Aviation Finance, 2009
Republic of China
Review of Regulatory Framework and Changes
T.S. Chang, T C Masters
The Republic of China (“ROC”) Congress (Legislative Yuan) passed into law several important amendments to the Civil Aviation Law (“CAL”) in June 2007. The most significant amendment is increasing the equity percentage a foreign citizen may hold in any local airlines to be right below 50%, as opposed to no more than one-third prior to the amendment.
On November 4, 2008, China and Taiwan signed the Cross-Strait Air Transport Agreement (the “Agreement”), with further amendments made in late April 2009. Under that agreement and starting in July 2009, local airlines from both sides will operate daily, direct two-way flights on newly opened direct routes to designated cities on either side of the Taiwan Strait for passengers and cargo carrier services, which is a major break-through of the previous charter flight arrangement and is expected to create more revenue to local airlines.
Financially-troubled Far Eastern Air Transport (FAT), one of the local major airlines, was forced to suspend its operations in May 2008, and is struggling to resume flights hopefully after it has restructured its finances. In general, the remaining five local airlines are living through yet another long drought in their business, mainly because of the competition from the Taiwan High Speed Rail (HSR). HSR has undermined the operation of local routes run by ROC airlines on Taiwan’s western corridor and has continued to pose as a serious competitor. In 2006, local flights serviced over 8.5 million passengers. In 2007, HSR’s impact reduced the number of local flight passengers down to 6.3 million. Currently only three air routes on Taiwan has regular flights as compared to the previous six air routes. The main reason that local airlines continue to operate profit-losing domestic routes is in hopes that more cross-strait flights will be distributed to them by the Civil Aeronautics Administration (CAA) under the Agreement.
Competition from HRS has been serious, but HSR has also accumulated US$2.13 billion in losses during its two-year operation, amounting to over 65 percent of the company’s capital. In addition, HSR has failed to meet customer expectations – with approval ratings dropping by six percent to 47 percent – which prompted the HSR to reduce its number of scheduled runs. Local airlines are thus forced to face the dilemma in having to offer more domestic flights on local routes, and have done so, that are not yielding profit, while expecting the direct flights under the Agreement will bring more revenue to them.
In April 2009, EVA Airways, Taiwan’s second largest carrier, posted its first quarterly profit since the end of 2007 because of increased charter flights to China and declining oil prices. In addition, China Airlines, Taiwan’s largest carrier, expects to make a profit with the increase in the number of direct flights to China, possibly ending six consecutive unprofitable quarters.
Productive economic activity and trading with China is essential for Taiwan’s economy. In 2007, Taiwan’s exports to China amounted to 40.7% of Taiwan’s total exports. By the end of that year, China constituted 55.4% of Taiwan’s overseas business investments. The number of mainland tourists is estimated to exceed 600,000 by the end of 2009. Opening direct flights will greatly reduce travel time that in turn promotes trading and tourism between the two sides.
Since 2003, China and Taiwan began implementing direct charter flights across the Taiwan Strait, but only during the Lunar New Year. In 2006, these direct flights were expanded into four special types of charter flights. In the summer of 2008, both sides commenced direct weekend charter flights.
Although those flights have begun since 2003, the small number of direct charter flights offered by airlines had been incomparable to the huge demand for cross-strait transport of passengers and cargo. Before the November agreement, most passengers and cargo had to be routed via a third place, mostly through Hong Kong. Compulsory indirect flights needlessly consumed valuable time and money from businesses and individuals.
The Agreement establishes a much needed systematic schedule of direct flights across the Taiwan Strait. In 2007, there were 4.95 million trips by passengers and 290,000 metric tons of cargo transported across the Taiwan Strait. The shorter flight routes reduce fuel costs by 40-45% and allow airlines to save up to US$140 million annually in costs.
While the Agreement opens up more business to local airlines to some degree, it has not yet sufficiently addressed the already huge and ever increasing demand in the air transportation needs in the Cross-Strait passengers and air cargo services.
Passenger flights. Pursuant to the Agreement, both sides may conduct 270 round-trip direct flights per week (7.5 times more than the previous number of weekly round-trip flights), but each may fly no more than 135 round-trip flights per week. The CAA completed the distribution of Taiwan’s 135 weekly cross-strait flights. For the time being, China Airlines and EVA Airways will each operate 30 weekly flights (including FAT’s 15 reserved flights until FAT resumes operation), while UNI Air and Mandarin Airlines will each receive 25 and TransAsia Airways will have 24. The one remaining weekly flight from Taichung to Shengchun will be shared between UNI and Mandarin on a rotating basis.
Cargo flights. Taiwan proposes that the number of weekly, direct cargo flights be increased to 300 because the load factor has increased from 70.3% in December 2008 to 90.6% in early April 2009. Currently, both sides may conduct 224 round-trip cargo flights per month with 15 additional flights during the peak cargo season, but each may fly no more than 112 round-trip flights per month. With the Agreement in place, both sides may offer regular and direct two-way cargo charter services. This gives both sides 2 flight points each and the choice to delegate 2 or 3 air carriers to operate them.
Since 1995, the Republic of China government has continued de-regulating the legal restrictions regarding registration and operation of foreign-owned aircraft in the ROC. Nowadays, foreign lessors/owners are allowed to lease foreign-owned aircraft to ROC airlines, and such leased aircrafts are eligible for registration of ROC nationality and operation in Taiwan; foreign owners are also permitted to register mortgages over foreign-owned, ROC-registered aircraft in the ROC in favor of its financier, and record lease registrations so as to avoid the joint and several liabilities of the ROC operator/lessee under the CAL.
New businesses have also been open to airlines since 1998. ROC and foreign airlines (if reciprocity requirement is met) are now allowed to operate air cargo terminals and ancillary services, including cargo loading and unloading.
Another major task of the government is to enhance aviation safety. The 1998 amendment to CAL inposed the following new requirements: (1) all aircraft must be inspected and certified for airworthiness by the CAA or its appointed third party, (2) an airline, with the CAA’s approval, may force passengers who remain in the aircraft after landing to leave the aircraft; and (3) a mandate to set up a new agency, the Aviation Safety Council ("ASC"), was given to take charge of investigating aircraft accidents. In 2000, the CAL was further amended to grant the ASC independent investigatory power. The CAA may not interfere with the investigation and must accept all corrective measures of aviation safety mandated by the ASC.
While local airlines have focused their business promotion on air freight business, on March 16, 2006, the Regulation of Civil Air Transport Enterprises was amended to lift restrictions on the age of cargo aircraft. Before the amendment, the age of a freighter used by ROC operator must have been under ten years old, and when an operator has used the same model of cargo aircraft for three years, the above age requirement was relaxed to fifteen years. Under the newly amended Regulations, these restrictions have been lifted and the age of cargo aircraft can be up to fourteen years. For aircraft that has been used for over fourteen years, it may continue to be used in service if CAA’s approval is given through filing an evaluation report, together with supporting documents (e.g., operation plan, maintenance plan, financial plan, and sourcing of pilot and training plan).
The CAA maintains a civil aircraft register. The register is established to record the aircraft bearing ROC registration marks (ROC nationality) and its ROC operator.
Aircraft owned by ROC government, national or legal entity (meeting the requirements of equity holding and directorship by ROC nationals) is eligible to be registered for ROC nationality with the CAA. Since 1995, if a foreign-owned aircraft meets the following conditions, it is also eligible for registration of ROC nationality:
(A) the aircraft is leased to an ROC operator and (1) the lease term exceeds six months, (2) the aircraft is operated by such ROC operator, (3) the crew is hired by the ROC operator, and (4) the aircraft has been de-registered from any foreign jurisdiction where it was previously registered; or
(B) the aircraft is purchased by an ROC person (individual, government or legal entity) under a conditional sale arrangement which meets the conditions described in (A) (2), (3) and (4) above.
After the aircraft has been registered for ROC nationality, mortgages and leases may be recorded with the CAA.
The registration applications are generally filed by ROC operator; in a few occasions, a foreign owner can also file the application.
Generally, only ROC-registered aircraft may fly on domestic routes in Taiwan, with but one exception (after the amendment to the CAL in 1998). ROC airlines may operate foreign-registered aircraft on domestic routes for a short period (less than six months) if (1) the aircraft used by the operator on the said route is placed under maintenance, and (2) the Ministry of Transportation and Communications has given approval for such operation.
To de-register an aircraft from the ROC registry, an application must be filed, generally by the ROC operator. If a mortgage is recorded over the aircraft with the CAA, the CAA will require a written consent from the mortgagee to de-register the mortgage before it approves a mortgage de-registration.
Only under certain circumstances will the CAA accept others to file for de-registration. If a mortgage payment default occurs and the aircraft is sold through judicial sale, the CAA will accept a de-registration application from the new owner. If default occurs under a conditional sale or lease, the foreign seller or lessor may apply for de-registration by submitting evidence of the ROC purchaser or lessee’s default.
Although Taiwan is not a signatory to the Chicago Convention of 1944 on International Aviation or the 1948 Convention on the International Recognition of Rights in Aircraft, Taiwan has a similar legal framework in recognizing foreign owners’ (lessors) and financiers’ interest in foreign-owned, ROC-registered aircraft.
When a foreign lessor leases its aircraft to an ROC operator and when such aircraft is registered for ROC nationality, the foreign owner’s name will appear on both the register and the Certificate of Registration issued by the CAA to the ROC operator, but such name entry will not constitute conclusive evidence of ownership. A foreign owner must provide further supporting documents, such as bill of sale, to establish its ownership interest in the aircraft.
The lease by a foreign lessor, on the other hand, can be registered with the CAA by recording the major terms of the lease, including the respective names and addresses of the lessor and lessee and the lease period, to establish its rights as a lessor. The CAA will record the lease on the register, but will not issue a separate certificate to either lessor or lessee; the CAA will make a notation on the Certificate of Registration (the reverse side). After the lease has been registered with the CAA, the foreign lessor will not be held jointly and severally liable with the ROC lessee for damages arising from any mishap involving the aircraft in the absence of the foreign lessor's negligence or fault contributing to the cause of such an accident.
A foreign lessor needs to note the rules of the ROC Ministry of Finance in differentiating finance lease and operating lease. If one of the following tests is met, the lease will be deemed a finance lease:
(1) title to the leased aircraft will be transferred to the lessee unconditionally at the expiry of the lease term (as compared to a purchase option for market value in an operating lease)
(2) the lessee is entitled to a purchase option on preferential purchase term
(3) the term of the lease is in excess of 75% of the useful life of the leased aircraft; and
(4) the current value of the aggregate rentals plus the preferential purchase price is in excess of 90% of the book value of the leased aircraft.
A lessor may directly enforce its repossession right upon lessee’s default only if the lease agreement has a direct enforcement clause and is notarized by a ROC notary public. Prior to April 1999, notarization was cost-prohibitive, but it is of a lesser concern under the current fixed fee system. As such, notarization of a lease may be considered to secure a lessor’s immediate repossession rights. In all other cases, unless a lessee voluntarily delivers the aircraft to lessor’s possession, a lessor must obtain a final court judgment, which generally takes at least six months to one year before repossession can occur. During such time, a lessor may apply to the court for a provisional injunction to require the lessee to take or refrain from taking certain actions relating to the aircraft. The lessor must in such instances post a bond in an amount set by the court to obtain the said injunction order.
ROC law on insolvency and bankruptcy proceedings generally will not affect a lessor’s right to repossess its aircraft.
A foreign financier financing a foreign lessor of a ROC-registered aircraft or ROC airline may register its security interest in the aircraft by creating aircraft mortgage and recording its mortgagee’s interest with the CAA.
Under ROC conflict of law rules, a mortgage created over a ROC-registered aircraft is governed by ROC law. A mortgage will take effect between the two parties when a mortgage agreement is signed, but it must be recorded with the CAA for perfection in asserting a defense against third parties.
The CAA does not separately keep an aircraft mortgage registry, but will note the submitted terms of the mortgage on the Certificate of Registration (reverse side).
A recorded aircraft mortgage typically enjoys priority over unrecorded or subsequently recorded mortgages, but is junior to possessory-type liens.
Chattel mortgages on engines and spare parts should be separately registered with agencies other than the CAA.
If the borrower defaults in his mortgage payment, the mortgagee may directly repossess the aircraft, or obtain a court order for repossession of the aircraft. Repossession through court enforcement usually requires one month.
After the aircraft has been repossessed, unless the mortgagee and mortgagor otherwise reach a voluntary settlement, the mortgagee must sell the collateral through a recorded private auction or judicial sale.
Although private auction in some cases may be expeditious, it leaves the mortgagee vulnerable to damages claims from the owner if the sale price of the aircraft is ”inappropriate.” As a result, judicial sale is a common remedy. The mortgagee may bid at the judicial sale and may offset the amount of its debt against the bid price if the mortgagee is the only first-priority creditor receiving the proceeds of such a bid.
ROC bankruptcy law generally will not prevent a mortgagee from repossessing an aircraft, but if the ROC borrower has been approved by the court for re-organization, the mortgagee will be subject to a court approved re-organization plan and may not enforce its repossession or other rights.
Parties may agree to litigate their disputes in a foreign jurisdiction, but ROC courts will enforce foreign judgments only if certain stringent requirements are satisfied, including the reciprocal enforcement of ROC judgments in the jurisdiction where the foreign judgment is rendered.
As an alternative to ROC courts, the parties may submit to binding arbitration. The arbitration may be agreed upon and conducted according to foreign arbitration rules or in a place other than Taiwan. In doing so, the arbitral award will be deemed a foreign arbitral award, and is required to have a ROC court judgment for recognition. If both the law governing the merits and the arbitration rules are ROC law, and the place of arbitration is in Taiwan, the arbitral award will be directly enforced by an ROC court when the parties have consented to such direct enforcement in their agreement.
ROC companies are permitted to keep accounts denominated in foreign currencies. Remittances from these accounts generally do not require prior governmental approval. The outstanding balance of loans with repayment denominated in foreign currencies must be reported periodically to the Central Bank of the Republic of China (Taiwan) ("Central Bank”). The Central Bank’s approval is needed to convert New Taiwan Dollars into a foreign currency, except that ROC operators may remit up to a certain sum each year without such approval. The amount permitted depends upon governmental regulations. The current amount is US$50 million each calendar year. ROC courts will render judgments in foreign currency. If enforcement of a foreign currency judgment results in New Taiwan Dollar proceeds, the judgment creditor can usually obtain the Central Bank’s approval for exchange conversion and remittance.
Finance leases generally are considered as extensions of credit, making them subject to ROC income tax to be withheld at the current 20% rate applicable to interest payments. Rent received under an operating lease is subject to ROC income tax, also currently at the rate of 20%. If approval is obtained from the Ministry of Finance, rent received under an operating lease is subject to a reduced rate effectively equal to 3.75% of the entire rent. In certain limited cases, international tax agreements will also reduce the applicable tax.