““CEOs go to their vacation homes just after companies report favorable news, and CEOs return to headquarters right before subsequent news is released. More good news is released when CEOs are back at work, and CEOs appear not to leave headquarters at all if a firm has adverse news to disclose. When CEOs are away from the office, stock prices behave quietly with sharply lower volatility. Volatility increases immediately when CEOs return to work.” —David Yermack, a New York University finance professor, whose recently released study shows a correlation between when CEOs take their private jets on vacation and movements in their companies’ stock price ”
The perfect airplane
Like other lawsuits, most of the ones involving business jets are settled out of court. Every once in a while, though, a corporate jet case will not only reach a judge but produce a decision that shines a spotlight into some dark corner of business aviation. One such case is JDI Holdings, LLC v. Jet Management, Inc., et al., 732 F. Supp. 2d 1205 (2010), which concerns a buyer’s desire for a perfect airplane.
As reported in the court’s decision, the buyer, who was looking to acquire his first business jet, approached a broker about an aircraft he represented for sale. Although the buyer didn’t purchase that aircraft, he did ask the broker to help him find another suitable jet. It didn’t take long for the broker both to identify a certain 1984 Cessna Citation III and to inform the seller of the buyer’s interest.
Having introduced buyer and seller, the broker then separately asked both of them for a sales commission, claiming a “customary” 5 percent fee (or $160,000 on a $3.2 million sale price). The buyer’s lawyer balked at paying a commission of this size, but the seller eventually agreed to pay the broker $150,000, less whatever it cost the seller to fix discrepancies on the aircraft following the prebuy inspection. As the court put it, the broker’s fee arrangement “undoubtedly gave him a strong incentive to ensure that the cost of the airworthy repairs remained as low as possible.”
Indeed, the broker advised the buyer’s attorney that–because a Phase 1-5 inspection had recently been completed–the prebuy inspection need consist only of logbook review. The buyer, however, decided he “didn’t mind paying a bit more to know the jet is perfect” and opted for a prebuy survey of the aircraft by a service center.
As the cost to fix discrepancies grew (finally totaling $79,000), the broker became distressed about his shrinking fee, so he took another swing at getting the buyer to pay him a commission, this time asking for 2 to 4 percent. The buyer knew nothing about the broker’s fee arrangement with the seller and agreed in the end to pay a $70,000 commission (about 2 percent). So, despite the lack of a written fee arrangement with either buyer or seller, both of them paid the broker a commission in connection with the sale…or was it the purchase?
What eventually got the buyer especially steamed up, however, was that not all discrepancies identified in the inspection were repaired. The purchase agreement gave the buyer the right to reject the aircraft following the inspection, but if he accepted it instead, the seller was obligated to fix only “airworthy” discrepancies.
It’s interesting to see the court, the parties involved and their expert witnesses struggling with this notoriously controversial term. As noted, the aircraft had recently undergone a Phase 1-5 inspection, followed by the prebuy survey. Then, after the buyer took delivery and discovered that the airplane wasn’t perfect, there was another Phase 1-5, this time paid for by him. Seasoned aircraft transaction folks won’t be surprised to hear that each of these shop visits uncovered numerous airworthy (and other) discrepancies.
Things might have worked out for the buyer if he had realized the seller had no obligation to fix non-airworthy discrepancies. But in a classic case of miscommunication, misunderstanding and probably wishful thinking, the buyer signed an acceptance of the aircraft without realizing this. Later, when he came to own the imperfect aircraft, he sued the seller, the broker, the service center that originally accomplished the Phase 1-5 and others, presenting the court with a laundry list of causes of action. The buyer lost on them all.
The case is instructive in several ways. First, the perfect airplane doesn’t exist. Turn maintenance technicians loose on any aircraft and they will uncover discrepancies, many no doubt affecting airworthiness. Brokers are fond of reminding buyers that a preowned aircraft isn’t brand new, but even factory-fresh airplanes routinely begin the delivery process with many–sometimes hundreds–of discrepancies of various levels of seriousness. Maintenance standards in aviation are extremely high, and few airplanes can survive detailed scrutiny without discovery of potential items to be addressed.
Second, the search process, or lack of one, was inherently flawed by the buyer’s apparent failure to conduct adequate market research–or any research at all. Thus, even assuming the Citation III was the right jet for him, he apparently made no attempt to analyze the market for that model to determine the best value or how this particular serial number stacked up against other available airplanes. Currently, as many as 47 Citation IIIs are listed for sale, including a dozen that date from 1984. As this case demonstrates, asking a broker who tried to sell you an airplane to simply find you a “suitable” one can be a prescription for disaster.
Third, if a buyer has the discretion to reject an aircraft following a prebuy inspection, he should be able to accept it subject to, basically, anything–as long as the seller is obligated only to fill reasonable requests for repairs. Though he didn’t realize it, the buyer’s contract didn’t give him the option of accepting the aircraft subject to all discrepancies being cured. Of course, no seller is likely to agree in a contract to fix every discrepancy of every description. But if it had been open to the buyer to make his acceptance subject to the cure of all discrepancies, at least buyer and seller could have had a dialogue about what was reasonable to fix. The nose tire, for example, was bald, but the service center either didn’t look at it or thought it had some life remaining, so under the contract the buyer couldn’t condition his acceptance on replacing the nose tire, which the buyer was forced to change after closing.
Most important, the case underscores why buyers need to get unbiased advice throughout the acquisition process from maintenance technicians, consultants, attorneys and other professionals representing their interests. (The seller certainly understood this in structuring his brokerage fee arrangement.) A prime example is the buyer’s failure to hire his own technical representative to advise him about what should be included in the prebuy inspection, monitor the inspection and review and discuss discrepancies. Instead, the buyer relied on a broker being paid a commission by the seller who directly benefited to the extent that the seller spent less to fix the aircraft. No wonder this jet acquisition ended in a lawsuit.