A Guidebook for Airport-Airline Consortiums (2014)

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35 Where more complex circumstances exist at an airport, there are a number of additional con- siderations related to the application of the consortium model that stakeholders should take into account. The mechanics of forming a consortium are fairly straightforward. However, the dif- ferences between airports and airline operations at those airports result in nuances that clearly can affect the outcome of a consortium application effort. A number of these considerations and nuances are documented by the case studies in Appendix D of this Guidebook. Additional examples based on the authors’ experience are presented in Chapter 8. Stakeholder Involvement and Communication Stakeholder involvement in the consortium formation process including clear, frequent com- munication among the stakeholders is of paramount importance. Airlines that desire a con- sortium should document their positions and communicate with the highest possible levels of airport management to ensure there is conceptual agreement and support at that level, before initiating efforts with airport staff. Similarly, airlines that desire a consortium should also com- municate their positions at the highest levels necessary within their companies to ensure that there is conceptual agreement and support at those levels as well. Airports that desire a consor- tium may also find it necessary to document their positions and communicate to the airlines that would be involved in such an undertaking. Sponsorship Sponsorship of the consortium concept is necessary to create sufficient momentum for the consortium enterprise. Without a sponsor and sufficient momentum, it may be difficult to con- vince the stakeholders to prioritize the feasibility study, obtain approval, and proceed with the implementation of a proposed consortium. Experience shows that although there may be sound business reasons to implement a con- sortium and general support for a consortium among stakeholders, there may be a lack of lead- ership among the airlines that prevents progress from being made. There may be a variety of reasons for this including the following: • The lead airline at that airport may be committed to other higher priority activities. • There may be an opinion within the airline community that the consortium will not produce sufficient cost savings or operational efficiencies for the efforts to be worthwhile. • The airline station managers might not want to release contractual management to a consortium. • Airline staff might not thoroughly understand the consortium model, making them hesitant to present it to their internal airline management. C H A P T E R 8 Decision-Making Guidance and Considerations

36 A Guidebook for Airport-Airline Consortiums Similarly, experience shows that although there may be sound business reasons to implement a consortium and support for a consortium among the airlines at a given airport, there may be reluctance among airport management that prevents progress from being made. There may be a variety of reasons for this including the following: • Airport management may be committed to other higher priority activities. • Airport management may believe that the consortium will not produce sufficient cost savings for the effort to be worthwhile. • Airport management might not want to release contractual management to a consortium. • Airport staff might not thoroughly understand the consortium model, making them hesitant to present it to senior management. • Airport management may believe that the airline community cannot effectively manage con- tracts and deliver sufficiently high service levels, resulting in equipment and systems not being properly maintained. • Airport management may believe that the airline community will not commit sufficient resources to properly maintain airport-owned equipment. • Airport management may believe that a consortium will increase risks related to damages and cost recovery. • Airport management may believe that the implementation of a consortium will result in orga- nized labor issues at the airport. Committed sponsorship, combined with stakeholder involvement and communications, can often overcome these obstacles. The early production of a feasibility study can help provide the information necessary to gain support and build momentum at all necessary levels. Business Entity Selection The selection of a business entity will affect the manner in which a new consortium is struc- tured and managed. Table 1 indicates that the 39 airport-airline consortiums have been orga- nized as follows: • Corporations 19 • Limited Partnerships 1 • Limited Liability Companies 19 It should be noted that the limited liability company structure was not available in many states in the 1990s, but became more widely available and generally accepted during the following decade. The limited liability company structure has fewer formalized requirements compared with the “C” corporation, making the limited liability company structure more flexible and adaptable to the consortium requirements. A number of consortiums have been formed as nonprofit corporations. However, as discussed in Chapter 4 of this Guidebook, consortium activities may not qualify for tax-exempt status. In such cases, other forms of legal entities, such as a limited liability company, may be more appro- priate for a new consortium. Airport Involvement Historically, the airports’ primary role with consortiums has been that of landlord. In that capacity airports seek to ensure compliance with the consortiums’ purpose; compliance with the terms of the lease, license, or other enabling agreement; payment of all fees and charges; access by non-member airlines; high quality service delivery; and professional maintenance of

Decision-Making Guidance and Considerations 37 key airport assets. Airports also represent the public trust by ensuring the smooth and efficient operation of the airport, and protecting and promoting the interests of the traveling public and the local community. Airports usually adopt an oversight role with respect to consortiums, to exercise their rights and protect their interests. Clearly defined performance standards and reporting requirements are of primary importance to the relationship between the airport and the consortium. Perfor- mance standards and reporting requirements that were established during consortium forma- tion often lead to better communications and relationships between the parties. However, if the airport requires particular performance standards and reporting from the consortium, the airport must have sufficient dedicated staff to review, analyze, and provide feedback. Occasionally, airport management indicates a desire to include one of their staff as a rep- resentative on the consortium Board of Directors or Member Committee. This approach has worked well for DANTeC and SAAC, which include an airport representative on their respective Boards of Directors and Member Committee. However, the 37 other known consortiums do not include an airport representative on their Boards of Directors, and these consortiums have been able to communicate effectively with airport staff and have satisfied all airport requirements. Additionally, these consortiums have avoided making business decisions that would negatively affect their airports. Experience indicates that it is usually possible to initially satisfy airport management con- cerns through agreements that include appropriate provisions to ensure that those concerns are addressed. Examples include limiting the decisions the consortium is empowered to make, requiring specific procurement practices, requiring the consortium to report specific decisions, and requiring the consortium to report operating activity on a periodic basis. The relation- ship between the airport and consortium is better if clear performance standards and reporting requirements are established upon formation. In most cases, therefore, it becomes unnecessary to include an airport management representative on the consortium Board of Directors. Key airport concerns addressed in the agreements for consortiums without participating airport representation include the following: • Proper maintenance of airport assets • Safety of operations • Continuity of daily operations • Timely payment of debt service, rents, fees, employees, vendors, and others • Customer convenience • Environmental and hazardous materials considerations • Compliance with laws, ordinances, policies, and procedures • Limited liability of the airport • Compliance with purchasing procedures • Professionalism of the operator and the operations Scope Definition Reaching a definitive agreement between airport management and the airlines regarding the scope of responsibilities that will be assigned to a consortium is often a difficult, time-consuming process. The issues that generally result in an extended scope negotiation include organized labor concerns, entrenched incumbent management, and airport-wide employment practices. Usu- ally, these issues can be overcome if an effective financial plan and management approach for the proposed consortium have been prepared.

38 A Guidebook for Airport-Airline Consortiums It should also be noted that it is challenging to prepare an effective feasibility study without a definitive scope assignment for the consortium. Feasibility Study As is documented in Chapter 3, a financial feasibility study is almost always included as a com- ponent of the consortium formation process. One component of a financial feasibility study may be a comparison to current operating costs. However, if a new consortium is being implemented for a new facility, there may be no current costs for a comparison. In this case, it may not be pos- sible to quantify cost savings that would result from implementing a consortium. Further, consortiums may be used to improve service levels, which may not necessarily reduce costs. In this case, stakeholder expectations and objectives must be clearly understood, so they are properly addressed in the feasibility study. Cost Allocation Methodologies Consortium airline and operator consensus is that simpler cost allocation methodologies are easier to understand, are more transparent, and are therefore preferred. Bookend examples include the following: • LAXSUL uses a single cost center and all costs are allocated to users based on the number of each airline’s passengers using the lounge. • TOGA has more than 20 cost centers to which costs and revenues are allocated, and which are then allocated to the TOGA partner airlines based on a number of formulas for enplanements, deplanements, gallons of fuel used, leased areas, aircraft size, number of aircraft movements, and more. Capitalization Capitalization of the consortium is one of the more challenging aspects of consortium forma- tion. Capitalization is intended to provide sufficient cash in an operating reserve to pay contrac- tors and vendors, until the reserve is replenished by monthly airline payments. Historically, consortium capitalization funding has been provided by airline contributions, loans (from the airport, an airline, or a bank), or advance invoicing of the consortium’s airline participants. Generally, airlines are not in favor of making substantial paid-in capital contributions to consortiums to create sufficient operating reserves. Airlines usually support small consortium membership fees, and an alternate source for the majority of capitalization funding. Alternate sources have worked well in the past, however, they are dependent on availability and approval requirements. Loans will require an undetermined amount of time to implement, because of the necessity to reach a loan agreement between the consortium and a third party. Further, loans may require collateral as security or pledges from the airline members. Unsecured loans typically carry higher interest rates. The advance invoicing of airlines that will use the consortium’s services involves an agree- ment among the airlines to pay for future services on an estimated basis, with the costs being

Decision-Making Guidance and Considerations 39 reconciled after the estimated invoice period has passed. If this approach is used for capitaliza- tion, it is important for the airline parties to communicate frequently with their home offices to ensure that initial payments are processed in a timely manner. Project Financing Consortiums associated with capital projects will require a source for capital funding. Fund- ing sources are diverse and vary widely in their scope and definition, depending on the type of financing (bonds, bank loan, airport loan, etc.), the size of the financing, the security pledged for the financing, and so forth. The duration necessary to secure funding cannot reliably be estimated until a particular source is identified and its requirements understood. Examples of capital funding include the following: • Midway Airlines’ Terminal Consortium (MATCO) and CICA TEC have provisions in their respective Airline Use and Lease Agreements under which the airlines approved the capital program of the airport, and the airport assigned to the airlines and their consortium the responsibility and funding for the development of the airline equipment (baggage handling systems, passenger boarding bridges, gate systems, etc.) associated with the project. • SFO Terminal Equipment Company (SFOTEC) had a letter agreement with the City of San Francisco under which the City loaned the consortium several million dollars that the consor- tium could use for the capitalization of the consortium and to procure equipment necessary for the start-up of the new international terminal. • LAX Shared Use Lounge Company (LAXSUL) secured a loan with a private bank that provided project funding for the development of new lounge facilities. The loan documents were several hundred pages long and included a mortgage-like facility that was registered with the county. • Terminal One Group Association, L.P. (TOGA) engaged the New York City IDA to issue rev- enue bonds to finance the development of JFK Terminal One. The financing documents num- ber several thousand pages because of the complexities, disclosures, and guarantees required of the bond process. Depending on the size of the financing, municipal revenue bonds may be an attractive alterna- tive for project financing because of their comparatively low interest rates, high leverage, and long amortization periods. If bonds are being considered then significant coordination with the airport and local government will be necessary, since it is likely that the bonds will be issued through a local government agency and may rely on the local government’s tax-exempt status when the bonds are issued. Preparation of Agreements There are a number of approaches to preparing the various agreements that will be necessary to implement a consortium. However, the following are the most common: • The airport management staff, in consultation with the airlines, is usually responsible for the preparation of the agreement that delegates authority for the consortium to operate and maintain facilities, equipment, systems, and services at the airport. This agreement may take the form of a lease, a license, or an operating agreement, depending on the airport. • The airlines, their consultants, or legal counsel, are usually responsible for the production of the consortium legal entity documents that provide for the ownership, governance, and operation of the consortium. These documents typically require airport approval to ensure that they are not discriminatory and will not prevent new entrants from accessing and using the airport facilities.

40 A Guidebook for Airport-Airline Consortiums • The airlines, their consultants, or legal counsel are usually responsible for the production of the access agreements that provide non-member airlines and ground handling companies access to the consortium controlled facilities, equipment, systems, and services and serve to protect the consortium by requiring insurance coverage, indemnification, and security deposits. Access agreements typically require airport approval to ensure that they are not dis- criminatory and will not prevent new entrants from accessing and using the airport facilities. • The lenders and their counsel, in consultation with the airlines, usually prepare project- financing documents. Airport management staff may be involved as well, depending on the project and the size and type of the financing. Indemnification and Insurance In general, consortiums engage with airport authorities, fuel system operators, and member airlines, among others. Some level of risk is inherent in each relationship. Because of such risk, questions can arise as to whether a consortium should be liable for the acts of other entities, such as the fuel operator, or whether the consortium’s members should be liable for the acts of the consortium. To address these questions and risks, various consortium agreements typically contain indem- nities that insulate one or more parties from the actions of another. And to further shift these risks, such agreements often require indemnifying parties to purchase insurance. Airlines that operate outside of a consortium will also shift their risks in a similar fashion. However, the transaction costs to airlines operating outside of a consortium will likely be greater. For example, the share of insurance premiums paid by a member of a consortium is generally less than the premium paid by an airline for a policy covering only itself. As discussed in Chapter 5, legal entities such as corporations and limited liability companies also insulate member airlines from liabilities that might otherwise be incurred by an airline that is not a consortium member. Typically, a consortium will indemnify the entity that owns and operates an airport (e.g., a municipal airport authority) from liabilities arising from the operations of the consortium. Such an indemnity will often be part of a lease for the ground, infrastructure, and other improvements associated with the facilities, equipment, or systems controlled by the consortium. From the per- spective of the member airlines, such an indemnity should not, and usually does not, extend to the member airlines. Rather, if the landlord is concerned with the consortium’s ability to pay for an indemnified loss, some form of financial assurance is usually required. Often, a landlord will accept insurance, including environmental insurance, in lieu of more classic forms of financial assurance. Agreeing on documented baseline environmental conditions of the airport property can protect a consortium from claims that its operations caused environmental damage that may have existed prior to the consortium’s operations. A consortium, via an operating agreement, will usually pass on the risks associated with fuel- ing and related operations to the operator. The consortium will also require the operator to obtain insurance with limits sufficient to cover a realistic, yet significant loss. Often the consor- tium also requires that the insurance name the consortium and its members as insureds. Typi- cally, an operator will pass the costs of premiums and deductibles directly to the consortium. As a result, it is in the consortium’s interest to require a reasonable and appropriate amount of insurance. Since the insurance will usually protect the consortium and its members as well, the consortium will benefit from policing the insurance policy’s terms, and negotiating the coverage when possible, such as with environmental remediation and liability coverage. Sometimes, a party other than the operator may want to access the consortium controlled facilities, equipment, and systems. In such a case, the other party should similarly indemnify the consortium for any damage that it might cause, and obtain insurance with appropriate terms.

Decision-Making Guidance and Considerations 41 The agreements governing the formation and operation of a consortium will usually expressly state that the obligations and liabilities of the consortium will not pass to the member airlines. The consortium will also indemnify the member airlines for any liability alleged against the air- lines arising out of the consortium’s activities, including the activities of directors and officers of the consortiums. Since any indemnity is only as good as the money backing it up, it is important for a consortium to properly insure itself and its directors and officers, and to see that, to the extent possible, the member airlines are insureds under the policies. The relationship between consortium members is usually more complicated. On the one hand, consortium agreements often require that all member airlines waive any claims they might have against another member airline arising from such other airline’s good faith activities per- formed on behalf of the consortium. On the other hand, a member may be required to defend and indemnify other members from claims and liabilities arising from that member’s use of the consortium’s facilities, equipment, or systems. However, all indemnities and waivers usually exclude from their scope claims and liabilities arising from an indemnitee’s willful misconduct or gross negligence. Environmental Concerns Underground and aboveground storage tanks, underground and aboveground pipelines, tanker trucks, and the movement of jet fuel through these systems lead inexorably to the poten- tial release of jet fuel into the environment. Because releases may result in significant environ- mental damage, investigation, and cleanup costs, the parties associated with the operation of jet fuel systems contractually specify and allocate environmental responsibilities and liabilities. Where airport land and infrastructure are being leased, the landlord (often a municipal air- port authority) will insist that the consortium comply with, and cause its contractors to comply with, all environmental statutes and regulations. The landlord will also likely require that the consortium use state of the art leak prevention and detection systems, and implement best prac- tices to avoid releases into the environment. The landlord will also require that the consortium defend and indemnify the landlord from all claims and liabilities arising from environmental releases associated with the operation of the jet fuel system, and require the consortium to obtain environmental remediation and liability insurance. A consortium should consider conducting an environmental assessment to determine the baseline environmental conditions before enter- ing into a lease. By conducting an environmental assessment, the parties will have a simpler way of determining whether environmental conditions post-date the lease, and are therefore likely the responsibility of the consortium, or pre-date the lease, and are therefore the responsibility of another party. Implementation Consortium implementation includes many activities that range from the filing of entity doc- uments with the state, to participating in the start-up of a new facility. Key considerations to the implementation of a consortium include the following: • The filing of articles of incorporation, or similar documents based on the business entity cho- sen, with the state to incorporate the new consortium should be carefully timed. The filing is instantaneous with some states and requires weeks with others. The filing and registration should be completed early enough that the consortium is officially able to conduct business as necessary. However, the filing begins a requirement for tax filing and therefore should not be accomplished in a calendar year prior to the start of actual consortium operations.

42 A Guidebook for Airport-Airline Consortiums • The initial meeting of the consortium requires significant preparation. A draft agenda should be provided to the participants in advance of the meeting, listing all business that will be con- ducted. Contracts and agreements that are to be approved should be circulated in advance and questions answered. Officer duties and authority should be discussed in advance and ratified at the initial meeting. Officer candidates should be identified in advance. • It may be a prerequisite to procure major contracts in advance of the initial meeting, depend- ing on the timing of the consortium’s first meeting and schedule for the initiation of the consortium’s scope of responsibilities. • If consortium start-up coincides with facility start-up, then consortium contractors must have been procured early enough to provide them with sufficient commitment, direction, and authority in advance to allow them to become licensed at the airport, hire their employees, badge their employees, train their employees, and procure equipment and supplies before their actual operational duties begin. • Key members of the consortium management staff should be secured in advance of consor- tium start-up to provide them enough lead time to procure contractor and vendor services required by the consortium, establish consortium bank accounts, initiate consortium busi- ness systems, secure required registrations, licenses, and so forth. Consortium Staffing The case studies presented in Appendix D indicate that the AATC has direct employees, while the other consortiums use management companies to provide consortium management staff- ing. Both approaches work well; however, there are pros and cons including the following: Pros • When a consortium sources its staff through a management company, the consortium can rely on the management company’s senior management to provide expertise and guidance during consortium start-up and operation. • When a consortium sources its staff through a management company, and a key employee departs, the consortium can rely on the management company to provide a temporary replace- ment and locate a permanent replacement. • When a consortium sources its staff through a management company, the airlines approve a staffing budget and approve key individuals in leadership positions. • When a consortium sources its staff through a management company, the management com- pany, as an independent contractor, is responsible for all of its own employment responsibilities. • When a consortium directly hires employees, it avoids paying a contractor’s overhead and profit margin for those employees. Cons • When a consortium directly hires employees, the airlines become responsible for direct employees hired by the consortium including all employment matters such as the definition and administration of wage rates, the definition and administration of benefits, employee screening, hiring, disciplining, firing, and so forth. • When a consortium directly hires employees, and a key employee departs, the consortium must rely on its internal resources to backfill for that employee and the airlines must conduct a key employee procurement process until a replacement is found. • When a consortium sources its staff through a management company, the consortium will pay a profit margin and a portion of the contractor’s overhead.

Decision-Making Guidance and Considerations 43 Operations Once the consortium is established and the facility, equipment, system, or service is opera- tional, the consortium’s activities should settle into a normal rhythm. A learning curve will exist during the first year of operation to assess the equipment, procedures, policies, and personnel involved with the operation. Some equipment may experience breakdowns during the first year. However, contractor and manufacturer warranties will likely provide for repairs or replace- ments. Internal policies, procedures and budgets will be tested and revised as necessary. Mem- bers, employees, and vendors will experience a new working environment. The commencement of any new operation brings with it a new set of challenges. However, by opening day, the parties have already been working together for some time and have established working relationships. This is also a very exciting and rewarding period for those involved in the consortium as they see tangible results and begin to reap the benefits of their efforts.