- The Commission is committed to evaluate the functioning of Regulation 261/2004 by the end of December 2010;
- The voluntary payment of compensation through state aid seems an unlikely prospect;
• Consumers (and their champions) will be reluctant to see watered down the "rights" which have been bestowed upon them by Regulation 261;
- Airlines might therefore benefit from concentrating upon the European Commission's evaluation with a view to securing some relief from their potential liabilities under Regulation 261;
- We discuss below the possibility of setting up a reserve fund along the lines of that administered by the UK Civil Aviation Authority to cover tour operator failure.
State of the industry
These are not happy times for the European aviation industry. In recent years, increased airport security measures imposed due to the ongoing terrorist threat have deterred many potential passengers from flying, whilst airlines have had to face sharp rises in fuel prices coupled with a worldwide economic slowdown that has depressed both revenue and yields.
As if airlines in Europe did not already have enough on their plates, the eruption of an Icelandic volcano in April 2010 shut down European airspace entirely for several days and has caused isolated disruption to flight operations ever since: not being able to operate during the airspace closures was one issue, but airlines are now facing the additional financial burden imposed on them by EC Regulation 261/2004 of reimbursing the hundreds of thousands of passengers stranded worldwide during airspace closures for their expenses incurred whilst stranded abroad.
The UK's airline industry is highly competitive, and UK travellers benefit from the quality of service, choice of airlines and routes and low fares that only a healthy competitive market can bring. The UK economy as a whole benefits from a healthy UK airline industry, as the passenger and cargo traffic that the industry generates is vital to a whole host of other UK businesses.
Competition does, however, come at a price: and in the case of the airline industry, that price is reduced yields and low margins. Airlines must now, more than ever, do what they can to keep control of their traditionally high fixed operating costs, increase load factors and generate ancillary revenues. Operating margins remain either wafer thin or non-existent at full-service carriers, whilst even low cost carriers have seen profits and margins squeezed in recent years. Airlines may disagree on what business model is the most sustainable in the current environment, but what they can all agree on is that the burden of complying with Regulation 261/2004 due to matters outside of their control is a burden the industry could do without.
The industry could also do without being treated as a soft target and a cash cow for politicians. UK Air Passenger Duty is the highest in the world, ostensibly for environmental reasons, but in reality APD duties form part of the Treasury's general revenues. A move towards a per-aircraft tax may benefit some low cost carriers on popular, high load factor routes but will no doubt be detrimental to the industry as a whole as the cost of a ticket will become yet more expensive on many routes.
Meanwhile, it is clear to all what APD revenues will not be spent on: airport infrastructure. No new runways will be built at any of London's three main airports in the foreseeable future, effectively condemning passengers and airlines using such airports to the congestion and inefficiency at peak periods to which they have become accustomed.
An inevitable result of the current state of the aviation industry has been for airlines to merge and consolidate: Air France-KLM, the Lufthansa group, Continental / United and British Airways / Iberia point towards a future with fewer, larger players in the aviation market. The BMI group has been merged into Lufthansa whilst even Virgin Atlantic has announced that it is open to merger proposals.
Regulation 261/2004 – the final straw?
IATA estimates that airlines worldwide lost $1.7-1.8bn as a result of the European airspace closures due to volcanic ash in April 2010. The AEA have quoted losses of €850m, and ELFAA have suggested a figure of €200m for the same period.
Whilst the quoted loss amounts are estimates, and take into account a range of different factors, a substantial portion of the quoted losses of European airlines will be attributable to the refunds and compensation payable pursuant to EC Regulation 261/04 ("Regulation 261") to customers whose flights were delayed or cancelled due to the April 2010 airspace closures.
Regulation 261 is often known as the 'denied boarding regulation', and was designed to give consumers protection in the event that a passenger was denied boarding owing to the airline having overbooked his or her flight – and no doubt to act as a deterrent to the airlines' practice of overbooking. Regulation 261 does not appear to contemplate a scenario where European airspace is closed by the authorities for days at a time due to a natural event such as a volcanic eruption, and, as a result, it has come in for much criticism from airlines who, aside from the losses arising from their inability to operate their core business during this period, had an open-ended care obligation imposed on them by Regulation 261 in respect of those passengers who were unable to travel due to the airspace closures.
So is Regulation 261 still fit for purpose? Arguably, whilst the Regulation continues to serve its basic purpose as a consumer protection measure in the event of flight delays or overbooking, when applied to more extreme (but by no means uncommon) forms of air travel disruption such as the volcanic ash airspace closures, or the severe winter weather experienced over much of Europe during the winter of 2009-10, the Regulation is found wanting. It exposes airlines to potential liabilities to passengers well in excess of the prices such passengers have paid for their air tickets – despite the fact that the event giving rise to such liabilities is completely outside the airlines' control. Meanwhile, the judgment of the ECJ in the case of Sturgeon has blurred the line between delay and cancellation in the Regulation to such an extent to render the original distinction between the two concepts meaningless (to the detriment of airlines) and further support the case for reform of the Regulation.
We understand that following a recent meeting between the Commission and representatives of IATA, the Commission may publish further guidance on the interpretation of Regulation 261 by the end of 2010 – recognition perhaps of the difficulties that stakeholders have had in interpreting the existing Regulation 261.
Another interesting issue to note is that similar legislation to Regulation 261 now exists in relation to the European rail industry in the form of Regulation 1371/2007, but that member states have the right to opt out from such legislation until at least 2024 – and many Member States (including the UK) have chosen to do so. No such opt-out is available in relation to Regulation 261, to the detriment of the European aviation industry. Regulation 261 is currently under review, according to a recent statement to the European Commission. We set out below in more detail some of the reasons why Regulation 261 should be reformed, and our suggestions as to what form such changes could potentially take.
Reforming Regulation 261
1) Reducing the burden on the airline industry following disruption caused by events outside of their control
a) 'Extraordinary circumstances' to be treated differently from matters within the airline's control?
Recital 14 to Regulation 261 states that: "As under the Montreal Convention, obligations on operating air carriers should be limited or excluded in cases where an event has been caused by extraordinary circumstances which could not have been avoided even if all reasonable measures have been taken. Such circumstances may, in particular, occur in cases of political instability, meteorological conditions incompatible with the operation of the flight concerned, security risks, unexpected flight safety shortcomings and strikes that affect the operation of an operating air carrier."
It is notable that the only reference to 'extraordinary circumstances' in Regulation 261 is in Article 5(3), which states that airlines are not obliged to pay compensation under Article 7 where they can prove that such flight cancellation is caused by extraordinary circumstances.
Despite the wording of the Recital, where 'extraordinary circumstances' cause a flight cancellation or delay, the passenger's right to care under Article 9 of Regulation 261 still applies. It is arguable that the spirit of the wording of Recital (14) should be applied throughout the Regulation, such that airlines need not pay compensation under Article 7 nor be under an obligation to care for passengers under Article 9 following a cancellation or delay owing to 'extraordinary circumstances'.
There is no definition of 'extraordinary circumstances' in the Regulation, although Recitals (14) and (15) give some examples of what may constitute an extraordinary circumstance. It may be preferable that the term is not subject to a closed-list definition, as to limit its scope limits its usefulness as a concept.
b) Application of fixed monetary amounts throughout Regulation 261?
In the alternative, if airlines are to be liable to care for passengers in accordance with Article 9 notwithstanding 'extraordinary circumstances', then why should such obligation of care be for an open-ended duration and for potentially unlimited amounts?
Regulation 261 sets out, at Article 7, fixed compensation amounts (depending on the length of the affected flights) for passengers affected by flight cancellations. It is arguable that fixed limits should also be applied to airlines' care obligations pursuant to Article 9, for example setting out fixed amounts for expenditure by passengers on specified items such as accommodation and refreshments.
The potential advantages of a fixed compensation scheme to airlines are twofold – airlines will have the ability to estimate their potential compensation liability on a per-passenger basis, whilst also cutting down on the administrative burden of having to process individual passenger claims for varying amounts and for a variety of different losses.
There are also potential advantages for passengers – who will know what amount of compensation they will receive, and will have greater certainty that they will receive such compensation.
There are also potential disadvantages to a fixed compensation scheme. Fixed compensation amounts may be set at a high level in order to have a deterrent effect to airlines from making ad-hoc flight cancellations for financial reasons, with the result that the financial burden on airlines actually increases as a result. Furthermore, consumer rights groups may argue that fixed compensation amounts may not necessarily compensate affected passengers for all of their unforeseen expenditure, unless set at a level which the airline industry may view as uneconomic.
c) Comparison with the Montreal Convention
The Montreal Convention, in its preamble, states that it recognises the importance of ensuring the protection of consumers when travelling by air and also the need for equitable compensation based on the principle of restitution. The preamble also states that one of the Convention's objectives is the further harmonisation and codification of the rules governing international carriage by air. Does the imposition of additional passenger care and compensation obligations on EU airlines, and airlines departing from EU airports, not then detract from the Montreal objectives by introducing additional obligations and burdens on certain carriers to the benefit of carriers not impacted by such rules?
It is notable that, at Article 19, the Montreal Convention specifically excludes airlines from liability for damage caused by delays where the airline can prove that "it and its servants and agents took all measures that could reasonably be required to avoid the damage, or that it was impossible for it or them to take such measures". This is the cross reference to 'extraordinary circumstances' referred to in Recital (14) of Regulation 261, and adds weight to the argument that the care obligation under Article 9 of Regulation 261 should not apply in the context of cancellations caused by 'extraordinary circumstances'.
In addition, the Montreal Convention sets out fixed limits of liability in respect of all liabilities of airlines to passengers, except in the event of death or injury. By analogy, should the liabilities of airlines under Regulation 261 not also have fixed caps or limits on liability, as argued above?
Furthermore, the Montreal Convention provides for a compensation regime – it does not do what Regulation 261 purports to do at Article 9 and impose a positive obligation on airlines to care for passengers. It is arguable that Article 9 of Regulation 261 should similarly be amended to provide for a compensation rather than a care regime, as this is what happened in practice during the ash crisis. The ash crisis was so sudden and wide ranging that it was unrealistic for airlines to organise accommodation and care for their passengers.
Likely outcomes of any review of Regulation 261
Even the most well-argued case for reform of Regulation 261 will come up against a significant obstacle – that of the European Commission's preference for consumer protection legislation, and a general unwillingness at the EU level to be seen to be watering down the rights of EU consumers in favour of business.
Airlines therefore have to be aware that, whilst there is a likelihood that Regulation 261 may be amended following the review that is currently being undertaken by the Commission, major reforms of the Regulation in favour of the airline industry cannot be guaranteed and piecemeal changes that are designed to address some of the difficulties faced by airlines and passengers during the volcanic ash crisis are the most likely outcome of any such reforms.
Airlines should also be aware that calls for reform of Regulation 261 could backfire and result in an even greater burden being placed on airlines in future – many would however argue that this is a risk worth taking.
It is therefore important to think laterally, and consider that, if the Regulation does not change, what other measures could be taken to lessen the impact on the airline industry in the event of a major disruption to services in future?
Many passengers stranded by the recent volcanic ash airspace closures found that their travel insurance provided them with little or no assistance in respect of their additional accommodation costs and expenses, which no doubt placed a further burden on European airlines as affected passengers sought to rely heavily on the airlines' Regulation 261 obligations.
Consumers can now buy top-up travel insurance cover from certain insurers and tour operators that covers flight disruption caused by airspace closures due to 'acts of God'. However, as the volcanic ash disruption recedes from consumers' memories, the extent to which passengers will be willing to pay extra for such cover is debatable.
Another difficulty is the price-sensitive nature of the travel insurance market, with many customers opting for the cheapest product available with little regard for the terms of such insurance and the extent of coverage. The travel insurance industry will argue that it is giving customers what they want: a basic product at a basic price.
But would consumers be willing to pay extra for a more comprehensive travel insurance policy that covered flight cancellations due to natural disasters? Frequent business travellers and those leisure travellers who are going on an annual family summer holiday to Disneyworld might have an interest in purchasing more comprehensive travel insurance if the benefits were made clear to them. Perhaps the airline industry needs to do more to extol the benefits of more comprehensive travel insurance to travellers, for example via airline websites at the time of flight booking – how many such policies airlines are able to sell to price-sensitive consumers in a competitive travel insurance market is another story entirely.
The final point to be noted in relation to travel insurance is that the primary responsibility of the airline to fulfil its obligations under Regulation 261 remains in place – however, a passenger that is able to claim back most of their travel disruption expenses from their travel insurer is potentially less likely to make a claim for the same losses against the airline, although it is then open to the insurer to request that such passenger's rights are assigned to the insurer.
Should airlines consider purchasing some form of air travel disruption cover as part of their own insurance policies? No doubt the costs of such cover would be high, and one wonders whether insurers will even offer such cover to European airlines following recent events, but this should be weighed up against the financial exposure of airlines to Regulation 261-related costs and expenses following a major disruption to air services.
Given that the majority of air passengers will continue to travel without comprehensive travel insurance, an alternative would be to create a fund along the lines of the UK's ATOL protection scheme, to which each air passenger would contribute a nominal sum via a mandatory levy on each air ticket purchased in the EU.
Contributions collected would be placed in a fund, again not unlike the ATOL Air Travel Trust, with the fund to be made available to affected parties in the event passengers are left stranded as a result of significant disruption to European air services caused by an event outside the control of the airlines (for example volcanic eruption, natural disaster or terrorist threat).
The concept of a 'rescue fund' is in principle a simple one – however, the practicalities of how such a fund will be collected, administered and paid out will need to be debated and agreed amongst the numerous potential stakeholders.
For example, what amount will be levied on each passenger, and how will it be collected? Will this be an EU-wide measure administered centrally, or will individual Member States run their own schemes? Who will be able to claim from the fund – will it be a fund available to reimburse passengers directly, or will it be a fund to help support commercial organisations such as airlines who are themselves having to reimburse passengers directly as a result of Regulation 261? Will the fund also be made available to support airport operators, tour operators and other companies who have incurred losses as a result of airspace closures? Should it be available following all types of air travel disruption or should it only be available following certain 'force majeure' type events? Should the fund be used to 'requisition' other forms of transport in order to repatriate stranded passengers when airlines are unable to operate?
The CAA's ATOL protection scheme proved its value following the collapse of the XL group in 2008 when it funded the repatriation to the UK of tens of thousands of stranded UK travellers. The XL experience also provided some valuable lessons, for example, in the time that it took to process all claims from affected travellers and the raising of the levy from £1 to £2.50 per passenger due to the deficit caused by the sheer volume of XL-related claims and repatriation costs.
If details can be agreed with the relevant stakeholders, it is arguable that such a fund represents the most practical and economical way of accounting to parties affected by force majeure-related airspace closures: it takes the onus off Member States to provide direct support at a time when many are grappling with significant budget deficits, spreads the cost of such disruption amongst the travelling public for a relatively small fee per head and relieves airlines of the sole responsibility of funding their potentially very significant Regulation 261 obligations.
The experiences of airlines and their passengers during the recent volcanic ash airspace closures were far from positive – airlines found themselves having to foot substantial costs in order to meet their statutory obligations, despite the airspace closures being entirely outside their control. Passengers meanwhile found themselves being treated differently depending on which airline they were booked with, and not knowing what costs they would have to foot themselves and what they could potentially recover.
It is clear that there is scope for reform of Regulation 261 – the legislation was drafted for a particular purpose, and when applied to an extreme and large-scale event such as the volcanic ash airspace closures, it produced absurd results: for example, European airlines having to meet Article 9 care obligations for passengers that exceeded the cost of their air ticket by a multiple of ten or more.
That said, it is unlikely that the European Commission will want to take away or reduce consumer rights that have been enshrined in law for a number of years. Airlines should, therefore, lobby to have Regulation 261 amended to remove such onerous obligations such as the open-ended right of care in force majeure situations, or have the Regulation amended so as specify fixed compensation amounts in such circumstances.
Meanwhile, the airline industry needs to consider how best to persuade the travel insurance industry to offer more comprehensive products, and to put pressure on EU Member States to establish rescue funds as advocated above.
Stakeholders may not agree on how Regulation 261 need be amended and what other steps need to be put into place – what all stakeholders can agree on, however, is that the status quo cannot continue and that changes will have to be made to EU air passenger rights legislation if the industry is to survive another major disruption along the lines of the volcanic ash airspace closures. Finally, it must be remembered that there are many other causes of air travel disruption aside from volcanic eruptions, for example severe weather and air traffic control failures, that occur regularly and which will also cause airlines to need to fulfil their Regulation 261 obligations from time to time. The industry should therefore seize the initiative now and look at ways of reforming Regulation 261 or mitigating their exposure to Regulation 261 costs.
For further information please contact Chris Healy or Richard Venables.