Roundtable: Aviation
We bring together three of the world's leading aviation lawyers to discuss increased regulations, industry optimism, areas of activity and dealing with aviation accidents.
Participants
Bob Craft
Holland & Knight LLP
USA
Who’s Who Legal: How has the industry performed over the past year? Is there room for optimism in the future? Is transactional and financing work likely to pick up?
Berend Crans: Growth figures do allow for optimism. According to IATA, 2010 will be a good year for airlines. Boeing’s forecast indicates an average annual growth of airline traffic of 5.3 per cent over the next 20 years and Airbus’ forecast was raised, on 14 December 2010, to an average annual growth of 4.8 per cent. These numbers lead to expected deliveries ranging from 26,000 (Airbus) to 30,900 (Boeing) aircraft during the next two decades. In view of these numbers, transactional and financing work is very likely to pick up.
Obviously, these numbers also entail a huge funding requirement – in the region of US$3.6 trillion for the period – the question is whether the financial markets can handle this volume. New innovative financing methods may be required for these volumes, perhaps also involving instruments issued to non-institutional investors. In addition, export credit agencies could play an important role in facilitating financing of aircraft by providing export credit guarantees.
At the same time, rising fuel prices (how long until we see oil prices exceed US$120 again?) environmental concerns and political and economic instability, may adversely affect growth over the coming years.
Bob Craft: The industry as a whole saw improvement in 2010, but the recovery has been uneven among the various sectors. Several
low-cost startup airlines went out of business, as did Mexicana. There was some consolidation, with BA acquiring Iberia and with Continental and United merging.
The airline industry has had an excellent return in the US and in certain parts of the world as a result of its disciplined decisions of the last three years. My aircraft-finance partners tell me that the airline industry has obtained needed financing but not more than was needed. In the US, there has continued to be a conservative approach to ordering new aircraft, and this will have been a very good thing for those airlines in the years to come if they can now replace their older fleets in time to be efficient during this period. Financing for used aircraft has been far harder to get due to the continued smaller lending capacity caused by the recession. Equity has been fairly available, but the equity has still wanted leverage and has not found enough deals to fully use the available equity while their sources are still interested.
Finally, the export credit agencies have all responded to the crisis of the last three years with amazing volumes of transaction support. In the aftermath there is a new ASU (Aircraft Sector Understanding) expected in the very near future, and much of the next couple of years’ worth of financing of new aircraft by airlines and some of it by lessors will be affected by how the ASU comes out.
(The ASU is an agreement among the OECD nations concerning guaranteed credits and government financing of aircraft. It initially related to Boeing and Airbus but has been renegotiated to apply to Embraer and Bombardier, and the revised version has been submitted for approval by the OECD nations).
In all, there is a sense that the transactional and financing work for the industry has been increasing and will continue to pick up. In particular, the capital markets have responded and shown the capacity to do more. Although this is still an uncertain time, the fact that M&A deals are beginning to be done again is an encouraging sign. The new deals and signs of other activity cause us to expect that transaction work in 2011 will be more significant than in 2010.
The reasons for the past volatility of fuel prices are the subject of much debate, and the situation will be monitored by the FAA and others to determine whether investor activity and speculation are having any significant impact on the price of oil. If such an impact is found, there will likely be regulatory intervention to reduce volatility. Assuming that the fuel prices and weather problems stay at reasonable levels (and that there are no 9/11-type events), 2011 should be a better year than 2010. Although some still believe that general economic growth in the US will continue to be slow, a number of analysts are confidently predicting substantial growth in 2011 and thereafter. This will of course help the airlines both directly and indirectly.
Serap Zuvin: The global crisis naturally affected the aviation sector, but these effects are gradually disappearing and more recently the aircraft financing sector had a fine year. On the other hand, the world is still experiencing the aftermath of the worst financial crisis since 1929 and we believe that this crisis will bring about a macroeconomic rebalancing between “emerging countries” and previous world leaders, specifically between China and the USA. Our longer term prediction is that the market will move from West to East, although the biggest fleet is based in the states and will continue to do so for the foreseeable future. Brazil, Russia, India and China will continue with their advanced rapid economic growth in the aviation arena as well as other sectors; and recently Turkey and other countries such as Indonesia and Australia have also stood out in this market.
Potential and existing purchasers and lessees have reduced their spending in the last two and a half years, but now in Turkey optimism has unquestionably returned and investment in the aviation sector is now increasing.
As a result, in recent times the work load of aviation law firms has had to shift from transactional and financing activities, to dispute resolution, because of the hard times of the debtors in making the payments and fulfilling the duties under their respective financing agreements. But in 2010, when compared to 2008 and 2009, the emphasis has returned to transactional consultancy.
Airlines lost around US$1.7 billion due to travel disruptions caused by the volcanic ash cloud from Iceland, and while Turkish airports were not closed down many flights to Europe were cancelled, and private Turkish airlines were negatively affected.
In any case, the number of the registered aircraft with the Turkish CAD was 814 in 2009 and as of today it has increased to 902. Similarly, the number of the helicopters registered with the CAD has increased from 55 to 74. During the last year, the passenger carriage capacity of the Turkish operators has increased from 41,853 to 47,980, and this reflects the type of growth that has seen Turkey’s economy rise to the 17th largest in the world.
Who’s Who Legal: The level of regulation in the industry appears to be on the rise. Is this the case in your experience, and what demands are these new regulations making upon clients?
Berend Crans: One of the concerns which lessees and lessors may have is the proposed overhaul of IFRS lease accounting. The proposed requirements would supersede IAS 17 in IFRSs and the guidance in Topic 840 on leasing in US GAAP. For lessees, which would have to recognise an asset representing its right to use the leased asset for the lease term as well as the liability to make lease payments, the new requirements would entail balance sheet extension. This may have an impact on financial ratios. Lessors would recognise an asset representing its right to receive lease payments and, depending on its exposure to risks and benefits associated with the underlying asset, either: recognise a lease liability while continuing to recognise the underlying asset (a “performance obligation approach”); or derecognise the rights in the underlying assets that it transfers to lessee and continue to recognise a residual asset representing its rights to the underlying asset at the end of the lease term (a “derecognition approach”). With respect to the derecognition approach, it is noted that there would be significant changes in the measurement of the right to receive lease payments, the recognition of lease income and measurement of residual assets. For more information see the Exposure Draft ED/2010/9 which can be found on the IFRS website (www.ifrs.org).
Bob Craft: The level of regulation is increasing, with air carriers being subject to a level of intervention and oversight that is unmatched in any other transport sector. In the US there are proposed new passenger-rights rules that would require airlines to put their tarmac-delay commitments into their contracts of carriage with the passenger, which might give each passenger a right of action against the airline. Airline marketing practices are also being aggressively regulated. Most recently, airlines are being required to prominently disclose the airline that will actually be operating each flight, whether by virtue of a code-share or otherwise.
Serap Zuvin: Effective regulation and satisfactory supervision of the authorities is essential in order to provide for a safe and rapid market growth.
Aviation has always been a heavily regulated area in Turkey. On occasion, new regulations are introduced with respect to certain tax advantages, such as reduction of VAT applicable on the sale or lease of aircraft, which directly affects the aviation industry, but such changes do not occur on a regular basis.
Recently, the increased liabilities relating to the enactment of the Montreal Convention in Turkey by the Turkish parliament are likely to provide difficulties for local aviation companies. Compulsory involvement of governmental authorities in almost every step of aviation transactions can also prove problematic.
Such regulations, for example, require certain agreements, including cross-border aircraft financial lease agreements and certain security packages, ie, mortgage agreements are drafted ex-officio by the Turkish notary publics. Furthermore, a registration requirement exists for the cross-border aircraft financial lease agreements with the Banking Regulation and Supervision Agency of the Prime Ministry of Turkey. Almost every action taken with respect to the aircraft by the lessors, lessees and the owners of the aircraft are required to be reported to the Turkish Civil Aviation Directorate.
Who’s Who Legal: Have environmental considerations continued to gain in importance in recent months? What type of work are lawyers being called on to do in this sector?
Bob Craft: Environmental issues are at the top of everyone’s radar screen, especially given the controversy that has been generated by the EU’s Emissions Trading Scheme, which is slated to be implemented in 2012, and which US carriers have sued to block. In addition to the legal wrangling over ETS (and the efforts to get ICAO to come up with its own scheme), there is a huge focus on the development and use of alternative fuels.
Serap Zuvin: The aviation sector is the only industrial sector for which various targets have been set globally for environmental protection purposes. Every year, numerous conferences such as the UN Climate Change Conference are held in the area with the attendance of airline companies, airport operators and other industry players. These leading players have agreed to cooperate to reduce the hazardous affects of airline transport to the environment. The initial target is simply the utilisation of new technologies, which will reduce the consumption of oil, the successful management of waste, an increase in recycling and a reduction in the dependency of the sector on fossil fuel.
Who’s Who Legal: Aviation is clearly one of the most international areas of law, almost by definition. Which countries have been particularly active in recent times and which are likely to become more so in the future?
Berend Crans: Obviously countries with healthy economic growth figures are likely to be and become active in aviation. Boeing’s most recent forecast for China for the next two decades indicated a requirement of 4,330 new aircraft with domestic passenger traffic growth at 7.9 per cent per anum.
Slightly less spectacular are growth forecasts for India; but still an average annual growth of 5.6 per cent is very attractive if compared with saturated markets in Europe and the US. Similarly, Latin America and the Middle East have shown remarkable recovery in 2010 in comparison to 2009 (with growth figures of 23.6 and 17.6 per cent respectively). In the CIS there is great potential growth in the domestic air traffic market. For instance, more than 150 million people live within a three-hour flight from Moscow and low-cost air travel is currently accounting for only 4 per cent of domestic air traffic. On this basis, I believe that domestic and regional air traffic will be the premier growth markets. As larger segments of the population in certain regions will be able to afford air travel, one would expect that domestic and regional travel will benefit first from this development.
This view is supported by the forecasts for African aviation. Boeing’s forecast calls for the delivery of 710 aircraft for the African market over the next two decades. Africa’s current fleet is almost 20 years old on average and the market demands newer and more fuel-efficient aircraft.
This implies a large demand for single-aisle aircraft with up to 100 seats and a growing competition in that segment. According to Boeing the global market will take delivery of 30,900 new aircraft over the next two decades, of which 69 per cent will be single-aisle aircraft. Airbus’ forecasts similar numbers.
So we are also likely to see increased competition in this market, with players other than the traditional two. China’s ARJ21 aircraft, expected to have its first delivery late 2010, the Embraer 190/195, Bombardier’s CRJ1000NextGen, India’s RTA, the Sukhoi Superjet 100, Mitsubishi’s RJ and, who knows, the Fokker 100 NG may all be fierce competitors of Boeing and Airbus.
Bob Craft: We are seeing a lot activity in Mexico and South America. With regard to international aviation disputes, at the moment the most active dispute is between Canada and the UAE over Emirates’ access to the Canadian market, and these countries are now engaged in a trade war that has extended well beyond the confines of aviation. As to future disputes, Russia is likely to be a hotbed of activity, especially given its policy toward overflight charges. I should add that, from a financing viewpoint, the total Cape Town Convention ratification response, with over 30 countries becoming parties to the Aircraft Protocol and with more expected soon, is a major international law event. It is reasonable to expect some new expansion of financing and leasing in those countries that ratify and properly implement the Convention and Protocol. Some of the larger nations – China, India, and Indonesia, among others – have already ratified, and others such as Brazil and Russia are working hard to accomplish this in their countries. The EU also has ratified, thereby permitting individual nations to do so in the EU. The ratifications by the smaller countries may also be influential as precedents for good and effective international aviation-law implementation (examples are Singapore, New Zealand, South Africa, Panama, Malta, Ireland, Norway, Malaysia and Ethiopia). Since all of the ratifying nations will share a substantial body of the same basic law as to aircraft, engine, and helicopter sales, security agreements, and leases, this can only enhance the financing and aviation legal activity in those countries.
Serap Zuvin: The civil aviation industry has grown quite rapidly in recent years, with the highest growth observed in Gulf countries. According to a report drafted by Emirates Industrial Bank, the number of aeroplanes owned by civil aviation companies of Gulf countries has reached to 478 in the first half of 2010. Middle Eastern civil aviation companies have achieved nearly 20 per cent growth; while European airlines could only achieve 2.3 per cent growth in the same period.
Russia and Brazil were also quite significant emerging markets, and similarly, in 2010 Turkish Airlines left its mark on the international civil aviation arena. Turkish Airlines has attracted attention by signing sponsorship contracts with Barcelona and Manchester United Football Clubs and increased the size of its wide-bodied and long-range aircraft fleet.
Who’s Who Legal: With tighter regulation and technological advances, will crash-related work form a decreasing part of law firms’ aviation practices in future?
Berend Crans: Statistics show that since the 1950s the percentage of accidents caused by pilot error dropped from 58 per cent to 46 per cent in the 2000s (source:www.planecrashinfo.com). The question is whether tighter regulation and technological advances will indeed further eliminate the human factor as a cause of accidents. This may be the case. At the same time, the increased use of larger aircraft may lead to more casualties in the event of an air crash.
What may reduce aviation litigation is a more uniform approach to liability criteria, the methods of calculation of damages in the event of death or mental or bodily injury (economic as well as non-economic damages). There is not a lot of progress in that respect and certain jurisdictions, including the US, are still plaintiffs’ favourites.
As a result, I would not expect a significant drop in accident-related practice in the near future.
Bob Craft: Aviation safety has improved greatly. In the last 10 years or so, better training and technology (such as enhanced ground proximity warning systems), in conjunction with systems and programs that monitor aircraft and crew performance and that gather safety-risk data on a mandatory and voluntary basis, have halved the rate of fatal accidents in the US involving airliners with ten or more seats. Nevertheless, there are still a number of major accidents in the US and in other countries, and the US National Transportation Safety Board continues to be very concerned that these accidents were preventable. Of course, sometimes it is the new technology that causes or contributes to the accident by operating in an improbable or unknown way that the operator was not sufficiently warned about. Moreover, people who follow these things are also constantly seeing reports of near accidents – events that just barely missed being catastrophes despite the safety improvements – so we know that accidents will inevitably keep occurring. In any event, this year has been one of the busiest for those of us at my law firm who advise and represent airlines in connection with aircraft accident investigations and litigations, and we are expanding, not reducing, this area of our aviation practice.
Our aviation-casualty practice is growing in part because it is not dependent on accidents that take place in the US. As Berend points out, the US is still one of the plaintiffs’ favorite jurisdictions (though some other countries’ laws and levels of damages are increasingly attractive to plaintiffs) and there is much litigation in the US arising out of foreign accidents. In cases arising out of a non-US airline’s accident outside the US, when the airline (pursuant to the Montreal or Warsaw Convention) is immune from lawsuit in the US the plaintiffs commonly commence lawsuits in the US against the manufacturers of the aircraft and its relevant components. The defendants then move to dismiss these lawsuits on the ground of forum non-conveniens; the success of such motions depends on the parties and the facts and the potentially applicable laws.
Serap Zuvin: To the best of our knowledge, during 2009 and 2010, no aircraft which is registered with the Turkish CAD has been involved in a crash-related incident. Technological advances and increased regulation will save hundreds of lives in the future, and while this may decrease the work load of law firms in connection with aviation crash claims, lawyers will continue to be essential in the sector in terms of other aspects of law, such as financing, insurance and the establishment of preventive measures.