document

Citation: 64 J. Air L. & Com. 901 1998-1999

Content downloaded/printed from HeinOnline (http://heinonline.org)Thu Jun 5 16:23:53 2014

-- Your use of this HeinOnline PDF indicates your acceptance of HeinOnline's Terms and Conditions of the license agreement available at http://heinonline.org/HOL/License

-- The search text of this PDF is generated from uncorrected OCR text.

-- To obtain permission to use this article beyond the scope of your HeinOnline license, please use:

https://www.copyright.com/ccc/basicSearch.do? &operation=go&searchType=0 &lastSearch=simple&all=on&titleOrStdNo=0021-8642

CHOOSING HOW SAFE IS ENOUGH

TWA Flight 800."7 These recommendations are now being im-plemented by the FAA nationwide.48

B. CONSTITUTIONAL AND GENERAL IMPLICATIONS OF THE GORECOMMISSION RECOMMENDATIONS

Attacks on the Gore Commission's recommendations havecome from several fronts.49 One such front includes scholarsconcerned about constitutional problems associated with theuse of state-of-the-art bomb-screening technology."° Invasion ofprivacy issues have surfaced because some of the bomb-screen-ers enable the operator to see through a person's clothing to hisor her naked body.51

The Gore Commission's recommended use of passenger pro-filing5 2 perhaps gives rise to the most heated constitutional de-bate stemming from the Commission's final report.5" Otherprivacy interests could be violated through passenger profiling,such as the right not to have a criminal record exposed tonongovernment aviation personnel. 4 Moreover, the use ofprofiles can potentially single out an individual in a discrimina-tory manner; for example, a profile would be discriminatory if itunfoundedly singled out Arab or Muslim Americans as a group

47 See id. at 3. The report stated:In the wake of concerns over the crash of Trans World AirlinesFlight 800, President Clinton asked the Commission to focus its at-tention first on the issue of security. He asked for an initial re-port . . . including an action plan to deploy new high-technologymachines to detect the most sophisticated explosives.

Id.48 See Klein, supra note 45, at 7.49 SeeJames A. Hooper, ACLU May Challenge Passenger Profiles, FLA. TODAY, Mar.

9, 1997, at 10A; Nelms, supra note 14 at 30; Donna Rosato, U.S. Airlines to StartProfiling, Bag Matching, USA TODAY, July 10, 1997, at 1A.

50 See Strossen, supra note 1, at 1-2. Strossen states that the remote chance of aterrorist attack supports her argument. See id. at 2. She points out that, "thechance that any passenger will die en route for any reason is only 1 in 8 million,making flying 100 times safer than driving." Id.

51 See Nelms, supra note 14, at 30. See infra Part III.B.1. for further discussionof bomb-screening equipment and its privacy implications.

52 See Ross, supra note 18, at 5; Nelms, supra note 14, at 34.53 See Tiffany Danitz, Snooping on Passengers Under FAA's Watchful Eye, INSIGHT

MAG., Mar. 31, 1997, available in 1997 WL 9711043. But see Gore Commission Propos-als Are A Mixed Bag, AVIATION WK. & SPACE TECH., Feb. 24, 1997, at 82 (arguingthat the Gore Commission offered many guidelines to ensure that civil libertiesare not violated).

54 See Ross, supra note 18, at 5.

1999]

JOURNAL OF AIR LAW AND COMMERCE

more likely to pose a terrorist threat.55 Like passenger profilingcriticisms from civil libertarians, the Gore Commission's sug-gested use of passenger-bag matching technology has also beencriticized by airport and airline officials as impractical and likelyto cause significant delays in the aviation infrastructure.56

1. Bomb-Screening Equipment

Gore Commission Recommendation 3.15 urges that state-of-the-art bomb-screening technology be employed to minimizepotential terrorist threats.57 The recommendation states that"[n]ew developments such as computerized systems with highresolution digital displays, innovative use of color to highlightthreat objects, and ability to accommodate technologies such asthreat image projection to maintain screener performance, canprovide enhanced security. 5

18

Unlike the constitutional issues raised in passenger profiling,the civil liberties concerns involving the use of heightenedbomb-screening technology were not addressed by the GoreCommission. 5 Some experts have described the new state-of-the-art bomb-screening equipment proposed in the Gore Com-mission as subjecting individuals to a "virtual strip search," thusraising potential invasion of privacy issues. 60 The Gore Commis-sion's final report has been criticized by those who believe thereis absolutely no limit on the type of bomb-screening equipmentthat may be used.61 One such device is manufactured by Ameri-

55 See Donna Abu-Nasr, Arab and Muslim Americans Say Profiling DiscriminatesAgainst Them, ASSOCIATED PRESS, July 17, 1997, available in 1997 WL 4875401. Seeinfra Part III.B.2. for further discussion of passenger profiling and its privacy andcivil liberties implications.

56 See Nelms, supra note 14, at 33.57 GORE COMMISSION, supra note 13, at 17.58 Id.5) See id. at 17, 19.60 Strossen, supra note 1, at 2. Strossen argues:

As a frequent flyer and civil libertarian, I already suffer embarrass-ment and outrage when an airport security official scrutinizes-infull view of other passengers-the TV monitor with the projectedimage of the contents of my carry-on baggage. I can hardly imag-ine enduring a comparable scrutiny of the projected image of mybody. And my concerns are heightened by a [feature on onebomb-screening device] of which its producers are particularlyproud: a joystick-driven ZOOM option, which allows the operatorto enlarge selected portions of the image. I am a privacy buff.Therefore I do not want to travel-in effect-in the buff.

Id. at 2.61 See id. at 1-2.

902


can Science and Engineering Company and is actually in use atone foreign airport.62 The machine can produce images of anindividual's private bodily areas, as well as reveal private condi-tions, ranging from mastectomies to catheter tubes. 3 Use ofthis type of bomb-screening technology could expose airportsand airlines to invasion of privacy litigation and might pose sig-nificant public relations problems for them as well.64

2. Passenger Profiling System

Gore Commission Recommendation 3.19 suggests that pas-senger profiling systems be used to identify potential terrorists.65

The Commission recommended three steps be implemented

[t]o improve and promote passenger profiling[:] First, FBI, CIA,and BATF [Bureau of Alcohol, Tobacco, and Firearms] shouldevaluate and expand the research into known terrorists, hijack-ers, and bombers needed to develop the best possible profilingsystem. They should keep in mind that such a profile would bemost useful to the airlines if it could be matched against auto-mated passenger information which the airlines maintain. Sec-ond, the FBI and CIA should develop a system that would allowimportant intelligence information on known or suspected ter-rorists to be used in passenger profiling without compromisingthe integrity of the intelligence or its sources. Third, the Com-mission will establish an advisory board on civil liberties ques-tions that arise from the development and use of profilingsystems.

66

Perhaps the greatest drawbacks regarding passenger profilingare the civil liberties and discrimination issues the Gore Com-mission clearly recognized.67 Despite this governmental recog-

62 See id. ("American Science and Engineering Company is now promoting its

'BodySearch' Contraband Detection System, which can reveal such personallyprivate areas and information as breasts and penises, and their relativedimensions.").

63 See id.64 See Nelms, supra note 14, at 30.65 GORE COMMISSION, supra note 13, at 18.66 Id. at 19.67 See Profile System Still Being Developed, but Limits Urged, ASSOCIATED PREss, Feb.

12, 1997, available in 1997 WL 4856039; Stephen Franklin, Fitting the Terrorist Pro-file: Which One Would You Stop and Search?, CHI. TRIB., Apr. 13, 1997, at 1. TheCommission, by ensuring Department of Justice monitoring of passenger profil-ing, "clearly recognized" the potential that a profiling system could have the ef-fect of selecting individuals based on national origin, racial, ethnic, religious, orgender characteristics. See GORE COMMISSION, supra note 13, at 19. Moreover, bystating that "[s]earches arising from the use of an automated profiling system

1999] 903

904 JOURNAL OF AIR LAW AND COMMERCE

nition, a prototype of the profiling system, known as theComputer-Assisted Passenger Screening (CAPS) program, wasdeveloped by Northwest Airlines with a grant from the FAA.68

On December 31, 1997, the FAA officially offered CAPS to allmajor airlines with hopes that the airlines would eventually vol-untarily adopt the system.6 9 Little is known about the specificcriteria CAPS draws upon in its profiling analysis because theinformation contained in the profile is largely confidential toprevent circumvention by terrorists; however, critics claim theprofiles will contain information regarding "each passenger'stravel history, identification information, whether the ticket waspurchased with cash or credit and with whom the passenger istraveling. '70 The Gore Commission has called such screening"positive profiling," as it seeks out those who meet beneficial cri-teria in order to single out the terrorist.7 1

The Gore Commission's Final Report provides that "[n] o pro-file should contain or be based on material of a constitutionallysuspect nature-e.g., race, religion, national origin of U.S. citi-zens."7 2 However, profiling systems have come under heavy crit-icism by Arab and Muslim Americans, who claim that passenger

should be no more intrusive than search procedures that could be applied to allpassengers," the Gore Commission must have known that privacy issues could beraised. Id.

68 See Michael Higgins, Looking the Part: With Criminal Profiles Being Used More

Widely to Spot Possible Terrorists and Drug Couriers, Claims of Bias Also on the Rise, 83A.B.A. J. 48, 52 (1997)

69 See id. While airline adoption of CAPS might not occur immediately, the Air

Transport Association (ATA), a representative organization for the major air-lines, defends CAPS as an important security component. See id.

70 Danitz, supra note 55, at 22.71 Id. It is difficult to view the Gore Commission's asserted "positive profiling"

as anything but a wolf in sheep's clothing. I argue that singling out the potentialterrorist by removing those with beneficial criteria from suspect consideration istantamount to "negative profiling." In other words, a person will likely be cho-sen as suspect due to some "negative" quality in his or her profile. See, e.g., Hig-gins, supra note 70, at 52.

72 GORE COMMISSION, supra note 13, at 19. The report further states:Factors to be considered for elements of the profile should bebased on measurable, verifiable data indicating that the factors cho-sen are reasonable predictors of risk, not stereotypes or generaliza-tions. A relationship must be demonstrated between the factorschosen and the risk of illegal activity .... Procedures for searchingthe person or luggage of, or for questioning, a person who is se-lected by the automated profiling system should be premised oninsuring respectful, non-stigmatizing, and efficient treatment of allpassengers.


profiling discriminates against them by unfairly targeting themfor increased security scrutiny."v The American-Arab Anti-Dis-crimination Committee and the Council on American-IslamicRelations declared in separate statements that the profiling sys-tem "has turned the Arab community into scapegoats."74

Houeida Saad, Director of the American-Arab Anti-Discrimina-tion Committee, claims her organization has received confiden-tial documents from security manuals of various airlines,containing discriminatory questions: "Are there stamps fromArab countries in the passport?," "Does your customer have apassport from a Middle East or Arab country?," and "Does yourcustomer have an Arab sounding name and were they born inthe Middle East or in an Arab country?"75 Such questions, civillibertarians believe, reflect stereotypes that tend to single outindividuals who pose no real threat.76 According to the DOT,no airline has been fined for discriminating in its screening ofpassengers. 77 However, the DOT's Aviation Consumer Protec-tion Division (ACPD) only began tracking complaints of biasedpassenger searches in early 1997.78 Since that time, the ACPDhas fielded forty-six complaints.79

Lawsuits are beginning to be filed around the country by Araband Muslim Americans who claim their constitutional rightswere infringed upon due to these profiling systems. s0 For exam-ple, Hassan and Julia Abbass, Cleveland, Ohio physicians, havefiled a four million dollar civil rights suit against U.S. Airways,Inc. (USAir), claiming the airline wrongfully isolated them forterrorist scrutiny because Hassan Abbass, a U.S. citizen born inSyria, is an Arab-American."1 On May 24, 1997, USAir officialssingled out the Abbasses from approximately 200 St. Martin-bound passengers for special scrutiny.8 2 The Abbasses claim the

73 See Abu-Nasr, supra note 57, at 7.74 Id.75 Id.76 See Strossen, supra note 1, at 1. CAPS is partially intended as a solution to

these types of discriminatory questions because it only allows airline computers,not airline officials, to evaluate passenger data. See Higgins, supra note 69, at 52.FAA spokeswoman Rebecca Trexler stated, "'With this new system, [ticket agents]would just look at their screen and see a red or a green-a stop or a go .... Sothat automates the whole process. It takes the human element out."' Id.

77 See Higgins, supra note 70, at 52.78 See id.79 See id.80 See Abu-Nasr, supra note 57, at 7.81 See Higgins, supra note 70, at 48.82 See id.

1999] 905


airline staff escorted them through metal detectors, searchedtheir luggage, and tagged their bags with fluorescent labels read-ing, "Positive I.D." 3 While the Abbasses did pass inspection,they assert the other passengers looked at them cautiously; infact, some passengers rearranged their seating on the airplaneto avoid sitting next to the Abbasses.84 According to thecouple's attorney, USAir officials, when asked by Hassan Abbasswhy the inspection was occurring, told him, "'Well, there arethese guidelines and you meet the guidelines."'8 5

3. Passenger-Bag Matching System

A security system related to the passenger profiling system in-volves matching passengers with their bags to deter would-beterrorists from purchasing an airline ticket only to check a pieceof luggage containing a bomb.8 6 The Gore Commission's Rec-ommendation 3.24 states that "[n] o unaccompanied bag shouldbe transported on a passenger aircraft unless (1) it has beenscreened by a screening method that meets the FAA standard,or (2) it belongs to a passenger who at the time of check in wasneither randomly selected for security review nor selected by theprofile for further review. '8 7 Passenger-bag matching becamestandard procedure for international flights after the explosionof Pan Am Flight 103 over Lockerbie, Scotland-an explosioncaused by a plastic explosive device contained in a bag checkedwithout the passenger actually boarding the plane.88

The new passenger-bag match procedures have come underattack by two leading aviation lobbying groups, the Air Trans-port Association (ATA) and Airport Council International-North America (ACI-NA)."' While the groups claim that bagmatching is generally a good idea, they also state that requiringfull bag-matching without procedures and equipment in placewould effectively shut down the aviation system.9"

83 Id.84 See id.85 Id.

86 See James Ott, Profiling to Boost Security, But Funding Still an Issue, AVIATIONWK. & SPACE TECH., April 28, 1997, at 42.

87 GORE COMMISSION, supra note 13, at 22.88 See id.89 See Nelms, supra note 14, at 33. The ATA is a lobbying group for commercial

airlines, while the ACI-NA lobbies for airports in North America.90 See id.; See infra Part III.C.2. for a discussion of flight delays associated with

passenger-bag matching. The ATA and ACI-NA effectively argue that any delay

906


C. COST IMPLICATIONS OF THE GORE COMMISSION

RECOMMENDATIONS

1. Cost in Dollars

Gore Commission Recommendation 3.1 advises that approxi-mately one hundred million dollars be devoted annually to en-sure adequate aviation safety and hinted that more might beneeded.9 Among the funding options discussed by the GoreCommission is a provision recommending an "aviation user se-curity surcharge," which would impose a security tax on eachairline passenger.9 2 This security tax would coexist with otherfederal funding obtained from other sources.93

The Gore Commission's recommendations raise serious ques-tions regarding the availability of funding to carry out theplan.94 While the Gore Commission recommendations put themajority of the burden of payment for the system on the federalgovernment, the feeling in Washington is that airports and air-lines will have to pay a major portion of the bill.95 This feeling issupported by Anthony Broderick, the former chief of safety atthe FAA, who testified before the Senate Aviation Subcommit-tee, addressing the Gore Commission's Recommendations.9"Broderick testified that the FAA does not have adequate re-sources to bring aviation security into the future.9" An airlineconsultant, addressing the cost issues to air carriers of the GoreCommission's recommendations, stated:

Inaccurate comments combined with knee-jerk action for thesake of action, resulting in the grounding and possible demise ofan air carrier, and quick fix procedures without consideration ofbenefit relative to cost, is detrimental and expensive .... Theloss of any air carrier under these circumstances is unacceptable.

resulting from passenger-bag matching compliance will hinder the profitability oftheir constituents, the airlines, and North American airports.

91 GORE COMMISSION, supra note 13, at 14.

92 Id.

93 See id.94 See Ott, supra note 88, at 42.95 See Nelms, supra note 14, at 29; see also Asra Q. Nomani & Andy Pasztor, White

House Backs Plan for Air Safety, but Calls for no Big Increases for FAA, WALL ST.J., Feb.13, 1997, at A20.

96 See FAA Funding Inadequate to Meet Requirements, Experts Say, AIR SAFETY WK.,

Mar. 10, 1997, at 1.97 See id.

1999] 907


The possible utilisation [sic] of $1.1 billion tax dollars on a onein 8 million probability of incidence is at best questionable. 9

The ATA has held the position that, since it is the country thatis targeted in a terrorist attack, the country should be preparedto pay to defend itself.99 ATA spokesperson David Fuscus statedthat "[w]e've long claimed that attacks on U.S. airlines are at-tacks against the government, made for political reasons. Theairline is just a surrogate."'00

2. Cost in Delays

Time and flight delays are inevitable drawbacks to the newGore Commission recommendations. 10 1 Even though the bur-den is likely to be significant due to security delays associatedwith the new recommendations, this cost has not been explicitlyconsidered in any of the proposals endorsed by the Gore Com-mission.10 2 The burden of increased delays is evidenced by sig-nificant flight delays in countries that have rigorous aviationsecurity procedures in place. 10 3 For example, while Israel hasthe most advanced security system in the world, passengers trav-eling in Israel often spend three hours in the airport gettingtheir baggage and themselves inspected.10 4 A large number ofcomplaints have originated from the airlines, which complainthat passenger-bag matching will significantly delay boardingprocedures and therefore cause flight delays.10 5 David Fuscus,spokesperson for the ATA, stated that, during peak times at Chi-cago's O'Hare International Airport, twenty planes dock everyfifteen minutes. 06 Thousands of passengers rush to connectingflights that leave, on the average, twenty-five minutes later.0 7

Tracking every bag, instead of containers of bags, Fuscus says,would be "impossible."'0 According to a recent FAA study, de-

98 Knibb & Walker, supra note 46, at 40. (quoting Stephen McArdle, an airlineconsultant employed by AvSolutions in Virginia, who believes that the Gore Com-mission recommendations could force some airlines into bankruptcy courts).99 See Nelms, supra note 14, at 33.100 Id.

10, See Hahn, supra note 20, at 17.102 See id.103 See id. at 16-17.104 See id at 16.105 See Mark Fischetti, Defusing Airline Terrorism, TECH. REv., Apr. 1997, at 38,

43; see also Gore Commission Proposals Are A Mixed Bag, supra note 55, at 82.106 See Fischetti, supra note 107, at 43.107 See id.108 Id.

908


lays incurred from bag matching might cost the airlines morethan two billion dollars a year in lost revenues. 10 9 Some com-mentators, however, believe the cost will be even more than twobillion dollars annually. 1 °

3. Cost in Lives

Some authorities have stated the Gore Commission's recom-mendations could cost the lives of several Americans."' As air-line ticket prices rise, which the Gore Commission concedes islikely to occur as a result of its recommendations, the number ofpersons traveling by air will correspondingly drop. 1 2 Those per-sons displaced by the high cost of air travel usually travel by au-tomobile; because the fatality rate is significantly higher onAmerican highways than in American airspace, the Gore Com-mission could indirectly cause more deaths than would haveotherwise occurred but for its recommendations."' For exam-ple, one recent study has hypothesized the effects of delayscaused by passenger-bag matching on the driving public.' 14 Thestudy conducted by Robert W. Hahn theorized that a one-hourairline delay increase could lead to more than one hundred ad-ditional road fatalities per year as annoyed and time-pressed fly-ers drive instead of fly. 11 5

4. Cost in Wasted Effort

The extravagant cost of the implementation and the delaysthat will inevitably be caused by the Gore Commission's recom-mendations have caused some commentators to ask how safe issafe enough. 6 An argument exists that air travel will always in-

109 See id.110 See Hahn, supra note 20, at 17. Hahn states that "[t]hese delay-cost esti-

mates do not include the costs of hiring and training additional personnel, oracquiring, installing, operating, and maintaining new equipment to comply withthe new mandates." Id.M See Nelms, supra note 14, at 34; Hahn, supra note 20, at 17-18.112 See Nelms, supra note 14, at 34.113 See id. "The higher fatality rate of automobile travel will consequently lead

to an increase in overall fatalities." Hahn, supra note 20, at 18.114 See Robert W. Hahn, Security Measures: A Cure Worse Than the Disease?, AVIA-

TION WK. & SPACE TECH., Feb. 3, 1997, at 74.115 See id. "This increase in road fatalities is likely to greatly exceed the number

of lives saved by instituting antiterrorist measures, thus resulting in a net increasein overall fatalities." Id.

116 See Hahn, supra note 20, at 15; see also, Alexandra Marks, Air Safety: How

Much Is Enough?, CHRISTIAN SCI. MONITOR, Dec. 1, 1997, at 1; Knibb & Walker,supra note 46, at 40.

1999] 909


volve risks, and unless we ban air travel altogether, the risks willbe ever present." 17 In fact, some research tends to indicate thatair travel is safer than ever, despite heavy media coverage of air-line disasters like TWA Flight 800.118 The Gore Commissioneven recognizes the excellent safety record maintained by theaviation industry:

Commercial aviation is the safest mode of transportation. Thatrecord has been established not just through government regula-tion, but through the work of everyone involved in aviation-manufacturers, airlines, airport operators, and a highly-skilledand dedicated workforce. Their combined efforts have pro-duced a fatal accident rate of 0.3 per million departures in theUnited States.119

Despite this assimilation, the Gore Commission seems to indi-cate, by using language such as "[c] ost alone should not becomedispositive in deciding aviation safety and security rulemakingissues,"'120 that a cost-benefit analysis is immaterial in settingforth aviation safety and security standards. 12' The cost to thepassenger, however, might be determinative of whether that pas-senger flies at all. 122 According to ATA figures, for every onepercent increase in airline ticket prices, passenger traffic dropsby one percent.1 23

IV. CONCLUSION

The choice between freedom or fear is contextual in our dailylives. For the general public outside of the aviation setting, per-haps antiterrorist regulation is appropriate to answer the fearscaused by the recent waive of domestic terrorism. The bomb-ings of the World Trade Center and the Alfred P. Murrah Fed-eral Building in Oklahoma City raised this fear, and the AEDPA

117 See Hahn, supra note 20, at 15.118 See id.119 GORE COMMISSION, supra note 13, at 5.120 Id. at 8.121 See Hahn, supra note 20, at 15-16. Cost-benefit analyses, while never popu-

lar, must be studied for the public good. See generally id. at 15 (stating that "[o]neof the most disturbing aspects of the [Gore Commission's] report is the lack of aserious discussion of the costs and benefits of the recommendations"). If thegeneral public outside of the aviation infrastructure is more susceptible to a ter-rorist attack, as I argue, our resources should be directed at preventing such anattack. Similarly, if the greatest danger arising from air travel relates to mechani-cal failure, then more funds should be directed towards minimizing that risk.

122 See Nelms, supra note 14, at 34.123 See id.

910


attempts to address it. While arguments exist as to the unconsti-tutionality of the law, the legislation was likely appropriate.Considering the vulnerability of the general public to a terroristattack, choosing to regulate, over choosing fear, seems to be themore apropos solution.

The choice of fear over freedom, however, is unacceptable inthe mostly secure aviation infrastructure. Air travel was the saf-est form of transportation before July 17, 1996, when 230 pas-sengers on TWA Flight 800 perished over Long Island. Nothinghas changed. Air travel continues to be, and always will be, thesafest form of transportation. The death of 230 individuals gavebirth to antiterrorist governmental activity, embodied in theGore Commission, which has done absolutely nothing to com-bat the real cause of those deaths: mechanical failure. The GoreCommission's irrational goal was to make the safest mode oftravel even safer, despite the many costs involved.

At some point, Americans must answer the question: "Howsafe is enough?" As a society, we have an integral choice tomake. We can choose to succumb to fear and live in a countrywhere we are treated as prisoners when we choose to fly. Con-versely, we can choose to enjoy our freedoms when we travel byair. We can be free to maintain our dignity, self-respect, andprivacy by not being subjected to a "virtual strip search" by state-of-the-art bomb-screening equipment. We can be free to not besingled out and embarrassed by our government personnel andgovernment-empowered personnel by not falling victim to a dis-criminatory passenger profile. Moreover, we can be free to nothave our precious personal and governmental resources allo-cated to an already adequate system by rejecting the costly GoreCommission proposals. The choice is ours to make. The choiceis clear.

19991

912 JOURNAL OF AIR LAW AND COMMERCE [64

CONSOLIDATION OF THE AEROSPACE AND DEFENSEINDUSTRIES: THE EFFECT OF THE BIG THREE

MERGERS IN THE UNITED STATES DEFENSE INDUSTRY

Amy J. BOATNER

TABLE OF CONTENTS

I. INTRODUCTION .................................. 914II. MERGER AND ACQUISITION ACTIVITY IN THE

UNITED STATES ................................. 915III. THE DEFENSE INDUSTRY'S RECENT HISTORY. 918IV. THE BIG THREE MERGERS IN THE UNITED

STATES ............................................ 920A. BOEING-MCDONNELL DOUGLAS ................. 920B. RAYrHEON-HUGHES ............................. 922C. LOCKHEED MARTIN ............................. 923

1. The Proposed Lockheed Martin-NorthropGrumman Merger ............................ 924

2. The Result of the Failed Merger ............... 925a. The Future of Lockheed Martin ....... 925b. The Future of Northrop Grumman ... 925

V. THE FIGHT FOR THE LARGEST DEFENSECONTRACT IN HISTORY ......................... 927

VI. THE STRUGGLE TO CONSOLIDATEAEROSPACE AND DEFENSE INDUSTRIES INTHE EUROPEAN UNION ......................... 928A. HISTORY OF THE EUROPEAN INDUSTRIES ......... 928B. RECENT DEVELOPMENTS, REMAINING HURDLES

AND THE OVERALL GOAL FOR EUROPE'S NEAR

FUTURE ......................................... 929VII. THE MERGERS OF SECOND AND THIRD TIER

COMPANIES AND DIVISIONS .................... 935VIII. OTHER GLOBAL EFFECTS ....................... 936

A . A SIA ............................................ 936B . RUSSIA .......................................... 936C . ISRAEL .......................................... 936D . C HINA .......................................... 937

913


E. Tm WAN ......................................... 937F. AUSTRAL A ...................................... 939G . TU RKEY ......................................... 940

IX. CONCLUSION ..................................... 940

I. INTRODUCTION

D URING THE past five years, the United States defense andcommercial aerospace industries have experienced an un-

precedented wave of mergers and acquisitions. More than twodozen major firms have merged into three giants: Boeing-Mc-Donnell Douglas, Lockheed Martin, and Raytheon-Hughes.'

Boeing's recent $14 billion merger with McDonnell Douglasand $3.1 billion merger with Rockwell International's aerospaceand defense unit resulted in a company with $48 billion in an-nual sales and an estimated 225,000 employees. 2 Moreover, Ray-theon is in the process of a $2.95 billion merger with TexasInstruments and a $9 billion merger with Hughes Aircraft; theproduct of the merger will be a company with annual revenuesof $17 billion.' Additionally, Lockheed Martin recently pro-posed an $11.2 billion merger with Northrop Grumman, wherethe result would have been a company with $37 billion in annualsales and 230,000 employees.4 Although the merger was neverrealized, Lockheed Martin remains the number two company inthe United States, with annual sales of $28 billion. 5 The specif-ics of the failed merger are discussed infra Part II.

Although Boeing-McDonnell Douglas (worth $48 billion inannual sales), Lockheed Martin ($28 billion annual sales), and

I See Vago Muradian, Battle for UDLP Proves that Consolidation Trend is Continu-ing, DEF. DAILY, Aug. 15, 1997, available in LEXIS, Legis Library, Dfdly File.

2 See Andy Patrizio, Mergers Pose IT Challenge, INFO. WEEK, Sept. 22, 1997, at 105,available in 1997 WL 14148022; Carol Haber, Defense Fireworks Light 4th, ELEC.

NEWS (1991),July 7, 1997, at 1.3See Kevin O'Toole, Aerospace Top 100: Only the Beginning, FLIGHT INT'L, Aug.

20, 1997, available in LEXIS, Market Library, Prompt File; Bruce Balestier, Billion-Dollar DeaLs; Consolidation, Strategic Planning Drive Activity, N.Y. L.J., Aug. 14, 1997,

at 5. At the time of publication, consolidation and streamlining of the two com-panies were under way.

' See Andy Dworkin, Lockheed Martin to Buy Northrop Crumman, DAL[AS MORNING

NEWS, July 4, 1997, at IA, 34A. Some sources report that the value of the mergerwould have been as low as $8.3 billion. See Teddie Weyr, Lockheed TerminatesNorthrop Merger, A.P. ONLINE, July 16, 1998, available in 1998 WL 6696370. Othersources report the merger price was $10.7 billion. See Shareholder's Suit AllegesNorthrop Inflated Stock Price, OPANGE COUNlY REG.,July 25, 1998, at C2, available in1998 WL 2639760 [hereinafter Shareholder's Suit].

5 See Weyr, supra note 4.

914

AEROSPACE & DEFENSE INDUSTRIES

Raytheon ($17 billion annual sales) are the top three defenseindustry competitors, it is worth noting that Boeing and Lock-heed are significantly larger than the nearest competitor, Ray-theon.6 The consolidation of the top American aerospace anddefense companies "carried out under the watchful eye of thePentagon, appears to be largely complete. The endgame ...has[, however,] left only two fully capable platform manufactur-ers in Boeing and Lockheed Martin. 7

But why has the aerospace industry declined from almost fiftyindependent competitors in 1985 to only three in 1999?8 Whathas driven the merger wave, and what will be the competitiveeffect of such consolidation?

Part II of this article discusses recent merger and acquisitionactivities in the United States. Part III is a historical overview ofdemands within the defense industry leading up to the heavymerger and acquisition activity. Part IV discusses the Big ThreeMergers, while Part V examines the fight between the Big Threefor the largest defense contract in history. Part VI and VII high-light the international and local effects of the Big Three Merg-ers. Specifically, they discuss the mergers' effects on theEuropean market and on all second and third-tier companies,respectively. Part VIII is a brief analysis of other global marketsin the wake of the U.S. mergers.

II. MERGER AND ACQUISITION ACTIVITY IN THEUNITED STATES

In recent years, mergers and acquisitions have taken a leadingrole in many corporate business strategies.9 Companies, adher-ing to the philosophies of world-wide competition and eco-nomic efficiency, are spinning off unnecessary divisions andacquiring divisions that support their overall business plans.' 0

To illustrate, in 1995 the total value of mergers in the UnitedStates involving U.S. companies was roughly $458 billion,1" but

6 See O'Toole, supra note 3.7 Id.8 See Hearing on Defense Mergers Antitrust Implications Before the Subcomm. on Anti-

trust, Bus. Rights & Competition of the Senate Judiciay Comm., 105th Cong. (1997)(statement of Mike Dewine, Senator from Ohio).9 See DennisJ. Block et al., Current Trends in the Market for Corporate Control, 972

PLI/CORP 7, 11 (1997).10 See id.

H See id.

1999] 915


in 1994, mergers only totaled $347.1 billion, which is a stagger-ing $110.9 billion increase in just one year. 12

Globally speaking, the value of corporate mergers in 1994 wasat an all time high of $572 billion.13 This record was crushed in1995 when corporate mergers increased fifty-one percent andtotaled roughly $866 billion.14 Moreover, in 1996, corporationsannounced deals totaling an even more impressive $1.14 tril-lion.' 5 The telecommunications and defense industries and themega-mergers occurring within them helped push the total tothis astonishing amount.

Acquisitions made overseas by U.S. companies rose substan-tially from $31.4 billion in 1994 to $53 billion in 1995.16 Addi-tionally, foreign purchases of American companies increasedfrom $44 billion in 1994 to $50.2 billion in 1995.17

In fact, there were 10,300 domestic deals officially announcedin 1996, which makes it the most active year in merger and ac-quisition history. Coupled with a strong market and perceivedlow inflation, the merger and acquisition activity hit records -

surpassing the 1995 record of only 9030 deals worth $522billion.19

Factors influencing those "trends in the market for corporatecontrol" included "(i) the strength of the national economy; (ii)the level of the stock market; (iii) the availability of acquisitionfinancing; and (iv) legislation and agency action that has or willlead to deregulation in certain industries."2

Because the aforementioned factors sparked the drive for cor-porate control, two characteristics are particularly apparent intoday's market.

First, there "is a substantial increase in the number and valueof strategic transactions," which is "where a company acquires ormerges with another ... or divests itself of a subsidiary ... inorder to further long-term strategic purposes."21 The pur-

12 See id.13 See id.14 See id.15 See Louis S. Freeman, General Overview and Strategies in Representing Sellers, 403

PLI/TAx 7, 15 (1997).16 See Block, supra note 9, at 12.17 See id.18 See Freeman, supra note 15, at 15.19 See id. at 15-16.20 See Block, supra note 9, at 12.21 Id.

916


chaser, in these transactions, sees the target as a business whose"operations would strategically supplement or complement [its]existing operations. '2 2 Therefore, the company to be acquiredis either in the same industry as the purchaser or "is in a busi-ness that would allow the acquirer to integrate vertically with thetarget and gain long-term benefits. ' 23 A strategic divestment, onthe other hand, occurs when a corporation gets rid of a subsidi-ary or the like that does not supplement or complement itslong-term goals or business philosophies.24

Second, the number of financial transactions continues to besmall. A financial acquisition results when an investor acquiresan undervalued company in order to use the company's cashreserves or assets. 25 In a financial acquisition, the target and itspurchaser may not even be in the same industry, much less ben-efit each other.26

In the market for corporate control, there is a trend towardlong-term strategic transactions and away from mere financialacquisitions.2 1 Strategic deals are usually negotiated transac-tions, and they take longer to close and have a higher rate offailure than the pure financial transaction. 28

Aside from the increase in strategic transactions, there is anincrease in the number of "mega-size" deals.29 There were sev-enty-five merger and acquisitions (M&A) in 1995 that individu-ally totaled $1 billion or more, and they collectively totaled$199.1 billion.3" These seventy-five M&A deals were 51.3% ofthe total value of deals throughout 1995.31 Only forty-seven"mega-size" deals valuing $135.4 billion occurred in 1994.2

Interestingly, it is the nation's two hundred largest industrialcorporations that led the wave of mega-mergers. 33 "They notonly have bought 'small' and 'medium-sized' corporations, but

22 Id.23 Id.24 See id.25 See id. at 12-1326 See id. at 13.27 See id.28 See id.29 See id. at 36.30 See id.!1 See id.32 See id.33 See Walter Adams &James W. Brock, The 'New Learning' and the Euthanasia of

Antitrust, 74 CAL. L. REv. 1515, 1541 (1986).

9171999]


- increasingly- they have merged with one another. '34 Merg-ers of this magnitude are occurring in the aerospace and de-fense industries and are having a tremendous world-wideimpact.

III. THE DEFENSE INDUSTRY'S RECENT HISTORY

After the Cold War, defense budgets and expenditures formilitary procurement diminished, which ultimately caused a de-crease in the number of weapons programs.15 The total U.S.defense budget declined 35.4% from $390 billion (in FY-97 dol-lars) in 1985 to $252 billion in 1997.36 More importantly, how-ever, it is the procurement budget that suffered from thesemassive cuts. It has fallen sixty-five percent from $125 billion (inFY-97 dollars) in 1985 to about $44 billion in 1997. 37 "A declinein demand of this magnitude, which occurred in an industrythat had invested heavily in plants and infrastructure in the early1980's based on expectations of continued growth in the de-mand for weapons and military systems, led quickly to over-capacity among defense contractors. ' 38 As a result, suchovercapacity led to increased overhead for military programs.3 9

The defense industry thus "responded by reducing capacitythrough consolidation, which has resulted in a significant de-cline in the number of defense contractors."40

The 1995 $10 billion merger of the then top two and threedefense contractors, Lockheed Corporation and Martin Mari-etta, led up to the Big Three Mergers in the U.S. aerospace anddefense industries.4' This merger followed the $2.17 billionmerger of Grumman Corporation and Northrop Corporation in1994.42

The Lockheed Martin merger is an example of a defensemerger entered into under a consent agreement with the Fed-

34 Id.35 See Prepared Statement of Robert Pitofsky Before the Subcomm. on Antitrust, Bus.

Rights and Competition of the Senate judiciary Comm., 105th Cong. (1997) (statementof Robert Pitofsky, Chairman, Federal Trade Commission).36 See id. at II.37 See id.38 Id.39 See id.40 Id.

41 See Martin Marietta-Lockheed Merger is Approved, N.Y. TIMES, Mar. 16, 1995 atD4.

42 See Roy J. Harris, Jr., Northrop Offer of $2.17 Billion Wins Grumman, WALL ST.J., Apr. 5, 1994, at A3, available in 1994 WL-WSJ 298095.

918


eral Trade Commission (Commission) to remedy antitrust con-cerns. The antitrust problem existed in "the market for Space-Based InfraRed Early Warning (SBIR) Satellite Systems, a $22billion satellite system that uses highly sophisticated electro[-]optical sensors to detect hostile missile launches against theUnited States or its allies."43 Lockheed, which teamed withHughes, and Martin Marietta, which teamed with NorthropGrumman, were the top two teams competing for the SBIR con-tract. As part of the Commission's consent order, Lockheed andMartin Marietta were prohibited from enforcing their teamingagreements with their respective partner. Thus, new teams werecreated to fight Lockheed Martin for the contract.44

Other mergers creating the merger wave included MartinMarietta's $208.5 million acquisition of General Dynamic'sspace systems division1 5 and its $3.05 billion purchase of Gen-eral Electric's aerospace division.46 Lockheed also purchasedGeneral Dynamic's Tactical Military Aircraft operation for $1.52billion,47 while Hughes Aircraft Co. bought General DynamicCorp.'s missiles division for $450 million."8 The Carlyle Group,for $200 million, acquired Textron's aerostructures business."Loral Corp., Carlyle Group and Northrop Corp. separatelypurchased LTV's missiles and aircraft divisions for $476 mil-lion.5 0 The Carlyle Group also purchased General Dynamic'selectronics division for $60 million and later sold it to Tracor for$110 million.51 Carlyle, in the same year, purchased Voughtfrom LTV, "strengthened it, and sold it to Northrop Grumman

43 Pitofsky, supra note 35, at V.44 See id.45 See Martin Marietta Carp.: Acquisition is Completed of General Dynamics Unit,

WALL ST. J., May 3, 1994, at B4, available in 1994 WL-WSJ 294634.46 See Division Won't Attack Martin Marietta Deal, 64 ANTITRUST & TRADE REG.

REP. (BNA) No. 1609, at 397 (Apr. 8, 1993); see also Alexander Nicoll, PentagonChanges Defence Game, FINANCIAL POST (Bloomberg), Mar. 31, 1998, available in1998 WL 10757577.

47 See Lockheed's Purchase of General Dynamics' Fighter Unit is Closed, WALL ST. J.,Mar. 2, 1993, at A12, available in 1993 WL-WSJ 711130.

48 See Steven Pearlstein, General Dynamics to Sell Unit; Hughes Expands MissileBusiness with Purchase, WASH. POST, May 12, 1992, at C1, available in 1992 WL2188510.

49 See Muradian, supra note 1.50 See Frederick Rose, Loral, Northrop, Carlyle Complete LTV Acquisitions, WALL ST.

J., Sept. 1, 1992, at A6, available in 1992 WL-WSJ 638419.51 See Muradian, supra note 1; Carlyle Group: Firm Completes Purchase of General

Dynamics Unit, WALL ST. J., Nov. 24, 1992, available in 1992 WL-WSJ 626377.

1999] 919


for a $100 million profit. 5 2 Olin Corp. purchased Aerojet,5 3and Loral purchased IBM's Federal Systems Co. 54 and Ford Mo-tor Co.'s aerospace division. 55 In short, the aerospace and de-fense industries have never seen such a high level of mergersand acquisitions.

The effect of the aforementioned wave of mergers and acqui-sitions is that big corporations have become even larger andstronger, and the population of defense industry competitorshas diminished drastically.

IV. THE BIG THREE MERGERS IN THE UNITED STATES

"The worldwide airline industry employs over 21 million peo-ple and accounts for [at least] $740 billion or 4% of the world'seconomic production. '56 Thus, mergers that are of the magni-tude of the Boeing-McDonnell Douglas, the Raytheon-Hughes,and the proposed Lockheed Martin-Northrop Grumman merg-ers naturally must withstand scrutiny from the U.S. Government.However, the market for large commercial aircraft is world-wide,and the European Union, with a similar competitive structure, isan integral part of this world market. While European airlineswill potentially make-up almost one-third of purchasers over thenext ten years, the combined market share of Boeing-McDon-nell Douglas is about two-thirds of the European Union mar-ket.57 Thus, the United States and the European Union shareconcerns over anticompetitive mergers in the aerospace indus-try. As a result, both the U.S. Government and the EuropeanCommission must approve mergers of this magnitude.

A. BOEING-McDONNELL DOUGLAS

"[F] ollowing one of the most detailed and wide-ranging inves-tigations in the history of merger enforcement," the FederalTrade Commission did not challenge Boeing's acquisition of

52 Muradian, supra note 1.53 See CenCorp Completes Sale of Line, WALL ST.J., May 3, 1994, at C13, available in

1994 WL-WSJ 294597.54 See Loral Corp.: IBM's Federal System Unit Is Bought for $1.52 Billion, WALL ST.J.,

Mar. 2, 1994, at B4, available in 1994 WL-WSJ 302921.55 See Charles W. Stevens & Rick Wartzman, Loral Wins Bid to Buy Ford's Aero-

space Unit, WALL ST. J., July 24, 1990, at A3, available in 1990 WL-WSJ 568507.56 James C. Lanik, Stopping the Tailspin: Use of Oligopolistic and Oligopsonistic

Power to Produce Profits in the Airline Industry, 22 TRANsp. L.J. 509, 510 (1995).57 See The Commission Clears the Merger Between Boeing and McDonnell Douglas

Under Conditions and Obligations, RAPID, July 30, 1997 available in LEXIS, EurcomLibrary, Rapid File [hereinafter Commission].

920


McDonnell Douglas."8 The Commission concluded that "the ac-quisition would not substantially lessen competition or tend tocreate a monopoly in the global commercial aircraft market. 59

On the military side, the Commission found that "Boeing andMcDonnell Douglas currently develop fighter aircraft and mili-tary helicopters for different missions, and there are no antici-pated Defense Department procurements of fighter aircraft ormilitary helicopters or other domestic military markets in whichthe two firms would likely compete. '"60

The result of the $14 billion merger between the world's larg-est civilian aircraft company and one of the biggest U.S. militarycontractors was the world's largest aerospace and defense com-pany.61 At the time, Boeing dominated the large commercialaircraft market with sixty-four percent of the market share. 62

Additionally, McDonnell Douglas was "the world's number twodefen[s]e manufacturer and leading manufacturer of militaryaircraft.

63

For 1997, Boeing reported its first yearly loss in fifty years. 64

Boeing's pretax charge against fourth quarter earnings for themerger was slightly more than expected at $1.4 billion.65 Aftertaxes, the charge for McDonnell Douglas was about $0.91 pershare.66 In addition to competing for the joint strike fightercontract, discussed infra Part VI, Boeing planned to start thenew 737 production line at the Douglas factory in Long Beach,California.6 7 Boeing-McDonnell Douglas is also in the processof consolidating its own commercial, space, and defensefacilities.68

58 Pitofsky, supra note 35, at V.59 Id.60 Id.

61 See Stanley Holmes, European Restructuring Urged to Compete with Boeing, SEAT-

TLE TIMES, June 17, 1997, at El, available in 1997 WL 3239040.62 See Commission, supra note 57.63 Id.64 See Laurence Zuckerman, $1.4 Billion Boeing Charge to Force First Yearly Loss

Since '47, N.Y. TIMES, Jan. 22, 1998, at D5.65 See id.66 See id.

67 See State Battles for Jet Fighter; Boeing May Choose Facility in St. Louis, L.A. DAILY

NEws, Aug. 10, 1998, at N3, available in 1998 WL 3866480 [hereinafter StateBattles].

68 SeeJames Wallace et al., Boeing Would Pick St. Louis for Fighter Assembly, Report

Says Project Would be World's Biggest Defense Program, Lockheed Also Seeks Contract, ST.

Louis POsT-DIsPATCH, Aug. 10, 1998, at Al, available in 1998 WL 3347112.

1999] 921


Currently, "Boeing builds the F-15 Eagle, the F-18 Hornet,and the F-18 Super Hornet. . ., as well as the T-45 Goshawk jettrainer and the re-manufactured Harrier II Plus for the MarineCorps."6 9 The Navy could purchase 548 of the new F-18 SuperHornets.")

B. RAYTHEON-HUGHES

The Justice Department decided on July 2, 1997, to approveRaytheon's merger with Texas Instruments "on the conditionthat Raytheon [sell Texas Instrument's] defense radarmicrochip-making unit. '71 This division of Texas Instrumentsproduced leading edge, "high-power[ed] amplifier monolithicmicrowave integrated circuits (MMICs) ' 72 chips that "extend thepower and range of radars, enabling them to scan airspacequickly and efficiently with a lower probability of detection" byenemies. 73 MMIC products are distinct from other products be-cause they are made with gallium arsenide, a substance that isharder and faster than the silicon used in other circuits. 74

"Raytheon [was] required to sell TI's MMIC business within180 days, or within five days from the time the court approve [d]the settlement, to a firm 'having both the capability and intentto continue to develop, make and sell MMICs that meet [De-partment of Defense] requirements."'7 5 Without this condition,the price of advanced military radars would have increased dra-matically.76 These high prices would have impacted taxpayers aswell as the DOD.77

The Raytheon-Hughes merger also underwent "intense scru-tiny in the air-to-air missile arena. '78 In addition, LockheedMartin is scaling back infrared units, which means Raytheon-Hughes could potentially corner the infrared defense market. 79

The merger was nevertheless approved.

69 Id.

70 See id.71 Mergers and Acquisitions: News in Brief, FACTS ON FILE WORLI) NEWS DIG., Sept.

4, 1997, at Al.72 Id.

73 Anthony L. Velocci, Jr., Raytheon, Rivals Score with TI Compromise, AVIATIONWK. & SPACE TECH., July 7, 1997, at 45.

74 Haber, supra note 2, at 175 Id.76 See id.77 See id.78 Id.79 See Infrared Reductions, AEROSPACE DAILY, Aug. 11, 1997, at 220.

922


Interestingly, the Ballistic Missile Defense Organization(BMDO) was recently seeking a Lead System Integrator to de-velop the National Missile Defense (NMD) system. Boeing withHughes and the United Missile Defense Co. (UMDC) (which isa partnership between Lockheed Martin, Raytheon, and TRW)separately contracted to study the NMD system before the Ray-theon-Hughes merger was realized. 0

Although both Raytheon and Hughes were studying the ef-fort, the Pentagon ultimately awarded Boeing the $1.6 billioncontract to oversee the National Missile Defense program. "Thecontract includes options for up to seven years of continued de-velopment effort. It is potentially worth $5.2 billion" forBoeing."l

After the Raytheon-Hughes merger, Raytheon planned to cutat least "8000 jobs and take a pretax charge of as much as $400million [in order] to wring costs from the $12.5 billion in de-fense acquisitions made [in 1997]."82

C. LOCKHEED MARTIN

"Lockheed Martin is a highly diversified [corporation] princi-pally engaged in the research, design, development, manufac-ture and integration of advanced-technology products andservices. [Its] core businesses span aeronautics, electronics, en-ergy and environment, information and services, space and stra-tegic missiles, telecommunications and systems integration. 8 3

In 1994, Northrop Corporation and Grumman Corporationmerged to form Northrop Grumman. Lockheed Corporationand Martin Marietta merged in 1995, creating Lockheed Martin.In 1997, Lockheed Martin planned to merge with NorthropGrumman, thereby creating what would have been the secondlargest aerospace and defense company in the world. The twocompanies entered into a definitive agreement in order to "fur-

80 See Defense Brief, DEF. DAILY, Aug.15, 1997, available in 1997 WL 8106993; seealso Boeing Wins $1.6 Billion NMD Contract, DEF. DAILY, May 1, 1998, available in1998 WL 7193867 [hereinafter Boeing Wins].

81 Id.82 Raytheon is Expected to Cut at Least 8,000 Jobs, ORLANDO SENTINEL, Jan. 22,

1998, at B5; Raytheon May Cut Deeply, PITTSBURGH POsT-GAZETTE, Jan. 22, 1998, atC1.

83 Lockheed Martin and CSOC Partners Demonstrate Model Architecture For FutureSpace Operations, PR NEWSWIRE, Jan. 21, 1998, available in LEXIS, Market Library,Iacnws File.

1999] 923


ther enhance efficiencies and increase global competition. 8 4

The product of the merger would have been a corporation thatwas originally "more than 20 once-independent companies. ' 5

The merger, however, was never realized.

1. The Proposed Lockheed Martin-Northrop Grumman Merger

The proposed merger was valued at roughly $11.2 billion, andthe merger would have produced a company with $37 billion inannual sales, a close second to Boeing-McDonnell Douglas. 6

The proposed larger company "would have combined what[was] five independent companies just three years ago, andwould have solidified Lockheed Martin's position as the nation'slargest defense contractor," accounting for twenty-five percentof the Pentagon's budget.8 7

The companies' product lines were to compliment each otherin that Northrop Grumman offered a large commercial airplanecomponents division and expertise in stealth technology, two di-visions Lockheed Martin had not yet delved into. 8 Both compa-nies build weapons and warfare systems for jets, and the biggerLockheed Martin would "have cornered the market in sometypes of electronic warplane systems."89

Furthermore, "Northrop Grumman... joined Lockheed Mar-tin's bid to develop and build the Joint Strike Fighter, a nextgeneration warplane," in direct competition with Boeing for the$200 billion contract, which will ultimately be awarded in2001.90 Unfortunately, however, the U.S. Governmentthreatened to sue the two companies based on antitrust con-cerns. This proposed merger is the largest challenged by theU.S. Government.9 The government claimed that the two com-panies, ifjoined, would hinder efficient competition in the elec-tronics and missile warning systems areas.92

84 Northrop Grumman Reports Record 1997 Sales, Earnings; Operating Profit Exceeds

$1 Billion; Net Debt Reduced by $510 Million, PR NEWSWIRE,Jan. 21, 1998, available inLEXIS, Market Library, Iacnws File.

85 Dworkin, supra note 4, at 34A.86 See id. at Al. Not all sources agree on the value of the merger. See Weyr,

supra note 4 (anticipating $8.3 billion); Shareholder's Suit, supra note 4, at C2 (an-ticipating $10.7 billion).

87 Weyr, supra note 4.88 See Dworkin, supra note 4, at 34A.89 Id.90 Id.; see infra notes 111-23, and accompanying text.91 See Weyr, supra note 4.92 See id.

924


Attorney General Janet Reno claimed that if the merger wereto go through, "America could face higher prices and lowerquality in advanced tactical and strategic aircraft, airborne earlywarning radar systems, sonar system, and several types ofcourtermeasure systems that save our pilots from being shotdown when they are flying in hostile skies."93 Her stated goalwas to protect soldiers' lives and taxpayers' wallets.94

2. The Result of the Failed Merger

Because the proposed merger failed, Lockheed Martin andNorthrop Grumman must develop new strategies to survive insuch a competitive market.

a. The Future of Lockheed Martin

Lockheed Martin, based in Bethesda, Maryland, remains aworld-wide corporation competing in five sectors with a total ofsixty business units.9 5 It has 173,000 employees and had $28 bil-lion in sales in 1997.96 The company produces F-16 fighters inFort Worth, Texas, and will remain a heavy hitter in the aero-space and defense industry. 97

b. The Future of Northrop Grumman

Kent Kresa, Northrop Grumman President and Chief Execu-tive Officer, stated that although the merger was in the best in-terests of its constituencies, Northrop Grumman "will continueas a strong, independent competitor in the aerospacemarketplace."98

Northrop Grumman, headquartered in Los Angeles, Califor-nia, currently makes B-2 stealth bombers and the MX missile.99

Moreover, as the sixth largest U.S. defense contractor, it had $9billion in revenue in 199800 and 52,000 employees. 101

93 Id.

94 See id.95 See Patrizio, supra note 2, at 105.96 See Weyr, supra note 4.97 See Wallace, supra note 68, at Al; Boeing Would Build Fighter in St. Louis, DAi-

LAS MORNING NEWS, Aug. 10, 1998, at 2D, available in 1998 WL 13093719.98 Weyr, supra note 4.

99 See id.100 See Anthony L. Velocci, Jr., Dashed Merger Resets Clock for Acquisitive Defense

Rivals, AVIATION WK. & SPACE TECH., July 27, 1998, at 23, available in 1998 WL8144859.

101 See Weyr, supra note 4.

1999] 925


One of Northrop Grumman's advantages is that it is not con-strained by the acquisition limitations placed on the larger com-panies. Hence, the company can grow in multiple directions.For example, Northrop is looking into nonmilitary markets suchas information technology and commercial aerostructures. 1 2

Additionally, the company is "interested in expanding its de-fense electronics franchise, which . . . has the greatest growthpotential." 03

Northrop Grumman primarily serves the following markets:"airborne surveillance, airborne radar, countermeasures, mili-tary subcontracts, and commercial aerostructures."'1 4 Further-more, its revenues in these areas are comparable to (if notgreater than) those of its competitors. 5

Many analysts believe that, in this industry, size matters andthat Northrop must increase its overall size if it is to successfullycompete with Raytheon and Lockheed Martin. 06 But the possi-bility remains "that Northrop Grumman ... could find itself thetarget of another deep-pocketed suitor.'01 7 Even so, the com-pany should take the time necessary to assess what is in its share-holders' best interest and what makes the most business sense.

It is worth noting that in 1997 Northrop Grumman was valuedat $8.3 billion, and in 1998, it was worth only $5.2 billion, a $3.1billion loss in value. 08 With its stock worth less daily, NorthropGrumman may not be able to achieve the type of deals itneeds.'o

Interestingly, Daimler-Benz of Germany, General ElectricCompany of Britain, and British Aerospace are all interested inacquiring part or all of Northrop Grumman. 110

102 See Velocci, supra note 99, at 23.103 Id.104 Id.105 See id.106 See id.107 Id.108 See Vago Muradian, Stock Price Drop Blamed on Failed Lockheed-Northrop Deal,

DEF. DAILY, Aug. 6, 1998, available in 1998 WL 7194592.109 See id.110 See Barry James, By Mergers and Deals, Defense Industry Spins a Worldwide Web,

INT'L HERALD TRIBUNE, July 27, 1998, at 11, available in 1998 WL 4793194.

926

1999] AEROSPACE & DEFENSE INDUSTRIES 927

V. THE FIGHT FOR THE LARGEST DEFENSE CONTRACTIN HISTORY

The largest contract in military history will be awarded inSpring 2001. The contract is to build the joint strike fighter, thenext generation warplane. It is potentially worth $750 billionand could be a twenty to twenty-five year commitment.1"1 Thecontract "could create 20,000 new aerospace jobs . .. and forevery aerospace job, it could create five to nine spin-off jobs."'' 12

Boeing and Lockheed are the finalists vying for the contract.

The joint strike fighter is "[i] ntended to serve the Air Force,Navy, Marine Corps and British Royal Navy... [and] will be thefirst fighter required to perform ... multiservice roles."' 3 Spe-cifically, "[t]he Navy wants a fighter that can land and take offfrom an aircraft carrier. [In addition, t]he Marines and RoyalNavy want a fighter that can replace Harrierjets, which are capa-ble of short takeoff and vertical landing."' 14 The fighter mustalso be capable of avoiding air and ground radar detection,which means it must be stealthy.' 1 5

The U.S. Department of Defense could purchase almost 3000of the fighters by 2020 at $219 billion." 6 Military experts esti-mate that the joint strike fighter program has the potential to bevalued at $300 billion." 17

Boeing and Lockheed are in the process of building proto-types, which will be completed by late 1999 or early 2000. Eachcompany will build two demonstration fighters that will competeagainst the other company's two fighters. "[F]light testing willbe [conducted] at Edwards Air Force Base and later at theNavy's Patuxent River test facility in Maryland." ' a If Boeingwins the contract, the fighter could be produced in St. Louis,Missouri; whereas, if Lockheed obtains the contract, the fightercould be produced in Fort Worth, Texas.1 9 Because companiesare known to change their minds regarding production sites,neither location is definite.

H See State Battles, supra note 67, at N3.112 Id.

113 Id.

114 Id.

115 See id.116 See id.; Wallace, supra note 68, at Al.117 See Wallace, supra note 68, at Al.118 State Battles, supra note 67, at N3.119 See id.


The Pentagon is supposedly trying to determine who canbuild "the best airplane at the cheapest price. "12

' There are,however, multiple factors that enter the equation. For example,some states will offer tax benefits for equipment purchased spe-cifically for the joint strike fighter program, thereby decreasingthe bottom line cost of production. 121 In addition, there are al-ways political forces that will try to bring a contract of this mag-nitude to its home state. For example, if Boeing gets the JointStrike Fighter contract, they will probably produce the two larg-est fighter projects in the country in St. Louis, Missouri. 122

In fact, this contract is so vital to the U.S. defense industrythat some experts anticipate that there will not be just one win-ner. These experts anticipate that both Boeing and LockheedMartin will share the contract. 123

VI. THE STRUGGLE TO CONSOLIDATE AEROSPACEAND DEFENSE INDUSTRIES IN THE

EUROPEAN UNION

Due to the mega-merger wave in the aerospace and defenseindustries in the United States, the world is entering a new aero-space era with the international goal of consolidation; however,it is only beginning.

A. HISTORY OF THE EUROPEAN INDUSTRIES

While Boeing has at least sixty percent of the world's commer-cial aircraft business, Europe has over thirty percent. 24 In fact,"Europe's three biggest players, Aerospatiale, British Aerospaceand Daimler-Benz Aerospace, cannot [collectively make] thesame sales as Boeing- [McDonnell Douglas], ' 125 and corpora-tions must make a move if they are to survive in such a competi-tive market.

Europe actually does have the potential to consolidate andcompete with the big players in the United States. Currently inEurope, there are at least thirty-two companies producing air-

120 Id.

21 See id.122 See Wallace, supra note 68, at Al.123 See id.124 See Holmes, supra note 61, at El.125 O'Toole, supra note 3.

928


craft, helicopters, missiles, defense electronics and/orsatellites. 126

It is worth noting that the U.S. Government heavily invests inaerospace research and development. The U.S. budget for mili-tary procurement, including research, amounts to twice the sup-port provided by the European Union Member Statescombined.1 27 In addition, the support for the research for largecivil aircraft in the United States is around four times the sup-port provided by the European Union and its Member Statescombined.

128

Europe must concentrate on the world, defense-related mar-ket that overall has a shrinking demand. Furthermore, there istension on Member States' defense budgets because there aretoo many suppliers in the European defense industry. 129

Acknowledging that steps need to be taken, the EuropeanCommission is taking "a European approach to the Europeandefen[s]e industries, which includes both short and long termmeasures to increase European competitiveness in thesemarkets."3 0

B. RECENT DEVELOPMENTS, REMAINING HURDLES AND

THE OVERALL GOAL FOR EUROPE'S NEAR FUTURE

The European Commission will propose rules applicable tothe acquisition of defense equipment. 31 Specifically, the Euro-pean Commission plans to protect certain confidential informa-tion, especially that information a Member State feels is a matterof national security.132

Consolidating Europe's defense industry will demand settingstandards used by Defense Ministries. Moreover, if civil and mil-itary industries consolidate, duplication will decrease and eco-nomic advantages will be realized. 33

126 Commission Urges Industry to Restructure, Keep Up with the U.S., EUROWATCH,

Oct. 31, 1997, available in LEXIS, World Library, Eurwch File.127 See id.128 See id.129 See Defense Industry: Embryonic Common Policy, EUR. REP., Oct. 25, 1997, avail-

able in 1997 WL 13047467.130 Id. (These measures include policies to deal with public defense contracts,

export requirements and consolidated customs duties for imports.)131 See id.132 See id.133 See id.

1999] 929


Yet another short term measure needed to combat competi-tion is aligning tariff arrangements for customs."' In 1988, theEuropean Commission proposed that the Council temporarilysuspend customs duties for certain military equipment, and thatthe suspension be adopted as a permanent measure. 13 5 Differ-ing national approaches for tariff arrangements for imports isnot acceptable. Thus, Article 28 of the European Community(EC) Treaty is the "only permissible legal basis for granting au-tonomous suspensions.""''"

The medium term measures to confront competition apply tocompetition policy, export controls, structural funds, market ac-cess, taxation, and institutional matters. 13 7 For example, theMember States currently use an eight step approach to deter-mine whether to grant a license for a specific export; whereas, atwo-step approach involving "exchanges of information on ex-ports of weapons.., and the creation of a system for eliminatingdistortions between the various national treatments" should befollowed. '

As far as taxation among Member States is concerned, theproposals include the "exemption of goods and services for thedefen [s] e of Member States where the goods and services are tobe supplied within the EU."'3 9 There may also be "exemption ofgoods and services for supranational collaborative programs for[the] defen[s]e of Member States" and harmonization of whichgoods and services could receive the value-added tax (VAT)rates." "

Although the short and medium term measures appear prom-ising, if adopted, some corporations may individually take stepsto enhance competition. For example, AlliedSignal andBFGoodrich are rumored to have an eye on Europe141 . Further-more, British Aerospace is allying with Lockheed Martin as illus-trated by their relationship on a Joint Strike Fighter bid;however, British Aerospace admitted that the priority should begiven to European consolidation in order to create a company

134 See id.135 See id.136 Id.137 See id.138 Id.13, Id.140 See id.

141 See O'Toole, supra note 3.

930


capable of competing with the American giants. 142 GeneralElectric Corporation, which is not related to the GE in theUnited States, may also begin to focus on the United States.143

Furthermore, US Airways recently placed an order for a maxi-mum of 400 Airbuses. The US Airways order is the largest that"Airbus has ever won and is a significant victory for the Euro-pean consortium in the U.S. market, which is dominated by Boe-ing. "144 Airbus, which is owned by Aerospatiale of France,Daimler-Benz Aerospace of Germany, British Aerospace of theUnited Kingdom and CASA of Spain, had 460 new orders in1997, compared to 326 in 1996.145 "Airbus account[ed] for 43%of new aircraft sold in the world since January [1997] andhop[ed] to take 45% of the market over 1997 as a whole, . . .[which] would place the European aircraft manufacturersahead of its target of 50% of the world market in 2002."146

The Airbus consortium, which groups manufacturers of civil-ian aircraft from Britain, France, Germany, and Spain, "aims toattack the monopoly Boeing has with its 747 aircraft. With theA340-500 and 600 models at the lower end and the [A]3XX(large passenger jet), [Airbus plans] to squeeze Boeing ... fromboth sides. 1 47 "The A3XX large passengerjet will offer the larg-est passenger capacity, with 480-600 seats per plane.1 48 Inter-ested parties in the venture include a Japanese partner andcompanies such as Alenia of Italy and Sweden's Saab.1 49 Thejumbo jet "will be faster, quieter, more cost-efficient and able tofly farther than the [B]oeing 747."150 The A3XX will, however,cost at least $10 billion per aircraft.151 Moreover, Airbus is talk-

142 See id.

143 See id.144 Michael Skapinker, US Airways Confirms Big Airbus Order, FIN. TIMES

(London), Nov. 4, 1997, at 5.145 See DASA FY Sales - 3 (Bischoff Sees Major Decisions on Shaping Industry), Ex-

TEL EXAMINER, Jan. 20, 1998, available in LEXIS, Asiapc Library, Xinhua File.146 Airbus Looks to Euro to Confirm Global Presence, TRANSPORT EUROPE, Oct. 25,

1997, available in LEXIS, Eurcom Library, Eurtrn File (emphasis added).147 DASA's Bischoff - 2 (DASA to Attack Boeing 747 Monopoly), EXTEL EXAMINER,

Jan. 20, 1998, available in LEXIS, BusFin Library, Extex File [hereinafter DASA'sBischofj].

148 See id.

149 See id.150 Airbus Weighing Super Passenger Jet, XINHUA NEWS AGENCY, Jan. 15, 1998,

available in LEXIS, Asiapc Library, Xinhua File.151 See id.

1999]


ing to a Chinese partner and Alenia about developing a new100-seater aircraft to rival Boeing's 717 aircraft. 152

Airbus also embraced an order from the U.S. Air Force topaint sixty A10 Thunderbolt aircrafts. While it may not appearto be much, it is the first U.S. defense contract won by the com-pany since the Gulf War. 151

Airbus must become the core of the entire aviation industry inEurope, including the military aircraft market, if it is to success-fully compete against Boeing. In response to Boeing's threaten-ing market power, leaders of Britain, France and Germanyproposed, in December 1997, to expand the Airbus consortium,which groups civilian aircraft industries of France, Germany,Britain and Spain, into an "integrated company that would alsoproduce fighter jets, helicopters and missiles."' 54 The resultwould be a civil-defense consortium that could compete with thebig American rivals. Once these companies consolidate, thedoor is open for other European companies to join, specificallySweden's Saab-Scania AB, Italy's Finmeccanica and Dassault Avi-ation SA, and Lagardere SCA's Matra division in France. 55 Nospecific timetable is set for the consolidation efforts.

Italy appears "'extremely interested' in proposals for the reor-gani[z]ation of the [E]uropean aerospace and defen[s]e elec-tronics industry, and fully approves the reorgani[z]ation of[A] irbus. ''156 The Italian Government is pushing Italian corpo-rations to consolidate, and it is specifically planning for Aleniato join the Airbus consortium. 157

Even without consolidating civil and defense sectors, Airbus isdoing extremely well in its aggressive attack on Boeing-McDon-nell Douglas. Airbus won nearly forty percent of the market in1996, and received an order for thirty-four aircraft (worth £1billion, or roughly $1.5 billion) from Belgian flag-carrier Sabenain 1997.158 At the end of October 1997, Airbus had 425 aircraft

152 See DASA's Bischoff supra note 146.153 See id.154 EU Official Welcomes Call for Aerospace Restructuring, XINHUA NEWS AGENCY,

Dec. 10, 1997, available in LEXIS, Asiapc Library, Xinhua File.155 See WRAP/Airbus-2: No Timetable for Broad-Based Combination, Dow JONES

NEWS SERV., March 27, 1998; Sieff, supra note 145, at A16.156 Italy Backs European Aerospace Restructuring, XINHUA NEWS AGENCY, Dec. 9,

1997, available in LEXIS, Asiapc Library, Xinhua File.157 See id.

158 See Mark Milner, Airbus Order Closes Gap on Boeing, GUARDIAN (London),Nov. 19, 1997, at 24.

932


orders compared to Boeing's 469, and it appears Airbus is evencloser to its goal of fifty percent of the market. 159

Europe is feeling a sense of urgency to consolidate becausethere is already such a disparity between the United States andEurope in "such high-tech fields as lasers and optronic surveil-lance."'160 But the sense of urgency has lessened somewhat sinceWashington opposed the Lockheed Martin-Northrop Grummanmerger. According to Manfred Bischoff, then Chief ExecutiveOfficer of Germany's Daimler-Benz Aerospace S.A. (DASA),"[i]f Europe and the other countries are not prepared to takeup the challenge [imposed by American companies, specificallyin the high-tech weapons arena,] the United States may be head-ing towards a singular technological position [of high-techweapons dominance] that will be permanent." '161

The unanimous vision, which will begin with the expansion ofAirbus, is a unified European Aerospace and Defense Company.Efforts to expand the Airbus consortium, however, have beenthwarted by "France's reluctance to give up state control of Aer-ospatiale and the defense electronics giant Thomson-CSF. 162

Fortunately, however, the French government recently an-nounced a pending merger with Matra, which would make Aer-ospatiale part of the private sector.163 Lagardere will be thelargest private owner holding thirty to thirty-three percent of thecombined group.1 64 Although the state will retain less than fiftypercent, it will nevertheless be the largest shareholder.' 65

The French decision to privatize Aerospatiale is pivotal. Themerger shows that European defense-industry integration isFrance's priority. 166 Moreover, the Aerospatiale-Matra mergercreates, in one move, a group encompassing a variety of busi-nesses including "Europe's largest guided weapons, satellitesand helicopter companies, a substantial software engineering

159 See id.16 Martin Sieff, Ready for Take Off? Europeans Eye Consolidation of Aerospace

Firms, WASH. TIMES, March 2, 1998, at A16, available in 1998 WL 3441213.161 Id.162 Id.

163 Douglas Hamilton, BAe and Dasa Plan Europe Defence Tie-up: Aviation Shares

Take Off on Merger Speculation, HERALD (United Kingdom), July 25, 1998, at 23,available in 1998 WL 8172454. (Matra is the defense sector of Lagardere, anotherindustry conglomerate.)

164 See Amy Barrett, Aerospatiale Will Be Privatized Following Merger, ASIAN WALLST. J., July 24, 1998, at 2, available in 1998 WL-WSJA 12982943.

165 See id.166 See id.

1999] 933


and communications business, plus significant shareholdings inEurope's prime commercial aircraft group, Airbus, [and a] re-gional aircraft group ATR and combat aircraft company Das-sault Aviation. ' 67 Unfortunately, however, this merger isaccompanied by German and British fears that the governmentin Paris will gain too much power through this privatization." 16

Consolidation appears to be Europe's ultimate goal, andthere are other forms of real progress toward realizing the visionof unity. For example, the Spanish and Italian governmentshave already begun privatizing their defense and aerospace in-dustries.169 The privatization of Spain's CASA could be com-pleted by the end of 1999.170 Moreover, the merger betweenItaly's Finmeccanica and Britain's General Electric Co., whichwould merge the companies' missile, naval and radar systemsbusinesses, is viewed as, "a key step in state-owned Finmeccan-ica's move to privatization.' ' 71 A joint holding company in theNetherlands will manage the operation, and the companies maymerge other divisions in the future. 172

In addition, GEC-Marconi, after recently acquiring Tracor for$1.4 billion, is interested in American corporations, specificallysome units of Northrop Grumman.1 73 Northrop Grumman,however, claims that it is not interested in selling its assets.174

Nevertheless, this is an example of transnational cooperationthat may be surfacing.

Interestingly, the United States Government and the Euro-pean Commission recently approved the $35 billion merger be-tween Daimler-Benz of Germany and Chrysler, thereby makingthe German company's aerospace unit forty-seven percentAmerican owned.1 75

167 Alexis Rendell, Attacking MOVES (Aerospataile, Matra Hautes TechnologiesMerger), FLIGHT INT'L, July 28, 1998, available in 1998 WL 11807002.

16- See France's European Partners Fear Industrial Domination, DEF. NEWS, August 3,1998, at 1, available in 1998 WL 9010101.

-. See John D. Morrocco & Michael A. Taverna, Consolidation Plans Hinge onFrench Role Efforts to Create a Single European Aerospace/Defense Firm Undercut by Paris'Foot-Dragging Over Aerospatiale, AVIATION WK. & SPACE TECH., April 6, 1998, avail-able in 1998 WL 8143258.

170 See id.171 Id. (The merger should lead to annual revenues of $1.5 billion. See id.)172 Id. (The companies avianics, guns, and armored vehicle sections could be-

come prime merger targets. See id.)173 See Vago Muradian, Defense and Aerospace Stocks Rise as Investors Shop for Bar-

gains, DEF. DAILY, August 10, 1998, available in 1998 WL 7194615.174 See id.175 See id.

934


Trans-Atlantic alliances are a tradition in the industry in orderto share risk, knowledge, and technology between companies.In addition to the cooperation between British Aerospace andLockheed Martin on the Joint Strike Fighter program, there aremultiple examples of such international working cooperations.For example, British Aerospace creates wings and wing parts forAirbus and Boeing - even though both companies are vying forcontrol of the civil aircraft market.17

' Boeing provides "systemsfor British Aerospace's Nimrod early warning and reconnais-sance aircraft. ' 177 Additionally, Boeing jets have Rolls-Royce en-gines. 11 Similarly, Daimler-Benz Aerospace Co. and Pratt &Whitney (an American engine producer) have a strategic alli-ance, while Daimler-Benz and Rockwell Corp. build "a tail-lessaircraft as a technology demonstrator. 1 7 9

VII. MERGERS OF SECOND AND THIRD TIERCOMPANIES AND DIVISIONS

Although the U.S. Defense Department opposed the mergerbetween Lockheed Martin and Northrop Grumman, it will sup-port second and third-tier level mergers and acquisitions, pro-vided the combined companies do not threaten efficientcompetition. 180

There is a whole different level of subcontractors that mustcome together if they are going to compete. After all, contrac-tors are realizing that two or three subcontractors are easier todeal with than ten or twelve.' 8 ' Hence, there will be an unprece-dented wave of mergers within this level of defense and aero-space producers.

For example, large second-tier companies may make some ac-quisitions. General Dynamics Corp., the submarine and tankmaker out of Falls Church, Virginia, has indicated its interest inexpanding. 8 2 The rocket motor producer Cordant Technolo-

176 SeeJames, supra note 109, at 11.

177 Id.

178 See id.

179 Id.180 See Velocci, supra note 99, at 23.181 See Benjamine Mark Cole, Economic Pressures Driving Aerospace Consolidation,

L.A. Bus. J., July 28, 1997, available in 1997 WL 9559198.182 See Frederic M. Biddle, Defense-Industry Consolidation May Not Be Over Yet,

WALL ST. J., July 20, 1998, at B4, available in 1998 WL-WSJ 3502196.

1999] 935


gies Inc., formerly Thiokol Corp., is another company interestedin expanding beyond its current line of production.1 3

VIII. OTHER GLOBAL EFFECTS

A. ASIA

There is also a slow, but steadily rising Asia-Pacific sector inthe competitive aerospace industry. Mitsubishi Heavy Indus-tries, Kawasaki, and Samsung are among the top competitors, inAsia. None have made moves from suppliers to prime contrac-tors, but the long-term nature of the business indicates that sucha move will likely occur in the future."8 4

B. RussA

While Russia's defense industry may not be prominent likeEurope's, it is alive. Russia will offer to manufacture mediumrange Tu-214 airliners for Iran, which will be manufactured by acompany in Kazan, the capital of the Tatarstan Republic.I8 5 Ad-ditionally "[o]ut of [the] Russian air companies, the Aeroflot-Russian International Airlines is interested in purchasing tenplanes, the Khabarovsk Airline [is interested in] ten[,] and theState Transport Company "Russia" [is interested in] two," at anaverage price of $25 million each. 86 Sales are most promisingin China, Asia, and in the Middle East; but sales are not likely inEurope due to the competition of Boeing and Airbus.

C. ISRAEL

Israel has been criticized by the general manager of Elisra,one of Israel's top defense companies, for not promoting andencouraging the consolidation of duplicate defense compa-nies."' For example, three Israeli companies operate in theelectronic warfare (EW) sector, yet there has been no move tomerge the companies. 88 General manager Avner Raz urged thegovernment that "[t] his idea should be treated seriously, consid-

183 See id.184 O'Toole, supra note 3.185 See Itar-Tass Economic News Digest of Januay 19, TEL. AGENCY OF THE SOVIET

UNION, Jan. 19, 1998, available in LEXIS, News Library, Ttass File.186 Id.

17 See Ministry Criticized for Not Doing Enough to Help Defense Industries, BBC SUM-MARY OF WORLD BROADCASTS, Jan. 13, 1998, available in LEXIS, Aust Library,Bbcswb File.

188 See id.

936


ering that the worldwide EW market is [worth] $5 billion dollarsannually." '189 The Israeli aerospace sector should not be over-looked as a competitor because Elisra outbid Luton of theUnited States for a contract to supply $40 million of EW systemsfor naval planes in Australia.19 It also sold $15 million worth ofsystems to Germany and will be supplying passive early warningsystems for Israel's Black Hawk and Yasur helicopters.19 '

D. CHINA

Although the Chinese civil aircraft market is controlled byBoeing-McDonnell Douglas, Chinese officials have stated thatthey want to increase Airbus's current market share of fifteenpercent in order to bring Airbus closer to Boeing's market sharelevel. 192

Interestingly, Airbus has a sector in China called Airbus Indus-try China, and because the Asia-Pacific region has pulled in onequarter of Airbus's total sales, this region proves to be an inte-gral market for Airbus. 19' Airbus acknowledges that there is anenormous potential for an increase in China's market.

E. TAIwAN

Taiwan began focusing on the aerospace industry over thepast two decades so that it could improve its technology and in-dustrial capabilities in order to better compete in the world mar-ket. 94 One hundred and seventy public and privateorganizations make up Taiwan's aerospace industry.1 95 It em-ploys roughly 11,500 personnel and produces some $400 millionin aerospace related manufacturing.196 By 2000, Taiwan wantsto increase production to $1.38 billion and employment to14,500.197

189 Id.190 See id.191 See id.192 See Project News Airbus Sets Goal, CHINA ECON. REv., Jan. 23, 1998, available in

LEXIS, World Library, Curnws File.193 See Fauziah Ismail, Airbus Industry Looks to China, NEW STRAITS TIMES (Malay-

sia), Nov. 18, 1997, at 1, available in LEXIS, News Library, Curnws File.194 See Taiwan Commercial Aerospace Industry Overview, INT'L MKT. INSIGHT REP.,

Aug. 13, 1997, available in LEXIS, World Library, Intmkt File [hereinafterTaiwan].195 See id.196 See id.197 See id.

9371999]


Taiwanese officials have furthermore claimed that the aero-space industry is "one of the ten industries of vital importance toTaiwan's economic future."' 8 In fact, an agenda was set in 1995to make Taiwan an "'Asia-Pacific Aircraft Repair and Mainte-nance Center' within the next five years."' 9 9

Currently, France and the United States supply 90.2% of Tai-wan's total import value, and the aggregate value of importedaircraft repair parts is $90 million.0 0 It is unquestionable thatTaiwan wants to develop its own industry for aircraft parts, butonly a handful of Taiwan's companies can satisfy Federal Avia-tion Administration (FAA) standards.20 '

Imports will remain important for Taiwan for the near future,and competition from other countries should increase as illus-trated by Airbus selling aircraft to Taiwan. But, American sup-pliers will probably continue to dominate the market. 20 2

Taiwanese officials are encouraging domestic firms to cooper-ate and work with foreign firms in order to build a viable aero-space industry.2 3 Taiwanese corporations are slowly beginningto compete with such cooperative joint venture programs. Forexample, Lockheed Martin, in 1996, formed an $87 million co-operation through which it will transfer technologies and com-puter software in an effort to help bolster Taiwan's aviationmaintenance industry.2114 Moreover, Taiwan will manufacturefifty percent of rudders for Dassault Aviation's Falcon line ofaircraft.

2 5

Basically, Taiwan has four prominent organizations that pro-vide for its aerospace research and development. Two of thefour (the Committee for Aviation and Space Industry Develop-ment (CASID) and the Center for Aviation and Space Technol-ogy (CAST)) actively promote the industry and its potential.20 6

Currently, Taiwan's aerospace industry is focusing on develop-ing, manufacturing, assembling and selling regional aircraft." 7

198 Wendy Tien, Taiwan-Aircraft Parts for Repair and Maintenance, NAT'L TRADE

DATA BANK MKT. REP., May 7, 1996, available in LEXIS, Asiapc Library, MktrptFile.

199 Id.200 See id.201 See id.202 See id.203 See id.204 See Taiwan, supra note 190.205 See id.206 See id.207 See Tien, supra note 194.

938 [64

1999] AEROSPACE & DEFENSE INDUSTRIES 939

F. AUSTRALIA

Australia has very few aircraft manufacturers and as a result,must import almost all aircraft and parts.2 °8 Interestingly, thetotal Australian aerospace industry employs only 12,000 peopleand has revenues of $1.5 billion - compared to $85 billion inthe United States and $47 billion in the European EconomicCommunity.209 The Australian aerospace industry "is becomingmore trade oriented with manufactured exports in excess of$350 million," and an additional $350 million in re-exports.21 0

The total revenues for aircraft maintenance and repair in Aus-tralia is roughly $400 million.21 '

Australia, however, is a great opportunity for American suppli-ers of aircraft and parts. The United States leads in aircraft,parts, and ground support equipment sales, and Australian sup-pliers can anticipate steady growth.212 Moreover, "[t]here is astrong preference for U.S. produced equipment in all areas ofaviation and aerospace in Australia, both in defense and civilmarkets. ' 213 Further, Kaman Aerospace, a smaller U.S. com-pany, will provide the Australian Navy with the SH2-G helicop-ter, which is an encouraging sign that other contenders canenter the competitive market.214

The Australian Government has established defense procure-ment policies that identify the aerospace industry as a specificindustry to be developed.2 5 Boeing, as a result of acquiringRockwell, recently formed Boeing-Australia, which is its first op-eration based outside the United States.21 6 Other U.S. compa-nies have also created a stronger presence in Australia in aneffort to profit from already planned military aircraftpurchases.1 7

208 See Phil Keeling, Australia - Aircraft and Parts, NAT'L TRADE DATA BANK

MKT. REp., Apr. 1, 1997, available in LEXIS, Aust Library, Mktrpt File.209 See id.

210 Id.

211 See id.

212 See id.

213 Id.

214 See id.

215 See id.

216 See id.

217 See id.


G. TuRKEY

Out of the North Atlantic Treaty Organization (NATO) coun-tries, Turkey has the second largest army. Nevertheless, it mustimport most if its advanced weapons from the United States andother Western countries. 218 Currently several companies arecompeting for a $3 billion contract to build 145 combat helicop-ters for Turkey.219 Companies from seven countries have ex-pressed an interest in the contract, including Boeing-McDonnellDouglas and Bell Helicopter Textron (the AH-1 Cobramaker) .220

IX. CONCLUSION

The big three mergers in the U.S. defense industry have senta world-wide message to corporations in the aerospace and de-fense industries. If existing corporations want to survive in anintensely fierce market, they must act now or Boeing-McDonnellDouglas, Lockheed Martin and Raytheon-Hughes will continueto dominate the civil and defense industries.

The European Airbus consortium is rising to the challengeand aggressively pursuing half of the aircraft market share. TheEuropean Union also acknowledges the threat of competitionand is pulling its Member States together to attack the Americangiants. The new millennium presents a challenge in that it willmake or break the European Union's hold on the aerospacemarket.

The United States and Europe are undoubtedly thepredominate contenders in the aerospace and defense indus-tries; however, corporations in other countries will attempt tosurvive locally through joint ventures and cooperation with thebig players.

Nevertheless, the mergers and acquisitions of the 1990s havechanged the aerospace and defense industries forever and havesparked a new round of consolidation to move this industry intothe new millennium.

218 See U.S. Firms to Bid for Producing Choppers for Turkey, XINHUA NEws AGENCY,

Jan. 5, 1998, available in LEXIS, Asiapc Library, Xinhua File.219 See id.220 See id.

940

IN RE TRAVEL AGENCY COMMISSION ANTITRUSTLITIGATION: A CASE OF NONPRICE PREDATION

WITHIN THE TRAVEL INDUSTRY*

IAN E. PATE**

Wer reitet so spdt durch Nacht und Wind?Es ist der Vater mit seinem Kind;

Er hat den Knaben wohl in dem Arm,Er faBt ihn sicher, er halt ihn warm.

- Der Erlkinig, by Goethe.

I. INTRODUCTION

W TH MOST THINGS these days, we are confronted withVnumerous choices that complicate even the simplest travel

plans. As Goethe expressed in the above stanza, traveling can, attimes, be stressful, so we seek security and peace of mind fromthe Night and Wind. For those travelers using travel agencies,the complexity and worry of travel is eased by the accumulatedexperience of travel professionals who are more accustomed indealing with airlines and other travel providers. For example, inone particular test, a travel agency saved a flier $1,000 on a flightfrom Chicago to Tokyo "by spotting hairline distinctions be-tween minimum-stay requirements among airlines."' Thus, onecan imagine the frustration of each traveler who, on his own,has to learn "the travel business," suffer the effects of "revenuemanagement,"2 or otherwise go to each airline either by phoneor the Internet in an attempt to make the best deal. As with

* Dieser Artikel ist in Dankbarkeit der Firma und Belegschaft von "Overseas

Travel" gewidmet, die mir die Welt gezeigt haben, und all den anderenPersonen, die diese Reise so lohnend machten.

** B.A., Economics, Florida State University, 1996; J.D., Florida State Univer-sity College of Law, 1999.

1 Lynn Woods, Airfares Just Keep on Skyrocketing, KIPLINGER'S PERSONAL FIN.

MAG., Jan. 1998, at 127.2 Revenue management is the "well-developed strategy" whereby one seat on

an airline may carry nine, sixteen, nineteen, or even thirty different fares. See


most things these days, this time could be spent more produc-tively elsewhere.

While airlines may be welcoming the day of no commissionpayments, it is unlikely that travelers will benefit. Travel agentshave expertise and experience, which they use to create stress-free travel plans. Like a tax accountant or a lawyer, a travelagent navigates through the complexities of his trade so that hisclient does not have to. But this service is not ultimately free.

Since the airlines stopped paying commissions on ticket salesin 1995, travel agencies have quickly been forced out of busi-ness. If there were ever an example to highlight the goals andpolicies behind antitrust laws, the dissolution of one businessgroup due to the strong-arming of another makes an excellentcause celebre. Since the commission cuts by the airlines, travelagents have fallen by the way side, seemingly unnoticed. Thispaper will therefore bring to light the tenuous business relation-ship between the airlines and travel agencies and attempt topick up where the court in In Re Travel Agency Commission Anti-trust Litigation left off-that is, to provide a legal analysis of theairlines' termination of that relationship.

As might be evident, the legal conclusion of this paper is thatairlines were engaging in collusion and conspiracy to eliminatetravel agencies. Granted, there is no express legal obligation forairlines to pay commissions, and the airlines claim legitimate jus-tifications for their actions. Therefore, antitrust law will be setforth as relevant to this specific situation, and thereafter, theairlines' business decisions will be analyzed to separate legiti-mate business conduct from unlawful collusion and unreasona-ble restraints on trade. In doing so, this paper will concludethat the airlines' major motivation for bringing about such achange was the pursuit of increased oligopoly power and profits.

A. THE LAWSUIT: IN RE TRAVEL AGENCY COMMISSIONANTITRUST LITIGATION

3

In 1995, the American Society of Travel Agents (ASTA)brought suit against the seven largest American airlines, whichcontrol eighty-five percent of the domestic air travel market, for

Jeffrey Leib, Fare Game: Airline Pricing Plans Aim High; Goals are Full Planes, Top-Dollar Tickets, DENVER POST, Nov. 15, 1998, at A-01.

3 898 F. Supp. 685 (D. Minn. 1995) [hereinafter Travel Agency].

942

THE TRAVEL INDUSTRY

antitrust violations.4 Earlier that year, the defendant airlineshad brought about a fundamental change in both the air travelindustry and the nature of the business relationship betweentravel agents and airlines. Since 1960, airlines had paid a cus-tomary ten percent commission to travel agents for each ticketsold, and after deregulation of the airline industry, the "use oftravel agencies significantly increased."5 Over the years, the trav-eling public developed a reliance on travel agents for advice andbooking, especially as the airlines' fare structures became morecomplex.6 In turn, the travel agents developed a reliance oncommission income, and the airlines utilized this system as anefficient means of ticket sales and distribution. By the time ofthe commission cuts and caps, travel agencies were selling eightypercent of airline tickets.'

The beginning of the end occurred on December 1, 1994,when Delta Airlines reduced its commission on internationalfares from the customary ten percent to eight percent followingleaks to the press earlier that fall indicating Delta's compensa-tion scheme to travel agents was under reconsideration.8 Then,on February 9, 1995, Delta announced commission caps on do-mestic flights,9 effective immediately. While Delta did not actu-ally implement these caps until April 1, the other airlinesquickly followed suit."°

Within twenty-four hours of Delta's February announcement,both American Airlines and Northwest Airlines announced thatthey were also implementing Delta's plan, to be effective as soonas they adjusted their respective computerized booking pro-grams." On February 13 and 14, United, USAir, TWA, andContinental all announced their own commission plans based

4 See id. at 687 n.1. Defendants were American Airlines, Delta Airlines, North-west Airlines, United Airlines, USAir, Continental Airlines, and Trans World Air-lines (TWA). See id. Defendants' market share is measured in terms of revenuepassenger miles. See Plaintiffs' Consolidated and Amended Class Action Com-plaint, at 13, In re Travel Agency Comm'n Antitrust Litig., 898 F. Supp. 685 (D.Minn. 1995) [hereinafter Plaintiffs' Complaint].5 Omega World Travel, Inc. v. Airlines Reporting Corp., No. 98-1033, 1999 WL

46756, at *1, (4th Cir. Feb. 3, 1999) (per curiam).6 See id.7 See Allison Connolly, Travel Agents Take Third Hit from Airlines, MIDDLESEX

NEWS, Dec. 6, 1998.8 See Plaintiffs' Complaint, supra note 4, at 21.9 See Travel Agency, 898 F. Supp. at 687.10 See id. The caps were $50 on round-trip tickets priced above $500 and $25

on one-way tickets priced above $250. See id.11 See Plaintiffs' Complaint, supra note 4, at 22.

1999] 943


on Delta's. 12 Within days of Delta's announcement, the long-established partnership between the airlines and travel agentswas over.

After two more rounds of cap reductions, United Airlines,American Airlines, Northwest, Continental, Delta, and USAirhad limited commission payments to $100 for round trips and$50 for one-way trips.13 These caps had a far more profoundimpact on agent income than the reduced commission rates.For example, for a round-trip ticket costing $3,742, an eight per-cent commission would yield $299.36. The travel agency, how-ever, would only receive $100 due to the cap-a forfeiture ofnearly $200 in commission.' 4 One agency reported that the ag-gregate forfeiture amount meant a twenty percent reduction ingross revenue, severely undercutting its ability to operate at aprofit. 15

The reduced commission structures quickly became the normacross most air carriers,16 and except for America West andNorthwest Airlines, administrative exchange fees (at $75.00)and commission fees (at $25.00) became identical among thedefendant airlines.1 7 Ironically, almost a year before Delta madeits first intimations of commission reductions, the U.S. DistrictCourt of Washington D.C. had enjoined the airlines from engag-ing in collusive practices regarding fares. 18

Although ASTA survived a difficult summary judgment chal-lenge,' 9 it settled out of court for $86 million, which was dividedamong ASTA members20 after attorneys' fees were collected. 21

Considering that ASTA's domestic membership numbersaround 11,00022 and travel agents were losing around $1 million

12 See id. at 23-24.13 See Connolly, supra note 7.14 See id.15 See id.16 See U.S. Domestic Carrier Commission Policies, DATELINE ASTA (ASTA, Alexan-

dria, Va.), Oct. 1997, at 4.17 See Airline Administrative Exchange and Commission Fee Chart, DATELINE ASTA

(ASTA, Alexandria, Va.), Jan. 1998, Issue II, at 2.18 See United States v. Airline Tariff Publ'g Co., Civ. A. No. 42-2854 SSH, 1994

WL 454730, at *1 (D.D.C. Aug. 10, 1994).19 See Travel Agency, 898 F. Supp. at 691.20 See Fax from Jeanne Epping, President & Chief Executive Officer, ASTA, to

all ASTA members 1 (Sept. 5, 1996) (on file with author).21 See Fax from Jeanne Epping, President & Chief Executive Officer, ASTA, to

all ASTA members I (Sept. 6, 1996) (on file with author).22 See Plaintiffs' Complaint, supra note 4, at 11.

944

THE TRAVEL INDUSTRY

daily,23 this settlement was no impressive victory. But ASTA andits counsel feared protracted litigation with an uncertain out-come. 24 Moreover, the Department of Justice stated that it"would not permit any agreement requiring the lifting of thecaps," and the court expressed its unwillingness to "direct thefuture commission policies of the airlines. '25 Therefore, ASTAaccepted the settlement offer, which was "among the largest ofall antitrust settlements. 26

Since the settlement, ASTA has called into question other an-ticompetitive airline practices. Because travel agents are depen-dent upon the airline owned and operated computerizedbooking systems such as the Computer Reservations Systems 27

(CRS), Airlines Reporting Corporation 28 (ARC), and Ameri-can's closely held SABRE, 29 they have been subject to furtherabuse. For one, ASTA requested that ARC include a space onthe airline tickets showing the printing fees that the travelagents were forced to pass along to their customers in lieu of acommission payment,30 and the Department of Justice has inves-tigated "possible tacit collusion among the airlines through[ARC]."' 31 Second, ASTA emphasized "that the airline-owned

23 See Skye McQueen, Comment, The Summary Judgment Standard in AntitrustConspiracy Cases and In Re Travel Agency Commission Antitrust Litigation, 62 J. AIR L.& COM. 1155, 1158 (1997).

24 See Fax, supra note 20 at 1. See also Fax from DATELINE ASTA to all ASTAmembers 2 (June 10, 1997) (on file with author).

25 Fax, supra note 20, at 1.26 Id.27 CRS "is essential to all travel agencies because it carries the fares, schedules,

and flight availability of all carriers and receives and dissemintates the informa-tion collected by the Airline Tariff Publishing Company on a daily basis." Plain-tiffs' Complaint, supra note 4, at 4.

28 "ARC provides a centralized method for administering most of the details ofthe agency relationship between airlines and travel agents." Id. "Its purpose is toact as a clearinghouse through which airlines and travel agents deal with eachother. It provides three services to its members: agency accreditation, the provi-sion of common ticket stock, and a centralized reporting system through whichthe agencies report and settle their accounts with the airlines." Omega WorldTravel, Inc. v. Airlines Reporting Corp., No. 98-1033, 1999 WL 46756, at *1 (4thCir. Feb. 3, 1999) (per curiam).

29 SeeJennifer Michels, First Class Travel Insists Airline Collusion is Alive and Well,TRAVEL AGENT, June 22, 1998, at 6.

3o See ASTA's Post-Cuts Strategy Fights Today for Travel Agents' Future, DATELINE

ASTA (ASTA, Alexandria, Va.), Special Issue No. 18-97, at 1.31 Russell A. Klingaman, Predatory Pricing and Other Exclusionary Conduct in the

Airline Industry: Is Antitrust Law the Solution?, 4 DEPAUL Bus. LJ. 281, 293 (1992).But see Omega World Travel, Inc. v. Trans World Airlines, Inc., 111 F.3d 14 (4thCir. 1997) (denying Omega's motion for a temporary injunction preventing TWA

1999] 945


SATO directly competes against all travel agents. SATO's costfactor, which is equivalent to the agent's commission, is muchhigher than 8 percent. "' 2 This raised the question of whetherthe airlines' claim that they can more efficiently distribute tick-ets is indeed valid. Third, travel agents complained of new diffi-culties in using SABRE and in negotiating for SABRE contracts.Some also alleged that American was creating tying contractswhereby travel agents' corporate clients were enticed to get SA-BRE access themselves in order to get corporate discounts. Rely-ing on the Department of Transportation's own statement that"the agency system is the most efficient means of distributingtickets," ASTA requested the DOT to investigate similar abusesof the airline-owned CRS, 1 such as the prevention of displaybias, shorter contract options, and the prohibition on tying ar-rangements, 4 but to no avail. In addition to leaving travelagents exposed to this further harassment at the hands of air-lines, the end result of the settlement was to leave the possibleillegality of the airlines' conduct unaddressed.

B. THE TRAVEL AGENTS' RESPONSE

Before the major airlines implemented their second round ofcommission cuts, the president of ASTA, Mike Spinelli, deliv-ered a speech at ASTA's 67th World Travel Congress wherein heasked, "Isn't this the greatest business in the world?"35

This world has 5.5 billion people. By 2020, we reach 8.5 billionpeople! Only 550 million of them travel internationally. By2005, left alone, travel will grow by 50 percent .... For thosetaking trips, travel agents make 55 percent of the decisions [, andfrequent fliers] prefer to call travel agents over and above anyother booking means, like airlines, the Internet, or their ownpC.

3 6

In answering his own question, he concluded, "Indeed, it is thegreatest business in the world! '317

from canceling agency's ARC subscription on the grounds that the agency's anti-trust allegations will probably fail in light of the "at will" nature of the contract).

32 Klingaman, supra note 3133 ASTA Appeals to DOT for Fair Consumer Access to Air Fares, DATELINE ASTA

(ASTA, Alexandria, Va.), Jan. 1998, Issue I, at 1.'34, See id.35 ASTA President Mike Spinnelli, Address at ASTA's 67th World Travel Con-

gress (Sept. 8, 1997), in DATELINE ASTA (ASTA, Alexandria, Va.), Sept. 1997, at1.

36 Id.

37 Id.

946

THE TRAVEL INDUSTRY

In support of his optimistic outlook, Spinelli could point tonumerous endorsements of the travel agent system as the ideal,and most popular, means of ticket distribution. For example,the Federal Trade Commission's Bureau of Consumer Protec-tion applauded ASTA for keeping consumers aware of variousschemes of travel fraud.3 8 ABC's news program, 20/20, advisedtravelers to use travel agents after conducting a comparison ofbetween "airline ticket prices as quoted by a travel agent versusairline reservations agents."39 Fodor's, the largest English lan-guage travel guidebook publisher, also endorsed the use oftravel agencies,4" as did numerous other newspapers andmagazines.4

For travel agents, such accolades were nice to hear, but didnot pay their bills. In its fight against commission cuts, ASTAwas forced to expend dwindling resources lobbying federal andstate congresses for favorable legislation as part of its "Opera-tion: Take Control" initiative.4 2 Such efforts included the draft-ing of model state legislation, called the "Travel Agency FairTreatment Act" (TAFT), to "bar any travel service supplier from'substantially changing the competitive circumstances of an ap-pointment without good cause.""' At the federal level, ASTAlobbied Congress to pass various laws to improve travel serviceand to regulate collusive practices.44

38 See FTC Applauds ASTA, DATELINE ASTA (ASTA, Alexandria, Va.), Mar. 1998,Issue I, at 3.

9 Why Use a Travel Agent? Ask 14 Million 20/20 Viewers, DATELINE ASTA (ASTA,Alexandria, Va.), Feb. 1998, Issue II, at 1.

40 See id. at 4.41 See LA Times Shines Light on Value of Knowledgeable Travel Agents, DATELINE

ASTA (ASTA, Alexandria, Va.), Oct. 1996, Issue I, at 6; Consumer Group StudyTouts the Value of Travel Agents, DATELINE ASTA (ASTA, Alexandria, Va.), Nov.1997, Issue II, at 4 ("California PIRG [Public Interest Research Group] Con-sumer Advocate Jon Golinger said that it is ridiculous that consumers aren't be-ing told the lowest airfares . . . .He also said that airlines won't stop theirdeceptive pricing practices [such as passive bookings, back-to-backs, hidden city,and refunding the non-refundable] unless consumers and the Department ofJustice put an end to them."); ASTA in the News, DATELINE ASTA (ASTA, Alexan-dria, Va.), Jan. 1998, Issue I, at 4, Issue II, at 3 (highlighting those newspapersrecommending the use of travel agents for airline bookings).

42 See Critical "Take Control" Legislation Efforts Need Push from ASTA Members,

DATELINE ASTA (ASTA, Alexandria, Va.), May 1998, Issue I, at 1.43 ASTA Proposes State Law for Fair Treatment of Travel Agencies, DATELINE ASTA

(ASTA, Alexandria, Va.), Dec. 1997, Issue I, at 2.44 See ASTA Takes Member Concerns to the United States Congress, DATELINE ASTA

(ASTA, Alexandria, Va.), Apr. 1998, Issue I, at 1, 6 (Summarizing S. 1331-Avia-tion Competition Enhancement Act of 1997; H.R. 2748-Airline Service Im-

1999] 947


ASTA also launched a national public relations campaign toeducate the public about the new ticketing fees, which travelershave never paid before. Named the "Air 'Fair' Challenge," thisinitiative called upon travelers to ask airlines:

For the specified route, do other airlines offer lower fares? Doother airlines have a non-stop or direct flight, or provide moreconvenient departure times? Could you suggest a hotel down-town? Is there a number where I could call you directly later?Have other travelers had any problems at this destination?45

Numerous other activities and tips also appeared throughoutASTA's newsletter, DATELINE ASTA.

II. ARGUMENT

Section One of the Sherman Act states, "[e]very contract,combination in the form of trust or otherwise, or conspiracy, inrestraint of trade or commerce among the several States, or withforeign nations, is declared to be illegal."46 Literally, this textwould prohibit any contract or agreement between two business-persons because by its very nature, a business agreement re-strains trade. For this reason, the Sherman Act is limited tothose agreements that unreasonably limit trade. In other words,only agreements with an anticompetitive effect, and thus harm-ful to consumers, are considered Sherman Act violations.

To prove a Sherman Act violation, a plaintiff must establishthree prima facie elements. 47 The first is proof of a contract,agreement, or conspiracy for the purposes of restraining trade.The second is proof that the restraint affects interstate com-merce. The third element, which developed through case law, isproof that the restraint of trade is unreasonable. Thus, a con-spiracy in violation of the antitrust laws is one that limits theability of firms to form those business arrangements that benefitconsumers.

48

provement Act of 1997; H.R. 3160-Airline Competition and Lower Fares Act; S.803-United States Cruise Tourism Act of 1997; and "Consumer Access to TravelInformation Act of 1998").

45 Agents Challenge Airlines: Provide the Same Level of Quality Travel Service,DATELINE ASTA (ASTA, Alexandria, Va.), Dec. 1997, Issue I, at 1.

46 15 U.S.C. § 1 (1994).47 See, e.g., Fuentes v. South Hills Cardiology, 946 F.2d 196, 198 (3d Cir. 1991)

(delineating the necessary elements of a § 1 claim).48 See Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586

(1986).

948

THE TRAVEL INDUSTRY

The defendant airlines' conduct satisfied all three of these el-ements. Because the defendants' operations are wide-spread,this analysis assumes the second element-the restraint affectsinterstate commerce. The analysis thus focuses on the first andthird elements and concludes that the airlines colluded to elimi-nate travel agents and that this behavior was an unreasonablerestraint of trade.

A. COLLUSION

In proving the first element, that the defendants engaged inconcerted action, a plaintiff need not have direct evidence suchas a "smoking contract" revealing that the respective businesseshad any specific intent to collude. Rather, a plaintiff maydemonstrate collusion inferentially through circumstantial evi-dence. The reason for this is perfectly sensible since firms rarelysign formal contracts to collude. More often deals are done sur-reptitiously, and for the antitrust laws to be enforceable, plain-tiffs must be able to show collusion through other means.49

While reliance on inferential evidence is necessary in antitrustlitigation, courts hold the quality of this evidence to a high stan-dard and greatly limit the range of possible inferences.5"

1. Surviving Summary Judgment

In order to enforce this high standard, the U.S. SupremeCourt established a specific summary judgment inquiry that aplaintiff's evidence must satisfy in an antitrust case. In Matsu-shita Electric Industrial Co. v. Zenith Radio Corp., the SupremeCourt stated two issues that district courts should consider at thesummary judgment stage: (1) whether the defendants had anyrational motive to join the alleged conspiracy, and (2) whetherthe defendants' conduct is consistent with the defendants' in-dependent interests.5 In evaluating these issues, the SupremeCourt advised the district courts to "consider the nature of thealleged conspiracy and the practical obstacles to its implementa-tion. '5 2 In other words, the purpose of the inquiry is to deter-mine whether the collusion makes good business sense.

49 "As is usual in cases of alleged unlawful agreements to restrain commerce,[plaintiffs are] without aid of direct testimony that the [defendants] entered intoany agreement with each other to impose the restrictions .... Interstate Circuit,Inc. v. United States, 306 U.S. 208, 221 (1939).

50 See Matsushita, 475 U.S. at 588.51 See id. at 587.52 Id. at 588.

1999] 949


The summary judgment inquiry established in Matsushita isoften characterized as a stricter or heightened summary judg-ment standard." In Travel Agency, the airline defendants arguedthat Matsushita established a heightened standard of proofwhereby plaintiffs must support their inference with evidencefalling just short of a preponderance.54 The court in TravelAgency, however, was quick to point out that plaintiffs carry nospecial burden under Matsushita to survive summary judg-ment.55 Rather, the Matsushita inquiry distinguishes inferencesthat are reasonable in business terms from those that are not.56

Travel Agency survived summary judgment, despite the height-ened standard instituted in Matsushita.57 By virtue of ASTA'scase surviving summary judgment under this special standard,one can infer that ASTA's allegations had some merit. Unfortu-nately, the court offered no in-depth commentary, but insteadseemed satisfied that ASTA's contentions were sufficiently rea-sonable based on the evidence that ASTA wanted to present.58

While it is not necessary in light of the district court's opinion toargue that ASTA's case should survive summary judgment, it ishelpful to distinguish Travel Agency from Matsushita to see whyASTA survived summary judgment. In this way, it becomes clearthat unlike in Matsushita, collusion made perfectly good busi-ness sense in Travel Agency.

In Matsushita, American television manufacturers alleged thattwenty-one Japanese corporations conspired to "dump" Japa-nese-made televisions on the American market at prices belowproduction costs. 59 The goal, as alleged, was to drive Americanmanufacturers out of business and later increase prices at willafter American competition had been eliminated. The Courtfound, however, that the plaintiffs' inferences of price predationmade no economic sense and that the defendants had no mo-

53 See also Brokers' Assistant, Inc. v. Williams Real Estate Co., 646 F. Supp. 1110,1113 (S.D.N.Y. 1986) (citing Matsushita as indication of "a growing willingness onthe part of the federal courts to use summary judgment as an effective tool forexpediting litigation").

54 See Travel Agency, 898 F. Supp. at 690.55 See id. (quoting Eastman Kodak Co. v. Image Technical Services, Inc., 504

U.S. 451, 468 (1992)).56 See id.57 See id. at 690-91.58 ASTA asserted the existence of "a set of occurrences, speeches, meetings,

events, official and unofficial corporate utterances, and conferences," which was"purposefully designed to communicate" the desire to collude. Id. at 691.

51 See Matushita, 475 U.S. at 577-78.

950

THE TRAVEL INDUSTRY

tive to join the conspiracy.60 In support of this conclusion, theCourt emphasized that the defendants had engaged in this activ-ity for over fifteen years.6' If their plan, as alleged, had beensuccessful, the Court reasoned that the Japanese manufacturerswould have to greatly increase prices, requiring yet another actof collusion, to recoup the losses incurred over such a long pe-riod of time. These high prices would, in turn, encourageAmerican upstarts or Korean manufacturers to enter the mar-ket.6 2 The proposition that the Japanese firms could eventuallyeliminate all of their rivals, recoup all of their lost income, andmaintain the monopoly in order to earn the subsequent monop-oly profits was unreasonable." Instead, the Court found it morelikely that the Japanese "were just engaged in hardcompetition."

64

The lynchpin of the Supreme Court's analysis was that therewas little economic motive for firms to conspire to charge preda-tory prices. The airlines in Travel Agency, however, were not en-gaged in predatory pricing, but rather nonprice predation.Under nonprice predation, the predatory firms suffer no short-term losses and need not totally exclude rivals for success. 65 In-stead, the predatory firms make rivals' operations unprofitableby increasing the targets' costs, limiting the targets' income, orboth.66 Later, when the firms gain market share, they raiseprices above prior competitive levels.67 In other words, to forma cartel for the purposes of nonprice predation makes goodbusiness sense from the viewpoint that the colliding firms sufferneither short-term nor long-term losses.

ASTA showed that the circumstances reasonably tended to ex-clude the possibility that the airlines acted independently.Thus, ASTA survived summary judgment:

[D]uring the late 1980s, American Airlines and United Airlinesmade separate unilateral commission cuts. Competitor airlinesdid not follow, and travel agents' customers apparently patron-

60 See id. at 587.61 See id. at 591-92 n.15 (quoting Judge Easterbrook, The Limits of Antitrust, 63

TEX. L. REv. 1, 26-27 (1984)).62 See id.63 See id.64 Id.

65 See ABA ANTITRUST SECTION: MONOGRAPH No. 18, NONPRICE PREDATION

UNDER SECTION 2 OF THE SHERMAN ACT 8 (1991) [hereinafter NONPRICEPREDATION].

66 See id.67 See id.

1999]


ized airlines which continued to pay the 10% commission. BothAmerican Airlines and United Airlines abandoned their commis-sion revision programs shortly thereafter. Extrapolating fromthis evidence, [ASTA] suggest[ed] that [the defendant air-lines] . . . conspired to ensure all airlines would cutcommissions. 6"

The reason for this original failure to cut commissions is sim-ple. Travel agents have the power to direct flyers to those air-lines providing better terms to both the traveler and the travelagents. This ability to influence bookings provides airlines withan added incentive not to be the lone airline slashing commis-sions."9 If the airlines acted together, however, they couldthwart this ability and pay less, or eventually nothing, incommissions.70

2. Parallelism

While showing that collusion would have been economicallyplausible gets a case past summary judgment, it is, alone, insuffi-cient to win a case. To win, a plaintiff first must prove concertedactivity or a "conscious commitment to a common scheme"shared by the co-conspirators, 7' but this does not mean a plain-

68 Travel Agency, 898 F. Supp. at 688 n.5. See also Plaintiffs' Complaint, supra

note 4, at 4 ("In 1981, United lowered its commission rates by imposing a systemof flat fee commissions, based on miles traveled per ticket. After the system was inplace for only four or five days, United reverted to the system of percentage com-mission rates when other carriers declined to follow United's lead.").

69 To increase their patronage, new entrants to the market or other airlines

without the market share that the defendants in Travel Agency enjoy often use thepower of travel agents to direct flyers to those airlines offering favorable terms.Even after the big airlines cut their commissions, these smaller airlines continuedto offer customary commission rates. By November 1997, those airlines that didnot cut commissions included American Trans Air, Eastwind Airlines, Laker Air-ways, Midway Airlines, Air Tran Airlines, and other similarly small domestic andforeign carriers. See Airlines That Have NOT Cut Commissions, HOT FLASHES (Cen-tral/North Fla. ASTA, Bartow, Fla.), Nov. 1997, at 3.

70 "The airlines estimate, and for these purposes the plaintiffs have not con-tested, that they will realize substantial savings as a result of the revised commis-sions. For example, Northwest Airlines estimates an annual savings of $50-58million .... American Airlines estimates a $150 million annual savings." TravelAgency, 898 F. Supp. at 688 n.6.

71 Monsanto Co. v. Spray-Rite Service Corp., 465 U.S. 752, 768 (1984). See alsoRochez Bros., Inc. v. North Am. Salt Co., Inc., 1994 WL 735932, at *3 (W.D. Pa.Nov. 2, 1994) ("[T]here is no specific requirement under § 1 that the allegedconspirators have a complete 'mutuality of interest."'); Petruzzi's IGA Supermar-kets, Inc. v. Darling-Delaware Co., 998 F.2d 1224, 1243 (3d Cir. 1993) ("[T]hedefendants need not share the same motive. Rather, all that is required is thatthey each have a motive to conspire.").

THE TRAVEL INDUSTRY

tiff must demonstrate an express agreement.7 2 The same pow-ers of inference permitted to present a case with genuine,triable issues of fact may also be used to prove an inferred agree-ment among competitors to satisfy the first element of a SectionOne violation.73

Evidence of parallel business behavior, or parallelism, is oneway of proving this first element of conspiracy and collusion, butabsolute parallelism alone will not support a Section One claim.A plaintiff must also prove that the parallelism was not the resultof coincidence, independent actions, or the natural forceswithin the relevant market; but instead, the parallelism was pur-poseful and served as the basis for the actions of each colludingfirm.

To prove actionable parallelism, the plaintiff must distinguishnatural parallel behavior from conscious parallel behavior. Nat-ural parallel conduct can often be consistent with the rationalexercise of independent business decisions. For example, inTheatre Enterprises v. Paramount Film Distributing Corp.,"4 suburbantheaters alleged that various movie producers and distributorshad conspired "to restrict 'first-run' pictures to downtown Balti-more theatres, thus confining its suburban theaters to subse-quent runs and unreasonable 'clearances."' 75 After first notingthat there was no direct evidence of an illegal agreement, theCourt proceeded to list the various economic factors behind thearrangement. 76 Thus, what appeared to be collusion betweenfilm producers was in fact attributable to legitimate businessconsiderations. Courts are less willing to allow an inference ofanticompetitive conduct when the conduct in question has sig-nificant procompetitive benefits 77 or when allowing such an in-ference might chill management's reasonable attempts tomaintain a firm's competitive edge.78

72 See Standard Oil Co. of New Jersey et al. v. United States, 221 U.S. 1, 50-60

(1911); Wilcox v. First Interstate Bank of Oregon, 815 F. 2d 522, 525 (9th Cir.1987).73 See Theatre Enterprises, Inc. v. Paramount Film Distributing Corp., 346 U.S.

537, 540-41 (1954). "[A]n agreement may be inferred from circumstantial evi-dence of 'a common design and understanding."' Wilcox, 815 F.2d at 525 (quot-ing American Tobacco Co. v. U.S., 328 U.S. 781, 810 (1946).74 346 U.S. 537 (1954) (suit brought under §§ 4 and 16 of the Clayton Act).75 Id. at 538.76 See id. at 539-40.77 See In re Coordinated Pretrial Proceedings in Petroleum Products Antitrust

Litigation, 906 F.2d 432, 439 (9th Cir. 1990).78 See id. at 440.

1999] 953


For example, banks set their prime lending rate similar orequivalent to major banks. 9 Reliance on the rates, which indus-try leaders establish, is a convenient way for the banks to deter-mine the national market rate.80 This process serves to stabilizeinterest rates."' In comparison, those markets that are not asstabile, but rather supercompetitive, also tend to be naturallyparallel as firms attempt to avoid price wars. 82 These very differ-ent market structures share the common characteristic of signif-icant interdependence among the competing firms.8"

A market dominated by an oligopoly presents a similar situa-tion of natural parallelism and interdependency."[O]ligopolists acting independently might sell at the sameabove-marginal cost price as their competitors because the firmsare interdependent and competitors would match any price cut.Therefore, they quickly learn that price cuts do not increasemarket share and return to their noncompetitive pricing. 84

The airline industry, especially after deregulation, is an exampleof parallelism in an oligopolistic market. Because the airlinesoperate within an "extremely competitive" market, a change infare price by one "will inevitably result in a similar change byother carriers. 85

Precisely because of the detrimental effects of price wars orother consequences associated with such a tight market, the dis-trict court in Continental Airlines, Inc. v. American Airlines, Inc.used reasoning similar to that used in Matsushita and found analleged scheme of collusive price predation in the airline indus-try as economically implausible.8" To prove parallel conduct inthat case, the plaintiff, Continental Airlines, cited public state-ments by the defendants, American Airlines, United, and Delta,announcing price cuts "almost simultaneously." Continental al-leged that the price cuts were an attempt to force it from therelevant market.8 7 The court, however, reasoned that the largerairlines "would not be able to maintain supracompetitive prices

79 See Wilcox, 815 F.2d at 528.80 See id. at 526.81 See id. at 528.

8,2 See Petruzzi's, 998 F.2d at 1244.8 3 See id.84t Id.85 Continental Airlines, Inc. v. American Airlines, Inc., 824 F. Supp 689, 703 (S.D.

Tex. 1993).- See id.M7 See id.

954

THE TRAVEL INDUSTRY

long enough to recover their losses and make a profit ... "88Therefore, because the defendant airlines had no rational mo-tive to collude, parallel action was not conclusive proof ofcollusion.

In Travel Agency, the same airlines made announcements ofcommon conduct within a very short time span, and in responseto antitrust allegations, posited the same defense. "[A]irlinesoperate in an oligopolistic market, with widely disseminated in-formation. Under such conditions, they argue that rapid pricecoalescence is an economic inevitability. They claim these fac-tors led to the swift adoption of the [commission cuts.]" 8 9 Butboth American and United Airlines quickly abandoned theirearlier, unilateral attempts to cut commissions.9" Therefore, itseems the only successful way to cut commissions would be towork together, the motive to maintain the cartel being the addi-tional profits that each of them would inevitably make.

The airlines' assertion in Travel Agency that the swift adoptionof commission cuts was due to natural parallelism in an oligo-polistic market may actually tend to establish an inference ofcollusion. First, if the commission cuts were indeed due to com-petitive pressure, one would expect these savings to be passedalong to consumers. But despite the airlines' assertions that thecommission cuts are a cost-cutting measure, airfares have dra-matically increased in price in the year since then with domesticflights increasing by 17% and international flights by 30%.91Second, the defense of natural parallelism is unconvincingagainst an allegation of nonprice predation. In Continental, itwas clear to see how price predation could seriously injure thecolluding parties, especially if they had no reasonable expecta-tion of a return on their "investment" in below cost pricing. Innonprice predation, however, those in the cartel not only gainduring the predatory behavior, but gain later when the competi-tion is eliminated. Interdependency of a natural oligopoly can,

88 Id.

89 Travel Agency, 898 F. Supp. at 688.

90 See id. at 688 n.5.

91 See Woods, supra note 1 at 127. The airlines' have a track record of notpassing savings along to consumers. For example, when certain federal airlinetaxes reverted, the airlines did not lower fares, but rather increased them by tenpercent. Likewise, as the cost ofjet fuel fell to a nine-year low, airfares continuedto rise. See ASTA Calls on Airlines to Pass Along Savings on Fuel Prices to Travelers,HOT FLASHES (Central/North Fla. ASTA, Bartow, Fla.), April, 1998, at 4.

1999] 955


therefore, be evidence of unlawful nonprice predation ratherthan a defense to it.92

Similarly, firms may cite to the legitimate effects of a naturaloligopoly as pretext for collusion that, in of itself, may be con-strued as evidence of collusion:93

[S] tatements regarding the competitiveness of the air transporta-tion market cut both ways: they also tend to support an inferencethat the alleged conspirators could have reasonably believed thattheir scheme had a good chance of success because the factorscited ... would tend to mask [their] actions. Air carriers tend tomatch the price changes of other air carriers. Thus, the allegedconspirators could have reasonably assumed that it would not at-tract too much unwanted attention if other airlines lowered (atthe beginning of the conspiracy) or raised (after smaller compet-itors had been driven from the market) their prices in responseto American's price initiatives.94

If the public has grown accustomed to a certain degree of priceparallelism, then the airlines might also feel comfortable thattheir up-to-now successful defense of oligopolistic coaslescencewill also mask nonprice parallelism.

3. Plus Factors

After showing that the parallelism between named firms isconscious rather than natural, the second analysis necessary inextrapolating unlawful collusion from parallel business activityconsists of "plus factors." Without the added plus factors, con-scious parallelism, per se, would not support a violation of theSherman Act.9" These plus factors are, in effect, the little bitextra needed before the courts will allow circumstantial evi-dence as conclusive proof of collusion. Examples of plus factorsinclude "price parallelism, product uniformity, exchange ofprice information, and opportunity to meet to form anti-com-petitive policies."96

92 See Barry v. Blue Cross of Ca., 805 F.2d 866, 869 (9th Cir. 1986) (holdingthat interdependence is required to infer a conspiracy from parallelism.).

93 See Dimidowich v. Bell & Howell, 803 F. 2d 1473, 1479-80 (9th Cir. 1986).94 Continental, 824 F. Supp. at 705 (the quotation continues: "Moreover, many

inefficient air carriers have gone bankrupt since deregulation, and observersmight tend to credit the passing of a few more smaller carriers to inefficiencyrather than to predatory pricing.").95 See Theatre Enterprises, 346 U.S. at 541.96 Wilcox, 815 F.2d at 525-26.

956

THE TRAVEL INDUSTRY

Through plus factors, a plaintiff shows not only that the paral-lelism was conscious, but also that the named firms had both aplausible reason and an opportunity to collude. Depending onthe case, this often amounts to re-proving that the parallelismwas conscious, but with more conclusive, direct evidence of anagreement. At times, it even appears that the requirement forthese additional factors contradicts the Court's assurance thatbecause of the difficulty in proving antitrust violations throughdirect evidence, inferential evidence suffices.9 7

For example, in American Tobacco, Co. v. United States, 8 the de-fendant cigarette manufacturers were quite bold in their pricefixing schemes. Within the same day of defendant Reynolds'unexpected increase of its list price, the other major competi-tors raised their list prices to the same level, seizing "the oppor-tunity of making some money."9 9 When consumers switched tominor, cheaper brands in response to the price hike, the de-fendants again acted in concert, this time to lower prices to alevel that would eliminate the competition from the minorbrands.'00 Then the defendants began to raise prices again; thistime, when a retailer heard of a price hike announcement fromone producer and attempted to buy from another, the other re-fused to fill the order until it had also announced its pricehike. 10'

Of course, as antitrust law has evolved, so has big business'sattempts to act more surreptitiously. In Interstate Circuit, Inc. v.United States,10 2 a movie exhibitor sent a letter to eight film dis-tributors naming all eight as addressees in the letter. The letterurged the distributors to include in all subsequent licensingagreements with exhibitors a provision fixing prices on admis-sion and another provision limiting the number of double fea-

97 See, e.g., Petruzzi's, 998 F.2d at 1233-42. (approving defendants' testimonialevidence of an agreement and secretly recorded tapes of defendants discussingtheir agreement as acceptable plus factors, but disapproving evidence in the formof market analysis presented by expert testimony and defendants' infrequent ac-count turnovers as insufficient to draw definite conclusions despite their sugges-tive value); Wilcox, 815 F.2d at 528 (requiring proof of an agreement in the formof actual price fixing rather than inferential proof based on proffered evidence);United States v. Container Corp. of America, 393 U.S. 333, 337 (1969) (approv-ing plaintiff's proffered evidence of a confidential, informal agreement to fixprices charged to specific customers).

98 328 U.S. 781 (1946).- Id. at 805.100 See id. at 806.101 See id. at 808.102 306 U.S. 208 (1939).

1999] 957


tures. Subsequently, all eight distributors put these provisionsin their contracts. This letter did not reveal an agreement, for-mal or informal, but rather its evidentiary value was limited toshowing that each distributor was aware "that the proposals wereunder consideration by the others."10' The Interstate Circuit let-ter highlights the second way in which plus factors are used-that is, to show that the conduct would be in the parties' self-interest if all acted in the same way, but would be contrary totheir self-interest if each acted alone. Such evidence is the mostcompelling plus factor. 10 4

Each was aware that all were in active competition and that with-out substantially unanimous action with respect to the restric-tions for any given territory there was risk of a substantial loss ofthe business and good will of the subsequent-run and independ-ent exhibitors, but that with it there was the prospect of in-creased profits. 105

Because the proposal meant a dramatic departure from previ-ous business practices, the court reasoned further that withoutan agreement diversity of action would follow:

It taxes credulity to believe that the several distributors would, inthe circumstances, have accepted and put into operation withsubstantial unanimity such far-reaching changes in their businessmethods without some understanding that all were to join, andwe reject as beyond the range of probability that it was the resultof mere chance.1

0 6

The Third Circuit restated this principle in Petruzzi's IGA Su-permarkets, Inc. v. Darling-Delaware Co.'07 In Petruzzi's, the defend-ants had an agreement not to bid as aggressively on each other'sexisting accounts as they bid on new accounts. The Third Cir-cuit noted that these actions, if done independently, would beagainst the self-interest of the individual defendants. 0 This factwas an important plus factor that the court considered in revers-ing the district court's granting of summary judgment.

Another plus factor is the opportunity to collude such asthrough correspondence, meetings, or other communications.This can be necessary to prove "that the defendants were con-

103 Id. at 222.104 See id.105 Id. at 222.106 Id. at 223.107 See 998 F.2d at 1242-45.108 See id.

958

THE TRAVEL INDUSTRY

scious of each other's conduct and that this awareness was anelement in their decision making processes."' 9 For example,the Interstate Circuit letter served as a vehicle to create awarenessof one distributor's proposal. 110 Indeed, the courts treat infor-mation disseminated privately as more suspect than throughpublic channels,1 ' but this does not mean that exchange of in-formation publicly as with the banks in Wilcox is per seinapplicable.

The most probable reason why some courts require almost orabsolute direct proof of carteling as the plus factor, while othersallow less stringent forms of circumstantial evidence, may be re-lated to the type of antitrust violation alleged. In those caseswhere plaintiffs had to carry a higher standard of proof, the al-leged anticompetitive conduct consisted of fixing prices at anartificially low level to drive out weaker competitors. 12 In such acartel, there is great incentive to cheat because firms are per-haps incurring losses or at least foregoing greater earnings bycharging below market prices. 113 But in nonprice predation, thecolluding firms bear no losses, and as a consequence, this "gametheory" or "prisoner's dilemma" is not a problem. For this rea-son, the heightened standard placed on plus factors found inprice predation cases should not be applied in nonprice preda-tion case such as Travel Agency.

As an example of nonprice predation, the court in Brokers'As-sistant, Inc. v. Williams Real Estate Co." 4 found persuasive evi-dence of opportunity to collude without "direct evidenceexplicitly showing agreement among all the defendants," butrather, from a substantial amount of evidence from which onecould infer the existence of a conspiracy. 15 Thus, the main argu-ment in Brokers' concerned the sufficiency of the plaintiffs evi-dence of the defendants' opportunity to collude.

109 Id. at 1243. See also Pittsburgh Plate Glass Co. v. United States, 260 F. 2d 397,

401 (4th Cir. 1958) ("The proposition is too elementary to require elaboration,that participation in a criminal conspiracy need not be proved by direct evidence;,a common purpose and plan may be inferred from a "development and a collo-cation of circumstances."'" (quoting Glasser v. United States, 315 U.S. 60, 80(1942))).

110 See Interstate Circuit, 306 U.S. at 222.III See Wilcox, 815 F.2d at 526-27.112 See Petruzzi's, 998 F.2d at 1233; Wilcox, 815 F.2d at 525; American Tobacco, 328

U.S. at 806.113 See Petruzzi's, 998 F.2d at 1233.114 646 F. Supp. 1110 (S.D.N.Y. 1986).115 Id. at 1118.

1999] 959


The Brokers' Assistant (TBA) compiled lists of available com-mercial office space and prospective tenants. For a fee, TBAprovided its lists to commercial real estate brokers. TBA ob-tained the information for its lists from brokers such as the de-fendants. When the defendants all at once stopped providingthe information to TBA, TBA sued alleging that the defendantshad conspired to put TBA out of business.

TBA proffered a variety of evidence to show an agreement ex-isted. First, a representative of one of the defendants met with aTBA representative and stated that his real estate brokerage firmwould no longer provide market listings that he and the othershad been providing TBA and each other for quite some time.' 16

Then, the defendant called the other brokerage firms and in-formed them that he was no longer providing the lists to TBA.117

Because there were disputes as to what exactly had been said inthese various conversations,"1 " defendants argued that this evi-dence was inconclusive as to whether "defendants knew whateach other was doing, much less that any of them agreed withany other."1 9

Instead, defendants argued that the evidence only supported"findings of mere communications among competitors and con-scious parallelism. ' 120 The court, however, disagreed with thedefendants' characterization of the evidence. Echoing InterstateCircuit, the court observed that shortly after these conversations,the defendants simultaneously reversed a long-standing businesspractice. 2 Taken together, this evidence pointed towardconspiracy.

In applying plus factors to Travel Agency, the two principal evi-dentiary considerations are motive and the opportunity to forma collusive agreement. 122 As discussed in the summary judgmentanalysis, the facts of Travel Agency reasonably supported an infer-

116 See id. at 1115.117 See id.11 However, "[i]t is undisputed that at this [initial] meeting Cohen [defend-

ant's representative] also told Gross [plaintiff] that major brokerage firms . . .would from that time on refuse to provide TBA with listings of available space."Id.

IIl, Id. at 1117.120 Brokers', 646 F. Supp. at 1117.121 See id. at 1118.122 Certainly others exist such as price parallelism and product uniformity, but

considering the nonprice predation element and the service-centered nature ofair travel, these other plus factors derived from pricing and manufacturing activi-ties are mostly inapplicable.

960

THE TRAVEL INDUSTRY

ence that the alleged antitrust activity made good businesssense. Proving an actual agreement to collude, in contrast,might have been more difficult. But drawing upon the strongindications of motive to cartel, coupled with the nonprice pre-dation argument, the court would not have required direct evi-dence of conspiracy as in Wilcox or Petruzzi's. Rather, ASTAwould have been allowed to rely on evidence showing that thecircumstances pointed to the existence of an agreement, ormore likely, a tacit understanding.

a. Motive in Travel Agency

As regards the first plus factor, motive, there exists strong sim-ilarities between Brokers' and Travel Agency. 12 3 For example, inboth cases there were refusals to deal and the sharing of infor-mation by the defendants. Also, both cases involved serviceindustries.

The defendants in Brokers'were large real estate brokers who,for a commission, solicited tenants to rent office space in thegreater New York area. A substantial part of the trade was thecompilation of lists of prospective tenants and available officespaces. These lists were customarily shared among licensed bro-kers. The plaintiff, TBA, was a relatively young company thatdeveloped a computerized brokerage system to coordinate thissolicitation process. It relied heavily on these lists, as did all realestate brokers, and had invested a considerable amount of capi-tal in its operations. TBA claimed that many in the communityfavored using TBA's system, and that it provided better, moreefficient service without directly competing with the brokers. 124

Also, TBA claimed that by adding to the aggregate of listing in-formation among brokers, it furthered the business interests ofall. 125

123 Note that Brokers' addressed these issues in a summary judgment proceed-ing and presents no actual holding or findings based on any final adjudications.See Brokers', 646 F. Supp. at 1117 ("The issue before this Court upon defendants'motion for summary judgment is not whether TBA has presented enough evi-dence to establish its antitrust claim. Rather, the Court only faces the question ofwhether defendants have satisfied their burden so as to be entitled to summaryjudgment.").

124 "Subscribers were enthusiastic about the service. Even non-subscribers ap-peared to appreciate the benefit TBA conferred upon the real estate market." Id.at 1115.

125 TBA also claimed that it provided a promotional services to the business atlarge, because it "issued press releases, conducted surveys, placed advertisementsin newspapers and trade journals, joined the Real Estate Board, circulated pro-

1999]


When the established brokers stopped providing these lists toTBA, TBA's business was devastated. 126 The court found it clearthat without the lists, "the value of TBA's services to its subscrib-ers was certainly reduced. TBA's 'faucet was turned off;' it was'dead in the water."1 27

In justification of their action, the defendants claimed that"TBA merely redistribute [d] listings provided by the brokers."'' 21

The defendants also argued that TBA was a free rider, using in-formation on which they had spent time and money to compilefor their own use. 129 Although defendants attempted to intro-duce evidence and arguments to support an inference of in-dependent action, the court found only one reasonableinference based on the nature of the defendants' conduct:

The inference of anticompetitive motives on the part of defend-ants can be bolstered by engaging in some basic economic rea-soning. If TBA's service survived absent any one defendant'slistings in its data base, but with the listings of all remaining de-fendants, including the withdrawing individual defendant's ri-vals, the withdrawing defendant would be damaged. Informationregarding its competitors' space would receive wider distributionthan information about its own space. Therefore, getting all thedefendants to join the boycott was essential for any one defend-ant to succeed in suffocating TBA.511

Applying this same economic reasoning to the facts of TravelAgency, the circumstances surrounding the commission cuts andinstitution of commission caps indicates an anticompetitive mo-tive and a plausible reason to collude. To begin with, the les-sons learned during earlier attempts at unilateral cuts made theairlines aware of their need to collude for the scheme to be suc-cessful. That is, by acting alone, each stood a substantial risk ofloss of business and goodwill from their main distributors, the

motional brochures, gave demonstration and receptions for brokers (includingdefendants), and canvassed potential customers." Id. at 1121.

126 See Brokers, 646 F. Supp. at 1116 ("TBA has cut its staff and moved to

smaller offices. TBA has curtailed its services and no longer provides listings ofretail stores and industrial space. In sum, TBA's business has declinedmarkedly.").

127 Id.128 Id. at 1114.129 See id. at 1119-20. By casting TBA in the light of a free rider, the defendants

hoped to invoke Supreme Court cases protecting the right of businesses to pro-tect their investments from free riders. See id. at 1120 n.38.

130 Id. at 1122.

962

THE TRAVEL INDUSTRY

travel agencies, similar to that between the movie distributorsand exhibitors found in Interstate Circuit.

Because of the volume of ticket sales generated through travelagencies, agencies had the very real ability to negatively impactone airline's business by encouraging travelers to book withthose airlines not cutting commissions. The source of this influ-ence comes from the access travel agents have to the full gamutof booking information and the ability to "weed" through it.This is similar to the way TBA's services organized and con-densed information to better facilitate market transactions. Thecrux of the services provided by both TBA and the airlines wassimply better organized information. Not only did this benefitconsumers directly by enabling them to make better choices,but it had the indirect commercial benefit of maintaining acheck against the airline's oligopoly.

More importantly, the airlines had to act together if they wereto create such a fundamental change in how airline tickets weresold, which the Supreme Court in Interstate Circuit found tellingof collusion. In Brokers', the court was cognizant of the coopera-tive relationship between TBA and the larger brokerage houses.In Travel Agency, this synergy was far more pronounced. Thetravel agents and airlines had developed a symbiotic relationshipspanning many decades. But fearing that travel agents werebenefiting too much from this relationship, or rather, that travelagents were an easily eliminated cost of doing business, the air-lines acted to force them out of business in order to strengthentheir oligopoly power, which they needed in order to chargeabove-market, supra-competitive prices.

Another important similarity between these cases consists ofthe strong consumer preference shown for the one beingsqueezed-out. As with TBA, there is strong evidence that thepublic generally favors using travel agents over direct booking,even with the advent of the Internet. This reflects two factors ofthe business of travel agencies that are, by themselves, docu-mented by direct evidence. The first is that travel agents are abetter, more efficient way of retailing or distributing airline tick-ets. The second is that ASTA has no qualms with existing in adual distribution system whereby the airlines develop Internetservice.13' If these factors were not true, then logically the pub-lic would no longer prefer travel agents.

11 Two nationally syndicated columnists "emphasized the advantages of usingtravel agents over booking travel on the Internet, noting that: 'a call to a travel

1999] 963


Travel Agents is distinguishable from Brokers' because there isno free rider problem that would strengthen the airlines' claimthat they were acting with legitimate business conduct. Travelagents pay a substantial fee for computer links to schedulingand bookings even though much of this information is availablefree on the Internet or by calling the airlines directly. In return,the airlines pay a commission for the travel agents' service ofbringing customer and carrier together.

Lastly, in American Tobacco, the Supreme Court ruled that evi-dence of a rise in prices during a time of surplus indicates theexistence of a cartel. 13 2 When the defendants in that case sum-marily raised their prices for cigarettes, the costs of tobacco andmanufacturing had been falling for years. 33 Therefore, theCourt could find no economic justification for the price in-crease. 1 4 Similarly, the airlines slashed commissions at a time ofrecord profits and falling fuel costs and taxes. 35 The irony isthat "the airlines continue to raise their fares and cut commis-sions for their primary distribution system (travel agents) whileraking in record profits. The airlines have realized a 600% com-bined profit increase in the last year alone. 1 36 Yet, the airlinesclaimed that the cuts were legitimate, independent actions toreduce operating costs in their competitive market. Viewed inlight of the airlines' wide profit margins, such a claim seemsmore like a pretext than a legitimate business decision.

b. Opportunity to Collude in Travel Agency

The other principal plus factor ASTA would have had to es-tablish is the airlines' opportunity to collude. ASTA had no di-rect evidence of an agreement, not even an informal agreement.

agent will produce the lowest fare and book a flight in a single swoop. The agentcan also handle other travel arrangements, such as hotels and car rentals. Com-puters can't suggest alternatives."' ASTA in the News, DATELINE ASTA (ASTA, Alex-andria, Va.), Nov. 1997, Issue II, at 4.

The Travel Industry Association determined that travel agents were the pre-ferred source over the Internet and other sources from a survey based on thefollowing criteria: reservations, prices, types of vacations, schedules, where to go,things to do, and maps. See Travel Agents vs. the Internet, DATELINE ASTA (ASTA,Alexandria, Va.), Dec. 1997, Issue I, at 4.

132 See American Tobacco, 328 U.S. at 805.133 See id.134 See id.135 See ASTA Calls on Airlines to Pass Along Savings on Fuel Prices to Travelers, supra

note 91.136 Agents Challenge Airlines: Provide the Same Level of Quality Travel Service,

DATELINE ASTA (ASTA, Alexandria, Va.), Dec. 1997, Issue I, at 1.

964

THE TRAVEL INDUSTRY

ASTA did assert, however, that various meetings and other ex-changes of information took place, which suggested an overallsubtle scheme of forming the cartel terms. This was in additionto evidence of nearly simultaneous and identical cuts in commis-sions. ASTA argued that the airlines:

participated in a knowing conspiracy involving public speeches,electronic communications, subtle press releases, private dinnersfor airline executives and attendant antitrust counsel, and indus-try-bonding meetings at the Super Bowl and other locations.Plaintiffs do not deny that the airline industry needs to controlcosts, but argue it was not happenstance that each defendant,within days, "stumbled" onto the identical price structure chosenby their confederates. Plaintiffs seem to acknowledge the statisti-cal probability that a cube of ice can appear in a vat of boilingwater, but doubt they have seen one yet.137

While it is for a factfinder to adjudicate the true evidentiaryvalue of these assertions, the district court found it compellingenough to use it as a primary basis for allowing ASTA's case tosurvive summary judgment.'38

In Pittsburgh Plate Glass Co. v United States,13 9 the Fourth Circuitheld that such communications between the defendants shortlybefore the parallel behavior was sufficient evidence to sustain acriminal antitrust conviction. In Pittsburgh Plate Glass, the mem-bers of a mirror manufacturing association all sent their respec-tive customers announcements of price increases within days ofreturning from the association's annual convention. TheFourth Circuit held:

[P]roof that PPG announced a price rise identical with that an-nounced almost simultaneously by its competitors was notenough by itself to convict. However, PPG's "conscious parallel-ism," in light of its apparent close connection with the climax ofthe conspiracy, reasonably permitted the jury to infer that PPGsent the letters pursuant to an agreement with some or all of theconspirators. 140

The district court in Brokers'came to the same holding undersimilar reasoning. 4 1 The plaintiffs in Brokers' had no direct evi-dence showing any agreement between the defendants. Thecourt, however, still denied summary judgment because the evi-

137 Travel Agency, 898 F. Supp. at 690.138 See id. at 691.139 260 F.2d 397, 401 (4th Cir. 1958).140 Pittsburgh, 260 F.2d at 401141 See Brokers', 646 F. Supp. at 1118.

1999] 965


dence that the defendants communicated with one anothershortly before the parallel conduct allowed a reasonable infer-ence of a conspiracy. 14 2

B. UNREASONABLE RESTRAINT OF TRADE

Assuming ASTA could have successfully proven concerted ac-tion with the intent to collude, it would then have had to provethe final element, unreasonable restraint of trade. There aretwo means of proving that a restraint of trade is unreasonableand harmful to competition. The first and easiest way is to pig-eon-hole the business activity into a pre-recognized category ofunlawful conduct' 43 These categories comprise business prac-tices that are so facially anticompetitive that further inquiry isunnecessary. 44 Generally, the courts will find firms in per seviolation of section one of the Sherman Act when they colludedirectly, or indirectly through persuasion of others in the mar-ket, to deny a competitor access to a supply or facility that thecompetitor needs to compete.145 Also, the colluding firms usu-ally enjoy a dominant position in the marketplace.' 46

When the conduct is not a per se violation, courts apply theRule of Reason. 47 Under this analysis, the plaintiff must provethat the anticompetitive effects outweigh any procompetitivebenefits. "'

The conduct in Travel Agency is a vertical restraint, which fallsunder the Rule of Reason. 49 The airlines argue efficiency (or,

142 See id.143 See Northwest Wholesale Stationers, Inc. v. Pacific Stationery and Printing

Co., 472 U.S. 284, 289 (1985).144 See id. at 289-90; see also Northern Pac. Ry Co. v. United States, 356 U.S. 1, 5

(1958).45 See Northwest Wholesale Stationers, 472 U.S. at 294; Harkins Amusement Enter.

v. General Cinema Corp., 850 F. 2d 477, 486 (9th Cir. 1988) (per se violation"where joint efforts by firms disadvantage competition by inducing suppliers orcustomers to deny relationships the competitors need in order to compete").

146 See Northwest Wholesale Stationers, 472 U.S. at 294.147 See id. at 295-97; Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 59

(1977).148 See Northwest Wholesale Stationers, 472 U.S. at 294.14, Nonetheless, it should be emphasized that the per se rule is not entirely

inapplicable in this case. In Northwest Wholesale Stationers, the plaintiff failed to geta per se ruling because it still had access to the relevant market. See id. at 295 n.6.Even though the facts may not make out a prima facie case under the per se rule,"[s]uch activity might justify per se invalidation if it placed a competing firm at asevere competitive disadvantage." See id. Thus, the assertion by the defendants inTravel Agency that travel agents still have access to book tickets might not provide

966

THE TRAVEL INDUSTRY

reduction in transaction costs), freedom to change theirmethod of distribution, and freedom not to deal with competi-tors, none of which necessarily indicate blatantly unlawful be-havior. There is also evidence, however, that the airline industryis concentrated enough that vertical restraints would be a viablemeans of accomplishing market dominance. 150 Therefore, anyvertical restraints imposed in this industry should be subject tocareful Rule of Reason analysis.

1. Evidence of Anticompetitive Effects

The Rule of Reason draws a thin line between legitimate busi-ness conduct and anticompetitive conduct. Because the distinc-tion is often difficult to make, the courts require compellingevidence of adverse anticompetitive effects.1 5 1 Proof of actualdetrimental effects, however, is not necessary if an analysis of thepertinent market structure shows that the defendant has theability to set prices independent of market forces. 15 2

Situations involving a dual distributorship, where supplierssell both directly to buyers and through independent dealers,fall under vertical restraint analysis. 153 In the dual distributor-ship between airlines and travel agents, an unreasonable re-straint can take the form of an unlawful refusal to deal, proof ofwhich hangs on this difficult distinction between legitimate busi-ness conduct and unlawful anticompetitive behavior. 154

One method of determining an unlawful refusal to deal is theIntent Test, 15 5 which attempts to distinguish a firm's right to

a strong defense if their actions severely impeded the travel agents' ability to dobusiness. Also, evidence of horizontal collusion among the airlines to eliminatetravel agency commissions would invoke per se analysis. See Illinois Corp. Travelv. American Airlines, Inc., 806 F.2d 722, 726 (7th Cir. 1986).

150 See Klingaman, supra note 31.15 See United States v. Arnold, Schwinn & Co., 388 U.S. 365, 380-82 (1967).152 See FTC v. Indiana Fed'n of Dentists, 476 U.S. 447, 460-61 (1986); NCAA v.

Board of Regents, 468 U.S. 85, 109 n.38 (1984).153 See Arnold, Schwinn, 388 U.S. at 372.154 See Aladdin Oil Co. v. Texaco, Inc., 603 F.2d 1107, 1113-16 (5th Cir. 1979)

(discussing the distinction between concerted activity that is an innocent aspectof business and concerted activity that is inimical to competition).

155 Compare Alaska Airlines, Inc. v. United Airlines, Inc., 948 F.2d 536, 544 (9thCir. 1991) (holding that a facility is essential "only if control of the facility carrieswith it the power to eliminate competition in the downstream market.") with Of-ficial Airline Guides, Inc. v. FTC, 630 F.2d 920, 925-26 (2d Cir. 1980) (holdingthat the essential facilities doctrine was not applicable because the monopolistpublisher of flight schedules engaged in a different line of commerce than theplaintiff air carrier).

1999] 967


deal with whomever it pleases (legitimate business intent) frommonopolistic practices (anticompetitive intent).156 TheSupreme Court held in Aspen Skiing Co. v. Aspen Highlands SkiingCorp.157 that the right to refuse to deal with a competitor is notabsolute. 5 Rather, there might exist limited circumstanceswhen cooperation to some degree is necessary for effective com-petition and consumer welfare.'5 9

Aspen is a ski resort comprised of four major skiing venues, 6 °

three of which were owned by the defendant, Ski Co.'61 Entryinto the market is limited by geographical considerations andgovernment environmental regulations. 6 2 When each venuewas individually owned, an interchangeable ticket replaced theolder tickets good for only one venue. This new ticket systemwas based on a similar method used in the Alps and quickly be-came popular among skiers who wanted to ski throughoutAspen. Over the years, the interchangeable ticket continued toimprove. It became easier for skiers to use, and the revenueallocation system became more accurate.

However, after Ski Co. had acquired three of the four resorts,it began to express a desire to discontinue the ticket's use, stat-ing that it wanted to compete for skier loyalty directly and elimi-nate the "administratively cumbersome" method of ticketmonitoring.'63 In response to Ski Co's criticism that the methodof revenue allocation was inaccurate, the plaintiff, Highlands,offered to hire a third-party auditor to audit the revenue alloca-tion. In addition, Highlands offered to accept a fixed percent-age of total ticket revenue that was well below the actualpercentage of time skiers actually spent at Highlands' facility. Inthe end, Ski Co. simply rejected all of Highland's offer and dis-continued participation in the interchangeable ticket.

The plaintiff's attempts to operate without the joint ticketswere frustrated by Ski Co.'s misleading advertising and other

156 See United States v. Colgate & Co., 250 U.S. 300, 307 (1919).157 472 U.S. 585 (1985).158 See id. at 601 (reaffirming Lorain Jornal Co. v. United States, 342 U.S. 143

(1951)).159 See id.-6 See id. at 587-88.

161 See id. at 589-90.162 See Aspen Skiing Co., 472 U.S. at 588.163 See id. at 591-92.

968

THE TRAVEL INDUSTRY

tactics. 164 Moreover, the plaintiff was unable to- protect itselffrom its loss of revenue and skiers. "The development of a newdistribution system for providing the experience that skiers hadlearned to expect in Aspen proved to be prohibitivelyexpensive." '1 6 5

In support of its position, which was accompanied by an ami-cus curiae brief filed by American Airlines, 166 Ski Co. asserted itsright not to cooperate with its competitors. 167 Ski Co. could not,however, offer any plausible efficiency justifications for refusingthe interchangeable ticket. Its new ticket system was no moreefficient than the one it replaced. 168

Echoing Interstate Circuit, the Court consequently found thatSki Co. was not motivated by efficiency concerns but "was willingto sacrifice short-run benefits and consumer goodwill" to inflictinjury on its rival.169 The Court focused on how Ski Co.'s actionsbrought about a fundamental change "in the pattern of distribu-tion that had originated in a competitive market and persistedfor several years."'170 In addition, this distribution system waspracticed throughout the world, which supported Highlands' ar-gument that this was the most efficient method of selling lifttickets. 17 ' Furthermore, consumers were benefited from thisjoint lift ticket. Instead of having to go to the individual compet-itors for access, they could buy one ticket for access to all of the

164 See id. at 593-95. These other tactics are also forms of nonprice predation

where the goal is to raise a rival's cost above his income. See NONPRICE PREDA-TION, supra note 65, at 8-9.

165 Aspen Skiing Co., 472 U.S. at 608.166 See id. at 587.167 "Aspen Skiing Corporation is required to compete. It is required to make

independent decisions. It is required to price its own product. It is required tomake its own determination of the ticket that it chooses to offer and the ticketsthat it chooses not to offer." Id. at 598 n.22.

168 See id. at 609.169 Id. at 610-11.170 Id. at 603. "In any business, patterns of distribution develop over time; these

may reasonably be thought to be more efficient than alternative patterns of distri-bution that do not develop. The patterns that do develop and persist we may callthe optimal patterns. By disturbing optimal distribution patterns one rival canimpose costs upon another, that is, force the other to accept higher costs." Id. at604 n.31 (quoting R. BoRKx, THE ANTITRUST PARADOX 156 (1987)). "In § 1 caseswhere this Court has applied the per se approach to invalidity to concerted refus-als to deal, 'the boycott often cut off access to a supply, facility or market neces-sary to enable the boycotted firm to compete... and frequently the boycottingfirms possessed a dominant position in the relevant market." Id. at 604 n.31(quoting Northwest Wholesale Stationers, 472 U.S. at 294).

171 See id. at 603.

9691999]


resorts. 172 Consumer surveys and expert testimony indicatedstrong consumer preference for, and reliance on, the inter-changeable ticket.1 73

Applying this case to Travel Agency, it becomes clear that thereexists a credible allegation of unreasonable restraint on the partof the airlines. Consumers have shown a preference for makingtheir travel arrangements through travel agents. And a similardual distribution system of selling tickets had evolved betweenthe travel agents and the airlines both in this country andaround the world.

The relationship that developed over the years benefited bothtravel agents and airlines. Travelers could either buy their tick-ets directly from the airlines, or if they wanted "thorough coun-seling," could patronize "full-service agencies. ' 174 In this way,travelers had differing levels of service based on their particularpreference.

1 75

American [Airlines] has no particular reason to cram unwantedmoney down the throats of travel agents. If travel agents arecharging too much for their services, why does American not re-duce the commission and thereby angle for passengers withlower net prices at no cost to itself? It must be purchasing somesort of valuable service from these travel agents. 1 76

Both distribution systems were similar in that the relevantservices were not "resold." In Aspen Skiing, the resorts ran theirrespective ski lifts independently of each other, but revenuesfrom the ticket did not reflect actual usage. Instead, revenueswere based on percentages. Thus, there was the potential thatthe distribution system resulted in one resort bearing the risk ofreduced sales revenue of the other. In Travel Agency, the airlinesestablished their independent schedules and pricing, whichwere provided to travel agencies through ARC to sell to consum-ers. As with any true agency relationship,'7 7 the principal, the

172 See id. at 605-06.173 See id. at 606-07174 See Illinois Corporate Travel, 806 F.2d at 728. The Seventh Circuit empha-

sized that the plaintiff was not alleging conspiracy among the airlines, but be-tween one airline and other travel agents. See id. at 726. The court did notexpress an opinion as to the legal effects of such a conspiracy between airlines,but it did seem to have a strong opinion that travel agents are important to theindustry at large.

175 See id. at 729.176 Id. at 728.177 "The relation of travel agent to airline is not substantially different from the

relation of broker to real estate owner, of brokerage house to investor, or of

970

THE TRAVEL INDUSTRY

airlines, bore certain risks that were not passed on to theagents. 17

1 However, travel agents accounted for eighty percentof all domestic airline sales. 179

Of course, the airlines would like the funds "siphoned off' bycommissions but they have offered no real efficiency justifica-tions for eliminating travel agents. Without the travel agents,the airlines will have to bear the administrative costs of ticketsales themselves; therefore, it is incorrect to assume that withoutthe travel agents these costs will simply disappear.

In fact, the added administrative burden might prove to bemore costly. For example, there is the cost of redundancy.Travel agents pooled their expertise and services at one locationbut sold tickets from all of the airlines. Now, each airline musthave its own distribution system. Furthermore, the airlines'ticket sales staff cannot provide the sort of expertise and cour-tesy that professional travel agents offer.

Finally, like the ski resort in Aspen Skiing, travel agents faceddifficulties in adapting to the new business circumstances in theface of nonprice predatory conduct. Travel agents were alreadytied to the airlines with exclusive dealing contracts in order tohave access to airline schedules, prices, and bookings. Com-puter programs providing the access, such as SABRE, are notfree, and in fact require commitments to long-term contracts.Thus, as travel agencies faced reduced commissions, the addedliability of long-term, expensive contracts was further incentivenot to stay in business.

Travel agencies also incurred the added expense of lobbyingefforts and public relations campaigns in an attempt to stay prof-itable with the new commission policy. In light of various legalobstacles and strong consumer resistance to the new printingfees, these added costs only increased the burdens on existingtravel agents and discouraged new agents from entering themarket.

travel agent to hotel, rental car company, or other provider of travel services." Id.at 725; see also Plaintiffs' Complaint, supra note 4, at 3 ("Through accreditationby ARC, the travel agents are agents of the defendant airlines with respect to thesale of airline tickets and, in essence, serve as the airlines' distribution system.").

178 "The travel service operator takes no risk of unfilled seats or of the many

problems, from mechanical difficulties to weather, that may make the airline un-able to deliver transportation as promised. The airline takes all credit risks onthe credit cards it accepts .... [T]he travel agent loses its commission when thetraveler does not show and has his ticket refunded, but this is true of any agentwhen a sale falls through." Illinois Corporate Travel, 806 F.2d at 725.

179 See Plaintiffs' Complaint, supra note 4, at 3.

1999]


2. Balancing Procompetitive Effects with Anticompetitive Effects.

The courts recognize that some changes in a vertical distribu-tion system benefit consumers by improving efficiency, andthus, promote interbrand competition. 180 In order to separatethose vertical restraints with the "redeeming virtues" of promot-ing competition from those that facilitate collusion or the exclu-sion of rivals, the Rule of Reason is implicit in every decisionsustaining vertical restrictions."8 1 However, it is much easier toassert improved efficiency than it is to prove.182 First, economicanalysts find measuring the difference between transaction costsbetween vertically related firms and transaction costs within a sin-gle vertically integrated firm problematic. This in turn makesproving the procompetitive benefits of vertical mergers diffi-cult."' Therefore, a defendant must prove through concretefacts all issues relating to efficiency, including the efficiencies ofalternatives and the impact on consumers.184 Second, those effi-ciency savings that can be proven will be taken into accountamong other factors, but do not constitute an absolute de-fense. 5 In fact, cost savings to the integrating firm are not rele-vant; rather, "efficiences are relevant only to the extent that theycan be expected to result in benefits to consumers."186

The efficiencies defense works well when applied to firms thatproduce goods that are later resold through retailers, and thecourts have developed the defense within this context. The rea-sons usually given for legitimate vertical integration is the needto eliminate distortions from various forms of market failures,8 7

to facilitate the flow of information between levels, or to mini-

180 See Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36, 54 (1976).181 See id.182 See U.S. DEPARTMENT OF JUSTICE, MERGER GUIDELINES § 3.5 (1984).183 See ABA ANTITRUST SECTION: MONOGRAPH No. 14, NON-HoRIZONTAL

MERGER LAW AND POLICY 8 (1988) [hereinafter NON-HoRIZONTAL MERGERS].184 See id. at 90 (referring to the second criteria suggested to the courts in eval-

uating efficiency claims as posited in U.S. Department of justice's Memorandumin support of Plaintiffs Motion in Limine Relating to Efficiencies 4, 13-18,United States v. Archer-Daniels-Midland Co., Civ. No. 83-51-D (S.D. Iowa, May 4,1987)).

185 See id. (quoting U.S. Department of Justice, Statement Accompanying Re-lease of Revised Merger Guidelines, 49 Fed. Reg. 26,823, 26,826 (1984)).

186 Id. (quoting in part the five criteria suggested to the courts in evaluatingefficiency claims as posited in Department of justice's Memorandum in Supportof Plaintiffs Motion in Limine Relating to Efficiencies 4, 13-18, United States v.Archer-Daniels-Midland Co., Civ. No. 83-51-D (S.D. Iowa, May 4, 1987)).

187 Such as build-ups in inventory, cyclical problems associated with markets,and coordinating non-peak load production periods.

972

THE TRAVEL INDUSTRY

mize transaction costs in advertising, sales presentations, etc. 188

These costs represent situations that occur at the retail level andpose financial uncertainty on the producer.

Vertical merger theory and the efficiencies defense have notbeen developed in the context of the retail role played by travelagents. Looking at the reasons for vertical integration in thiscontext, there are few potential procompetitive effects of verti-cal integration. Travel agents, who were already well-establishedin their role as independent agents, posed none of the tradi-tional concerns that a producer might have over what occurs atthe retail level. First, travel agents were the most efficient meansof ticket distribution, a state of affairs that always benefits con-sumers. Second, there were never any quality control problems,and travel agents had little impact on an airline's overall man-agement or investment decisions. Third, the airlines were notbound to restrictive retail contracts like many upstream retailsuppliers. Rather, the airlines were making a considerableamount of money from the fees travel agents pay for access tocomputerized airline schedules and bookings such as SABREand ARC. Finally, travel agents were paying for supplementaladvertising and other promotional activities from which the air-lines directly or indirectly benefited. Therefore, what first ap-pear to be legitimate efficiency claims begin to look more likethe displacement of an efficient distribution system. Indeed, atthe end of 1998 one travel agency stated that when the agencymiddlemen are cast off, "consumers will have to pay more even-tually when airlines hike up fares to hire people to do what[travel agents] do.' 1 89

Another consideration is whether the airlines may be seekingto eliminate a lower link in the distribution chain to facilitatehorizontal collusion. Thus, the focus shifts from the retail-levelfirm to upstream, market-dominate firms that will be in the posi-tion to form a stronger oligopoly as a result. Anticompetitiveconsequences are likely if (1) the upstream firms are generallyprone to collusion already and (2) a large share of the upstreamproduct is sold through vertically integrated retailers.' 90 When amarket is highly concentrated, it is considered oligopolistic if

188 See id. at 87-91.18 See Connolly, supra note 7.190 See NON-HoRIZONTAL MERGERS, supra note 183, at 81 (referring to U.S. DE-

PARTMENT OF JUSTICE MERGER GUIDELINES § 4.221 (1984)).

9731999]


price parallelism is common.' 9 ' Clearly, the airlines have a his-tory of following each other's lead in pricing, commission cuts,and other business practices. In fact, they have even admitted toparallelism, albeit natural parallelism, and have been the subjectof criticism for growing ever more concentrated. 19 2

In the business environment after Travel Agency, the condi-tions at the horizontal level become more conducive to collu-sion. Without the travel agents' ability to funnel customers andprovide expert advice, and thereby foster competition via help-ing upstarts and supporting those with the best deals,9 3 airlinescan more easily collude. That is, for those airlines that want tocheat the horizontal cartel, travel agents would pose a temptingresource to use in undercutting the less-competitive offers fromthe cartel members. In the absence of travel agents, it becomeseasier to monitor the cartel members, and there is less incentiveand opportunity to cheat. 194

Similarly, the airline cartel may need to eliminate a disruptivemiddleman to strengthen its market dominance. "Successfulcollusion in the upstream market often depends on relativelyacquiescent buyers in the downstream market. Aggressive buy-ers can disrupt a cartel's operations by encouraging cartel mem-bers to cheat the cartel policy."'19 5 By analogy, travelers who buydirectly from the airlines will be more at the mercy of the air-lines than travel agents, who are more aggressive in curbing air-line oligopoly power.

III. CONCLUSION

One could infer from the facts of Travel Agency and its sur-rounding developments that the airlines engaged in nonpricepredation to bring about a fundamental change in the businessenvironment of the air travel industry. Although there was no

191 See 1995 VERTICAL RESTRAINTS GUIDELINES OF THE NATIONAL ASSOCIATION OF

ATTORNEYS GENERAL § 4.8, Mar. 27, 1995. Practices constituting price parallelismin this context include: (1) price leadership, (2) pre-announced price changes,(3) price rigidity in response to excess capacity or diminished demand, (4) pub-lic pronouncements and discussions of the 'right price' for the industry, (5) sys-tematic price discrimination, and (6) past collusion regarding prices ormarketing practices. See id.

192 See Klingaman, supra note 31.193 See Airlines That Have Not Cut Commissions, supra note 69.194 See NoN-HoRIzoNrAL MERGERS, supra note 183, at 80-82 (discussing that de-

creasing the costs of monitoring cartel performance is one prerequisite to form acartel).

195 See id. at 82.

974 [64

THE TRAVEL INDUSTRY

one single piece of evidence conclusively establishing antitrustviolations in Travel Agency, the facts and the inferences drawnfrom those facts demonstrate that this sort of conduct could rea-sonably occur in an industry as concentrated as the airline in-dustry. Airlines have every business incentive to build a cartel.Only through a cartel's collective power could the airlines drivetravel agents out of business and retain those funds that are nor-mally paid out in commissions. Moreover, once travel agentsare eliminated, the airlines gain added oligopoly power to facili-tate the full range of collusive practices such as parallel pricemaintenance.

When the airlines cut commissions paid to travel agents, theyjustified their actions as a more efficient, cost-saving measureand promised that these savings would lead to airfare reduc-tions. But the post-commission cut era has not led to the prom-ised reductions in costs and airfares. In January 1998, Kiplinger'sPersonal Finance Magazine reported that "[a] irfares have taken offover the past year or so, and it will probably be a while beforethey come back down to earth," with business passengers beinghit hardest.' 96 Earlier in 1996 and 1997, business fares increasedby 9% and 16%, respectively, and 1998 saw a 5% to 6% increase;since 1994, business fares have increased by 30%. 19 7 By the be-ginning of 1999, the major airlines were again announcingairfare increases "on business tickets by 2 percent and leisuretickets by 4 percent, effective immediately,"' 98 while some ob-servers have reported an average increase of 3% and 7%,respectively. 99

Analysts blame a strong economy and increased demand fortravel as the reason behind the increase, z°° but others have men-tioned the oligopolistic dynamics of the industry, whereby theairlines tend to act either in unison, or not at all, for fear oflosing business to others.20 1 With these rate increases, "the in-dustry's profits are likely to rise to a record for the fourthstraight year. "202 It also seems evident that the warnings of the

196 Woods, supra note 1, at 127.197 See Guy Boulton, As Air Fares for Businesses Continue to Rise, Some Find Ways to

Contain Cost, THE COURIER-JOURNAL (Louisville, Ky.), Feb. 18, 1998, at 1E.198 Heather Pauly & Francine Knowles, Airfares on the Rise, 4% Hike for Major

Carriers, CHICAGO SUN TIMES, Jan. 30, 1999, at 1.199 See Chris Woodyard, Firms Stretch Travel Dollars Higher, Costs Bump Employees

into Coach, or Even into Vans, USA TODAY, Mar. 16, 1999, at lB.200 See Boulton, supra note 197.201 See Pauly & Knowles, supra note 198.202 Id.

9751999]


travel agencies, prior to their minimization, may be bearingtrue. Without travel agents to temper the effects of the airlineoligopoly, the airlines are far less shy in taking advantage oftheir position. Because there are no real alternatives for travelin the United States or internationally, and because modern so-ciety and commerce require travel, the airlines now have oneless check on their control of market prices. While businessesare certainly allowed to find ways of cutting costs, they may notdo it illegally. Instead of being a legitimate business move, theairlines' actions appear to be an attempt to drive travel agents'income below their costs-the classic definition of illegal non-price predation.

Articles

VAODi

CA-1

4 a. a 6.614

I**

UAS. I

WHEN LESS CAN BE MORE: FRACTIONAL OWNERSHIPOF AIRCRAFT-THE WINGS OF THE FUTURE

EILEEN M. GLEIMER*

I. INTRODUCTION

B USINESS AVIATION has grown substantially over the lastseveral years and is expected to continue growing.' One of

the fastest growing segments of the industry is fractional owner-ship.2 In fact, fractional ownership programs have grown at the

* Eileen Gleimer is a Member of the firm, Boros & Garofalo, P.C., a Washing-

ton, D.C. law firm specializing in aviation law. She has authored several articlesand is a participant in industry committees and a frequent speaker on the topicof corporate aircraft operations and fractional ownership. She graduated fromThe American University, B.S., cum laude, in 1979, Emory University School ofLaw, J.D., with distinction, in 1982 and received a Certificate in Executive Interna-tional Business from Georgetown University School of Business, Center for Inter-national Business Education and Research in July 1996. She wishes to expressher gratitude and appreciation to her partner Gary B. Garofalo for his contribu-tions to this article.

I See, e.g., Anthony L. Velocci, Jr., Growth of Fractional Ownership Assured DespiteTurbulence Ahead, AVIATION WK. & SPACE TECH., Oct. 19, 1998, at 58 (citing Allied-Signal's Annual Business Aviation Market Outlook) (over 6500 business aircraftvalued at nearly $78 billion are projected to be delivered between 1999 and 2009with 10% going to fractional ownership programs); AlliedSignal Forecast PredictsBusiness Jet Market Will Stay Hot Through 2009, WKLV. Bus. AVIATION, Oct. 19, 1998,at 171 (citing AlliedSignal's Business Aviation Market Outlook); Grdon A. Gil-bert, AlliedSignal Forecasts Big Bizjet Boom; Sees $78 Billion Sales Over 10 Years, Bus. &CoM. AVIATION SHOW NEWS, Oct. 19, 1998, at 16; The CIT Group Predicts ContinuedNear-Term Growth for Business Aircraft in '98-99, WKLY. Bus. AVIATION, Aug. 3, 1998at 51; Kate Sarsfield, Fractional Progress, FLIGHT INT'L, Sept. 17, 1997, at 64 (citingTeal Group Ten Year Business Plan) (business aircraft ownership is expected togrow by approximately 30% over the next ten years); Fractional &Joint Ownership:Corporate Jet Manufacturers and Operators Perspective, STRATEGIC RESEARCH INSTI-

TUTE, FRACTIONAL & JOINT OWNERSHIP INTERESTS FOR BUSINESS JET AIRCRAFT,

March 1, 2 & 3, 1998, Belleview Mido Resort Hotel, Clearwater, FL [hereinafterSRI FRACTIONAL CONFERENCE].

2 See R. Randall Padfield, Commentary: Fractions Ain't Easy, AVIATION INT'L NEWS,

May 1999, at 2 (Rolls Royce estimates that between 1999 and 2017, 3500 businessjets representing 36% of new corporate aircraft will be delivered to fractionalownership programs); Gordon A. Gilbert, Fractional Sales Will Spur Market Growth,Bus. & COM. AVIATION, Nov. 1, 1998, at 30 (fractional ownership programs will

979


rate of fifty percent per year 3 and are still growing.4 In spite oftheir youth, fractional ownership programs are perhaps the sin-gle largest customer of new aircraft and have acquired billionsof dollars of aircraft in the last two years.5

In general terms, fractional ownership programs are multi-year programs covering a pool of aircraft, each of which isowned by more than one party and all of which are placed in a

be one of the driving forces in aircraft sales over the next 20 years); Kate Sar-sfield, Richard Santulli, FLIGHT INT'L, Oct. 28, 1998, at 28 (fractional ownershipaccounts for over 20% of total business aircraft sales worldwide); Fractional Owner-ship Attracts New Demand for Business Aircraft, Bus. & COM. AVIATION SHOW NEWS,Oct. 19, 1998, at 16; Gordon A. Gilbert, Fractionals Provide Momentum for Industry,NBAA '98 SHOW NEWS, Oct. 19, 1998 (fractional ownership is a major catalyst inthe growth of business aviation); Sarsfield, Fractional Progress, supra note 1, at 64(citing Teal Group Ten Year Business Plan and CIT Group Report) (fractionalownership is driving an expansion of the business aircraft market).

3 See Gilbert, Upbeat Manufacturers Continue to Set Billings Records, See Healthy Fu-ture, WKLY. Bus. AVIATION, Feb. 15, 1999, at 71.4 See Fractional Ownership Attracts New Demand for Business Aircraft, supra note 2,

at 16; see also Margaret Allen, Airlines Enter Tractional Ownership' Niche, DALLAS

Bus. J., July 4, 1997, at 4.5 See, e.g., Upbeat Manufacturers Continue to Set Billings Records, See Healthy Future,

supra note 3, at 72 (in addition to accounting for 15% of the new business jetsdelivered each year, fractional programs make a significant contribution to fuelsales, charter activity, and pilot hiring). See also Roy Norris, Pitfalls of FractionalOwnership, PROF. PILOT, Feb. 1999, at 96 (EJA accounted for 30% of the business

jet aircraft purchased in 1997); Charles Alcock, EJA Signs Up for $3B in New-BizjetOrders, NBAA CONVENTION NEWS, Oct. 20, 1998, at 1 (EJA contracted with Gulf-stream for 22 GV aircraft and 14 GIV-SP aircraft, valued at $1.3 billion; withCessna for 50 Citation Sovereign aircraft plus options for 50 more valued at $650million; and with Boeing Business Jets for 9 aircraft with options for 16 morevalued at almost $1 billion); Velocci, Growth of Fractional Ownership Assured DespiteTurbulence Ahead, supra note 1, at 58 (orders for 340 aircraft valued at $4.7 billionhave been placed for the NetJets program and 20% growth is projected in eachof the next five years in the number of new aircraft joining fractional ownershipfleets and in the number of new fractional owners); Michael A. Taverna, Falcon inFractional Ownership Plan, AVIATION WK. & SPACE TECH.,Jan. 5, 1998, at 65 (Execu-tive Jet Aviation's order for 24 Dassault Falcon 2000 aircraft valued at $500 mil-lion is the largest business jet sale in dollar terms in Dassault history); Sarsfield,Fractional Progress, supra note 1, at 64 (15% of aircraft sold by Raytheon are forfractional ownership programs);Don Dzikowski, Prime Fleet Can Cut Costs for High-Flying Corporate Execs, FAIRFIELD CouNTY Bus. J., Jan. 6, 1997, at 1 (fractionallyowned aircraft represent more than $1 billion in assets with more than $1.1 bil-lion on order). Early in the life of fractional ownership programs, Raytheonnoted that NetJets was Raytheon's "single most important distribution channel."Anthony L. Velocci, Jr., Business Flying Industry Debates Value of Fractional Shares,AVIATION WK. & SPACE TECH., Aug. 29, 1994, at 66.

980

FRACTIONAL OWNERSHIP OF AIRCRAFT

dry lease 6 exchange pool to be made available to any programparticipant when the aircraft in which such participant owns aninterest is not available. As an integral part of these multi-yearprograms, a single management company provides the manage-ment services to support the operation of the aircraft by theowners,7 and administers the aircraft exchange program' on be-half of all of the participants. By purchasing an interest in anaircraft that is part of the program, an owner gains round-the-clock access to a private jet at a fraction of the cost. In additionto access to the aircraft in which it owns an interest, it also hasaccess to all other aircraft in the program, as well as the supportof a management company that will handle all arrangements re-lating to maintenance, crew hiring, and all administrative detailsrelating to the operation of a private aircraft. 9

Because fractional ownership allows parties to purchase thepercentage of an aircraft reflecting their actual needs, these pro-grams meet the needs of divergent groups, including newcom-ers to business aviation who do not require full-time use ofbusiness aircraft10 as well as companies seeking to supplement

6 A dry lease is the lease of an aircraft where the crew is provided by the lessee.See Interpretation 1991-53, 3 Fed. Av. Dec. 1-126 (Sept. 23, 1991) (Clark Board-man Callaghan).

7 See Eileen M. Gleimer, Corporate Aircraft Operations: The Twilight Zone of Regula-tion, 62 J. AIR L. & CoM. 987, 1007 (1997) [hereinafter Corporate Aircraft Opera-tions] for a discussion of management companies.

8 The fractional ownership programs typically refer to the dry lease exchangeas an "interchange." The "interchange" component of a fractional ownershipprogram is not an "interchange" as defined by the Federal Aviation Regulations[hereinafter FARs], but rather contemplates that each of the aircraft will be oper-ated by the party using it at the time. See 14 C.F.R. §§ 91.501 (b)(6), (c)(2)(1998); infra notes 105-106 and accompanying text. Although not specificallystated, an FAA-defined "interchange" contemplates that each party will continueto operate its own aircraft regardless of who is using the aircraft at a particulartime. See id.

9 See, e.g., David Field, Jet Time Sharing Gains Altitude; Rival Companies ExpandFleets, USA TODAY, Nov. 26, 1996, at 5B; Perry Bradley, Fractionals: Friend or Foe?,Bus. & COM. AvIATION, Nov. 1, 1996, at 76; Charles Jacobs, Tired of CommercialFlights? How About a Time Share in a jet?, N. Bus., May 31, 1995; Velocci, BusinessFlying Industry Debates Value of Fractional Sales, supra note 5, at 66.

10 See Paul Berner, Market Outlook Remains Solid, AviATION MAINTENANCE, Dec.1998, at 16-17 (more than 70% of the participants in fractional ownership pro-grams have never owned an aircraft); Velocci, Growth of Fractional Ownership As-sured Despite Turbulence Ahead, supra note 1, at 58 (70-80% of the participants infractional ownership programs are new to business aviation); The CIT GroupPredicts Continued Near-Term Growth for Business Aircraft in '98-'99, supra note 1, at51 (CIT estimates 80% of fractional ownership participants are first-time aircraftbuyers); SRI FRACTIONAL CONFERENCE, supra note 1, Fractional &Joint Ownership:

1999]


their own fleet of business aircraft without the expense of hav-ing to purchase or lease additional aircraft. 1 By offering a solu-tion to a wide spectrum of entities, the number of participantsin these programs has grown significantly during the twelveyears that the programs have been in existence.1 2

This popularity, however, has also attracted a significantamount of controversy in the aviation industry.13 This articlewill address the development, growth and regulatory frameworkof fractional ownership programs as well as the controversy sur-rounding these programs and their likely future.

II. THE GROWTH OF FRACTIONALOWNERSHIP PROGRAMS

Historically, as business aircraft became more complex, thecost of acquiring, owning, operating and maintaining the air-craft greatly increased. Recognizing that business aviation dif-fered significantly from commercial aviation and that businessaircraft were becoming more sophisticated, the FAA in 1972adopted a new subpart in Part 91 that governed large and multi-

Corporate Jet Manufacturers and Operators Perspective, Presentation of RaytheonTravel Air (80% of the participants are concept buyers who are new to businessaviation), Presentation of Executive Jet NetJets (70% of the participants are newto aircraft ownership and 50% never chartered business aircraft). According toAlliedSignal, fractional ownership plans for business aircraft "continue to growdramatically at double-digit annual rates, expanding the pool of aircraft ownerswell beyond the historical operator population." AlliedSignal Forecast Predicts Busi-ness Jet Market Will Stay Hot Through 2009, supra note 1, at 171 (citing Allied-Signal's Business Aviation Market Outlook).

11 See generally, Kate Sarsfield, Fractional Surgery, FLIGHT INT'L, 6-12 Oct. 1999, at53; Paul Lowe, Ire in the Ranks Leads NBAA to Poll Its Members on Frax, AVIATIONINT'L NEWS, Sept. 1999, at 21; Bill Wagstaff, The Fract Pack: Fractional Jet Ownership,MILLIONAIRE MAG., Sept. 1999, at 220; David Esler, Using Fractionally Owned Air-craft for Supplemental Airlift, Bus. & COM. AVIATION, Nov. 1, 1998, at 66. See alsoBradley, supra note 9, at 79-80. As a trade off for the elimination of many of theadministrative headaches associated with acquiring and operating business air-craft, fractional owners frequently pay a premium. This stems from the fact thatalthough the program manager (or its affiliate) usually gets a discount and otherconcessions when purchasing aircraft due to the potential size of the order, itsells the share based on the list price which even the purchaser of a single aircraftrarely pays. The impact of this somewhat inflated price is generally not apparentuntil the share is sold by the fractional owner, since the price will then be basedon fair market value. See Norris, supra note 5, at 98-99.

12 See infra notes 19-80 and accompanying text.

13 See infra notes 165-180 and 232-246 and accompanying text.

982


engine turbine-powered aircraft.14 These rules imposed addi-tional requirements on the operators of such aircraft in order toensure a higher level of safety, and at the same time, eliminatedmany of the administrative, financial and organizational require-ments imposed on commercial operators that were purely eco-nomic in nature.15

Among other things, the FAA adopted rules that expandedthe types of operations that could be performed for compensa-tion without requiring the operator to obtain air carrier or com-mercial operator operating certificates.' 6 The FAA recognizedthat the heightened safety standards then being adopted ade-quately addressed safety concerns, and that with such a level ofsafety, additional operating flexibility could be provided to cor-porate operators. In the FAA's own words,

the decision to proceed with the upgrading of Part 91 for largeand turbine-powered multiengine airplanes is an importantthreshold step in the FAA policy to remove, to the extent possi-ble, those differences in safety standards that are primarily eco-nomic in nature and result in unnecessary restrictions orlimitations on aircraft operators. In accordance with that policy,the need for different or additional safety standards for corpo-rate operations should be resolved on the basis of safety, ratherthan economics or juristic semantics. 17

Because this approach afforded aircraft owners the potentialto recoup a portion of their investment by spreading the cost ofthe aircraft, business aircraft became available to entities thatdid not need full time use of aircraft. From the FAA's perspec-tive, as long as common carriage was not involved, cost sharingwould be permitted.' 8

14 See Large and Turbine-Powered Multiengine Airplanes, 37 Fed. Reg. 14,758(1972) (final rule); see also Large and Turbine-Powered Multiengine Airplanes,36 Fed. Reg. 19,507 (1971) (proposed rule).

15 In recognition of the increasing sophistication of these aircraft and to en-sure safety, the FAA applied certain operating rules to these aircraft that did notapply to smaller, less complex aircraft. For example, among other things, theFAA required large and multi-engine turbine aircraft to be equipped with instru-ments that previously were required only for commercial operators and to carrycertain emergency and survival equipment. See 37 Fed. Reg. 14,758, 14,760-62(1972); see also 36 Fed. Reg. 19,507, 19,509-11 (1971).

16 See 37 Fed. Reg. 14,758, 14,759, 14,760-63 (1972).17 37 Fed. Reg. 14,758, 14,759 (1972).18 Several types of operations were permitted by the new rules, such as

timesharing, joint ownership, and interchange arrangements. Each authorize anoperator of an aircraft to share the usage of aircraft on a limited basis with thirdparties. See Corporate Aircraft Operations, supra note 7, at 997-1003. Even though

1999] 983


As the cost of business aircraft continued to increase, how-ever, these cost-sharing alternatives did not always meet theneeds of businesses. Many businesses wanted ready access to air-craft and were willing to pay the fully allocated cost of owningand operating the aircraft but did not need to use the aircraft asufficient number of hours tojustify such an expenditure. In aneffort to address the needs of those businesses that wanted toacquire business aircraft but could not justify the purchase of awhole aircraft, Executive Jet Aviation (EJA) in 1986 introducedNetJets, the first fractional ownership program, by offering in-terests in a fleet of eight Cessna Citation II aircraft.' 9 TheNetJets program allows a party to purchase an interest in an air-craft, while at the same time have access to other aircraft in theprogram by way of an interchange arrangement in case the air-craft in which it owns an interest is not available. Under theNetJets program, the owners also contract for the services of acommon management company that administers the in-terchange and provides the support necessary to facilitate theoperation of the aircraft by an owner, whether the aircraft is theone in which the owner had an interest or is obtained under theinterchange arrangement. The creation of this alternativemethod of acquiring aircraft ° enabled many more parties to en-joy the benefits and flexibility of operating business aircraftunder Part 91 of the FARs.

the operator is receiving limited compensation and the third party is paying forthe operation, the FAA allowed the operation to be conducted under Part 91 bytreating them as exceptions to the general rule that requires an operator that isreceiving compensation to be licensed. In the absence of such exceptions, theoperator would have to comply with the more stringent rules contained in Parts121, 125, 129, or 135 of the FARs, depending on the size and type of aircraft andthe nature of the operation and operator. For a more detailed discussion on therules applicable to commercial air operations, see Corporate Aircraft Operations,supra note 7, at 990-93. See infra notes 111-130 and accompanying text for a dis-cussion of the impact of requiring aircraft in fractional ownership programs to beoperated under the rules governing commercial operations.

19 See Anthony Bianco, What's Better Than a Private Plane? A Semiprivate Plane,Bus WK. July 21, 1997, at 57. The name NetJets actually covers the fractionalownership programs offered by EJA and its affiliate, Executive Jet, Inc. (EJI)which is involved in the Gulfstream Shares program and ajoint venture with theBoeing Business Jet. See infra notes 31-42 and accompanying text. See also DaleSmith, Fractional Ownership: A Maintenance Perspective, AIRCRA~r MAINTENANCE,

Oct. 1997, at 34.20 See How to Start a Corporate Flight Department, "Ownership Options," National

Business Aircraft Association (visited June 5, 1998), <http://www.nbaa.org.library>.

984

1999] FRACTIONAL OWNERSHIP OF AIRCRAFT

NetJets' success2" confirmed the viability of the concept offractional aircraft ownership.22 Not surprisingly, this successcaused competition in the area of fractional ownership pro-grams to increase. In June 1995, Business JetSolutions, a com-pany jointly owned by aircraft manufacturer Bombardier, Inc.and AMR Combs Inc., American Airlines' charter affiliate, be-gan the FlexJet program with fourteen aircraft2 and became thesecond major participant in the burgeoning fractional owner-ship market.2 4

Two years later, the NetJets program had 95 aircraft and 700owners, 5 and the FlexJets program had 24 aircraft and 120 own-ers.2 6 With such obvious success in the fractional ownershipbusiness, a third major competitor appeared. Specifically, inJune 1997, Raytheon Aircraft Company announced that it, too,would be entering the fractional ownership market though itssubsidiary, Travel Air, by offering shares in Raytheon-manufac-tured aircraft, namely, the Hawker 800XP mid-size jet, theBeechjet 400A lightjet and the Beech King Air B200 twin turbo-prop. 27 Travel Air was the first of the big three fractional owner-ship program managers to offer turboprop aircraft.28 In

21 In the early stages of its development, NetJets was faced with a recession inthe United States, which substantially and adversely impacted its developmentand placed the future of fractional ownership programs in question. As the econ-omy improved, the sale of fractional shares also improved and EJA offered addi-tional and larger aircraft in the NetJets program. See Bianco, supra note 19, at 58.

22 See Anthony L. Velocci, Jr., Executive Jet Poised to Take NetJets Abroad, AVIATION

WK. & SPACE TECH.,June 19, 1995, at 47. By mid-1995, there were 255 owners inthe NetJets program. See id.

23 As a result of Bombardier's ownership interest in Business JetSolutions,FlexJet offered interests only in aircraft manufactured by Bombardier, such as theLearjet and Challenger. In 1998 AMR sold its interest in the FlexJet program toBombardier and withdrew from the FlexJet program. See Bombardier Will TakeOver FlexJet From AMR Combs, Bus. & COM. AVIATION, Jan. 1998, at 17.

24 See Velocci, supra note 22, at 47.25 See Linda Martin, NetJets Spends Big With Raytheon, Bus. & COM. AVIATION, July

1, 1997, at 36.26 See Business JetSolutions: Two and Counting, Bus. & COM. AVIATION, July 1997,

at 27. Flex Jet's growth has continued bringing its fleet to seventy aircraft sup-porting 365 owners. This gives FlexJets a 25% share of the fractional ownershipmarket. See Maintaining a Constant Flow of New Aircraft is Goal for FlexJet Fractionals,AVIATION WK. SHOW NEws, Oct. 13, 1999, at 107.

27 See Raytheon to Begin Fractional Aircraft Ownership Flight Operations in August,WKLY. Bus. AVIATION, June 9, 1997, at 254; see also Raytheon Aircraft Press Re-lease, Raytheon Aircraft Reveals Raytheon Travel Air Fractional Ownership Plan, June 4,1997.

28 See Raytheon to Begin Fractional Aircraft Ownership Flight Operations in August,supra note 27, at 254. Because, unlike the jet aircraft, the King Air turboprop

985


addition, Travel Air was the first program that would offer thesame aircraft being made available by one of its major competi-tors.2 9 By September 1999, Travel Air had three hundred own-ers and forty-seven aircraft in its program. °

Although EJA's relationship with manufacturers had tradi-tionally been that of customer and supplier, in 1995 an affiliateof EJA, Executive Jet, Inc. (EJI) created Gulfstream Shareswhich offered Gulfstream GIV-SP aircraft in conjunction withGulfstream Aerospace Corporation.3' Gulfstream Shares cur-rently has over one hundred customers and a fleet of thirty-fouraircraft.3 2 In October 1997, EJI and Boeing Business Jet an-nounced the formation of a joint venture to introduce the Boe-ing Business Jet into NetJets. 3 Despite its development ofspecialized programs with Gulfstream and Boeing, however, theNetJets program continues to rely upon the products of variousmanufacturers, including Cessna, Raytheon and Falcon. 4

Based on its success 5 in the United States and the increasingglobalization of business, EJA expanded overseas through thecreation of NetJets Europe in 1996 as a partnership among EJA,

aircraft is geared to short-haul flights, Travel Air bases the turboprop aircraft atsix locations throughout the United States. See id; see also Paul Seidenman &David Spanovich, Raytheon Travel Air's First Year Includes Explosive Growth, FLYINGCAREERS, Oct. 1998, at 10.

29 See Raytheon to Begin Fractional Aircraft Ownership Flight Operations in August,supra note 27, at 254. Because the NetJets program, unlike FlexJets and TravelAir, was not tied to a particular manufacturer, it not only offered the Hawker800XP to its customers, it purchased twenty such aircraft less than a monthbefore Travel Air's announcement.

30 See Kirby Harrison, Travel Air Tops 300 Frax Share Owners, AVIATION INT'L

NEWS, Sept. 1999, at 10. Raytheon has also implemented a lease option for theTravel Air program. See id.

31 See Gulfstream Shares (visited Oct. 2, 1998) <http://www.gulfstreamaircraft.com/prod/shares.htm>. As the Gulfstream GV aircraft are manufactured, they,too, will be added to the program. See id.

32 See Executive Jet Purchases Three Additional Gulfstream IV-SP Aircraft for Gulf-

stream Shares Program, Bus. WIRE, Sept. 7, 1998.33 See Boeing Business Jets and Executive Jet Announce Joint Venture, PR NEWSWIRE,

Oct. 21, 1997.34 See Executive Jet, promotional material, NetJets is a Unique Program of Frac-

tional Aircraft Ownership from Executive Jet, Inc. Among other aircraft, NetJets offersshares in the Citation VII, Hawker 800XP, Citation X, Gulfstream G-IV, Gulf-stream G-V, Falcon 2000 and Boeing Business Jet.

35 One mark of the success of fractional ownership programs is the $725 mil-lion purchase by Warren Buffett of EJI in the summer of 1998 through BerkshireHathaway, Inc. SeeJack Olcott, Business Aviation and the Buffett Factor, NBAA Di-GEST, Aug. 1998, at 2.

986

1999] FRACTIONAL OWNERSHIP OF AIRCRAFT 987

Swiss-based Zimex Aviation and Air Luxor in Portugal 6.3 Theprogram, which was launched with three Citation SII aircraft,has added four Citation VII aircraft and now supports over thirtyowners. 37 This program allows participants in the NetJets pro-gram in the U.S. to take the U.S.-based aircraft to Europe andthen use the NetJets Europe aircraft within Europe and allowsparticipants in NetJets Europe to do the reverse.3 8 Based on theimportance and potential of the European market, Business Jet-Solutions is also expanding its FlexJets program to Europe. 9

36 See Oliver Sutton, Fractional Ownership Takes Off in Europe, INTERAVIA Bus. &TECH., Sept. 1997, at 27; see also NetJets Europe Fractional Jet Ownership Program Find-ing Success on European Continent, INT'L HERALD TRIB., Special Advertising Supple-ment, June 1997. In early 1999, Executive Jet acquired Zimex Aviation's interestin NetJets Europe. NetJets Europe is now a joint effort of Executive Jet and AirLuxor. See Charles Alcock, Zimex Out of NetJets Europe, AVIATION INT'L NEWS, Feb.1, 1999, at 8.

37 See Charles Alcock, EJA Adapts Fractional Ops to Fit European Realities, AVIATION

INT'L NEWS, Dec. 1, 1998, at 44. Because of the airport access restrictions at themajor European hubs and other limitations on the ability to support the networkand ensure the availability of aircraft, NetJets Europe is not growing at the samerate as its U.S. counterpart. Nevertheless, EJA believes that in five years NetJetsEurope will support a fleet of fifty aircraft. See id; see also Charles Alcock, NetJetsStrengthens Euro Fleet, AVIATION INT'L NEWS, May 1999, at 28; Sarsfield, RichardSantulli, supra note 2, at 28; Edward Phillips, Economic Growth Fuels Rise in EuropeanBusiness Flying, AVIATION WK. & SPACE TECH., Sept. 22, 1997, at 69; Sarsfield, Frac-tional Progress, supra note 1, at 64.

38 See supra note 37, at 69; see also NetJets Europe Fractional Jet Ownership ProgramFinding Success on European Continent, supra note 36. Because of operating restric-tions imposed by the governing regulations in Europe and the higher cost associ-ated with operating in Europe, EJA's ability to intermingle aircraft between theU.S.-based and the European-based programs is limited. In addition, themonthly and hourly charges are higher for NetJets Europe than in the U.S. pro-gram because of the higher operating costs in Europe. In order to accommodatethe more restrictive and costly operating environment which exists in Europe forbusiness aircraft, Europe was divided into two zones and guarantees availabilityonly in one of the zones which encompasses Austria, Belgium, Czech Republic,Denmark, Finland, France, Germany, Gibraltar, Greece, Budapest, Ireland, Italy,Luxembourg, Malta, Netherlands, Norway, Warsaw, Portugal, Slovakia (Bratislavaonly), Spain, Sweden, Switzerland, and the United Kingdom. See Alcock, EJAAdapts Fractional Ops to Fit European Realities, supra note 37, at 44.

39 In the first phase of its expansion, North American FlexJet owners are usingaircraft within Europe. In the second phase, a structure will be set up in Europeto support European travelers. See FlexJet's Program Expands to Europe, WINGSMAC., Issue 5, 1999, at 20. Raytheon Travel Air is also studying an internationalexpansion that would likely start in Europe or South and Central America withpossible future expansion in the Pacific Rim and the Middle East. See RaytheonEyes International Expansionfor Travel Air, AVIATION INT'L NEWS, Feb. 1, 1999, at 10.Initially, the expansion would serve North American customers visiting interna-tional destinations. By mid-2000, Travel Air expects to extend its program to


Fractional ownership has been introduced in the Middle Eastthrough an expansion of the Gulfstream Shares program.4 ° TheNetJets Middle East program, which started in June 1999, is acoordinated effort of Gulfstream Shares and National Companyfor Air Services, a Saudi Arabian company, which shares the riskin the program and acts as the operating partner.4' The NetJetsMiddle East program is expected to involve the purchase anddelivery of twelve GIV-SP aircraft between 1999 and 2003 andthe provision by Gulfstream of two core fleet aircraft and techni-cal and sales and marketing support.42 EJA has also announcedplans to expand to the Far East and South America.43

In addition to the growth and global expansion by the majorfractional ownership program managers, numerous fractionalownership programs have developed throughout the UnitedStates and abroad. The development of programs abroad hasbeen somewhat hampered by the regulatory constraints of thecountries involved. One of the earliest programs in Europe wasdeveloped by the UK-based London Jet Share (LJS) Company in

Europe, South America or Asia. See Raytheon Travel Air Looks Abroad for New Frac-tional Owners, Bus. & CoM. AVIATION, Mar. 1999, at 20.

40 Executive Jet is not the first company offering fractional ownership of air-craft to seek inroads in the Middle East. In 1997, CoreJet was expected to oper-ate three Citation VII aircraft in its Dubai-based Jet Partners program andexpected to add additional aircraft. See R. Randall Padfield, The Fractional AircraftIndustry: A Brief Overview, AVIATION INT'L NEWS, Fall 1997. After the loss of ex-pected financing, CoreJet's plans were put on hold. Upon receiving financingand assistance from the South African KBH Group, Corejet has ordered fourCessna Citation Xs which are expected to enter service from a Dubai base in thefirst quarter of 2000. See Charles Alcock, Corejet Tries to Get Frax Program Airborne,AVIATION INT'L NEWS, Mar. 1999, at 48.

41 See Executive Jet Accelerating Growth of NetJets Fractional Aircraft Ownership Pro-gram in Europe (visited June 12, 1999) <http://www.netjets.com/cfbin/news/story.cfm?ST.ID=21> ; Saudis Approve NetJets Middle East Plans, AVIATION INT'LNEWS, Dec. 1, 1998, at 3.

42 See Gulfstream Says Middle East Fractional Ownership Deal is Worth $335 Million,WKLY. Bus. AVIATION, Apr. 6, 1998, at 153. The core fleet in a fractional owner-ship program consists of aircraft owned or leased by the program manager or itsaffiliate which are placed in the interchange pool in order to assure that aircraftare available to satisfy the needs of the fractional owners. It may also includeaircraft in which all of the interests have not yet been sold. See Norris, supra note5, at 96-98.

43 See Bill Davis, The Pleasures of Private Aircraft: Alternatives to the Airlines, MiL-LIONAIRE MAG., Nov. 1999, at 240, 248; Taverna, supra note 5, at 65. In 1995,AvShares, a program offering partial ownership of used business aircraft to LatinAmerican operators, was offered by Avlease & Finance Group of Florida. See Gra-ham Warwick, Corporate Competition, FLIGHT INT'L, Oct. 11, 1995. It does not ap-pear that the AvShares program was successfully implemented.

988

FRACTIONAL OWNERSHIP OF AIRCRAFF

late 1994.4 At the time the program was developed, sharedownership of an aircraft on the British civil aircraft register wasnot permitted.45 In 1995, the Corpavia Club was created 46 tofacilitate the time-sharing of aircraft for the benefit of its mem-bers." By limiting the use of the club aircraft exclusively to theclub members and their guests, the aircraft were operated onthe private registry.48 Since it was developed as a structure forprivate as opposed to commercial use, both Corpavia and LJSwere able to avoid the restrictions placed on commercial opera-tions in Europe.49

More recently, Airshare, a UK-based fractional ownership pro-gram, indicated that it would be entering the market in early1999 with one used and one new Cessna CitationJet.50 As is thecase with NetJets Europe, the Airshare program would be oper-ated under a commercial air operator's certificate, charge amonthly management fee and an occupied hour rate, and

- See Gunter Endres, How to Join the Jet Set in a High-Flying Timeshare (SharingCorporate Jets), THE EUROPEAN, Feb. 10, 1995, at 30. London Jet Share Companyoffered three shares per aircraft to facilitate the availability of aircraft to the own-ers. It also made back-up aircraft available to ensure it could meet its contractualobligations. The sale of the aircraft was accomplished by the recordation of alien against the aircraft in favor of each of the owners. The agreements prohib-ited the use of the aircraft as security for any individual owner and requiredunanimous consent for the aircraft to be sold. Despite this restriction on sale,however, an owner could sell its share as long as the transferee assumed all finan-cial responsibility. See id.

45 See id. The U.K. eventually changed the law to permit up to twenty ownersper aircraft. See 1995 No. 1970, Civil Aviation, The Air Navigation (No. 2) Order1995, Article 119(10) (a) (i) (1995). See also Aline Sullivan, Private Plane OwnersFind Skies Friendliest in the U.S., INT'L HERALD TRIB., Aug. 30, 1997, at 17.

46 The program was based on a five year membership with the ability to exit

the club after two years. As with other programs, there was a fixed charge and anhourly charge. See id. There was also guaranteed availability using backup JetAviation aircraft. See Corpavia Club Promotional Material, at Operations (on filewith author).

47 See Corpavia Club Promotional Material, "Club Description" (on file with au-thor). See also "Rules & Regulations of The Cooperatieve Corpavia Club U.A.,"Article 3.1. (Jan. 1996).

48 See Corpavia Club Promotional Materia "Club Description" (on file with

author).49 See How to Join the Jet Set in a High-Flying Timeshare (Sharing CorporateJets), supra

note 44, at 30. See also Corpavia Promotional Material; "Club Description" (on filewith author). Corpavia, however, does not appear to have attracted sufficientinterest. As a result, Jet Aviation, the operating entity in the Corpavia Club hasdiscontinued its participation in the program.

50 See Charles Alcock, London Firm to Challenge Netfets Europe, AVIATION INT'L

NEWS, Dec. 1, 1998, at 42. Airshare intends to sell interests in the new aircraftand use the pre-owned aircraft for backup.

1999] 989


would distinguish between flights within the primary area ofwestern Europe and the more outlying areas.51 Fractional own-ership of single and twin engined helicopters maintained to UKCivil Aviation Authority Public Transport standards was also of-fered by First Heli-Network (FHN) located in England followedby a fractional ownership and lease program offered by Skyhop-per in the United Kingdom with two Sikorsky S-76 and one Bell430 helicopter and an Agusta A109E to be added in the nearfuture.52

Another variation of a fractional ownership program is beingoffered in Europe by Share Plane, a Swiss-based program usingsingle engine Pilatus PC-12 turboprop aircraft. In this program,the participants do not acquire any equity interest in the air-craft. Instead, their membership entitles them to 125 flighthours per year under a five-year contract. At the expiration ofthe term, the participant has the option to walk away or torenew.

5 3

Although fractional ownership programs are developing inEurope and the Middle East, the programs have not caught onin Canada largely because of the unfavorable regulatory envi-ronment.54 Although fractional ownership programs in the U.S.have not been considered commercial for FAA regulatory pur-poses,55 Transport Canada classifies such programs as commer-cial.56 Transport Canada has taken such a position becauseunder Canadian law, legal responsibility is vested in the party

51 See id. In Airshares' case, the operator would be Ad Astra. Unlike NetJetsEurope, Airshares would not agree to repurchase the fractional owner's interest,but rather, would simply endeavor to do so. See id.; see also Charles Alcock, Air-share Frax Venture Prepared for Takeoff AVIATION INT'L NEWS, May 1999, at 40. Inaddition to the sale of fractional interests, Airshare has also introduced a frac-tional leasing option. See Charles Alcock, UK's Airshare Launches C Frax LeasingProgram, AVIATION INT'L NEWS, Oct. 1999, at 100.

52 See First Heli-Network (last modified Dec. 4, 1998) <http://www.first-heli-net-work.co.uk/intro.htm>. FHN indicated that fractional ownership could lower anowner's cost by approximately eighty percent. See id.; see also Mike Vines, FirstUK. Fractional Ready to Hover, Bus. & COM. AVIATION, Oct. 1999, at 70.

53 See Charles Alcock, Swiss PC-12 Frax Firm Catches Pilatus' Eye, AVIATION INT'L

NEWS, Oct. 1999, at 12.54 See Roger Newman, Corporate Time-Shares? Aircraft Fractional Ownership Plan is

Stalled in Canada, WINGS MAc., Issue 5, 1998, at 36.55 See infra notes 168 and 182-184 and accompanying text.56 See Newman, supra note 54. Out of concern for the unfair competitive ad-

vantage that a U.S. fractional ownership program operated under non-commer-cial rules would have over a Canadian program operated under commercialrules, the Canadian aviation authorities and trade associations are awaiting theresults of the FAA's review of fractional ownership. See Harry Weisberger, Can-

990

FRACTIONAL OWNERSHIP OF AIRCRAFF

actually flying and maintaining the aircraftY.5 As a result, thefractional owners would merely be viewed as clients of the com-mercial operator.58 In addition to the aviation regulatory issues,Canadian securities laws would require those offering to sellshares of aircraft in fractional ownership programs to file pro-spectuses and comply with the securities laws governing limitedpartnerships.5 9 Legal constraints aside, the economics of frac-tional ownership in Canada are not as favorable as in the U.S.The major cities in Canada are far more dispersed than in theU.S. or in Europe.6 ° Such distances would substantially increasecosts to account for the ferry flights61 making a fractional owner-ship program less attractive.

Both in the U.S. and abroad, not all programs have fared well.Some companies have announced but never implemented orhave started but discontinued the programs.62 The reasons forthe discontinuation or decision not to implement the programvary. Some did not attract sufficient interest.6 3 Others backed

ada's Bizav Issues Mirror Those of the US, AVIATION INT'L NEWS, Aug. 1999, at 40 andinfra notes 168-231 and 247-250 and accompanying text.

57 See Newman, supra note 54.58 See id.59 See id.6o See id.61 See id.62 For example, Prime Fleet was a proposed fractional ownership program,

which would have utilized used aircraft of various types through the joint aus-pices of Prime Airborne, which would provide the management services, andFleet Capital Leasing, which would provide the financing. Under this program,at the end of five years, there would be no restrictions on the owners' dispositionof its interest. See Al Levin, Prime Fleet Plans for Fifteen Planes and 150 Employees inPre-owned Aircraft Venture, SYRACUSE Bus., Feb. 15, 1997, at 1; Dzikowski, supra note5, at 1; Gordon A. Gilbert, Fleet Capital and Prime Airborne Enter Fractional Industry,Bus. & COM. AVIATION, Dec. 1, 1996, at 30. The Prime Fleet program, however,was not implemented. See Padfield, supra note 40. In addition, HeliShare, a frac-tional ownership program developed to offer shares in Eurocopter AS-355 heli-copters with backup provided by comparable twin engine helicopters, was notimplemented. See id.; see also Helishare Debuts Fractional Ownership of Helicopters,HELICOPTER NEWS, Feb. 14, 1997. In part due to the different regulatory, geo-graphic and economic environments, certain of the programs based overseashave also failed. For example, the Jet Time program offered by the NationalAirways Corporation in Johannesburg, was unable to sign up any customers. SeeGordon A. Gilbert, Shared Owner Program in Africa is Having a Slow Start, Bus. &COM. AVIATION, Oct. 1, 1997, at 26. The Jet Network program developed by AirLondon was also unable to implement a successful program. See Sarsfield, Frac-tional Progress, supra note 1, at 64.

63 See The Fractional Aircraft Industry: A Brief Overview, supra note 40 (HeliSharewas not finding sufficient demand for its shared helicopter program); Gilbert,Shared Owner Program in Africa is Having a Slow Start, supra note 62, at 26 (of the 8

1999]


away when the magnitude of the capital investment for a suc-cessful program became clear.64 In spite of some of the unsuc-cessful programs, new companies continue to enter thisburgeoning market 65 and others are growing. These smallerand newer programs provide potential business aircraft ownerswith a host of choices. For example, unlike the three primaryfractional ownership programs, some of these programs offerpre-owned as opposed to new aircraft66 or are regional in scopeas opposed to national.67 Programs have also been developed

aircraft ordered from Raytheon, National Airways Corporation was only able tosell one aircraft in its Jet Time program, and that sale was to a single owner).

64 See The Fractional Aircraft Industry: A Brief Overview, supra note 40 ($40-$50million worth of the core fleet aircraft would be required to support the PrimeFleet program); Sarsfield, Fractional Progress, supra note 31, at 64 (the manager ofJet Network determined that at least four aircraft were required to implement theprogram).

65 PowerFlite Incorporated has proposed a program emphasizing primarily pis-ton engine and turboprop aircraft and both fixed-wing aircraft and helicopters.This Texas-based program would limit the upgrades in aircraft type althoughdowngrades would be unlimited. See Powerlite website (last modified Nov. 16,1998) <http://www.powerflite.com>. American Business Charter has also devel-oped a program at Addison Airport near Fort Worth, Texas. Unlike many of theother fractional programs, American Business Charter will charge for return tripseven if the aircraft is flying back to the base empty. See Bill Davis, American Busi-ness Charter: Leading the Way in Business Aviation, MILLIONAMIE MAG., Nov. 1999, at238.

VIPShair, a regional fractional ownership program managed by NorthAmerican Jet is using pre-owned Gulfstream. See Charles Alcock, North AmericanJet Starts Used Frax Plan, NBAA CONVENTION NEWS, Oct. 21, 1998, at 11. AmericanJet International of Houston, Texas developed a fractional ownership programusing pre-owned LearJet aircraft. See SRI FRACTIONAL CONFERENCE, supra note 1.

67 The PlaneSense fractional program managed by Alpha Flying has opera-tions based in the Northeast region using Pilatus PC-12 single engine turbopropaircraft. See The Fractional Aircraft Industry: A Brief Overview, supra note 40. VIP-Shair has a prime service area covering a 1500 mile radius of Chicago. SeeAlcock,supra note 66, at 11. Aviation One, an eastern Massachusetts-based company isoffering shares in Piper Saratogas for its Flight Shares fractional program servingpoints in the Boston area. See Fractional Leasing of New Piper Saratogas, FLYING, Apr.1999, at 36; see also Aviation One (visited Apr. 30, 1999) <http://www.aviation-one.com>. Direct Air offers a program for both regional and national use withBeech Barons for regional and Pilatus PC-12 aircraft for national use. See DirectAir (visited Sept. 29, 1999) <http://www.flydirectair.com>. Carina Star Shareshas introduced a regional fractional ownership program based in Hilton Head,South Carolina, using Beech Barons and Bonanzas. The aircraft in the CarinaStars program are scheduled through its website on a first come, first served basis.See Baron/Bonanza Fractional Program Off the Ground, AVIATION INT'L NEWS, Apr.1999, at 10. HeliFlite Shares, a Texas-based entity, offers Bell 430 intermediatetwin-engine helicopters for its fractional ownership program, which will be ini-tially target customers based in Texas, with further regional expansion plannedfor a later date. See Texas Firm Rolls Out Innovative Regional Executive Transportation


using helicopters, some exclusively and others in conjunctionwith fixed-wing aircraft.68

Of the newer programs entering the fractional ownershipmarket, two stand out based on their growth and prominence.First, Flight Options, a company owned by Corporate Wings, of-fers a fractional program using pre-owned aircraft which oper-ate on a national basis from Flight Options' Cleveland, Ohiobase. 69 Although Flight Options is only one year old, it hassigned one hundred fifty participants, having broken the onehundred participant mark nine months after beginning the pro-gram.7" To support these participants, Flight Options' fleet hasgrown to forty-three aircraft."v

Solution With Order of New Bell Aircraft; HeliFlite Shares to Set Standard for TurnkeyFractional Ownership of Corporate Helicopters in Providing Cost-Effective Answers to Re-gional Transportation Needs, PR Newswire, Oct. 19, 1998. Executive AirShares man-aged by Executive Aircraft Services of Scottsdale, Arizona was reported to offer afractional ownership program for used mid-range, medium cabin aircraft for usethroughout the Southwest United States. See More Regional Fractional OwnershipPrograms Are Emerging, Bus. & Com. Aviation, Jan. 1, 1998, at 30. Barken Interna-tional of Salt Lake City, the manager of the fractional ownership program In-tejets, set up a program to service the Salt Lake City region. SeeJacobs, supranote 9. American Jet International of Houston, Texas developed a fractionalownership program using pre-owned Learjet aircraft for participants with travelrequirements centered around Texas. See SRI FRACTIONAL CONFERENCE, Develop-ing a Used Aircraft Fractional Ownership Program, supra note 1; see also Jet Shares (vis-itedJune 6, 1999) <http://www.jetshares.com> (seeking commitments for sharesin a Learjet to operate in the northeast United States).

68 AirShare, a program being developed by Pro Aircraft Management, will of-fer fractional interests in Sikorsky helicopters. It will also offer fractional ownersthe ability to obtain blocks of time on Pro Aircraft's fleet of fixed wing aircraft.See R. Randall Padfield, AirShare Spools Up S-76 Helicopter Frax Program, AVIATION

INT'L NEWS, Apr. 1999, at 75. Following its acquisition of Associated AircraftGroup, a helicopter operator, Sikorsky Aircraft implemented a Manhattan-basedfractional ownership program for helicopters. See Gordon Gilbert, Sikorsky GivesFrax Helo Program a Whirl, AVIATION INT'L NEWS, Mar. 1999, at 8. Unlike manyother fractional programs, the helicopters will be operated under Part 135 andusage will be allocated based on flight units - a concept which combines timealoft and distance traveled. See Bill Wagstaff, Sikorsky Factory Backs Northeast Frac-tional Plan, AVIATION INT'L NEWS, Aug. 1999, at 70. This program is the onlyhelicopter fractional program offered by a helicopter manufacturer. See JohnMorris, Sikorsky Expands Fractional Program as It Aims to Stimulate Helicopter Use, Axi-ATION WK. SHOW NEWS, Oct. 13, 1999, at 57.

69 See Irwin Stambler, Used Jets are Lure in Ohio Frax Program, NBAA CONVENTION

NEWS, Oct. 20, 1998, at 25.70 See Paul Lowe, Flight Options Shows Startling Growth, NBAA CONVENTION

NEWS, Oct. 12, 1999, at 149.71 See Bill Sweetman, Flight Options is Doing Better Than Expected With Used Aircraft

for Fractional Ownership, AVIATION WK. SHOW NEWS, Oct. 13, 1999, at 106.

1999] 993


The other major player to enter the fractional ownership mar-ket is Wayfarer Aviation, which introduced the StarShares pro-gram.72 The StarShares program offers shares in turbopropaircraft with the response time varying based on the proximity ofthe origin and destination to New York City. 73 Participants inthis program are also entitled to upgrade a portion of their allo-cated hours to jet aircraft that are in Wayfarer's fleet of man-aged aircraft. 4

The acceptance of fractional ownership as a segment of busi-ness aviation is reflected not only by the continued increase ofcompanies offering fractional ownership but also by the fact thatan average of thirty owners have acquired fractional interestseach month75 and forty to forty-five aircraft are being added tothe NetJets fleet alone per year.76 This rate of growth causedthe number of owners in the program to reach 1100 and thenumber of aircraft to reach 170 by October 1998. 77 When thenumber of aircraft in the second and third largest programs,Business JetSolutions' FlexJet program and Raytheon Travel Air,respectively, are added, the number of aircraft in these pro-grams in late 1998 exceeded 225.78 As 1999 draws to a close,fractional ownership is a multi-billion dollar industry with morethan 1500 owners and 300 aircraft. 79 In spite of its size, Allied-

72 Wayfarer Aviation was formed in 1956 to manage aircraft for the Rockefellerfamily. See Paul Richfield Wayfarer to Sell King Air Shares, Bus. & COM. AVIATION,May 1999, at 35. Subsequent to the implementation of this program, WayfarerAviation was acquired by TAG Aviation. See Harry Weisberger, Wayfarer Buy MakesTAG World's Largest Charter Op, AVIATION INT'L NEWS//ONLINE: NBAA CONVEN-

TION NEWS (visited Oct. 18, 1999) <http://www.ainonline.com/nbaa-wayfer-erd3_1.htm/>.

73 See Wayfarer Launches King Air Fractional Program Aimed at New York Market,WKLY. Bus. AVIATION, Apr. 5, 1999, at 155.

74 See Richfield supra note 72, at 35.75 See Velocci, Growth of Fractional Ownership Assured Despite Turbulence Ahead,

supra note 5, at 58.76 See Perry Bradley EJA Boosts European Shares Program, Bus. & COM. AVIATION,

Oct. 1998, at 74.77 See Velocci, Growth of Fractional Ownership Assured Despite Turbulence Ahead,

supra note 5, at 58. By September 1999, NetJets had 218 business jets in its fleet.See Wagstaff, supra note 11, at 225.

78 See Kate Sarsfield, Fractional Divide, FLIGHT INT'L, Oct. 14, 1998, at 45. Byearly 1999, the Raytheon Travel Air program included 10 Hawkers, 16 Beechjetsand 7 King Airs serving 200 owners. See Raytheon Eyes International Expansion forTravel Air, AVIATION INT'L NEWS, Feb. 1, 1999, at 10.

79 See Sarsfield, supra note 11, at 56 (the five major programs - Executive Jets'NetJets, Bombardier's FlexJets, Raytheon's Travel Air, Flight Options and Way-farer's StarShares - have 329 aircraft and 1567 shareholders). According to Avia-tion Data Service of Wichita, there were only 24 aircraft and 89 fractional

994


Signal estimates that "[o]nly a small fraction of [the] total po-tential [fractional ownership] market has been developed todate."80

III. PARTICIPATION IN FRACTIONALOWNERSHIP PROGRAMS

Although the programs vary somewhat," the structure of allof the programs are fundamentally similar.8 2 Virtually all of theprograms involve the acquisition of an interest in an aircraft, 3

the execution of a management agreement with the programmanager, the execution of an agreement with the other co-own-ers of the aircraft and the execution of an interchange agree-ment with all program participants whereby the interest isplaced in a pool of aircraft consisting of all aircraft in the pro-gram. 4 The term of the agreements is typically five years duringwhich time the participant pays the manager a fixed monthlymanagement fee and an hourly fee for each hour the partici-pant flies in its aircraft or any aircraft from the interchange

shareholders in 1993 and 165 aircraft with 743 fractional shareholders in 1997.See Phil Rose, NBAA and the Fractional Issue: An Early Verdict, PROF. PILOT, Oct.1999, at 30; Barry Rosenberg, Fractionals: Love Them or Hate Them But They AreFueling the Bizjet Boom, AVIATION WK. SHOW NEWS, Oct. 12, 1999, at 76.

80 Gordon A. Gilbert, Fractional Strength Drives Continued Bizav Growth, NBAACONVENTION NEWS, Oct. 12, 1999, at 88; AlliedSignal Forecast Predicts Business JetMarket Will Stay Hot Through 2009, supra note 1, at 171; see also Gilbert, AlliedSignalForecasts Big Bizjet Boom; Sees $78 Billion Sales Over 10 Years, supra note 1, at 16.

81 Certain of the differences stem from the different regulatory environmentsin the jurisdictions where the programs are based. See supra notes 44-61 and ac-companying text.

82 See SRI FRACTIONAL CONFERENCE, Fractional & Joint Ownership: Corporate JetManufacturers and Operators Perspective, supra note 1; Sarsfield, Fractional Progress,supra note 1, at 64. See also David Field, Jet Time Sharing Gains Altitude: Rival Com-panies Expand Fleets, USA TODAY, Nov. 26, 1996, at B5; Bradley, supra note 9, at 76.

83 Although the vast majority of participants in fractional ownership programsown an interest in an aircraft, certain parties participate in these programs byvirtue of aircraft lease agreements. These leases typically arise in one of two ways.First, a participant may lease an interest from a third party, such as a financinginstitution, pursuant to an operating or a finance lease. Second, a party maylease an interest from the program manager or an affiliate of the program man-ager until the aircraft in which such party has contracted to purchase an interestbecomes available. In either case, the lessee is treated as an owner for purposesof its participation in the day-to-day aspects of the program. For purposes of thisarticle, unless the context requires otherwise, all references to interest owners orprogram participants shall include parties who are owners or lessees of theinterests.

84 See infra notes 105-106 and accompanying text for description of the in-terchange aspect of fractional ownership programs.

19991 995


pool, and there is no charge for deadhead time.85 The numberof hours allocated to the participant is based on the percentageof its interest in the aircraft. The programs generally allow theparticipant to require the program manager or its affiliate torepurchase the aircraft after a specified period of time.86

Although an interest in a specific aircraft is acquired, the partici-pant, through the interchange agreement, has access to theother aircraft in the program if the aircraft in which it owns aninterest is not available. The participant may also trade up to amore expensive aircraft or down to a less expensive one with thenumber of hours deducted from the participant's total alloca-tion being adjusted to reflect the difference in the aircraft.

Some of the smaller programs have slight variations in theirstructure although they all generally contemplate the purchaseor lease of an interest, the execution of a management agree-ment and the availability of an alternate aircraft if the aircraft inwhich the participant acquired an interest is not available. Atleast one program, Skyshare, offers shared aircraft ownershipfor owners/pilots and smaller companies in local markets withpiston and turbine powered aircraft through a franchise ar-rangement with fixed base operators at various locationsthroughout the United States. 87

85 The deadhead portion of a flight is that portion required to bring the air-craft to the location where the participant will originate its flight or to return theaircraft to its base. See Robert Searles, Fractionals Can Fracture Deadheads, Bus. &COM. AVIATION, Oct. 1998, at 62. Many fractional owners experience cost savingsbecause the programs allow a company to control the deadhead expenses. SeeDavid Esler, Using Fractionally Owned Aircraft For Supplemental Airlift, Bus. & COM.AVIATION, Nov. 1998, at 66; See also Bradley, supra note 9, Nov. 1996, at 82. Be-cause the cost of the deadhead segments is built into the various fees paid to themanager, an owner whose travel involves little deadhead will be subsidizing anowner with substantial deadhead needs. See Norris, Pitfalls of Fractional Ownership,supra note 5, at 100. There are, however, certain programs that charge partici-pants for deadhead segments. See supra note 65.

86 See SRI FRACTIONAL CONFERENCE, Fractional & Joint Ownership: Corporate JetManufacturers and Operators Perspective, supra note 1, and Developing a Used AircraftFractional Ownership Program. But see Alcock, supra note 50, at 42 and accompany-ing text; Alcock, supra note 53 and accompanying text.

87 See Firm Offers Fractional Ownership Franchises to FBOs, Bus. & CoM. AVIATION,

June 1998, at 28. The Skyshare program allocates aircraft usage based on thenumber of days and not the number of hours as is done by most of the otherprograms. Although access to other aircraft in the program is provided, access isnot guaranteed as aircraft are provided on a first-come, first-served basis. In addi-tion, the program is based on the assumption that the participant will leave fromits home base. As such, deadheading expenses would be attributable to the par-ticular owner. See Skyshare International (last visited June 13, 1999) <http://www.skyshare.com>; see also Skyshare likes Multi, NBAA CONVENTION NEWS, Oct. 20,

996


For the programs that guarantee aircraft availability, the pro-gram manager generally relies on a combination of core fleet"8

and outside charter capacity.89 The need for core fleet to en-sure that there are an adequate number of aircraft available forthe participants is particularly important in the early stages of aprogram when the number of aircraft in the interchange pool isquite limited90 and in national programs where the aircraftcould be located in geographically distant locations.9 1 For ex-ample, when NetJets Europe was started, a core fleet of aircraftwas already in place so that the participants could be assured theavailability of aircraft.9 2 Although the relative percentage ofcore fleet aircraft may decline over the course of the program,the need for such aircraft does not disappear if the programmanager wishes to guarantee the availability of aircraft to theparticipants.9

1998, at 55. By September 1999, Skyshare had ten franchisees. See Sky Shore Inter-national Add Franchisees, Bus. & COM. AVIATION, Sept., 1999, at 24.

See Perry Bradley, Flight Options Opts for Used Aircraft That Cost Less But AreMore Readily Available, Bus. & CoM. AvIATION SHOW NEws, Oct. 20, 1998, at 106("Flight Options plans to maintain a 50% core fleet-to-owned aircraft ratio tolimit the amount of flying that is sold off to outside charter operators to aboutfive percent. . . ."); Anthony L. Velocci, Jr., Executive Jet Attempts to Defy Odds WithEuropean Venture, AviATiON WK. & SPACE TECH., Aug. 26, 1996; Jacobs, supra note9, (a program manager must have a "critical mass of aircraft in order to operatenationwide ... ." requiring a substantial investment of capital); see also GrahamWarwick, Two Ways to Time Share (Part-Ownership of Corporate Aircraft), FLIGHT INT'L,Sept. 28, 1994; SRI FRACTIONAL CONFERENCE, Developing a Used Aircraft FractionalOwnership Program, supra note 1.

89 Charter operators provide approximately 17-18% of the flights in fractionalownership programs. See Fred Gevalt, Fractional Ownership: The Wolf in Sheep'sClothing, THE AIR CHARTER JOURNAL, Mar. 1998.

90 EJA itself acknowledged relatively early in its program that it has had to beconservative in its expansion because of the investment required in obtainingcore fleet aircraft when introducing a new aircraft type into the program. See'Anthony L. Velocci, Jr., Industry Debates Value of Fractional Shares, AVIATION WK. &SPACE TECH., Aug. 29, 1994; see also Warwick, supra note 88.

91 See Velocci, supra note 90.92 See Anthony L. Velocci, Jr., Executive Jet Attempts to Defy Odds With European

Venture, AVIATION WK. & SPACE TECH., Aug. 26, 1996.93 See Norris, supra note 5, at 98 (the growth of the total fleet reduces a pro-

gram manager's dependency on core fleet and charter); see also Warwick, supranote 88.

1999] 997


IV. THE OPERATION OF AIRCRAFT IN FRACTIONALOWNERSHIP PROGRAMS

A. THE REGISTRATION OF FRACTIONALLY OWNED AIRCRAFTr

EJA's NetJets program was developed using concepts that theFAA had already blessed in Part 91 of the FARs. 94 Many of theseconcepts require the aircraft to be U.S. registered.95 As a result,the first responsibility of an owner is to cause its interest in theaircraft to be registered at the FAA. In order to be registered atthe FAA, the aircraft must be owned by citizens of the UnitedStates 96 or owned by a corporation organized and doing busi-ness under the laws of the United States or one of the states,provided that the aircraft will be based and primarily used in theUnited States.97

94 14 C.F.R. pt. 91 (1998).95 See 14 C.F.R. § 91.501(a) (1998).96 A citizen of the United States is defined as

(A) an individual who is a citizen of the United States;(B) a partnership each of whose partners is an individual who is acitizen of the United States; or(C) a corporation or association organized under the laws of theUnited States or a State, the District of Columbia, or a territory orpossession of the United States, of which the president and at leasttwo-thirds of the board of directors and other managing officersare citizens of the United States, and in which at least 75 percent ofthe voting interest is owned or controlled by persons that are citi-zens of the United States.

49 U.S.C. § 40102(a)(15).97 See 14 C.F.R. § 47.3(b)(1)(A) (ii) (1998). The FAA considers an aircraft to

be based and primarily used in the United States if at least 60% of the flighthours are accumulated on flights between two points in the United States duringeach six month period following the registration of the aircraft at the FAA withthe first six month also including the remaining portion of the month in whichthe aircraft is registered. See 14 C.F.R. § 47.9(b) (1998). Registration under thisoption requires the submission of certain corporate documentation, certifica-tions and information in addition to evidence of ownership. See 14 C.F.R.§ 47.9(a) (1998). If any of the co-owners rely upon this option for registration,the ability of that party to be compensated in any fashion for the operation ofaircraft would be limited because any aircraft operated by such party would bedefined as a foreign civil aircraft under economic-based regulations administeredby the U.S. Department of Transportation. See 14 C.F.R. § 375.1 (1998). See Cor-porate Aircraft Operations, supra note 7, at 1006-07, and Beware Part 375: A Trap forthe Unwary, NBAA DIGEST, July 1998, at 4, for a more detailed discussion of theimplications of being classified as a foreign civil aircraft. The aircraft itself wouldnot likely be treated as a foreign civil aircraft when it is operated by the U.S.citizen owners. There are, however, no DOT interpretations addressing thisissue.

1999] FRACTIONAL OWNERSHIP OF AIRCRAFT 999

In order to register the aircraft with all of the co-owners iden-tified, an application for registration must be filed each time aparty is added or removed from the ownership of the aircraft.Because the change of even one party results in a change ofownership, all of the co-owners must sign the registration appli-cation, even the ones that were already listed as registered own-ers.98 Given the relatively frequent addition of participants tofractional ownership programs and the logistical difficulty asso-ciated with securing all of the required signatures,99 the pro-gram managers have developed a practice under which theprogram manager signs the application for each of the co-own-ers pursuant to a power of attorney granted by each of the co-owners to the program manager authorizing such execution."°

B. THE REGULATORY FRAMEWORK FOR OPERATING

FRACTIONALLY OWNED AIRCRAFT

Since their implementation in 1986, fractional ownership pro-grams have been operated under Part 91.101 Despite the promi-nence and phenomenal growth of these programs, however, theterm "fractional ownership" is not defined or even mentionedby name in Part 91 or anywhere else in the FARs. Nevertheless,the concept is based on three key Part 91 concepts-all of whichare long-accepted parts of business aviation.'0 2

98 See 14 C.F.R. § 47.13(f) (1998).99 The FARs contain very specific requirements for the execution of docu-

ments being filed with the FAA. Among other things, these regulations identifythe parties who are authorized to execute documents on behalf of an applicantor registered owner. See 14 C.F.R. §§ 47.13(c), (d), (e) and (f) (1998).

100 The FAA will accept documents signed pursuant to powers of attorney onlyif the originally signed power of attorney (or a certified copy thereof) is submit-ted with the application. See 14 C.F.R. § 47.13(c)(3) (1998). In the case of acorporation, a certified copy of the resolution of the board of directors authoriz-ing the grant of the power of attorney must also be filed. See 14 C.F.R. § 47.13(d)(1998). As is the case with all documents filed with the FAA, each signature mustbe an original. See 14 C.F.R. § 47.13(a) (1998).

101 There is at least one program which holds itself out as a fractional owner-ship program where the aircraft are operated by the manager under Part 135 ifthe aircraft being used by the participant is not the aircraft in which the partici-pant owns an interest. See SRI FRACrIONAL CONFERENCE, Developing a Used AircraftFractional Ownership Program, supra note 1; see also supra note 68.

102 Due to the differences in the regulatory environments, however, the struc-

ture of NetJets Europe is somewhat different than the structure of the U.S.-basedprogram. See Alcock, EJA Adapts Fractional Ops to Fit European Realities, supra note37, at 44. For example, the ownership interests of the participants in the NetJetsEurope program are registered with the Civil Aviation Authority in Portugal, thejurisdiction in which the aircraft are registered. See Fractional Ownership Takes Off


The first is joint ownership. The FAA defines joint ownershipas "an arrangement whereby one of the registered joint ownersof an airplane employs and furnishes the flight crew for thatairplane and each of the registered joint owners pays a share ofthe charge specified in the agreement. 1 0 3 Under the FAR defi-nition, there is an operating joint owner and one or more non-operating joint owners and the non-operating joint owner(s)compensate(s) the operating joint owner for the cost of suchoperations. By contrast, the agreement among the fractionalowners does not contemplate that one owner will operate forthe other. Instead, each owner is operating for itself. Thus, theconcept of owning a share of an airplane in a fractional pro-gram is not a joint ownership as defined by the FAA, but ratheris more in the nature of a co-ownership which itself is a wellrecognized and accepted FAA concept.104

The second is the interchange. The interchange is the mech-anism by which owners have use of aircraft when the aircraft inwhich it purchased an interested is not available. The FARs de-fine an interchange agreement as "an arrangement whereby aperson leases his airplane to another person in exchange forequal time, when needed, on the other person's airplane, andno charge, assessment or fee is made, except that a charge maybe made not to exceed the difference between the cost of own-ing, operating and maintaining the two airplanes."10 This defi-nition contemplates an exchange of wet leases (i.e., aircraft withcrew) between two parties, each of which has its own aircraft.'0 6

in Europe, INTERAVIA Bus. & TECH., Sept. 1997, at 27. Following registration, atthe outset, the aircraft in the NetJets Europe program were based either in Lis-bon, Portugal, where EJA's partner, Air Luxor, is located or in Zurich, Switzer-land, where its former partner Zimex Aviation is located. See Edward Phillips,Economic Growth Fuels Rise in European Business Flying, AVIATION WK. & SPACETECH., Sept. 22, 1997, at 69; see also supra note 36. In addition, unlike its U.S.counterpart, NetJets Europe operates under a commercial certificate in accord-ance with the Joint Aviation Regulations Ops 1 requirements issued by the Euro-pean Joint Aviation Authorities. See EJA Adapts Fractional Ops to Fit EuropeanRealities, supra note 37, at 44. See also supra notes 44-59 and accompanying text.

103 14 C.F.R. § 91.501(c)(3) (1998).104 In addition to the Part 91 definition ofjoint ownership, the FAA recognizes

the existence of co-owners in its regulations governing aircraft registration. Infact, the Application for Aircraft Registration which is required by the FAA to besubmitted by an applicant for aircraft registration lists "Co-owner" as one of thetypes of registration. See 14 C.F.R. §§ 47.31, 47.7(d)(1) (1998), and AC Form8050-1.

105 See 14 C.F.R. § 91.501(c)(2) (1998).106 Although the definition of interchange does not refer to the crew, it is clear

that the FAA contemplated that interchanges would involve the provision of air-

1000

Documents

document