Aircraft owner trusts in the U.S. got a black eye on Feb. 24, 2021, when the U.S. Attorney in the Eastern District of Texas announced that a grand jury returned an indictment against two well-known participants (defendants) in business aviation for criminal activity involving Aircraft Guaranty Corp. and Wright Brothers Aircraft Title. Although one of the defendants owns these companies, both defendants allegedly used the owner trust and escrow services to perpetuate criminal enterprise since 2016 involving illicit aircraft transactions valued at approximately $350 million.
The indictment cited 22 allegedly “offending aircraft transactions.” The defendants allegedly facilitated bogus aircraft transactions using non-U.S. citizen owner trusts, often called “NCTs,” and concealed the movement of funds in and out of escrow accounts. They also allegedly participated in international drug trafficking, engaged in conspiracies to commit money laundering, wire fraud, export violations, and aircraft registration violations.
Finally, the indictment alleged the defendants violated FAA and Department of Commerce regulations requiring aircraft registration with the U.S. while concealing the aircraft’s true ownership. There’s more, including an apparent Ponzi program using illegally obtained loan funds to cover aircraft purchase deposits.
Fortunately, the Indictment has not derailed the use of NCTs from what I see and advise in my practice. And for the people aware of the case, it represents an unprecedented extreme abuse of owner trusts and an inapplicable anomaly.
Regardless of the outcome of the case, the defendants have exposed prospective trust customers and thousands of current trust beneficiaries, owner trusts, and escrow companies, among others, to potentially negative repercussions. It is conceivable that NCTs could experience heightened FAA scrutiny, legislative actions on disclosing NCTs parties like Congressman Stephen Lynch (D-Massachusetts) introduced in 2017, fewer registrations at the FAA by non-citizens, unwelcome media attention, and more criminal investigations into escrow and trust companies.
Understanding a Non-citizen Trust
A brief description of NCTs will help put the allegations and use of NCTs in context. Non-citizen owner trusts function amid extensive regulation and transactional scrutiny. The FAA requires an aircraft owner (not the aircraft operator) to qualify for registration on the U.S. registry.
To register an aircraft in the U.S., the aircraft owner must be a “citizen of the United States” under 49 U.S.C. §44102(a)(1)(A) and 14 C.F.R. §47.7(c) (citizen). For an NCT, the owner trustee must either be an original U.S. citizen or a resident alien to qualify for registration of an aircraft at the FAA.
A foreign national—the term used in the Indictment, among others—does not qualify as a citizen but typically can hold a beneficial interest in an NCT as the “trustor.” The owner trustee of the NCT can qualify as a citizen, hold legal title to the aircraft, register an aircraft at the FAA, and sign documents as the aircraft owner. An FAA policy clarification issued in 2013 requires reporting and other responsibilities of the owner trustee.
To serve as the citizen for a foreign national-trustor, owner trustees must submit an application for registration (AC Form 8050-1), owner trust and operating agreements, and an affidavit of citizenship of the owner trustee. After reviewing this documentation, the FAA will issue an opinion on whether the owner trustee qualifies as a U.S. citizen for aircraft registration purposes.
Contractually, the non-citizen trustor and the owner trustee create the owner trust that holds legal title to the aircraft by entering into an NCT agreement. They also enter an operating agreement, a form of a lease by the trustee, as the registered owner (lessor), to the trustor, as the operator (lessee) of the aircraft.
The operating agreement transfers to the trustor most owner-type obligations that it can by law, including complying with all applicable laws, operating and maintaining the aircraft, exercising operational control for aircraft operations, paying all related costs and taxes, and indemnifying the trustee for aircraft-related claims and liability.
Notably, the policy clarification provides that trustees, as aircraft owners, have the same responsibility as any other aircraft owner to comply with applicable laws and regulations, which should incentivize owner trustees to review their due diligence efforts.[i]
Benefits of NCTs
An owner trust affords prospective aircraft owners, as trustors, and other transaction parties practical benefits. For income tax planning, the trust is a disregarded entity, which means the IRS focuses on the trustor as the taxpayer.
A trustor can attend to matters under the operating agreement roughly like a member or manager of a single purpose –an aircraft LLC. For example, under the operating agreement (not through or by the trustee), a trustor, like an LLC member or manager, can silo all aspects of the aircraft costs and use, such as accounting, paying property tax, hiring accounting, legal, tax and other professionals, recording business and personal travel hours, and collecting aircraft charter revenue.
The owner trustee holds legal title to the aircraft under the trust agreement, enabling lenders to take security interests untouched by other debt, liens, or other possible conflicting rights of an operating company and its creditors. Any trustor (citizen or non-citizen) can structure trusts to provide privacy, transaction support, and shared ownership.
These important features, among others in business aviation, appeal to enterprises, executives, individuals, and families. Finally, an NCT allows a non-citizen to secure U.S. registration of an aircraft in compliance with the FARs. It is this aspect of NCTs that the defendants allegedly manipulated and exploited to such an extreme that the Indictment seems to astonish almost everyone in my transactions who understands NCTs.
Diligence and Safeguards
Substantial safeguards already exist to form and use NCTs correctly. An owner trustee should always perform “know-your-customer” (KYC) diligence. Where lenders or lessors provide funds to purchase or lease aircraft, they too conduct KYC diligence.
Their documents contain extensive representations to identify unqualified credit risks or prohibited persons with whom they cannot transact by law. Law firms increasingly do or should access services to verify the background of non-citizen trustors and conduct, to the extent feasible, due diligence that mitigates the risk of illegal activity.
Escrow companies now appear to require the use of purchaser deposits only for the applicable transaction—not always a simple task in transactions like a “back-to-back,” a sale and purchase through any intermediary who first buys the aircraft as the purchaser from the true seller and then instantly becomes the seller and sells the aircraft to the true purchaser.
But more can or perhaps should be done to improve upon legal compliance by owner trustees, escrow companies, law firms, and their customers. The Indictment should help inform owner trustees, escrow agents, lawyers, and other deal participants of red flags without sacrificing or unreasonably hindering the application of NCTs.
Certain law firms—which, like all law firms, are bound by legal ethics rules—can provide legal advice, escrow services, and also supplemental due diligence driven by their legal ethics, training, and experience. Further, the indictment should prompt conversations about best practices in structuring owner trusts, mitigating risks of abuse, and revisiting the scope and methods of due diligence covering non-U.S. citizen trustors, owner trust companies, and escrow services involved in aircraft transactions.
Owner trusts provide a well-understood and essential tool for ownership and financing of aircraft by citizens and non-citizens. The facts in the Indictment should not, therefore, deter the continued reliance on non-citizen trusts. Still, the disturbing betrayal of trust alleged in the Indictment may create significant concern, but that seems unlikely to last long if other trusts and escrow companies do not follow suit.