The value of due diligence exists in the eyes of the beholder. Their place in an aircraft transaction informs their diligence criteria, inquiries, and judgment.
Most financiers consider the five Cs (character, capacity, capital, collateral, and conditions) and investigate each element before closing a loan or lease. Sellers ensure that they transfer good titles to qualified buyers. Aircraft buyers traditionally perform comprehensive due diligence in all phases of a purchase transaction.
However, in the current seller’s market, buyers that require excessive or even customary diligence may cause a seller to kill the deal and move on to another buyer waiting in the wings that may not require the same level of diligence. As a result, some buyers sacrifice diligence to buy an airplane, any airplane.
To initiate due diligence and avoid costly mistakes, buyers should steel themselves; it is hard to be objective, especially for first-time buyers, during the potentially emotional journey of seeing beautiful time machines for sale. Buyers should also engage experienced aviation professionals, including an aircraft broker, technical consultant, aviation counsel, insurance broker, aviation tax expert, escrow company, and FAA counsel.
Starting when a buyer first seriously considers purchasing an aircraft, the buyer should spool up professionals to guide the buyer through the buying experience, in five diligence areas along with financing.
Right Aircraft, LOI, and APA
With the assistance of an aviation broker or consultant or both, a buyer should first develop a mission profile that informs the aircraft broker in the search for the right aircraft. This profile refers to a buyer’s criteria for an aircraft that will serve most, if not all, of the air travel the buyer envisions.
With that profile in mind, a buyer should involve the technical consultant, aviation lawyer, and tax expert before signing a letter of intent (LOI) to obtain an analysis of the broad implications of buying the target aircraft.
The LOI establishes the non-binding terms of a purchase as an outline of terms in a detailed aircraft purchase agreement (APA). Buyers often negotiate LOIs without the assistance of experts, which may result in accepting unfavorable LOI terms that APA negotiators cannot adjust to a favorable or even a fair position.
To purchase what I call a “clean machine,” a buyer customarily hires a qualified aircraft facility to conduct a pre-purchase inspection (PPI) within a work scope negotiated in the APA. The inspection facility identifies discrepancies and makes repairs needed to put the aircraft in airworthy or better “delivery condition,” as stated in the APA.
During the PPI, the buyer’s technical consultant should have in-person access to the aircraft and the authority to speak with PPI staff to ensure the inspection is thorough, complete, and consistent with the agreed work scope.
Economics and Tax
One of my clients not long ago bemoaned how much more his used aircraft cost to operate and maintain than planned. To minimize surprises, a prudent buyer will project the true cost of ownership, operation, and maintenance of the target aircraft.
I liken this situation to the original cell phones: the cost of the phone may be significant, but the unpredictable minutes will burn a hole in your pocket. So it goes with aircraft and the true cost of ownership, operations, and maintenance.
Many buyers plan to charter their aircraft to offset financing, operations, and maintenance costs and to rationalize the purchase. In conducting due diligence, buyers should not fool themselves into thinking that, with rare exceptions, they will make money chartering an aircraft. Some charter operators overstate revenue estimates to induce buyers to add their aircraft to the operator’s charter fleet.
By running multiple economic cases with realistic assumptions, a buyer may determine that chartering makes sense and benefits the owner, operator, and charter customer. If not, the buyer should decide whether to purchase anyway.
In every purchase, buyers should, at the LOI stage, analyze the tax aspects of ownership to project the availability of depreciation—including bonus depreciation—of the aircraft, federal excise tax, the deductibility of trade or business expenses, and the effect of personal use of the aircraft.
Local property and state sales, use tax, and income taxes can move the economic needle. An aviation tax accountant and the aviation counsel should assist with comprehensive pre-tax and after-tax analysis, planning, and structuring.
Although financing requires additional effort, cash buyers should still talk to specialized financiers, who often provide useful perspectives and economic options, even if the buyer sticks with cash.
Legal Structuring, Trust, and KYC Analysis
Aviation, FAA, and other lawyers perform multifaceted due diligence. They should delve into the background of buyers, sellers, and other transaction participants as needed to avoid business dealings with bad guys, including any blocked or sanctioned person—notably Russian oligarchs, elites, and banks.
In the U.S., sales and financing documents should include appropriate representations and warranties covering no violation and compliance with such laws as the USA Patriot Act 2001 and other laws administered and enforced by, among other agencies, the U.S. Department of Commerce’s Bureau of Industry, Security (BIS) and the U.S. Department of the Treasury Office of Foreign Assets Control (OFAC).
This required diligence effort includes a multi-step know-your-customer (KYC) inquiry, especially by cautious financiers.
FAA counsel scours the FAA and international aircraft registries for title and lien history. Meanwhile, aviation/finance lawyers conduct searches under the Uniform Commercial Code or similar laws to identify and remove liens and ferret out potential red flags about the aircraft’s ownership and lien history.
Aviation lawyers structure transactions to mitigate personal liability risk, comply with the Federal Aviation Regulations (FARs) for U.S.-registered aircraft and similar laws elsewhere, optimize tax savings, and plan for aircraft management.
Since the Guaranty Trust case arose in 2021, where an escrow and trust company allegedly committed fraud using owner trusts, lawyers, escrow agents, and trustees, I often exercise extra care to prevent abuses of owner trusts and to ensure owner trusts comply with relevant laws.
Safety in Operations and Maintenance
The importance of safety in aviation cannot be overstated. Every buyer should perform due diligence to personally see and objectively confirm a culture of safety and best practices exhibited by their Part 91 flight department, management company, or Part 135 charter operator.
Buyers should expect, at a minimum, full compliance with the standards promulgated under FAR Part 91 (private use by an owner) or FAR Part 135 (commercial transportation or charter operator) as the baseline, not the goal line, standards.
Buyers tend to gravitate toward the idea that managing risk starts with purchasing insurance. Not so. Risk management ends with insurance because insurance responds when something bad has happened.
Insurance indemnifies covered risks of property damage, loss of life, or personal injury. It does not ensure safety or best practices involving the aircraft, highly trained crews, and compliance with relevant laws.
Risk management begins with assessing and mitigating risk to protect the lives of buyers/owners, operators, and other passengers, avoiding unsafe operations as noted above, and shielding personal wealth from personal liability to others.
To be emphatic, buyers must obtain comprehensive and adequate limits (dollar amounts) of insurance, optimally parsed by an aviation insurance expert. In the process, buyers should obtain a policy endorsement, not just an informational certificate, to evidence coverage.
Aircraft transactions have become increasingly complex, which requires more rather than less diligence. Although burdensome at times, due diligence is not optional. It requires deliberate analysis, common sense, and speed.
The outcome should be a reasoned choice to make a smart buy or walk away from a bad deal. It is tempting for buyers to take more risks without conducting a thorough PPI or other diligence, especially when pushed to do so by sellers exercising their market power. But a buyer may ultimately be better off looking for another airplane than flying away in a potential albatross.
David G. Mayer is a partner in the global Aviation Practice Group at Shackelford, Bowen, McKinley & Norton, LLP in Dallas, which handles worldwide private aircraft matters, including regulatory compliance, tax planning, purchases, sales, leasing and financing, risk management, insurance, aircraft operations, hangar leasing, and aircraft renovations. Mayer frequently represents high-wealth individuals and other aircraft owners, flight departments, lessees, borrowers, operators, sellers, purchasers, and managers, as well as lessors and lenders. He can be contacted at firstname.lastname@example.org, via LinkedIn, or by telephone at (214) 780-1306.
None of the discussions in this blog creates an attorney-client relationship or provides legal advice of any kind. Readers should consult their trusted aviation advisors for transaction and other assistance in matters contemplated in this blog. The opinions expressed in this column are those of the author and not necessarily endorsed by AIN Media Group.