If you want transparency and ethical conduct in your aircraft buy/sell transactions, certain back-to-back structures might not work for you. David Mayer elaborates…
In its basic form, a back-to-back occurs when an aircraft broker buys an aircraft from the principal seller and then immediately sells the aircraft to the end-user buyer. Brokers enter into a purchase agreement with the seller and then a separate sales agreement with the buyer.
Usually, neither the buyer nor the seller sees the terms of the other’s agreement with the broker. Understandably, the broker enjoys an intermediary position where it need not, depending on the circumstances, disclose the full compensation to the broker’s client and/or to the client’s counterparty.
In this structurally insulated place, a broker can engage in questionable conduct, illustrated in this egregious hypothetical back-to-back:
- A broker exclusively represents a seller that wants to sell its G280 for $10m.
- The broker advises the seller that the seller should ask $9m.
- The seller does so, and the broker finds an off-market buyer who is willing to pay $9.5m.
- The buyer makes a $250,000 ‘deposit’ to buy the G280, and the broker instructs the escrow agent to use this $250,000 deposit as the broker’s own deposit to satisfy the broker’s deposit obligation under a purchase agreement with the seller (the broker’s client).
- Then, the broker ‘purchases’ the G280 from the seller using the buyer’s funds.
- The broker immediately sells the G280 to the buyer for $9.5 million.
For the broker, this sequence results in a cashless transaction because the broker uses the buyer’s $250,000 deposit and other purchaser funds to perform the broker’s purchase agreement with the seller.
The broker retains a $500,000 ‘cut’ of the purchase price at closing, as well as a fee of $150,000 from the seller at closing—a total of $650,000. However, the seller believes the $150,000 fee is full compensation to its broker and has no knowledge of the $500,000 received by the broker.
Since the buyer and the seller received their agreed purchase and sale price, respectively, the broker has no reason to disclose to anyone, especially the seller, that the broker received a $500,000 payday.
Can Back-to-Back be Ethical?
Did the broker wrongfully take $500,000 in sale proceeds from its client, the seller? Is the broker’s unethical behavior characteristic of self-dealing, or of a conflict of interest?
Should the broker have disclosed the $500,000 cut to the seller—the broker’s client, which it is supposed to be representing—and explain to the buyer how the buyer’s deposit and purchase price funds were used?
Despite the broker’s improper conduct illustrated above, back-to-backs often make sense for economic, transactional, cultural and other reasons.
For example, in domestic and, perhaps more often in international buy/sell deals, the buyers or sellers might refuse to pay broker’s fees, especially to a buyer’s agent or broker. However, the buyer and/or the seller might agree to the broker’s use of a back-to-back as an acceptable, if not essential, way to compensate the broker.
Like all back-to-backs, the hypothetical example above should have been executed transparently, honestly, ethically and with minimized legal risk.
So, is the key to conform to, and build on currently available principles and practices of ethical conduct in buy/sell deals?
You can see a trend moving affirmatively in that direction as company policies, industry guidance, and regulatory mandates seem to be coalescing to promote integrity, transparency, honesty, accountability and ethical conduct in aircraft buy/sell transactions, including back-to-backs.
In particular, current industry guidance supports the evolving trend. In December, the NBAA approved a formal statement, ‘Ethical Business Aviation Transactions’. The statement outlines best practices for ethical transactions between buyers and sellers of business aircraft products and services.
A month earlier, the National Aircraft Resale Association (NARA) elected Brian Proctor as its president. Proctor has pledged to continue efforts “to ensure that members abide by the association’s Code of Ethics,” which includes requirements for honesty, integrity and transparency.
The National Air Transportation Association (NATA) approved a ‘Statement Regarding Ethical Conduct’ in January 2013 and two months ago renewed its call for a code of ethics for General Aviation based on principles of safety, integrity, respect, accountability and ethical conduct.
Finally, certain title companies have implemented policies aimed at questioning, if not stopping improper and potentially illegal cash flows in closings in which they manage funds. In other instances, brokers and other industry companies have established a culture of ethical conduct.
Heightened Legal and Tax Risks
Back-to-backs lacking transparency and/or stretching ethical boundaries might also heighten legal and tax risks for the parties.
The parties might experience these risks if, for example, the warranty of title granted by the seller does not reach the buyer, stopping at the broker under its bill of sale, even though the buyer bargained for the warranty of the principal seller; state sales or use taxes become payable by the unsuspecting buyer as a result of incomplete tax exemption work by the broker; tax and other liens of the broker attach to the aircraft when the broker takes title and clouds the true buyer’s title to the aircraft; and/or the use of the buyer’s deposit and other purchase funds by the broker may lead all parties into contract disputes, potentially arising out of diligence of title companies.
To enhance the integrity, quality and delivery of products and services in Business Aviation, including back-to-backs, industry players should ideally comply with the applicable ethics statements/codes of NBAA, NARA and NATA.
To do otherwise can breed distrust in transacting with each other and shows a player’s disrespect for our industry’s core values.
This article was first published in AINalerts.