Pinnacle Airlines' Chapter 11

Pinnacle's primary customer is Delta Airlines (“Delta”). As of the Petition Date, Delta had three capacity purchase agreements with Delta (the “CPAs”). The Capacity Purchase Agreements pay Pinnacle a fixed fee based on each departure, flight hour and block hour (essentially accounting for taxi time and other ground operations). The CPAs also compensate Pinnacle for fuel, maintenance, ground handling and other costs. While Pinnacle also currently flies passengers for United Airlines and, to a lesser extent, US Airways, it anticipates winding down those services during 2012. Pinnacle maintains a fleet of 197 Bombardier Jets to cover services to Delta. At the present time, it is still operating some remaining turboprop aircraft serving United and US Airways. Its aircraft were primarily financed by Export Development Canada (“EDC”), although Delta also funded some of its aircraft. Pinnacle's aircraft spare parts and engines were financed by CIT Leasing.

The airline blames competitive pressures on regional carriers, coupled with increased fuel costs and reduced margins, for its bankruptcy. It is concerned, particularly, about delays integrating its operations with those of Mesaba, another regional carrier it acquired in 2011, as well as unprofitable customer contracts, poor operational performance and issues related to its collective bargaining agreement with its pilots' union. Pinnacle specifically mentions seniority rules which cause retraining and re-basing expenses as its senior pilots choose new routes. However, it is clear that Pinnacle also seeks to reduce employee wages and benefits as well as challenging work rules.

Pinnacle's current customer contracts are not profitable and Pinnacle has been operating at a growing loss prior to bankruptcy. In order to correct its operations, it has decided to focus all of its operations on two renegotiated CPAs with Delta. The balance of Pinnacle's operations will not be continued after December, 2012.

The Delta Relationship

Unlike many of its competitors that have filed in the last few years, Pinnacle has a leg-up on survival. Specifically, it has an agreement with its key customer, Delta, on the terms of a partial Plan. Other than a result of financing, however, the terms of the Plan are not specific and are contingent on a number of factors, not all of which are within Pinnacle's control. As part of the overall plan for Pinnacle, Delta also agreed to modify its CPAs with the struggling airline. One CPA was terminated altogether, while the two remaining CPAs have been renegotiated to change the reimbursement rates and to remove rate reductions that would have taken effect in the existing agreements.

Delta's relationship with Pinnacle establishes certain parameters for all parties-in-interest. As a result of the court's approval of post-petition financing from Delta, the latter is now Pinnacle's lender, pre- and post-petition secured creditor, only major customer, de facto plan co-sponsor, and unsecured creditor. Delta's role is critical, as Pinnacle is winding down relationships with its only other customers, leaving Delta as its sole customer.

Delta's role actually expands during the case. In order to exit Chapter 11, Pinnacle will require exit financing. However, the exit financing market remains weak, and the many risk factors inherent in regional air operations makes Pinnacle a difficult candidate for exit financing. Ultimately, after approaching 18 different parties for financing, Delta offered the most reasonable terms. The Unsecured Creditors Committee negotiated changes to Delta's financing, seeking limited relief to enhance its investigative power and extend certain deadlines. Ultimately, the financing agreements were modified in limited ways, extending the deadlines for Pinnacle to perform certain actions and reducing certain payments by Pinnacle.

Exit Financing

The major objection to Delta's financing came from the USW, which asserted that the proposed financing amounted to a de facto or sub rosa plan, depriving parties-in-interest of critical rights at the very commencement of the case and providing Delta with too much control over Pinnacle's bankruptcy. The USW's objections were overruled and the court approved the Delta financing, as modified by agreement with the Committee.

Delta has agreed to provide exit financing, if Pinnacle is: 1) able to establish a business plan; 2) negotiate union concessions; 3) modify its payments to the EDC and other prepetition creditors for its aircraft; and 4) reach overall agreements with creditors that are acceptable to Delta. The latter must be “reasonable” in determining whether union concessions and other creditor agreements are acceptable to it, and the court will determine if Delta's rejection of any such agreements is “reasonable.” Although Delta apparently is not seeking to acquire Pinnacle itself, it is hard to overstate its role in this case.

Delta is not making loans, or renegotiating its CPAs out of the goodness of its heart, nor out of a desire to become a lender to other airlines. Although Delta is making a good return on its loan (12.5%), it is making its loan and other accommodations to Pinnacle because it believes that it can use Pinnacle as its lowest-cost supplier to provide regional service to its customers and that Delta is best off if Pinnacle remains independent. As Delta is Pinnacle's only remaining customer, all other interests in the case need to recognize that they alienate Delta at the risk of forcing a liquidation of Pinnacle. At the same time, however, the only real leverage that creditors and parties-in-interest have comes from threats to Delta's business interests. If Delta wants to keep Pinnacle alive, and if Pinnacle has no customers other than Delta, the “deal” for creditors can only be improved if Delta sees a risk to its business strategy in this case.

Impact of Delta Relationship on Other Parties-in-Interest and the Case

The outlines of the economics of the case are established by Pinnacle's arrangements with Delta. Pinnacle's revenue will be generated entirely by its new contracts with Delta. At the same time, Pinnacle's near-term cost of operating capital will be the 12.5% charged by Delta. While Delta needs Pinnacle to provide regional service, the balance of leverage strongly favors Delta unless it can be upset by a credible threat to Delta's business interests. By reaching agreement with Delta, and unless the economic terms of that agreement can be altered by a credible threat, Pinnacle has taken major steps to resolve one of the two core issues of every bankruptcy case ' how much money is going to be available for distribution.

Of course, some issues remain that will determine ultimately how much is available for distribution, including factors such as fuel costs and consumer demand. Moreover, other factors remain within Pinnacle's control, including the sale or rejection of excess aircraft, the wind-down of operations for United and US Airways and other cost-cutting measures. Still, the most major decisions impacting on the Debtor's future revenue, as well as its future interest expense, have been already established.

The only way this calculus may be upset is through a threat to Delta's business interests. A threat could come in one of three ways. The first would be through locating a credible merger partner for Pinnacle that was strong enough to be independent of the Delta relationship. Unfortunately, the likelihood of finding such a merger partner is slim, as most smaller airlines seem to reducing capacity, rather than expanding. A second threat would come if creditors sought the liquidation of Pinnacle. However, many of Pinnacle's creditors are not well-served by liquidation, as vendors wish to retain a customer and unionized employees wish to retain their jobs. While a threat of liquidation may upset Delta's plans, it is unclear if a serious, credible threat can be made that would be sufficient to cause Delta to adjust the terms of its agreements with Pinnacle.

Finally, the union bargaining process may yield results which force a change in the structure of the deal. If the union contracts are more expensive, Delta is likely to try to force other constituencies to absorb those costs. However, it is possible that there is a minimum distribution that Delta would want to maintain, forcing it to absorb some portion of employee costs.

Assuming that Pinnacle does not suffer any operating reverses, and that Delta goes forward with its expressed intention of providing exit financing on the current program, the rest of this case is likely to focus on a zero-sum game over the other core issue in all bankruptcy cases ' who gets the available money. Claimants include Delta, Pinnacle's unions (and their constituency, employees), secured creditors and unsecured creditors. While Pinnacle remains the Debtor-in-Possession, in control of the agenda of its Chapter 11 case, the decisions it makes from this point forward impact third parties far more than on Pinnacle's survival.

The Unions

Pinnacle's unions are major players in this zero-sum game. The Delta exit financing requires savings on Pinnacle's union contracts as Pinnacle is obligated to seek wage reductions and other concessions from its labor unions. Unlike secured creditors, whose distribution will be determined based on the value of their collateral and a “fair and equitable” term for repayment determined either by negotiations or by the court under Section 1129(b)(2)(A) of the Bankruptcy Code, the unions do not have any fixed standards establishing future wage and labor conditions.

Under Section 1113 of the Bankruptcy Code, Pinnacle has the legal right to reject its labor contracts if it can show that its proposals to the unions are necessary to ensure an exit from bankruptcy and that all parties (including creditors and the EDC) must be treated fairly and equitably. Implicit in the Code is the conclusion that, because the Code requires some distributions to creditors, “fair and equitable” with respect to labor contracts requires Pinnacle maintain sufficient operating income to fund payments to other creditors. In other words, unless Pinnacle's post-bankruptcy operations greatly exceed expectations due to enhanced consumer demand, the distributions to other creditors will come, in part, from concessions made by (or required of) the Union.

This means that every concession from the union benefits creditors. Similarly, most preserved employee benefits will increase Pinnacle's costs and reduce the amount available for unsecured creditors.

Conclusion

The good news for Pinnacle's creditors is that it seems likely that their flight will arrive, after (of course) a reasonable delay. The bad news is that Delta has filled the first-class seats. Worse still, the premium coach seats have been taken by secured creditors, and Pinnacle's general creditors are fighting for the center seats with the unions and other parties-in-interest. Upgrades on this flight may not be available, and will depend on creditors' ability to find some leverage sufficient to make Delta leave the comfort of first class and enjoy the pleasures of coach.

Max J. Newman is a shareholder of Butzel Long, based in its Bloomfield Hills, MI office. 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 April 1, 2012, Pinnacle Airlines became the 11th smaller airline to file Chapter 11 since the Oct. 17, 2005, effective date of major amendments to the Bankruptcy Code (“BAPCPA”). Eight of the ten prior smaller airlines wound up discontinuing operations or being acquired, but Pinnacle seeks to buck that trend and continue operating under its existing name. In order to do so, it has reached an agreement with its critical customer, Delta Airlines (“Delta”) on a partially-prepackaged plan. Pinnacle's bankruptcy represents an example of a case where one third-party's interests ' in this case, Delta ' dominate the reorganization proceedings. Although Delta's agreement with Pinnacle does not specify the treatment required of other creditors and parties-in-interest, the framework created by the agreement leaves other parties-in-interest, especially Pinnacle's unions, only a narrow boundary for adjusting their interests.

About Pinnacle

Pinnacle is a regional airline, headquartered in Memphis, TN. It employs more than 7,500 in its operations, flying more than 1,300 flights daily. Pinnacle's flights provide transportation between hubs and smaller cities for passengers ticketed by major carriers.

Pinnacle's primary customer is Delta Airlines (“Delta”). As of the Petition Date, Delta had three capacity purchase agreements with Delta (the “CPAs”). The Capacity Purchase Agreements pay Pinnacle a fixed fee based on each departure, flight hour and block hour (essentially accounting for taxi time and other ground operations). The CPAs also compensate Pinnacle for fuel, maintenance, ground handling and other costs. While Pinnacle also currently flies passengers for United Airlines and, to a lesser extent, US Airways, it anticipates winding down those services during 2012. Pinnacle maintains a fleet of 197 Bombardier Jets to cover services to Delta. At the present time, it is still operating some remaining turboprop aircraft serving United and US Airways. Its aircraft were primarily financed by Export Development Canada (“EDC”), although Delta also funded some of its aircraft. Pinnacle's aircraft spare parts and engines were financed by CIT Leasing.

The airline blames competitive pressures on regional carriers, coupled with increased fuel costs and reduced margins, for its bankruptcy. It is concerned, particularly, about delays integrating its operations with those of Mesaba, another regional carrier it acquired in 2011, as well as unprofitable customer contracts, poor operational performance and issues related to its collective bargaining agreement with its pilots' union. Pinnacle specifically mentions seniority rules which cause retraining and re-basing expenses as its senior pilots choose new routes. However, it is clear that Pinnacle also seeks to reduce employee wages and benefits as well as challenging work rules.

Pinnacle's current customer contracts are not profitable and Pinnacle has been operating at a growing loss prior to bankruptcy. In order to correct its operations, it has decided to focus all of its operations on two renegotiated CPAs with Delta. The balance of Pinnacle's operations will not be continued after December, 2012.

The Delta Relationship

Unlike many of its competitors that have filed in the last few years, Pinnacle has a leg-up on survival. Specifically, it has an agreement with its key customer, Delta, on the terms of a partial Plan. Other than a result of financing, however, the terms of the Plan are not specific and are contingent on a number of factors, not all of which are within Pinnacle's control. As part of the overall plan for Pinnacle, Delta also agreed to modify its CPAs with the struggling airline. One CPA was terminated altogether, while the two remaining CPAs have been renegotiated to change the reimbursement rates and to remove rate reductions that would have taken effect in the existing agreements.

Delta's relationship with Pinnacle establishes certain parameters for all parties-in-interest. As a result of the court's approval of post-petition financing from Delta, the latter is now Pinnacle's lender, pre- and post-petition secured creditor, only major customer, de facto plan co-sponsor, and unsecured creditor. Delta's role is critical, as Pinnacle is winding down relationships with its only other customers, leaving Delta as its sole customer.

Delta's role actually expands during the case. In order to exit Chapter 11, Pinnacle will require exit financing. However, the exit financing market remains weak, and the many risk factors inherent in regional air operations makes Pinnacle a difficult candidate for exit financing. Ultimately, after approaching 18 different parties for financing, Delta offered the most reasonable terms. The Unsecured Creditors Committee negotiated changes to Delta's financing, seeking limited relief to enhance its investigative power and extend certain deadlines. Ultimately, the financing agreements were modified in limited ways, extending the deadlines for Pinnacle to perform certain actions and reducing certain payments by Pinnacle.

Exit Financing

The major objection to Delta's financing came from the USW, which asserted that the proposed financing amounted to a de facto or sub rosa plan, depriving parties-in-interest of critical rights at the very commencement of the case and providing Delta with too much control over Pinnacle's bankruptcy. The USW's objections were overruled and the court approved the Delta financing, as modified by agreement with the Committee.

Delta has agreed to provide exit financing, if Pinnacle is: 1) able to establish a business plan; 2) negotiate union concessions; 3) modify its payments to the EDC and other prepetition creditors for its aircraft; and 4) reach overall agreements with creditors that are acceptable to Delta. The latter must be “reasonable” in determining whether union concessions and other creditor agreements are acceptable to it, and the court will determine if Delta's rejection of any such agreements is “reasonable.” Although Delta apparently is not seeking to acquire Pinnacle itself, it is hard to overstate its role in this case.

Delta is not making loans, or renegotiating its CPAs out of the goodness of its heart, nor out of a desire to become a lender to other airlines. Although Delta is making a good return on its loan (12.5%), it is making its loan and other accommodations to Pinnacle because it believes that it can use Pinnacle as its lowest-cost supplier to provide regional service to its customers and that Delta is best off if Pinnacle remains independent. As Delta is Pinnacle's only remaining customer, all other interests in the case need to recognize that they alienate Delta at the risk of forcing a liquidation of Pinnacle. At the same time, however, the only real leverage that creditors and parties-in-interest have comes from threats to Delta's business interests. If Delta wants to keep Pinnacle alive, and if Pinnacle has no customers other than Delta, the “deal” for creditors can only be improved if Delta sees a risk to its business strategy in this case.

Impact of Delta Relationship on Other Parties-in-Interest and the Case

The outlines of the economics of the case are established by Pinnacle's arrangements with Delta. Pinnacle's revenue will be generated entirely by its new contracts with Delta. At the same time, Pinnacle's near-term cost of operating capital will be the 12.5% charged by Delta. While Delta needs Pinnacle to provide regional service, the balance of leverage strongly favors Delta unless it can be upset by a credible threat to Delta's business interests. By reaching agreement with Delta, and unless the economic terms of that agreement can be altered by a credible threat, Pinnacle has taken major steps to resolve one of the two core issues of every bankruptcy case ' how much money is going to be available for distribution.

Of course, some issues remain that will determine ultimately how much is available for distribution, including factors such as fuel costs and consumer demand. Moreover, other factors remain within Pinnacle's control, including the sale or rejection of excess aircraft, the wind-down of operations for United and US Airways and other cost-cutting measures. Still, the most major decisions impacting on the Debtor's future revenue, as well as its future interest expense, have been already established.

The only way this calculus may be upset is through a threat to Delta's business interests. A threat could come in one of three ways. The first would be through locating a credible merger partner for Pinnacle that was strong enough to be independent of the Delta relationship. Unfortunately, the likelihood of finding such a merger partner is slim, as most smaller airlines seem to reducing capacity, rather than expanding. A second threat would come if creditors sought the liquidation of Pinnacle. However, many of Pinnacle's creditors are not well-served by liquidation, as vendors wish to retain a customer and unionized employees wish to retain their jobs. While a threat of liquidation may upset Delta's plans, it is unclear if a serious, credible threat can be made that would be sufficient to cause Delta to adjust the terms of its agreements with Pinnacle.

Finally, the union bargaining process may yield results which force a change in the structure of the deal. If the union contracts are more expensive, Delta is likely to try to force other constituencies to absorb those costs. However, it is possible that there is a minimum distribution that Delta would want to maintain, forcing it to absorb some portion of employee costs.

Assuming that Pinnacle does not suffer any operating reverses, and that Delta goes forward with its expressed intention of providing exit financing on the current program, the rest of this case is likely to focus on a zero-sum game over the other core issue in all bankruptcy cases ' who gets the available money. Claimants include Delta, Pinnacle's unions (and their constituency, employees), secured creditors and unsecured creditors. While Pinnacle remains the Debtor-in-Possession, in control of the agenda of its Chapter 11 case, the decisions it makes from this point forward impact third parties far more than on Pinnacle's survival.

The Unions

Pinnacle's unions are major players in this zero-sum game. The Delta exit financing requires savings on Pinnacle's union contracts as Pinnacle is obligated to seek wage reductions and other concessions from its labor unions. Unlike secured creditors, whose distribution will be determined based on the value of their collateral and a “fair and equitable” term for repayment determined either by negotiations or by the court under Section 1129(b)(2)(A) of the Bankruptcy Code, the unions do not have any fixed standards establishing future wage and labor conditions.

Under Section 1113 of the Bankruptcy Code, Pinnacle has the legal right to reject its labor contracts if it can show that its proposals to the unions are necessary to ensure an exit from bankruptcy and that all parties (including creditors and the EDC) must be treated fairly and equitably. Implicit in the Code is the conclusion that, because the Code requires some distributions to creditors, “fair and equitable” with respect to labor contracts requires Pinnacle maintain sufficient operating income to fund payments to other creditors. In other words, unless Pinnacle's post-bankruptcy operations greatly exceed expectations due to enhanced consumer demand, the distributions to other creditors will come, in part, from concessions made by (or required of) the Union.

This means that every concession from the union benefits creditors. Similarly, most preserved employee benefits will increase Pinnacle's costs and reduce the amount available for unsecured creditors.

Conclusion

The good news for Pinnacle's creditors is that it seems likely that their flight will arrive, after (of course) a reasonable delay. The bad news is that Delta has filled the first-class seats. Worse still, the premium coach seats have been taken by secured creditors, and Pinnacle's general creditors are fighting for the center seats with the unions and other parties-in-interest. Upgrades on this flight may not be available, and will depend on creditors' ability to find some leverage sufficient to make Delta leave the comfort of first class and enjoy the pleasures of coach.

Max J. Newman is a shareholder of Butzel Long, based in its Bloomfield Hills, MI office. 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].