Order Proposing Clarification of Contract Bulk Fare Exemption Authority

DEPARTMENT OF TRANSPORTATION

Office of the Secretary

Order Proposing Clarification of Contract Bulk Fare Exemption

Authority

SUMMARY: We are publishing the order in its entirety as an appendix to

this document.

DATES: Issued in Washington, DC., September 21, 1994.

FOR FURTHER INFORMATION CONTACT: Patricia Thomas, Office of Aviation

Analysis, Room 6401, 202-366-9721, or William J. Wagner, Office of

Assistant General Counsel for Aviation Enforcement and Proceedings,

Room 4116, 202-366-9342, U.S. Department of Transportation, 400 Seventh

Street, SW., Washington, DC 205590.

John V. Coleman,

Director, Office of Aviation Analysis.

[Docket 44369; Order 94-9-31]

Exemption of Persons Who Contract for the Purchase of Blocks of Seats

on Scheduled Service Pursuant to Applicable Tariffs for Resale to the

Public

Order to Show Cause

Summary

By this order, we are proposing to clarify the extent to which

activities by contract bulk fare operators are covered by the exemption

granted to such persons by Order 88-9-2.

Background

By Order 81-7-109, the Civil Aeronautics Board (the Board) granted

to persons who contract for blocks of seats with U.S. and foreign

direct air carriers a blanket exemption from the requirements of

sections 401, 402, and 403 of the Federal Aviation Act (the Act)\1\ and

of part 221 of the Board's regulations to the extent necessary to allow

such persons, commonly referred to as ``contract bulk fare operators,''

to resell the seats without filing tariffs or themselves having to

obtain a certificate of public convenience and necessity or a foreign

air carrier permit, as applicable.\2\ By Order 88-9-2, the Department

continued this exemption.

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\1\Pub. L. 103-272, enacted July 5, 1994, revised and recodified

the Federal Aviation Act within Subtitle VII of Title 49 United

States Code (Transportation) (the statute). For convenience in this

order, we will refer both to the old section numbers in the Act and

the new section numbers in the statute. The applicable provisions of

sections 401, 402, and 403 are now contained in Subpart II (Economic

Regulation) of Subtitle VII.

\2\Under 49 U.S.C. 40102(a)(2) (see former section 101(3) of the

Act), any person who engages, either directly or indirectly, in air

transportation operations is deemed to be an air carrier. 49 U.S.C.

40109 (see former section 101(3)) provides that air carriers not

directly engaged in the operation of aircraft (i.e., ``indirect''

air carriers) may be relieved from certain provisions of the statute

to the extent and for such periods as the Secretary of

Transportation decides are in the public interest.

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Traditionally, the marketing arrangement authorized by this

exemption has been utilized by direct air carriers as an additional

tool to enhance their marketing efforts but which is incidental to

their overall scheduled service operations. The blanket exemption

allows these direct air carriers to contract to sell a portion of their

seats to middlemen (contract bulk fare operators). These contractors

are then free to sell individual tickets to customers, either with or

without a ground package, at whatever price their business judgments

dictate. The contractors generally pay for the seats in advance and are

sometimes subject to cancellation penalties for returning unsold

seats.\3\ The direct air carrier continues to market seats on these

flights on its own behalf through the normal air transportation

distribution system.

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\3\See Orders 80-2-112 and 81-7-109.

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The exemption is subject to certain disclosure and consumer

protection provisions, specifically (a) that any direct air carrier

implementing such marketing programs shall file tariff rules that

clearly describe the relationship that exists between the direct air

carrier and the passenger and that establish that, upon payment by the

passenger, the direct air carrier bears the responsibility for

safeguarding the passenger's money; (b) that any direct air carrier and

any contractor operating under the exemption shall insure that

consumers receive clear and conspicuous notice before payment of any

special contractual conditions imposed either by the contractor or by

the direct air carrier that are applicable to the passenger,\4\ and (c)

that any direct air carrier implementing these marketing programs in

foreign air transportation must file tariffs that state the prices to

be charged to the contractor.\5\

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\4\These conditions include the following: the terms and amount

of any cancellation penalties, fees for reservation changes, or

other special charges; limits on voluntary refunds--specifically,

notice that clearly informs the passenger of risks in the event of

voluntary cancellation by stating the exact amount of the applicable

refund for such cancellation; limits on involuntary refunds,

rerouting or ticket reissuance rights; limits on ticket

endorsability or special ticket purchase; check-in or reconfirmation

requirements; if true, the fact that the passenger may be assessed

price increases after ticket purchase; if true, the fact that flight

dates and times are not guaranteed at the time of purchase; and

information on the allocation of responsibility between the

contractor and direct air carrier for the passenger's funds and

transportation. See Orders 86-9-61 and 88-9-2.

\5\Originally, the exemption granted by Order 81-7-109 also

required that direct air carriers file with the Board the names and

addresses of each contractor. This condition was eliminated by Order

88-9-2.

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Current Usage

We have recently been faced with two novel situations in which U.S.

direct air carriers and their contractors are attempting to avail

themselves of this exemption.

In the first, the contractor uses the exemption to sell scheduled

service in conjunction with an existing U.S. direct air carrier pending

Department action on the contractor's own application for certificate

or commuter authority. Indeed, the relationship between the contractor-

applicant and the direct air carrier, while portrayed as a contract

bulk fare arrangement, in fact can be substantially more. The

contractor-applicant may provide the ground handling, may be involved

in hiring personnel to staff the operation, and may even arrange for

the aircraft to be used in the service. The contract operations may

also be in markets that are geographically distinct from the

``regular'' scheduled operations of the direct air carrier. The

situation is compounded by the fact that the direct air carrier may

also register with the Department to use the trade name of the

contractor-applicant for these services.\6\ Typically, all of these

arrangements are scheduled to terminate upon the contractor-applicant's

receipt of its own operating authority.

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\6\Part 215 of the Department's Regulations (14 CFR part 215)

establishes a regulatory system of registration and notification by

air carriers who propose to use a trade name. Upon compliance with

these requirements, use of the trade name is typically allowed.

However, the Department will not register a trade name when it is

certain that use of such name would constitute an unlawful holding

out under 49 U.S.C. 41101(a) (see former section 401(a) of the Act)

or there is a significant potential for, or actual, public confusion

or other unfair or deceptive practices prohibited by 49 U.S.C. 41712

(see former section 411 of the Act). If the registration of an air

carrier trade name will help effectuate an arrangement that will

unlawfully circumvent our fitness standards, we have the authority

to reject the name registration.

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In the second situation, the U.S. direct air carrier and contractor

seek to convert an existing Public Charter program in which they are

parties to scheduled service through use of the contract bulk fare

exemption. Often, the direct air carrier holds charter-only authority

and files an application with the Department seeking scheduled

authority in order to operate under a contract bulk fare arrangement.

In some cases, the operations represented by the contract bulk fare

arrangement constitute most, if not all, of the scheduled operations

proposed by the direct air carrier. In general, these operations are

indistinguishable from charter flights, except that the contractor and

direct air carrier are not subject to the consumer protection

requirements applicable to Public Charter flights contained in 14 CFR

part 380. Those rules require, among other things, the establishment of

escrow accounts and surety arrangements for the protection of passenger

funds, and the signing of operator-participant contracts that detail

the rights and obligations of the passenger, charter operator, and

direct air carrier.

Common to both situations is the fact that, in markets covered by

the bulk fare contract, the contractor has agreed to buy the entire, or

virtually the entire, capacity of the aircraft and is responsible for

all of the marketing of that capacity. Normally, the direct air carrier

does not perform any marketing function and does not sell air

transportation on its own behalf in the markets covered by the

contract. Rather, its sole function is to operate the aircraft for

which it is paid a set price.

Discussion

The statute establishes a regulatory framework for conducting air

transportation operations that balances a liberal entry policy for new

air carriers, both direct and indirect, with Congress' concern for

operational safety and consumer protection. Under the statute, a person

who wants to engage in air transportation of passengers has two

choices; either be found fit as an airline (i.e., direct air carrier)

or qualify as an indirect air carrier. In the case of the person who

seeks to operate as a U.S. direct air carrier, that person has to meet

a three-part test of demonstrating that it has the managerial

competence, financial capability, and compliance disposition to operate

the proposed airline safely and without imposing an undue risk on the

public.\7\ Until the Department finds that the applicant is fit to

operate and it is issued appropriate direct air carrier authority, it

is prohibited from advertising or otherwise holding out its services to

the public (see 14 CFR 201.5). The intent of this rule is to prevent

companies who have not or cannot meet the Department's rigorous fitness

test from collecting money from potential passengers, thus exposing

them to financial risks. While ultimately many applicants may be found

fit and given U.S. direct air carrier authority, often this is not

before a number of substantive changes have been made in the management

team, ownership structure, or financial arrangements undertaken by the

applicant. To allow such applicants to commence operations under the

guise of a contract bulk fare arrangement prior to being found fit

poses a potentially serious risk to consumers that we believe is not in

the public interest.

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\7\The applicant must also demonstrate that it is a U.S. citizen

as defined in 49 U.S.C. 40102(a)(15) (see former section 101(16) of

the Act).

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In the case where an entity does not want to operate as a direct

air carrier or its agent, but still wants to market air transportation

on its own behalf, it is not subject to a fitness review, but must

comply with the requirements that the Department has established to

ensure that consumer funds and expectations are protected. This means

complying with the consumer protection provisions of the Public Charter

rules (14 CFR part 380) or, in limited circumstances, the conditions of

the contract bulk fare exemption.

In our view, the fundamental characteristic that distinguishes the

typical contract bulk fare marketing arrangement contemplated in the

exemption from the two situations described above lies in who is the

true ``operator'' of the services in an economic sense--who has

control. In the typical contract bulk fare arrangement, that control

rests with the direct air carrier. Although the contractor assumes the

risk for those seats that it has purchased from the direct air carrier,

the direct air carrier has control over the scheduling of the flights

involved, allocation of seat inventory, and ultimate responsibility for

safeguarding the passengers' money. Moreover, since a contract bulk

fare arrangement is merely one of a number of marketing tools used by a

direct air carrier, that arrangement would be incidental to the overall

scheduled operations of the direct air carrier. The risk of exposure to

the direct air carrier from one contractor would therefore also be

limited.

On the other hand, in the contractor-applicant and charter-

conversion situations, the contractor is the ``true'' operator in an

economic sense, and the purported contract bulk fare arrangements are

the driving force behind the operation. Although the direct air carrier

is responsible for the operation of the flight, the contractor controls

the scheduling, allocation of inventory, and price, and bears that risk

for marketing most, if not the total capacity, of the aircraft. Under

these circumstances, it is difficult to distinguish these operations

from those performed by a direct air carrier under a wet lease

arrangement or by a charter operator under the Public Charter rules.

More importantly, if the contract bulk fare operator should for any

reason fail to remit collected funds, the direct air carrier

nevertheless ultimately bears the responsibility to the passengers for

either providing the air transportation or paying refunds. While this

may not pose any undue risk in the case of a carrier with other

substantial operations, in the situations described above, the amount

of monies for which the direct air carrier could be held liable may be

so great as to endanger its own economic viability and ultimately

adversely affect its other customers.

Decision

We continue to believe that the contract bulk fare concept can be a

valuable marketing tool for direct air carriers, and, where properly

used, that the conditions imposed in our exemption orders provide

adequate protection for consumers. However, when the Board originally

granted--and we continued--the contract bulk fare exemption, it was

envisioned that this authority would be used by existing scheduled

carriers as a tool to expand their marketing capabilities, and that

such contracts would be incidental to their other scheduled operations.

It was not envisioned that applicants for direct air carrier authority

could use the contract bulk fare mechanism as a means of ``jump-

starting'' their proposed operations prior to being found fit, or that

these arrangements would be used as a means of avoiding the Public

Charter consumer protection requirements. Thus, it is our view that the

two situations described above were not intended to be covered by the

exemption granted by Orders 81-7-109 and 88-9-2. More importantly, the

arrangements have the potential to create great risks for consumers,

since they could be used to circumvent our fitness requirements or the

consumer protection provisions of our charter rules.

Therefore, we have tentatively decided to amend the exemption to

require that the direct air carrier be, as discussed above, the

``true'' operator of the service in an economic sense and the contract

bulk fare arrangement be incidental to that carrier's overall scheduled

operations. The direct air carrier may not use a contract bulk fare

arrangement as the only means of holding out its scheduled services,

but must, in fact, be holding out on its own behalf the scheduled air

services that are also being sold under the contract bulk fare

arrangement. Practically speaking, this means that the direct air

carrier would be responsible for holding out scheduled service in its

own name through the traditional marketing mechanisms of the industry,

such as listing its flights in the Official Airline Guides or major

computer reservations systems, or using travel agents or

advertisements.

We do not wish to preclude the customary use by direct air carriers

of the contract bulk fare exemption in the many resort or vacation

markets in which they currently use it as an additional tool to expand

the marketing of their scheduled service by selling seats to tour or

cruise operators for packaging and resale. The direct air carriers

involved in the these situations typically have extensive scheduled

service operations elsewhere and the particular services involved in

the contract bulk fare arrangement are under the ultimate economic

control of the direct air carrier. We would consider these operations

to be incidental to the overall scheduled operations of the direct air

carrier even if it were to result in the sale of a large portion or

even a majority of the seats in a particular market. In such

circumstances, the contract bulk fare operations would not pose an

undue risk to consumers or to the direct air carrier.

While we have been considering a clarification of the existing

exemption, we have taken no action against contract bulk fare

arrangements in which contractors could sell up to 85 percent of the

seats on each flight in the markets in question.\8\ However, such

arrangements would not be permitted in the future to the extent that

they are inconsistent with the policies we are proposing here. We will,

however, consider requests for individual exemptions in specific cases.

Moreover, in reviewing applications to register trade names and for new

scheduled authority, we propose to apply the policies expressed in this

order. Thus, if we are convinced that the use by a direct air carrier

of the trade name of a contractor would constitute an unlawful holding

out under section 41101(a) or should there be a significant potential

for, or actual, public confusion or other unfair or deceptive practices

prohibited by section 41712, we would not register the trade name for

the direct air carrier. Nor would we approve an initial scheduled

service application for U.S. certificate or commuter authority which

relies primarily on a contract bulk fare arrangement as the underlying

basis for the proposed scheduled operations.

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\8\See, e.g., Orders 94-6-39, Mahalo Air, Inc., and 94-3-38,

Great American Airways, Inc. In those orders, we also noted our

concerns over the use of contract bulk fare arrangements as the

primary means of marketing specific scheduled services, and

indicated our intent to re-examine and clarify our policies with

regard to such arrangements.

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Objections

We will give interested persons 15 days following the date of

issuance of this order to show cause why the tentative findings and

conclusions set forth here should not be made final; answers to

objections will be due within 10 days thereafter. We expect such

persons to direct their objections, if any, to the policies proposed in

this order. We will not entertain general, vague, or unsupported

objections. If no objections are filed, we will issue an order that

will make final our tentative findings and conclusions.

Accordingly,

1. We direct all interested persons to show cause why we should not

issue an order making final the tentative findings and conclusions

stated above to amend the exemption granted by Order 88-9-2, that

permits the use of contract bulk fare arrangements, to provide that the

use of such arrangements for scheduled services must be incidental to

the overall scheduled services of the direct air carrier, and that the

direct air carrier must hold out the same scheduled service as its own

and exercise ultimate economic control over the service.

2. We direct any interested persons having objections to the

issuance of an order making final the tentative findings and

conclusions stated above to file them with the Documentary Services

Division, Department of Transportation, 400 Seventh Street, SW,

Washington, D.C. 20590, in Docket 44369, no later than 15 days after

the date of issuance of this order; answers to objections shall be

filed no later than 10 days thereafter.

3. If timely and properly supported objections are filed, we will

accord full consideration to the matters or issues raised by the

objections before we take further action.

4. In the event that no objections are filed, we will consider all

further procedural steps to be waived and we will enter an order making

final our tentative findings and conclusions.

5. We will publish a copy of this order in the Federal Register.

By:

Patrick V. Murphy,

Acting Assistant Secretary for Aviation and International Affairs.

[FR Doc. 94-23789 Filed 9-26-94; 8:45 am]

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