The Federal Aviation Administration (FAA) is currently proposing changes to its policy on treatment of non-citizen trusts (NCTs). These are trust vehicles employed to obtain U.S. registration of aircraft owned beneficially by parties otherwise not meeting the citizenship criteria required under U.S. law. The FAA’s proposals involve substantial changes to existing industry practices and relationships in the use of such trusts. Comments to the FAA from the public on the proposed policy changes are due no later than August 17, 2012.

NCT Structure

Early in the 20th century, Congress began imposing a citizenship test for eligibility of aircraft owners to register their aircraft on the U.S. registry. The initial reason was concern that foreign owners of U.S. aircraft might impede U.S. access to needed transport in time of war. A subsequent reason was protection of the young U.S. airline industry from potential unfair domestic competition from foreign operators. The citizenship requirement continues today.

However, parties not meeting the citizenship requirement frequently desire to register aircraft under the U.S. “N” registration mark. Many reasons may be involved, such as financing by a foreign lessor, or temporary registration of a flyable but not yet interior-fitted aircraft, or a foreign operator’s desire to have the aircraft inspected and maintained pursuant to U.S. rules. Under current FAA regulations and practice, parties not meeting the citizenship criteria may utilize the FAA civil aircraft registry by transferring ownership of an aircraft to a U.S. trust institution or other U.S. citizen, to hold in trust for the foreign owners. This arrangement, known as a restrictive owner trust or NCT, is created by a specialized trust agreement entered into between the trustee and the beneficial owner or trustor.

The current FAA regulations on aircraft registration by trusts for all types of trustors, both U.S. citizen and non-citizen, became effective January 1, 1980. The current regulations codify previous administrative practice of the FAA on aircraft registration in the name of a trustee. For NCTs only, the regulations require submission of various documents, including a trustee affidavit certifying to no knowledge of any “reason, situation or relationship” whereby any party not meeting the definition of a U.S. citizen “would have more than 25 percent of the aggregate power to influence or limit the exercise of the trustee’s authority.” Also, the trust instrument must provide that non-citizen parties together will not have more than 25 percent of the aggregate power to direct or remove a trustee. (Trusts that hold security interests in U.S. civil aircraft, as well as those holding ownership interests, are subject to the same requirements.)

Under these rules, it is the practice of prospective trustees to pre-clear the trust agreements and related affidavits with the Office of Aeronautical Center Counsel (ACC) at the FAA Registry before applying for registration. The trust agreements are reviewed by ACC before execution to verify that their terms adequately incorporate the required limits on power of non-citizens. Over the years, a standard form of NCT agreement acceptable to the FAA has developed.

Additionally, at the time of entering into any aircraft trust agreement, the parties typically also sign a separate operating agreement making clear that possession, use, operation and maintenance of the aircraft rest with the trustor or a third-party operator — in any event, not with the trustee. The operating agreement is designed to aid in protecting the trustee in the event of tort claims arising from operation of the aircraft. Under the trust structure, the trustee acts as only an accommodation party, holding the legal title of the aircraft.

FAA Concerns Behind Proposed Changes

Aircraft Operated Abroad. In many cases, such foreign-beneficially-owned aircraft are based and operated outside the U.S. In its Notice of Proposed Policy Clarification, the FAA reported that when an aircraft mainly operates abroad, the FAA often has difficulty complying with its Chicago Convention obligations of aircraft oversight for enforcement of safety rules. For example, that Convention obliges the U.S. to require that U.S.-registered aircraft comply with the flight and maneuver rules of the country of operation. As a result, from time to time, the U.S. must share with another nation certain information regarding a particular aircraft and its operations. The FAA reports it has experienced problems in doing so where the trustee has been unable to elicit information from the foreign operator in timely fashion. The FAA states that it encounters the most difficulty obtaining information from trustees of aircraft used in General Aviation and aerial works operations (as opposed to commercial airlines and charter air operations).

Side Agreements. The FAA’s current regulations require submission of “each document legally affecting a relationship under the trust” for FAA review in advance of registering an aircraft to a trustee owner. The FAA states that despite these regulations, it frequently has not been provided with all documents needed to understand the true arrangements among owner trustees, trustors and operators regarding the possession, use and operation of NCT aircraft. Such documents include the aircraft operating agreements mentioned above and other side agreements if any. The FAA notes it has discovered too late that some undisclosed side agreements contain terms additional to or different from those in the trust agreement displayed to the FAA.

Power to Remove Trustee. Another issue for the FAA is the perceived inadequacy in some trust agreements of limitations on the power of non-citizens to remove the trustee. According to the FAA, clauses in some trust agreements have granted non-citizen trustors more than 25% of the aggregate of such power, where the removal is stated to be “for cause,” and without adequately enumerating what events will constitute “cause.”

Other Concerns. In addition to enforcement of safety rules and access to information on the true operator, the FAA cites further reasons why disclosures by NCTs should be enhanced, as follows: (a) the law enforcement needs of the U.S. Drug Enforcement Administration, U.S. Immigration and Customs Enforcement, States and localities; (b) International Civil Aviation Organization responsibilities; (c) concerns on the part of foreign countries; and (d) U.S. national security. The FAA has announced that because of the above concerns, in the future it will require greater cooperation and transparency from trustees of NCTs that own “N”-registered aircraft.

Proposed Policy Changes

The FAA states that in the future it will require submission, along with any draft trust agreement, of all operating and other side agreements involving transfer of custody and use of the aircraft. If no such side agreement is submitted, the trustee’s affidavit must contain an additional declaration to the effect that no such agreement or arrangement is being entered into by the trustee.

The FAA also is proposing to require trustees of NCTs to obtain and disclose within short deadlines up-to-date information on registered aircraft including (in two business days) their operators, managers, records locations and operating routes and (in five business days) their crew, future operations and actual records. The FAA could shorten the times in an emergency.

Additionally, the FAA has published a set of amendments to the standard NCT agreement form developed over the years, which it proposes as a means of remedying the problems uncovered with current NCT ownership practices. On the whole, the proposed amendments enhance the powers of owner trustees and restrict the powers of beneficiaries or trustors. The amendments proposed by the FAA are the following:

1. The trust agreement provision on trustee removal would contain a 25% limitation on aggregate power of non-U.S. citizens.
2. “Cause” for a trustee’s removal would be defined as “willful misconduct or gross neglect so as to endanger the Trust estate.”
3. The FAA would delete the existing requirement for the trustee to lease the aircraft to any lessee under any lease pursuant to instruction from the trustor.
4. The FAA would delete the existing requirement for the trustee to distribute the aircraft from the trust estate pursuant to the trustor’s instructions.
5. The direction for the trustee to register the aircraft would add the requirement that any operating agreement shall be filed with the FAA.
6. The trust agreement would include the above proposed obligations of the trustee to provide operational and maintenance information to the FAA within two or five business days, with the cooperation of the trustor, and with the proviso that the information shall be provided immediately “in an emergency identified by the FAA.”
7. The new form trust agreement would require the trustee to forward any emergency FAA airworthiness directives immediately to the trustor, the lessee or both.
8. The trustee would be required to notify the FAA “by the most expeditious means available” of its removal or resignation as trustee.
9. The trustee would be required to authorize inspections of the aircraft by U.S. and foreign government officials.
10. “In all matters arising under the Agreement,” the trustee shall have absolute and complete discretion, shall be free of the trustor’s influence or control and shall exercise its duties as it deems necessary to protect the interests of the U.S. government. In the prior version, such discretion and freedom were limited to matters involving ownership and operation of the aircraft by the trustee.
11. The FAA would remove the restriction against the trustee’s amending leases and operating agreements without the consent of the trustor.
12. The provisions on trustee discretion and freedom from influence and control would be made “paramount and superior” to any other provisions in the trust agreement or any other agreements between the trustee and the trustor.
13. The trustor no longer would be permitted to remove a trustee for disapproving a proposed transfer of an aircraft beneficial interest, a lease or an operating agreement.

Public Comments

The FAA’s proposals were contained in a Notice issued in February 2012 following its consideration of comments voiced at a public meeting on NCTs held by the FAA in Oklahoma City, Oklahoma in June 2011, and written comments submitted by aviation industry participants before and after the meeting. A second meeting was held June 6, 2012, with written submissions before and after.

At the second meeting, several representatives of the FAA and the industry aired concerns and suggestions refashioned in light of various considerations. The trust industry objected that the two-day and five-day disclosure requirements could prove an impossible standard for trustees to fulfill, raising the potential for trustees to incur direct FAA sanctions, and thereby creating a reputational risk intolerable to institutions. The same issue applies to foreign investors serving as trustors under the NCT structure. NCTs form a vehicle whereby foreign lessors finance U.S.-registered aircraft, and the exit of trustees or investors from NCT business could curtail airlines’ and corporate operators’ much-needed access to foreign capital. Also, without NCTs, American corporations that fail the citizenship test merely by having a foreign President would have to re-register in a foreign country, resulting in unavailability of the important safe-harbor operations provided under FAR 91.501. FAA representatives noted, however, that on too many occasions the FAA has been unable to respond to frequent inquiries of foreign civil aviation agencies about operators of NCT-owned U.S. aircraft being operated in repeated violation of local rules. The FAA appeared to acknowledge an industry suggestion that trust agreements could place an affirmative duty on trustors to produce the information timely, failing which the trustee could resign and avoid sanction. Aviation finance lawyers stated that since operating agreements in effect create leaseholds, to require their submission for the FAA’s ancillary files (which are publicly searchable) would create potential clouds on title. One industry participant suggested the title problem could be cured by keeping FAA-filed operating agreements confidential in the manner of leases filed under FAA truth-in-leasing regulations. The lessors and trust companies objected that requiring trustees to retain copies of operational documents might ensnare them in tort or regulatory liability from which they hitherto were immunized by statute by virtue of complete non-involvement with operations.

At the conclusion of the meeting, the FAA requested that interested parties express in writing their further views on possible unintended consequences of the policy changes. In public notices, the FAA has stated that it intends to issue a final Policy Clarification, based on all the public comments, not long after the 2012 meeting and the close of the comment period. The comment period has been extended and will close on August 17, 2012.

If you wish to discuss the issues involved in the FAA’s proposals, or desire assistance with submission of public comments to the FAA on the NCT proposals, please contact either the authors of this client alert, or your Smith, Gambrell & Russell, LLP attorney.