Big companies that file for bankruptcy are about as subtle as jumbo jets lumbering down the runway. Companies now noisily rummage around in the financial markets, looking for debtor-in-possession loans, so they have money to operate while in Chapter 11. They gab with unions that represent their workers and creditors and banks that hold their debt. Some even put out press releases telling the world just how well they're doing.
But American Airlines parent AMR Corp. has done none of that, opting instead for a Nov. 29 stealth Chapter 11 filing in the U.S. Bankruptcy Court for the Southern District of New York in Manhattan, shocking its unions, its creditors and Wall Street. When the company's official committee of unsecured creditors said the filing was made on a "widely unanticipated timetable," it was apparent just how successful AMR was in flouting the slick, prepackaged protocol that has increasingly come to characterize corporate reorganizations. AMR hoarded $4.1 billion in cash, enabling it to avoid making a ruckus in the DIP markets. It ordered $38 billion worth of planes four months before submitting its Chapter 11 petition -- hardly a distress call about what was to come. Nor did it tell its unions that its latest offer to them would be its last before a bankruptcy filing.
The cunning with which AMR carried out its pre-Chapter 11 business and its long resistance to bankruptcy when so many of its rivals filed so readily shows that the Fort Worth-based carrier has no interest in the kind of quick, well-oiled bankruptcy proceeding, where financing and reorganization plans have been vetted, voted on and delivered with a blow in the bankruptcy petition itself. Instead, AMR has girded for a fight.
"This is the return of a real reorganization," says Lawrence Perkins, a senior managing director at restructuring and advisory firm Conway MacKenzie Inc. who is not on the case. "It will be messy, and it will be long. This company will require an operations and financial restructuring, and those tend to be messy."
Preordained bankruptcies have become the order of the day. Billion-dollar marine oil transporter General Maritime Corp. and electricity producer Dynegy Inc.'s subsidiary, Dynegy Holdings LLC, both filed for Chapter 11 in November with prenegotiated plans, which were hammered out well before a bankruptcy filing but have not yet been voted on by creditors. Jackson Hewitt Tax Service Inc. made a prepackaged filing -- one negotiated and already approved by creditors -- on May 24 and exited less than three months later on Aug. 16.
And when companies aren't predisposing themselves to a well-choreographed solution, they are filing for bankruptcy with sales in place. Both Friendly Ice Cream Corp. (Oct. 5) and Hussey Copper Corp. (Sept. 27) filed with stalking-horse bidders by their side. Dallas Stars LP, owner of the National Hockey League team, filed on Sept. 16 with both a prepackaged plan and sale in place, and emerged just three months later.
"The profession has evolved," Perkins says, referring to the bankruptcy bar and other restructuring advisers. "It's more efficient, and the capital community, which invests in these companies, [no longer casts a] stigma against bankrupt companies."
Several factors have facilitated the prepack evolution. More lenders and asset managers are willing to deploy capital into a bankrupt company compared to 10 years ago, Perkins says. And the 2005 amendments to the federal Bankruptcy Code and the extensive claims trading over the past decade have transformed the Chapter 11 process from one controlled by debtors to one more often run by creditors.
Claims buyers aren't lenders, but quick profiteers, so they will force the sale or liquidation of a bankrupt company to get their money out faster, says Stanley Samorajczyk, a bankruptcy lawyer at McNamee, Hosea, Jernigan, Kim, Greenan & Lynch PA. As a result, he says, companies try to reach deals more quickly with creditors in order to keep some semblance of control over their bankruptcies. Prepacks allow that to happen.
That's not to say there isn't bloodletting involved with a prepack. Everyone comes out "bloody and bruised from the conference room with a prepack in hand," says Anthony Michael Sabino, a bankruptcy law expert at St. John's University in Queens, N.Y. "Prepacks are messier than you think. You just don't see the mess because it's done behind closed doors."
Whether AMR's decision to undertake a so-called free-fall bankruptcy -- just another term for a traditional Chapter 11 filing without a prepackaged plan or sale attached -- will spark a trend reversal remains to be seen, but since the airline filed, two other major companies, Eastman Kodak Co. and Hostess Brands Inc., have submitted petitions without prior spadework. They, too, are faced with the same high labor and benefits costs, competitive issues and debt woes that felled AMR.
Alas, the carrier's problems are multifaceted and far-reaching, going beyond a simple financial restructuring and requiring operational fixes, fuel-efficient equipment, lower labor and benefits costs, reduced unfunded pension liabilities, a revamped debt structure, and a strategic adjustment to fewer travelers and more competitive pressures -- all things creditors really aren't equipped to deal with. "It has too large and too far-flung of a constituency to have done a prepack," Sabino says.
Culturally, AMR isn't predisposed to a prepack, either. As far back as the 1980s, then-CEO Robert Crandall seemed to be barking at the moon, castigating Continental Airlines Inc. for being the first major airline to file for Chapter 11 on Sept. 23, 1983.
That resistance continued into the administration of Gerard J. Arpey, who succeeded Donald J. Carty as president and CEO on April 24, 2003, and was elected chairman in May 2004 (Crandall stepped down in 1998). Arpey was outspoken in trying to keep the company out of Chapter 11 and said publicly that filing for bankruptcy would be an admittance of failure on the part of management, says Michael Derchin, an analyst at CRT Capital Group LLC who follows AMR. Arpey retired on Nov. 28, the eve of the bankruptcy filing.
Arpey's successor, Thomas W. Horton, formerly AMR's president, was more amenable to a Chapter 11 stay. "Horton is famous for saying he wanted to take the company to the car wash, which was a euphemism for bankruptcy," says a source close to the company who asked not to be named.
Horton's and the board's willingness to file bankruptcy, however, never meant that they were going to give up the fight. In fact, the company didn't let on about a filing at all. AMR has been working with its unions in the hopes of reaching new collective bargaining agreements for the past five years, but the unions say there was no sense of urgency from the airline to get a deal done; AMR never even brought up the B-word. As Conway MacKenzie's Perkins notes, just because AMR filed without a prepackaged or prenegotiated plan, or even a sale in place, doesn't mean it was an eleventh-hour filing. The carrier did strategic planning and accumulated a war chest of cash, he says.
AMR's rivals succumbed much sooner and more often. Continental Airlines wrapped up its first bankruptcy case in 1986 and filed for a second time on Dec. 3, 1990, in the U.S. Bankruptcy Court for the District of Delaware in Wilmington, exiting April 27, 1993. When US Airways Group Inc. sought Chapter 11 protection on Aug. 11, 2002, in Alexandria, Va., it didn't have a prepackaged plan in place, but it had secured a $200 million equity investment to fund its reorganization plan, subject to higher and better offers, from Texas Pacific Group. It emerged on March 31, 2003, with an increased investment offer of $240 million from the Retirement Systems of Alabama, giving it a 37% stake in the reorganized airline.
United Air Lines Inc. parent UAL Corp. filed for Chapter 11 on Dec. 9, 2002, in Chicago, exiting on Feb. 1, 2006, with $3 billion in exit financing to fund its reorganization plan. United and Continental merged in 2010. US Airways filed for a second time on Sept. 12, 2004, and exited on Sept. 27, 2005, after it was acquired by America West Holdings Corp. for $850 million.
Delta Air Lines Inc. filed for Chapter 11 on Sept. 14, 2005, in Manhattan and exited on April 30, 2007, after reorganizing its business and obtaining $2.5 billion in exit financing. Northwest Airlines Corp. also filed in Manhattan on Sept. 14, 2005, and emerged on May 31, 2007, with $1.975 billion in exit financing. Delta and Northwest later merged in 2008.
AMR was the lone holdout, a tradition started by Crandall that Carty and Horton never wavered from. "I felt at the time [of Continental's first bankruptcy] that they should be forced to liquidate rather than cut costs and come back into the market with a huge cost advantage," Crandall says now. "It had nothing to do with the ethics or morality of the situation. By declaring bankruptcy in the 1980s, [Continental] gained a tremendous cost advantage to companies that didn't."
Some observers believe AMR's window of opportunity to file and steady its flight was early last decade. Crandall was out of the corner office, and the post-Sept. 11 recession and spiking oil prices caused almost every other airline to file for Chapter 11.
"American liked to keep control of the process, which is part of the reason they didn't file for bankruptcy protection back in 2003, when they had good reason to do so at that point," says CRT Capital's Derchin, who worked at AMR as the director of market planning in the 1970s. "They could have filed and, perhaps in hindsight, should have. But they opted not to, and instead [sought] voluntary concessions from its labor."
Arpey, who declined comment, shared Crandall's aversion to bankruptcy, but for different reasons. "Arpey is a very moral person, and he felt it was immoral for a company to declare bankruptcy," says one source. Another is more cynical, noting that he was AMR's 39th-largest shareholder and had millions of dollars on the line. "Arpey had a vested interest in keeping the company out of bankruptcy," this source says. "I don't believe that he voluntarily retired for one second. He was forced out."
Horton and Arpey, now a partner at Houston private equity firm Emerald Creek Group LLC, were at odds over which direction the company should go in, given Horton's comfort level with a bankruptcy filing. AMR's board of directors wanted to keep Arpey at the company in some capacity, but he stepped away and left because he didn't agree with the bankruptcy filing, the source says. Derchin says Arpey knew AMR needed a fresh start and walked away without severance.
Even Crandall, who agrees with Derchin that a filing should've probably been made years ago, says AMR had no choice. "All of their competitors had already declared bankruptcy and used bankruptcy to lower their costs," he says. "There was no way for [American Airlines] to compete. They can't have higher costs than their competitors and exist in the airline business. Every company has to do what its competitors have done to reduce costs."
Now the real work will begin. Because AMR avoided Chapter 11 for so long, when it finally did file it did so with "fewer scheduled passengers carried and a smaller fleet than either the Delta-Northwest and United-Continental restructured and consolidated carriers or Southwest," the unsecured creditors' committee wrote in court filings. In its own court documents, AMR notes that it has the highest operating costs today, compared with United, Delta and US Airways, and Derchin says union labor costs alone put AMR at an $800 million-a-year disadvantage to its rivals, meaning management must reduce labor costs, wages and pension obligations while increasing productivity.
From 2000 to 2010, AMR suffered almost $11.5 billion in net losses -- it made profits only in 2000, 2006 and 2007 -- because it had to keep prices competitive even while its costs were so much higher than rivals.
But not everyone is convinced. One source says that AMR likes to blame its problems on its labor costs, but what it doesn't publicize is that it does more maintenance on its planes in-house than other airlines, artificially inflating those expenses and keeping its vendor costs lower than its competitors.
Others agree. "Everyone has recognized that American's problem isn't a cost issue, it's a revenue issue," Association of Professional Flight Attendants president Laura Glading tells The Deal magazine. "They are hiding behind a cost issue, but if you look at the revenue, that's where they fall behind."
Glading has a point. In 2000, AMR had revenue of $19.7 billion; in 2010, it had almost $22.2 billion, or just 12.5% more. By contrast, Delta's revenue nearly doubled in the same time frame, to $31.75 billion in 2010 from $16.74 billion in 2000.
Allied Pilots Association spokesman Howie Schack notes that AMR did threaten to go the bankruptcy route in 2002 and went to its unions for help. The carrier achieved labor peace in 2004 by reaching new employee contracts with its three major unions -- the APA, APFA and the Transport Workers Union. The unions recognized AMR's financial stress and provided a significant five-year concessionary pay cut and agreed to other scheduling and benefit cuts in 2003 through new collective-bargaining agreements, Schack explains. Pilots absorbed a minimum 23% pay cut -- others took more -- with the proviso that their pay would be restored over a five-year period.
The APA has one CBA with the debtor, which covers 8,500 active American Airlines pilots. Compare that with the 25,000 employees at American Airlines and its American Eagle unit covered by 11 CBAs with the TWU, which has provided $620 million in concessions annually to AMR since 2003, according to TWU spokeswoman Jamie Horwitz. Those concessions for the TWU consisted of increased productivity and an agreement to help bring in third-party maintenance work to the airline, which would help the company raise hundreds of millions of dollars a year from doing work for other airlines.
The APFA, which represents almost 17,000 American Airlines flight attendants through one CBA, took 33% reductions in their packages, which cut pay, sick time and vacation and changed schedules. Glading says the company has received roughly $3 billion in concessions from the flight attendants since 2003.
AMR went through a "virtual bankruptcy" because the unions gave the company everything that others who went through bankruptcy did, Glading says. "We hoped that they could turn it around, but they couldn't," she says, blaming management's lack of a viable business plan during that time.
The pilots union contracts became amendable in 2008, and the debtor had been negotiating with them for five years, up until Nov. 11, when they stalled. Both parties put a final offer on the table in mid-November, and the deal was "very close to getting done," Schack says.
The TWU, whose CBAs were changeable in 2007, was even closer to reaching a deal with AMR, Horwitz notes. The union and the debtor reached a tentative agreement for its fleet service workers' CBAs at midnight on Oct. 25 that was about to be voted on. A deal with the dispatchers was reached on Nov. 13, but hadn't reached finalized voting, and although a deal with the mechanics had been voted down on Aug. 25, 2010, they were making progress on a new pact, he explains. In fact, the TWU thought it was making serious progress and moving toward completion of the contracts.
The only union not close to a deal seems to be the APFA, which had been negotiating a new CBA since May 1, 2008. The union and AMR haven't had a sit-down session since last spring because AMR has focused more on reaching a deal with its pilots, Glading says.
But Schack says AMR never told the pilots union that if they didn't take the latest offer -- a 3% to 7% raise over a three-year period through October 2015 -- that the company would end up in Chapter 11. "The company had a comprehensive proposal on the table prior to bankruptcy, and presented it as something they could live with," Schack says, noting that talks petered out because the pilots union felt that the 3% immediate raises were invalid because of the removal of certain premium pay for night and international flying.
On Feb. 1, AMR did make proposals to each of its three major unions. Still, when negotiations begin over the next few weeks, the air will be charged; one key element of each proposal is the termination of pension plans. Moreover, union contracts can be broken in bankruptcy -- it's one of the appeals of a filing -- and several bankrupt airlines have gotten court approval to do just that, the most recent being United's Chapter 11 case. But once a court grants the airline's rejection of a contract, the union involved and the carrier usually come to terms, Samorajczyk says.
AMR debtor counsel Harvey Miller of Weil, Gotshal & Manges LLP didn't return calls, while the carrier's corporate counsel at the firm, Thomas Roberts, refused comment. But both men shouldn't expect any kind of conciliatory tone from AMR's unions. The pilots, for one, have made sacrifices since 2003 and are now seeing their pension plan threatened.
AMR "didn't take advantage of the cost reductions during that time, so it's hard to be sympathetic," says Schack, who predicts talks could go badly. "We want to see success at American Airlines, and we want to see them quickly and successfully make a business plan to get them back to an industry-leading airline. We don't see giving another substantial pay cut and long-standing concessions as the solution."
As TWU president James C. Little put it in a statement on the day of AMR's filing, "This is likely to be a long and ugly process and our union will fight like hell to make sure that front line workers don't pay an unfair price for management failings."
What will make talks all the more bitter is the fact that, between 2003 and 2011, American Airlines executives were granted bonuses in excess of $100 million in some years when the unions were giving concessions, a situation union officials say was contrary to Arpey's "share the pain, share the gain" mantra.
But the union issue is just one of the things on AMR management's plate and isn't the sole key to its successful reorganization, a fact recognized by the carrier's creditors. "The committee understands that the debtors' reorganization cases are neither a labor transformation nor a debt recapitalization exercise; instead, transformation challenges surrounding revenue, city share, network, fleet, product, labor and capital structure must be creatively resolved," wrote the unsecured creditors' committee in a court filing.
Sabino of St. John's says AMR will have to use Chapter 11 to get "lean and mean" by discarding leases, modernizing its fleet and ridding itself of inefficiencies, in addition to renegotiating labor contracts. Debt, too, must be drastically trimmed. As of Sept. 30, the company had $10.9 billion in debt, which consists of $4.6 billion in secured variable and fixed-rate debt maturing through 2023. The interest rates on that debt vary from 1% to 13%. AMR also owes $2 billion on enhanced equipment trust certificates with maturities through 2021 that are priced from 5.1% to 12% per annum. There are $1.6 billion in revenue bonds maturing through 2036 that carry interest rates from 6% to 8.5%. AMR has $1 billion outstanding on 7.5% senior secured notes due 2016 with U.S. Bank NA as the trustee and Wilmington Trust Co. as the collateral trustee.
The company also has $460 million in 6.25% senior unsecured convertible notes due 2014. Wilmington Trust is the trustee on the unsecured notes as well. In addition, AMR owes $214 million on debentures priced at 9% to 10.2% that are due 2021, and $173 million in 7.88% to 10.55% notes due 2039.
Disputes with debtholders are likely. In fact, one early battleground may be AMR's $1 billion worth of 7.5% senior secured notes. Derchin says they are securitized by AMR's airport slots in London, Tokyo and Beijing, even though it's not clear that those are lienable assets because they are owned by municipal governments, not the company.
Then there's AMR's roughly $7.9 billion in unfunded pension liabilities. AMR has four benefit plans for 130,000 participants. In a court filing, the Pension Benefit Guaranty Corp. noted that "if all four plans terminated, the resulting liabilities assumed by the PBGC would constitute a multi-billion dollar loss, resulting in a PBGC claim of approximately $10 billion and lost benefits to plan participants in an amount PBGC estimates to be $1 billion." According to a Jan. 12 statement from PBGC director Josh Gotbaum, "counsel for American claims that it needs to kill its employees' pensions in order to be competitive with other major carriers."
The numbers tell a different story: Delta Airlines, which reorganized in bankruptcy, pays an average of $13,210 per employee in pension costs -- almost two-thirds more than American's prebankruptcy cost of $8,102.
With the PBGC joining the fight on the side of the unions, AMR will have another negotiating slog to deal with. But deal with it it must. "The critical issue is getting their labor costs and pensions competitive," Derchin says. "Until they do that, they won't be in a rush to exit [from bankruptcy]."
Operationally, AMR needs to replace its old gas-guzzling fleet with a newer, fuel-efficient one. As of Nov. 1, the airline had a fleet of more than 600 jet aircraft and provided 1,800 daily departures to its 160 destinations. American Eagle has a fleet of 300 aircraft and provides 1,500 daily departures to more than 175 destinations in North America, Mexico and the Caribbean.
Management dealt with a big part of this rebuild on July 20, when it announced that it had placed a $38 billion order to acquire 460 narrow-body, single-aisle aircraft from Boeing Co. and Airbus SAS beginning in 2013 and extending through 2022. Besides that equipment, Judge Sean Lane approved procedures on Dec. 22 in the Manhattan bankruptcy court enabling AMR to buy 32 Boeing aircraft right away. "American could go from having one of the oldest fleets to one of the youngest in the industry," Derchin says.
Lastly, AMR will have to take stock of its various leases and decide which ones to keep or break -- another bankruptcy perk. The airline has 903 aircraft leases for its mainline and regional service, including American Eagle, but it has made decisions on only 19% of them, according to a Jan. 20 analyst report from Michael Linenberg at Deutsche Bank AG.
Then there are hundreds more ground leases at airports that must be dealt with. Deciding which aircraft and ground leases to assume, reject or renegotiate will be tricky, Derchin says, because the task will be time consuming and can get contentious.
But Horton has already tried to rally the troops, noting in a Dec. 15 letter to employees that the work ahead "will undoubtedly be a path with many twists and turns -- much will be unpredictable and we'll have to confront challenges as they come."
He also wrote that AMR would retain its fierce independence. "There will be outside parties who may try to knock us off our path. Some will say we should shrink the company dramatically, close hubs and lay off thousands more to create the greatest value for creditors. Some will say the company should be sold or broken up. And as we've seen before in this industry, there may be opportunists who wish to acquire our company while we are in this situation."
Horton didn't have to wait long to be proved right. On Jan. 25, US Airways confirmed that it had retained advisers to explore a potential bid for AMR. History does argue that such a merger will happen, the pattern being that a carrier spends time in Chapter 11 and is either bought while still in it or shortly thereafter.
The most recent occurrence was in 2010, when Continental merged with United, which had exited Chapter 11 four years earlier. Usually, it doesn't take long. Northwest emerged from bankruptcy on May 31, 2007; Delta completed its acquisition of Northwest on Oct. 29, 2008. US Airways fell into the Chapter 11 breach itself and was bought out through an acquisition by America West Holdings, with the merged carrier keeping the US Airways name.
Derchin gets the sense AMR wants to stay independent and isn't entertaining a merger or asset sales. But not entering into a marriage with a healthy carrier will be hard to resist, given that most watchers predict that an AMR reorganization will be drawn out and difficult. Indeed, the airline could become the best argument for why future debtors shouldn't resist putting together a prepackaged bankruptcy.
"The speed with which the company can address the union contracts will affect how fast it can reorganize," says Jeffrey Erler, a bankruptcy attorney at Bell Nunnally & Martin LLP who's not involved in the case. (Besides other lawyers in the case already mentioned, counsel to the official committee of unsecured creditors, including Jack Butler and others at Skadden, Arps, Slate, Meagher & Flom LLP, declined comment.) "Once everyone has sufficiently beaten their chest, cooler heads will prevail and arrive at a sensible solution."