Wednesday, March 11, 2009

The End of Virgin America?

The Wall Street Journal reported yesterday that Virgin America's primary U.S. investors, hedge funds Cyrus Capital Partners LP and Black Canyon Capital LLC, sold their 77% stake in the airline back to the U.K.-based Virgin Group.  The transaction may compromise Virgin America's compliance with federal law.

Under the Federal Aviation Act, 49 U.S.C. § 41101(a), "an air carrier may provide air transportation only if the air carrier holds a certificate [of public convenience and necessity]" from the Department of Transportation.  This certificate can only be issued to a carrier which the legislation defines as a "citizen of the United States undertaking by any means, directly or indirectly, to provide air transportation," § 41101(a)(2).  For the purposes of the statute a "citizen of the United States" means

(A) an individual who is a citizen of the United States;

(B) a partnership each of whose partners is an individual who is a citizen of the United States; or

(C) a corporation or association organized under the laws of the United States or a State, the District of Columbia, or a territory or possession of the United States, of which the president and at least two-thirds of the board of directors and other managing officers are citizens of the United States, which is under the actual control of citizens of the United States, and in which at least 75 percent of the voting interest is owned or controlled by persons that are citizens of the United States.

49 U.S.C. § 40102(a)(15) (emphasis added).

Unless Virgin America has found replacement U.S. investors since yesterday, it is currently operating above the statute's limit of 25% on foreign investment in the voting securities of a U.S. airline.  A similar violation of the foreign ownership threshold was enough for the DOT to dispose of Virgin America's initial certificate application in 2006 (though the Department opted to also examine the statute's other requirement that an airline be "under the actual control" of U.S. citizens).  See U.S. DOT, Application of Virgin America . . . , Dkt. No. OST-2005-23307, Order to Show Cause (Dec. 27, 2006), at 14-15 & 21.  While The Wall Street Journal also reported that in order for Virgin America "[t]o ensure [it] remains controlled by U.S. investors in the short term, representatives of the departing shareholders will remain on Virgin America's board until new shareholders are found," it still does not solve the problem created by the Virgin Group apparently exceeding the ownership cap.  The statute's "actual control" requirement, which is qualitative and notoriously vague, needn't come into play.  And even if it did, the fact that it has historically operated in the DOT's jurisprudence--in the words of former DOT Under Secretary for Policy, Jeffrey Shane--as the "it's for us to know and you to find out" standard means that Virgin America can hardly rest assured that its apparent compliance won't fall victim to whimsical application.

What this seems to mean is that as of this moment, Virgin America is operating U.S. domestic services as a foreign-owned carrier.  In other words, it's engaging in cabotage.  While there are no criminal penalties attached to what Virgin America seems to be doing, this latest development will no doubt expedite the DOT's ongoing review of Virgin America.  As discussed previously on the blog, Alaska Airlines filed a petition for the DOT to review Virgin America's citizenship status in anticipation of a withdrawal from U.S. investors.  Given the tough economic climate and the waning demand for air travel, the Virgin Group is unlikely to find enough domestic takers to satisfy the DOT.  If the carrier is forced to cease operations, it will be interesting to see what (if any) effect it has on the ongoing negotiations between the U.S. and EU for a second stage air transport agreement.  No doubt the U.K., which has never been shy about its willingness to suspend the first agreement, will frown upon it.

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