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Virgin Territory—Foreign Ownership of US Airlines

Greg Cirillo
September 2007 | AirWorthy: Insights into Current Aviation Legal Issues

A non-US citizen's ability to invest in, purchase or establish an airline and hold an air transport certificate from the US Department of Transportation (DOT) has always been a "hot" topic politically and in the financial community. Citizenship requirements are rare under US law and generally only apply to industries where physical or financial security is at stake, because limiting the universe of available investors restricts access to capital, which, in turn, limits an entity's value. In fact, while much of the US airline industry was in bankruptcy from 2001 through 2005, many of those airlines were pressing Congress and the DOT to change or reinterpret the current laws and regulations in order to permit more foreign investment. Foreign capital was seen as a means to recapitalize the US airlines.

In December 2005, when it was announced that Sir Richard Branson's brainchild, "Virgin America," had applied to the DOT for an air carrier's certificate, several US airlines embraced the restrictions on foreign ownership that they previously sought to reduce or eliminate. An interesting battle ensued. Sir Richard prevailed. Technically, however, neither Sir Richard nor Virgin Group could prevail.

Under US law (49 U.S.C. § 41102), an air transport certificate can only be held by a US citizen, which is defined as: (1) an individual who is a US citizen; (2) a partnership, each of whose partners is an individual who is a US citizen; or (3) a corporation or association organized under US law, (a) of which the president and at least two-thirds of the board of directors and other managing officers are US citizens, (b) which is under the actual control of US citizens, and (c) in which at least 75 percent of the voting interests is owned or controlled by persons who are US citizens. In addition to this statutory requirement, the DOT requires that the applicant demonstrate none of the indicia of foreign control that the DOT has historically considered relevant. So, Virgin America could not be controlled by Sir Richard, nor could it be controlled by Virgin Group.

To meet the above requirements, the organizers of Virgin America created a corporate ownership structure using multitiered entities, restricted voting rights and management positions, all designed to address the statutory formulae and the precedent developed by the DOT over many decades. The resulting ownership structure, when depicted graphically, resembles a huddle of squid.

At first, the opposition toVirgin America prevailed, and by Order dated December 27, 2006 (DOT Order 2006-12-23), the DOT tentatively ruled that Virgin America's proposed corporate ownership structure did not meet the requirements for US citizenship. There were several reasons for denial, but among them were Virgin Group's trademark license to Virgin America that included unique conditions and remedies that implied that Virgin Group would have undue influence on Virgin America's operating decisions. The Order also got personal, finding that Virgin America's CEO and Director, Frederick Reid, was beholden to Sir Richard as evidenced by their history—including the fact that Mr. Reid's association with Virgin America dated back to 2004, before there was any US ownership. The DOT concluded that Mr. Reid's personal fealty to Sir Richard suggested that, regardless of numerical ownership, British interests actually controlled Virgin America.

Virgin America's complex ownership structure hoped to piggyback on a recent DOT ruling that allowed Hawaiian Airlines to emerge from bankruptcy with an ownership structure not strictly meeting the DOT's standards for avoiding actual control by foreigners. In a letter ruling in support of Hawaiian Airline's reorganization, the DOT took a flexible view in assessing the citizenship of the entities in the Hawaiian ownership matrix and expressed comfort with an aggregated 49.9% foreign ownership, noting that this was permissible because it was both passive (not interested in management) and diffuse (with no single shareholder or group dominating). The DOT declined to apply this flexible approach (called the "multiplying out" approach) to Virgin America, noting that the foreign interests had both an incentive and ability to exert management influence, and that the foreign investors were not diffuse, but rather showed a narrow aggregation of ownership in a smaller group.

Having lost the battle for its aggressive ownership structure, Virgin America (working with the DOT) went back to the blackboard (a very large blackboard) and crafted a revised structure with adjustments to capital structure and the trademark license, as well as a phaseout of Mr. Reid's role, in order to meet the DOT's requirements. Finally, the DOT gave Virgin America its US air transport certificate (DOT Order 2007-5-11, May 18, 2007).

What is often overlooked by aircraft operators is that the citizenship requirement applies to ALL forms of air transport certificates. So, for example, each and every Part 135 charter certificate holder must meet the US citizenship requirements. But holders of Part 135 certificates have been known to "inadvertently" lose their US citizenship in connection with a merger, acquisition or major capital transaction. It is vital that certificate holders keep this citizenship requirement in mind when engaging in any such transaction. The DOT does not "police" citizenship requirements, but objections are generally raised by competitors.

For more information, please contact Greg Cirillo at 703.905.2808 or gcirillo@wileyrein.com.

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