Story ID: 
AINsight: Due Diligence in Back-to-back Aircraft Transactions
By: David G. Mayer
Caption: More scrutiny is needed by buyers in back-to-back aircraft deals
Word Count: 1319
Due diligence in private aviation has never been more important in today’s dangerous world populated with bad actors. Increasingly, fraud, cybercrime, money laundering, and terrorism compound the risks in standard (two-party) and back-to-back used aircraft purchase transactions.
Despite these concerns, some purchasers and sellers understandably feel frustrated that due diligence for them is repetitive or unnecessary. After all, they negotiate an aircraft purchase agreement to minimize their risk and memorialize their business agreement. It’s hard to disagree even as aircraft transactions become increasingly complex.
However, a myopic focus on the aircraft purchase agreement rather than broad risk management efforts may subject the deal participants to government inquiries, enforcement actions, or civil and criminal penalties. It is not hyperbole to say that deal participants should regard regulatory agencies as serious stakeholders in due diligence failures with substantial power and seemingly unlimited enforcement budgets.
Defining Due Diligence
Due diligence basically means doing your homework around buying or selling a private aircraft. That type of due diligence differs from diligence in selecting an aircraft management company, an FBO or MRO, or buying a company that holds a Part 135 certificate. And diligence for banks varies from other entities due to vast regulations, “know your customer” (KYC) rules, and internal policies.
Due diligence is not one-dimensional. It is a team sport that combines the efforts of deal experts for the parties. It is a dynamic process and adjusts to its purposes and findings.
Each relationship involving the parties must withstand and pass rigorous legal and practical assessments. An odd or troubling fact or finding, such as a suspicious seller, generically called a “red flag,” should lead to further questioning and an acceptable course of action in the transaction as part of the due diligence.
Core Due Diligence Requirements and Goals
At a high level, the core due diligence processes and requirements should include the following:
	Identifying parties. Identifying and verifying the identity and reputation of the purchasers, sellers, financiers, escrow agents, and aviation brokers;	Complying with laws and policies. Assessing pre- and post-closing compliance with laws applicable to the parties, aircraft operations, and other material aspects of the transaction;	Confirming deal purpose and intent. Validating and testing the intent and purposes of the parties entering into the buy/sell transaction;	Tracking sources and uses of funds. Identifying and verifying each source and use of funds, including every fund transfer, including depositing funds into, out of, and between escrows; and	Assessing aircraft information. Examining the aircraft’s pre-aircraft purchase agreement flight destinations and hangar locations, export/reexport/transfers, aircraft registrations, airworthiness, and aircraft documents.
In any standard (purchase-seller) or back-to-back transaction (multiple parties), the objective of due diligence is to conduct a comprehensive and thoughtful investigation that enables the parties to close a “clean” deal as per the aircraft purchase agreement. In other words, the goal is to finish and ease monitoring the deal without a material risk of the intervention of bad guys or the violation of laws, rules, and regulations.
Methods and Laws To Conduct Due Diligence
Due diligence should start when an aviation broker, technical consultant, or aviation attorney first meets his or her client. Broadly speaking, they should be suspicious, investigate, document their findings, develop risk profiles, and use common sense to balance due diligence and the ever-present drive to close transactions at a fast pace. As the other deal team experts come on board, they should collaborate by using a similar approach adapted to their organizations.
Lawyers and other deal team experts may draft checklists to guide their due diligence, request the parties to complete questionnaires, and obtain copies of “beneficial owner” filings under the Corporate Transparency Act, enforced by the Financial Crimes Enforcement Network (FinCEN). Independent search engines such as Google and proprietary software facilitate due diligence. The aircraft purchase agreement should contain representations and warranties of the parties that test and/or are consistent with their disclosures and confirm apparent legal compliance.
The appropriate professionals can also apply the Customer Due Diligence (CDD Rule), issued by FinCEN, which establishes continuous compliance requirements to improve financial transparency and prevent criminals and terrorists from misusing companies to disguise their illicit activities.
The deal teams should consider sanctions lists like those published by the Office of Foreign Assets Control (OFAC), which administers Russian sanctions, to identify bad actors. Banks must adhere to recently published guidance for compliance with the Export Administration Regulations (EAR) issued by the Bureau of Industry and Security (BIS).
Incorporating the USA PATRIOT Act and the Bank Secrecy Act (BSA), banks must also adopt customer identification programs under the BSA anti-money laundering law. For more, see “Due Diligence” from the National Aircraft Finance Association.
APPLYING DILIGENCE METHODS IN A BACK-TO-BACK TRANSACTION
Amid many variations, back-to-back structures involve one or more intermediaries—likely a broker/dealer—buying an aircraft from an initial seller and reselling it to another party, sometimes another broker/dealer. That purchaser, in turn, can sell the aircraft to another purchaser, and so on.
Imagine a seller’s aircraft broker/dealer represents an Eastern European owner-seller who, for cultural reasons, will not pay a broker’s commission. However, the original seller will sell his/her aircraft to the seller’s broker without concern about resale. Then, in a separate transaction, the seller’s broker sells the aircraft to the end-user purchaser under a separate, substantially identical aircraft purchase agreement, ideally at a higher price. This structure involves two separate sales, heightened complexity, and more due diligence touchpoints.
If the seller’s broker discloses the back-to-back sales to all participants (pricing can remain private), this type of back-to-back deal may work for economic, legal, cultural, and other reasons. However, if the seller’s broker does not disclose the back-to-back sale to the deal participants, the failure to disclose creates a lack of transparency.
In that case, the failure may deprive the participants of the opportunity to conduct the necessary due diligence, expose the participants to potential actions by the alphabet soup of government regulators, or result in violations of law—all with potentially negative consequences (see “AINsight: Ethics Not Antithetical to Back-to-back Deals”).
Addressing Diligence Findings
How do the parties address problems they find in due diligence? Assuming the participants find a material deal risk, in my experience the deal teams overcome the issues through further investigation, restructuring the deal, or seeking appropriate consents. Unfortunately, the parties may be forced to terminate the transaction if they cannot resolve material issues carrying unacceptable risks. In some cases, even before that, lawyers and other participants may withdraw from a deal to mitigate their personal, reputational, enterprise, and financial risks.
Parting Thoughts
Purchasing and selling private aircraft should be a positive experience. However, bad actors can, in an unsuspecting world, disrupt these transactions through fraud, cybercrime, money laundering, terrorism, or other criminal activity.
They can create havoc for all participants by violating applicable laws, drawing the attention of law enforcement, endangering careers, and damaging personal and corporate reputations. Sometimes the bad guys prevail, but skilled and thorough due diligence is a significant way to facilitate a smooth landing of an aircraft purchase and sale transaction.
The material in this blog is not intended to be, nor should it be construed or relied upon as, legal advice. The comments, recommendations, and analysis expressed in this blog are those of the individual author, David G. Mayer, and they may not reflect the opinions of AIN Media Group. Your use of this blog does not create an attorney-client relationship between you and the author or his law firm. If specific legal information is needed, please retain and consult with an attorney of your selection.