This research paper was commissioned by the Canada Transportation Act Review. It contains the findings and opinions of the author(s) and does not necessarily represent the views of the Review Panel or its members.

International Aviation Framework and Implications for Canadian Policy

Research conducted for the Canada Transportation Act Review

Report prepared by
Peter P.C. Haanappel

March 2001

INTERNATIONAL AVIATION FRAMEWORK AND
IMPLICATIONS FOR CANADIAN POLICY

By

Prof. Dr P.P.C. Haanappel
With a contribution by
Dr. P.M.J. Mendes de Leon

Both of the International Institute of Air and Space Law

Universiteit Leiden, Netherlands

March 2001

ABSTRACT

The first part of the paper examines current trends in international air transport, including international air transport to and from Canada. These trends include open-skies agreements and their provisions on airline alliances; the efforts towards air transport liberalisation in international organisations, such as the International Civil Aviation Organization, the World Trade Organisation, the United Nations Conference on Trade and Development, and the Organisation for Economic Cooperation and Development; and the creation of regional common aviation areas, in particular the European Union and the European Economic Area, and the proposed Transatlantic Common Aviation Area.

The second part of the paper discusses the legal and regulatory implications for Canada, if it were to allow, as a matter of policy, foreign airlines and investors to participate in Canadian domestic air transport. This second Part is divided into two sub-parts: the implications for Canada of a grant of cabotage rights to non-Canadian airlines; and the implications of allowing foreign airlines and/or investors the right to establish themselves in Canada as Canadian carriers, including the effect that this may have on airline ownership and control clauses in Canadian bilateral air service agreements.

INTERNATIONAL AVIATION FRAMEWORK AND IMPLICATIONS FOR CANADIAN POLICY

1. Current trends in international air transport

Ever since airline deregulation began in the US around 1975 and spread to other countries -often under the term liberalisation- as of the 1980s, the air transport world has been changing. In countries other than the US -Canada is an example- these changes were often accompanied by airline privatisation, in whole or in part. Privatisation has led to a situation where Governments, in their international air transport dealings, have often become less mindful of the interests of former State owned `flag carriers', and more mindful of the overall economic interests of international air transport, including the interests of international airports, whether or not served by `flag carriers', and especially the economic contribution that such airports may make to a country's overall prosperity. Nevertheless, it is generally recognised that a hub airport needs a strong hub carrier and its feeder carriers to be an effective competitor in (international) air transport.

Many airlines, since deregulation / liberalisation, have been firm believers in the economic laws of enlargement of scope and route network, and in the advantages of hubbing, whether alone or with alliance partners or feeder carriers. The world's largest and strongest carriers have, again alone or with alliance partners, the ambition to become global carriers. However, it should be noted that a number of low-cost and low-fare carriers rely far less heavily on hubbing. Southwest in the US and easyJet in Europe are good examples.

Enlargement of scope, globalisation and liberalisation are therefor the principal trends, both at the airline and at the (inter) governmental levels. Increasingly, airlines enter into domestic mergers or take-overs, such as the take-over by Air Canada of Canadian Airlines International. However, they are severely restricted in engaging in international mergers or take-overs by national ownership and control provisions in bilateral air transport agreements and national laws. The issue of ownership and control is discussed separately under no 4 below.

Governments attempt to deal with scope / network enlargement, globalisation and liberalisation in various ways. These developments at the governmental and intergovernmental levels are in part contradictory, and it will be a number of years before clear, consistent policy lines can be drawn. The following developments will be discussed:

a. the conclusion of open-skies agreements, often including specific provisions on alliances

Over the past eight to nine years, the US has concluded some fifty open- skies agreements (amongst others, with Canada). Generally, these agreements contain open third, fourth, fifth and sixth freedom regimes1 for scheduled international air services, and allow multiple and unlimited designation of carriers under the agreements. Cabotage (eighth and ninth freedom) rights are not granted (see no 2 below). There are no restrictions on capacity and frequencies of flights. There are liberal pricing regimes, generally only permitting the disapproval of carriers' tariffs if both aeronautical authorities under the agreement agree to do so (double or dual tariff disapproval).

To date, it has been US policy to liberalise international air transport through bilateral agreements, wherever possible, open-skies agreements. In some regions of the world, such as Europe, the US has concluded open-skies agreements with many neighbouring countries, allowing effective use of fifth freedom rights by US carriers if, commercially, they wish to do so. The US -contrary to Europe, as will be shown later- seems to have little faith in multilateralism in international air transport. A very recent exception is a multilateral agreement in the context of APEC between the US, Brunei, Chile, New Zealand and Singapore, thus like-minded liberal aviation nations, which basically takes the form of a multilateral open-skies agreement, albeit one with a particular ownership and control clause that will be discussed later in this paper. However, it seems that this mini-multilateral has run into some implementation problems at the level of the US Department of Transportation (DOT) (see also below no 4).

The US DOT is also the agency that is in charge of giving antitrust approval to airline alliances that use potentially competition restricting practices (joint venture agreements), such as common pricing, revenue sharing, joint scheduling and the like. It is noteworthy that the DOT does not allow such alliance carriers to participate in multilateral IATA tariff co-ordination on routes included in the alliance network.

It is US policy that above-mentioned alliances can only be approved if there is an open-skies agreement in force between the countries of which the alliance carriers are corporate citizens. The open-skies agreement will already contain provisions pertaining to alliance agreements.2 Specific alliance agreements subsequently need the aforementioned DOT approval and antitrust immunity. The reason for an open-skies agreement as a condition precedent is that with its liberal route structure, unlimited designation of carriers and some of the other liberal rules, mentioned above, an open-skies agreement takes away some of the potentially competition restricting aspects of alliances.

Route rights3 are one thing. Alliances and the code-sharing / blocked space / leasing techniques that they use, are another. It is one of the merits of open-skies agreements that they contain special provisions on the question when these techniques are permitted and on which routes.4 In this context, it should be mentioned that there is an unresolved conflict between States in international air transport law and policy as to whether code-sharing requires underlying route authority in a bilateral agreement or whether it is rather a form of `glorified' interlining for which bilateral route rights are not necessary.5

b. efforts in world-wide organisations towards liberalisation and globalisation, principally through ICAO, WTO and UNCTAD

At the time of the Chicago Conference on International Civil Aviation of November - December 1944, there was insufficient agreement between participating nations to make world-wide economic, commercial regulation of international air transport possible. In particular, the two major air powers of the world were in disagreement: the US favoured liberalism and the UK, at the time, protectionism. A compromise did not prove to be possible, notwithstanding, for instance, Canada's efforts to mediate. Hence, the Chicago Convention on International Civil Aviation contains few multilateral rules on the exchange of traffic rights between nations, except to some degree Article 5 on non-scheduled flights (see also no 2 below in the context of cabotage). In order to give like-minded, more liberal nations in 1944 an opportunity multilaterally to agree on the exchange of traffic rights for scheduled international air services, two other agreements were opened up for signature: the International Air Services Transit Agreement, containing a multilateral grant of over-flight rights and rights for technical stops;6 and the International Air Transport Agreement exchanging multilaterally third, fourth and fifth freedom rights.7 Over 100 nations in the world are parties to the Transit Agreement, i.e. out of the some 185 states Parties to the Chicago Convention itself.8 Only some ten States are Parties to the Transport Agreement, thereby making it a failure for ratification purposes,9 although is should be noted that, if ICAO member States become serious about global, multilateral liberalisation of commercial air transport regulation, the old Transport Agreement may very well be used as a basis, as a model (see also no 2 below in the context of cabotage).

It is this situation that led to bilateralism in international commercial air transport regulation, starting with a model bilateral air transport / air services agreement, drafted on the occasion of the 1944 Chicago Conference; through the famous 1946 Bermuda 1 model, called after the first post world-war agreement between the US and the UK; through so-called liberal agreements in the late 1970s; to open-skies agreements as discussed above.10

Between 1947 and 1974, succeeding ICAO Assemblies paid little attention to multilateralism in commercial, international air transport. Since that time, this has changed at Regular Assemblies, and Special Air Transport Conferences have also been organised.11 Nevertheless, notwithstanding valuable papers and discussions, ICAO meetings have not managed to innovate and change, and move away from bilateralism in international air transport to multilateralism, or to multilateral liberalisation. As mentioned earlier, there has been no `revival' of the 1944 multilateral International Air Transport Agreement. The North - South debate, different national socio-economic policies, and the long-standing preference of the US for bilateralism, mentioned above, are all so many reasons. This inability to innovate and change, amongst other things, explains a move away from discussions in the world's specialised aviation body, ICAO, towards parallel discussions in the WTO and to a lesser degree in UNCTAD: both are international organisations of a general economic vocation. The move away from the specialised body to the general bodies has frequently been criticised. The fact, however, remains that there are now parallel discussions, and in the case of WTO even a parallel agreement.

The GATT (General Agreement on Tariffs and Trade) Secretariat, the predecessor of the WTO, for many years was involved in the preparation of the General Agreement on Trade in Services (GATS) which, finally, saw the light in 1995. The GATS in principle applies to trade in air transport services, but the practical effects of this principle are very limited, since the main agreement is accompanied by a special `Annex on Air Transport Services). The Annex makes it clear that, in international air transport, `hard rights', i.e. route rights12, remain subject to bilateral air transport / air services agreements between nation pairs. Only three so-called `soft rights' in international air transport are currently subject to the multilateral GATT/GATS regime: (off-line) aircraft repair and maintenance, the selling and marketing (but not the pricing) of air transport services, and computerised reservation systems.

One of the significant features of the GATS and the Air Transport Annex is that there is a once every five year review process of the Annex, with a view, amongst other things, further to liberalise international air transport services by progressively including more aspects of international air transport into the Annex. The first review process started in 1999-2000, and has not yet been terminated. Many ideas have been mooted as to which additional air transport services should be included in a revised Annex. In the area of hard rights, currently not covered by the Annex, over-flight rights and rights for non-scheduled air services (already covered, at least in part, by the Chicago Convention on International Civil Aviation and the International Air Services Transit Agreement: see above), and rights for air freight services have been mentioned. In the area of soft rights, ground handling, ownership and control of airlines, wet-leasing of aircraft, airport and air navigation charges, and customs and/or facilitation procedures have all been mentioned. Generally, the EU has been more enthusiastic about enlarging the scope of the Air Transport Annex than the US has been.

UNCTAD's interest in international air transport is of rather recent vintage. Earlier in its history, UNCTAD was particularly active in maritime transport and produced a Code of Conduct on Liner Conferences in the 1970s. UNCTAD pays special attention to the interests of developing nations. One of the interesting features of its 1999 Report on "Air Transport Services: The Positive Agenda for Developing Countries"13 is that it seems to suggest that trading aviation interests for other economic interests, in other economic sectors, may not be so bad for developing nations at all. This suggestion, however, is very much at odds with the traditional `wisdom' of bilateral trading in international air transport to the effect that aviation interests should be exchanged for aviation interests.

Summing up: of all global multilateral attempts at international air transport liberalisation in recent years, only the ones of GATT/GATS/WTO have borne concrete fruits, and that in a limited fashion. Whether, however, one should put all one's eggs into one and the same WTO basket for the future, is risky. In the first place, ICAO is still there and may produce some world-wide agreement in the future, e.g. at the forthcoming Air Transport Conference, likely to be held in 2003. Second, GATT/GATS/WTO operate, amongst other things, with a Most Favoured Nation (MFN) rule, and if, in the future, this would be applied to route rights, to `hard' rights, that would be the antithesis of current reciprocity in bilateral air transport/services agreements; a sometimes proposed `conditional' application of MFN to route rights could only be of a limited, transitional nature. Third, at the time of writing it is very uncertain what the outcome of the current review of the Air Transport Annex is going to be. Fourth, it is uncertain that global, world-wide air transport liberalisation will be the preferred option of States rather than bilateralism or regional economic bloc-forming, as borne out by, for instance, the EU, the EEA and the ECAA (see below). On the other hand, what pleads in favour of a GATT/GATS/WTO approach to international air transport is something, mentioned in the first paragraph of this paper, namely airline privatisation, which diminishes the interest of Governments to give special treatment to no longer State owned airlines and which, in the long run, may cause States to deal with air transport as any other, i.e. as an ordinary business.14

c. efforts to liberalise parts of the international air transport market, such as the OECD proposals for a liberalised international air cargo transportation regime

On several occasions, the air cargo market has served as a guinea pig for air transport liberalisation. Notably, this was the case for US domestic air transport with the Air Cargo Reform Act of 1977, which preceded the Airline Deregulation Act of 1978 by one year. It also happened in the EU, where intra-EU air cargo services were fully liberalised, in 1992, about one year before the third and final EU air transport liberalisation package (see below). It is also to be recalled, as mentioned before, that air cargo services are mentioned in the framework of the first review of the GATS Air Transport Annex.

In today's context, it is noteworthy to look at OECD's proposals in this context.15 In a 1999 Report,16 the OECD examines the international air cargo market in detail, and suggests certain measures for liberalisation, for instance through the WTO or ICAO, and especially for the operation of multimodal transportation services (integrated/courier/express operators).

d. regional initiatives

Regional multilateral initiatives towards international air transport liberalisation are nothing new. For instance, as early as 1956, the European Civil Aviation Conference (ECAC) opened up for signature a regional agreement aimed at the liberalisation of non-scheduled air services in the region. Regional multilateral liberalisation of scheduled international air services would have to wait much longer, until the 1980s, and principally the 1990s. Since that time, such regional initiatives have sprung up in different parts of the world, e.g. in South America (the Cartagena Agreement of 1991 in north-western South America, for instance) and in Africa (the Yamoussoukro Declarations), and this with various degrees of practical success. The most important form of multilateral air transport liberalisation, however, has occurred in the EU. What has no doubt helped, is that, strictly speaking, the EU is more than a multilateral grouping of States: it is a supranational organisation where member States, currently fifteen in number, have durably surrendered parts of their sovereign powers to common institutions: the legislative Council of Ministers, the executive Commission, and the judicial European Court of Justice. Even at that, the process was long. The European Economic Community (EEC), the predecessor of the EU, was created in 1958. It would not be until the mid-eighties that the Community took the political decision to create an internal air transport market without frontiers, to be completed between 1987 and 1993 (with the third air transport liberalisation package). That internal market was indeed accomplished in 1993, with some transitional measures lasting until 1997, but it remains an internal market. Air transport relations between the EU, its member States and third countries remain -with some exceptions, to be described later- covered by bilateral air transport agreements between individual EU member States and third countries. By comparison, it is interesting that the North American Free Trade Association (NAFTA) does not include commercial air transport matters, although, in practice, there are very liberal bilateral air transport agreements in force between the three member States.

A brief description of the EU internal air transport market (3rd liberalisation package) will follow:

· air carrier licensing: there are common licensing rules in the EU that are applied by national aeronautical authorities in the member States. Basically, an `undertaking' shall be granted an operating license if it possesses an Air operator's certificate (AOC), a safety certificate, and if it submits a satisfactory business plan for the first two years of operation. A Community carrier must be majority owned by an EU member State or member States, or by nationals of such member States. This rule makes it possible that nationals of one EU member State, including airlines of one member State, set up an airline in another member State: this is the right of establishment which will be further discussed in no 3 below.

· market access: once validly licensed, a Community air carrier may serve any route in the EU, both in the scheduled and non-scheduled mode: in the EU country that has licensed it (domestic service), in international intra-EU services, and in domestic air services in other EU countries (cabotage: see no 2 below).

· pricing: there is total pricing freedom for cargo rates and almost total pricing freedom for passenger fares on routes within the EU, subject to the ability of member States to intervene in excessively high fares to the detriment of the consumer, or in excessively low fares which would result in widespread losses among all air carriers.

· competition: the EU competition rules apply to air services within the EU, subject to a number of exemptions, the most important ones of which are in favour of non-binding inter-airline consultations on passenger air fares for the purpose of interlining, and in favour of the airlines' slot allocation procedures (both exemptions are currently under review).

As mentioned before, the EU internal air transport market of 1993 only covers air transport within the Community. The Community has not yet assumed general extra-territorial competence to negotiate, as a single unit, air transport agreements with third countries. Hence, the rule is still bilateral air transport agreements between individual EU countries and third countries outside the EU. However, there are already exceptions:

· there is an association agreement between the EU on the one hand and Iceland, Norway and Liechtenstein on the other, together constituting the European Economic Area (EEA). This association agreement covers most EU economic activities, including air transport. An association agreement basically means that non-EU countries take over EU legislation as their own. Hence, the EU internal air transport market of 1993 now covers air transport within an area comprising 18 countries: the 15 EU countries plus Iceland, Norway and Liechtenstein.

· there is an air transport specific association agreement between the EU and Switzerland, whereby Switzerland agrees to apply EU air transport legislation. The agreement has been signed, but is not yet in force. It will enlarge the internal air transport market to 19 countries.

Furthermore, there are ongoing air transport negotiations for the conclusion of a European Common Aviation Area (ECAA) between the 18 EEA countries and 11 Eastern European nations, whereby these 11 States would take over EU/EEA air transport legislation, possibly with transitional measures and periods, so as to enlarge the internal air transport market to 29 European States (if one includes Switzerland).

Much has been said and there has been much speculation about air transport negotiations between the EU as a whole and the US. EU authorities have espoused the idea of a Transatlantic Common Aviation Area (TCAA), as proposed by the Association of European Airlines (AEA).17 A TCAA agreement would not be an association agreement, like the EEA or ECAA agreements, but a convergence / harmonisation agreement where EU and US policies18 would be moulded to create a single, liberalised EU/US/North Atlantic market in which airlines of both sides could participate. A TCAA Agreement, in the common aviation area, would provide for freedom to provide services for carriers of the US and the EU; it would give these carriers the right of establishment in both the US and the EU; it would contain liberalised airline ownership rules, a liberalised policy with respect to the leasing of aircraft, and a harmonised competition / antitrust law regime.

Whereas there is a considerable degree of support for a TCAA concept on the side of the EU Commission and Council, this does not seem to be the case in the US. This is particularly true for the idea to give EU carriers the right of establishment in the US. Although there are no official US proposals for a US - EU air transport negotiation, it seems that the US would be more inclined towards an open-skies bilateral agreement between the EU as a whole and the US.

e. conclusion

As mentioned in the introduction to this review of current trends in international air transport, there are several, sometimes contradictory, or perhaps rather seemingly contradictory trends in governmental and intergovernmental attempts to liberalise international, commercial air transport regulation. To date the most concrete results have been attained by bilateral open-skies agreements, by the GATS Air Transport Annex, and by regional common aviation areas. There seems to be little agreement on how to deal with air transport relations between a large economic bloc, like the EU, and a large air transport market, such as that of the US.

2. Cabotage

Allowing foreign airlines to serve domestic routes, i.e. cabotage, is one way to increase domestic airline competition. According to Article 7 of the [Chicago] Convention on International Civil Aviation, States may reserve domestic air transport to their own national carriers, which most States do, stating so in their domestic air transport legislation and/or their bilateral air transport agreements. If States nevertheless grant cabotage rights to foreign countries and their airlines, Article 7 provides that this may not be done exclusively and explicitly. This proviso in Article 7 is complicated and will be explained in some detail. Other questions that will be addressed include:

a. what Canada can do unilaterally with respect to cabotage

If the Canadian government chooses as its policy to open up its domestic routes to non-Canadian airlines -i.e., cabotage-, Canada should amend its legislation, as the Canada Transportation Act (henceforth: CTA) reserves the operation of domestic services19 to Canadians holding a Canadian aviation document.20 It is true that the CTA makes provision for an exception to the rule that domestic services may be operated only by Canadians holding an aviation document, but this exception does not seem adequate for the conduct of a new policy pertaining to the opening up of domestic services to foreign operators. For instance, the exemption may be granted "in the public interest" only, and for a limited period of time.21

Cabotage rights are traffic rights. Governments may grant traffic rights to foreign operators using the following three methods:

(i) Traditionally and typically, traffic rights, including cabotage rights, for the operation of scheduled air services, are granted under bilateral air services / transport agreements. In most cases, bilateral agreements contain a standard, `no cabotage' clause under which airlines of the bilateral partner are forbidden from flying domestic routes in the territory of the other country. This is also the case for Canada's bilateral agreements.

(ii) There are two examples of traffic rights, which can be or have been granted under unilateral policies of a state.

(i) There is a tendency to grant traffic rights, in the exceptional case of the EU including cabotage rights, on a plurilateral or multilateral basis. This practice will be discussed in c) below.

Whatever policy Canada may choose, that is, whether or not to grant cabotage rights, and if so to grant cabotage rights on a unilateral, bilateral, plurilateral or multilateral basis, and whether for the operation of scheduled or non-scheduled services, it will be bound by the Treaty obligations of the 1944 Chicago Convention on International Civil Aviation. The most relevant provision for the grant of cabotage rights is Article 7 of this Convention.23

Article 7 consists of two sentences which, as a matter of convenience,24 will be referred to as Article 7(1) and Article 7(2) respectively. Least of all problems are posed by Article 7(1). One could be tempted to examine the question whether or not the definition given by the CTA25 with respect to "domestic service" including services between a point in Canada and a point in "no men's land" is justified in light of Article 7(1) of the Chicago Convention,26 but it would seem that such an examination is not particularly useful in the context of this paper. All that can be said is that Article 7(1) confirms Canada's sovereign power to allow or to refuse foreign operators to operate intra-Canadian cabotage routes. A potential problem could arise if Canada would indeed allow foreign airlines to operate intra-Canadian air services, be it on a scheduled or on a non-scheduled basis. In cases where the grant of scheduled or non-scheduled cabotage rights is made to non-Canadian operators, the second paragraph of Article 7 of the Chicago Convention comes into play. At the outset, it should be said that Article 7(2) does not excel in clarity. A host of commentators have tried to give a meaningful interpretation to this provision, especially to the words "specifically" in conjunction with "on an exclusive basis". In light of the ambiguity in its formulation, there have been proposals within ICAO to delete paragraph 2 from Article 7 of the Chicago Convention. However, those proposals were not accepted.27 That means that the international aviation community has to live with the text of Article 7(2) as it stands.

Meanwhile, State practice pertaining to the grant of cabotage rights could have contributed to giving a meaningful interpretation to this provision. However, examination of State practice does not help much either, because only in very rare cases have cabotage rights been granted, and, if so, on an incidental basis only. For instance, in 1998, Peru's Congress passed a law allowing foreign airlines to operate domestic routes, opening these routes to competition after widespread passenger complaints over delayed and cancelled flights by domestic carriers. The measure was designed to enable the Peruvian government to grant special permission to interested foreign airlines that wanted to operate domestic routes to its most attractive tourist destinations. The Peruvian law cannot be said to include a grant of cabotage rights which was specifically made to any other contracting State to the Chicago Convention on an exclusive basis; it has not provoked reactions from foreign governments.

In one case, namely the State practice as applied by the Member States of the EU, it could be said that indeed the grant of cabotage rights comes very close to the prohibition foreseen by Article 7(2) of the Chicago Convention. Since 1997, EU air carriers enjoy full cabotage rights within the respective territories of the EU Member States. It can be argued that the grant was "specifically" made "on an exclusive basis" between EC Member States, for the benefit of their own EU airlines. Indeed, no other airlines than EU airlines enjoy intra-EU cabotage rights; the grant was made "on an exclusive basis" among EU Member States, excluding all other contracting States to the Chicago Convention. The EU measures on the grant of intra-EU cabotage rights have not resulted in any formal reaction or protest from non-EU states. But then: the EU has a hybrid status in public international law: it is less than a federal State; it is, as a supranational organization, more than a multilateral grouping of independent States. Also: foreign, non-EU protest might have led to the cancellation of or the threat to cancel the still existing fifth freedom rights that some non-EU nations and their airlines have on intra-EU international air routes.

The short answer to the first question therefor seems to be:

Canada can unilaterally grant cabotage rights provided that:

- it amends its national legislation;

- it lifts its ban on the grant of cabotage rights as foreseen in the bilateral agreements concluded between Canada and other countries;

- it takes into account the scope of Article 7(2) of the Chicago Convention, be it that State practice demonstrates that the scope of this provision in practice is very limited.

b. what Canada can do in renegotiated bilateral agreements

If the re-negotiation includes the deletion of the standard clause pertaining to the refusal of the grant of cabotage rights, and the Canadian government has meanwhile amended its CTA as indicated above, Canadian negotiators will be in a position to put the grant and/or the exchange of cabotage rights on the table, always keeping in mind the complications which Article 7(2) of the Chicago Convention may cause. Much more relevant than Article 7(2) may be the matter of reciprocity. Reportedly, this point has been on the table and may again come on the table between Canadian and US negotiators.

In a bilateral setting, cabotage rights may be bartered against cabotage rights, but other policy options are also possible. For instance, a country can grant cabotage rights and ask for seventh freedom rights in return.28

c. what can be done multilaterally to facilitate cabotage

Conceivably, Article 7 of the Chicago Convention could be amended so as to delete paragraph 2. This possibility has already been alluded to earlier,29and it seems doubtful that the required majority of States could be found to support such a change. It is also highly unlikely that a revised an updated ICAO Air Transport Agreement [see no 1 b) above] would contain a multilateral grant of cabotage rights.

The Air Transport Annex to the GATS and its periodical revisions were briefly discussed in no 1 b) above. Eventually the exchange of cabotage rights might make it to the agenda of an Air Transport Annex revision, but this is certainly not on the table for the current round of revision negotiations.

Cabotage is a more realistic subject of discussion in the context of the TCAA, briefly discussed in no 1 d) above. In September 1999, the Association of European Airlines (AEA) launched a policy statement entitled: "Towards a Transatlantic Common Aviation Area". This policy statement sets out AEA's views on the basic objectives, structure and key components of a new regulatory framework for air transport relations in the Transatlantic Area. The overall objective is to replace the current fragmented regulatory regime by a unified system that on the one hand gives airlines full commercial opportunities on an equal basis and on the other hand ensures that their activities will be governed by a common body of rules, avoiding unnecessary regulation.30

In regard to market access, the basic objective is that all airlines of the parties to the TCAA will have unrestricted commercial opportunities to conduct the business of air transport anywhere within the CTAA. Realistically, the authors of this policy statement are aware of the fact that the US has reservations about cabotage.

The TCAA is designed to be concluded between the EC and the US. The TCAA proposal makes provision for "third countries" to join the TCAA agreement. At some point, Canada, with its strong aviation links with both the US and some of the EC Member States, may be interested in further exploring accession to the TCAA.

This having been said, the plurilateral TCAA agreement is not so relevant now because:

- progress on developing the TCAA is very slow, inter alia because of lack of enthusiasm on the US side;

- again, reservations on cabotage may be made on one side (the US) or on both sides (the US and the EU);

- Canada has not yet clearly manifested its will to join the TCAA.

That brings us to the conclusion that Canada's possibilities for action on a multilateral basis are limited, at least for the time being. An amendment of Article 7(2) of the Chicago Convention must be considered as an academic exercise. Accession to the TCAA, with a possible exchange of cabotage rights among the TCAA countries, is an interesting policy option in the longer run. So is the expansion of the GATS Air Transport Annex. This paper has not examined a possible reopening of NAFTA so as to include air transport (cabotage).

d. whether a grant of cabotage rights can be limited

The answer is yes.

It belongs to the sovereign powers of Canada to grant cabotage rights:

- on certain routes;

- with capacity restrictions;

- for a limited period of time;

- with tariff restrictions (for instance, no price leadership for foreign carriers on Canadian's domestic routes);

- to the airlines of certain countries.

However: Canada may select certain countries, and their airlines, for the operation of its domestic routes, but may want to keep in mind that Article 7(2) of the Chicago Convention is still in place. The provision is becoming rather obsolete, but it must be mentioned as a caveat. As a precaution, Canada might wish to make cabotage rights to certain selected countries and their carriers subject to very short cancellation periods, in case other nations protest and threaten to retaliate.31 The above applies primarily when Canada grants cabotage rights in the context of a unilateral policy or in the framework of bilateral agreements. If Canada were to engage in plurilateral32 or multilateral discussions,33 it would - policy wise - be more difficult to make reservations on certain routes, to impose capacity restrictions and the like, because the exchange of cabotage rights would be part of a larger picture. Under plurilateral or multilateral discussions, the - more than two - parties engage in trade in air transport services in order to achieve longer-term policies and trade objectives. To make reservations on specific points would deny the value of the over-all trade benefits for the participating countries. This does not prevent States, including Canada, from engaging in a plurilateral agreement to liberalise access to domestic markets and to adopt a gradual approach, that is, lifting cabotage restrictions in terms of capacity, routes, tariff freedom, during a certain transitional period.34 The policy of the EC with respect to cabotage rights provides an example.35

The answer to question d) is therefore that the Canadian government is in a position to make reservations to the grant of cabotage rights, but that its discretionary power to do so is more limited when the grant is made in a plurilateral or multilateral context. The reason for this limitation is related to trade and policy arguments rather than to legal arguments.

e. whether it is expedient only to allow consecutive cabotage in Canada or also stand-alone cabotage

The question refers to the "expediency" of the grant of certain cabotage rights. "Expediency" seems to be a matter of policy rather than of law. However, the choice between the grant of "consecutive" or "stand-alone" cabotage rights is not only a matter of policy but has some legal implications.

"Consecutive" cabotage, also called the eighth "Freedom of the Air", refers to the operation of a domestic route as an extension, or segment, of an international route. For instance, if Air France would have the right to pick up passengers and cargo in Montreal destined for Toronto on a route Paris-Montreal-Toronto, this would be consecutive cabotage. "Stand-alone" cabotage, also called the ninth "Freedom of the Air", refers to purely domestic carriage, that is, without any connection to the international network of the foreign carrier. For instance, if American Airlines were to operate the Vancouver-Calgary route independently of its US network, this would be stand-alone cabotage.

"Stand alone" cabotage, or the ninth "Freedom of the Air" would be at the bottom of the scale of the "Freedoms of the Air", and, consequently, the least negotiable one. The ninth Freedom would be the freedom, which most affects national sovereignty.

The legal texts which have been examined above, that is:

- Article 7 of the Chicago Convention;

- the standard clauses in bilateral agreements; and

- the CTA;

do not make a distinction between "consecutive" and "stand-alone " cabotage. The term "domestic service" as defined by the CTA can be understood as including both "consecutive" and "stand-alone" cabotage.36 The only document, which distinguished between the two types of cabotage, was the "Third Package" of the EU37 which allowed "consecutive" cabotage to EU carriers (under specified conditions) between 1992 and 1997, but not "stand-alone" cabotage which was only added in 1997.

The distinction between the two forms of cabotage may be complicated by so-called own-traffic stopovers. In the hypothetical Air France cabotage example above: if an Air France passenger, ticketed Paris - Montreal - Toronto, would make a stop-over of a couple of days in Montreal and continue to Toronto on a later Air France Paris - Montreal - Toronto flight, is this passenger then still a consecutive cabotage passenger or has he become a stand-alone cabotage passenger? The former interpretation -i.e., still a consecutive cabotage passenger- is usually held to be the correct one, although there is no formal authority to this effect.

The grant of "stand-alone" cabotage rights to foreign air carriers will have a greater impact on the functioning of the intra-Canadian air transport market than the introduction of consecutive cabotage. Moreover, stand-alone cabotage must be accompanied by the grant of the right of establishment to foreign carriers in Canada, so that they can do effective business in the country. This, however, is not the same right of establishment as will be discussed in no 3 below. In the context of stand-alone cabotage, it is the right of establishment as a foreign carrier in Canada (probably to be governed by bilateral agreement between Canada and the foreign Government responsible for the foreign carrier in question). No 3 discusses the possibilities for foreign airlines or other investors to establish themselves as Canadian carriers in Canada.

3. The right of establishment

The legal and other complications of allowing foreign carriers to serve Canadian domestic air routes (cabotage) can be avoided by allowing foreign interests (airlines, capital) to set up, in whole or in part, i.e. with or without also Canadian equity participation, Canadian airlines to serve Canadian domestic routes. These airlines would be fully-fledged Canadian airlines like all others today, subject to, for instance, the same technical, safety, and commercial requirements, and the same labour, immigration and fiscal regulations. To this end, Canadian domestic airline ownership and control legislation would have to be amended, notably the definition of "Canadian" in s. 55 of the CTA. One would have to delete from the definition the words "... that is controlled in fact by Canadians and of which at least seventy-five per cent, or such lesser percentage as the Governor in Council may be regulation specify, of the voting interests are owned and controlled by Canadians". It is to be noted that in order to effectuate the right of establishment, mentioned above, the use of the discretion of the Government does not seem to suffice. An ordinary reading of the definition may not allow the Governor in Council to reduce Canadian content to nil; moreover, the use of discretion by the Government would probably not create enough legal certainty for foreign investors; at any rate, "control in fact" does not seem to be subject to the possible "discretion" of the Governor in Council.

The domestic airlines Ansett and Virgin Blue in Australia seem to be the clearest examples of Australian airlines set up and owed by foreign interests (namely Air New Zealand and Virgin of the UK). In the EU, there are also examples of the right of establishment in a foreign country, but usually with mixed ownership from various EU countries. A good example is German BA, a German carrier, with mixed German - British ownership, under the effective control of BA. Swissair - Sabena may be become another example, once the Swiss -EU air transport agreement comes into force [see no 1 d) above] and Swissair will take an 85 percent stake in Sabena, instead of the current 49,5 percent.

Nos 1 d) and 2 c) above have shown that, within the EU, Community carriers can exercise cabotage rights and have the right of establishment throughout the Community (such as BA's establishment of German BA in Germany). It is not insignificant to note that, since 1993, when these rights were created by the EU's third air transport liberalisation package, the use of cabotage rights has in practice been very limited, whereas the right of an EU carrier from one EU country to establish itself in another EU country has been used more frequently.

It is to be noted that, where in the exercise of the right of establishment, the foreign investor is a foreign airline, it seems normal that the airlines involved use code-sharing techniques. E.g., German BA flights carry BA flight numbers; many Swissair and Sabena flights carry the flight numbers of both carriers.

4. Ownership and control in an international context

If Canada allows the right of establishment, as outlined in no 3 above, there will be Canadian airlines that, in terms of Canada's bilateral air services / transport agreements, are not substantially owned and effectively controlled by Canadian interests. If Canada would allow mergers/take-overs between Canadian and non-Canadian carriers, the same situation would occur (see no 1 above). If it would then be Canada's policy to allow these airlines also to fly international routes to/from Canada, Canada's bilateral air services / transport agreements would have to be modified with respect to their ownership and control clauses (in addition to the above discussed change in Canadian domestic law, namely s. 55 of the CTA). Foreign nations might not be willing to do so, or only for a "price", i.e. (an)other "hard" or "soft" right(s) in their favour.38 Canada is not hindered by two multilateral agreements of 1944 that include restrictive ownership and control provisions: it withdrew from the International Air Services Transit Agreement in the 1980s and it was never a Party to the International Air Transport Agreement [see no 1 b) above]. It is also relevant to look at what other countries are doing in this respect:

The following will examine some of those changes or proposed changes and their relevance to the question of the right of establishment of foreign airlines/investors in Canada as Canadian air carriers.

a. the multilateral situation: (i) in 1983, ICAO adopted a recommendation allowing the designation by one developing nation of the airline of another developing nation in the same regional economic grouping: so-called `community of interest designation'.40 This does not seem particularly relevant in the Canadian context of the right of establishment. (ii) in November 2000, an APEC multilateral open-skies agreement was signed. Traditional substantial national ownership and control was replaced by a requirement than an air carrier must be effectively controlled by the designating Party's citizens, subject to a discretionary right of another Party to reject a designation if substantial ownership of the designated carrier is vested in nationals of the Party receiving the designation. In the meantime, the new clause has already been subject to a US DOT Show-Cause Order regarding the airline ownership reporting requirements to which non-US carriers are subject under the agreement.41 Also this clause does not seem particularly relevant in the Canadian context of the right of establishment, since it only liberalises ownership requirements, partially, and does not liberalise control requirements. (iii) For a possible, future TCAA it is proposed to follow the EU model: for traffic within the common aviation area any carrier may operate that is majority owned and effectively controlled by member States and/or nationals of member States. For traffic between the common aviation area and points outside thereof, traditional national substantive ownership and effective control forces remain in force. This is a weakness, perhaps unavoidable weakness of the EU / proposed TCAA system, since it makes airlines subject to two different ownership and control regimes, depending on the routes in question. For this reason, and also because Canada, in the short run, is not likely to join any common aviation area, the EU / proposed TCAA model is not very relevant in the Canadian context.

b. the bilateral situation: (i) a couple of general remarks first: the clause that an airline, designated under a bilateral agreement, must be substantially owned and effectively controlled by the designating State and/or its nationals, is a permissive one. The country, receiving a designation, may refuse it, but is not obliged to do so.42 Further, substantial ownership is usually interpreted as majority ownership; effective control seems to be the dominant criterion and is a question of fact, for instance related to the nationality of the Board members of an airline, or the question whether there is a single, very large equity holding in foreign hands, although, looking at all equity, there is majority national ownership. (ii) A Task Force on Ownership and Control of the European Civil Aviation Conference (ECAC) has recently developed a model bilateral clause which may be a solution for many countries and their airlines and which also seems highly relevant in the context of the right of establishment by foreign airlines / investors in Canada: a designated airline must be incorporated in and have its principal place of business43 in the country of designation.44 (iii) Germany, in a number of recent instances, has negotiated a designation clause allowing Germany to designate German owned and controlled carriers, but also carriers majority owned and effectively controlled by other EU States and/or nationals of such States: not particularly relevant in a Canadian context; (iv) The UK has recently revised its model air service agreement, particularly in the light of multinational airline alliances, to the effect that airlines must have their principal place of business in the designating country and must have their air operator's certificates issued by that country.45 This model UK clause is as relevant as the proposed ECAC clause, but it seems a weakness that the place of incorporation is not mentioned as a condition.

c. Conclusion: it is recommended that

(i) if Canada allows the right of establishment as Canadian carrier to foreign airlines / investors; and

(ii) if Canada would allow such airline(s) to fly international routes,

it use a clause in its bilateral negotiations (new agreements and amendments to existing agreements) based upon the place of incorporation and principal place of business in Canada.

1 Regarding third through sixth freedom this means between, for instance countries A and B, that carriers of country A can transport traffic from any point in country A (including traffic coming from behind country A, i.e. 6th freedom) via any intermediate point (i.e. intermediate fifth freedom) to any point in country B (i.e. third and fourth freedom), and onwards (with traffic rights) to any point beyond country B (i.e. beyond fifth freedom). Mirror rights apply to the carriers of country B. It is to be noted that for fifth freedom traffic the concurrence of a third country is required.

2 See Art. 8(7) of the US Standard Open-Skies Agreement. On this provision, see also footnotes 4 and 5 below, and text thereto.

3 See footnote 1.

4 Art. 8(7) of the US Standard Open-Skies Agreement (see footnote 2) provides, in part: "In operating or holding out the authorized services on the agreed routes, any designated airline of one Party may enter into cooperative marketing arrangements such as blocked-space, code-sharing or leasing arrangements, with i) an airline or airlines of either Party; and ii) an airline or airlines of a third country, provided that such third country authorizes or allows comparable arrangements between the airlines of the other Party and other airlines on services to, from and via such third country ; provided that all airlines in such arrangements 1) hold the appropriate authority and 2) meet the requirements normally applied to such arrangements."

5 The US (see footnote 4) seems to have chosen for the requirement of underlying route authority. However, it is to be kept in mind that, where open-skies bilaterals apply, route authority is extremely broad and open-ended (see footnote 1 and text thereto).

6 First and second freedom rights.

7 See footnote 1.

8 Currently, Canada is not a Party to the Transit Agreement, but it is Canada's policy, in times of normal air transport relations between nations, to act as if it is Party to the Transit Agreement.

9 Canada, like most nations, was never a Party to the Transport Agreement.

10 See text to footnote 1.

11 Lastly, the World-Wide Air Transport Conference on International Air Transport Regulation: Present and Future (Montreal, 23 November - 6 December 1994). The next Special Air Transport Conference will likely be held in 2003.

12 See footnotes 1 and 6, and text thereto.

13 UNCTAD Doc. TD/B/COM.1/EM.9/2, 15 April, 1999 (especially at para. 71).

14 And this again notwithstanding the fact that international air transport has always had, and will perhaps always retain some national security implications, potentially calling for `special treatment'.

15 OECD sometimes acts as a de facto think-tank for the WTO.

16 Regulatory Reform in International Air cargo Transportation, OECD Doc. DSTI/DOT(99)1.

17 "Towards a Transatlantic Common Aviation Area", AEA Policy Statement, AEA Publication, Sept. 1999.

18 Other jurisdictions (like, e.g., Canada) could also join.

19 Defined as: "an air service between points in Canada, from and to the same point in Canada or between Canada and a point outside Canada that is not in the territory of another country"; see, section 55 CTA.

20 See, section 61 CTA; next to the above nationality requirements, section 61 requires an operator of domestic services to have the prescribed liability insurance coverage and to meet the prescribed finical requirement.

21 See section 62 CTA.

22 See, Article 5 of the Chicago Convention: "Each Contracting State agrees that all aircraft of the other contracting States, being aircraft not engaged in scheduled international air services shall have the right, subject to the observance of the terms of this Convention, to make flights into or in transit non-stop across its territory and to make stops for non-traffic purposes without the necessity to obtain prior permission, and subject to the right of the State flown over to require landing. See also no 1 b) above.

23 "Each contracting State shall have the right to refuse permission to the aircraft of other contracting States to take on in its territory passengers, mail and cargo carried for remuneration or hire and destined for another point within its territory. Each contracting State undertakes not to enter into arrangements which specifically grant any such privilege on an exclusive basis to any other State or an airline of any other State, and not to obtain any such exclusive privilege from any other State."

24 The Chicago Convention itself does not make such a distinction.

25 In section 55.

26 Restricting domestic services to services between two points within a single territory.

27 Cf. Minutes of the 7th Plenary Meeting of the Sixteenth Session of the ICAO Assembly; Doc. 8775 A16-Min. P/1-9; see also: ICAO Doc. A18-Min. P/12 at 123.

28 Seventh freedom rights, rarely exchanged to date, can be described as traffic rights for the airlines of country A between countries B and C, independently of traffic between countries A and B. For instance, if the US were to grant Canada 7th freedom rights in exchange for US airlines receiving 8th freedom (cabotage) rights in Canada, Canadian carriers could set up air services between, e.g. Miami and points in the Caribbean, independently of air services between Canada and Miami. Obviously, the relevant Caribbean nations would also have to give their consent.

29 See footnote 27 and text thereto.

30 See, AEA Policy Statement, Towards a Transatlantic Common Aviation Area, 1999, at 1.

31 Short cancellation periods are Swiss practice: Switzerland allows foreign carriers with international rights to both Geneva and Zurich to co-terminalize these cities and to carry local, domestic traffic between these two cities. These foreign carriers, exercising cabotage rights, may not be price leaders in the domestic Geneva - Zurich market.

32 Cf. CTAA and NAFTA [no 1 d) above].

33 Cf. GATS [no 1 b) above].

34 See also, Section 62 of the CTA.

35 The "Third Air Transport Package" of 1992 foresaw a gradual liberalization of cabotage routes within Member States. Domestic markets of EC Member States were opened up to EC carriers in 1992, but were subject to capacity restrictions. These restrictions were lifted on 30 April 1997.

36 See footnote 19 and text thereto.

37 See footnote 35.

38 Hard rights in this context are route rights in terms of the nine freedoms of the air, as discussed in this paper (see also footnotes 1, 6, 28 and text thereto). Soft rights refer to other bilateral provisions, such as those on pricing, capacity/frequencies and commercial opportunities.

39 It is to be noted that the Chicago Convention on International Civil Aviation of 1944 contains no provisions on ownership and control of airlines. This would, however, not prevent the ICAO Council or Assembly from recommending, in the future, new standard clauses on ownership and control of airlines for the use in bilateral or multilateral air transport agreements.

40 ICAO Res. 18/2, 24th ICAO Assembly (1983).

41 See US DOT Order 2001-1-13, Jan. 18, 2001 (Docket OST - 2000-8393). A Show-Cause Order is a quasi-judicial proceeding whereby certain regulatory action is proposed for implementation unless interested parties bring forward valid arguments not to do so.

42 For instance, Aerolineas Argentinas, for many years principally in Spanish hands, does, in most cases, not seem to have been hindered by foreign refusals or withdrawals of designations.

43 Re `principal place of business' the ECAC text refers, inter alia, to ICAO's Air Transport Regulation Panel which "suggests that in assessing a carrier's principal place of business, a state should take into account whether a carrier has a substantial amount of its operations and capital investment in physical facilities in the designating state, paying income tax and registering its aircraft there, and employing a significant number of nationals in managerial, technical and operational positions."

44 The ECAC clause is essentially the same as the so-called Hong Kong clause, developed to suit the particular structure of Cathay Pacific, owned by the Swire Group of the UK, allowing Hong Kong to designate a carrier incorporated in and having its principal place of business in Hong Kong.

45 See Department of the Environment, Transport and the Regions. The Future of Aviation. The Government's Consultation Document on Air Transport Policy, Dec. 2000, para. 281-283.