All posts tagged 'aircraft leasing'

The Difference Between "Wet" and "Dry" Aircraft Leases

Many times an aircraft owner who is not fully utilizing the owner’s aircraft will lease the aircraft to maximize the use of the aircraft and to recover some of the aircraft owner’s expenses. One of the areas about which aircraft owners and operators are frequently confused is the difference between a “wet” lease and a “dry” lease. I’ll give you a hint: It’s not about the fuel.

The “Wet” lease

14 C.F.R. §110.2 defines a “wet lease” as “any leasing arrangement whereby a person agrees to provide an entire aircraft and at least one crewmember.” (Note no reference to fuel)

Ordinarily, the parties entering into wet lease arrangements are certificated air carriers such as airlines operating under 14 C.F.R. Part 121 and charter operators conducting operations under 14 C.F.R. Part 135. This makes sense since these air carriers have the authority to use aircraft and crew to carry passengers and property for compensation or hire. Non-air carrier aircraft operators conducting operations under Part 91 are prohibited from carrying passengers and property for compensation or hire except in very limited circumstances.

However, 14 C.F.R. § 91.501(c) does provide for certain timesharing and interchange arrangements in which both the aircraft and crew are provided together. And although these arrangements are considered wet leases because they include both aircraft and crew, they are Part 91 operations in which the parties to the transactions do not need to be air carriers.

The “Dry” lease

In a dry lease arrangement, the aircraft owner is providing the aircraft to the lessee without crew. (Here again, whether the aircraft is provided with or without fuel has no bearing on the type of lease) Neither the lessor nor the lessee is required to hold an air carrier certificate in a dry lease arrangement, although nothing prohibits either party from being an air carrier.

Operational control

One of the key issues that distinguishes a “wet” lease from a “dry” lease is “who has operational control.” 14 C.F.R §1.1 defines operational control as “the exercise of authority over initiating, conducting or terminating a flight.” In a “wet” lease situation, since the lessor is providing both aircraft and crew, the lessor maintains operational control of all flights. In a “dry” lease situation, the lessee provides its own crew and the lessee exercises operational control of its flights.

If the lease is for private use or commercial, non-Part 135 use, typically each party will have operational control of the aircraft when it is in that party’s possession. Oftentimes in this situation, operational control will revert to the lessor during the times when the lessee is not using or possessing the aircraft.

What’s The Issue?

So, why is this distinction between “wet” and “dry” leases so important? Well, in the absence of a specific exemption (such as under 14 C.F.R. § 91.501(c)) the lessor who is operating an aircraft under a wet lease will need to have an air carrier certificate and operate under the regulations that govern air carriers (e.g. Part 121 or Part 135). This means the lessor will have to comply with regulations that are stricter than Part 91 including regulations relating to the types of airports the lessor may utilize, crew qualifications, crew rest and duty times, maintenance requirements etc. And those regulations increase the lessor’s cost to operate. Additionally, the lessor under a wet lease is required to remit federal excise tax (“FET”) on the amount charged to the lessee.

A lessee operating under a dry lease is permitted to operate under Part 91 and is not required to comply with many of the more restrictive and costly requirements of Parts 121 or 135. And federal excise tax is not due on the amounts paid by the lessee to the lessor, although sales tax is often assessed on the lease rate. For private operators, these are significant advantages. However, they also need to be weighed against the responsibilities, and potential liability, that goes along with having operational control of a Part 91 dry lease operation.

The situation may get confusing when parties decide they want the best of both worlds. Unfortunately, these Part 134 ½ operations, as I call them, are usually FAA enforcement actions waiting to happen. For example, if the lessor provides the lessee with the aircraft under a dry lease and that same lessor also supplies the crew under a separate agreement the FAA will likely view that as a wet lease arrangement since the lessor is providing both aircraft and crew. If the lessor does not hold an air carrier certificate then the FAA will consider those flights to be illegal charter flights. Additionally, the IRS would also probably assess FET on those flights.

A similarly improper arrangement occurs if the lessor leases the aircraft to the lessee and then requires that the lessee obtain the crew for the flights either from a specified source, usually affiliated with or controlled by the lessor. If the lessor does not hold an air carrier certificate, the FAA would also consider this a wet lease arrangement. Since the aircraft and crew are coming from closely related or affiliated sources, the FAA views them as both coming from the lessor.

It is important to keep in mind that the FAA will look beyond the actual written agreements to determine the relationships between the parties and how the arrangement is actually being conducted. Although a lease is written as a dry lease and says “Dry Lease” at the top of the agreement, for example, that doesn’t mean that the FAA can’t take the position that the arrangement is really being conducted as a wet lease. And if the FAA takes that position when the lessor who is actually operating the aircraft for the lessee does not have an air carrier certificate, then that will be a problem for the lessor, and potentially for the lessee as well.

Conclusion

The distinction between “wet” and “dry” leases isn’t always clear to aircraft owners and operators. However, it is important to understand the difference because each situation has separate regulatory obligations and requirements. Failure to comply with the legal requirements applicable to the chosen lease structure can result in problems for both the lessor and the lessee.

Additionally, as with all written agreements, it is essential that you carefully review all of the provisions of any aircraft lease before you sign. Consultation with an experienced aviation attorney beforehand can help you protect yourself, whether lessor or lessee. By taking the time to understand the terms of the aircraft lease and the applicable regulatory requirements, both parties can ensure that their expectations are met and their interests protected.

Is Now A Good Time To Lease An Aircraft?

If you are looking at acquiring an aircraft, you may be evaluating whether to lease or buy the aircraft.

What is a Lease?

In a lease, the owner such as a bank (the lessor) allows you (the lesee) the use of an aircraft for a fixed period of time. An operating lease is a lease whose term is short when compared to the useful life of the asset. For example, an aircraft which has an economic life of 30 years or more may be leased to a company for five years as an operating lease. This can be a simple leasing transaction where at the end of the lease, the aircraft is returned to the lessor. There may also be the option to buy the aircraft at Fair Market Value (FMV) at a set point during the lease and/or at the end of the lease itself.

In an operating lease, the residual value risk shifts to the lessor.

In today’s market, pre-owned aircraft values have plummeted and selling prices are relatively low.  Most aircraft values are likely to recover in the next few years. In such a market, why would you want to have the lessor accept the residual value risk? You, as the lessee, have a lower residual value risk than at any time in the last decade. Buying a good quality aircraft now leaves you with a minimal risk of the aircraft losing a substantial amount of its value in the future.

Leasing is better than financing if you do not need the tax write-off from tax depreciation. Aircraft can be written off to zero value for tax purposes in eight or fewer years. If your company isn't making a profit, tax depreciation is of reduced or no value anyhow. Your business, as the lessee still can write off the lease payments as an expense.

You can't use the tax write-off for a personal aircraft. In that case, lease payments/terms may be more favorable than a loan.

If you are a company, leases may be "off balance sheet" as far as long term debt goes.

As a company, the operating lease may be considered as “off the balance sheet” as it is not technically a long term debt. This can improve the financial ratios used to evaluate the fiscal heath of a company. However, the SEC and investors are getting savvier about "off balance sheet" deals. New rules may also affect the ability to qualify a lease for this accounting treatment. This consideration requires tax advice from someone knowledgeable about your business.

Getting out of a lease early is easy, just pay it off!

Are you certain to need the aircraft for the full lease term? You can walk away from a lease at any time: just pay off the remaining lease payments. This can get quite costly. Read your lease terms carefully. If there is a possibility that you will want out of the lease early, you may not be a good candidate for a lease.

Lease or loan: both require financial disclosure.

Credit is tough these days, the financial institution will want to know your full financial picture. If you don’t want to disclose your full finances, then a lease (or loan) may not be in the cards for you.

Need it now, pay cash.

I wrote in 2009 that cash is king in the aircraft transaction. That is still true. You will get the best deal and the quickest closing in a cash transaction. There is no need for pending approval of financing conditions in the purchase and sale.

Leases can work for some companies and individuals. You need to examine your ownership, tax and risk requirements and review the lease documents carefully to fully understand all the terms and restrictions.

 

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