The DNA of Commercial Civil Aviation Disputes

by Johannes P. Willheim, Partner, Jones Day^[1]

Introduction

The Hague Court of Arbitration^[2] is a private non-government initiative aspiring to serve the global aviation industry by providing and promoting specialised arbitration and mediation services. Its launch ignited a debate about whether there is a need for specialised dispute resolution services for aviation disputes or if general courts or any of the generalist arbitral and mediation institutions around the world are not equally well placed to provide effective and efficient dispute resolution services to the aviation industry.^[3] In essence, this debate evolves around the question of whether there is anything so special about aviation disputes that merits a special approach to managing and resolving them. This question is very different from the general determination of the most effective (generic) dispute resolution method for a specific dispute or category of disputes or, more specifically, whether arbitration (in general) is more suitable than litigation for resolving aviation disputes and, if so, why.

The answer to the question of whether there is a need for specialised dispute resolution services can only be found in a more profound analysis of aviation disputes: more specifically, in an analysis of, in particular:

• where and when aviation disputes typically arise (i.e., under which relationships, including between which parties, and during which phases);
• what causes aviation disputes;
• which issues commonly need to be resolved and what it usually takes to do so; and
• the circumstances that may shape the dispute resolution process and influence effective outcomes.

This chapter addresses these matters for common types of commercial aviation disputes, but not disputes with consumers (i.e., passenger disputes). The questions of whether the commercial aviation disputes described in this chapter are best managed and resolved by a specific dispute resolution method, and whether there is a need and justification for specialised dispute resolution services for these types of disputes, are addressed in other chapters of this guide.

Fundamental characteristics of civil aviation markets

Introduction

The specificities of commercial aviation disputes are best described and analysed on the basis of commercial transactions that typically take place on the market. One way of doing this systematically is to look at different market segments and then at the different levels of the value chain within these market segments.

In very broad terms, the market for aviation comprises all business activities relating to the development, production and operation of aircraft. An aircraft is a device that is used, or intended to be used, for flight. Categories of aircraft include aeroplane, rotorcraft, glider, lighter-than-air, powered-lift, powered parachute and weight-shift-control.^[4]

Market segments

There are many ways of defining a market, depending on the purpose of the definition.^[5] Based on the use of aircraft, the following very broad markets can be discerned: (1) civil aviation; and (2) the use of aircraft for military purposes. This chapter focuses on the market for civil aviation which, following the classification of the International Civil Aviation Organization (ICAO), can further be segmented into the markets for commercial air transport services and general aviation.

The market for commercial air transport services involves the transport of passengers, cargo or mail for remuneration or hire.^[6] It is further segmented into scheduled (commonly referred to as the airlines market) and non-scheduled operations. Scheduled air services are, in particular, characterised by being performed by aircraft for the transport of passengers, mail or cargo for remuneration in such a manner that each flight is open to use by the public and are operated so as to serve the public between the same two points, either according to a published timetable or within flights so regular or frequent that they constitute a recognisably systematic series.^[7]

All civil aviation operations other than scheduled air services and non-scheduled air transportation operations for remuneration or hire are defined as general aviation by the ICAO. General aviation activities are further classified into instructional flying, business flying, pleasure flying, aerial work and other flying.^[8]

The market for commercial aviation and the various segments of this market, as well as for general aviation, differ mostly at the actual operational level (i.e., the operation of aircraft for commercial or general aviation purposes) while at the same time sharing many commonalities at the other market levels of the value chain. Unless reference is made to the specificities of either market, the following description of commercial activities along the value chain and of the typical commercial disputes typically arising at the various levels of the value chain, applies to both market segments unless express reference is made to either the market for commercial aviation or the general aviation market.

Civil aviation market value chain

Starting from top of the value chain of a broadly defined civil aviation market and proceeding to its bottom, this market can be divided into the following levels:

• innovation and product development;
• production;
• sales, finance and delivery;
• operation; and
• retirement of equipment.

The level for innovation and product development shapes the future of aviation. It spans the development of entire new aircraft and the development of new systems or system improvements (propulsion, avionics, etc.) or individual parts and components. Innovation and product development for the aviation market is extremely resource and time intensive owing in particular to stringent regulatory and certification requirements. This is the reason why, once certified, airframes and systems are kept on the market for as long as possible and form the basis of continued advancements to meet changing commercial needs and other requirements (e.g., environmental, social and governance (ESG) requirements) instead of being replaced by new products and systems. The most prominent example of this market reality is the development of the Boeing 737-800 and later models of this product line, better known as the 737 Max, to compete with the Airbus A320. However, this has changed in the more recent past. In particular, major technological advancements (e.g., the use of composite materials or completely new flight instrumentation technologies and resulting new avionics suites) and increasing regulatory pressures on the aviation industry (stemming mostly from the transition from fossil fuels to clean energy sources with the aim of achieving climate change goals) have led to a substantial increase in innovation and product developments compared with the past. The market entry of new forms of transportation by electric vertical take-off and landing aircraft (eVTOLs) intended for use as flying taxis adds to this trend.

The production level is the market segment in which (1) aircraft are assembled by airframe manufacturers and (2) aircraft systems and aircraft parts are produced by the system providers and manufacturers supplying the airframe manufacturers (the original equipment manufacturers (OEMs)). Production of the commercial aircraft mostly used for scheduled flights (i.e., the market for commercial airliners) is a global duopoly shared by EU-based Airbus and US-based Boeing. The market for business jets and aircraft and for general aviation aircraft is more fragmented – key players include Bombardier, Cessna, Cirrus, Daher, Embraer and Piper. It is notable that the more complex the aircraft systems and parts, the fewer OEMs there are to cater to the airframe manufacturers; for example, there are only a few suppliers of aircraft engines or avionics suites.

Depending on their type (e.g., airliners, business jets, training and other general aviation aircraft), new aircraft are sold through either the direct sales channels of airframe manufacturers or independent sales representatives. Airbus and Boeing, the world’s two largest manufacturers of commercial airliners, deal directly with the airlines that are their prime customers. The relationships between airframe manufacturers and their airline or fleet customers are highly strategical and long-term, which significantly affects the way in which disputes that arise between the manufacturers and these customers are managed and resolved: there is a strong tendency to use negotiated and amicable solutions.

Used aircraft can be sold by airframe manufacturers or their sales representatives but independent brokers and dealers as well as listings (mostly online) dominate this market. It is much less strategic than the market for new aircraft as the majority of transactions are a single interaction between the parties involved (i.e., the seller, the intermediary (broker or dealer) and the buyer).

Owing to the very high acquisition and operation costs of aircraft, and the rigorous regulatory regimes governing the operation of aircraft, securing financing and the maintenance programmes required to operate an aircraft, form an essential part of the acquisition process. More specifically, financing and entering into certain maintenance agreements (e.g., for engine programs) are closely intertwined with the purchase of an aircraft and, as a consequence, the seller frequently cooperates with financial services providers and certified maintenance operators.

Commercial aircraft are either operated by airlines, including cargo airlines, or charter companies with an air operator certificate. General aviation aircraft are operated by approved training organisations, air ambulance service providers and private owners, including corporations operating their own corporate jets.

The operation of aircraft, be it commercial or civil aviation aircraft, requires extensive infrastructure as well as a myriad of services and support functions. The most important of these is the national airspace infrastructure comprised of the various airspaces as classified by the competent civil aviation authorities on the basis of uniform international standards set by the ICAO, navigational aids for pilots, air traffic control (ATC, which is responsible for managing the movement of aircraft in the sky to ensure efficient traffic flow and to prevent collisions) and weather services for pilots. Other essential aviation infrastructure are the airports where aircraft take off, land and park and where multiple support services, such as fuelling, maintenance and passenger handling, are provided.

The safe and efficient operation of aircraft requires multiple services, such as ATC, maintenance, insurance, ground handling, including, in particular, fuelling, marshalling, luggage handling, catering and passenger services. The provision of most of these services requires specialised training and certification by the competent civil aviation authorities.

The final stage in the value chain in the aviation industry is the retirement of aircraft, the final stage of the life cycle. Market activities at this level have become more diverse, sophisticated and lucrative. Companies specialised in the retirement of aircraft provide services such as converting and repurposing (e.g., from passenger plane to cargo plane), dismantling aircraft to sell or recycle parts, and storing, preserving or disposing of aircraft. As with the activities at the other levels of the value chain, the vast majority are subject to stringent regulatory requirements, including ESG-related regulation.

The market structure at each level of the value chain and, more specifically, the high interdependence of relatively few players at certain markets levels, in particular at the production level, have a significantly influence on how disputes are being managed and resolved. In practice, the high interdependence of market players and the long-term nature of pivotal business relationships (e.g., between airframe manufacturers and airlines) have led to a tendency to avoid the escalation of disputes and to resolve emerging disputes amicably in the interests of preserving good relations for the long term.

Typical aviation disputes along the value chain

Innovation and product development

At the innovation and product development level, disputes typically arise under joint research and development activities for new aircraft, aircraft systems and components,^[9] and can include both corporate and commercial transactions. The parties to these transactions may be airframe manufacturers and OEMs or innovators of new aviation equipment and technologies and their business partners, in particular financiers, which vary depending on the maturity of the innovators. Although such disputes may be triggered by sector-specific causes (e.g., delays in obtaining mandatory certifications), disputes at this market level are mostly typical of those in most commercial spheres, such as shareholder disputes or breach of contract and early termination disputes.^[10]

When it comes to the formal set-up and financing of innovation and product development activities, disputes most commonly emerge from one party breaching its obligations, such as making specific monetary or other contributions or obtaining regulatory approvals.^[11]

The main driver for disputes at this level, however, is intellectual property (IP) rights, such as disputes about the (co-)ownership of IP either contributed by a party or created during joint innovation and product development activities, as well as the future use and commercialisation of IP.^[12]

As at any market level, commercial disputes arising from any innovation or product development activity are frequently caused by delays, cost overruns and supply chain disruptions.

Regulatory constraints and long lead times on the one hand and changing customer expectations and public perception on the other shape how disputes are managed and resolved at this market level. The necessity to seek regulatory approvals and to obtain certifications is inherent and usually build in transactions at this level. Similarly, technical challenges are overcome by parties being flexible and collaborating to overcome technical challenges. In practice, most disputes arising from (asserted) breaches of contractual obligations require formal resolution at this market level.

Production

At the production level, a broad range of disputes may arise in particular between airframe manufacturers and their suppliers or subcontractors,^[13] or between airframe manufacturers and their customers (i.e., airlines, fleet operators or individual buyers).

These disputes typically arise under joint ventures for the production of aircraft parts or systems,^[14] supply contracts for aircraft parts or systems, technology transfer or licensing arrangements for IP used in aircraft parts or systems,^[15] sales and purchase contracts, and financing and insurance contracts. An emerging type of dispute to which airframe manufacturers and suppliers of aircraft parts and systems are exposed are ESG-related disputes brought against them by non-governmental organisations, shareholders and other stakeholders.

Causes for disputes at the production level are mostly technical issues, such as design flaws, quality control issues or performance discrepancies^[16] and, increasingly, supply chain disruptions and their effect on the production processes (in particular, delays and extra costs). Other issues, such as regulatory concerns (e.g., certification and airworthiness standards or safety issues) and ensuring compliance with increasing and constantly changing regulatory requirements, including with ESG requirements, as well as delays in certification processes, may disrupt production processes and delivery schedules. IP disputes typically are caused by differences in the understanding of the licensing terms, including commercial terms, in particular, as well as the admissibility and validity of certain licensing terms. The terms of various types of technology transfer agreements can be subject to strict antitrust and competition law rules that may affect their validity and enforceability (e.g., exclusivity stipulations may be unlawful and invalid if their object or effect is a restriction of competition). Financing and insurance disputes at the production level are mainly caused by cost overruns, non-compliance with certain assurances and covenants, and incidents during production that fall within the scope of insurance contracts.

The regulatory density and the complexity involved in the production of aircraft, and the specificities of the market structure with few, often dominant, airframe manufactures and highly dependent parts and systems suppliers, shape the way disputes at this level are managed and resolved. This is exacerbated by the major potential effects of negative public perception of safety, reliability and environmental issues on the industry, in particular at the production level. Regulatory requirements, in particular mandatory certifications, introduce a level of expected uncertainty that may substantially affect production processes and associated costs as well as time schedules. The parties affected by these known unknowns tend to consider regulatory issues as risks associated with their contractual arrangements (e.g., by assigning clear responsibilities for regulatory requirements and associated risks in the form of representations and warranties or covenants) and to resolve the implications of these amicably unless the consequences of regulatory requirements are caused by breaches of contractual obligations to ensure compliance with those regulatory requirements subject to the agreed standards (e.g., best efforts). The complexity involved in production is not only technical (i.e., the necessary combination of often highly sophisticated components and systems) but also the product of the many parties, often from different jurisdictions, and their interdependence.

Sales, finance, insurance and delivery

Disputes in respect of aircraft sales, finance and delivery typically arise under the aircraft sales and purchase agreement or finance and insurance agreements.

The disputes at this level are usually caused by late payments or payment defaults,^[17] late or defective deliveries, non-compliance with representations and warranties or covenants, and incidents resulting in damage to aircraft. Many of the representations and warranties as well as covenants are aimed at ensuring continued airworthiness of aircraft and compliance with regulatory requirements (e.g., compliance with maintenance cycles and programmes, use of certified parts and components only or work only performed by certified maintenance organisations).

The manner in which disputes are being handled varies considerably depending on the type of customer. More specifically, disputes relating to the sale of airlines or large fleet operators tend to be resolved amicably owing to the specificities of the market structure (i.e., the duopoly of manufacturers and large customers) whereas disputes for other commercial aircraft or general aviation aircraft more frequently require resolution in formal processes.

Operations

At the level of the operation of aircraft, disputes arise under service contracts with service providers and customer service contracts.^[18] Disputes may also arise under collaboration agreements, such as code sharing agreements or airline alliances.

Typical causes for disputes at this level are disagreements about responsibilities,^[19] failure to comply with regulatory requirements, lack of resources (e.g., qualified and certified personnel), supply chain disruptions (e.g., for spare parts), labour disputes leading to strikes, overbookings, flight cancellations and delays (caused by the weather or labour disputes).^[20] Antitrust or competition law concerns may give rise to disputes under cooperation agreements between operators if they are likely to restrict the parties from competing with each other or result in the exchange of strategic business information (or both).^[21]

In particular at the operation level, the aviation industry is and will increasingly be exposed to a new wave of disputes about ESG-related issues, in particular relating to climate and greenwashing claims as well as compliance with reporting obligations.^[22]

Safety concerns and public perception coupled with regulatory requirements are the main factors enabling disputes to be resolved at the operational level. For these reasons, aircraft operators in particular have a strong interest in keeping disputes confidential. Another important driver of how disputes at this market level are managed and resolved is time, as any unforeseen delay and downtime of planes is economically detrimental for aircraft operators.

Retirement

Activities at this level are the least prone to disputes. If at all, disputes arise mainly under commercial agreements for asserted breaches of contractual obligations (e.g., non-payment).

DNA of commercial aviation disputes

As can be seen from the description of the types of disputes that most commonly emerge at the various levels of the value chain in the civil aviation market, they arise under corporate and commercial transactions that can be seen at the respective level of the value chain in almost any industry:

• cooperation and financing agreements and licensing agreements at the innovation and product development level;
• cooperation, financing, licensing and supply agreements at the production level;
• sale and purchase as well as financing and insurance agreements at the sales, finance and delivery level;
• service and use agreements at the operational level; and
• sales and purchase agreements at the retirement level.

Nevertheless, there are a number of characteristics in aviation disputes the composition and sum of which form a unique DNA.

The operation of aircraft is international by nature and so are all other activities at all levels of the value chain. Airframe manufactures license IP and procure aircraft systems from rights holders and suppliers from around the globe. Aircraft are sold around the world and financed and insured by specialised financial services providers (mostly in a different location from the seller and the buyer). And once an aircraft is put to a different use or disassembled or stored away, it or its parts again travel the world.

In particular at the production and the operational levels, multiple parties are involved and the various transactions among these parties are intertwined; for example, a delay by one supplier may delay the assembly of an entire aircraft and, as a consequence, its delivery, or a shortage of qualified handling personnel at one airport may delay flights to multiple destinations and have ripple effects on flight schedules around the world.

Hardly any other industry is as meticulously regulated as the aviation industry. The aim of most regulations are to ensure safety and efficient traffic flow management across borders, to preserve effective competition and to implement and achieve ESG goals. Literally no non-certified part, including aircraft furnishing, may be installed on an aircraft and almost no service may be provided during the production or operation of an aircraft by personnel who are not specially trained and certified, and no aircraft may be flown without the required and internationally accepted certifications and certified crew.

Aircraft and their operation and the key infrastructure needed for the operation of aircraft is highly technical and IP-intensive.

The effective resolution of aviation disputes is often time critical not only to avoid capacity impasses, to secure efficient traffic flows and to mitigate often enormous financial risks, but also to ensure effective enforcement of legal measures. The seizure of an aircraft, for example, requires swift decision-making and enforcement actions to prevent the aircraft in question simply being removed from access by competent authorities by flying it to another jurisdiction.

Conclusion

Although not essential, the effective and efficient management and resolution of aviation disputes, because of their particular characteristics, will benefit from decision-makers, arbitrators and party representatives having the relevant legal (regulatory) or technical expertise and necessary industry insights, and from dispute resolution processes that are geared towards resolving the complex cross-border disputes that frequently involve highly technical issues of fact and law in a timely manner.

The establishment of the Hague Court of Arbitration and the interest it has attracted are testimony to the market having recognised that aviation disputes merit special attention to provide the market with skilled service providers, and efficient and effective dispute management processes. It is hoped that this guide will contribute to the emanation of relevant know-how.

 

Endnotes