OST-97-3237 / OST-99-5582 / United and Mexicana / Joint Petition for Reconsideration / June 24, 1999

Joint Application of

for an exemption under 49 U.S. C. §40109 and a statement of authorization under 14 C.F.R. §212 (U.S.-Mexico code sharing)

United and Mexicana seek reconsideration of the imposition of this condition which raises a substantial and important question of policy. On reconsideration, United urges the Department to eliminate the condition on the United/Mexicana code share in accordance with the

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1. In Order 99-5-2, the Department announced its intention to review exclusivity agreements in code-sharing arrangements on a case-by-case basis, taking into account a variety of factors. Id. at 6-7. While "the presence ... of Open Skies [is] a strong indicator of freely competitive market conditions ... this remains rebuttable." Id. at 7. In the order approving U.S.-Mexico code-share services, however, the Department seems to consider the absence of Open Skies between the U.S. and Mexico as uniquely dispositive in its decision to disallow exclusivity between United and Mexicana, rather than taking into account the particular competitive characteristics of the U.S.-Mexico market. Order 99-6-6 at 7. U.S.-Mexico is an exceptionally liberal, open, and competitive air transportation market. Currently there are ten U.S. carriers and seven Mexican-flag carriers that provide scheduled service between the U.S. and Mexico. The U.S. and Mexico receive more service by more carriers than almost any other country-pair in the world.

2. The recent bilateral negotiation resulting in the January 26, 1999 U.S. -Mexico Memorandum of Consultations ("MOC") further expands this market liberalization. As the Department acknowledged in its February 15, 1999 press release detailing the benefits provided by the new agreement:

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• Four carriers from each country may provide code-share services between the U.S. and Mexico in each transborder city-pair market. This is in addition to the two carriers from each country who may currently provide direct service. Code-sharing services may take place between any U.S. and any Mexican point.
• Code sharing may take place between a U.S. and a Mexican carrier, between two U.S. carriers, and between two Mexican carriers. The agreement allows open code-sharing beyond gateway cities.
• Major service improvements are anticipated as a result of this new agreement. There are currently pending applications before the DOT for code-sharing between approximately 10,000 U.S.-Mexican city-pair markets. /1
• Charter programs may operate upon notification of the other government, eliminating advance approval requirements.

In sum, there are a large number of city pairs being served by 17 U.S. and Mexican carriers, making it one of the most open and competitive international markets in the world. The Department's order contains no analysis that would indicate that the exclusivity arrangement between United and Mexicana would adversely effect competition in that market.

3. The Department's denial of limited exclusivity in the code-sharing between United and Mexicana based on the "restrictions" in the U.S. Mexico market is inconsistent with its decision to let stand limited exclusivity provisions between Northwest and Air China in one of the most restrictive markets in the world: U.S.-China. See Order 99-5-2 at 8. In contrast to the open, liberal nature of the U.S.-Mexico bilateral agreement, under the U. S. -China bilateral agreement:

1/ Many of these code shares were, in fact, approved by Order 99-6-6. Indeed, under the liberalized U.S.-Mexico agreement, it was not necessary for the Department to deny a single new code-share application.

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• There are only three U.S. carriers that are allowed to serve the U.S. -China market, only two of which (Northwest and United) offer passenger service.
• Third-country code sharing is not allowed, which imposes a significant burden on all U.S. carriers trying to do business in China.
• U.S. carriers can only code-share to China with three designated Chinese carriers: Air China, China Eastern, and China Southern, whereas there are no limits on the number of Mexican-flag carriers with whom code-sharing is allowed.

China's market is highly restrictive, not only empirically, but especially in comparison with Mexico, and needs liberalization and stimulation of competition in a way that Mexico does not. If any form of an exclusivity arrangement is permitted between Northwest and Air China, then it should also be permitted between United and Mexicana. The Department conditioned the Northwest/Air China code share to allow Northwest to preclude Air China from code sharing only with any designated U.S. airline. Because the U.S. -China agreement only allows two U.S. combination carriers to be designated, this condition has the effect of allowing Northwest (a designated carrier) to preclude Air China from code sharing with United, the only other designated U.S. carrier in the U.S. -China market. Although the Department stated that the condition also applied reciprocally to Air China (i.e.. Air China could preclude Northwest from code sharing only with designated Chinese carriers), that statement is simply wrong. /2 In fact, under the terms of the U. S./China bilateral air services agreement, Northwest is not permitted to code share with undesignated Chinese carriers, but may do so only with designated carriers of that country. Air China, therefore, is allowed to enforce the full scope of exclusivity for which it contracted.

2/ See Order 99-5-2 at 8 where the Department noted the importance of preserving "Northwest's ability to code share with other, undesignated Chinese carriers. . ."

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The net result of the limited condition on the Northwest/Air China code share is to allow Northwest to preclude Air China from entering into a code share with United and to allow Air China to preclude Northwest from entering into a code share with China Eastern or China Southern. In these circumstances, the Department should explain its rationale in conditioning United/Mexicana to disallow any exclusivity while conditioning Northwest/Air China to disallow exclusivity only to a limited extent, given the relative degree of competition allowed under the two relevant bilateral agreements.

4. Prior to the January 26, 1999 MOC, the Department approved U.S. -Mexico codesharing when there were pre-existing exclusivity agreements between code-share partners. The trend in the Mexican market since then has been towards, rather than away from, liberalization and increased competition. Disallowing code-sharing exclusivity now, after allowing it in a less open and competitive situation, is inconsistent, absent a full explanation of the basis for such disparate treatment. Moreover, as noted above, the Department should explain why code-share exclusivity should be totally disallowed in the case of U.S. -Mexico arrangements but not in the case of those in the more restrictive U.S. -China market. /3

Indeed, given the considerable historic experience with code sharing between the U.S. and Mexico under contracts which provide for exclusivity, if there were a problem, the Department should be able to articulate what it was. Any attempt to articulate such a problem

3/ See Airmark Corp. v. F.A.A., 758 F.2d 685, 692 (D.C. Cir. 1985) ("an agency must provide a reasoned explanation for any failure to adhere to its own precedents.") (Citations omitted). See also Northwest Airlines, Inc. v. U.S. Department of Transportation, 15 F.3d 1112, 1121 (D.C. Cir. 1994) ("[a]n agency should not gloss over or swerve away from prior precedent without discussion.") (citing Japan Air Lines Co. v. Dole, 801 F.2d 483, 486 (D.C. Cir. 1986)).

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would, however, be doomed to failure in circumstances where no problem exists. Any competitive harm from code-share exclusivity arrangements should be demonstrable from actions of carriers under those arrangements or from the market results those arrangements have produced. There are, however, no such problems to which the Department can point that were caused by exclusivity provisions in the U.S. -Mexico market. Nor, more importantly, has the Department explained how, even if such a problem existed, it would be affected by the newly liberalized terms agreed between the U.S. and Mexico for code sharing.

Indeed, the U.S. engaged in protracted negotiations with Mexico over code sharing and never once mentioned code-share exclusivity as causing any problems that needed to be addressed. Mexicana and its government are justifiably perplexed to now face punitive conditioning action by DOT after Mexico entered into an agreement on code sharing that gave the U.S. everything it was seeking.

5. In the particular circumstances of the U.S. -Mexico market, an exclusivity provision is especially important as a means of increasing competition. United is the number six U.S. carrier in the U.S. -Mexico market, with a departure share well below five percent. /4 Similarly, Mexicana's share of transborder frequencies is only 18.5%. United and Mexicana entered into an alliance with each other in an effort to become more competitive in the U.S.-Mexico market. That market is dominated on the U.S. carrier side by American and Continental, which together operate over 66 percent of the total frequencies operated by U.S. carriers. Individually, each carrier's share of the transborder market is approximately seven (7) times greater than United's,

4/ Based on schedules published for July 1999, United's departure share of transborder U.S. -Mexico services is just 2. 1 %.

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and is largely equivalent to the share held by Mexicana. If Mexicana were free to cooperate with American or Continental, and United were free to code share with Aeromexico, the largest Mexican carrier, a crucial purpose of their alliance with each other would be thwarted. /5

Indeed, from a public interest perspective the Department's condition seems to invite just the result that would be most anticompetitive. It would allow the carriers that dominate the market to "free ride" by seeking to enter into their own alliances with the formerly exclusive partners and thereby enhance their market leadership. In the U.S. -China market, the Department allowed Northwest to preclude a code share between Air China and Northwest's only U.S.-flag competitor - - United. This was based on concern that with only two U.S. carriers designated and operating combination service there could be "adverse competitive circumstances were both to code share with Air China ... reduc[ing] the latter's incentive to code share with other U.S. carriers." Order 99-5-2 at 8. But in the more competitive U.S. -Mexico market, United is not allowed even to preclude its partner from code sharing with one or both of the dominant U.S.-flag carriers. This inconsistent result is nowhere explained. /6

5/ Market share data is based on departures in OAG, July 1999. Commuter carrier departures were included in market shares for large aircraft code-share partners.

6/ Delta has also sought reconsideration of the imposition of what it describes as anti-exclusivity conditions on U.S. -Mexico code-shares. See Petition dated June 22, 1999, in Dockets OST-99-5593, et al. In its petition, Delta describes the Department's condition as arbitrary and capricious in part because of its retroactive nullification of the Delta/Aeromexico exclusivity arrangement and the consequent hardship this imposes on Delta. (Delta Petition at 3-5) As described below, a similar hardship is imposed on United and Mexicana which also negotiated their code-share agreement in reliance on the Department's then existing policy not to interfere with or condition such exclusivity arrangements.

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United and Mexicana have also made a considerable investment to make their alliance work efficiently. This includes investment in computer system upgrades, marketing, advertising, training and other areas where needed to create a seamless connecting product attractive to consumers. This investment was made in reliance on their mutual exclusivity agreement. Without that exclusivity, either carrier's willingness to go forward with these investments becomes problematic as they each fear the value of the investment may be lost if their partner is lured away by a major competitor, in United's case by Aeromexico and in Mexicana's by American or Continental.

The lack of exclusivity, as mandated by Order 99-6-6, risks destabilization of the United/Mexicana code share. The Department has already concluded that this and other U.S.-Mexico code shares produce important public benefits. Since there is no specific harm to competition or consumers cited as deriving from the exclusivity arrangement, the Department's "anti-exclusivity" condition creates the risk of destabilizing a beneficial arrangement for no apparent reason.

6. The conclusion is inescapable that the Department is using a single, rigid criterion-the absence of an Open Skies agreement-as a basis for making its decision, rather than making an evaluation on a case-by-case basis as it indicated it intended to do. Certainly, in any regulatory regime that depends on a case-by-case application of a policy, the Department has an obligation to explain more fully than it has done how the policy applies to different cases. /7

7/ See Davila-Bardales v. I.N.S., 27 F. 3 d 1, 5, (1 " Cir. 1994) ("the prospect of a government agency treating virtually identical legal issues differently in different cases, without any semblance of a plausible explanation, raises precisely the kinds of concerns about arbitrary agency action that the consistency doctrine addresses. . .").

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It is hard to imagine an international market more competitive than that between the U.S. and Mexico. And yet, the Department has imposed a more restrictive condition on exclusivity here than it did in the case of Northwest/Air China in a market where competition is virtually foreclosed by the terms of the U. S./China bilateral air services agreement.

In light of the highly competitive characteristics of the air service market between the U.S. and Mexico, United and Mexicana ask the Department to reconsider its actions relating to their code-share exclusivity provision. The U.S.-Mexico situation should be evaluated in the totality of the circumstances, which include an extremely liberal bilateral agreement that facilitates competition, a large number of competing carriers in both countries, and a recently negotiated MOC between the two governments which shows their desire to expand and liberalize the joint air traffic regime.

7. In conclusion, United and Mexicana strongly urge the Department to reconsider its action in conditioning the exclusivity term of the United/Mexicana code-share arrangement. On reconsideration, United urges the Department to reverse that action in light of the vigorous competition that characterizes the U.S. -Mexico transborder market and the broad opportunities for expansion of U.S. -Mexico competition. Given the foregoing, there is no need to condition the exclusivity provision of United/Mexicana code share and certainly no need to condition it

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more strictly than is the case with respect to the condition applicable to the code share between Northwest and Air China.

Respectfully submitted,

ROBERT D. PAPKIN

CHARLES F. DONLEY

SQUIRE, SANDERS & DENTSEY, L.L.P.

JEFFREY MANLEY

KIRKLAND & ELLIS

DATED: June 24, 1999