What if ... American hadn't avoided bankruptcy in 2003?

Nov. 20, 2007
Labor and management united to save the airline then; but those moves have led to a wider gap between them

It took late-night confrontations, the resignation of its top leader and a near-collapse of the deal, but everyone at American Airlines Inc. breathed a collective sigh of relief in April 2003 when unionized workers finally agreed to deep pay cuts that kept the company out of bankruptcy

Today the carrier is making a profit. But it has unhappy employees, heavy debt and higher labor costs than most of its major competitors. It also doesn't get a lot of credit for having avoided the plunge into Chapter 11.

What should be a happy memory instead is a complex subtext in increasingly acrimonious labor negotiations.

Both sides wear the avoidance of bankruptcy as a badge of honor.

American officials point out that employees are getting much more in pensions and benefits than those at the airlines that went into bankruptcy; the unions reply that it was all thanks to their sacrifices, which saved the airline and created the wealth being pocketed by top executives.

Nearly five years after the court filings were put away unused, it's worth examining American's decision to avoid the bankruptcy path taken around the same time by United Airlines Inc., Delta Air Lines Inc., Northwest Airlines Corp. and US Airways Group Inc.

All of American's constituencies say they are happy that the airline avoided a trip to bankruptcy court.

Certainly there are no complaints from owners of AMR Corp.'s publicly traded shares, which were nearly worthless in early 2003 and are now valued at more than $5.5 billion.

But among American's executives and employees, there are much-discussed downsides.

In investor conference calls, meetings with employees and discussions with the news media, American officials frequently lament the carrier's cost disadvantage compared with peers that lowered their labor expenses in bankruptcy.

Jeff Brundage, American's senior vice president of human relations, acknowledges that the airline wishes it had the unit labor costs of its competitors that went through the bankruptcy process.

But "I also look at our nonlabor costs and say I'm glad we have that," he said.

"If you want to look at our business in its individual pieces, you could lust after a whole host of other things at other carriers."

American continues to fund generous pension plans and helps pay for retiree medical coverage, costs that the bankrupt airlines were able to chuck or reduce, he said.

"But we've also benefited by reducing much of our nonlabor costs, and we've done a good job as a result of avoiding bankruptcy and improving the balance sheet," Mr. Brundage said.

On the labor side, the pay cuts employees were asked to accept in 2003 were so deep that some union officials questioned at the time whether they would be better off letting the airline file for bankruptcy.

The Transport Workers Union agreed to pay cuts for its mechanics, dispatchers, fleet service clerks and other ground workers. But that path was better than the one that led to bankruptcy court, the union says today.

"We don't believe we would be better off in bankruptcy," said Dennis Burchette, lead negotiator for the TWU.

"Look at the people who have chosen that path. The only people who benefit in bankruptcy are lawyers and bankers."

Double-digit cuts

In 2003, American's three major unions - the TWU, the Allied Pilots Association and the Association of Professional Flight Attendants - agreed to contracts that helped give AMR the $1.8 billion in annual cost-cutting it demanded to avoid a trip to federal bankruptcy court.

The unions agreed to double-digit percentage cuts in pay rates plus reductions in benefits and changes in work rules to make the carrier more productive.

In retrospect, Allied Pilot Association spokesman Karl Schricker says, it was better than letting management, debtors and a bankruptcy judge decide how deep the cuts would go.

As union leaders learned at a conference last month on the Railway Labor Act, which governs airline negotiation, Section 1113 of the bankruptcy code allows managements to get around collective bargaining, he said. That wasn't Section 1113's intent, but it was how the courts interpreted it in airline cases, he said.

Now that AMR is profitable again, the pilots' union is pushing hard to get back all the items it gave up in 2003 and more.

In addition to simply restoring prior levels of compensation, it wants pay increases that account for cost-of-living raises along the way, on the grounds that executives already are benefiting through their pay and other compensation, and that the union concessions saved the company.

"We didn't just bail out American Airlines and AMR Corp.," Mr. Schricker said. "We bailed out the leaseholders. We bailed out the debt holders. We bailed out the shareholders. We bailed out everyone."

Decades of drama

American's dance with bankruptcy was just part of a decades-long drama for the airline industry that kicked into high gear shortly after deregulation was instituted during the Carter administration.

With the federal government no longer regulating fares and markets, airlines had to adjust to a new, tougher reality, just as fuel prices soared during the Iran hostage crisis that began in 1979.

Frank Lorenzo, who had taken control of Continental Airlines Inc. in 1983, took that carrier into bankruptcy court to cut its costs and persuaded a bankruptcy judge to abrogate its labor contracts. The airline filed for bankruptcy again in 1990 and almost entered bankruptcy once more in late 1994 and early 1995.

Continental survived after a new team of managers reorganized its finances and operations.

But survival of bankrupt airlines in the 1980s and 1990s was the exception. Aviation pioneers Braniff International, Eastern Air Lines Inc., Pan American World Airways Inc. and Trans World Airlines Inc. all died in bankruptcy court.

The first Braniff emerged once in 1984, only to go back into bankruptcy two more times.

After selling its best international assets, Pan Am died in December 1991 when its reorganization plan collapsed. Eastern parked its airplanes the last time in January 1991. American bought TWA's assets after TWA filed for bankruptcy a third time in January 2001.

It wasn't pretty, but during the deregulation shakeout, consolidation in the industry was seen as a good thing by many analysts.

That was the reality when American was deciding whether to file in 2003: Bankruptcies most often left their participants sickly or dead.

But this decade's round of bankruptcy filings was different - it hit the biggest, and traditionally strongest, members of the club rather than the fading aviation giants that were on their way down or the entrants that folded during their first downturn.

With the help of bankruptcy judges, troubled airlines reorganized their finances with lower costs, including dumping pension plans on the Pension Benefit Guaranty Corp.

As a result, four of American's biggest competitors - United, Delta, Northwest and US Airways - have emerged from bankruptcy in the last few years as among the strongest carriers around.

In the third quarter ending Sept. 30, all four of those airlines had higher operating profit margins - operating profit as a percentage of operating revenue - than AMR.

Chapter 11 strategy

Coinciding with airline deregulation, bankruptcy reorganization had become a part of business strategy after a 1978 rewrite of the bankruptcy laws, said Michael Alderson, a finance professor at St. Louis University in St. Louis.

In today's business world, Dr. Alderson said, filing for bankruptcy is "a corporate restructuring device, just like a spin-off, a divestiture, an equity carve-out, a merger. ... Really, Chapter 11 reorganizations are really no different than hostile takeovers or a leveraged recapitalization as a device for improving a company."

So would bankruptcy have been a good business decision for American Airlines?

No one would agree with that.

"I don't know any company that would want to go into bankruptcy unless they absolutely had to and had tried every alternative to avoid it," said Jerry Glass, president of F&H Solutions Group, a human resources consulting firm.

Mr. Glass was executive vice president and chief human resources officer at US Airways Inc. during two trips to bankruptcy court between 2002 and 2005.

The good part about bankruptcy is that companies can lower their debt and costs, he said.

"The problem is that bankruptcy leaves a lot of carcasses around," he said. "You have shareholders who are wiped out. You have employees whose contracts are severely modified and end up being incredibly disgruntled and unhappy coming out of it.

"You have a slew of other vendors and outside people whose contracts have been abrogated or severely modified. You don't create a situation where you've got a lot of constituents on your side when you go into bankruptcy," Mr. Glass said.

In addition, airline management has to consider the possibility that the reorganization will result in their being thrown out of the company.

"Those are all the reasons that nobody in their right mind would knowingly want to go into bankruptcy," Mr. Glass said. "It's just not a desirable place to be."

Moral questions

Officials on both the union and management side with American also see a moral issue.

"It amazes me that bankruptcy has lost its stigma in business," said Mr. Schricker of the pilots' union. "It used to be, a company went bankrupt and all these senior managers went away. Now it's like bankruptcy is just a business strategy - and that's not what America is about."

Mr. Brundage, the American Airlines executive, agreed.

"In some people's minds, they simply see bankruptcy as a business tool," he said, "and I think if you have a very short-term horizon, you probably can look at it as a business tool. ... If you look at bankruptcy as a failure of a business and not good for its long-term existence, then it's hard to quantify the intangibles associated with that."

Mr. Brundage said no one can say whether bankruptcy was a good idea for the other carriers until more time passes.

They will eventually have to deal with unions that will want their pay and benefits increased.

"I say we haven't had enough time play out yet to really understand what the implications are for the business long term," Mr. Brundage said.

"I hope we're proven right here, because we are the outlier."

THE ROAD NOT TAKEN

Based on what happened at the four major U.S. carriers that filed bankruptcy petitions in recent years, one can guess how AMR's constituencies would have been affected by a filing:

LABOR

The airline probably would have asked the bankruptcy court to freeze or terminate pensions. Salaries and some benefits probably would have taken bigger hits. On the other hand, employees might have gotten stock in a reorganized company.

INVESTORS

The 156 million shares of AMR then outstanding would be worthless, instead of their current market value of around $3.5 billion.

LENDERS

Secured lenders probably would have gotten equity in a new AMR. Unsecured creditors probably would have received only a portion of the money owed them. Aircraft lessors probably would have had to accept reduced payments, and older aircraft might have been returned to their owners.

EXECUTIVES

Any incentives based on the existing AMR stock would have been worthless, but AMR probably would have offered retention bonuses - both money and new stock - to keep executives through the reorganization.

BANKRUPTCY DETOURS

Of the nation's 10 largest airlines at the start of 2001, five took refuge in bankruptcy court this decade. One of them, Trans World Airlines, went into bankruptcy court as part of a plan to be bought. The others resorted to a Chapter 11 petition to survive. Here's a timeline:

Jan. 10, 2001: Trans World Airlines files for bankruptcy; American Airlines announces it plans to buy TWA's assets.

Aug. 11, 2002: US Airways Group files for bankruptcy.

Dec. 9, 2002: UAL and its United Airlines unit file for bankruptcy.

March 31, 2003: US Airways emerges from bankruptcy.

Sept. 12, 2004: US Airways files again for bankruptcy.

May 19, 2005: US Airways signs a merger agreement with America West Holdings.

Sept. 14, 2005: Delta Air Lines and Northwest Airlines file for bankruptcy on the same day.

Sept. 27, 2005: US Airways emerges from bankruptcy as the America West merger becomes effective.

Feb. 1, 2006: UAL emerges from bankruptcy.

April 30, 2007: Delta emerges from bankruptcy

May 31, 2007: Northwest emerges from bankruptcy.

SOURCE: Dallas Morning News research