Fractional Ownership Liability

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Not since fourth grade have fractions played such a major role in our lives. As AVweb has reported, the fractional segment is the driving force in aviation these days. It has created jobs for pilots and crew and has buoyed production numbers for new aircraft, engines and major components. But, is there a dark side? AVweb's Phil Kolczynski and his colleague Valerie Dunbar Jones examine the legal in's and out's of fractional ownership.

A new FAA rule, set for implementation in late 2002, will have a major impact on business aviation. Part 91 of the Federal Aviation Regulations (FAR) will be amended to add the new "Subpart K." Subpart K will distinguish fractional ownership programs from other traditional business aircraft ownership arrangements. The new rule will not affect the pre-existing requirements under FAR 91.501 et seq. regarding traditional corporate flight departments, flying clubs and various forms of Section 91.501 ownership.

A key element of the new rule for fractional ownership programs is that fractional owners (frac-owners) will be in operational control of any program flight requested by the frac-owner. Of course, the frac-owner will be able to depend on the program manager for aviation expertise. But the frac-owner will be required to sign an agreement promising not only to accept operational control responsibility for the FAA, but also acknowledging that "The owner may be exposed to significant liability risk in the event of a flight-related occurrence that causes personal injury or property damage." FAR 91.1013(a)(1)(iii).

Management, ownership and interchange agreements have customarily contained clauses suggesting some level of operational control on the part of a fractional owner. The new FAA rule clarifies the broad-based responsibilities of frac-owners. The new responsibilities and resultant exposure are significant when compared to traditional forms of aircraft ownership. Normally, passive owners who were not actually piloting the aircraft or performing maintenance on it would have little or no liability exposure compared to the operator or owner-pilot.

This article will explain aircraft-owner liability under state laws. Then, we will compare the new obligations and liability exposure of fractional ownership. We will also discuss the various types of exposure of frac-owners after the new rule, including air crash liability, FAA sanctions, employment issues and insurance. Throughout, we examine ways in which frac-owners and program managers can protect their interests in frac-ownership. Note: federal and state tax considerations associated with fractional ownership are significant and extensive, and we have elected not to address them within the scope of this article. Expert tax advice, in addition to the other counsel we recommend in this paper, should definitely be sought prior to entering into any aircraft ownership obligation.

Aircraft Ownership Liability Laws

scales/book/gavelTraditionally, there has been an important distinction in liability law between an "owner-operator" and a "non-operator owner." If an owner-operator (owner who pilots his aircraft) is negligent and that negligence causes damage or injury, that owner-operator is liable. This is also true when the owner is the pilot's employer. An employer is normally vicariously liable for the acts of an employee who negligently operates or maintains airworthiness of the aircraft for the owner.

Where aircraft ownership is purely passive — that is, the entity that holds title to the aircraft is not involved in piloting, maintenance or any form of operational control — there should be no liability. Under the modern laws of most jurisdictions, non-operator owners are not held liable for pilot negligence, or enjoy very limited liability. However, a warning is in order: some states have enacted specific aircraft-owner liability statutes or have old case law on the books purporting to make such passive owners liable for aircraft accidents. These old-fashioned laws are based on the notion that aircraft are hazardous flying contraptions. Some legislatures simply desire to make the owners pay when their aircraft cause damages regardless of control over the wrongdoing.

One example of such a provision is New York's General Business Law 251, which renders owners vicariously liable for the negligence of an operator where the aircraft is being used or operated for more than 30 days, with the express or implied permission of the owner. Liability attaches even if the operating pilot is not an employee of the owner and the owner has no control over the flight. Other states have limitations of liability, so that a passive owner with no actual control over the pilot or aircraft at the time of the accident will have limited liability exposure. In California, a passive owner can be held liable for the permitted use of its aircraft but damages are limited to $15,000.00 per injury or death, with a maximum of $30,000.00, and punitive damages are barred entirely.

Nevertheless, in the majority of jurisdictions and in the absence of a special statute imposing liability on aircraft owners, a passive owner who simply lends, rents or leases an aircraft to another party is usually not held liable for the negligence of that party. Most laws do not usually impute liability to aircraft owners unless they have been personally negligent or are the employers of parties who were personally negligent.

Those folks who spend their Saturday evenings curled up with the FAR may point to a provision in the Federal Aviation Act, 49 U.S. Code 44112, which seems to suggest that passive owners can be held liable even when they are not operating the aircraft. However, this statute has been interpreted by many courts as not creating a cause of action for vicarious liability on the part of the aircraft owner for air crashes. e.g., Malone v. Capital Correctional Resources, Inc. (Supreme Court of Mississippi, 2001).

In many jurisdictions, "non-operator" aircraft owners may usually avoid liability for aircraft accidents as long as:

  • The owner had no knowledge of any dangerous condition or defect in the aircraft when it is transferred to the control of another;
  • The owner is not the employer of the operator of the aircraft;
  • The owner was not the employer of the maintenance professional who signed off on the airworthiness of the aircraft;
  • The owner was not in control of the maintenance or operation of the aircraft at the relevant times when the problem developed which lead to the accident;
  • The owner did not negligently entrust the aircraft to an incompetent operator;
  • The applicable state law does not impose vicarious liability on owners who grant permission to others to operate the aircraft;
  • The owner does not assume liability for the operation of the aircraft by signing a contract accepting joint responsibility for operational control or airworthiness.

The last item on the list is an issue under the new Subpart K of Part 91. The new rule require frac-owners to sign a contract acknowledging operational control for their flights and accepting responsibility for airworthiness on their flights.

Fractional Ownership Programs

Fractional Ownership HeaderIn simplest terms, fractional ownership can be thought of as the aviation industry's answer to time-share condominiums. It is the fastest growing and at the moment, quite possibly the only growing area of general aviation. Although the attack on America through the hijacking of aircraft on September 11 has damaged many sectors of the aviation industry, the fractional ownership programs have prospered. For well under $1 million, depending on the type of aircraft, a business or person can purchase as little as a 1/16th share of a business class jet aircraft or a 1/32nd share of a personal transport helicopter. The fractional owner can send its employees, clients, and guests for trips on its fractionally owned aircraft or any aircraft in the fractional ownership program. This can be done for a small portion of what it would cost to own the same size corporate aircraft outright. A frac-owner's passengers may avoid many travel delays that are now endemic with airline trips. They enjoy expedited (though still thorough) security checks, and have much greater flexibility with regard to schedule control, itinerary, choice of destination airports, and in-flight amenities.

Fractional flying is conducted under FAR Part 91, the same rule applicable to private and corporate aircraft operations. The safety standards imposed by Part 91 are high, but not as stringent as those of FAR Parts 135 (air taxi and commuters) and 121 (larger scheduled air carriers). Some critics have voiced concern that fractional flying was insufficiently regulated. In reality, most fractional programs have been well run. Proponents of fractional programs can point to excellent safety records, which even some of the airlines may envy. The FAA has simply been trying to catch up with the explosion of business flying in this area, and address its policy mandate to protect the flying public. The new FAA rule will restrict fractional programs above and beyond the existing Part 91 standards to some degree, by introducing management, flight control, training, and operational restrictions. However, the new rule will also amend Part 135 to permit on-demand charter flights to operate under the same airport landing criteria, weather reporting requirements and departure standards as fractional program flights, updating the 1940s-vintage provisions of Part 135 to reflect the improved technological capability of modern business aircraft.

Operational Control

The New Rule on Fractional Ownership

FAA SealIn July 2001, the FAA issued a Notice of Proposed Rule Making (NPRM) proposing to add a new Subpart K to Part 91 to regulate fractional aircraft ownership programs. The comment period was extended to November 16, 2001, and is now closed. FAA sources report that the final rule should be implemented in late 2002. The rule likely would have been finalized earlier but for security priorities taxing the FAA since September 11. The following sections will discuss some key areas of exposure for fractional owners under the new rule, and provide suggestions of how these issues can be resolved.

Under the new FAA rule, frac-owners without aviation expertise will have operational control and safety responsibilities that may create liability exposure of which they were not previously aware.

Frac-owners' duties will include:

  • Operational control whenever the frac-owner has requested that any program aircraft (not necessarily the one in which the share is owned) carry passengers or property designated by the owner, regardless of whether the owner is on board. FAR 91.1009.
  • Operational control whenever the frac-owner's designated passengers are carried aboard an affiliated program aircraft, even though it is neither owned nor part of the same fractional ownership program. Thus, a fractional owner can be in operational control of a non-program aircraft. The FAA must be satisfied there is a sufficient relationship between the owner's program manager and the affiliated program manager. 91.1001(a)(2), 91.1001(e)(8), 91.1001(e)(9). Examples of affiliate programs may include fractional ownership operations created under the regulations of foreign countries.
  • Responsibility for compliance with the FAA-approved management specifications of the fractional program for any flight carrying the fractional owner's passengers. This duty exists even though the fractional owner clearly depends on the project manager for compliance with the management specifications. NPRM Preamble.
  • The right/duty to inspect and audit the practices of the program manager concerning the operational safety, record keeping and maintenance of the program aircraft. Arguably, with responsibilities for operational control and airworthiness, and given the wording of the regulation, the right to audit may be considered a duty. 91.1009(a)(1); 91.1003(b).
  • A non-delegable obligation to comply with every regulation in the new Subpart K for every flight carrying their passengers. 91.1001. Thus, fractional owners are responsible even if they delegate the authority to the program manager to carry out various tasks in the program.

Air Crash Liability of Fractional Owners

Crash PhotoUnder Subpart K, frac-owners will soon be responsible for complying with safety rules imposed on them by the FAA. This is unusual, because the FAA normally only imposes operational safety and airworthiness rules on FAA certificate holders who have aviation expertise. Will violations of these safety rules create liability on the part of the fractional owner?

Typically, in an air crash, a plaintiff must prove that a defendant had a safety duty, breached that duty and that the breach caused the accident, resulting in damages. Most crashes involve pilot errors while under operational control, or airworthiness problems. The new Subpart K rules appear to create federal duties on frac-owners in these areas. The new regulations may create a bountiful fishing ground for plaintiffs' attorneys after a fractional aircraft crash.

Attorneys may look to state laws to find a legal claim, on the basis that the frac-owners violated federal safety rules. If defense lawyers suggest that the rules were for regulatory purposes only, the plaintiffs can show that the frac-owner assumed liability risks for any accident when its representatives signed agreements prepared by the program manager. The new FAA rule requires not only that the frac-owner sign agreements to acknowledge that it has operational control, but further requires that frac-owners acknowledge that "[t]he owner may be exposed to significant liability risk in the event of a flight-related occurrence that causes personal injury or property damage." 91.1013(a)(1)(iii).

How Many Frac-owners Can be Sued?

If a major air crash occurs involving a fractional ownership aircraft after the new rules are implemented, one can expect that the program manager will be sued. The fractional owner in operational control, who has directed that his employees, guests or clients are carried on the flight, will also be sued. But what about the other fractional owners who were not using the aircraft on the ill-fated trip?

Some plaintiffs' attorneys use the shotgun approach to litigation by suing all relevant deep pockets after a disaster. The newspapers usually emphasize the deep pocket part — they forget to explain that the parties who had no safety duties related to the cause of the accident are soon dismissed from the lawsuits by lawyer's motions. The FAA rule only places responsibility for operational control and fractional program regulations on the fractional owner for its flight. But, once the fractional owner's flight has ended, has its liability exposure for a subsequent crash abated?

What if a subsequent crash occurs involving a fractional program aircraft that is not due to contemporaneous operational pilot error? For example, what if the subsequent crash results from prior maintenance malpractice, or an airworthiness deficiency? If that deficiency arose at the time when the previous frac-owner was in operational control and had the duty for compliance with all applicable regulations — would it be liable? There is an expression in the naval service that if it happens on your "watch," you may be responsible for the consequences. This may become the template for frac-owner liability exposure.

Is Fractional Aircraft Ownership a Passive Investment?

The new rule clarifies that fractional owners are not simply enjoying a cheap alternative to airline transportation or charter travel. Some advocates who facilitate the sale of fractional shares have recommended that, after owners sign on the dotted line, they should take a hands-off approach and "let the program manager do the managing." While it is never wise to interfere with expert management, frac-owners can no longer, in light of the new rules, be passive investors and business travelers. With the benefits, convenience, economy and flexibility of fractional flying come the burdens of operational control and safety rule compliance. These burdens can be carried by exercising the right — arguably, the duty — of inspecting and auditing the program.

The Right/Duty to Audit Program Management

Ramp CheckTo date, program managers have an enviable record of safety in the aviation industry. The FAA has recognized that many program managers in the fractional ownership field have been conducting their operations according to the industry's "best practices." The new FAA rule imposes joint compliance and operational control responsibility on both program managers and frac-owners. It is incumbent upon frac-owners to ensure that the best practices are being followed.

Before signing the agreements, upon renewal, and on a spot-check basis, owners may wish to inspect and audit the safety aspects of the program. Owners may use technical consultants, if necessary, to audit the operational and airworthiness matters, but the results may be discoverable in litigation. Attorneys with sufficient aviation experience can do such audits and inspections with confidentiality under the attorney-client privilege. Knowledgeable aviation attorneys should also be able to audit the various clauses in the operating contracts (purchase, management, ownership and interchange agreements) under the governing state law. They can also evaluate the critical insurance coverage upon which frac-owners must rely to protect against liability exposure. Notwithstanding large coverage limits in the fleet policies to cover foreseeable accidents, the risks to the frac-owner include the denial of coverage or the application of an exclusion to the occurrence, particularly where regulations may have been violated.

Even if insurance coverage is provided, there are questions of corporate accountability and adverse business consequences to frac-owners which can result from FAA sanctions, liability litigation, disclosure of court records and adverse publicity that may result if a fractional owner is accused of violating safety rules after a major air crash or even a survivable accident.

When fractional owners audit and inspect their programs, they must focus on flight crew qualifications, staffing, drug education, the initial and recurrent training of pilots and maintenance personnel, aircraft scheduling, passenger briefings, record keeping, vendor standards, and a host of other factors. The FAA stipulates that the new rules do not require any undue invasion of the manager's financial records or those records pertaining to the confidential movements of other owners.

Insurance

A frac-owner has exposure any time it is using its own shared aircraft, whenever it is using another aircraft in its program, and even when it is using an aircraft from some other program that is affiliated with the owner's program. That additional insurance is needed to protect against all foreseeable risks for all these flights is even more evident because of the new rule.

Frac-owners should carefully analyze the terms of their operating agreements and verify that their insurance coverage is consistent with the agreements. While a major accident clearly could create substantial liability exposure, a minor accident or incident could result in diminution in value, loss of use, and other damages not covered by insurance. Under many agreements, program managers may use the aircraft for Part 135 charter operations, significantly increasing the utilization, exposure to damage, and ordinary wear and tear. Will the value of the investment be protected?

Management agreements may contain provisions whereby the manager will procure "combined single-limit liability" coverage in amounts up to $200 million. Such insurance may be sufficient to cover air crashes unless there is another catastrophe of the magnitude of September 11. The protection from such coverage limits is reassuring — as long as the insurance carrier actually provides the expected coverage.

A duly diligent frac-owner will audit the specific requirements for insurance coverage by comparison to the use of aircraft by the other frac-owners and the program manager. Even if there is no violation of the FAA regulations, unauthorized usage, invalidating acts or excluded occurrences could result in a denial of coverage.

Some issues that should be examined when evaluating the strength of coverage include:

  • Does the insurance policy obtained by the program manager provide coverage for "war risk, hijacking and other perils [terrorism]?" Is there a force majeure clause in the agreement or insurance policy? Insurers are concerned about their exposure from a catastrophic occurrence like September 11. The wording of any exclusion for such events must be carefully analyzed. It must be clear that the coverage provided is for both "hull" and "liability" and for all aircraft used for frac-owner flights.
  • Most frac-owners have previously relied on the program managers to make sure that the fractional program functioned under the umbrella of the insurance. It is critical that the frac-owner is not deprived of coverage if the program manager is negligent and does something that might invalidate coverage. The management agreement might contain a clause that requires the insurance company to designate the manager as a "first named insured." The insurer should promise that the "named insured" coverage or "additional named insured" coverage for the frac-owners will not be invalidated by the negligence of the first named insured. Further, the program manager or its agents (crews, mechanics, etc.) may impair subrogation rights by signing vendors' hold harmless agreements, thereby voiding the coverage; again, the prudent frac-owner should take steps to prevent this eventuality.
  • Improper use of a fractional program aircraft by one of the frac-owners could result in the denial of coverage by the insurance company. The resulting exposure would be substantial, and the applicable agreements among the owners may be unenforceable due to bankruptcy or other factors. Thus, each frac-owner must insure against breach of the owner agreements to the extent possible, and audit the non-confidential use of program and affiliate aircraft to ensure compliance with the terms of the insurance contract.

Exclusions in Fractional Program Insurance Policies

Fractional HeloCommercial aircraft operators are forbidden by the Department of Transportation to carry less than the minimum required coverage under Federal regulations. Thus, exclusions or warranties providing limitations cannot be implemented for commercial flights without approval by the Department of Transportation. 14 CFR 205. A fractional ownership program is a general aviation operation controlled by Part 91. Federal regulations do not prohibit the use of exclusions in general aviation policies. Exclusions can be invoked to deny coverage (indemnification money) and allow the insurer to avoid its duty to defend (pay for defense lawyers). Depending on the policy, there can be exclusions for not having a valid airworthiness certificate, carrying excessive passengers, intentional misuse of the aircraft, etc. Here are some exclusions to watch out for:

Exclusion — Violations of the FAR

Many policies exclude coverage for certain regulation violations that create enormous risk that the insurance company did not underwrite. If such FAR violations are clear, specific and unambiguous, insurers may deny coverage. Examples may include the failure of any of the pilots to have valid and current medical certificates, or the use of the aircraft outside the specifications required for an airworthiness certificate.

Exclusion — Pilot Warranty Clause

Another exclusion common to aviation insurance policies involves the pilot warranty clause. Pilots are required to have certain certificates, ratings, experience and currency and need to have logged specific types of flight time. Insurers necessarily have strict requirements for the qualifications of the pilots because they are underwriting risks of flight that are largely controlled by pilots. If a pilot has an accident in circumstances in which the pilot was not qualified under the pilot warranty clause, the fractional owners may face a denial of coverage.

Exclusion — Territorial Limits

Policies usually contain limitations or exclusions regarding the geographical limitations on the use of the aircraft. Does the service area in the operating agreements coincide with the territorial limits? Are the program and affiliate aircraft being used outside of insured territorial limits such that an accident in the wrong place will invoke a denial of coverage?

Conflicts of Interest and Dilution Risks

While there may be a sufficient amount of indemnity coverage, the duty to defend each of the various participants can be an insurance issue. Although each party has a right to hire independent counsel, will the insurance company pay for up to16 frac-owners in an airplane crash, or up to 32 frac-owners in a helicopter crash? Insurance companies usually have the contractual right to choose their insured's defense counsel. There may not be a need for separate counsel for each owner in every crash; but if their interests are in conflict or potential conflict, disputes can arise as to the duty of the insurance company to pay for independent counsel for each owner. The program manager and frac-owner using the aircraft will usually have more exposure, as may frac-owners who had the "watch" when the problem began. The larger share owners may not be similarly situated to the smaller share owners. Sometimes program managers are also share owners. Some frac-owners provide their own pilots; others use pilots from the program manager. There may also be issues arising from affiliated program aircraft and pilots.

If a fractional program air crash occurs, the damages are likely to be enormous, especially considering the affluence of the typical passengers. The indemnification costs of multi-defendant, multiple-victim litigation can be staggering. Add in demands for defense counsel for each frac-owner, where a conflict or potential conflict exists, and even the most stalwart insurer will be tempted to have its coverage lawyers weighing its duty to indemnify and duty to defend. Certainly, coverage dollars may be consumed by multiple defenses, and frac-owners would be liable for damages in excess of the coverage limits.

Special Issues in Fractional Ownership After the New Rule

FAA Sanctions Against Owners

Fractional CitationEven though a fractional owner does not hold a license or certificate from the FAA, the new rules allow enforcement actions seeking monetary sanctions against fractional owners.91.1001; 91.1013(1)(iii). Fractional ownership programs are general aviation operations and not commercial aircraft operations.

The FAA's monetary clout against frac-owners is limited; in most cases it is $1,000.00 per violation up to a limit of $50,000.00. Thus, notwithstanding corporate or reputation problems in the event of a sanction by the FAA, the monetary stake is not that great.

The real threat to the fractional owner is that the FAA will take action against the program manager. The FAA can suspend or revoke the program manager's certificates. The FAA can revoke the management specifications for the fractional program. Either action would have the effect of grounding the aircraft in the program. The FAA has promulgated an amendment to Part 13 of the Federal Aviation Regulations, which states that the administrator of the FAA may revoke all or part of the management specifications issued to the program manager under Subpart K of Part 91. If the FAA grounded the program, who would compensate the fractional owners for the loss of use of their aircraft? Arguably, owners would have to charter aircraft at substantial expense and could suffer various consequential damages. Often, management agreements have a limitation of liability clause, disclaiming responsibility for loss of use, etc. It is unlikely that the program manager's insurance would cover such damages?

Non-Aviation Lawsuits

The new FAA rules do not address the employment relationship between the pilots and the program manager or the fractional owners. This is a matter of state contract law. Typically, the program manager employs the pilots, but independent contractors are also used. Frac-owners may also provide their own pilots for their flights. What if a flight crewmember does something other than cause a crash, such as commit a crime or some form of discrimination? Will the program manager be the only defendant? Will the fractional owner, in operational control of its flight, be exposed to liability for the misdeeds the air crew who are arguably the owner's agents on its trip? Will the program manager's insurance policy provide coverage for such an occurrence?

Employment Lawsuits

The escalation of wrongful discharge or discrimination lawsuits has been a plague for many businesses. Normally, the program manager is the employer of the crew and provides crew services for the flight. The new Subpart K rules require that whenever the fractional owner has directed the program manager to carry its passengers, the fractional owner is in operational control. In fact, the FAA has recognized in its Notice of Proposed Rule Making that a fractional owners "can initiate, conduct, redirect and terminate a flight." In order to do any of these things, a fractional owner must necessarily be able to direct the pilot to initiate, conduct, redirect or terminate a flight. If the frac-owner is dissatisfied with the crew on its flight can the frac-owner cause them to be terminated?

If the fractional owner has such power, does he have the "right to control" the crew sufficiently to be adjudicated an "employer" under the liberal employee protection laws of some states? In many jurisdictions, the employer is determined by the "right to control," not necessarily the party who issues the paycheck and W-2 form. There are some management agreements that contain pilot-selection clauses purporting to give the owner the right to select the pilots for his flights — a potential minefield for employer liability. We doubt that this issue has been tested in the courts because the control imposed on frac-owners by the FAA is unique. If a frac-owner in operational control gets sued for wrongful discharge or discrimination from an occurrence on a frac-owner's flight, will the program manager's insurance cover the lawsuit?

Drug Testing

The FAA proclaims that the new Subpart K embodies the "best practices" in the industry. Yet the FAA does not require random drug testing for fractional programs. Drug testing is required for Part 135 and Part 121 operations. The new rule only requires that program managers provide drug education. The owner is entitled to disclosure as to the nature of the education, be it of the "just say no" variety or better. The FAA allows drug testing in fractional programs and some programs use it. If the "best practices" are to be employed, then perhaps proper random drug testing should be the standard of care for all programs, even if not required by the FAA.

Conclusion

There may be something inherently illogical about imposing operational control responsibilities on time-share owners who do not have aviation expertise. Program rules designed to impose aviation duties on parties who are not in a position to really do anything to improve aviation safety may give rise to unintended consequences. However, from a business perspective, frac-ownership may be an efficient way to own a piece of a business' air travel requirements and may be good for some. Others may be better off with co-ownership arrangements under Part 91.501 et seq. Traditional corporate flight departments may be the answer for some high-volume users; the use of management companies with aviation expertise may suffice for others. Some businesspersons may prefer to simply pay a charter operator and take a trip without the burdens of ownership and now, FAA regulation. In any case, careful, professional evaluation of the options and their attendant benefits and risks is essential.

NOTE: The issues discussed in this article do not constitute legal advice. My objective is to alert you to some common issues so that you can avoid or minimize legal trouble. Anyone with an aviation law problem should be guided by the advice of his or her lawyer, under applicable federal and state laws, after a full and confidential disclosure of all relevant facts.