Democratisation of air travel has been a policy priority for India to promote balanced economic development and to improve regional air connectivity. UDAN scheme is one such example that represents this significant initiative in furtherance of such an objective. This scheme was introduced in 2016, under the National Civil Aviation Policy, and it was operationalised through a tripartite framework agreement between the Ministry of Civil Aviation, the Airports Authority of India, and participating state governments. The scheme rests on an uncomplicated but legally precise pillar: a competitive bidding process. Airlines surrender fare autonomy on a defined share of seats in exchange for a government-funded Viability Gap subsidy. Their rights and obligations are governed by a concession agreement enforced by the Airports Authority of India (AAI).
From Mandatory Route Obligations to Incentive-Based Contracting
UDAN was preceded by the Route Dispersal Guidelines (RDG), 1994. The 1994 Route Dispersal Guidelines were designed to encourage regional connections requiring airlines to deploy a prescribed percentage of their capacity on specified underserved routes and regions. But compliance and enforcement were low, limiting their effectiveness. To overcome this gap, UDAN offered financial incentives to the airlines based on regulatory requirements for operating services on regional routes, thus making it more lucrative to operate services on regional routes. This move from mandate to subsidy was thus a jurisprudential one, rather than a policy one it was an admission that compliance with regulation is not sufficient to secure compliance with behaviour in commercial aviation, but must be achieved by contract. This distinction is important because it affects all the things that flow downstream: the relationship between the State and the operator under the UDAN is not between a regulator and a licensee, but between contracting parties, where there is a concession agreement with rights and responsibilities on both sides.
Viability Gap Funding: Design And Legal Character
Viability Gap Funding (VGF) is part of this contractual arrangement. The subsidy under UDAN is not a blanket subsidy from the government but is a performance-based subsidy where the it will be granted only if the airline operates under its planes and provides the required passenger capacity at the regulated fares. This arrangement is subject to the SAO Concession Agreement between the Selected Airline Operator, the Airports Authority of India (AAI) and the relevant state government. A summary of the major rights and obligations of the operator is provided in this agreement, such as the approved airfare, annual fare revision, minimum flight frequency requirements, aircraft substitution procedures, and recovery of VGF. Additionally, it includes clauses that enable AAI to reclaim its overpaid amount, and the interest that subsisted after the audit. Consequently, the agreement is not simply a policy paper, but a commercial agreement with binding terms and penalties for breaches.
It is important to view Viability Gap Funding (VGF) as a solution to a problem. Typically in India, regional airlines have low demand in their routes, high operating costs and customer base that is very sensitive to ticket price. Consequently, this means that many routes do not have commercial value unless supported by government. VGFs complement the realistic revenue an airline can generate, and it is this “gap” that makes it worthwhile for airlines to fly to underserved and unserved areas.
The quantity of VGF is allocated by competitive bidding. If Airports Authority of India (AAI) comes up with a route in UDAN, it tells what the maximum subsidy will be. Airlines interested in participating in the program are first assessed technically for eligibility and capacity before being considered for the program. They submit the financial bids giving the quantity of VGF they need per seat. The route is typically awarded to the airline with the lowest subsidy. This way, market forces can decide rather than the estimates of the government how much financial support is needed.
VGF was originally supported by the Regional Connectivity Fund (RCF), which was backed by a levy on some domestic flights. The goal was to establish an independent financing system in the aviation industry. But as the scheme grew in size, the fund did not meet the subsidy demands, and thus payment was delayed. In light of this, the government has now directly provided funding for VGF under the Modified UDAN framework, which is now more reliable.
Duration of Support And Modified Udan
Another major factor of VGF is the length of time it is available for. Initially, the scheme lasted for three years only because it was felt that routes would become commercially viable after three years. But majority of routes were not able to operate when the subsidy was phased out. To tackle this, the Modified UDAN scheme has been extended to five years of VGF. This will give operators increased financial security and allow them to plan for longer periods when creating passenger demand but also mean that they will continue to be bound by contractual commitments and compliance under the concession agreement for a longer time.
For an operator coming to the UDAN framework, the concession agreement is both a business opportunity and a compliance obligation. An understanding of both aspects, and the legal ramifications if they come into conflict, is crucial before submitting a bid, as once a bid is awarded, obligations may not be easily unwound.
Operator Rights And Compliance Obligations
The concession agreement is a business proposition as well as a compliance burden for an operator joining the UDAN framework. The main draw of the scheme is the route exclusivity; for the life of the VGF support, the selected airline will be prevented from having direct competition on the route, enabling the airline to develop the route without any competition. But this protection is not comprehensive. It does not apply to other routes, level of competitors that travel the same route, or if the operator decides to discontinue service without authorization. There are also various permanent obligations that are required under the agreement. Operators are required to maintain the required flight frequency, seat availability and set the required prices, as well as operate with approved aircraft. The requirements are cumulative; that is, if the first requirement is met, the second is not automatically waived. A change in services, aircraft type and deviation from fare commitments are usually necessitated after being approved by the Airports Authority of India (AAI). Operators also have to comply with detailed reporting and audit requirements. VGF claims must be substantiated with operational and passenger information and AAI can review claims after they have been paid. If there are discrepancies (misreporting, calculation error, incorrect fare application) AAI can recover over-payments of VGF and interest. Thus, it is essential for operators to have the capability to undertake UDAN operations, as well as a strong compliance and record-keeping system. The extent to which the route can be sustained into the future is likely to be the most critical factor for operators. VGF is a funding mechanism for routes in their early years and not on an ongoing basis.
Conclusion
The concession agreement is both a business proposition and a regulatory requirement for an operator wanting to join the UDAN framework. The most attractive aspect of the scheme is the route exclusivity, which, in general, prevents other airlines from launching competition on the same route during the duration of the VGF support. This enables the chosen operator to build the market with no direct competition from the airlines. But this protection is partial and can be terminated if services are suspended without permission.
The long-term viability of the route is the most important factor. VGF is designed to help routes in their youth, and not to be a continuing stream of income. This therefore requires operators to spend the subsidy period in order to develop a viable, sustainable market and to create passenger demand. The scheme, Modified UDAN, is continuing to give financial support for five years, but the ultimate success of a route will depend on its commercial viability after the government financial support is withdrawn.
Author: Shyamli Shukla, Senior Associate
Co- Author: Naincy Kamal, Intern
