Uncharted Courses

American's Chapter 11 case appears designed largely to deal with its labor costs ' a goal similar to that of its competitors. BAPCPA did not make major changes to the provisions of the Bankruptcy Code relating to Collective Bargaining Agreements or retirement benefits. Accordingly, there will be some similarities between American's bankruptcy and those of other airlines. However, several factors differentiate American's Chapter 11 case from the other major airlines bankruptcies. These factors include:

• “503(b)(9) Priority Claims”;
• Shortened “Exclusivity”;
• American's planned near-simultaneous upgrade of its air fleets;
• Consumer perceptions and competition; and
• Changes in the exit financing market and reorganization strategies.

Changes in the law, technology and business since September 2005 will ultimately influence the outcome of American's case.

503(b)(9) Priority Claims

Under BAPCPA, creditors that supply goods to the Debtor within 20 days of the bankruptcy have administrative priority claims. Those claims are officially the highest priority unsecured claim, junior only to secured claims. Prior to BAPCPA, such creditors only had reclamation rights that had little value, as they were subordinate to any creditor with a security interest in the Debtor's inventory. In practical reality, 503(b)(9) claims often are subordinated to restructuring expenses (professional fees) and ongoing business expenses arising during the Chapter 11 case. Nevertheless, 503(b)(9) claims create a major barrier to confirmation of a Chapter 11 Plan.

These claims are material. Based on American's last pre-bankruptcy 10-Q filed with the SEC, American appears to buy more then $500MM in food and fuel every 20 days. Therefore, 503(b)(9) claims for those two categories alone likely would total more than a half-billion dollars! In addition, aircraft parts, supplies and myriad other goods necessary to run an airline would also be given 503(b)(9) priority. Under the Bankruptcy Code, if American confirmed a Chapter 11 Plan of Reorganization, the full amount of all 503(b)(9) claims ' likely well over $500MM ' would be due on the effective date of the plan. It should be noted that there are practical ways of modifying this strict Code requirement. Often, suppliers will agree to deferred payment terms or post-bankruptcy credit that may avoid the payment of a large lump sum. But, if American confirms a Chapter 11 plan, it will ultimately have to pay in full well over $500 MM in claims that the other airlines could modify. This is one of the factors that has lead to changes in the exit financing and reorganization markets described below.

Shortened Exclusivity

While most major airlines have exited bankruptcy in approximately 18 months, some have taken longer. The best example is United Airlines, which filed Chapter 11 on Dec. 9, 2002 and only emerged more than three years later, on Feb. 1, 2006.

In other industries, companies with significant collective bargaining issues have taken a long time to emerge from Chapter 11. For example, Delphi filed Chapter 11 on Oct. 8, 2005 (immediately before BAPCPA took effect) and emerged almost exactly four years later, on Oct. 6, 2009. Delphi took approximately 20 months to resolve its union issues, and 28 months to resolve other issues necessary to its reorganization.

American will not have the luxury of time granted similarly large companies. Instead, BAPCPA put a soft cap on the length of Chapter 11 reorganizations by limiting a debtor's exclusive right to file a plan of reorganization to, at most, 18 months (with 20 months as the maximum to confirm the plan). If “exclusivity” expires, any party in interest could file its own plan of reorganization for American and present this plan to the court and creditors. Therefore, while BAPCPA's cap on exclusivity does not absolutely bar American from passing the 20-month barrier, American will do everything in its power to file a plan within this time limit. American will feel more pressure to confirm its plan quickly than its competitors felt. This pressure may force the airline to divide its focus between issues with its unions and issues relating to exit from bankruptcy.

Change in Airfleets

On July 20, 2011, American placed orders for 460 new airliners and took options for another 465. The orders were for newer, upgraded and more fuel-efficient airliners like the Boeing 737 Next Generation, the Boeing 737 Max and planes in the Airbus 320 and 320neo family. While the other major airlines had pending orders for new aircraft at the time they entered bankruptcy, American is revamping a major portion of its fleet, replacing more than half of its airliners within the next two to three years.

Bankruptcy provides multiple avenues to dispose of unwanted aircraft:

• Rejection of leases of aircraft;
• Abandonment of owned aircraft, usually used where there is a purchase money security interest on the plane that exceeds the plane's value; or
• Sales free of liens under ' 363 of the Bankruptcy Code.

If American exercises these remedies, lessors or purchase money secured creditors could be left with only unsecured claims against the estate. At the same time, American also has flexibility with its new orders. While it may wish to comfort its vendors (Boeing and Airbus) and lenders that it will be able to fulfill its major commitments for new aircraft, American retains the ability to reject some or all of its contracts for the new aircraft if business conditions change (again at the cost of only an unsecured claim).

American may have increased difficulty funding its fleet transition while in bankruptcy. But, if it is able to find financing, bankruptcy will provide it with major advantages that other carriers did not possess, as it will be able to upgrade to more efficient aircraft without some of the major transition costs.

Flying Solo

Another important distinction between American's bankruptcy and those of its competitors arises because American is flying solo. In September 2005, four of the nation's seven major carriers were in bankruptcy. Public perception tends to view businesses operating in Chapter 11 as risky ' both because you might not want to book travel on a bankrupt airline six months in advance, or because you feel that a financially struggling airline might cut corners on passenger comfort or aircraft maintenance. Some of these fears are illogical (American is not likely to skimp on maintenance), while some may be rational (booking flights too far in advance may be risky). But, for a variety of reasons, if given a choice, many consumers will choose a non-bankrupt airline.

In September 2005, few of us had a choice. If you were flying to or from one of the four major bankrupt airlines' service hubs, you could not avoid flying a “bankrupt” airline, whatever your perception of the risks and costs involved might have been. In 2011, however, American is the only carrier of any size with a pending Chapter 11 case. Further, American faces competition in three of its five hub markets (New York, Los Angeles and Chicago). Only in Dallas and Miami is American the sole major carrier. Accordingly, the airline faces real competition and its bankruptcy may cost it customers.

In addition, the attorneys and courts (as well as the union) handling the other airlines were aware of the parallel processes occurring in other courts and could learn (and follow) each other. American's professionals are alone.

Changes in the Exit Financing Market and
Reorganization Strategies

Even prior to the enactment of BAPCPA, the market began favoring 363 asset sales free and clear of liens (often to a newly formed shell company known as a “Newco”) over plans of reorganization for the following reasons:

• An asset sale does not require creditor approval or a costly disclosure statement;
• The standard for approval of an asset sale is far more lenient than the many requirements to confirm a plan;
• The valuation of the business in an asset sale does not have to account for all goodwill based on projected business opportunities. Instead, it merely has to be the highest present value that a neutral party would pay;
• A 363 sales separates the operating assets of a bankrupt company from its residual liabilities;
• It can be completed much more quickly than a Chapter 11 plan; and
• The sale can be to a new shell company controlled by old management, and/or parties selected by the key parties in interest in the case.

BAPCPA has increased this trend, both by shortening exclusivity (enhancing the premium on speed) and through the introduction of 503(b)(9) claims, which greatly increase the cost of a confirmed plan.

The credit crunch and the current Great Recession further accelerated this trend. It is difficult enough to find exit financiers or equity investors willing to support a new company operating with the Debtor's old assets ' it is nearly impossible to find financiers willing to make loans that will be used to pay old debts.

Finally, the federal government gave the 363 sale to a Newco its stamp of approval through its sponsorship of the General Motors and Chrysler bankruptcies ' both of which were extreme examples of this trend. As a result, American is far less likely to seek to confirm a Chapter 11 plan and is far more likely than its competitors to seek to be acquired, either by a competitor, or by some new shell company. In doing so, it may preserve the advantages of bankruptcy that existed in 2005, without confronting the disadvantages to reorganization created by BAPCPA.

Max J. Newman is a shareholder of Butzel Long, based in the Bloomfield Hills, MI, office. Mr. Newman concentrates his practice in the representation of debtors, creditors committees, creditors and customers in all aspects of Chapter 11 reorganizations. He may reached at [email protected].

On Sept. 14, 2005, Delta and Northwest Airlines filed Chapter 11 cases, putting four of the seven then-existing major U.S. airlines at that time in Chapter 11 simultaneously (United and U.S. Airways were also in Chapter 11 then). One factor that dictated the timing of Delta's and Northwest's cases was beating the effective date of the major Bankruptcy Code Amendments (the BAPCPA), which applied to all cases filed on or after Oct. 17, 2005.

Although it faced many similar issues in 2005, American Airlines chose not to join its competitors in pre-BAPCPA filings. However, citing competitive disadvantages in its cost structure (as well as high fuel prices and customer pressures), American did file Chapter 11 on Nov. 29, 2011.

No major airline has filed Chapter 11 since the effective date of BAPCPA. Further, of the ten smaller airlines that filed Chapter 11 since that date, eight of them wound up discontinuing operations ' only two (Frontier Airlines and Sun Country Airlines) successfully emerged from Chapter 11 as operating airlines.

American's Chapter 11 case appears designed largely to deal with its labor costs ' a goal similar to that of its competitors. BAPCPA did not make major changes to the provisions of the Bankruptcy Code relating to Collective Bargaining Agreements or retirement benefits. Accordingly, there will be some similarities between American's bankruptcy and those of other airlines. However, several factors differentiate American's Chapter 11 case from the other major airlines bankruptcies. These factors include:

• “503(b)(9) Priority Claims”;
• Shortened “Exclusivity”;
• American's planned near-simultaneous upgrade of its air fleets;
• Consumer perceptions and competition; and
• Changes in the exit financing market and reorganization strategies.

Changes in the law, technology and business since September 2005 will ultimately influence the outcome of American's case.

503(b)(9) Priority Claims

Under BAPCPA, creditors that supply goods to the Debtor within 20 days of the bankruptcy have administrative priority claims. Those claims are officially the highest priority unsecured claim, junior only to secured claims. Prior to BAPCPA, such creditors only had reclamation rights that had little value, as they were subordinate to any creditor with a security interest in the Debtor's inventory. In practical reality, 503(b)(9) claims often are subordinated to restructuring expenses (professional fees) and ongoing business expenses arising during the Chapter 11 case. Nevertheless, 503(b)(9) claims create a major barrier to confirmation of a Chapter 11 Plan.

These claims are material. Based on American's last pre-bankruptcy 10-Q filed with the SEC, American appears to buy more then $500MM in food and fuel every 20 days. Therefore, 503(b)(9) claims for those two categories alone likely would total more than a half-billion dollars! In addition, aircraft parts, supplies and myriad other goods necessary to run an airline would also be given 503(b)(9) priority. Under the Bankruptcy Code, if American confirmed a Chapter 11 Plan of Reorganization, the full amount of all 503(b)(9) claims ' likely well over $500MM ' would be due on the effective date of the plan. It should be noted that there are practical ways of modifying this strict Code requirement. Often, suppliers will agree to deferred payment terms or post-bankruptcy credit that may avoid the payment of a large lump sum. But, if American confirms a Chapter 11 plan, it will ultimately have to pay in full well over $500 MM in claims that the other airlines could modify. This is one of the factors that has lead to changes in the exit financing and reorganization markets described below.

Shortened Exclusivity

While most major airlines have exited bankruptcy in approximately 18 months, some have taken longer. The best example is United Airlines, which filed Chapter 11 on Dec. 9, 2002 and only emerged more than three years later, on Feb. 1, 2006.

In other industries, companies with significant collective bargaining issues have taken a long time to emerge from Chapter 11. For example, Delphi filed Chapter 11 on Oct. 8, 2005 (immediately before BAPCPA took effect) and emerged almost exactly four years later, on Oct. 6, 2009. Delphi took approximately 20 months to resolve its union issues, and 28 months to resolve other issues necessary to its reorganization.

American will not have the luxury of time granted similarly large companies. Instead, BAPCPA put a soft cap on the length of Chapter 11 reorganizations by limiting a debtor's exclusive right to file a plan of reorganization to, at most, 18 months (with 20 months as the maximum to confirm the plan). If “exclusivity” expires, any party in interest could file its own plan of reorganization for American and present this plan to the court and creditors. Therefore, while BAPCPA's cap on exclusivity does not absolutely bar American from passing the 20-month barrier, American will do everything in its power to file a plan within this time limit. American will feel more pressure to confirm its plan quickly than its competitors felt. This pressure may force the airline to divide its focus between issues with its unions and issues relating to exit from bankruptcy.

Change in Airfleets

On July 20, 2011, American placed orders for 460 new airliners and took options for another 465. The orders were for newer, upgraded and more fuel-efficient airliners like the Boeing 737 Next Generation, the Boeing 737 Max and planes in the Airbus 320 and 320neo family. While the other major airlines had pending orders for new aircraft at the time they entered bankruptcy, American is revamping a major portion of its fleet, replacing more than half of its airliners within the next two to three years.

Bankruptcy provides multiple avenues to dispose of unwanted aircraft:

• Rejection of leases of aircraft;
• Abandonment of owned aircraft, usually used where there is a purchase money security interest on the plane that exceeds the plane's value; or
• Sales free of liens under ' 363 of the Bankruptcy Code.

If American exercises these remedies, lessors or purchase money secured creditors could be left with only unsecured claims against the estate. At the same time, American also has flexibility with its new orders. While it may wish to comfort its vendors (Boeing and Airbus) and lenders that it will be able to fulfill its major commitments for new aircraft, American retains the ability to reject some or all of its contracts for the new aircraft if business conditions change (again at the cost of only an unsecured claim).

American may have increased difficulty funding its fleet transition while in bankruptcy. But, if it is able to find financing, bankruptcy will provide it with major advantages that other carriers did not possess, as it will be able to upgrade to more efficient aircraft without some of the major transition costs.

Flying Solo

Another important distinction between American's bankruptcy and those of its competitors arises because American is flying solo. In September 2005, four of the nation's seven major carriers were in bankruptcy. Public perception tends to view businesses operating in Chapter 11 as risky ' both because you might not want to book travel on a bankrupt airline six months in advance, or because you feel that a financially struggling airline might cut corners on passenger comfort or aircraft maintenance. Some of these fears are illogical (American is not likely to skimp on maintenance), while some may be rational (booking flights too far in advance may be risky). But, for a variety of reasons, if given a choice, many consumers will choose a non-bankrupt airline.

In September 2005, few of us had a choice. If you were flying to or from one of the four major bankrupt airlines' service hubs, you could not avoid flying a “bankrupt” airline, whatever your perception of the risks and costs involved might have been. In 2011, however, American is the only carrier of any size with a pending Chapter 11 case. Further, American faces competition in three of its five hub markets (New York, Los Angeles and Chicago). Only in Dallas and Miami is American the sole major carrier. Accordingly, the airline faces real competition and its bankruptcy may cost it customers.

In addition, the attorneys and courts (as well as the union) handling the other airlines were aware of the parallel processes occurring in other courts and could learn (and follow) each other. American's professionals are alone.

Changes in the Exit Financing Market and
Reorganization Strategies

Even prior to the enactment of BAPCPA, the market began favoring 363 asset sales free and clear of liens (often to a newly formed shell company known as a “Newco”) over plans of reorganization for the following reasons:

• An asset sale does not require creditor approval or a costly disclosure statement;
• The standard for approval of an asset sale is far more lenient than the many requirements to confirm a plan;
• The valuation of the business in an asset sale does not have to account for all goodwill based on projected business opportunities. Instead, it merely has to be the highest present value that a neutral party would pay;
• A 363 sales separates the operating assets of a bankrupt company from its residual liabilities;
• It can be completed much more quickly than a Chapter 11 plan; and
• The sale can be to a new shell company controlled by old management, and/or parties selected by the key parties in interest in the case.

BAPCPA has increased this trend, both by shortening exclusivity (enhancing the premium on speed) and through the introduction of 503(b)(9) claims, which greatly increase the cost of a confirmed plan.

The credit crunch and the current Great Recession further accelerated this trend. It is difficult enough to find exit financiers or equity investors willing to support a new company operating with the Debtor's old assets ' it is nearly impossible to find financiers willing to make loans that will be used to pay old debts.

Finally, the federal government gave the 363 sale to a Newco its stamp of approval through its sponsorship of the General Motors and Chrysler bankruptcies ' both of which were extreme examples of this trend. As a result, American is far less likely to seek to confirm a Chapter 11 plan and is far more likely than its competitors to seek to be acquired, either by a competitor, or by some new shell company. In doing so, it may preserve the advantages of bankruptcy that existed in 2005, without confronting the disadvantages to reorganization created by BAPCPA.

Max J. Newman is a shareholder of Butzel Long, based in the Bloomfield Hills, MI, office. Mr. Newman concentrates his practice in the representation of debtors, creditors committees, creditors and customers in all aspects of Chapter 11 reorganizations. He may reached at [email protected].