Ancillary revenue¹ is big business for the airlines. The U.S. Bureau of Transportation Statistics (BTS) reported that for the 1st quarter of 2010 ancillary revenue was an average of 6.2% of total operating revenue for U.S. airlines. Industry consultant Robert Mann of R.W. Mann & Co. says airlines generate, on average, between $12 and $15 in ancillary revenue from each passenger not accounting for fees waived for elite fliers.

Baggage fees make up the largest portion of ancillary fee revenue. For the same quarter, American Airlines checked in $128.5 million in bag fees according to BTS, with US Airways and Continental falling just behind with $120.7 million and $76.6 million, respectively. Delta packed up nearly $218 million for the quarter. Baggage fees and charges for other “unbundled” services are now critical revenue streams and alone could make the difference between a profit and a loss². Charging for what was once included in the ticket price has its consequences, however.

American Airlines was recently sued in Washington state (Covarrubias v. American Airlines, Inc.) over baggage fees. The suit alleges that American’s passenger sought, and was denied, a refund of her baggage fee after her luggage was delayed and considered lost. Her complaint, which also seeks class action status, seeks damages for breach of contract and other claims for those in the class whose bags were, “lost, delayed, damaged, or destroyed during travel in the United States as well as flights originating from the United States to foreign destinations.” The basic argument is that if the airlines charge a baggage fee, they must refund it if they fail to deliver the bag on time and in the same condition as when it was checked. In news reports, American denied³ that the bag was lost and stated that refunds may be sought as part of the passenger’s lost or delayed baggage fee claim.

The U.S. Department of Transportation reports that nearly 27,000 mishandled baggage reports were filed with American in June 2010, with over 1 million reports filed with the top 18 reporting airlines. Substantial revenue is at risk, in addition to increased administrative costs to process refund claims if American loses. A loss would undoubtedly affect how all airlines approach this issue. But does the case have merit?⁴

Every passenger ticket issued on a U.S. carrier is subject to the carrier’s conditions or contract of carriage. American’s and all U.S. airlines’ conditions of carriage address their liability for lost, damaged or delayed baggage. For American, the passenger must notify the airline and file a claim. American’s basic liability is limited to the lesser of the actual value of the baggage or $3,300. The passenger may purchase excess valuation insurance to a total value of $5,000.

While the refund of baggage fees is not expressly addressed in American’s conditions of carriage, a passenger is not precluded from claiming a refund of the fee with the damage or loss claim. The complaint does not state what process, if any, the plaintiff followed other than making a verbal request for a refund of the baggage fee which was denied. If, after making a formal claim, a bag (whether damaged or not) is ultimately delivered and the passenger is compensated for any damage or delay, the conditions of carriage should shield American from liability for the express contract claim alleged in the complaint. Whether American must refund the fee if the bag is lost or destroyed is less clear.

Other allegations could prove more difficult for American to defend. The complaint argues that by charging a baggage fee separate from the ticketed airfare, American may have created a new and separate contract, similar to a shipping charge. American may therefore not have earned the fee if they failed to deliver the bag as the complaint alleges was impliedly represented and promised — on time and undamaged.

The question remains, and this suit will no doubt seek to answer, what is promised, if anything, by charging a fee and will the airlines’ contracts of carriage shield them from liability when they charge a baggage fee separate and distinct from the airfare? Whatever the outcome, the airline industry is no doubt watching, particularly given the potential class action status of the suit.

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