Baseball arbitration pitched to level the playing field in aviation

Introduction

Australian airlines are increasingly calling for “baseball arbitration” in a bid to rebalance bargaining over prices for airport services in Australia. This article considers why that proposal was made, how the arbitration model would work, and what can be done to make the process most effective.

Background – negotiating prices for aeronautical services

Prices for aeronautical services, such as runway access, at Australia’s major airports are currently set through direct negotiations between airports and individual airlines. According to many airlines however, major airports in Australia, including Sydney, Melbourne, Brisbane, and Perth, have outsized bargaining power, leading to imbalanced negotiations and higher prices for airport services. Australian airlines contend that they lack the countervailing market power to successfully negotiate a reduction in high prices for airport services, and that this disparity in bargaining power is causing economic harm.

Countervailing market power for an airline would mean the ability to credibly threaten withdrawal or a substantial reduction in its operations at an airport if it is unsatisfied with a negotiated price for services. This, however, is difficult in the Australian context for a number of reasons.

Most fundamentally, airlines depend on airports for their services, there is no alternative option for landing or accessing services if an airline disagrees with an airport’s prices.

Compounding this further, the major Australian airports have geographic monopolies, by virtue of the fact that there is usually only one airport per major city, and, at best, secondary airports are typically in a location that cannot directly compete for the bulk of airline traffic into the city. The commercial reality is that if an airline stops flying to a major airport, a competitor will quickly fill the gap.

Meanwhile, the effectiveness of the current regulatory regime is under question. Aeronautical service prices are regulated under the Competition and Consumer Act 2010 (Cth) (CCA), with monitoring by the Australian Competition and Consumer Commission (ACCC) providing the main protection against misuse of market power. Despite this, in the recent case of Perth Airport Pty Ltd v Qantas Airways Ltd (No 3) [2022] WASC 51 the Supreme Court of Western Australia held that Perth Airport was a “monopoly supplier” of aeronautical services and exercised “substantial market power”.¹ Although the airport largely succeeded in the action, Le Miere J awarded a lower rate for freight and non-passenger services than the airport sought.

Arbitration before the ACCC provides another potential check to this power imbalance, but in reality it is considered difficult to access and is often time-consuming. Part IIIA of the CCA provides that only services “declared” under the National Access Regime are arbitrable, such services being declared on a case-by-case basis which is a slow, uncertain process, and subject to judicial or administrative review once complete. In one case, an airline’s application to have certain domestic services at a major airport “declared” spurred five years of litigation.

A call for change – introducing compulsory “baseball” arbitration

Responding to an Australian Government inquiry in 2018, the peak body for Australian and New Zealand airlines proposed a new model for setting service prices. The airlines suggested amending the current regulatory regime to create a negotiate-arbitrate model, involving so-called “baseball arbitration” or “final offer arbitration” (FOA).

FOA was first developed by Major League Baseball in the United States of America (hence the name “baseball arbitration”) in response to the League’s “reserve system”.

FOA was seen as a means of enabling fairer salary negotiations and increasing player wages in the face of a system that was stifling salaries and prohibiting players from moving freely between teams.

In essence, the FOA process requires each party to put forward its final offer for a service, and an independent arbitrator then decides which offer is more reasonable. FOA differs from conventional arbitration insofar as the arbitrator lacks discretion to craft their own award; instead, the arbitrator must simply pick one of the offers put forward by the parties. Under this model, arbitration would be compulsory where a major Australian airport and an airline reached an impasse in negotiations over service prices.

According to the airlines and the ACCC, baseball arbitration would represent a real barrier to misuses of market power that drive prices to an unreasonably high level.

The Productivity Commission, which is the Australian Government’s independent research and advisory body, has rejected this proposal. The Commission disagrees in principle that the major Australian airports have misused their market power, and has expressed concern that the FOA model would not permit administrative or judicial review of decisions. The Commission has also warned that the model is likely to favour airlines, because an airline dissatisfied with the outcome of the arbitral process could modify its operations to mitigate the impact of a lower price, whereas an airport would have no option but to accept the ruling.

Despite being rejected by the Productivity Commission, the FOA proposal continues to attract support from airlines, and the recent decision in Perth Airport means the model is likely to be considered again in the Government’s next inquiry into regulation of airport services. For that reason, it is worthwhile to consider how a negotiate-arbitrate mechanism could operate in practice.

Final offer arbitration in practice

Advocates of the FOA model highlight two key benefits of the process. Firstly, it encourages parties to put forward reasonable offers for airport services in the first place. A complaint sometimes levelled against conventional arbitration is that arbitrators simply “split the difference” between the parties, and this perception in turn incentivises extreme positions. In contrast, FOA removes that incentive as, if one party’s offer is clearly unreasonable, the arbitrator will likely side with the more moderate offer put forward by its counterpart.

Secondly, this incentive to moderate offers should bring the parties closer together at an earlier stage in the dispute resolution process, increasing the prospect of a negotiated settlement before arbitration is even commenced. An early settlement reduces costs and can help maintain positive business links, which is particularly important in sectors like aviation where, by virtue of the small number of players in the industry, entities typically have long-term relationships.

Even where settlement is not possible,

FOA is generally faster and less expensive than conventional arbitration or litigation.

Indeed, a variety of sectors in other countries already rely on FOA, notably the US Federal Communications Commission, which has imposed FOA as a condition for vertical merger clearance in the broadcasting sector, and the Canadian transport industry, where it is available to shippers for the resolution of disputes with carriers and also in railway disputes.

In Australia, too, FOA is already used in the gas industry, with the Australian Energy Regulator acting as arbitrator.

This form of FOA was introduced into the National Gas Law and National Gas Rules in 2017 in an effort to address unequal levels of bargaining power and access to information faced by shippers when seeking access to pipeline services. The News Media and Digital Platforms Mandatory Bargaining Code, enacted in 2021, also provides for FOA to determine the amount which “designated” digital platforms must pay news businesses for using their content online.

Key design features

The airline industry has its own specific characteristics that differ to the sectors in which FOA has been used previously,

FOA is nevertheless a flexible process and there is no reason, in principle, that it could not be tailored to meet the needs of aviation parties.

This could be done either by statute or through standard rules that parties would select to govern the finer details of their arbitration.

Certain design choices are likely to enhance efficiency and improve the quality of outcomes in FOA:

• Limiting the types of disputes referred to FOA. It has been common in other sectors to strictly limit the types of disputes that are amenable to FOA. For example, the News Media and Digital Platforms Mandatory Bargaining Code involves arbitration only to resolve the remuneration paid by a digital platform that makes covered news content available. Similarly, limiting FOA to the setting of prices for services at major airports narrows the issues for determination, helps focus the dispute resolution process and protects other aspects of the parties’ relationship from the dispute. It also reduces the circumstances in which arbitration may be initiated.
• “Package offers” or “issue-by-issue”. This feature addresses how the disputing parties’ “offers” should be made. “Package offers” address all of the disputed issues, with the arbitrator choosing one of those packages in its entirety. “Issue-by-issue” offers, in contrast, involve the arbitrator choosing the most reasonable final offer on each issue. This allows each aspect of the parties’ dispute to be addressed individually and can be useful in circumstances where some of the issues are closely related. However, if there are several distinct issues – for example, the price of runway access and terminal usage – “issue-by-issue” offers can start to resemble conventional arbitration. In that situation, “package offers” may be more appropriate for ensuring efficiency of the process.
• Multiple final offers. Allowing multiple rounds of final offers can narrow the distance between the parties’ positions. A key benefit is that this better facilitates negotiated settlements. Where settlement occurs, the arbitration can be discontinued.
• Identity of the arbitrator. The use of independent commercial arbitrators is preferable, rather than designating a permanent authority such as the ACCC to perform that role, and has in fact been called for by the ACCC. Experienced commercial arbitrators are well placed to focus on the commerciality of the issues in dispute.
• Time for decisions. Under the current regime, the ACCC as arbitrator must issue a decision within 180 days. There is no reason why this period – or a shorter one – could not be used with FOA. Leading arbitration rules like the ICC Rules also require awards handed down within 6 months from the initiation of the dispute (although that period can be extended).

Conclusion

If FOA is to become part of the regime for setting prices of aeronautical services in Australia, careful consideration should be given to designing the mechanism in a way that best suits aviation parties. Lessons drawn from other sectors and from overseas offer a useful starting point, however input by local industry participants would be critical to establishing an effective process for disputes between airlines and the major airports.