Non-Citizen Trusts: Status of FAA Review, Observations and Practical Considerations

[nonmember]The US Federal Aviation Authority has made it clear to the aviation industry that it has serious concerns regarding the use non-citizen trusts (NCTs) and it is considering whether changes might be necessary. Edward Gross and Clay Thomas look at the current status of NCTs, why they are used and what might result from this recent FAA scrutiny.::join::[/nonmember][ismember]

The US Federal Aviation Authority has made it clear to the aviation industry that it has serious concerns regarding the use non-citizen trusts (NCTs) and it is considering whether changes might be necessary. Edward Gross and Clay Thomas 1 look at the current status of NCTs, why they are used and what might result from this recent FAA scrutiny.

For more than 30 years individuals and business entities who desired to register an aircraft with the US 2 but could not certify that they met the US citizenship test under the Federal Transportation Code 3 (the “Transportation Code”) have relied on non-citizen trusts (“NCTs”) to effect such registration.

During that period, aircraft owners, operators and financing parties have employed NCTs and assumed legal compliance by relying on the Federal Aviation Administration’s (the “FAA”) pertinent regulations and course of conduct. However, the FAA recently made it clear to the aviation industry that it has serious concerns regarding the use of NCTs and is considering whether changes might be necessary. This article summarizes the current status of NCTs, including some historical context and our view as to what might result from this recent FAA scrutiny. As noted below, the on-going collaborative efforts of the FAA and the aviation industry should yield mutually desired results, including by preserving NCTs while facilitating the FAA’s airworthiness objectives.

Background

Ownership Registration/US Citizenship

In the US, the FAA is responsible for maintaining the registration system for aircraft in accordance with the provisions of the Convention on International Civil Aviation 4 (the “Chicago Convention” or the “ICAO”).

The Chicago Convention establishes the common agreement among the contracting states that an aircraft registered with the registry of one of the contracting states may not be concurrently registered with the registry of any other contracting state. Unlike many Chicago Convention contracting states that require an aircraft to be registered in the name of the actual operator, the United States established an “owner registry” system and related laws and regulations requiring that aircraft be registered in the name of the legal owner.

U.S. aviation law establishes certain conditions under which an aircraft may be registered on the FAA registry, including that the registered owner must meet certain citizenship requirements.5  When applying for registration, the owner must certify that it is either: (i) a U.S. citizen, (ii) a permanent resident alien or (iii) a foreign corporation doing business in the United States.6

However, any foreign corporation registering its ownership of an aircraft must also base and primarily use the aircraft in the United States and comply with related reporting requirements.7 Business entities desiring to avoid these operational restrictions must pass a number of citizenship tests under the Transportation Code when registering an aircraft.

For example, partnerships are only considered U.S. citizens if each partner is also an individual who is a US citizen or a resident alien.8 Similarly, a corporation is only considered a US citizen if: (i) it is domestically organized, (ii) its president and two-thirds of its board of directors and other managing officers are US citizens and (iii) at least 75% of the voting interests are owned or controlled by U.S. citizens.9   

The FAA has typically judged the citizenship of limited liability companies in a manner similar to corporations.

The Federal Aviation Regulations (the “FARs“) also permit U.S. registration of aircraft using an ownership trust.10  Ownership trust registration was first validated by opinions issued by FAA internal counsel in the 1970’s, and ultimately pursuant to pertinent amendments to the FARs in 1979.11

The NCT registration process includes the applicant’s submitting to the FAA Aeronautical Center Counsel (the “ACC“) the NCT trust agreement together with any other documents relating to the core non-citizen control limitations under the FARs. Upon reviewing and approving the trust agreement, the ACC issues an opinion approving the FAA registration of the aircraft pursuant to the terms of the NCT trust documents.

This opinion is critical to aircraft owners, financing parties and others in establishing the validity of the NCT registration of an aircraft. Often, owner trustees in aircraft-related trusts are banks or trust companies organized under U.S. federal or state law. The trustee is the legal owner of the aircraft and the registered owner at the FAA, and like any other owner, the trustee must qualify for FAA registration by satisfying the citizenship requirements detailed above. The beneficiaries of these trusts need not necessarily satisfy the citizenship rules, but are subject to additional requirements and limitations with respect to the power they have to influence or limit the exercise of the trustee’s authority or to direct or remove a trustee.

This owner trustee/beneficiary distinction gave rise to the industry practice of relying on “non-citizen trust” arrangements in which the U.S. citizen trustee may serve as the registered owner of an aircraft even if the trust beneficiaries are not U.S. citizens. Simply stated, NCTs are discretionary trusts established by one or more beneficiaries who are not U.S. citizens for purposes of registering an aircraft with the FAA registry, pursuant to a trust agreement containing requirements and limitations complying with the pertinent regulations.12

At first, the related FARs restricted the percentage of non-citizen beneficial ownership of an NCT. These evolved so as to focus on restrictions intended to preserve the trustee’s independent authority with respect to certain matters pertaining to the aircraft.

Accordingly, the non-citizen beneficiaries in an NCT must have no more than 25% of the aggregate power

to influence or limit the trustee’s authority, which may be achieved by including pertinent trust agreement provisions limiting non-citizen beneficiaries from exercising more than 25% of the aggregate power to direct or remove the trustee.13 Such control limitation provisions have allowed those trusts where noncitizens hold in excess of 25% of the beneficial ownership interests to, nonetheless, qualify for US registration.

Use of NCTs. As discussed above, NCTs have been legitimized by regulation, FAA internal counsel opinions and governmental and industry acceptance over the past 30 years. As such, they are considered a reliable industry solution in circumstances where FAA registration is desirable but otherwise unavailable under the citizenship requirements. Some examples include:

Buyers and Sellers. Non-citizen aircraft purchasers often use NCTs to “N” register an aircraft in various circumstances including: (i) while it is being modified to comply with laws of the nation in which the aircraft will ultimately be registered; (ii) while being ferried to another country; (iii) if it is being refurbished or outfitted in the US before being exported and delivered to another country; or (iv) when registration in the owner’s country is not yet available because its type certification is still pending. Furthermore, non-citizen aircraft manufacturers and other sellers sometimes use NCTs to register aircraft being marketed in the US.

Aircraft Financings. Non-US citizen operating or financing lessors often use NCTs when FAA registering an aircraft, especially when the lessee or other essential party is situated in the US, or the beneficiary is a financing source, operating lessor or passive investor with US operations. US financing parties providing secured financing to non-citizen owners often require that the aircraft be US registered, necessitating the use of an NCT. US registration is preferred by these financiers for various reasons including: (i) collateral value benefits if the aircraft is FAA registered and maintained under the FARs; (ii) a diminished risk of unrecorded liens; and (iii) more favorable repossession, de-registration and disposition remedies, especially if available under the Cape Town Convention (because the United States is a signatory).14 Moreover, non-US citizen lenders who repossess an aircraft might use an NCT to register the aircraft while it is being stored or marketed to facilitate its disposition if it is likely that the new purchaser or lessee is situated in the US.

Multi-National Businesses. NCTs are essential for “N” registration by many larger US corporations because (a) either its president or the required percentage of its other managing officers and directors fail to meet the citizenship requirements, or (b) it cannot determine with certainty the citizenship status of its shareholders.

NCTs are frequently used by partnerships because the US registry is only available to partnerships owned solely by individuals who are US citizens. Without NCTs, these business entities might not have any registry available if they are unable to comply with the citizenship or other registration requirements of any other national registry.

FAA’s Recent Scrutiny

FAA’s 2010 NCT Warnings
During the spring of 2010, the FAA notified the Oklahoma City aircraft registration firms that ACC opinions issued with respect to future NCT-registered aircraft would contain qualifying text related to the validity of the structure, and also raised doubts about the validity of existing NCT registered aircraft. However, the FAA did not clearly articulate its concerns that were intended to be addressed by its change in approach to NCT-registered aircraft.

The FAA was made aware that ACC’s practice of issuing qualified opinions would effectively serve as a moratorium on NCT-registered aircraft because the aviation registration firms would advise clients that the validity of NCT-registered aircraft would be in doubt.15

As a result, parties to NCT-structured transactions would be unwilling to purchase, finance or operate aircraft with questionable registration. Industry members immediately responded by correspondence and meetings with various FAA officials, making it clear that this change in ACC opinion practice and any invalidation of existing NCTs could result in dire consequences to the industry. This uncertainty lasted for only a few weeks, and the FAA ultimately agreed to resume its long standing opinion procedures regarding NCT registration. But the FAA did note that it would continue to scrutinize the use of NCTs.

2011 Meeting-Crystallizing Issues
After deliberating for almost one year, the FAA issued a public notice to the industry (the “Notice”)16 that included a series of questions on the use of NCTs to be addressed at a public hearing that was held on June 1, 2011 in Oklahoma City. Prior to the June 1 meeting, a group comprising varied industry participants (the “Consultative Group“)17 formulated a response paper to address the questions and frame the issues the FAA intended to cover at that meeting.18

At the June 1 meeting, the FAA, the Consultative Group and other industry participants in attendance made presentations offering their respective perspectives. The FAA representatives raised various concerns during the meeting, both in their prepared presentations and in informal exchanges with industry members at the meeting. These concerns included: (i) the extent to which the trustee retains “control” of certain matters pertaining to the aircraft; and (ii) who should be responsible for due diligence and availability of information regarding the operational status of the aircraft.

The FAA expressed concern that non-citizen operators of NCT-registered aircraft will primarily base, operate and maintain the aircraft outside of the US, and by doing so impede the FAA’s ability to monitor, enforce and ensure compliance with the airworthiness and maintenance standards required of FAA-registered aircraft. FAA representatives mentioned various anecdotal accounts of NCT registered aircraft primarily operating outside of the US and not complying with FAA airworthiness requirements. In such circumstances, FAA representatives asserted that the FAA is not always able to exercise its US and ICAO responsibilities (but recognized that this latter circumstance is not unique to NCT-registered aircraft).

This failure could, in turn, lead to a potential dereliction of the United States’ duties as a Chicago Convention contracting state.19 In response to an industry member’s question during the meeting, an FAA representative confirmed that there were other concerns driving this review of NCTs, including those raised by homeland security and drug enforcement officials.

The presentations and discussions (both formal and informal) at the meeting were generally perceived as being constructive. FAA representatives assured attendees that the FAA will take a thoughtful, deliberative and collaborative approach to the NCT issue. A few notable points should be highlighted:

First, it is unlikely that the FAA will issue regulations or opinions rendering all NCT arrangements invalid.

Second, many of the FAA concerns with NCTs might be resolved through revisions to the standard form NCT agreements, including by (a) clarifying the owner’s unfettered control of essential aircraft-related matters, (b) re-examining which of the trust-related documents should be required for FAA fi ling, especially any agreements between the trustee and beneficiary other than the trust agreement that “legally affects a relationship under the trust”;20 and (c) allowing trustees greater flexibility to resign.

Third, the FAA’s most pressing need seemed to be making changes to the NCT process so that trustees could better serve as additional resources to the FAA for information about trustors/beneficiaries, operators and operations of an aircraft, including by establishing further NCT-related information reporting mechanisms.

Supplemental Submissions
The FAA agreed to accept further written submissions from the public on the NCT issue until July 1, 2011. The Consultative Group submitted such a response clarifying and emphasizing its position in the initial response paper and as discussed at the meeting.21 The Consultative Group’s collective submissions to the FAA proposed changes to certain provisions of form NCT trust agreements and, as appropriate, related lease agreements and operating agreements for the purpose of:

(i) formalizing the types and levels of due diligence already required (and already undertaken) by most trustees regarding their trustors/beneficiaries; (ii) requiring each trustor/beneficiary and any operator in contractual privity with the trustee (e.g., by an operating agreement or a lease agreement) to provide the trustee with contact information; (iii) requiring operators in contractual privity with the trustee to (A) provide the trustee with information regarding the location at which the aircraft is to be primarily based, and any transfers of the aircraft for operational purposes under operating agreements or lease agreements for periods of time exceeding 180 consecutive days,22 and (B) contractually require compliance by any “downstream” operators to provide the trustee with similar information required of the “operator”; (iv) requiring trustors/beneficiaries to provide information to the trustee on transfers by the trustors/beneficiaries of their interests in the trust;

(v) clarifying the respective responsibilities of the trustee and the trustor/beneficiary in providing information regarding the operator and the aircraft upon an FAA request, including by trust document provisions to which the trustee is permitted to, and the trustor/beneficiary shall, cooperate with FAA requests pursuant to the FARs for information regarding the operation, maintenance or location of the aircraft (e.g., providing such information to the FAA if already available, or by forwarding such legitimate requests for information to the operator of the aircraft for compliance); (vi) permitting the trustee to resign without first being replaced by another trustee in the event that the trustor/beneficiary or operator fails to fully and timely comply with its related agreements and obligations under the trust documents or other pertinent agreements (though any such resignation right must be exercisable in a manner that would preserve a financing party’s priority interests and insurance coverages in respect of the aircraft); and (vii) including “supremacy” provisions in the trust agreement, overriding any contrary provisions in any other existing or future documents to which trustor/beneficiary and trustee are parties, to prevent the impact of any side agreements affecting what the FAA might deem to be the essential authority of the trustee under the trust agreement (so the parties could only modify the control provisions or trustee removal provisions of NCT trust agreements by amending the trust agreement and filing the amendment with the FAA).

The supplemental response also included suggestions as to additional reporting mechanisms regarding the operator and operation of NCT registered aircraft. It seems likely that any meaningful solutions to the FAA’s concerns must include practical means by which the FAA will have access to information relating to the operator as well as to the operator itself. The least intrusive change might be to impose additional reporting requirements on operators to the extent not already covered by existing regulatory requirements, but that are consistent with existing US aviation law. The Consultative Group urged the FAA to take a collaborative view of the NCT issue and work with industry participants to better address the perceived problems created by NCT arrangements.

Until the FAA’s concerns about NCTs are addressed with finality through this collaborative process, the FAA should keep in place its “status quo” treatment of NCTs. Lastly, the FAA was urged not to make any solutions retroactively applicable to aircraft already registered through the use of an NCT.

Commentary-NCTs Aren’t the Culprit

FAA’s Enforcement Concerns.
NCTs by their nature are not inherently problematic. The FAA has expressed its concern that NCTs impede access to reliable operational information from non-owner operated aircraft, and consequently its ability to fulfil its ICAO responsibilities to ensure and enforce airworthiness compliance by operators of US registered aircraft.

However, any impediments to the FAA’s having access to information from the operator could exist in any circumstance in which the registered owner is not also operating the aircraft. These impracticalities are more appropriately attributable to the US aircraft registry being established as an owner and not an operator registry and are only coincidentally related to NCTs.

Registered Owners Don’t Always Operate Aircraft
Many US registered business aircraft are owned by a trust, a commercial/business entity or an individual who may or may not also be the operator of the aircraft. It is often the case that third-party aviation managers or operators are engaged by business aircraft owners who do not have the capacity to self-manage or operate the aircraft. Further, many aircraft owners enter into leases and other third-party dispositions or arrangements by which the owner surrenders possession and control of its aircraft to a third party. There is no meaningful difference in the potential risks cited by the FAA whether the aircraft is owned in NCTs or other trusts, or by individuals or business entities. It appears that NCTs are a convenient target for FAA scrutiny, unless the FAA has determined that the disproportionally small number of NCT registered aircraft would be more problematic than the much larger pool of non-NCT-registered aircraft being operated by parties other than the owner.

Rely on Operators for Info and Access.
Where the registered owner is not also the operator, the operator has an on-going responsibility to operate and maintain the aircraft in full compliance with all applicable laws and regulations. This allocation reflects the parties, having acknowledged that the operator (and not the owner) will have possession and control of the aircraft and therefore will be in the best position to ensure compliance. It is also likely that despite this allocation, an owner or other party imposing these obligations would find it impractical to force an operator to comply.

The Consultative Group urged the FAA to continue to hold operators accountable for any non-compliance, especially relating to matters having an impact on safety, because any non-compliance is more directly attributable to the operator’s conduct. Financing parties and lessors should be particularly wary of efforts to extend these compliance requirements to passive parties having an interest in an aircraft.23

Outcome? It is difficult to predict what the industry might expect from the FAA’s scrutiny of NCTs and the FAA’s collaboration with industry representatives over the past few months. It would be preferable to the industry if any changes in approach to NCTs are done collaboratively and formally and not by issuing new regulations. In its supplemental submission, the Consultative Group recommended that the FAA collaborate with the industry on a mutually acceptable FAA Aeronautical Center Counsel memorandum or opinion on NCTs addressing acceptable practices for establishing and maintaining NCTs for US registration of aircraft, including essential NCT trust agreement provisions. As noted above, it is likely that NCT-related changes will include additional fi lings or reports or other information being made available to the FAA regarding non-owner operators of NCT registered aircraft, especially if primarily based, maintained and operated outside of the US.

Suggestions

Operational Information. Although it seems unlikely that the FAA will deem NCT-structured transactions to be fundamentally flawed, parties relying on NCTs when structuring transactions should be mindful of the FAA’s concerns. If structuring a transaction as an NCT, it would be wise to engage the trustee and aviation counsel in a discussion regarding the form of the trust agreement, due diligence and reporting requirements, fi ling strategies and other evolving practices relating to NCT structured transactions.

Whether an aircraft is NCT-registered or otherwise -unless the owner of that aircraft is also the operator – the transactional documents should expressly obligate the operator of the aircraft to maintain and provide to the FAA all pertinent operational and maintenance information as and when required by law. Accordingly, whether the transaction is structured with or without an NCT, the transactional documents with the operator and with any other parties remaining in the chain of possession between the registered owner and the ultimate operator should include reporting and other provisions consistent with facilitating the reporting and other compliance requirements the FAA has mentioned as being desirable.

Meaningful Business Purpose. The aviation industry has relied for many years on NCTs to further the many legitimate business purposes referenced above. Parties structuring cross-border transactions should be especially mindful of the FAA’s willingness to continue to work with the aviation industry to preserve NCTs as practical structural devices for such purposes. Accordingly, it would be imprudent to employ an NCT registration structure merely to avoid operating restrictions, taxes, duties, permits or other legal requirements in the country where the aircraft is primarily operated or where the non-citizen beneficiary is actually located.

The implications of the FAA’s renewed scrutiny of NCTs and non-owner operator concerns are still evolving. Aviation industry members should continue to follow and actively participate in what we hope will remain a collaborative process.

Footnotes 

1 Edward K. Gross and Clay C. Thomas are attorneys in the Global Transportation Finance group of Vedder Price

2 Often referred to as being “N” registered.

3 The sections of Title 49 of the United States Code comprising those provisions formerly referred to as the Federal Aviation Act of 1958, as amended.

4 Convention on International Civil Aviation, Dec. 7, 1944, 61 Stat. 1180, 15 U.N.T.S. 295. This treaty establishes the common agreement among the contracting states that an aircraft may not be registered with the registry of more than one contracting state, and imposes obligations on contracting states to oversee matters pertinent to the airworthiness, licensing and operations of the aircraft registered in those states.

5 49 U.S.C. § 44102, providing the conditions under which an aircraft may be registered on the U.S. Civil Aircraft Registry under 49 U.S.C. § 44103.

6 49 U.S.C. § 44102(a)(1).

7 Id.

8 Id. § 40102(a)(15)(B).

9 Id. § 40102(a)(15)(C).

10 Generally, the trust is created under the common law or statutory law of a state by one or more beneficial owners of an aircraft. These beneficial owners convey the legal ownership of the aircraft to a bank, trust company or individual in the business of serving as a trustee. Trustee manages the affairs of the trust and serves in a fiduciary capacity for the benefit of the beneficiary, and has the right to resign or could be replaced by the beneficiaries, all subject to the terms and conditions of the trust agreement.

11 14 C.F.R. § 47.7(c).

12 A US citizen trustee acting on behalf of a non-U.S. citizen beneficiary can meet the requirement in 49 U.S.C. § 44102 that only “a citizen of the US ” is eligible to register an aircraft by submitting the Aircraft Registration Application to the FAA Registry together with the following: (a) a copy of each document legally affecting a relationship under the trust; and (b) the trustee’s affidavit stating that “the trustee is not aware of any reason, situation, or relationship (involving beneficiaries or other persons who are not US citizens or resident aliens) as a result of which those persons together would have more than 25 percent of the aggregate power to influence or limit the exercise of the trustee’s authority.” (See 14 C.F.R. § 47.7(c)(1),(2)). Additionally, the trust agreement must include a covenant that non-U.S. citizens “may not have more than 25 percent of the aggregate power to direct or remove a trustee” (See 14 C.F.R. § 47.7(c)(3)). Various interpretive opinions from Aeronautical Center Counsel have provided further guidance regarding other trust agreement provisions pertinent to the limitations on beneficiary control including that the trustee may be removed only for cause.

13 Id. §§ 47.7(c)(2)(iii), (c)(3).

14 The Cape Town Convention on International Interests in Mobile Equipment and the related Protocol on Matters Specific to Aircraft Equipment were finalized at a Diplomatic Conference held in Cape Town, South Africa in November 2001.

15 The economic impact and disadvantages arising from the loss of the NCT were described in two letters sent to the FAA in May 2010, one by the Association of Aircraft Title Lawyers (“AATL”) on May 4, 2010 and the other by various industry participants on May 11, 2010.

16 The Notice of Public Meeting (June 1) published in the April 26, 2011 Federal Register regarding U.S. Registration of Aircraft in the Name of Owner Trustees.

17 The AWG Industry Consultative Group was formed under the aegis of the Aviation Working Group (the “AWG”), a broad aviation industry coalition of commercial, business and general aviation owners, operators, manufacturers, financiers, lessors, trustees, lawyers and other service providers. Although Mr. Gross is an active member of the Consultative Group, the viewpoints expressed in this article are solely those of the authors and not of the Consultative Group, nor of any of its other participants.

18 The Consultative Group submitted to the FAA on May 26, 2011 an initial response paper to the questions posed by the FAA in the Notice.

19 ICAO, art. 18, 19, 61 Stat. at 1185.

20 Documents “legally affecting a relationship under the trust” for purposes of compliance with § 47.4(c)(2)(i) of Part 47 of the FARs must be fi led with the trust agreement, e.g., where the trustee and trustor or beneficiaries enter into a separate agreement by which the parties agree that, notwithstanding contrary provisions in the trust agreement, the trustor or beneficiaries and not the trustee will have control over certain matters pertaining to the aircraft, including those matters required by the FARs and related interpretations to have been exclusively reserved to the trustee.

21 As was the case with the initial response paper, the Consultative Group’s supplemental submission was delivered to the FAA by cover letter from Jeffrey Wool, Secretary General of the AWG. Each of the initial and supplemental submissions was specifically endorsed by a large number of companies, trade groups and organizations representing the commercial aviation, business aviation and general aviation industry.

22 The Consultative Group concluded that mandatory tracking of transfers of aircraft operation for periods of less than 180 days is not commercially practical in business aviation, general aviation or commercial aviation.

23 These parties have willingly participated in aircraft finance and leasing by relying on 49 U.S.C. § 44112, which exculpates investors, financing providers and lessors from liability for aircraft incidents provided that the aircraft is not in the actual possession or control of these interest holders when such an aircraft incident occurs. The perceived Congressional intent of this safe harbour is that the operator or other party in possession or control of the aircraft, not a passive financing party or lessor, should bear these risks.

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