"National carriers" - The Last Frontier
01 May 2008
It is an astonishing paradox that the industry in the forefront of promoting international commerce and integration should be subject to antiquated rules that hinder cross-border investment and expansion.
Uniquely among international industries, airlines are still subject to restrictive and protectionist rules regulating the nationality of those who own and control them. These generally operate at two levels - internationally, between pairs of states, and nationally, in that any air operator that wishes to obtain a licence from a state to operate must satisfy that state's laws on nationality of ownership and control.THE INTERNATIONAL DIMENSION
It is a common misconception that these restrictive rules at the international level are contained in the 1944 Chicago Convention, which contains nothing directly on the subject. However, it does enable states to impose restrictive rules, by confirming that every contracting state has sovereignty over the airspace above its territory, and that air services to or from a state require its special permission, which can be withheld or granted subject to conditions. This has resulted in a network of bilateral air services agreements being concluded between states under which they grant each other the right to designate airlines to operate air services between the two states, normally on a reciprocal basis. It is common practice to include in such agreements a "nationality clause" entitling one state to withhold or withdraw operating permission from an airline of another state if it is not substantially owned and effectively controlled by the other state or its nationals.
Unlike the provisions in national laws (discussed below), the requirement in bilateral agreements is not mandatory: rather, the other state has the right to withhold or withdraw traffic rights if the condition is not met, and there have been cases of states not invoking the right - for example, when Aerolineas Argentinas was almost wholly owned by Iberia, and currently with the growth of certain cross-border airlines in South America such as LAN. However, if an international airline wishes to continue operating all its routes, it needs to be satisfied that none of the states to or from which it operates will enforce the right. This is why the Air France/KLM merger is still in a transitional phase and has not yet proceeded to a full merger, which would give rise to the risk that states to or from which KLM operates could remove its operating rights on the basis that it was no longer Dutch-controlled. Moreover, bilateral partners are less likely to be indulgent when major airlines from important aviation states are concerned, as a higher ‘price' (either in terms of traffic rights for their airlines, or even in areas outside air services) may be extracted for the giving of the indulgence.
This archaic system persists even in the context of agreements that are liberal in other ways. The US "open skies" agreements provide a good example of this. They may significantly liberalise opportunities for air services between the US and the other states in question, but they still contain the traditional nationality clause (except as regards the EC, as discussed below), thus continuing to regulate the ownership and control structure of the airlines of each side.
However, there have been two ways in which the traditional restrictions have recently been modified. In the first place, some states have succeeded in replacing the traditional nationality clause in some of their bilaterals with a clause that changes the criterion from nationality of ownership and control to the airline's principal place of business (regardless of the nationality of its owners). This is a radical change, and consequently has not so far been widely effected.
The other change was brought about as a result of the judgment of the European Court of Justice in November 2002 in the challenge brought by the Commission to the legality of open skies agreements between a number of member states and the US. One of the court's findings was that traditional nationality clauses in these agreements infringe the provisions of the EC Treaty on right of establishment, because they prevent, for example, an airline from France establishing itself in Germany and operating services between Germany and the US. As a result of this, the Commission has been trying to persuade non-EC states to replace the traditional nationality clauses in their bilaterals with member states with a clause that recognises and permits ownership and control of an airline from any EC member state by EC nationals. This initiative has met with some success, in that the Commission has now concluded 36 such agreements, but they are generally with states that have a liberal approach to aviation policy anyway (eg, Chile, Singapore, UAE) or small states whose aviation industry is not very significant (eg, the Maldives, Paraguay).
More significantly, the Commission succeeded in persuading the US to accept such a provision in the EC-US Aviation Agreement, which came into provisional effect at the end of March 2008. While at the time of writing it is too early to see the full practical effects of this, Air France has already taken advantage of the new freedom to launch services between London Heathrow and Los Angeles, and it has been widely reported that British Airways is setting up a special venture to operate services between the US and cities in Europe outside the UK.
NATIONAL RULES
The nationality clause in bilateral agreements, which applies to the airlines of one state operating to or from another state, are often mirrored by provisions in the national laws of states that require air operators licensed by that state to be substantially owned and effectively controlled by nationals of that state. While the nationality clause in bilaterals does not impose a mandatory requirement, as opposed to giving states the power to withhold or withdraw traffic rights, nationality requirements in national laws are normally absolute, without scope for any exception.
Such laws in the EC member states as between themselves would clearly be contrary to the EC Treaty's provisions on freedom of establishment, and have now been replaced by a common EC requirement, although this only happened with effect from 1 January 1993. The requirement is provided by article 4 of EC Regulation 2407/92, which provides that, to obtain an operating licence (which is necessary for the carriage of passengers or cargo for remuneration and/or hire) a company established in the Community must be able to demonstrate to its national licensing authority that it is substantially owned and effectively controlled by EC member states or their nationals.
The rules are even stricter in some countries, such as the US, where foreign interests are only allowed to own up to 25 per cent of the equity share capital, and are not permitted to have "actual control", of an air carrier. The limitations imposed by this rule were demonstrated in the early 1990s, when KLM had to reduce the amount of participation originally intended in Northwest Airlines, and, more recently, with the establishment of Virgin America, where a number of modifications to management structure were required before it became acceptable to the US authorities. The sensitivity of the issue was also illustrated during the talks that resulted in the EC/US Aviation Agreement. A relaxation of this rule had been insisted on as an important priority by EC negotiators, and the US DoT tried to accommodate their wishes to some extent by a proposed administrative relaxation of the application of the rule, but heated opposition to this forced its withdrawal, and in the end the EC signed the Agreement nevertheless, although with a commitment to negotiate on the issue in a second phase, talks on which commenced in May 2008.
JUSTIFICATIONS
The concern about sovereignty, and the nationality restrictions that stemmed from it, were understandable at the time of the Chicago Convention, when much of the world was still at war, and defence considerations were paramount. Furthermore, while most airlines (with the notable exception of US airlines) were state owned, it was neither surprising nor inconvenient that their ownership and control should be tied to the state. However, although security has become an increasingly pressing concern, things have moved on since then, so that the strength of feeling that the issue still attracts is surprising, particularly in the United States. Despite the liberal approach of the US to other sectors of trade, even as regards certain aspects of air services (as shown by the open skies initiative), rational thinking seems to take flight when the possibility of foreign ownership of airlines arises - both in Congress and among trade unions.
The arguments traditionally put forward to justify the restrictions can be quickly demolished. Some argue that the rule is necessary to make the CRAF programme workable (the programme whereby the US government can requisition aircraft in times of war or emergency). However, as the Brattle Group conclusively demonstrated in its 2002 report on The Economic Impact of an EU-US Aviation Area, there is no reason it should be any more difficult to requisition aircraft from airlines if they are foreign owned than if they are US owned: indeed the Brattle Report concluded that "liberalisation of EU-US aviation trade and investment would not jeopardise US national security and it might enhance it". The recent increase in terrorist activity has given rise to understandable concerns about hostile foreign nationals gaining control of airlines and their aircraft, but it ought to be possible in other ways to ensure that airlines are not owned and controlled by persons who pose a security threat. As for the concern about jobs shown by US unions, this is difficult to understand, as freedom for foreign capital to be invested in a country's airlines is surely more likely to create rather than destroy jobs.
More easy to understand is the concern of some states, particularly smaller states and those which are heavily reliant on air transport links with the rest of the world, that their links will become controlled by foreign airlines or investors whose main objective is profit or the enhancement of their wider network and traffic, or both, rather than the interests of the state. But there are other ways of safeguarding national interests, such as capacity limitations in bilaterals, licensing regimes and public service obligation mechanisms.
LACK OF CERTAINTY AND TRANSPARENCY
Moreover, there is an undesirable degree of uncertainty about how the rules are applied in practice, which prejudices and discourages foreign investment. Both the US concept of "actual control" and the EC concept of "effective control" leave considerable scope for subjectivity. Indeed, although the rule is the same for all EC member states it appears to be applied with differing degrees of strictness among them: "appears to be", because it is impossible to document this with hard evidence, given that decisions by licensing authorities on the subject are not published, and their details are known only to the parties involved.
The UK CAA, for example, is known to take a strict approach, asking searching questions about the motives of non-EC investors (particularly airlines) taking stakes in UK operators, and examining whether there may be circumstances or arrangements that confer effective control on shareholders who on the face of it have only a minority interest. Arguably, given the strict requirements of the law, the CAA is only complying with its legal duties. This cautious approach is demonstrated by the guidance it has published on the application of the rule - uniquely, it would appear, among aviation authorities in EC member states.
The EC Regulation permits member states to ask the Commission to examine the application of the rules in a particular case, and the Commission must publish a formal decision. However, so far this has happened only once, in 1995, in connection with Swissair's investment in Sabena, and, as the Commission pointed out, this was a special case, as it was likely at the time that Switzerland would conclude an air transport agreement with the EC which would effectively treat Swiss nationals as EC nationals for the purpose of airline ownership (and such an agreement was subsequently concluded). Hence, while this decision is helpful, its precedential value is qualified.
GENERAL AVIATION
An unfortunate aspect of the national rules in most countries (and the EC rules) is that they apply not just to airlines but to all companies that carry persons or cargo by air for money, and thus apply to enterprises such as air taxi operators, many helicopter operators and even certain corporate jet operators, although none of the reasons traditionally given for justifying the rule make any sense in these contexts.
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The present situation is arguably archaic and unsatisfactory. It inhibits the international development of an otherwise highly international business and perpetuates the system of national flag carriers (whether they be owned by the state or not) and the continued existence of a larger number of airlines than is economically viable. The consequent inability of airlines to merge has meant the emergence and growth of the alliances to which most of the major airlines now belong (OneWorld, Star and SkyTeam).
The gradual modification that is coming about as a result of the European Commission's initiative concerning member states' bilaterals is welcome, although it is a slow process, and so far with limited results among significant aviation states. The acceptance of an EC nationality clause in the EC-US Aviation Agreement is an important step forward, but the negotiations demonstrated the sensitivities involved and difficulties in liberalising national rules. Nationality remains the last great frontier in aviation, and the industry will not be properly liberalised until it is allowed to function in this respect as most other industries.