Saturday, February 02, 2008
Legal Aspects of Aircraft Ownership - Part 1 - Using an Enterprise to Hold your Aircraft
Subscribe to Airspeed through iTunes or your favorite other podcatcher. Or listen online right here by clicking: http://media.libsyn.com/media/airspeed/AirspeedLaw1.mp3. It's all free!
A little less jet fuel and noise in this new series of next few episodes. But it’ll be no less exciting for many and it’ll be at least interesting for most others.
We’re going to get into an area where I have more expertise than I do as a pilot. As some of you may know from the blog or the website, when I’m not strapped into the back of a military jump plane or talking to NASA scientists or leaning into the microphone as my superhero alter-ego Stephen Force, I’m mild-mannered technology and aviation lawyer Steve Tupper.
I’m a member of a large Midwest law firm that practices just about every kind of law you can think of except maybe criminal. (By the way, we’re a professional limited liability company, so we have “members” instead of “partners,” so that’s why I say that I’m a “member.”)
I do mostly technology licensing and corporate transactions, and an increasing part of my practice is aviation and aerospace. The last few aviation matters upon which I’ve worked have included a Lear 35, a Gulfstream GIII, a Cessna Citation III, and a Fokker F100 (yeah, that’s a big Fokker), a Citation Sovereign, and a Falcon 2000. Other people at the firm do Part 121, Part 135, and other work and there’s even a guy in the LA office who ran a Part 121 and 135 operation before joining the firm.
So we’re going to spend some time on a topic that’s on almost every pilot’s mind: The legal aspect of buying an airplane.
Before we get started, here’s a disclaimer. (Of course there’s a disclaimer!) Please bear in mind that what you hear on this podcast is general information about the law that applies to some aspects or the purchase, sale, and operation of aircraft in the United States. It is not legal advice and it does not create any attorney-client relationship with any listener. Every client and every proposed or actual transaction is different, and you should retain your own qualified lawyer to advise you under your particular circumstances. I don’t attempt to cover all developments that could have an effect on you or your proposed or actual transaction. Rules of certain state supreme courts may consider this advertising and require that I advise you of such designation.
Also, I know that this is serious business. I take the law and the interests of my clients very seriously. But I’m also instructed by the stylings of Rod Machado, John and Martha King, Cornell Law School Prof. Faust Rossi, and Chicago-Kent Law Professor Mike Spak, who recognize that humor and storytelling are great tools that help get points across. Long story short, this stuff is so important that I wouldn’t dream of not using humor to get these points across.
There. Disclaimer over. On with the show.
There are a number of ways in which to purchase and own an airplane. The most popular are to own it personally in your own name, own it jointly with other individuals in the individuals’ own names, or have a separate enterprise like a corporation, limited partnership, or a limited liability company own it and have one or more individuals own interests in the enterprise.
There are many reasons not to own an aircraft in your own name or, in the case of a group, in the names of the individual members of the group. Those reasons include liability governance, and others.
First, let’s look at liability.
We live in a litigious society. People will sue at the drop of a hat. Or at the drop of a fuselage if it lands in the wrong place. Most of our fellow citizens are good Joes, but even the most even-tempered guy out there is going to be a little miffed if he comes home to find an airplane sticking out of his house. And even if he isn’t miffed because his insurance company pays him for the damage, the insurance company is going to be miffed about paying Joe the money and is probably going to come after whoever stuck the airplane into the house. There’s no free lunch out there.
And, as you can imagine, it gets even uglier if people get hurt, either in the air or on the ground.
So you want to do everything you can to set up as many firewalls against liability as the law allows. We’re not talking about dodgy derivative transactions here. Just the kinds of limitations of liability that are a time-honored part of the American legal landscape.
One of the easiest and most effective ways to limit liability is to use an enterprise. By “enterprise” I mean a business or other entity. Like a corporation, limited partnership, or limited liability company. Some people call them “entities” or “non-natural persons” or use some other term, but I like to call them “enterprises.”
The best way to understand the limited liability that enterprises offer is to look at the kinds of liability that are out there if you’re just an individual or a general partnership.
First, there’s individual liability. This is the easiest. Individuals are liable for their acts and omissions. If you stick the aircraft into Joe’s house, plan on Joe suing you individually. Or at least plan on Joe suing your estate.
If you lend the aircraft to your flying buddy Carl and Carl reeks of alcohol and is loading pianos into the back to push out of the plane over the practice area, plan to be sued individually for letting Carl use your plane when he hurts somebody or himself. That’s called negligent entrustment and there are other names for it (among them, impractical, ill-advised, and stupid).
Second, let’s talk about liability with other people.
34 states and the District of Columbia have adopted a piece of legislation called the Uniform Partnership Act with its 1997 amendments. Three states have adopted the Uniform Partnership Act, but have earlier versions in place. Other states have law that is very similar, so we’re going to use the Uniform Partnership act as the example here.
Note that there’s a difference between a general partnership and a limited partnership. Whenever I talk about a “partnership” without specifying what kind, I’m talking about a general partnership.
According to the Uniform Partnership Act of 1997, a partnership is “an association of two or more persons to carry on as co-owners a business for profit . . .” A “business,” by the way, “includes every trade, occupation, and profession.” In my limited experience, it’s a crapshoot as to what a judge or jury would find to be a “business for profit.” And there’s other state law that essentially calls any joint effort by two or more people a partnership. So, if you’re conservative – and you should be – you should assume that anything you do with another person toward a common goal is a partnership.
Now here’s the kicker. According to the Uniform Partnership Act, “all partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law.” Additionally, common law and other statutory law imposes joint and several liability on all the partners for any act or omission of any partner in furtherance of the objective of the partnership.
The magic and dangerous words here are “joint and several.” Joint and several liability means that the plaintiff can sue any or all of the partners, regardless of whether a particular partner was involved in the act or omission that brought on the liability. And, if the plaintiff wins a judgment, the plaintiff can collect from any one or more of the partners sued – again, regardless of whether the partner from which the plaintiff collects was himself or herself at fault.
Some examples here. If you own a plane in a partnership with Carl and Fred, all three of you are jointly and severally liable for any act or omission committed or omitted in furtherance of the partnership.
Carl goes out and borrows $10,000 against the airplane and signs a security agreement giving the lender a lien on the airplane: The lien against the airplane sticks.
Fred punches somebody in the nose on the ramp because he thinks that the other guy is tied down in the partnership’s spot: The guy with the flattened nose is probably going to sue all of you.
Carl takes off in his intoxicated state and starts pushing pianos out the back over the practice area: Get ready to be sued, even if you were at home reading the paper and had no idea that Carl and the pianos were up there.
And the plaintiffs in the last two cases could sue all of you and collect the whole thing from you, leaving you with only a right to get reimbursed by the other partners.
A partnership is usually a bad idea but, if you’re going to insist on owning an airplane as part of a partnership, at least try not to be the only partner with deep pockets.
So, having established that individual ownership and partnerships are usually not the best ideas, let’s talk about enterprises.
The thing you’re after is the limitation of liability that comes with the use of an enterprise. For example, here’s an excerpt from the Michigan Business Corporation Act. “Unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he or she may become personally liable by reason of his or her own acts or conduct.” [MCL § 450.1317(4); http://www.legislature.mi.gov/(wpvuqifiwwg52i55nwnmpvfn)/mileg.aspx?page=getObject&objectName=mcl-450-1317]
Most states have provisions like this in their corporate, limited liability company, and limited partnership acts. It means that, if you personally didn’t have any connection with the reason that the aircraft is sticking out of the house other than your ownership of a piece of the enterprise that owns the aircraft, you may well be okay.
So let’s look at the previous examples.
The lien on the airplane stays, although you can argue with the lender about whether it should have accepted Carl’s signature.
Fred punches the guy on the ramp. The plaintiff will almost certainly sue Fred. The plaintiff may even sue the enterprise. But if you didn’t have anything to do with the incident other than being a shareholder or member of the enterprise, the guy with the flattened nose probably isn’t going to be able to come after your house or your coin collection or your dog. At worst, he’ll clean out your buddy Fred and the assets of the enterprise (including the aircraft), but you’ll only be out whatever the value of your interest in the enterprise was.
Same with your piano-bombing buddy, Carl. As long as you didn’t have anything to do with his rendition of the Bumble Boogie from 4,000 feet AGL, your max burn will probably be whatever you paid for your interest in the enterprise.
I mentioned limited partnerships before. A limited partnership is a partnership that has at least one general partner and at least one limited partner. Generally, general partners have the unlimited joint and several liability that you’d expect for a partner in a partnership. However, the limited partners have the limited liability that you’d expect from a corporation or a limited liability company. There are tradeoffs. The limited partners usually have to be passive and can’t actively participate in the business of the limited partnership without taking on the liability of a general partner. Limited partnerships are pretty rare these days except in certain kinds of real estate deals and for tax reasons. I generally don’t recommend limited partnerships for aircraft deals. Limited liability companies and so-called “S-corporations” have most of the advantages that used to draw people to limited partnerships and are more appropriate for many deals and are much more common.
Some states have special enterprise laws that apply especially to aviation. For instance, Michigan law permits the formation of flying clubs. Under the law, a flying club is “a nonprofit entity organized for the express purpose of providing its members with an aircraft for their personal use and enjoyment.” (See MCL 259.91; http://www.legislature.mi.gov/(S(0a1y0oq43lt5hdmmvlybqr45))/mileg.aspx?page=getObject&objectName=mcl-259-91.) I’m not sure that there’s any particular benefit to organizing as a flying club. The statute requires, among other things, that all member’s interests be equal and the club can’t rent or charter its aircraft to others. The statute also limits the revenue that the club can raise from the use of the aircraft to that necessary for the “actual operation, maintenance, and replacement or upgrade of its aircraft.” Nevertheless, I guess that the law makes it clear that it’s okay to organize the enterprise as a nonprofit corporation, at least under some circumstances. Check the law in your state to see if any statutory or regulatory regimes help organizations own and operate aircraft. An aviation lawyer in your state will probably know the ins and outs of any similar law where you live.
There are disadvantages and caveats to owning an aircraft through an enterprise, too. Let’s look at the disadvantages first.
There’s more paperwork and formality. You have to file formation documents like articles of incorporation or organization. You have to have other governing documents like bylaws or an operating agreement. You have to have meetings or at least do consent resolutions.
You may have to file an additional tax return, even if the organization is a nonprofit corporation.
You may have to hire and pay professionals like lawyers and accountants to help you with the formalities.
I also have four caveats here on the liability side.
1. Even if you decide to go ahead with an enterprise, you’ll have to do several things to give you the best possibility of avoiding having a plaintiff do what’s called “piercing the corporate veil.” That’s where a plaintiff convinces a court to ignore the enterprise and its limited liability and allow the plaintiff to go after the owners individually. I say “corporate” veil, but the concept applies to corporations, limited liability companies, and other forms of enterprise.
There are several theories upon which plaintiffs usually base their veil-piercing efforts and most or all are based upon the general idea that the enterprise is a sham that doesn’t deserve to be treated as the barrier that it’s intended to be. Failure to observe corporate formalities like having shareholder or member meetings is a big one. Have at least annual meetings, keep records, and filing the required reports with the state.
Commingling assets between the enterprise and the individual owner or owners is another big one. Keep separate books and records for the enterprise and make sure that the enterprise has its own bank accounts. Also make sure that the other assets of the enterprise and the owners are kept separate. It’s probably not horrible if one of the members borrows the stakes and tiedowns to go to Oshkosh, but get nervous if one or more of the members start storing boats and motorcycles in the hangar to the point where you can’t fit the aircraft in there. If you can’t tell by observing your operations which assets are those of the enterprise and which assets are those of the owners, you probably have issues.
Plaintiffs also like to try to assert that the enterprise doesn’t have enough capital to carry on its business. The enterprise that owns the plane should probably have all of the resources that a reasonable person would have for the operation of the plane. Having enough money in the enterprise to handle the usual care and feeding of the airplane should be enough. That may include a TBO fund and enough money to purchase and maintain insurance, too. It all depends on how demanding the law of your state is.
The way you hold out the enterprise to the world also matters. If you walk around calling the airplane “your airplane,” or if you call your fellow enterprise owners your “partners,” don’t be surprised if the people with whom you deal are less than enthusiastic about recognizing the existence of the enterprise when it’s lawsuit time. Call yourself a “shareholder” or “member” of the corporation or limited liability company and use the name of the enterprise in contracts and other dealings with others. For example, sign documents “BobCo, LLC, by Bob Smith, its Member” so there’s absolutely no doubt about the parties with whom others are dealing and in what capacity.
Last, but not least, no enterprise will protect you from liability for your fraud. If you’re committing actual skullduggery, don’t expect the enterprise to protect you. And don’t ask me to be your lawyer.
2. Nothing about the limited liability associated with an enterprise will save you personally from liability if you were the guy or gal flying the aircraft or if you participated in flying the aircraft as part of the incident that led to the aircraft sticking out of Joe’s house. The same probably goes for other personal acts or omissions that lead to injury of someone, such as if you egged Fred on when he punched the guy on the ramp or helped Carl load those pianos into the aircraft. Individuals usually remain liable for their own contracts and torts regardless of whether there’s an enterprise involved.
3. All a lawyer and a legal structure can do is give you a chance of winning a lawsuit. Nothing, but nothing, will necessarily keep you from getting sued. There are no magic bullets. You may get yourself dismissed from the suit early on or you may win the suit, but it is in the nature of plaintiffs’ counsel to sue everyone who’s even remotely close to the suit’s blast radius and even getting out on summary disposition will probably cost you a lot of money in legal fees. Remember through all of this that even the best lawyer on the planet can only give you a good chance of winning a lawsuit. No lawyer on the planet can keep you from getting sued if the plaintiff really wants to sue you.
4. Get your own lawyer to explain this under your particular circumstances. I told you this stuff was complicated!
I recorded and published the episode as a service to myclients and friends for informational purposes only, and not for the purpose of providing legal advice. You should not consider any information on this website to be legal advice and should not act upon any such information without seeking professional counsel. Use of, and access to, this website or the episode audio does not create an attorney-client or any other relationship between me or my firm and the user. Accordingly, please do not send me any confidential information unless and until a formal attorney-client relationship has been established, as such information will not be protected by the attorney-client or any other privilege. Certain jurisdictions may consider the episode or this post advertising and require that we inform you of same.