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The Morality of the American Airlines Chapter 11 Reorganization

A corporation which files bankruptcy is considered to be proactively using a strategic business tool. But a human being who files bankruptcy is considered to be irresponsibly breaking promises to creditors.  

Let’s see if this difference in attitude makes sense using the example of the bankruptcy filing of American Airlines in late November.

Selecting just a very few characteristics of the American Airlines Chapter 11 “reorganization,” here’s how they compare to a consumer Chapter 13 “adjustment of debts”:

1. Reason for filing:  As I said in my last blog, at the time of its bankruptcy filing the airline had no immediate financial reason for filing. But it had a mediation hearing scheduled in early December in its drawn-out negotiations with its pilots union. The Chapter 11 filing canceled that mediation and gives management much more leverage against its employees, especially its pilots, who would be hurt the most by American defaulting on its pensions.

In digging a little deeper since my last blog, there in fact WAS a financial deadline that the November 29 filing clearly intended to beat. American had financed an engineering and maintenance center in its Fort Worth, Texas headquarters in the early 1990s, and related to that was obligated to pay close to $50 million in unsecured municipal bonds on December 1. Those bonds lost most of their value with the bankruptcy filing. Who are the bondholders thatwho got hurt? New York Life was a major holder of these bonds, meaning that their life insurance customers were indirectly affected.

In Chapter 13, consumers similarly often file to stop some bad event from happening—a foreclosure, wage garnishment, a vehicle repossession. How would you weigh the morality of preserving a family home or vehicle or paycheck against threatening the loss of employee pensions or eating away at the value of investors’ life insurance?

2. Cash on hand:  When American Airlines filed its case, it had more than $4 billion in cash or cash-like assets, by far more than any other airline that has ever filed Chapter 11. It announced that it expects to be able to ride through the Chapter 11 case without having to borrow any more. So it filed when it was nowhere close to being financially strapped. Why did it do so, besides to gain leverage against its unions and to avoid big payments to bondholders so that it could hang onto its money longer? Because having that much money gives it more independence, so it has more leverage to dictate the terms of any potential merger.

In contrast, most consumers filing bankruptcy wait until the bitter end, when they have exhausted all their other alternatives, often when putting off filing is not in their best interest. Classic examples: using otherwise protected retirement money or borrowing from relatives. Most people delay at least in part out of a sense of moral obligation—they want to pay their creditors, don’t want to see themselves as irresponsible. So what’s more honorable, learning about your options early and then prudently filing bankruptcy when it can best serve you (and your family and your future), or instead doing everything possible to avoid filing no matter the long-term costs? Maybe consumers can learn something from business bankruptcies here, but if anything consumers seem to weigh bankruptcy decisions much more morally than businesses do.

3. Assets:  One bit of controversy that has come out of American Airlines case is a swanky piece of real estate it owns, apparently free and clear, used by its highest executives. It’s a five-story home in one of the most exclusive areas of London, worth about $30 million.  Now that amounts to only one thousandth of its $30 billion in debt, a relative drop in the bucket. But if you are trying to wrestle concessions out of your labor unions, and have a judge overseeing your operations, that kind of opulence obviously doesn’t help make your moral case.

In a consumer bankruptcy, you can protect assets that are “exempt,” but those exemptions generally cover only your bare essentials. In a Chapter 13 case you can usually also keep exempt assets that are not exempt, but you need to pay for the privilege. Businesses tend to get away with a lot more on the grounds of “business necessity.” So what’s a more moral procedure, a consumer bankruptcy which makes you account for and then either surrender or pay for any nonexempt assets, or a business bankruptcy which is not as restrictive about assets?

Business decisions, including and especially to file a bankruptcy reorganization, are moral decisions because they can hurt people. American Airlines will likely break many thousands of promises through its Chapter 11 case. Likely a large portion of those broken promises will be to employees who invested in and counted on those promises for many years. In contrast, most individuals who file bankruptcy are not directly harming other individuals. That doesn’t necessarily make it better morally, but my point is personal bankruptcies are at the very least not morally worse than business bankruptcies, even though that is how they are commonly portrayed. Both business and personal bankruptcies have a moral component. Maybe that component should be emphasized more in the former and less in the latter.

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Anatomy of the American Airlines Bankruptcy

The reason American Airlines filed Chapter 11 bankruptcy is so that it could break promises it made to its employees and its aircraft suppliers. It is the only major airline that had not filed bankruptcy after 9-11.

According to its website, the airline “took this action in order to achieve a cost and debt structure that is industry competitive and thereby assure our long-term viability and ability to continue delivering a world-class travel experience for customers.”

In other words, they couldn’t stay in business if they had to keep their promises.

It couldn’t “achieve” a “cost and debt structure that is industry competitive” without bankruptcy for two main reasons.

1) Its management made some bad bets about leasing jets which are now outdated and much less fuel efficient than newer ones. It can’t get out of these lease contracts without bankruptcy.

About 40% of American’s jet fleet of 619 planes are MD-80s made by McDonnell Douglas Corp. before it was bought out by Boeing, so they are no longer in production. They are being replaced by newer jets which are about one-third more fuel efficient. Just last July the airline announced it would buy 460 single-aisle jets in the industry’s biggest-ever order, and now says it wants to still go through with that order.

2) The airline’s negotiations with its labor unions have been dragging out, with mediation scheduled to start in early December with its pilots’ union. A Chapter 11 gives management major leverage against its employees, including with the ever-sensitive issue of pension benefits.

To enable American to avoid filing bankruptcy back in the years immediately after 9/11—during 2005 Delta, Northwest, United Airlines and US Airways were all in Chapter 11—its unions made concessions worth about $1.6 billion annually. “We agreed to sacrifice based on the expectation that our airline would regain its leadership position,” wrote David Bates, president of the Allied Pilots Association. We “will fight like hell to make sure that front-line workers don’t pay an unfair price for management’s failings,” according to James Little, the international president of the Transport Workers Union, which represents aircraft mechanics and baggage handlers.

Why did American file Chapter 11 now? It did not have an immediate cash crunch—it had $4.1 billion in cash and short-term investments to fund current operations. It did not even have to look for immediate “debtor-in-possession” financing when it filed its Chapter 11 case, as is often the case. The timing must surely have had to do with its labor negotiations. Plus the company had some big debts coming due next year, and ever increasing pension funding costs that it hopes to dump or trim. So instead of waiting until it had not choice, the company filed the bankruptcy reorganization as a strategic move.

Check back here for my next blog, which I’m calling “The Morality of the American Airlines Chapter 11 Reorganization,”comparing it to an individual filing a consumer bankruptcy.

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Basic Rules about Business Bankruptcy

If your business needs bankruptcy help, getting it done might not be much harder than a personal bankruptcy. But it depends on how your business is set up and how much you owe.

A couple blogs ago I said that I would soon explain some of the most important benefits of filing a business Chapter 13 case. And I said we’d start by assuming that your business is a sole proprietorship. In other words, the business and you are together legally as a single entity. That is, you have NOT set up your business as a separate legal entity–a corporation or limited liability company (LLC), or a formal or informal partnership.

But first, what if your business IS NOT a simple sole proprietorship, but instead is in one of these other forms?

If so, and you want to preserve your business through some kind of bankruptcy solution, I’ve got no choice but to start by telling you that it’s time (probably past the time) to have a meeting with a competent business bankruptcy attorney.  There are advantages and disadvantages of every form of doing business. But one practical disadvantage of running your business as a corporation/LLC/partnership is that this tends to make things significantly more complicated in the bankruptcy world.

That being said, here are a few straightforward things I can tell you that will make you just a bit more prepared when you visit me or another attorney:

1. Only an “individual” can file Chapter 13. Meaning that you and your sole proprietorship can together file a Chapter 13. But a corporation, or LLC, or partnership can’t.

2. Chapter 13s are sometimes called “wage-earner plans,” probably because one legal requirement is that you have a “regular income.” But that just means “income sufficiently stable and regular to… make payments under a plan under Chapter 13.” So if your sole proprietorship business income—combined with any other income—is even somewhat stable, you may well qualify under this requirement.

3.  But even if your business IS a sole proprietorship, you and your business together CAN’T file a Chapter 13 case if your total unsecured debt is $360,475 or more, or your total secured debt is $1,010,650 or more. These may seem like relatively high amounts but remember they include BOTH personal and business debts. Also the unsecured debt amounts can include less obvious ones such as the portions of your mortgages and other secured debts in excess of the value of the collateral. So a $750,000 debt secured by real estate now worth $550,000 equates to $200,000 in unsecured debt. And that’s before even looking at your regular unsecured debts.

4. If you are over one of the above debt limits, you can still file a Chapter 7 case, but that is almost never a way to save a business. Otherwise, your option is a Chapter 11, which is a hugely more complicated repayment procedure than Chapter 13.

5. A business corporation, LLC, or partnership can file a Chapter 11 case to keep the business afloat. But because of the very high attorney fees (easily 10 times the cost of a Chapter 13), and high filing fee plus ongoing court and U.S. Trustee fees, Chapter 11 is unfortunately not a practical solution for most small businesses. One of the biggest shortcomings in the bankruptcy world is the lack of a cost-effective method to deal with small business reorganizations. Many local bankruptcy courts have tried to address this with streamlined “fast-track” Chapter 11s, but the cost is often still prohibitively high.

As I said, if you are trying to save your financially struggling business, it is very important that you get competent business bankruptcy advice, and as soon as possible. You have likely been working extremely hard at trying to keep your business alive. Now you need a game plan to start directing your energies in a constructive direction.

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