Changing skies: implications of the new 'Operational Control' regulations.

A change in the law governing the way fractional aircraft operations are run takes effect early next year and fractional customers--the owners of fractional shares in airplanes run by programs such as NetJets, FlexJet and Flight Options--will have to give serious consideration to the potential effect those changes could have on their use of the aircraft.

February 17, 2005 is the day "Part 91, Subpart K" takes effect for the major national programs. This rather peculiar name identifies the particular section of the Federal Aviation Regulations ("FARs") that governs fractional aircraft programs. The FARs are the rules the Federal Aviation Administration ("FAA") enacts to govern all aspects of public and private aviation in the United States. With the implementation of 91K looming, fractional customers will need to decide whether they want to accept the legal responsibility of "operational control" for every flight they take--and no one can say, at this point, what that responsibility might mean if an accident were to occur involving the owner's aircraft. More on that subject in a moment.

First, however, a few brief words of introduction for the uninitiated. Fractional ownership, in simplified terms, is the concept by which between two and 16 owners acquire an ownership interest in an aircraft (normally a jet airplane) and the right to fly whenever they want, subject to certain limited restrictions regarding things like holiday usage and minimum notice requirements. The number of hours the owner can fly each year depends on how big an interest the person owns. A sixteenth, the smallest airplane share permitted by law, will normally entitle the owner to 50 hours of flight time each year, while a half-owner could use the airplane as much as 800 hours a year.

Fractional ownership is sometimes described as "time sharing" for jet aircraft, but it's actually very different from a time share in a resort condo in that the fractional owner can essentially order a jet whenever he or she wants it. The customer is not limited to certain pre-set days or times. The program operator--companies such as NetJets, Flexjet, Flight Options and Citation Shares--assume the responsibility for having enough jets in their fleet to meet the demands of their customer base. On peak days (such as holiday weekends), owners may have to wait longer or adjust their departure times. In a worst- case scenario, a program operator may have to charter jets from outside its regular fleet to satisfy the demand.

In return for the luxury of this on-demand private jet service, the owner pays an initial purchase price (normally the market value of the airplane divided by the size of the fractional share), a monthly management fee (regardless of whether the owner uses the airplane in a given month or not) and an hourly charge for every hour the airplane is actually flown. Fractional ownership is not cheap. A one-sixteenth interest in a used Cessna Citation V Ultra currently runs $312,500 while the same size share in a Gulfstream G-V is $2.4 million. Buying one-half of a new G-V from NetJets will set you back $19.25 million. Monthly management fees can range from $5,800 to $107,000 and the hourly operating costs vary from $1,400 to $3,200. But, for the well-heeled, fractional ownership is akin to owning the right to use a private jet--a limousine in the sky--whenever you want it, without the attendant hassles of hiring and training the pilots, buying the fuel, providing the insurance coverage, maintaining the airplane, etc. The program operator assumes the responsibility for all of these tasks. And, depending upon how they use the aircraft, fractional owners can take advantage of extremely attractive opportunities for depreciation of their shares and business expense deductions for the actual costs of operation.

Now, back to Subpart 91K. The biggest change that 91K makes in U.S. aviation law is that it spells out, definitively and for the first time, when a fractional customer has "operational control" over a flight. "Operational control" means--in the words of the FARs--that the owner is "ultimately responsible for safe operations and for complying with all requirements [of the FARs], including those related to airworthiness." The fractional owner can delegate these duties to the program manager by contract--which, of course, owners always do--but now, under the new rules of Subpart 91K even when the owner delegates management responsibility to the aircraft operator, "the owner and the program manager are jointly and individually responsible" for compliance with the law. And a fractional owner is in "operational control" under 91K whenever that owner has instructed the fractional program manager to conduct a flight and that flight actually takes place.

Most fractional owners are wealthy individuals and savvy businesspeople and words like "ultimately responsible" and "jointly and individually responsible" make them, and the lawyers hired to protect them, squirm. What's a fractional owner to do?

ON DEMAND CHARTERS

At this point, another brief primer. Another type of private jet transportation available to the well-to-do is on-demand charter. The basic difference between fractional ownership and on-demand charter is that, in fractional programs, the customer actually owns a share of an aircraft while in on-demand charter, the customer is a customer only, hiring the charter operator on a per-flight basis, first-come, first-serve, with no guarantee that an airplane will be available when the customer calls. Charter customers can't take tax write offs for depreciation because they don't own the plane. Charter operators generally own their own airplanes or manage them for third-party owners. On-demand charter programs operate under a different section of the FARs known as Part 135 and they are governed by a different set of rules.

Because Part 135 involves for hire by the general public common carriage, the FAA has always looked at it with heightened scrutiny. The agency monitors Part 135 more strictly because the operators are being paid for their services and the people riding in the back are relying on the charter operators to know what they're doing. By contrast, since fractional programs first came on the scene in the late 1980s, they have always been governed under Part 91 (not Subpart 91K) of the FARs, which is the set of regulations that pertains to "general aviation," meaning everyone who owns and operates their own airplanes, both fractional and individual owners. The FAA applies a stricter standard to Part 135 than Part 91. And one element of that stricter standard is the express recognition that it's the Part 135 operator who's in "operational control" of the flight and not the customer sitting in the cabin.

In many ways, fractional programs and Part 135 operations have always looked a lot alike. They both involve the use of private business jets that will take the customer wherever he or she wants to go, usually on just a few hours' or few days' notice. There's an executive terminal with the airplane and crew waiting right outside, no long check-in lines, no metal detectors with laptop computers, cell phones, keys and shoes all being shoved along a conveyor belt. The only other passengers on an executive jet are whomever the customer is taking on the flight and often there's a hot, privately catered meal, perhaps with a nice bottle of wine and a bouquet of fresh flowers, waiting on board. In larger aircraft, some of the seats will convert to sleeping berths if the client wants to take a snooze. So, one might ask, why will the 91K owner now have to bear the ultimate responsibility of "operational control" while the charter customer does not?

The rationale behind this dichotomy arises out of the FAA rule-making process that led to the implementation of Subpart 91K. In response to concerns about the largely unregulated nature of fractional jet ownership programs and complaints from the charter industry of discriminatory treatment, the FAA convened a panel in 1999 that included representatives of both the fractional and charter industries. Part 135 operators claimed they were being unfairly held to a stricter set of operating rules even though there were no significant differences in the flight experience for the fractional owner and charter customer, while the fractional industry desperately wanted to continue its operations under Part 91. Ultimately, the task force agreed upon a set of compromise recommendations to the FAA that resulted in some relaxation of the Part 135 rules and, at the same time, the creation of a new set of regulations under Part 91 that would govern fractional programs exclusively. This was Subpart K. The new rules took effect in September 2003 for any new entrants to the fractional industry, but existing operators were given until February 2005 to bring their programs into compliance. And part of the price for remaining under Part 91 was that fractional share owners had to expressly acknowledge, for the first time, that they were in "operational control" of the flights flown on their behalf. Though not specifically intended, this was, in effect, a trade-off for the fractional owner's right to depreciate their share of the aircraft in the same way that single owners of whole aircraft used for business always have.

THE INSURANCE ISSUE

Is there a way for fractional owners to protect themselves from the potentially dire consequences of "operational control"?

One possible answer to that question is, "insurance, insurance, insurance." We always counsel our clients, whether they are considering one of the big established fractional programs or a newly formed, regional start-up, to determine how much insurance the program manager is carrying, what it covers and who the insurer is. For example, under its management contracts, NetJets agrees to carry between $300 million and $400 million in passenger liability coverage per occurrence, depending on the model of aircraft, and $50 million in third-party liability. No judicial judgment or known settlement of claims in an accident involving business or executive-type aircraft has ever yet exceeded those amounts--but that doesn't mean it couldn't happen, particularly when one considers the net worth of many of the individuals flying on these airplanes. That's one reason why many of our clients choose to buy their own excess limits policies, intended to provide additional insurance coverage that isn't shared with any of the other fractional owners.

So the insurance coverage should be all you need, right? Well maybe. Let's say you're a big-shot Hollywood producer and a fractional owner. You want to pitch an idea for a new motion picture to a couple of recent Oscar winners and offer to fly them from New York to Los Angeles on a fractional jet you order up. Together, the two stars' net worth is well in excess of $400 million. Under old Part 91, the program manager, the company that provides the airplane and the crew and the pilot training and the maintenance for the airplane, is in operational control of the flight. If something were to go seriously wrong with that flight and the passenger claims exceeded the policy limits on the insurance policy, the lawyers would be looking to the program manager. But under new Subpart 91K, the fractional owner--that's you, the Hollywood producer, lounging by the pool at the Beverly Hills Hotel and waiting for your guests to show up--is "ultimately responsible for safe operations." If the program manager's maintenance department screwed up something on the ground that caused the accident, you, the fractional owner, and the program manager will be "jointly and individually responsible" if, for example, the airplane didn't meet federal airworthiness standards.

Obviously, the scenario described above is an unlikely one, but it most assuredly is not just a lawyer's scary hypothetical. Even NetJets, which has been trying to sooth owner concerns while, at the same time fulfilling its obligation to notify owners of the impending changes in the law, has acknowledged in writing that "owners may have liability risk in connection with operation of the aircraft ... for enforcement actions for noncompliance [and] liability if a flight-related occurrence causes personal injury or property damage."

ALTERNATIVES TO RISK

Are there any alternatives to incurring such risks? Yes, there are.

One option for the fractional owner is simply to insist that all flights flown at the owner's direction be flown under Part 135. NetJets, the first fractional program, actually began nearly 20 years ago as an off-shoot of a Part 135 charter company. For that reason, NetJets has always had the capability to conduct flights under Part 135 as well as under Part 91. Indeed, flights NetJets flies for lessees, as opposed to owners, are always flown under Part 135. Similarly, Bombardier, the Canadian transportation conglomerate that owns both Learjet and the Flexjet fractional program, will soon have the capability to fly all of its Flexjet aircraft and fractional clients under the Part 135 certificate of a sister company. And Flight Options, the third major national fractional provider, says it, too, expects to be ready to operate under Part 135 by February 17, 2005. If these forecasts are correct, then the three largest national programs, which collectively hold the lion's share of the domestic fractional jet market, will all be able to give their customers the option of flying under Part 135 instead of Subpart 91K. When that occurs, a fractional owner will be flying under the same set of rules that govern on-demand charter flights--and will not bear responsibility for "operational control" of its flight.

Notwithstanding the concern over "operational control," are there circumstances where it might be more appropriate for a fractional owner to elect to fly under Subpart 91K? The answer to that question is "yes."

On domestic flights, operations conducted under Subpart 91K and Part 135 will generally be indistinguishable. One difference, however, will involve security clearance. Under 91K, the flight crew will have to see a photo ID for the lead passenger only, who would normally be the fractional owner. The lead passenger can then verbally confirm that everyone else flying on the airplane is the same person whose name was called in to the operator earlier and now appears on the flight manifest. For flights flown under Part 135, the flight crew will need to see a photo ID for every passenger over 18 and will have to match those passengers up with the flight manifest.

NEW RUNWAY REQUIREMENTS

Another area where fractional operations flown under 91K may be more attractive to the owner involves runway landing requirements. One of the reasons why fractional operators were so anxious to stay under Part 91 when the FAA first began looking at fractional rule-making was the so-called "60% rule." This is a regulation imposed upon Part 135 operators which demands that they be able to bring an airplane to a complete stop within 60% of the total available runway length. Take Santa Monica Airport (SMO) for example. The runway at SMO is only 4,987 feet long. This means a Part 135 operator cannot land an airplane at SMO if the manufacturer says it takes more than 2,992 feet to bring that aircraft to a full stop on dry pavement. However, the 60% rule doesn't apply under Part 91, which has given fractionals a huge operational and marketing advantage over charter operators which they have exploited for years. During the rule-making process that led to the institution of Subpart 91K, the Part 135 providers pushed the FAA to abandon or relax the 60% rule in order to "level the playing field." Ironically, when the FAA issued its final 91K regulations, the agency didn't gut the 60% rule, but elected instead to impose a similar requirement on the fractional operators. At the same time, however, the FAA also provided the fractionals a loophole through which they could fly to avoid the full impact of the 60% rule. A fractional operator which creates something called a Destination Airport Analysis Program (DAAP) and secures prior FAA approval of the program will be permitted to land aircraft at 80% of the available runway length instead of 60%. The requirements for approval of a DAAP are rather technical and involve things such as weather reporting stations and alterative airport availability, but the point here is that there may be occasions when a fractional flight flown under Part 135 will not be able to land at a particular airport when the very same airplane with the very same passengers and baggage on board will be able to land if the flight is flown under 91K.

In the end, however, the main area where fractional customers may encounter problems when flying under Part 135 rather than Subpart 91K will involve international trips. This is because fractional flights become subject to the laws and rules of the host country when they cross international borders and foreign nations often impose restrictions (called cabotage) that prevent operators from other countries from flying revenue-producing flights within the borders of a foreign country. For example, NetJets cannot ferry a flight to Canada to pick up a passenger nor can it transport passengers from point-to-point within Canada under Part 135. Also, depending upon the destination and when the flight is scheduled, the fractional operator may require a longer lead time in order to obtain a landing permit when the flight is flown under Part 135. All of this means a fractional customer win probably not be able to wait until the last moment to "declare" its intention to fly an international fractional flight under Part 135.

That brings us to the last point and that is under the new rules, fractional managers who are certified to conduct operations under both Subpart 91K and Part 135 will be able to offer their owners the option to choose their operational program on a flight-by-flight basis. For potential customers considering a fractional investment, especially in a new start-up or a regional program, the operator should be asked whether it will have the capacity to conduct flights under both 91K and 135. There are a few Part 135 charter companies around the country that have given consideration to obtaining Subpart 91K certification because many of the operating standards are now so similar but, for the most part, smaller fractional programs started after September 2003 when 91K took effect for new programs will probably only qualify under 91K unless they are a spinoff from a pre-existing Part 135 certificate holder.

WHAT'S NEXT

In the next few weeks, all current fractional customers will have to decide what they want to do about the "operational control" conundrum. NetJets has already begun sending out letters to its owners asking them whether they want to fly under 91K or 135 and Flexjet and Flight Options owners can anticipate receiving similar letters in the near future. Owners who fail to reply to the operator's inquiry must, by law, be flown under Part 135 beginning February 17th. However, owners who respond will have the right to elect operations under 91K or 135. And, as noted above, owners will also have the right to designate the applicable regulations on a flight-by-flight basis should they so choose. Even though it will involve a bit more work, savvy fractional owners may want to consider the selective approach and give serious thought to those occasions when they would prefer not to be in "operational control" of their flight.

Stephen Hofer is a partner with the law firm of Bailey & Partners in Santa Monica, California, and heads the firm's corporate and transactional department. He has been with the firm since 1992 and specializes in aviation law, including aircraft sales, leasing and licensing, fractional ownership, Part 135 operations, tax issues, and FAA regulatory matters.