The Transportation Dept. tentatively
rejected Virgin America's application for a U.S. operating
certificate last week after concluding the carrier was not
sufficiently owned and controlled by U.S. citizens, as required by
law.
The decision
threatens to ground Virgin America before it can fly a single
passenger, though it already has acquired nine aircraft and hired
more than 160 employees. Virgin America, based in San Francisco,
was hoping to take off flight this spring with San Francisco-New
York as its first route.
Virgin America
officials said they were confident the company could address the
issues raised by the DOT and ultimately receive its approval to
operate. Virgin, which has until Jan. 10 to file its response,
declared, "We remain committed to getting our wings."
The DOT rarely
overturns its tentative decisions, however, and its numerous
objections to Virgin America's plan could be difficult, if not
impossible, to address in a way that would satisfy both the DOT and
Virgin America's investors, including Virgin Group Chairman Richard
Branson.
To satisfy the
DOT's objections, Virgin America would have to change its
ownership, its corporate structure and its licensing agreement with
the Virgin Group to use the Virgin brand name.
The 49% test
Under U.S. law,
foreign interests can own no more than 49% of a U.S. carrier and no
more than 25% of its voting stock. U.S. carriers also must be under
the "actual control" of U.S. citizens.
Virgin America's
first problem is the most fundamental. In the "show-cause order" it
issued on Dec. 27, the DOT said it tentatively concluded that U.S.
citizens did not own 75% of the carrier.
According to the
history of the company as detailed by the DOT, Virgin America was
initially incorporated as Best Air. The Virgin Group provided its
financing, developed a business plan, assembled a team of
experienced aviation executives, ordered aircraft and sought U.S.
investors to own and control Best Air.
On Nov. 21, 2005,
Virgin America came under the control of VAI Partners, a Delaware
investment company that now holds 75% of the capital stock and
voting interest.
But the DOT
concluded VAI Partners is not majority-owned by U.S. citizens
because of the involvement of Cayman Islands entities or foreign,
limited partnerships.
In some previous
cases, the DOT had permitted equity funds to invest in U.S.
carriers even if they included passive foreign investors, but the
DOT said it could not take that approach in the Virgin case because
"the foreign interests are neither diffuse nor passive, due to the
extensive involvement of, and financial interest held by, Sir
Richard Branson and the Virgin Group."
"Given that the
majority of VAI's owners are tentatively regarded as foreign, we
must tentatively conclude that VAI is not a U.S. citizen," the DOT
said.
The 'actual control' test
Even if Virgin
America could somehow restructure the ownership to overcome this
obstacle, it faces another: The DOT also cited a variety of reasons
for concluding that Virgin America is not under the "actual
control" of U.S. citizens.
Among the factors
cited by the DOT:
" Virgin America
CEO Fred Reid appears to owe his appointment to Branson, the
airline's largest foreign minority owner.
Although Reid is
a U.S. citizen, the DOT said, "the long and intricate association
of Mr. Reid with the Virgin Group constitutes one of several
circumstances that, taken together, persuade us tentatively that
Virgin America is not actually under the control of U.S.
citizens."
" VAI Partners
appointed six of the airline board's 10 directors, and since the
DOT concluded VAI is not a U.S. citizen, the board is not really
controlled by U.S. citizens.
" The Virgin
Group's involvement in Virgin America's creation -- providing the
funding to develop a business plan, recruiting and hiring
executives, purchasing aircraft and soliciting U.S. investors --
"offers further indication of foreign control," the DOT
said.
"In spite of
Virgin America's claim of sudden independence for its U.S.
management, the facts surrounding the applicant's creation cannot
be ignored," the DOT said. "They are part of the totality of
circumstances that must be considered in determining its present
citizenship."
" The licensing
agreement Virgin America has with Virgin Group to use its brand
name gives the Virgin Group too much control. The DOT said it
identified several conditions "that significantly restrict Virgin
America's commercial decision-making authority and essentially
prevent Virgin America from acting as an independent air
carrier."
" Debt agreements
between Virgin America and the Virgin Group "show that Virgin
America's survival is contingent upon the financing provided by the
Virgin Group," and U.S. investors bear little or no
risk.
"This certainly
suggests that U.S. investors were brought in for the purpose of
creating an impression of U.S. citizenship," the DOT
said.
A road map to approval?
Despite these
objections, Virgin America said it believed it could use the DOT's
tentative decision "as a road map to address the issues raised and
to demonstrate to the DOT that Virgin America will meet all
ownership and control requirements."
It added that it
planned to respond by Jan. 10 "so that we may move forward with DOT
certification; launch our airline; and bring new, high-quality
service and much-needed competition to the marketplace."
But it could be a
tough sell. The DOT's tentative decision stands in stark contrast
to its efforts for the past year to push through a rules change
that would have allowed some foreign control of U.S. carriers,
which it argued was necessary to provide more capital to U.S.
carriers by encouraging foreign investment.
Congressional
opposition forced the DOT to retreat, and its tentative decision in
the Virgin America case shows the DOT, for whatever reason, is
taking a hard-line approach as advocated by opposing U.S. airlines
such as American, Continental Delta and US Airways.
At one point, the
DOT even seems to go beyond the "actual control" standard it had
tried to modify by suggesting that "the appearance of control" is
also a factor.
In emphasizing
that it does not oppose licensing and franchising agreements with
foreign airlines in general but only the terms of the Virgin
Group-Virgin America agreement, the DOT said: "Such arrangements
could pass muster if they avoid the appearance, and reality, of
foreign control over the purported U.S. air carrier."
To contact reporter Andrew Compart, send e-mail to [email protected].