the increased charter demand. Consequently, if an aircraft owner is allowing its aircraft to be chartered through an exclusive lease, then it is important to remember to take the outlined steps required to protect the aircraft so that the charter use does not negatively impact the value of the aircraft.