With U.S. stock indexes rising and the economy showing signs of life, business jet buyers seem to be returning to the market. Much like horses at the start of a race, they appear to be champing at the bit, waiting impatiently for the starting gate to open.

There’s a sense that values have become compelling after freefalling for more than three years in some cases. The bargains won’t last, however, because the increased buyer activity is already leading to higher average pricing for a growing number of models. While the reversal in the downward trend is not across the board, it seems increasingly likely that market lows on many popular aircraft were reached last year.

Realization of such a fact typically results in an initial rush of buyers and then to a period where sellers start to try to command more for their aircraft and buyers pull back. This causes the market to move in fits and starts. Where are the best deals now? In the super-mid-size segment, you can find Dassault Falcon 2000s and Gulfstream G200s at inviting prices. In the large-cabin arena, the Bombardier Challenger 604 and Gulfstream GIV markets are flooded. But act quickly, as 2012 could see rising demand for these models.

As for small-cabin jets, including the owner-flown group, this is a terrific time to act for anyone thinking of getting into aviation. There are so many viable options in this segment that it’s as if a welcome mat were being laid out for the first-time buyer. In the $1 million to $2 million range, you can find Citation Vs and Ultras, Beechjet 400XPs and Learjet 31As.

In fact, some owners who bought Daher-Socata TBM850s for more than $3 million or Pilatus PC-12s for even higher amounts are reevaluating their positions due to the low prices in the entry-level segment of the jet market. This could be the year when many jet buyers wind up feeling like a kid in a candy store.

Like other lawsuits, most of the ones involving business jets are settled out of court. Every once in a while, though, a corporate jet case will not only reach a judge but produce a decision that shines a spotlight into some dark corner of business aviation. One such case is JDI Holdings, LLC v. Jet Management, Inc., et al., 732 F. Supp. 2d 1205 (2010), which concerns a buyer’s desire for a perfect airplane.

As reported in the court’s decision, the buyer, who was looking to acquire his first business jet, approached a broker about an aircraft he represented for sale. Although the buyer didn’t purchase that aircraft, he did ask the broker to help him find another suitable jet. It didn’t take long for the broker both to identify a certain 1984 Cessna Citation III and to inform the seller of the buyer’s interest.

Having introduced buyer and seller, the broker then separately asked both of them for a sales commission, claiming a “customary” 5 percent fee (or $160,000 on a $3.2 million sale price). The buyer’s lawyer balked at paying a commission of this size, but the seller eventually agreed to pay the broker $150,000, less whatever it cost the seller to fix discrepancies on the aircraft following the prebuy inspection. As the court put it, the broker’s fee arrangement “undoubtedly gave him a strong incentive to ensure that the cost of the airworthy repairs remained as low as possible.”

Indeed, the broker advised the buyer’s attorney that–because a Phase 1-5 inspection had recently been completed–the prebuy inspection need consist only of logbook review. The buyer, however, decided he “didn’t mind paying a bit more to know the jet is perfect” and opted for a prebuy survey of the aircraft by a service center.

As the cost to fix discrepancies grew (finally totaling $79,000), the broker became distressed about his shrinking fee, so he took another swing at getting the buyer to pay him a commission, this time asking for 2 to 4 percent. The buyer knew nothing about the broker’s fee arrangement with the seller and agreed in the end to pay a $70,000 commission (about 2 percent). So, despite the lack of a written fee arrangement with either buyer or seller, both of them paid the broker a commission in connection with the sale…or was it the purchase?

What eventually got the buyer especially steamed up, however, was that not all discrepancies identified in the inspection were repaired. The purchase agreement gave the buyer the right to reject the aircraft following the inspection, but if he accepted it instead, the seller was obligated to fix only “airworthy” discrepancies.

It’s interesting to see the court, the parties involved and their expert witnesses struggling with this notoriously controversial term. As noted, the aircraft had recently undergone a Phase 1-5 inspection, followed by the prebuy survey. Then, after the buyer took delivery and discovered that the airplane wasn’t perfect, there was another Phase 1-5, this time paid for by him. Seasoned aircraft transaction folks won’t be surprised to hear that each of these shop visits uncovered numerous airworthy (and other) discrepancies.

Things might have worked out for the buyer if he had realized the seller had no obligation to fix non-airworthy discrepancies. But in a classic case of miscommunication, misunderstanding and probably wishful thinking, the buyer signed an acceptance of the aircraft without realizing this. Later, when he came to own the imperfect aircraft, he sued the seller, the broker, the service center that originally accomplished the Phase 1-5 and others, presenting the court with a laundry list of causes of action. The buyer lost on them all.

The case is instructive in several ways. First, the perfect airplane doesn’t exist. Turn maintenance technicians loose on any aircraft and they will uncover discrepancies, many no doubt affecting airworthiness. Brokers are fond of reminding buyers that a preowned aircraft isn’t brand new, but even factory-fresh airplanes routinely begin the delivery process with many–sometimes hundreds–of discrepancies of various levels of seriousness. Maintenance standards in aviation are extremely high, and few airplanes can survive detailed scrutiny without discovery of potential items to be addressed.

Second, the search process, or lack of one, was inherently flawed by the buyer’s apparent failure to conduct adequate market research–or any research at all. Thus, even assuming the Citation III was the right jet for him, he apparently made no attempt to analyze the market for that model to determine the best value or how this particular serial number stacked up against other available airplanes. Currently, as many as 47 Citation IIIs are listed for sale, including a dozen that date from 1984. As this case demonstrates, asking a broker who tried to sell you an airplane to simply find you a “suitable” one can be a prescription for disaster.

Third, if a buyer has the discretion to reject an aircraft following a prebuy inspection, he should be able to accept it subject to, basically, anything–as long as the seller is obligated only to fill reasonable requests for repairs. Though he didn’t realize it, the buyer’s contract didn’t give him the option of accepting the aircraft subject to all discrepancies being cured. Of course, no seller is likely to agree in a contract to fix every discrepancy of every description. But if it had been open to the buyer to make his acceptance subject to the cure of all discrepancies, at least buyer and seller could have had a dialogue about what was reasonable to fix. The nose tire, for example, was bald, but the service center either didn’t look at it or thought it had some life remaining, so under the contract the buyer couldn’t condition his acceptance on replacing the nose tire, which the buyer was forced to change after closing.

Most important, the case underscores why buyers need to get unbiased advice throughout the acquisition process from maintenance technicians, consultants, attorneys and other professionals representing their interests. (The seller certainly understood this in structuring his brokerage fee arrangement.) A prime example is the buyer’s failure to hire his own technical representative to advise him about what should be included in the prebuy inspection, monitor the inspection and review and discuss discrepancies. Instead, the buyer relied on a broker being paid a commission by the seller who directly benefited to the extent that the seller spent less to fix the aircraft. No wonder this jet acquisition ended in a lawsuit.

As a big-ticket asset promising large potential tax adjustments, a business jet easily captures the attention of IRS auditors. Given the woefully complicated tax rules applicable to these aircraft, who can blame the IRS for seeking additional revenue opportunities in the flight department?



The best way to survive an audit is never to have one. Even if you buy a fractional share or lease an aircraft–options that are arguably less likely to result in an audit than purchasing a jet outright–it’s important to be mindful of the tax traps that business airplanes often unwittingly fly into. Just reciting the names of some key danger zones can be chastening: at-risk rules, passive losses, hobby losses, entertainment disallowance–plenty of ­audit potential lurks in these areas. The good news is that even if you cut corners and made mistakes in tax planning when you acquired your aircraft, it may not be too late to reverse or at least minimize the damage.



Basically, there’s only one way to run into trouble with the IRS: failing to pay the taxes you owe on a timely basis. This can happen because you underpaid or ignored specific taxes, such as the transportation excise tax or a taxable fringe benefit; or because you improperly took deductions against taxable income for aircraft-related expenses.



The former frequently comes down to the facts of the case: was there taxable transportation or a taxable fringe benefit? Talking to the IRS about such issues can be frustrating since there is often a major disconnect between aviation tax professionals and the government agency about the facts regarding situations subject to tax. (Witness, for example, the notorious Air Transportation Excise Tax–Audit Technique Guide, which the IRS published in 2008.) Minimizing audit risk in this arena may simply involve doing your best to comply with the rules while pulling down the blinds and hoping for an intelligent, not overly zealous revenue agent.



The second area–improper aircraft-related tax­deductions–involves complicated law. The threshold question can be particularly problematic with regard to business aircraft: do costs related to its use represent an ordinary and necessary business expense? Business aviation CPA Jed Wolcott in Fort Lauderdale, Fla., sees increasing audit activity in this area, especially for aircraft owned by special-purpose entities or where aircraft expenses are disproportionately large by comparison with revenues and other expenses.



“The company should justify that it has legitimate business reasons for using private air transportation, such as improving the efficiency of key executives,” Wolcott said. Operating a roadside lemonade stand in Palm Springs, for example, would not reasonably require use of a Citation X to transport the owner to Chicago to stock up on lemonade mix. Ideally, Wolcott noted, the company will document in writing that it has studied the issue and reasonably concluded that private air transportation was beneficial.

Are aircraft-related tax audits increasing? Wolcott doesn’t think so, though audits in particular areas may be on the rise as the focus of the IRS changes. The availability of 100 percent bonus depreciation, for example, has certainly captured auditors’ attention–it involves a giant one-time expense and often represents the first time a company takes an aircraft depreciation deduction.



An audit begins with a field examination, after which the auditor will write up his conclusions for the taxpayer. If the taxpayer doesn’t agree, he can appeal the results, and if he loses on appeal, he can go to court. A frequent mistake, according to Wolcott, is waiting to contest issues until after the IRS auditor completes his examination. In other words, don’t just send the auditor down to see your ­bookkeeper as though you have nothing to hide. “The field examination is the most important step,” Wolcott said. “Anything you can talk the auditor out of is gone forever. After that, it becomes much more difficult and expensive to win the point.”



Wolcott’s motto is “paper it to death.” IRS auditors love to go through the aircraft records and talk about each flight: What was the purpose? Who was onboard? Was entertainment involved? Sometimes the auditor will make the taxpayer prove he’s entitled to a deduction on a flight-by-flight basis. The flight records should therefore contain the information ­required to substantiate a deductible expense (see "A Recordkeeping Checklist for Aircraft Owners" below). And don’t assume you can make up the records once you’re audited or confine the auditor to a self-serving summary prepared for his benefit. IRS regulations require that flight-related records be contemporaneous, not concocted later.



IRS audits aren’t the only source of tax troubles. Revenue-hungry states are always looking for ways to impose sales and use taxes on business jet owners. It’s crucial, therefore, that before taking delivery of an aircraft, you map out your strategy for avoiding use tax not only in the state where you’ll base the jet, but also in states that you may fly to regularly, especially if you have significant contacts with those states, such as by having a residence or business there.



But well-crafted plans to avoid or minimize state and federal aircraft-related taxes are of no benefit if you don’t follow them. Wolcott confirmed that tax professionals often help aircraft buyers to create elaborate structures to own, lease, operate and manage an aircraft only to discover later that the client hasn’t been complying with the plan.



In summary, get good tax advice when you buy an aircraft and make sure you continue to follow it. And before becoming the subject of an audit, learn what records you need to be keeping and be sure you retain them. It’s the best way to make the audit process as painless as possible.

 

A recordkeeping checklist for aircraft owners



Here are the records you should keep contemporaneously for each person on each flight leg:



• Date of flight

• Departure airport

• Arrival airport

• Flight hours and miles

• Passenger manifest

• Purpose of flight for each passenger

• Relation

The business jet finance market is changing, just like the rest of the world economy. It’s becoming more highly regulated, more conservative and more international. Its biggest challenge is the surfeit of cash that many aircraft buyers have on hand with no compelling place to invest. The banks, which find themselves in a similar situation, famously prefer to lend money to people who don’t need it, and in today’s business jet market, there are more of those people than ever before. However, if you’re looking for financing, here’s a strategy for locating the best deal.



1. Find the right aircraft at the right price. Most aircraft finance institutions–even the ones that say they are “asset-based”–are “credit shops.” Their overwhelming focus is on the ability of their customers to pay back the financed amount. But that doesn’t mean they ignore the aircraft altogether; banks still want to be confident that you aren’t paying too much for it and that the value of their collateral won’t sink like the Titanic. Make sure to get expert advice about the value of the aircraft you choose, and be mindful that the older it is, the harder it will be to finance. Moreover, make sure it’s right for your needs, so you won’t be charged penalties to pay off a loan early or get out of a lease because you purchased too much or too little aircraft for your travel or budgetary requirements.



2. Pay attention to timing. Aircraft financings sometimes used to be arranged virtually overnight. No more. If you want financing, start the process as soon as possible. You can get a good idea about financing costs and terms simply by talking to a lender generally about the airplane model, model year and estimated acquisition cost before ever signing a letter of intent to purchase an aircraft.



3. Determine who will buy the airplane. That sounds easy, but it can be a complex subject. If you’re a first-time buyer, I recommend retaining aviation counsel to help with this at the start of the process. Factors that influence who buys the aircraft include liability concerns, FAA ownership and operating rules, often-obscure tax considerations like the “at-risk rules,” public company reporting requirements and the ability of business partners or others to use or help pay for the aircraft. The identity of the buyer will also directly influence the choice of financial institution. A commercial enterprise won’t get an aircraft loan from a private bank, but the CEO might.



4. Decide on a loan or a lease. For most airplane buyers, the availability of tax benefits will determine this choice. If you can use the tax depreciation, a loan may be the best option; if not, consider leasing, where you can still get the benefit of tax depreciation through lower financing costs. If you’re uncertain, request proposals for both. Note, however, that while all aircraft financial institutions provide loans, many don’t offer leases.



5. Choose credit-based or asset-based financing. If you want your lender to put greater weight on the aircraft’s value as opposed to your creditworthiness, you’ll have limited options, and if you want non-recourse financing, you’ll have even fewer choices. A related issue is whether you’ll need maximum flexibility in structuring the financing, in which case you may be better off with a non-bank institution that is less bound by federal and state banking rules and regulations.



6. Consider relationship-based financing. Aircraft financiers differ in their appetite for making so-called transaction-based loans–one-off financings with someone the bank may not otherwise do business with. In other words, if a bank focuses chiefly or exclusively on aircraft financings for existing clients, you should probably look elsewhere unless you’re one of those clients. Your private bank, for example, may offer extremely attractive financing terms for an aircraft purchase, allowing you to leverage off an existing relationship. Keep in mind, though, that an aircraft loan through your private bank will be cross-collateralized to other assets pledged to the institution. Further, a “relationship” may actually hurt you if the bank feels it already has too much credit exposure to you or your company.



7. Solicit proposals. Once you do your homework, you’re ready to ask several financial institutions for proposals. Your acquisition consultant should be able to suggest likely aircraft financiers for you to consider. In addition to the amount of the financing, loan or lease, fixed- or floating-rate and recourse or non-recourse, you’ll need to request a term, proposed down payment and maybe even a proposed amortization. A 100 percent 12-year loan on an 18-year-old aircraft with 25-year amortization will likely find few takers, but an 80 percent five-year loan on a five-year-old aircraft with 10-year amortization may prove quite popular. You won’t know until you ask.



8. Negotiate your deal. This is the key moment. It’s when a little creativity goes a long way–for example, by negotiating for the addition of an option to switch to fixed rates in the future as part of a low-cost floating-rate deal. Remember that proposals are typically confidential, so don’t send one lender’s proposal to another lender to try to get a better offer. But you can certainly let a lender know if its terms aren’t competitive with other proposals you’ve received.



9. Make your selection. Don’t assume you should just choose the lender offering the best overall financial deal. That’s an important consideration, of course, but not the only one. Does the lender have a track record in aircraft finance, or is this one of its initial or infrequent forays into the field? Can the lender deliver what it promises, especially in time for closing?



10. Wrap up the deal. Your lender will have to do its due diligence–on you and/or your company, the aircraft and the underlying purchase deal. It will want to see tax returns, financial statements, the purchase agreement, the prebuy report–all kinds of things. It may also require a written appraisal. Make sure your aviation attorney reviews the financing documents. Aviation transaction lawyers do this all the time, and often more efficiently than high-priced finance counsel. They know where the aviation skeletons are buried–prohibitions on Part 135 flights, limitations on flight hours, unreasonable lease return conditions. It’s worth hiring an expert.

 

Aircraft Financial Institutions

Private and Commercial Banks and Affiliates



Banc of America Leasing

Global Corporate Aircraft Finance

Addison, Texas

Michael T. Amalfitano

(972) 455-5855

CBI Leasing, Inc.

Aircraft Finance & Leasing

Commerce Bank, N.A.

Lake Forest, Ill.

Sean K. Patrick

(847) 295-4601

Chase Equipment Finance, Inc.

Tampa, Fla.

Chad E. Colby

(813) 483-8246

CIT Bank

CIT Aerospace Business Aircraft

Plantation, Fla.

Mike Kahmann

(954) 359-4646

City National Bank

Aircraft Finance Group

Irvine, Calif.

David W. Maurer

(213) 673-8929

The Citigroup Private Bank

Global Aircraft Finance

New York

Mary T. Schwartz

(212) 559-0561

Deutsche Bank Private

Wealth Management

Private Aviation Finance

Chicago

David W. Rodin

(312) 537-1510

Fifth Third Bank Leasing

Boston

Matt McNamara

(617) 573-5191

First Republic Bank

Aviation/Marine Finance

San Francisco

James F. Simpson

(415) 296-5783

First Source Bank

Laird Professional Building

Downingtown, Pa.

Jeffrey Lindstadt

(610) 269-1683

Key Equipment Finance

Corporate Aviation Finance

Boston

Patti Ann Sullivan

(978) 261-5201

PNC Aviation Finance

Boise, Idaho

Wayne Starling

(888) 339-2834

RBS Aviation Finance

Manchester, N.H.

Donald A. Synborski

(603) 634-7522

SunTrust Equipment Finance & Leasing Corp.

Corporate Aircraft Finance

Towson, Md.

B.J. Honeycutt

(410) 307-6732

U.S. Bank Equipment Finance

Capital Equipment Group–Corporate Aircraft

Denver

Pete J. Georgelas

(303) 585-4036

Wells Fargo Equipment Finance, Inc.

Corporate Aircraft Division

Los Angeles

Robert C. Lebano

(310) 789-5036

Other Financial Institutions

Cessna Finance Corp.

Wichita, Kan.

Perry Bridges

(316) 660-1392

Export-Import Bank of the United States

Transportation Division

Washington, D.C.

Robert F. X. Roy, Jr.

(202) 565-3557

GE Capital Corp.

Corporate Aircraft Finance

Danbury, Conn.

Brent P. Godfred

(203) 749-6657

Guggenheim Partners, LLC

Business Aviation Investments

Woodbridge, Conn.

James A. Crowley

(203) 393-7247

Prudential Capital Group

Atlanta

Robert Penfold

(770) 701-2410

Just as different singers often offer widely varying interpretations of the same song, different observers view the used jet market from diverse vantage points. Moreover, a buyer’s or seller’s perspective on the market can make, impede or prevent a sale.

A few years ago, when sellers received hard evidence of their aircrafts’ reduced values, some stoically declared that they would wait for the market to recover before selling. I resisted the urge to ask, “When will that be?” but it seemed fairly clear within the brokerage community that the market would not be recovering anytime soon. Since it has not, these owners presumably still have their aircraft.

At the same time and with the same information, other owners interpreted the initial downturn as a sell signal and got out. These owners may have recognized that the market would never return to its previous lofty levels.

Still other owners simply did not care much where values were headed as they viewed their aircraft not as a commodity but as a much-needed business tool that performed its intended purpose regardless of whether it was worth a few million more or less.

Of course, many owners care a lot about value and for them the good news is that prices are finally stabilizing. There are more than 500 fewer aircraft for sale today than there were a few years ago, when inventory levels topped 3,000. That might suggest prices should be moving up and maybe they soon will, but right now the average price of all business jets for sale remains nearly $1.5 million below the average reached at the inventory peak.

Clearly, we’re still in a buyer’s market and–with toppled governments and economic mayhem capturing the world’s attention–there exists no shortage of buyers looking to lower the expectations of sellers. Still, one man’s music is another man’s noise, and each buyer and seller will continue to interpret market signals differently.

One thing’s for sure: While inventory may be slowly ratcheting down, predicting at what point a pricing recovery might ­occur remains a fool’s game.

When you need legal help buying, owning, operating or selling an aircraft, whom do you call? Many people contact their regular business attorney. That can be a big mistake.

When Paul Fireman, founder of Reebok International, decided to buy a brand-new Gulfstream 450, he phoned a large Boston law firm known for its expertise in real estate and other areas. A recent review of the firm’s website and the 75 practice areas listed on a dropdown menu there shows no evidence of aviation expertise. Nevertheless, the firm referred Fireman to a staff attorney who allegedly described aircraft acquisitions as his specialty, though the firm’s website description of his practice makes no mention of aviation.

With the attorney’s help, Fireman’s company, Willowbend Aviation, LLC, acquired the G450 in 2009. Willowbend subsequently filed suit against the law firm, claiming it lost significant federal tax benefits and faced Florida use-tax liability because of the attorney’s failure to provide competent advice. The complaint, which has yet to be adjudicated, asks the court to award treble damages–almost $14 million plus attorneys’ fees–under the Massachusetts consumer-protection statute.

Lawyers have a hard time turning down business. Years ago, when I was in private practice, I got a request to ­represent a titan of industry who was buying a new Gulfstream–provided I had experience in basing and registering aircraft in the Bahamas. It was painful to say no, but I lacked that experience. Later, I asked the lawyer who eventually took on the matter about his Bahamas background, and he said something like, “Oh, I didn’t have any. I just figured it out as I went along.”

Some lawyers will exaggerate their business jet experience, taking on matters they’re unqualified to handle. The problem with hiring non-experts isn’t so much that they don’t know things, but rather that they don’t know they don’t know them (see box).

What to do? First, when your regular law firm claims to have expertise in business aviation, ask whether it employs an attorney whose practice is devoted to business aviation--not someone who once helped a client with a NetJets share or an aircraft loan, but someone who focuses primarily on business aviation. (Note that I said “business aviation.” An airline lawyer isn’t what you want unless you’re buying an airline.) Then look him up on the firm’s website. I recently did that for a supposed aviation attorney and found a whole series of practice areas listed, with aircraft transactions dead last. The best business aviation attorneys don’t dabble in this specialty; they live and breathe it.

Even within business aviation law, however, you should be mindful of specializations. Four come readily to mind: regulatory (FAA/DOT regulations and compliance), tax (business aviation taxes and tax writeoffs); registration (title, liens and security interests); and transactions (aircraft purchases, sales, leases and financings). Many of the best aviation attorneys have expertise in two or more of these areas, and some have varying degrees of expertise in all of them or are associated with a law firm or practice group that does. Further, be sure to retain a lawyer who’s well versed in your state’s tax issues. Aircraft-related taxes and tax strategies vary enormously among revenue-hungry states like California, Texas, Florida and New York.

You can get recommendations for aviation attorneys from consultants, brokers and other industry professionals. Remember, though, to consider the source of such recommendations; an aircraft manufacturer hoping to sell you an airplane is unlikely to recommend an attorney who will put the company through the wringer. On the other hand, if you’re buying an aircraft from a particular manufacturer, it is very important to retain someone with recent experience negotiating contracts with that company. I recommend interviewing several candidates and questioning them in detail about their expertise. Can they provide the aviation tax advice you need? Are they too busy to take on your project? Who else in their office can you talk to when they aren’t available? Does this lawyer seem like someone you will work well with?

If you’re buying an aircraft, the most important thing your aviation lawyer should do is structure its ownership and operation to 1) minimize liability, 2) comply with FAA and DOT requirements and 3) minimize taxes and maximize tax deductions. Dealing with these three issues in isolation is relatively easy; putting them together in a satisfactory package can be enormously challenging. This is where your lawyer’s depth of knowledge and experience will be most telling. But the truth is that you should consult your lawyer about any major developments involving the aircraft, such as a new loan, a new management company, changes in use, changes in law, damage incidents or changes in insurance needs. Of course, you’ll also need an attorney when you sell the aircraft.

Finally, when retaining a lawyer for a major project, ask what it will cost. Attorneys hate this question, because projects often appear deceptively simple. Negotiating a purchase agreement with an aircraft manufacturer, for instance, can seem to be a relatively quick job–until tax and regulatory structure issues emerge, you decide to finance the progress payments and the draft management agreement arrives. When you discuss anticipated costs, be as specific as possible about the tasks required in order to avoid unexpected legal bills.

Legal Blunders

Here are some of the legal blunders I’ve encountered over the years. Most resulted when big, high-priced law firms attempted to operate outside their area of competence.

• Aircraft registration proved invalid because the owning company’s president was a French citizen.

• A research project on Connecticut law to determine whether purchasing a jet there would be subject to sales tax concluded incorrectly that tax would be payable.

• A client who regularly chartered out his airplane discovered that his aircraft loan agreement prohibited charter flights.

• Aircraft was grounded at closing because the buyer’s attorney sent the pink copy of the registration application to Oklahoma City.

• Part 91 aircraft operations were illegal because the lawyer put them in a “flight department company.”

BJT readers–who represent one of the highest-net-worth magazine audiences anywhere–clearly have the means to contribute to a better world. But what’s the best way to do that? It’s not always easy to determine which charities are most reputable and efficient and which will make the best use of your donations. As such, we’ve decided to spotlight one deserving organization per issue. All of the ones we’ll feature have received a four-star overall rating from Charity Navigator (charitynavigator.org), which evaluates philanthropic institutions based on their finances, accountability and transparency.

The Children’s Aid Society (www.childrensaidsociety.org) has been helping families cope with poverty in New York City neighborhoods since 1853. Children’s Aid caring begins even before birth, through prenatal counseling and assistance, and continues through the high school years with college-prep and job-training programs.

The charity addresses all aspects of a child’s development, from health care and academics to sports and the arts. And because stable children live in stable families, the organization offers housing assistance and domestic-violence counseling. The first free school-lunch program, the first industrial school for poor children, the first daycare program for working mothers and the first visiting nurse service were all Children’s Aid initiatives.

For most corporations, the purchase of a business jet represents a major transaction that requires approval of the board of directors. What should the directors consider when the company is thinking about buying an aircraft?

To discharge their fiduciary duty to the stockholders, corporate directors must determine whether acquiring an aircraft is reasonable and prudent. The fact that the company is performing well and making lots of money may mean that it can afford a business jet, but that doesn’t necessarily mean that the ­purchase would be justified. On the ­other hand, a company that isn’t performing well may find that a business aircraft would enhance its productivity and increase profitability. A study by NEXA Advisors commissioned by the National Business Aviation Association (NBAA) and others shows a direct and compelling correlation between business success and use of corporate aircraft.

Of course, directors can’t do their job ­properly if they have vested interest in the outcome (e.g., if the corporation is providing them with free use of its jets). A shareholder of financially struggling Chesapeake Energy Corporation recently filed a ­derivative action against the directors of the ­company, seeking to recover millions of dollars that had allegedly been wasted on personal flights. The complaint points out that the non-employee directors not only received magnanimous cash compensation (in 2011, when the board met four times, the directors’ compensation ranged from $467,026 to $620,438); the ­directors also awarded themselves 40 hours of personal use on the company’s NetJets shares. The complaint suggests that the board was crippled by a conflict of interest when sanctioning non-business travel by Chesapeake employees on NetJets shares.

A board is on stronger ground when a company uses its aircraft exclusively or predominately for its business. The time-saving and other advantages of ­using a corporate aircraft are well known. The directors may wish to retain an independent consultant to study the company’s travel patterns and advise about whether using a business aircraft makes sense. The NBAA’s “No Plane, No Gain” website (noplanenogain.org) ­offers valuable information for the directors to consider, including the NEXA study referred to earlier.

The directors should document the reasons for acquiring the aircraft and its anticipated use. This has many benefits, including tax deductions for business use. The directors should also consider creating a written policy that details who can use the aircraft and under what circumstances. The policy may even require key executives to use the company aircraft for reasons such as personal security and protection of confidential information.

But the elephant in the closet is personal use. Once the company has access to a business aircraft, corporate executives may wish to use it for personal travel. Should the directors reject out of hand the acquisition of an airplane that would be used–perhaps even mostly used–for non-business travel, especially on a no-charge basis?

The answer depends on the overall compensation package for executives provided by the company. The chief executive officer, for example, may receive compensation in many forms–stock options, a country club membership, a leased automobile. There is nothing wrong in concept with use of a company aircraft being a factor in the CEO’s overall compensation package. The board could require the executive to pay for the flights, which might reduce stockholder grumbles. But is there a real difference (other than proxy disclosure) between a compensation deal that includes $5 million in salary and $500,000 of free flight time on the company aircraft and one that ­stipulates a $5.5 million salary with the executive paying for the transportation? Note that FAA regulations impose restrictions on an executive’s ability to pay for flights and that there are tax consequences to consider for both the company and the employee in the case of personal flights.

Further, the directors could reasonably conclude that the company should acquire an aircraft specifically to provide non-business travel to certain executives or to transport them from their homes to company headquarters. Indeed, this is often a major issue in negotiations to hire a key executive who resides–and will continue to reside–far from the corporation’s offices.

If the company is public, it should carefully scrutinize non-business travel aboard its aircraft by key executives and their families to ensure compliance with SEC reporting regulations. Generally, the SEC requires that the aggregate incremental cost of the trip be reported, though the shareholder in the Chesapeake suit argued that fixed costs should also be included since a high percentage of the aircraft use was personal. Company filings must also disclose material transactions such as a lease or time share of the aircraft to the CEO.

The board has a responsibility to ensure that the company acquires the right aircraft for the right ­missions. It doesn’t make sense to buy a Gulfstream G550 to fly between New York and Boston. Nor does acquiring a whole aircraft (as opposed to a fractional share) make sense when the company anticipates ­flying an average of only 100 hours per year. The board may want to obtain advice from an acquisition consultant about the company’s best options for business aircraft travel.

Both the IRS and FAA recognize that companies may require an executive to use their aircraft even on personal trips, and taking advantage of accommodations offered by these agencies requires action by the board of directors. In response to concerns about the executive’s safety and security, the IRS offers tax advantages if the company has an overall security program or has obtained an independent professional determination that the executive should fly on company aircraft [See “How a Security Program Can Cut Flying Costs,” available at www.bjtonline.com.–Ed.]. Further, the FAA recently recognized that a company’s board of directors (or other governing body) could develop a policy designed to anticipate circumstances that loosen the restrictions on the ability of the executive to reimburse the company for flight expenses of non-business trips [See “Paying for Flights on the Company Jet,” available at wwwbjtonline.com.–Ed.].

To properly discharge their responsibility, the board should obtain independent, professional advice. If the directors make use of the significant resources available and exercise common sense, they can promote their company’s success through business aviation while avoiding the unenviable position of the Chesapeake directors.

An Action List for Board Members

• Determine whether buying the aircraft is reasonable and prudent.

• Ensure that it is the right model for the job.

• Consider hiring an independent consultant.

• Document reasons for acquiring the aircraft and its anticipated use.

• Consider creating a written policy regarding the airplane’s use.

• If the company is public, scrutinize non-business use to ensure compliance with regulations.

Having emerged battered and bruised from the 2008 recession, aircraft lenders face fresh challenges. While worldwide economic woes linger like a bad cold that won’t go away, these lenders can expect accounting and regulatory changes that may have a significant impact on their business.

The industry is already subject to substantial regulation, much of which requires banks to keep adequate reserves, “know” their customers, better understand international transactions and follow sources and uses of funds. As the business aircraft market becomes increasingly international, such regulations can hinder legitimate transactions. A Forbes 400 client purchasing an airplane from a European bank recently faced the kind of scrutiny normally reserved for convicted felons. But existing regulation is only part of the story. Worries about credit and collateral these days cause lenders to closely scrutinize the recipients of their loans, the models those customers are buying and how much exposure the lender already has to them in other credit facilities.

Regulators share these concerns. In an effort to prevent credit bubbles and resulting financial meltdowns like the one that occurred in 2008, international regulators are working on the so-called Basel III accords, which will likely have a big impact on aircraft loans and the world economy in general. These accords will be the third incarnation of reforms sponsored by the Committee on Banking Supervision of the Bank of International Settlements in Basel, Switzerland.

Two aspects of Basel III seem particularly significant for business aviation.

First, banks will need more capital–lots more. Over the rest of this decade, they will be required to stockpile reserves (primarily equity) equal to two and one half times the current requirement. For “systemically important” banks like Citi, Bank of America and Wells Fargo, the capital requirements will be even greater, in an effort to ensure that institutions that are “too big to fail” in fact don’t.

Second, banks will have to keep more of their capital liquid, to ensure that they can quickly discharge their obligations in an emergency and stay afloat. One of these requirements treats an aircraft loan as a completely illiquid investment, which in turn requires the bank to keep more capital on hand than in the case of other investments such as home mortgage or retail loans, which are more easily sold.

The net impact on business aircraft finance is difficult to gauge, but the situation doesn’t look promising. “Aircraft lending will continue to be available,” said Ford von Weise, who heads up global aircraft finance efforts at Citi Private Bank, “but Basel III will change the risk/return/reward relationships of aircraft finance for banks.” There will be an even greater focus on credit quality, with investment-grade credits benefiting from lower interest-rate spreads and especially favorable terms. Lesser credits, on the other hand, will experience higher interest-rate spreads simply because banks will need higher returns to compensate for the greater capital reserves required as the creditworthiness of the customer declines.

Banks will also greatly prefer financing aircraft for existing clients, since Basel III regards that as less risky than making loans to borrowers who have no relationship to the bank. “This is an advantage for private banks,” said von Weise, “since their mission is to develop relationships with clients and offer them a full range of financing options.” Moreover, longer-term aircraft loans will be more expensive because capital requirements increase as the life of a credit facility extends. After the first two years, risk exposure rises rapidly under Basel III, making financing with terms extending beyond three to five years much less advantageous for the bank due to the greater capital reserves required. Aircraft buyers looking for longer financing terms will have to pay for the privilege.

These factors have already led some European banks to view Basel III as a reason to abandon aircraft finance altogether. On the other hand, financial institutions like Guggenheim Partners and Prudential Capital Group that aren’t banks and aren’t subject to Basel III may actually benefit by having the bank competition tied up in regulatory knots. An opportunity exists here for non-Basel III financiers to grab a greater share of the aircraft finance market. Basel III may also cause smaller, regional banks to be more active in financing aircraft, especially older less-expensive models that are not ­attractive ­collateral for major lenders.

The U.S. implementation of Basel III has not been finalized, but von Weise said that few significant changes to the international strictures are likely, though the U.S. rules may vary in comparison with those in other jurisdictions. North America, the EU and major nations in Asia are expected to begin implementation of Basel III this year.

Aircraft Lease Challenges

Basel III is not the only change in store for aircraft finance. The “lease convergence project”–a joint effort by the Financial Accounting Standards Board and its international counterpart to create uniform standards for lease accounting–will cause aircraft leases to be booked as “right-to-use” assets, with a corresponding liability to make lease payments. These changes could make leases less attractive to companies that have traditionally employed them to keep business jets off the balance sheet. In addition, to the extent that aircraft are treated as assets where the lessee consumes “more than an insignificant portion of the asset,” the new rules may require more of the interest component of the lease payment to be recognized in earlier years–another blow to leases, from an accounting standpoint.

That’s too bad, because otherwise this is a good time to lease a business jet. With the imminent demise of bonus depreciation, the tax benefits of purchasing a factory-new aircraft are less appealing than they have been in years. But financial institutions that offer aircraft leases still have an appetite for depreciation–and for acquiring new aircraft in like-kind exchanges to shield depreciation benefits received in prior years. The result can be a relatively good deal for the lessee, especially for one that can’t use the tax depreciation benefits itself. And in a world where banks are looking for 10 to 20 percent down payments on loan financing, a lease is by definition 100 percent financing (subject to security deposits and the like). No wonder some banks report that aircraft leases represent a growing portion of their aircraft finance portfolio.

Basel III and the changes to lease accounting lie in the future–albeit a not-too-distant one. Meanwhile, aircraft lenders are still struggling with the problem that has haunted them for several years: cash. There’s a surfeit of capital out there looking for a home. An aircraft buyer recently said to me, “Why would I borrow money to buy an aircraft? I have more cash on hand than I know what to do with.”

International Aircraft Finance

The tepid aircraft finance climate in the U.S. has encouraged aircraft financiers in this country to seek out new customers overseas. Many American institutions have been financing aircraft in Europe for years. In fact, some U.S. lenders–CIT and Guggenheim come to mind–specialize in such transactions.

But other international markets–places like China, Russia, Brazil and the Middle East–pose greater challenges for aviation lenders. Jet buyers in these locations frequently have trouble understanding the requirements faced by U.S. banks in making aircraft loans and leases. Dealing with collateral–obtaining, perfecting and enforcing security interests in aircraft–is a major issue, for example. Even if the buyer is a reputable zillionaire, if he resides in a country where foreign investment is risky, it will likely have an ­impact on his ability to obtain financing from U.S. sources.

One prominent financier in the international market is the U.S. Export-Import Bank. Its mission is to provide financing (often in the form of guarantees of loans made by other institutions) to non-U.S. borrowers for the purchase of goods (including airplanes) manufactured in America. The vast ­majority of aircraft financings by the Export-Import Bank are commercial jets, but the Bank is nevertheless active in helping international buyers acquire U.S.-manufactured business jets. Last spring, Congress extended the lease on life of the Bank (a government agency backed by the U.S. government) for an additional three years, also phasing in an opportunity for it to significantly increase its loan exposure limit.

Fractional Shares

Financing the acquisition of fractional business jet shares is an aviation finance backwater. One reason is that lenders find it difficult to obtain meaningful collateral in the case of fractional shares. By definition, a fractional-share participant owns only an undivided partial interest in the aircraft. If the owner defaults, the bank can’t just foreclose on the share (let alone the whole aircraft) and sell it, since there’s no real secondary market for shares. The logical buyer is the fractional program itself, which is in the business of selling more shares, not buying them back and reselling shares already sold.

The original and still the largest fractional program, NetJets, had a relationship for years with a financial institution that provided loans to share purchasers. But in 2010, NetJets announced with much fanfare that it would provide its own financing for share purchasers through its parent company, Berkshire Hathaway. Some form of financing is still available from NetJets, but better deals may be available elsewhere. Flexjet, a NetJets competitor, does not offer financing but will make suggestions about appropriate third-party financial institutions.

Share purchasers who don’t want to write a check for a share should consider leasing instead. If you run the numbers, the lease may be a better deal–keeping in mind that if you purchase a share, you bear the risk that before the program repurchases it, the aircraft will decline in value. That is nearly always the case–and often dramatically so.

Even with stiffer requirements on down payments, amortization, term and aircraft age, business jet finance remains a good deal for good credits. With spreads of between 135 and 250 basis points over 30-day Libor, floating rates are currently below 3 percent and often below 2 percent for investment-grade credits. Fixed rates, though slightly higher, remain popular with buyers who plan to own an aircraft for at least five to seven years. This is still a good time to obtain debt or lease financing.

 

Aircraft Financial Institutions

Private and Commercial Banks and Affiliates

Banc of America Leasing

Global Corporate Aircraft Finance

15301 Dallas Parkway, Suite 830

Addison, TX 75001

Michael T. Amalfitano

(972) 455-5855

CBI Leasing, Inc.

Aircraft Finance

Commerce Bank N.A.

Lake Forest, IL 60045

Sean K. Patrick

(847) 295-4601

Chase Equipment Finance, Inc.

100 N. Tampa St., Suite 3300

Tampa, FL 33602

Chad E. Colby

(813) 483-8246

CIT Bank

CIT Aerospace Business Aircraft

1000 South Pine Island Road

Suite 5000

Plantation, FL 33324

Michael J. Kahmann

(954) 359-4646

Citi Private Bank

Global Aircraft Finance

153 East 53rd St.

New York, NY 10021

Ford von Weise

(212) 559-1444

City National Bank

Aircraft Finance Group

9 Executive Circle, Suite 105

Irvine, CA 92614

David W. Maurer

(213) 673-8929

Deutsche Bank Private

Wealth Management

Private Aviation Finance

222 S. Riverside Plaza, Suite 25 SE

Chicago, IL 60606

David W. Rodin

(312) 537-1510

Fifth Third Bank Leasing

225 Franklin St., 26th Floor

Boston, MA 02110

Matt McNamara

(617) 573-5191

First Republic Bank

Aviation/Marine Finance

111 Pine St., Ninth Floor

San Francisco, CA 94111

James F. Simpson

(415) 296-5783

First Source Bank

Laird Professional Building

110 Hopewell Road, Suite 2E

Downingtown, PA 19335

Jeffrey Lindstadt

(610) 269-1683

Key Equipment Finance

Corporate Aviation Finance

225 Franklin St., 18th Floor

Boston, MA 02110

Patti Ann Sullivan

(978) 261-5201

PNC Aviation Finance

4355 Emerald St., Suite 100

Boise, ID 83706

Wayne Starling

(888) 339-2834

RBS Aviation Finance

875 Elm St., Third Floor

Manchester, NH 03101

Donald A. Synborski

(603) 634-7522

SunTrust Equipment

Finance & Leasing Corp.

Corporate Aircraft Finance

300 E. Joppa Road, Seventh Floor

Towson, MD 21286

John J. Amato

(303) 775-6631

U.S. Bank Equipment Finance

Capital Equipment Group

–Corporate Aircraft

9050 17th St., Seventh Floor

Denver, CO 80202

Pete J. Georgelas

(303) 585-4036

Wells Fargo Equipment

Finance, Inc.

Corporate Aircraft Division

1800 Century Park East, 13th Floor

Los Angeles, CA 90067

Robert C. Lebano

(310) 789-5036

Other Financial Institutions

Cessna Finance Corp.

100 N. Broadway, Suite 600

Wichita, KS 67202

Perry Bridges

(316) 660-1392

Export-Import Bank of the United States

Transportation Division

811 Vermont Ave.

Washington, DC 20571

Robert F. X. Roy, Jr.

(202) 565-3557

GE Capital Corp.

Corporate Aircraft Finance

10 Riverview Drive

Danbury, CT 06810

Brent P. Godfred

(203) 749-6657

Guggenheim Partners, LLC

Business Aviation Investments

9 Sunset Circle

Woodbridge, CT 06525

James A. Crowley

(203) 393-7247

Prudential Capital Group

3350 Riverwood Parkway S.E., Suite 1500

Atlanta, GA 30339

Robert Penfold

(770) 701-2410

The used jet market has had to ­contend with more than its fair share of obstacles over the past few years and 2012 didn’t offer any relief. They say that when the stock market moves up it climbs a wall of worry and that’s probably not much different from how jet buyers view the aircraft market. That said, there may be a bit less to worry about than there was last year at this time.

If you looked only at inventory levels throughout 2012, you’d think this wasn’t a very upbeat year for transactions. But transactions are actually occurring at a frequency not seen for a few years. The fact that overall inventory has held steady suggests that a stable flow of new jets is entering the market. In addition, some zombie aircraft listings continue to distort the picture regarding the number of aircraft for sale. Consider that more than 400 of the current offerings have been on the market since 2009 or before and that nearly 70 percent of those are models built in 1989 or earlier. Being in your twenties can be great–unless you’re an airplane. Whether this group is legitimately for sale or is unsellable, at least as whole aircraft, remains unclear. But it’s worth considering that this segment represents 17 percent of today’s worldwide inventory–a significant portion.

Action remains concentrated, as it has been for some time, on aircraft built after 1999–the models many lending institutions consider good investments. Today, in North America, roughly 7 percent of aircraft in this group are for sale, which means they’re in reasonably tight supply. In Europe, 16 percent of these aircraft are available–a decidedly softer market, which makes for fertile shopping grounds. In fact, among some model types, there are now at least as many aircraft for sale in Europe as in the U.S.–a probable result of the large number of jets that European buyers absorbed in the mid-2000s.

So 2012 seemed to spur many to get back into the market and it perhaps brought risk-averse buyers a step closer to the pricing floor they may have been waiting for before plunking down their euros and dollars. Current pricing seems to be breaking the law of supply and demand, but if 2012’s level of activity continues, we could see some models adhere to this most basic of economic theses in the year ahead.

An airplane seller who was acting as his own broker told me that he’d been abandoned at the sales altar on three recent occasions, each time because of issues with buyer financing. “Welcome to the club,” I thought. “If selling airplanes were easy, everyone would be doing it.” Indeed, many deals fall apart due to a lack of funding options, creditworthiness issues, cold feet or some other impediment. That’s been particularly true in the last few years. Even the deals that are getting done seem to be taking an inordinate amount of time.

Meanwhile, I’m hearing more queries about lease options today than at any other point in the last 20 years. Most owners remain uninterested in subleasing their jets, but exceptions do exist: Among the nearly 2,600 business aircraft now on the market, 45 are available only for lease while the owners of another 50 or so would consider a lease or sale. Lease options include older, small-cabin aircraft like a Lear 35A; long-range, large-cabin models like the Gulfstream GV and Global Express; and practically everything in between.

The lease option is just another arrow in the quiver of owners who may not be in a position to sell for a host of reasons. For example, they may be upside down in the aircraft financially, which would make a lease attractive because it would allow them to avoid the lump-sum seller payout that would be incurred in an outright sale. Some may also view a lease as a way to ride out the storm that has hit aircraft values and tread water until a recovery happens.

Leasing terms and conditions vary widely. Some owners offer short-term arrangements; others prefer long term. Some don’t allow the aircraft to be chartered and many, if not most, have monthly or annual flight-hour restrictions, or have built-in price premiums if maximum allowable hours are exceeded. [For more on leasing, see “The Changing Face of Aircraft Lending” on page 26. –Ed.]

Buyers and sellers need to weigh such variables carefully, but they shouldn’t ignore the lease option. In a down market, it can offer a noteworthy alternative in the preowned arena.

It’s too early to predict overall sales for 2013, but one key indicator—the number of aircraft for sale—continues to tick lower, suggesting that a recovery is still ongoing. In fact, the number of available jets and turboprops is now at its lowest point in roughly five years.

It’s worth noting, however, that the North American and European markets today seem headed in opposite directions.

The Gulfstream G550 offers a case in point. Worldwide, it appears to be in tight supply with only 19 for sale—or fewer than 5 percent of the nearly 400 in operation. However, 70 percent of the available G550s are based in Europe, and they represent 15 percent of the G550s on that continent. By comparison, only 2 percent of North American-based G550s are for sale. (Full disclosure: one of these is listed with my company.) A similar disparity is evident with such models as the Dassault Falcon 7X and the Bombardier Global XRS. And when you look at all aircraft manufactured since 2002, you find that just 7 percent are for sale in the U.S., compared with 13.6 percent in Europe. The spread has narrowed a bit recently, but a clear imbalance remains. And it is not just the large-cabin segment that has experienced an inequality of distribution; it’s late-model small and midsize aircraft as well.

Why the difference? There could be a host of reasons but price is always a chief suspect. With the G550, also, it’s interesting to note that most recent sales have involved aircraft with an aft galley, which U.S. buyers seem to prefer. And all but one were enrolled in an engine-maintenance plan such as Rolls-Royce’s Corporate Care Program, or JSSI.

In the months ahead, the law of supply and demand could result in lower jet prices in Europe, which would likely boost sales there and bring inventory levels more in line with those in the U.S. I’m already seeing signs of that trend, with price drops listed for four European-based G550s in a recent weekly update from Aircraft Post.com.

If I owned a business jet, my worst nightmare would go something like this: my airplane is involved in an accident and I get sued for zillions of dollars in damages. I call an aviation attorney and she says the limited liability company (LLC) I formed solely to own and operate my aircraft (known as a “flight department company”) won’t limit liability after all because it was operating the jet illegally. Then I call my insurance broker and he says my insurer is denying coverage because the damage occurred on a flight that was operated illegally. The dream ends with me prospecting for gold in the Yukon under an assumed name.

Unfortunately, this nightmare rarely seems to visit the aircraft owners who should be having it regularly. Notwithstanding all of the publicity the flight department company “trap” has received in the last 20 years, it continues to snare unwary business jet owners. Here’s why.

Entities like corporations and LLCs were created so investors could own and finance a business without assuming responsibility for its liabilities. Thus, in the absence of legal no-nos like fraudulent conveyances and failure to observe corporate formalities, the classic way to protect business owners from liabilities is to isolate those risks in a separate liability-shielding entity. So, when a business lawyer gets a call from his client about purchasing an expensive, dangerous-sounding asset like a business jet, his first thought will probably be: we have to create a new entity to own and operate it.

Unfortunately, few business lawyers are well versed in arcane FAA rules and regulations, especially ones as counterintuitive as the flight department company trap. Suppose I buy a business jet and own and operate it in my own name. Since I’m flying myself around in my own aircraft, the FAA says I can follow the non-commercial Part 91 Federal Aviation Regulations. Now suppose I create a wholly owned LLC to own and operate my jet, the company’s only business. I may regard the LLC as a kind of alter ego; after all, I’m the sole owner, and it’s doing only what I could do myself—operating the aircraft. But the FAA doesn’t look at it that way. It considers my LLC a completely separate legal entity. Now I’m not flying myself around anymore; the LLC is flying me around. Put differently, my LLC is providing air transportation to a different person—me. And providing air transportation to others for compensation or hire requires, according to the FAA, a commercial certificate, which the LLC doesn’t have.

You might say: “Ah, but the flights aren’t for compensation or hire and aren’t commercial because there are no payments.” Unfortunately, the way the FAA looks at it, there will be plenty of payments: I will have to fund the LLC to cover all of its expenses, including fuel, pilots, hangar and insurance. Since the LLC is not engaged in any other business, where else will it get the money? Again, the FAA views the LLC and me as distinct legal persons for purposes of air transportation, so my capital contributions to cover expenses constitute compensation.

Next, you might say: “Why not just get a commercial certificate?” An easy answer would be that the FAA recently called a moratorium on issuing new certificates. But even without a moratorium, it could take me a year or two to obtain a brand new air-carrier certificate—a time-consuming and expensive process—while my jet sits idle in a hangar. It would be easier to contract with an existing certificate holder to operate the aircraft for me.

Now we come to the question every frustrated client will ask his aviation lawyer at this point: “What will happen to me if I ignore these rules and continue to operate the aircraft in the sole-purpose LLC?” The answer is, maybe nothing—which is why there are still so many flight department companies out there blissfully operating airplanes (including via fractional programs) in complete ignorance or dismissal of FAA requirements.

But remember my worst nightmare: the aircraft has an accident, the FAA investigates and revokes the licenses of my pilots and fines my LLC, people sue for damages, my insurance company denies coverage, my lender says loan covenants are violated and the IRS says I should have been paying transportation excise tax on those “commercial” flights. Granted, this nightmare hasn’t played out yet, but the FAA has raised the issue in some investigations and there’s no question the agency takes it seriously. Were your aircraft to have an accident, don’t count on that LLC to provide a liability shield from the consequences of the LLC’s aircraft operations in violation of federal law and without adequate capitalization and insurance to handle the consequences. There’s a case many plaintiffs’ lawyers would relish.

If you currently operate your jet via a sole-purpose LLC, what should you do? If you want to continue to operate under Part 91, have the LLC lease the aircraft to you and operate it yourself. (There’s no problem with the flight department company just owning the airplane.) You will be personally responsible for safe operation in that case, but you can purchase up to $500 million of liability insurance, which is more than enough to cover any business aviation damage award I’ve ever heard of.

Alternatively, move the aircraft operations to a company engaged in a trade or business. As long as the aircraft is used in a manner that’s incidental to and within the scope of that business, a commercial certificate is not required.

Finally, you could contract with a Part 135 certificate holder to operate the aircraft for you commercially. You will sacrifice some operational flexibility, and your costs and taxes will go up, but at least you’ll be able to say goodbye to flight department company nightmares.

8 reasons to avoid the flight department company trap

~ It’s illegal

~ Aircraft liability insurance may be voided

~ Possible default on contractual obligations requiring legal compliance

~ FAA fines

~ Loss of pilot licenses

~ Unfavorable tax consequences

~ Tort liability exposure

~ Potential bad publicity

Interest rates remain at historic lows, in part due to the Federal Reserve Bank’s continued efforts to keep them there. Doesn’t this mean that you should finance your next business jet purchase?

A good case can be made for doing just that. A jet owner I spoke to recently seemed interested in upgrading to a bigger, more expensive airplane simply to have an excuse to borrow money. Rates won’t stay low forever. If you can finance a jet purchase at an attractive rate for the next seven years, there’s a pretty fair chance that will look like a good deal at the end of the term.

You might expect that a jet buyer who wants to take advantage of low interest rates would choose a fixed-rate loan. But Ford Von Weise at Citi Private Bank said that most of its clients opt for floating LIBOR indexed rates. Ultra-high-net-worth borrowers can finance the purchase of a business jet today at a rate that’s well below 2 percent.

On the other hand, it’s hard to justify borrowing if you have a lot of cash. While low interest rates make loans cheap, they also minimize investment returns. Money markets and certificates of deposit earn almost nothing, and though longer-term debt investments may offer higher returns, they involve substantial risk. Warren Buffett reportedly said recently that long-term government bonds today are “the dumbest investment.” When rates go up, as someday they surely must, the price of those bonds will fall. A lack of good conservative investment options causes some jet buyers to invest their cash in a new aircraft.

This is the reverse of the situation a few years ago. In 2007, before the crash, a growing group of lenders competed ferociously to finance aircraft purchases. Good collateral, blue-chip borrowers and the possibility of other business opportunities proved irresistible to many lenders. All that changed when the market crashed in 2008, and aircraft finance has been slowly rebuilding ever since.

Of course, if you don’t have cash, financing may be the only way to buy the aircraft. Many high-net-worth individuals have their money locked up in illiquid investments, such as securities of privately held companies or restricted shares in public companies. Those securities can often be pledged to secure a loan to acquire an airplane. When a “liquidity event”­—the sale of a business, for example—is on the horizon, borrowers often plan to pay off the aircraft loan at that time.

Perhaps the best reason to finance your purchase is that you may have better things to do with your money than tie it up in an airplane. Though many conservative investments are showing low returns, less conservative ones obviously still offer earnings better than 2 to 3 percent per annum. Investors were gun shy for a while, but as one lender told me, more people now want to pursue higher-risk, higher-reward opportunities. Financing your purchase lets the bank tie up its money in a conservative investment while you pursue a more aggressive investment strategy.

But you should avoid being stuck in an unattractive financing. If the plan is to take advantage of ultra-low floating rates in the near term, consider adding an option to switch to a fixed rate if it looks as if rates will be going up. If the long-term strategy is to pay off the debt when interest rates rise to a level that makes the financing unattractive, avoid loans with blackout periods and prepayment penalties. According to Von Weise, Citi often allows its aircraft loans to be paid off at any time without penalty.

In part, a readiness to permit repayment of aircraft loans reflects the fact that the profitability of aircraft finance has been compromised by the capital reserves and liquidity requirements that banks—especially “systemically important” ones like Bank of America, Citi and Wells Fargo—are being required to keep pursuant to the Basel III accords. (See my article on the “Changing Face of Aircraft Lending” in BJT’s February/March 2013 issue.) Given the razor-thin margins of profitability on many aircraft loans, a bank may be delighted to discover that a borrower wants to pay one off.

Another reason to finance an aircraft acquisition cited by lenders is to avoid the risk of taking a loss on the purchase. One aircraft finance veteran told me that he is seeing many companies—Fortune 500 companies, for example—lease aircraft that never would have dreamed of doing so in the past. A lease typically offers a definite payment structure for a definite period of time, with no residual risk. When the lease ends, there’s no finger pointing at the company about why the aircraft turns out to be worth a lot less than expected. If its value has plummeted, that’s the lessor’s problem.

Moreover, the pending changes to lease accounting rules are unlikely to take effect until 2016 or 2017, according to aviation CPA Glenn Hediger, so in the meantime, leases still provide off-balance-sheet treatment for companies that don’t want to highlight possessing an aircraft. If you can’t use the tax-depreciation benefits of an aircraft purchase, a lease also has the potential of passing those benefits to you in the form of lower financing costs.

If you plan to lease, a factor that may make financing easier is the availability of bonus depreciation for factory-new aircraft delivered this year. This lets you write off the whole purchase price, assuming you’re eligible for bonus depreciation and can satisfy the special tests in 2013 for the 100 percent version. If you fail those tests but are otherwise eligible, you can still qualify for 50 percent bonus depreciation for factory-new aircraft delivered in 2013 and 2014. This allows you to write off a total of 60 percent this year in most cases, since you’re entitled to an additional 10 percent based on the normal MACRS depreciation schedule for the remaining 50 percent of the cost. If your financial institution buys the aircraft and leases it back to you, however, that institution gets the benefit of the bonus depreciation.

Bankers Like Some Airplanes More than Others

Lenders pay close attention to the cost, age and model of the aircraft. Suppose you’re buying a 1983 Challenger 601 for $1.5 million. It may be a perfectly good aircraft at the right price, but it won’t be attractive to a lender. First, it is well beyond the age tolerance of most lenders, who are looking for airplanes that won’t be more than 20 or 25 years old when the financing ends. Second, it is in a buyer’s market: almost 23 percent of Challenger 601s are reportedly available for sale or lease at present. No lender wants to have to resell an aircraft like that when the lease ends or the airplane is foreclosed on. Finally, the bank will put at least as much work into this $1.5 million financing as it would into financing a $50 million Global 6000.

As a result, one bank whose rep I spoke to has three tiers of aircraft: most desirable, somewhat desirable and undesirable. Factory-new or relatively new large-cabin and long-range models like the Global 6000, Gulfstream 550 and Falcon 7X inhabit the first category. For qualified buyers, the bank will work hard to win that business. Buyers of aircraft in the “undesirable” category will mostly likely have to go elsewhere for financing.

Will they find it? Maybe, but they’ll have to know where to look. Financing for a problem aircraft, a problem buyer or a problem structure probably fits in best at certain non-bank companies willing to take higher risks for a greater return. But with rates as low as they are, even these financings may prove more attractive than you expect. It doesn’t hurt to look.

Private and Commercial Banks and Affiliates

Banc of America Leasing



Global Corporate Aircraft Finance

Addison, Texas

Michael T. Amalfitano

(972) 455-5855



CBI Leasing, Inc.

Aircraft Finance

Commerce Bank N.A.

Lake Forest, Illinois

Sean K. Patrick

(847) 295-4601



Chase Equipment Finance, Inc.

Tampa, Florida

Chad E. Colby

(813) 483-8246



CIT Bank

CIT Aerospace Business Aircraft

Plantation, Florida

Michael J. Kahmann

(954) 359-4646



Citi Private Bank

Global Aircraft Finance

New York

Ford von Weise

(212) 559-1444

City National Bank

Aircraft Finance Group

Irvine, California

John Unchester

(917) 558-8460



Deutsche Bank Private

Wealth Management

Private Aviation Finance

Chicago

David W. Rodin

(312) 537-1510



Fifth Third Bank Leasing

Boston

Matt McNamara

(617) 573-5191



First Republic Bank

Aviation/Marine Finance

San Francisco

James F. Simpson

(415) 296-5783



First Source Bank

Downingtown, Pennsylvania

Jeffrey Lindstadt

(610) 269-1683



Key Equipment Finance

Corporate Aviation Finance

Boston

Patti Ann Sullivan

(978) 261-5201



PNC Aviation Finance

Boise, Idaho

Wayne Starling

(888) 339-2834



RBS Asset Finance

Manchester, New Hampshire

Donald A. Synborski

(603) 634-7522



SunTrust Equipment Finance & Leasing Corp.

Corporate Aircraft Finance

Towson, Maryland

John J. Amato

(303) 775-6631



U.S. Bank Equipment Finance

Capital Equipment Group

–Corporate Aircraft

Denver

Pete J. Georgelas

(303) 585-4036



Wells Fargo Equipment Finance, Inc.

Corporate Aircraft Division

Los Angeles

Robert C. Lebano

(310) 789-5036

Other Financial Institutions



Cessna Finance Corp.

Wichita, Kansas

Perry Bridges

(316) 660-1392



Export-Import Bank of the United States

Transportation Division

Washington, D.C.

Robert F.X. Roy, Jr.

(202) 565-3557



GE Capital Corp.

Corporate Aircraft Finance

Danbury, Connecticut

Brent P. Godfred

(203) 749-6657



Guggenheim Partners, LLC

Business Aircraft Investments

New York

Chris Miller

(212) 293-2818



Prudential Capital Group

Atlanta

Robert Penfold

(770) 701-2410

Two corporate aircraft runway accidents in recent years underscore the importance of understanding your aviation insurance policy and communicating key details to all pertinent parties. The 2007 accidents—in Nova Scotia, Canada, and Santa Barbara, California—resulted in no serious passenger injuries but caused millions of dollars’ worth of damage. In each case, the insurance carrier denied the claim because the pilot(s) failed to meet policy requirements.

Contrary to popular belief, insurance companies don’t like to reject claims. It’s bad PR for them and isn’t conducive to retaining their other policyholders. However, when aircraft owners fail to adhere to contract terms, insurers have little choice but to say no.

Here’s a look at the four mistakes that result in the largest percentage of claim denials. Avoid them and you’ll have the bulk of your coverage nailed down tight.

1. Using Unapproved Pilots

One of the easiest and most common ways to void your insurance is to allow someone to fly your aircraft without confirming that he or she meets your policy’s approved-pilot clause.

The policy will state exactly who is authorized to act as pilot in command or second in command. Typically, either these pilots will be listed by name or you’ll see an “open-pilot” clause, which stipulates broad credentials and experience required to operate the airplane.

Many policies also list additional mandatory requirements for pilots. For example, your insurer may stipulate that all pilots, whether named or conforming to an open-pilot clause, must annually complete a motion-based simulator training course designed for the make and model aircraft operated. (A Falcon 900 doesn’t equal a Falcon 2000.) After a loss, a claims adjuster would require documentation that the pilot flying the aircraft had, in fact, completed such training.

Insurance companies recognize the need for flexibility regarding who is allowed to fly your airplane. This is the intent of those open-pilot clauses. For example, if your regular pilot is ill or on vacation, this clause can give you the authority to ­utilize another pilot who meets the minimum standards set forth in the policy. The open-pilot clause isn’t designed to allow you to let other pilots operate the aircraft on a regular basis, however, so be careful when relying on this provision.

Some aircraft owners mistakenly believe it’s OK for a pilot who hasn’t been approved by the insurance company to receive instruction or log time, provided that someone who’s “insurance-approved” acts as pilot in command. However, insurance carriers define pilot in command to mean “sole manipulator of the controls.” Therefore, if the pilot handling the controls at the time of a loss isn’t approved under the policy, no coverage will apply.

Keep in mind that investigators attribute most accidents and incidents to pilot error. At each renewal of your insurance, you should provide your pilots with a copy of the approved-pilots section of your policy and encourage them to keep it in the cockpit as a reminder. Make certain they complete required recurrent training within the allotted time, as no grace period applies. You should list by name on the renewal application any pilot you employ regularly. Prior to using new pilots, have them complete a form verifying their credentials. Ask your insurance broker to submit that form to your insurance carrier and get its blessing.

2. Misunderstanding Approved-Use Clauses

One of the least understood and therefore most dangerous clauses in an aviation insurance policy is the one about “approved use.” This provision spells out what commercial or non-commercial uses the insurer will cover and what compensation the aircraft owner may receive for operation of its aircraft. Particularly with respect to policies written for non-commercial use, allowable reimbursement can vary widely.

The most basic and restrictive clause would allow for use in the insurance holder’s business as well as personal use, but not for hire or reward. In other words, any exchange of goods or services—be it a week at a friend’s vacation home or a case of your favorite wine—could violate the policy terms.

A more liberal wording of the usage clause would state that the policy shall not apply while the aircraft is used with the insured’s knowledge “for any purpose involving a charge intended to result in financial profit to such insured unless otherwise indicated herein.”

An even broader clause would cover “all operations of the named insured.” Insurers normally reserve this language for their best corporate-flight-department customers. It allows maximum flexibility on reimbursement for aircraft operations. If you can get it, this is the clause you want.

Why are insurers so focused on commercial versus non-commercial use? Because in the eyes of the law, an entity engaged in a commercial operation owes a much higher standard of care to the public. The courts will hold the commercial operator—and therefore the insurance company—much more liable than a non-commercial operator.

3. Incorrectly Listing "Named Insured"

The “named insured” is the policy’s owner—the person or company that is entitled to cancel, add, change and benefit from coverage and that has the right and responsibility to coordinate with the insurer on any claim, receive claim checks, return premium checks and respond to cancellation notices. An “additional insured,” on the other hand, simply shares certain parts of the liability coverage and does not have any other rights under the policy.

Many owners mistakenly list the registered owner (often a sole-asset LLC) as the only “named insured” and sometimes list the true operating company or principal owner as an additional insured. Consult with your insurance broker to determine whether it makes sense in your situation to list all owners as named insureds. If your policy doesn’t already have it, add the “broad form named insured” clause.

Properly structuring the named insured is crucial to assuring that coverage applies to the people or entities that need it. Why? Because many ancillary coverages, such as for use of non-owned aircraft, apply only to the named insured. For example, say the owner’s aircraft is on a flight and another executive of the company must therefore use charter. If the flight is chartered under the operating company’s name and that company isn’t listed as a named insured, the coverage for use of non-owned aircraft wouldn’t apply, leaving the operating company exposed to a lawsuit in the event of an accident.

You might think you needn’t worry about that and that your company couldn’t be sued if all you did was charter an aircraft. In fact, when an accident occurs, typically everyone involved in the loop of commerce for that flight will be brought into a lawsuit. One great benefit of your liability coverage is that it provides an attorney to defend you, even against a suit that is groundless.

Because the wording of aviation policies varies, it is critical that you review your risk profile with your insurance broker so he or she can help you properly structure your policy’s named-insured clause. The penalty for not doing so could be financial ruin.

4. Failing to Properly Review Contracts

Many of us routinely sign rental-car agreements, bank-loan documents and website use clauses without even a cursory review. Why? Because they’re long and loaded with legalese. That’s also true of aviation contracts—including purchase, financing and maintenance agreements, hangar leases and more—but the consequences of not reading and understanding them before you sign could be much greater. Among other things, these contracts could significantly affect your insurance coverage.

It is essential that you provide a copy to your insurance broker and attorney before you sign any such agreement. Almost without exception, they contain clauses requiring you to meet certain insurance conditions. Ignore these and you may find yourself in a nasty breach-of-contract lawsuit. In addition, most of these agreements contain indemnity clauses that—regardless of any insurance coverage you have—make you responsible for any losses.

Indemnity clauses merit particularly careful review as they can work against you in their most onerous form. Your aviation attorney can guide you through the process and suggest wording based on language common to the industry. The money you might save by not taking this step would seem trivial after a loss. So if you want to avoid the cost of an attorney, do it on contracts that don’t involve as much loss exposure. It just makes sense.

HULL AND LIABILITY INSURANCE BROKERS



Air-Sur, Inc.

Ormond Beach, Florida

Thomas K. Coughlin, (386) 672-6210



AirSure Ltd., LLC

Golden, Colorado

Bill Behan, (303) 526-5300



AON Risk Services, Inc.

New York, New York

Tracy Toro, (212) 479-3233



AIS Gallagher

Las Vegas

Brad Meinhardt, (702) 647-2333



Chartis Aerospace

Insurance Services, Inc.

Atlanta

Linda Parent, (404) 249-1800



Falcon Insurance Agency, Inc.

Kerrville, Texas

John Allen, (830) 257-1000



Frank Crystal & Co., Inc.

New York, New York

Louis M. Timpanaro, Jr., (212) 504-5850



Hope Aviation Insurance, Inc.

Columbia, South Carolina

Stuart Hope, (800) 342-4673



John F. Throne & Co.

Seattle

Brint Smith, (206) 622-3636



Insurance Office of America

Aerospace Division

Atlanta

John C. Averill, (770) 308-2398



L.L. Johns & Assoc., Inc.

Waterford, Michigan

Stephen Johns, (248) 666-4400



Marsh USA, Inc.

Atlanta

Nancy P. Gratzer, (404) 995-2480



NationAir Insurance Agencies, Inc.

W. Chicago, Illinois

Jeff Bauer, (630) 584-7552



PIM Aviation Insurance

Wichita, Kansas

Timothy K. Bonnell, Sr., (316) 942-0699



Travers Aviation Insurance

St. Louis

Glen Travers, (800) 888-9859



Wells Fargo Insurance

Services USA, Inc.

Cincinnati

Charles R. Tooley, (513) 333-2121



Willis Global Aviation

New York, New York

Melissa Harder, (212) 915-8213



Wings Insurance Agency, Inc.

Eden Prairie, Minnesota

Steve Bruss, (952) 942-8800

TITLE INSURANCE AGENT



Global Aviation Title

Insurance Agency, LLC

Oklahoma City, Oklahoma

Frank L. Polk, (405) 552-2201

Maybe not, but you’d be wise to carefully consider the question.

Unlike real estate lenders, most aircraft lenders don’t require title insurance, so airplane buyers rarely even know about it, let alone purchase it. That can be a big mistake.

As the name implies, title insurance covers your title to the aircraft, ensuring that you own it free and clear of liens and encumbrances. 

The list of potential title problems is sobering: forged de-registration notices, bills of sale or releases; invalid documents due to lack of signing authority or incompetence; litigation involving the aircraft; state and federal tax liens; mechanics’ liens—the list goes on. Title insurance guru Frank Polk compiled a list of more than 60 things that can go wrong with an aircraft’s title—most of which have been litigated—that might make you reconsider the value of this coverage.

Title concerns often arise when a buyer acquires an aircraft based or registered outside the U.S. A leading case illustrating the potential horrors of purchasing a foreign-registered aircraft is Faysound Ltd. v. Walter Fuller Aircraft Sales. Defendant Fuller purchased a Falcon 50 from the Philippine Presidential Commission on Good Government (PCGC), an organization supposedly recovering ill-gotten wealth from former cronies of deposed president Ferdinand Marcos. The PCGC had “seized” the Falcon in connection with a court proceeding against one Eduardo Cojuangco, Jr.; the Philippine registration of the aircraft was cancelled; and notice of the cancellation was sent to the FAA, stating that the aircraft was free and clear of lien. Fuller subsequently received a bill of sale from the PCGC (which he duly recorded with the FAA) in consideration of the purchase price, much of which was apparently used to pay off cronies of the new Philippine administration. 

Unfortunately for Fuller, Cojuangco didn’t own the aircraft; he was a shareholder of a company that leased it from a Hong Kong corporation called Faysound, which was the Falcon’s true owner. As a result, the PCGC never had any right to seize or sell it. When Faysound sued the hapless Fuller in a U.S. court to recover its aircraft, Fuller lost.

Title insurance can protect you from such problems, in part because of the due diligence the insurer will perform. If Fuller had purchased title insurance for the Philippines, the insurer would have discovered when checking the Philippine aircraft registry that the registration was merely that of a lessee/operator and was subject to a lease agreement with the real owner.

If the aircraft is based or has significant maintenance performed outside its jurisdiction of registration, you should ask the title insurer what diligence should be conducted and what coverage you can buy to provide the best protection. With the right diligence and coverage, the title insurance process can protect you against improper or forged deregistration notices, fraudulent sales, tax liens and other claims and issues unique to foreign deals (such as the invalidity of documents resulting from the peculiar requirements of a foreign jurisdiction).

A common misconception is that hiring a reputable title company to search the FAA Registry and International Registry for filings regarding the aircraft is sufficient to identify all potential title problems. Neither the FAA registry nor even federal law controls valid title; it’s controlled by applicable state law (or foreign law in the case of many imports), and not all liens are filed with the FAA.

Tax liens—a big source of title disputes since the economic downturn of 2008—offer a good example. “People forget to do tax-lien searches because they think all liens are filed with the FAA and that’s simply not the case,” Polk said. Thus, you can be the registered owner for FAA purposes but still end up in a dispute with the prior owner over a tax lien, perhaps requiring you to pay off a lien claimant.

Even checking FAA records and making a timely filing with the FAA may not win the day, as the parties learned in Shacket v. Philko Aviation. In this case, an aircraft dealer sold a Piper Navajo to Mr. and Mrs. Shacket, telling them he’d file the bill of sale for them with the FAA, as was “customary.” Instead of doing so, however, the dealer then purported to sell the same aircraft to Philko, which did file a bill of sale with the FAA. But even though Philko was the registered owner, the court held that the Piper belonged to the Shackets and found that Philko had “actual notice” that the dealer didn’t have good title to the aircraft. (Notoriously, the court said “actual notice” includes “knowledge of facts that would lead a reasonable person to inquire further into the seller’s title.”) Like Fuller, the folks from Philko probably wished they’d had title insurance. 

Savvy aircraft buyers not only get a bill of sale from the seller at closing; they also get a warranty of title, which is a standard part of nearly all airplane transactions. Instead of paying for title insurance, can’t the buyer simply rely on the warranty? That’s certainly an option, but many aircraft sellers are little more than shell holding companies that may not even exist when title problems surface. Further, a small group of sellers (mostly lenders and leasing companies) refuse to provide a general warranty of title. They may be willing to guarantee that they didn’t muck up the title, but they won’t guarantee that prior owners or other parties haven’t done so. In that case, title insurance is an absolute must, and you should ask the seller to contribute to its cost.

So should you obtain title insurance when buying an aircraft? It depends. The coverage is worth considering in every purchase of a non-U.S.-registered or -based aircraft, although even there, if you’re buying a jet from the queen of England, you can probably live without it. If you’re buying an aircraft based and registered in the U.S., title insurance may be worth having, depending upon the identity and financial condition of the seller, the nature of the seller’s title warranty and the history of the airplane. 

Jeff Wieand welcomes comments and suggestions at jwieand@bjtonline.com.

Reduced inventories of several models suggest that, after years of weakness, the used-jet market is finally turning around.

Though it’s too soon to start celebrating, we’re seeing more and more signs of a turnaround in the market for used jets.

One example: the number of preowned Gulfstream G550s for sale recently dropped below 10—down from 17 roughly a year ago. When you consider that more than 400 of this model are in operation, the small percentage on the used market is impressive. An increase in prices seems unlikely in the short term but we can expect values to at least stabilize if G550 inventory holds at or below current levels, as one might expect heading into the historically busiest sales period of the year. The immediate beneficiary of such stabilization would, of course, be the GV, a model whose inventory has slightly increased year-over-year. 

Supply of Bombardier’s Challenger 604, meanwhile, reached an all-time high at the end of 2012—but then buyers detected value and assaulted this segment with cold, hard cash, driving availability down to levels not visited in a couple of years. Buyers’ acute sense of value can tighten up a market over a couple of quarters, which is what has occurred here. While the Challenger 604 market remains supply-heavy, inventory seems likely to continue shrinking this fall, with levels stabilizing by the end of the year. Lending support to this thesis are the “sale pending” notices that accompany nearly 10 percent of the model’s current for-sale listings, plus a comparatively low supply of the successor model 605s for sale. 

Another large-cabin jet, the Falcon 7X, seems to have arrived at its trigger point, with most of the pricing in the sub-$40 million area. The aircraft has been selling at a rate of roughly one per month over the last six months, double the rate of the previous six months, bringing the number of choices below the 12-month moving average. n

Bryan Comstock welcomes comments and suggestions at bcomstock@bjtonline.com.

Good news: rates are at record lows. Bad news: a rock-bottom rate can trigger trouble.

Leasing plays a big role in business aviation. A lease transfers possession of an aircraft from the lessor (usually, but not always, the owner) to the lessee. If you think of property as a bundle of sticks, as I was taught to do in law school, the lease gives some (but not all) of those sticks to the lessee, including the right to operate the aircraft when it’s in the lessee’s possession.

Aircraft leases are sometimes described as either wet or dry. According to Federal Aviation Administration regulations, a lease is wet if the lessor directly or indirectly provides at least one crewmember along with the aircraft, in which case the FAA requires that the lessor retain operational control of flights. Arguably, this means a “wet lease” isn’t really a lease at all, but rather an agreement by the lessor to provide a transportation service to the lessee. Dry leases, on the other hand, are usually “operating” leases where the lessee operates the aircraft (or subleases it to another party to operate it for him). The lessor remains the owner, enjoying the benefit of tax depreciation and facing the burden of market depreciation.

There are many reasons to lease business jets. Leasing is currently the customary way for an owner to provide an aircraft to a Part 135 certificate holder for charter flights. Leasing is also a classic way of separating in different entities the liabilities associated with owning and operating an airplane. Many leases are designed to make aircraft available to affiliates of the owner or to avoid payment of sales or use tax on an airplane purchase. Financial institutions offer operating leases (usually between five and 10 years) to customers as an alternative to debt financing.

What’s a fair lease rate for an aircraft? It depends. Financial institutions consider a host of factors in setting the rate, including the term, interest rates, the lessee’s credit position, the availability of options for the lessee to purchase the aircraft and its estimated fair market value on termination. Lease rates to charter operators for purposes of revenue charter reflect the assumed hourly cost of operating the aircraft and the anticipated hourly revenue. As a rule, the charter operator will pocket approximately 15 percent of the gross revenue (excluding the fuel surcharge) and give the balance to the owner as a lease payment. Lease rates between aircraft owners and operators usually involve informed, arm’s-length negotiations based on the value of the aircraft.

But suppose there is no arm’s-length negotiation. In a typical business-jet ownership structure, a subsidiary company acquires the aircraft and immediately leases it to its parent company or another affiliate to operate. The purpose of this arrangement is often to minimize sales/use taxes by switching the target of the tax from the purchase price to the lease payments. Essentially, the initial transaction is regarded as a purchase for resale, so the ultimate “sale” subject to tax is the monthly (or hourly) lease.

In situations like this, there is an irresistible temptation to make the lease payment as small as possible. Assuming the applicable sales tax is 6 percent, if the aircraft is leased for $200,000 per month, the monthly tax is $12,000, and if it is leased for $20,000 per month, the monthly tax is a vastly preferable $1,200. But as aviation attorney Cliff Maine is fond of saying, pigs get fat and hogs get slaughtered. A state is unlikely to recognize an agreement as a bona fide lease if the rate is too low. When the state revenue department figures out that you low-balled the lease rate, it may impute its own rate or perhaps disregard the lease altogether and charge use tax on the full purchase price. Interest and penalties will follow as night follows day.

So how do you set a realistic lease rate? For a long time, the rule of thumb was 1 percent of the aircraft’s value per month. Applying this rule, a $200,000 monthly rate would be perfect for an aircraft you just bought for $20 million. But the cost of funds today is so low that the 1 percent per month rule has lost much of its relevance. Most monthly operating lease rates are well below 1 percent per month, especially for long-term leases of new or near-new aircraft, and sometimes as low as 0.4 percent.

Note that in setting the rate, the aircraft is valued as of the beginning of the lease, so if you’re paying $140,000 per month in the first year on a $20 million aircraft (0.7 percent), the percentage of the aircraft’s actual value represented by that payment will be much greater 10 years later. This is one reason, no doubt, why rates tend to be significantly higher for short-term leases (up to three years) than for long-term ones. If this concerns you, you could try to “mark the lease rate to market,” as it were, on some regular basis, to take into account the aircraft’s depreciation in value.

But even an economically sensible lease rate may not work in every jurisdiction. Some states have lease rate expectations more suitable for when Nixon was president. To take advantage of the resale exemption in Texas, for example, a lease between related parties must be in the “normal course of business,” and Texas has decided that a monthly lease rate of less than 1 percent (and more recently less than 1.13 percent) doesn’t qualify. As a result, when entering into a lease between related parties, it’s wise to obtain a written rate appraisal from an established professional that you can retrieve from the file when the state revenue agent knocks on the door. 

Aircraft sales-tax expert Phil Crowther suggests that you might try to provide in your lease that if the state decides the rate is too low, it is automatically and retroactively revised to be the minimum rate the state deems reasonable. That’s an interesting idea, but one yet to be tested in practice. Meanwhile, remember that hogs get slaughtered. 

Jeff Wieand welcomes comments and suggestions at jwieand@bjtonline.com.

Calculating the cost of personal use is as complicated as it is important.

When an employee takes a personal flight on his company’s aircraft, how do you calculate the trip’s cost or value? The answer depends on who’s asking the question and why.

The Federal Aviation Administration generally prohibits passengers from paying for flights that aren’t operated under a commercial certificate. “Payment” means forking over any kind of direct or indirect compensation. The FAA says, however, that if the flight is “within the scope of and incidental to” a company’s business, it can charge the employee the cost of “owning, operating and maintaining the airplane.”

That’s a broad standard for figuring costs. In interpretations, the FAA has said it’s acceptable to use the cost of aircraft usage as established by the company’s accounting department in the normal course of business and that the cost could represent a pro-rata portion of “all fixed and variable overhead expenses associated with the aircraft.” More recently, as part of a convoluted analysis that sowed more confusion than elucidation, the agency said that the cost could even include depreciation of the airplane.

On the other hand, if an employee’s flight is for personal purposes (and is thus not “within the scope of and incidental to” company business), such charges are prohibited. Instead, FAA regulations permit the employee in some cases to “time share” an aircraft for an amount equal to twice the actual fuel costs, plus certain stated expenses. Barring astronomical fuel prices, this amount won’t cover all of the company’s expenses for the flight—certainly not a pro-rata portion of the cost of owning, operating and maintaining the aircraft.

Compare this with the Internal Revenue Service’s approach. The IRS is interested in the cost or value of a flight for two main reasons. First, if an employee travels on company aircraft for personal purposes, the agency treats the flight as a perquisite and the employee as a recipient of taxable income. The IRS gives the company a choice in calculating the amount of that income. To the extent that the employee doesn’t pay for the flight, the company must impute his income using either the ride’s fair market value or a calculation method called SIFL. The former is basically the cost to charter the aircraft, while the latter reflects the cost of first-class airfare. Needless to say, the two numbers will be very different.

The second reason the IRS is interested in the cost or value of a flight is to determine the company’s deductible expenses for tax purposes. Companies usually want to deduct the cost of employees’ personal flights on their aircraft as a business expense. In 2004, though, Congress made this more difficult by limiting the write-off for certain top executives (so-called “specified individuals”) to the amount paid by (and/or income imputed to) those executives when the flight is for their “entertainment, recreation or amusement.” As a result, whenever a specified individual takes a non-business flight, a big chunk of the company’s expenses are often at risk of being disallowed for tax purposes.

How big a chunk? Since the IRS lets the company calculate income to the employee for the flight based on charter rates or Standard Industry Fare Level, one might think the business could use the same approach to calculate its lost deductions. Unfortunately for the company, that doesn’t work. IRS regulations provide that all fixed and variable flight costs—including an allocable portion of any interest expense used to finance the purchase of the aircraft, plus lease payments and tax depreciation on it—are at risk of being disallowed.

IRS rules for how to calculate these costs and assess the amount of the tax deduction disallowed are extraordinarily complicated and sometimes counterintuitive, and enterprising aviation tax accountants have created software to help the company do the job. The bottom line: if top executives frequently use the aircraft for personal “entertainment, recreation or amusement,” the company’s tax bill will go up.

Ironically, this inability to deduct entertainment flight costs creates yet another “cost” for the company—taxes—and yet another headache (this time for public companies) in calculating the cost of personal-use flights.

Like the IRS, the Securities and Exchange Commission regards free or discounted flights for employees on the company aircraft as a perquisite. In the case of free flights on corporate aircraft for certain top executives (often called “named executive officers”) that aren’t part of their employment duties, the SEC requires public companies to report what the commission calls the “aggregate incremental cost” of the flights as “other compensation” to such executives in the proxy statement. Unlike the FAA, the SEC isn’t focused on whether the executive can pay for the flight, and unlike the IRS, it doesn’t care what the actual value provided to the executive is. Its only concern is the additional cost the company incurs in providing the transportation, which has traditionally been thought to be similar to the direct operating costs (DOCs) of the flight—an amount less than, say, the cost of chartering the aircraft.

But as we just noted, if the IRS deems the executive’s flight “entertainment,” the company stands to lose significant tax deductions. Is this also an “aggregate incremental cost” that should be disclosed in proxy statements? Though loss of a tax deduction isn’t a “cost” per se, in an abundance of caution, some companies have been disclosing the fact (if not the amount) of the lost deductions as a result of personal-use flights. And, just to come full circle, if the deduction is a cost, receiving a tax deduction might be compensation, which is exactly what an old FAA interpretation concluded in proscribing flights by a tax-savvy operator who claimed they were conducted at “no charge.”

Even in this simplified account of a complicated subject, it’s apparent that companies face contradictory government standards in dealing with non-business flight expenses for employees and others that are certain to keep aviation lawyers and accountants busy for years to come.

Jeff Wieand is a senior vice president at Boston JetSearch and a member of the National Business Aviation Association’s Tax Committee.

Bizjet passengers often express confusion about when to give gratuities to pilots and crews. Here’s help. 

Bizjet passengers often express confusion about when to give gratuities to pilots and crews. Here’s help.

Should you tip your pilots? We hear this question often at Business Jet Traveler, so we did some research to help you know when to pull out your wallet.

We began by including questions about tipping in our third annual Readers’ Choice Survey, which drew responses from nearly 1,100 passengers. As we reported in our last issue, the greatest number (41 percent) said that they never tip, but 22 percent tip occasionally, 14 percent tip every time they fly, 13 percent tip frequently and 10 percent tip at the holidays in December. Of those who tip, 33 percent give more than $100, while 27 percent tip $25 or less.

One passenger we spoke with, who flies via a jet card, said, “It never dawned on me that you would tip pilots. I tip ground crew when they assist, but it seems strange to tip a pilot.” Another business jet traveler, on the other hand, said he goes out of his way to tip pilots. He added that they always appreciate it and that he has never seen a pilot who “felt in the least bit uncomfortable” about the gesture.

When is tipping appropriate? Unfortunately, no simple guidelines exist, but in surveying almost 100 pilots, we found that the type of flight makes a difference. Pilots who work in-house for corporations or individual clients seem to not expect gratuities. Some employers forbid their flight crews from accepting them, and some pilots find tipping offensive. In most cases, these pilots are well compensated by their employers.

“I get a good paycheck, a performance incentive [bonus] and stock options, just like the rest of the company,” remarked a pilot who asked to remain anonymous (as did most of those who spoke with us). “I have worked for three corporations and never expected a tip from passengers.”

For fractional and particularly charter pilots, however, salaries can be relatively low. Many pilots, even those who work for corporate flight departments, made a point of telling us that their brethren who fly charter should be tipped.

Charter pilots themselves typically say that they don’t expect tips but always appreciate them, especially for exceptional service. What constitutes ”exceptional”? If your charter pilot schleps 17 bags on your behalf, cleans up after your twin five-year-olds or prepares the cabin with lots of extras, you may want to offer a tip. As one pilot told us, “If I accomplish the flawless, multi-time-zone, multi-country, bureaucratic, hectic and maintenance-plagued mission with aplomb, a tip is a nice way for the passenger to show appreciation.” According to the pilots we surveyed, the average gratuity is $50 to $100 per flight per pilot.

Don’t worry if the charter company has a no-tipping policy. In the unlikely event that a pilot cannot accept gratuities or is uncomfortable doing so, he will undoubtedly still appreciate the gesture. And keep in mind that if you can’t say thank you by tipping directly, there may be another way. As one pilot commented, “Our company says ‘no tipping,’ but experienced passengers will say, ‘Have dinner on me.’”

What about tipping flight attendants and other onboard crew members? Joanne Cassar, a corporate flight attendant for nine years, said she believes that tipping is never expected or necessary, “but it’s always appreciated. It helps you to know that your service was good and the client is happy.” Cassar added that she shares her tips evenly with the rest of the onboard crew because she believes that she is part of a team.

Then there is the crew on the ground. Passengers and pilots do regularly tip line crew and baggage handlers, but there are exceptions. Maddy Gilad, chief pilot for Projet Aviation, an aircraft management and services company in Leesburg, Virginia, said that Projet usually builds into the cost of the flight tips for line people, handlers and fuelers and informs the passenger that the service is included. “That way,” she said, “the passenger can rest easy, knowing that all of those gratuities have been taken care of by us.”