By Stephen R. Hofer
President, Aerlex Law Group (1)
If a perfectly executed aircraft acquisition can be likened to a beautifully told fairy tale – “Snow White,” for example – then conflicts of interest are the poisoned apple. However, the twist in this particular saga is that it’s not only the Wicked Stepmother who can create danger for the heroine. The Huntsman or any of the Seven Dwarfs can also be a potential villain.
The phrase “conflict of interest” is normally thought of in legal terms and, in fact, there are laws and rules of professional conduct in every state that govern what lawyers can and cannot do in situations where an actual conflict exists or a potential conflict might arise.(2) The unpleasant reality, however, is that virtually every single person who plays a fiduciary role in an aircraft transaction, whether as an attorney or otherwise, may have opportunities to benefit from the transaction in a way that conflict with the best interests of the principal. Whenever a team of aviation experts is assembled to help a customer select, buy, sell, lease, manage or operate an aircraft, an array of conflicts can arise. Many of these situations may not rise to the level of a violation of law or warrant legal sanction, but they still constitute conflicts of interest. Unfortunately, the amount of money to be made in an aircraft transaction or the opportunities to cultivate future business may be so enticing as to make it difficult for some to resist temptation. For that reason, aircraft sellers and buyers should understand the many ways in which conflicts can occur and be vigilant throughout a transaction for the signs of an actual conflict. Persons who work in the aircraft transactional industry also need to recognize the conditions that can lead to conflict of interest, conduct their business according to the highest ethical standards(3) and encourage others in the industry to adopt, support and follow those standards.
In general terms, a conflict of interest arises whenever one’s personal interest in a matter and one’s duty to another party in the same matter conflict. Conflicts can also occur when a participant faces a real, apparent or potential conflict between the duties owed to two different parties regarding the same matter. In private aviation, conflicts of interest appear frequently because experts often perform many roles for individual customers. When a customer trusts a particular individual, they often will have that person perform a number of different tasks for them, and these multiple roles can lead to conflicts.
In order to help readers better understand the many ways in which conflicts of interest can occur in an aircraft transaction, what follows are a series of factual scenarios that present conflicts for the participants. This list is by no means complete and is simply meant to show some of the more common conflicts that can occur in business aviation.
Buyer and Seller have entered into a letter of intent for the purchase and sale of an aircraft. Seller suggests that Buyer use the Inspection Facility that has just completed a major inspection of the aircraft for Buyer’s pre-purchase inspection. If the Inspection Facility that performed the major inspection is also used for the pre-purchase inspection, there is a potential for conflict. It certainly is not in the Inspection Facility’s best interest to identify anything that was missed during the recent inspection, no matter how well it may have otherwise performed its duties during the prior inspection. If a different facility is used to conduct Buyer’s pre-purchase inspection, the second facility will use its own personnel and procedures and will be less likely to rely on or be influenced by the results of the recent inspection.
Buyer and Seller have entered into a letter of intent for the purchase and sale of an aircraft. Seller’s Broker suggests using an Inspection Facility that he uses often. The Inspection Facility is aware that many of its pre-purchase inspections come from the referrals that Seller’s Broker provides. The potential conflict is that the Inspection Facility wants to make sure that Seller’s Broker continues to refer inspection business so there is a risk the Inspection Facility will be more inclined to find in Seller’s favor in the event a subjective or questionable item is discovered during the pre-purchase inspection.
Broker’s commission structure is based on whether he helps sell or buy an aircraft for a customer. Broker receives double commission in the event he represents both a buyer and seller on a transaction. Therefore, a potential conflict is that Broker may be more likely to present aircraft he has listed to potential buyers rather than other, possibly more favorable aircraft listed on the market for sale.
Buyer currently owns an aircraft which is being managed, operated and chartered by Management Company, but Buyer has decided to replace his current aircraft with a different aircraft. Buyer decides to use the Management Company to help him select the replacement aircraft. Management Company will profit from chartering the aircraft when it is not in use. The potential conflict is that Management Company may suggest an aircraft it needs or wants on its operating certificate to build its charter business instead of the aircraft that will best suit Buyer’s needs.
Buyer and Seller have both used the same attorney in the past for different matters and now wish to retain the same attorney to draft the aircraft purchase and sale agreement and handle the closing for both parties. Buyer and Seller have fundamentally different and potentially conflicting interests and it will be difficult for the attorney to fully and zealously represent both Buyer and Seller, particularly if disputes arise at any stage of the transaction regarding the meaning of provisions in the contract or whether one of the parties is fulfilling its obligations under the contract.
Buyer asks his Broker for a referral to an Aircraft Lender. Broker’s recommended list includes lenders who can document and close a loan quickly, but not all of the lenders have the best lending packages for Buyer’s particular needs. Broker receives his commission on the day the sale closes. Therefore, a conflict may exist based upon Broker’s desire to close the sale as quickly as possible, which may not be in the best interest of Buyer as borrower.
A trusted member of the aviation team is asked to provide Buyer with a list of aviation insurance agents he recommends. The team member supplies a list and puts the agent who recently took him to dinner at the top of his list.
Seller A wants to sell its aircraft and Middle Man B offers to buy it. In fact, Middle Man B intends to immediately resell the aircraft to Buyer C, the expected ultimate user. In reality, Middle Man B does not have sufficient funds of his own to buy the aircraft and has to have Buyer C’s money in order to complete the transaction. Middle Man B also hopes to realize a profit on the difference between the price he is paying Seller A for the aircraft and the amount Buyer C has agreed to pay. In the aviation industry, this is known as a “flip” or “back-to-back” transaction. There are lots of different things that can go wrong in a back-to-back sale and these transactions must be carefully managed to avoid problems. In this particular instance, Buyer C places a deposit in escrow, but then discovers there is a condition applicable to the aircraft that he is unwilling to accept. It’s not clear from the purchase contract whether he has to accept the condition, but he refuses to proceed with the purchase and instructs the escrow company to return his deposit. Meanwhile, Seller A demands that Middle Man B proceed with the purchase and threatens him with a breach of contract lawsuit. Middle Man B likewise demands that Buyer C proceed with the purchase and also threatens legal action. The escrow company files an interpleader action and turns Buyer C’s deposit over to the court in Oklahoma City, leaving it up to the judge to decide who gets the money. Besides the direct and actual conflicts between the parties, back-to-back transactions also present other potential conflicts for the advisors to the parties. How much did the brokers and attorneys who were involved in the transaction know and did they disclose everything they were legally or ethically obligated to reveal? Was it even clear to the brokers and attorneys who they were actually representing?
Conflicts often arise when the expert in an area is asked to give advice and that advice is influenced by a factor that the customer isn’t aware of, doesn’t understand or doesn’t consider. Conflicts may be impossible to avoid, particularly when the customer would much rather use someone they know and trust instead of a disinterested third party. However, because of this, caution must be used by all parties to make sure that all known or potential conflicts are disclosed and mitigated as much as possible.
Awareness of conflicts is the best way for a customer to avoid or minimize the impact of each conflict. The team of experts that works on an aircraft sale or purchase can often be large. The broker, lender, insurance agent, aviation lawyer, in-house counsel, escrow agent, management company and inspection facility each have specific roles in the transaction and each have various interests that could result in conflict. In a traditional broker arrangement, the broker does not get paid until the transaction closes and, therefore, the faster the closing the better. The management company wants the aircraft on its charter certificate as quickly as possible so that it can start earning charter revenue. The inspection facility wants to have as many open work orders as possible in order to generate the most income.
When each member of the team has a different motivation, it is sometimes difficult to make sure that the team continues to always work in the best interest of the customer. In order to make sure all parties remain neutral, it is important for the customer to ask the correct team member to handle the appropriate task. It’s also vital that the customer perform his due diligence and ask potential team members tough questions about their practices, procedures, motivations and ethics. For example, prior to hiring a broker, the buyer should request and review the sources the broker intends to use to find the best available aircraft.
The good news is that most aircraft transactions have happy endings, but “happily ever after” for both buyer and seller can best be achieved when the potentially corrosive contamination of conflicting motives can be avoided.
(2) For example, Rule 3-300 of the California Rules of Professional Conduct, entitled “Avoiding Interests Adverse to a Client,” states, in pertinent part:
A member shall not . . . knowingly acquire an ownership, possessory, security, or other pecuniary interest adverse to a client, unless each of the following requirements has been satisfied:
(A) The transaction or acquisition and its terms are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which should reasonably have been understood by the client; and
(B) The client is advised in writing that the client may seek the advice of an independent lawyer of the client’s choice and is given a reasonable opportunity to seek that advice; and
(C) The client thereafter consents in writing to the terms of the transaction or the terms of the acquisition.
(3) Many trade organizations, such as the National Aircraft Resale Association, the Professional Aircraft Sales Association and the American Society of Appraisers, have adopted codes of ethics which enunciate standards their members are expected to follow when engaged in aircraft transactions.