Limited Liability and the Business Aircraft Owner
One of the most common concerns among first time aircraft buyers is the potential liability that comes with operating an aircraft. Certainly, the most common piece of bad advice given to first time aircraft buyers is, “just buy the aircraft in a separate limited liability company and you’ll never have any liability.” For numerous reasons, this is simply not true. Let us count the ways.
The Flight Company Trap
For those not familiar with this concept, the “Flight Company Trap” arises from the general philosophy of the Federal Aviation Administration (FAA) that if you own and operate an aircraft in a standalone company, that company is in the business of providing air transportation for hire. The FAA requires such a company to have an air carrier certificate and the failure to secure one is a violation of FAA regulations. This applies to both an LLC you own yourself and to the flight operations of a large public company. There are many articles out there that explain this concept and why it is true, but for purposes of this article, the important thing to know is this: if your standalone flight company does not have an air carrier certificate, you are running an illegal business. Instead of shielding owners from liability, this kind of operation exposes owners to significant risks.
Aircraft Operators Have Potential Liability and That’s The Way the FAA Wants It
Despite the Flight Company Trap, many owners will still purchase their aircraft in special purpose LLC, and there are many good reasons why you might do so. In those cases, however, the typical way to handle this is to have your LLC act as a leasing company and lease the aircraft to those who will use it. The lessees/operators might be one or more owners, their companies, unaffiliated third parties or perhaps a charter company. In each of those cases, if done correctly, each lessee will be the operator of the aircraft and be in “operational control” of its own flights.
Stated most simply, “operational control” refers to the ability and responsibility to control all aspects of a given flight, from where and when the aircraft will be flying to who will act as flight crew to whether the operations are in compliance with FAA rules. The lessee will commonly hire pilots to operate the aircraft, but those pilots typically are providing services to the lessee as the lessee’s agent. The important take away here is that the lessees will always have a potential direct line to liability as the operator, notwithstanding that the aircraft is owned in a special purpose limited liability company.
Insurance Will Not Cure an Improperly Structured Operation
Some first time buyers have assumed that worst case, if they are operating improperly from a limited liability shell, they will probably be just fine because they carry enough insurance. What they don’t realize is that most aviation insurance policies have exclusions that put your flight company operations at risk.
The primary issue here is that owners and operators typically insure for private, non-commercial operations only. Such flights are operated in the US under Part 91 of the FAA regulations, as opposed to commercial/charter operations which operate under Part 135 of the regulations. Part 135 requires an air carrier certificate but it also imposes higher standards as to operations, maintenance and FAA oversight. Further, Part 135 carriers bear greater risk and responsibility as common carriers. So when an insurance policy is issued to a Part 91 lessee but the lessee is operating in a way that requires a Part 135 certification, the insurer may claim it did not contract to insure a Part 135 operation and disclaim coverage.
Beyond the Corporate Veil
So assume for a moment that a buyer purchases an aircraft in an LLC, properly documents a leasing structure and does everything right from an FAA and an insurance point of view. Does that mean that the owner of the LLC will have completely protected itself from liability as an owner? Not necessarily.
There is a general presumption under most state laws that the shareholder in a corporation or a member in a limited liability company is not responsible for the debts or liabilities of the company. And in most cases, that will prove to be true. But creditors and claimants can sometimes “pierce the corporate veil” and seek recourse against owners where the company itself is a “mere instrumentality” of the shareholder. To state it another way, in circumstances where the entity not treated as separate from the owner, and is for all practical purposes the alter ego of the owner. Courts are generally reluctant to go beyond the corporate veil, but they will do so when the circumstances warrant it. The courts will generally look at nine factors. Among them:
- Does the company operate as a separate entity?
- Does the entity commingle its funds and assets with its parent company or owner? Does it have its own bank account?
- Does it fail to maintain its corporate records?
- Is the company under capitalized?
- Does the company maintain corporate formalities and maintain arm’s length relationships with related entities?
- Is there injustice or unfairness or fraud in respecting the separateness of the entity?
These rules vary by state (for a deeper dive, see “Keeping the Veil Closed – Which State Laws Provide Better Limited Liability Protection“), but the general concept applies across most states.
Whether or not a company maintains its formalities, there are also various statutes that impose owner liability notwithstanding the corporate shell. Among them, owners can have direct liability for certain environmental issues under CERCLA, for failure to collect and pay income taxes and FICA for their employees and for the failure of aviation companies to collect and remit federal excise taxes.
What is an Owner to Do?
How can an aircraft buyer protect itself despite all of these pitfalls? Following a few basic recommendations can help.
- When organizing a special purpose LLC, follow the corporate formalities. Your company is meant to act as a standalone, legitimate business so treat it accordingly.
- Plan for and understand the ownership and use structure for your aircraft usage and follow through on your planning in practice. Observe FAA truth in leasing rules, if applicable. Make sure the lessees understand and comply with their responsibility to maintain operational control.
- Buy enough insurance and make sure your insurer understands what it is insuring. Since operators will always have potential liability, carry enough insurance to protect against the likely risks. The limits of liability can vary, but consult with your broker and attorneys as to what limits are appropriate. Also, if you have a leasing structure or other variations on aircraft usage, provide copies of all leases and operative documents to your insurer in advance of the operations. Confirm that all parties involved are named as named or additional insureds on your liability policies.
- Understand your own tolerance for risk and plan accordingly. Operating your own aircraft is not for everyone. If you can’t get appropriate insurance limits for what you want to do, or if you are generally queasy as to the risk you want to absorb, consider chartering instead. Do your due diligence as to whether your charter operation has a good reputation and a good safety record. Get comfortable with the insurance limits it carries.
If you’re interested in learning more about purchasing a business aircraft, Kevin Johnson can be reached at email@example.com or by calling 952-995-9500. If you are interested in learning more about how particular state laws affect limited liability companies, check out the article “Keeping the Veil Closed – Which State Laws Provide Better Limited Liability Protection“.