Bankruptcy fears swirl again around American Airlines

With bankruptcy fears swirling again around American Airlines, some questions arise what happens to the orders AA has with Airbus and Boeing if the carrier goes into Chapter 11.

This hand-wringing piece paints a dire picture for Boeing. There is a lot to argue with over this particular writing, but the piece’s headline is particularly off-the-mark. (Note that the writer of the piece and the headline writer may not be the same person.)

Airbus and Boeing were well aware of American’s precarious financial condition before striking the deal last summer to lease and sell more than 400 aircraft (with options for hundreds more). American also had a pre-existing order with Boeing for 737-800s and a handful of 777s; and an MOU for 42+58 787s.

We understand that the deals with Airbus and Boeing for the A320 and 737 families somehow took into account the prospect of a bankruptcy filing. We don’t know how contracts would have been structured to protect the orders in the event of a bankruptcy, for under US law any contract may be voided (including labor contracts, under certain conditions). But here’s the reality: the likelihood of American voiding these contracts is, in our view, very remote.

Here’s why:

  1. American needs the planes. The MD-80s are old and getting older. By today’s standards they are very fuel inefficient and as they age, maintenance costs go up. The same is true for the 757s and the 767-200ERs. American has to replace these planes. The new orders will stand for this reason alone.
  2. The few remaining 777 orders will also remain. AA needs this, too.
  3. The MOU for the 787s will eventually be firmed up. This has been held up by the inability to achieve a pilot contract. Under bankruptcy, AA can void the contract and go for terms it wants. (Note to AA pilots: while it is much tougher for an airline to do this, it is not impossible, and there is a pretty clear case to be made for voiding your contract.)
  4. Airbus and Boeing have been through bankruptcies with US airlines many, many times and orders have remained throughout. Any assumption that the orders at American will simply go away in a bankruptcy ignores history.

What analysts fail to recognize is that typically the OEM contracts enable them to void contracts in case of bankruptcy by a customer–it’s not just a one-way street. Airbus and Boeing could void the AA contracts. But we think this unlikely as well. Airbus has great incentive to maintain its contract, having broken the Boeing monopoly. Boeing has great incentive to maintain last summer’s 737 deal because if it doesn’t, AA could simply up its A320neo order.

If American enters bankruptcy, we would expect some hard negotiating over the contracts and perhaps some adjustments but we expect them to remain. It is not unknown for Airbus in particular to participate in a reorganization by lending money to the airline. Boeing, through Boeing Capital, could easily do the same.

We can make an argument that American should enter bankruptcy. It can’t get a deal with its pilots. Its costs vs its peers are too high. It has a pension plan that others don’t have. Its debt is crushing. We acknowledge management’s antipathy to bankruptcy and appreciate that they don’t want to screw the pension, employees and lenders and lessors. But the pilots basically believe AA is fiddling with the books to make matters look worse than they are. (Of course, if this were true, a lot of AA’s officers could wind up in jail.)

We don’t know what will happen. But what won’t happen is a wholesale canceling of orders.

26 Comments on “Bankruptcy fears swirl again around American Airlines

  1. Everyone knew of the precarious financial position that AA was in when the contract/”arrangement” was entered into. The possibility of a bankruptcy had to be addressed in one way or another.

  2. “BA is seeking cost-cutting measures in other areas, including the possible closure of a military modifications plant in Kansas that could have been used to assemble the 737 MAX.”
    If they don’t sell the property, maybe they can still use it to assemble the MAX. Seems like some possible savings by not having to transport the fuselages across the country by train. What are the odds for Kansas getting the MAX assembly line?

  3. Note to journalists: AA pilots are paid much less than the industry average, and the 7% increase the union is proposing and AMR rejected keeps AA pilots below. Do some homework next time instead of repeating vague statements from corporate news releases. And check out how much the executives are taking home, and how much they plan to reduce that to “save the company”. AMR has been on a spending binge, not acting like a company in trouble, acting like a company that wants to show a loss. The pilots have good reason to be angry, they can see the spending and the executive bonuses and attempts to increase outrsourcing.

  4. IIRC, the first 230 new Airbus and Boeing airplanes in this order are already funded by Airbus and Boeing. So, AA will end up at least with these 230 A-319/-321s and the B-737NGs. I don’t think the first 230 airplanes are NEOs or MAX airplanes.

    If AA does file for bankruptcy protection (Chapter 11), they are not really in the pilot’s seat anymore, the court appointed trustee is. AA will present a plan to the trustees of the court, to include any and all contracts they want to cancel. Those holding the contracts with AA, labor unions, airports, etc., will get to present their side to the trustee, who goes to the judge with the trustee plan. The judge then approves one of the submitted plans, or a new plan with some parts from the ceditors/unions plan and AA’s plan combined.

    In the case of the new airplanes, AA, Boeing and Airbus can easily make the case AA needs them to be competitive. So, those contracts may be approved, and they could be modified.

    Then comes the time to exit bankruptcy protection, but that costs money. The money is needed to pay off the other creditors that loose their contracts, and those guys usually only get pennies on the dollar.

    The money AA will need can come from Boeing or Airbus. Airbus paid for US to get out of their last bankruptcy (US had two in this past decade), and made terms that they had a customer for life with US for that money. But this will be very different as Airbus might have to compete in a bidding war with Boeing to buy such future loyality.

    AA is playing this whole order and bankruptcy game like the true professionals they think they are.

    • KC, a trustee isn’t necessarily appointed in a bankruptcy. (Martin Shagrue was appointed a trustee in the Eastern bankruptcy.) The bankruptcy court judge oversees everything and has to approve, but management typically remains in charge unless they totally screw up, like Frank Lorenzo at EAL.

  5. I agree with you Scott, the piece’s headline is particularly off-the-mark. It should read “If American falters it could make Boeing fall.” 🙂

    Seriously, the pilots should have started earlier to try to find a solution. Of course they would have to make major concessions. They will have to, one way or another. The bargaining power is simply not there anymore. The same goes for Boeing’s unions by the way.

    The 2011 airline environment is very different than it was in 1978. AA looks like a dinosaur right now. Many unions are still acting today like if nothing had changed. Yes I miss the pre-deregulation days and the time before the Majors started to be referred to as “Legacies”. The pilots were commanding more money than a surgeon and the rest of the airline employees were benefiting from the situation as well. With some justification we can call that period the “good old days”. But in due time Rome came to fall, and so did the British Empire. And those who fail to recognize the possibility could soon find themselves in a much more precarious position than any negotiations carried in good faith would have done.

    On the face of it, even Boeing could fall one day. Nothing is impossible. When your time has come you’r dead. AA is on the threshold right now. A life extension will soon be offered to them, but with an accompanying further reduction of power for the unions. Chapter 11 is like an NDE. Once you have emerged from that you will never be the same thereafter.

    • Pre-Deregulation was “the good ol’ days” for everyone but the flying public, the airplane manufacturers, the aviation suppliers, the Service providers, the airports, etc etc. The ONLY people who benefited from regulation were pilots and the execs at airlines.

      Deregulation has been a massive boon to the general public, and the industry as a whole. I don’t miss those days one little bit. Billions of flights that never would have happened have occurred. The dinosaurs NEED to adapt or go out of business.

      • To me the legacies in the US market appear to be a group of walking dead having the occasional bout of “chap11” or in more fortitious moments a cosy hour by joining up.
        There seems to be no viable longterm remedy: entangled in unions, pensions and overaged planes they lack ideas and are incapable of expressing those.

        ( OK, a bit exagerated for sure, but .. )

  6. “We understand that the deals with Airbus and Boeing for the A320 and 737 families somehow took into account the prospect of a bankruptcy filing”

    By leasing the planes to AA they are still the owners and get the planes back. If they lend them the money to buy the plane they receiver could sell the planes and then pay just part of the outstanding loans based on how much money they allocate to the creditors.

    Airbus and Boeing could also secure loans to get priority in payments but even so they would most likely only get some part of the loan.

    • I think you’ve nicely described why 737 leasing rates are higher than those for the A320 ?

    • Wrong, Kemo Sabe.

      Lessors have no greater call on the airplanes than lenders. Under the bankruptcy code, Section 1110 provides for the return of all aircraft for which payments are not current after 60 days, whether lessor or lender. This Section has, however, been successfully challenged in past bankruptcies (notably Western Pacific), thus screwing the lessors and lenders. Remedies to fix the law followed but some smartie-pants lawyer might be able to figure out a loophole.

      From a practical standpoint, lessors and lenders may not want to get the planes back, depending on supply-and-demand, relationships, the cost of reconfiguring the airplane, etc.

      • Sorry to disagree with you but as long as the lessor is registered as owner they will get it back. They may lose unpaid lease payments and they may be required to keep the leases going under reorganization if the debtor can fulfill obligations during that period.

        Section 1110 is mainly about secured financing where the debtor is registered as owner and while the creditors have been granted the right to take possession over the asset it isn’t certain.

  7. Holly Hegeman (@PlaneBusiness) :
    AA should file. Period.

    It would be better if they didn’t. All parties should avoid it all costs. And in the case of the unions it would be “AT ALL COSTS”. To say “AA should file” is like saying “You should undergo chemotherapy in case you have cancer”. Both are extremely traumatic experiences.

    The unions are up against the wall. They have to make further concessions, way over and above the ones they have already made, no matter how big they were then. It has nothing to do with the size of the management’s self-appointed salaries and bonuses. That is strictly an ethical issue and should be dealt with separately.

    Good will on both sides is what it takes. AA has been for a long time one of the best run airline in the world. But times have change and a voluntary restructuring is way preferable to an imposed one. It would be really nice if AA could solve it’s problems without resorting to a painful filing. It would go down history as an extraordinary feat that everyone would be proud of. But I am afraid it’s too late now.

    • Unions are against a wall, but to say that they should deal with it dispassionately apart from management pay and related issues is to ignore human nature. Even if union leaders privately recognize that reductions are needed, they cannot afford to get ahead of their members, who may not be emotionally ready to concede this reality.

      It may take going into bankruptcy and the threat of Section 1113 to do this. As the bankruptcies of the prior decade show, while in theory you can do just as much outside of bankruptcy than in, the reality is that practically you can’t. American is living proof of it — the reason that it’s in trouble now is that it failed to get, outside of bankruptcy, what its peers got inside bankruptcy.

      • I know I am asking to much from the unions. And I know AA is asking too much from the unions as well. But it’s better to be asked than to be told.

  8. Reason (1) is true so far as it goes, but it’s not complete.

    While it is absolutely true that American needs to replace its MD-80s, the issue is whether the contracts with Boeing and Airbus can be materially improved upon. A bankrupt company only has an incentive to break contracts if (1) it doesn’t need what it has contracted for or (2) the contract is at above market prices, and can be significantly improved.

    If (1) is true, the contract will be broken. If (2) is true, the contract will generally be renegotiated.

    It is likely, however, that American has received among the keenest pricing of any airline in the world from both Boeing and Airbus. That being the case, there would be little point in breaking or modifying the contracts in bankruptcy.

    A wild card is if somehow Airbus or Boeing has managed to improve pricing relative to the other manufacturer. For instance, Boeing figures out how to price the MAX a lot lower, thereby providing an incentive to American to shift from Airbus to Boeing. If that happens, I’d guess the other manufacturer (Airbus, in this example) figures out how to respond in kind.

  9. AMR management are finance guys – “bean counters” – not business leaders of old. They are very good at fighting to lower costs, not good at much else. They beat up every supplier and every employee group for lower prices, but do little to increase income. Suppliers can be pushed hard by a major customer, but employees are captive in this labor market, and especially pilots. But this is why unions came into existence.

    I don’t like unions, they are a drag on efficiency and agility, and a symptom of poor management. But sometimes they are necessary to limit injustice. Military pilots are paid more than airline pilots and treated better. Our most senior and highest paid airline pilots are able to retire and step into a higher paying pilot job as a new-hire in the Middle or Far East where the shortage is acute. Pilot pay is too low to attract new pilots, it’s just not worth it when you look at what they sacrifice for what they get. The poor pay and work rules have resulted in a massive shortage of young pilots, there is no way for our airline industry to grow when the economy recovers. The unions have no power to negotiate under the RLA, and management has take great advantage of the situation.

    Supply and demand is quickly turning in the pilot’s favor, and AMR is trying to lock in a very long-term contract at bankruptcy pay rates. That’s smart, but the pilots aren’t stupid. They have a lot to lose in bankruptcy, but they prefer to lose it there than vote to give it up and lock it in for a decade.

    • You don’t think Chapter 11 would be favourable to the pilots, do you?

  10. The carriers who went bankrupt are paying their pilots slightly less than AA, and catching up as AA pay has been stagnant at 1992 dollars for over ten years. Other carriers (SW, FedEx, UPS, even Spirit) pay more than AA on comparable equipment. The formerly bankrupt pilots have pensions, 401k matching, and decent work rules. And they are coming up for contract negotiations, with hefty and consistent profits, raises are likely. So AA pilots don’t have a lot to lose, and could emerge in a better managed company with some stability. Delaying a long-term contract would have them negotiating in a better economy, an acute pilot shortage (look at coming retirements at all the carriers, and coming FAA rules requiring more pilots), and higher pay at all their peers.

    Short-term, no it won’t be good for several years, but it will certainly be better long-term if AA restructures, especially if they emerge better managed. But in reality, AMR is doing much better than they let on, bankruptcy would be an aggressive tactic. Search for (AMR CEO) Arpey’s Masters Thesis, where he concludes airlines should convince labor the company is in dire straights during contract negotiations. Look at the surge in capital spending over the past few years, that will be paying off soon. Look at how much debt has been paid off, and how much cash is on hand, and of course the third-of-a-billion in executive bonuses since ’03, they have been doing well. Bankruptcy to get lower labor contracts would be very risky for management, and even a judge can’t force the unions to accept long-term pay concessions. We could be back in negotiations in two or three years. If Arpey and company go for bankrupcty, it’s because “that’s all they got”, they have no strategies for improving the company beyond cost cutting.

  11. Scott :
    The formerly bankrupt pilots have pensions, 401k matching, and decent work rules.

    Yes, but what kind of pensions? My understanding is that these have been considerably reduced and might not be enough to support a living in some cases.

    I am not sure if the management wants to avoid Chapter 11, but I think it would be better for everyone to reach an agreement before the harsh conditions of “law protection” hit them. The pilots have a strategy to slow the negotiations as much as possible, hoping that time will be on their side. But they might soon find themselves in those “alternate law” conditions where the union will no longer be able to provide them with the “Alpha Floor” protection they need. And since AA is flying low right now the pilots might regret to have “stalled” the negotiations.

  12. Bankruptcy would be bad for the pilots, but hopefully cathartic to all employees. The relationship that management traded for shekels was the heart of the organization, as it is at successful SouthWest Airlines and most highly successful companies. The pilots were on board when they gave hundreds of millions per year in concessions to save the company in ’03, they believed in the company and their ability to rescue it. It would be absurd to try that argument again with less debt, more cash, huge management bonuses, huge capital spending, and a history of management abusing labor contracts. But that is exactly what management is doing, playing “chicken” against the employees.

    The current contract is over five years expired, and management has avoided negotiating for most of that time, delaying an expected raise. Now management needs a contract, and would like to rush it through as they did in ’03. The ’03 contract had gaping holes in it, and management has taken advantage of all of them in courts and mediation. The pilots are at a disadvantage in court and mediation under the Railway Labor Act, they need to review any new agreement carefully, and the timeline is spelled out in their union rules.

    Pensions at bankrupt carriers didn’t all go away, as is often reported. Pilot pensions at all airlines are complex, hard to compare, AA probably has the most money in theirs. But it was revised down long ago, and the last “A-scale” pilots who will get the most from it are approaching retirement. “B-scale” pilots are the majority now, reducing pension obligations. The pension is less of a sacred cow to them, but senior union officials are clinging to it. Bankruptcy might shake that loose, certainly to the detriment of many senior pilots. A type of reduced “C-scale” retirement is in the union offer, declined by management.

    The real sacred cow is outsourcing of jobs, or “scope”. There will always be warm bodies willing to do the job cheaper, and AMR is constantly looking for ways to displace AA employees with cheaper employees. Scope clauses have replaced loyalty in keeping experienced workers, but AMR has managed to overturn many of them in court. AMR would certainly petition a bankruptcy judge to allow them to turn over routes and markets to competitors with newer and cheaper employees, through marketing agreements. AMR has a history of switching routes to whoever is cheaper or less unionized, and employees sometimes are hired at the bottom of succeeding carriers in the same market. It makes sense from a quarterly-profit viewpoint, but the unions are wise to fight it.

  13. If AA goes into bankruptcy and comes out the other side, the orders/leases remain in one form or other, though possibly cut back or renegotiated. But the possibility of AA going the way of Pan Am, Eastern and others cannot be completely ignored – not immediately of course and not necessarily overnight, but still a possibility. Of course in those circumstances other carriers would have the opportunity to take up the slack, which would mean in part needing more equipment, as well as hiring staff etc.

  14. That is a lot of speculation fellows, on wether AA will go into bankruptcy or not!

    The more important question, I believe, is wether AA will continue to be an all
    737 operator, by buying the 737MAX only, split the deal with the A320NEO, OR
    go for an all common NEO fleet, IF it survives, which I believe it will!

  15. Bankruptcy is bad not only for pilots but for it’s employers as well. But sometimes the causes are mismanagement, stiff competition and market saturation. This dude is right:

    “It would be better if they didn’t. All parties should avoid it all costs. And in the case of the unions it would be “AT ALL COSTS”. To say “AA should file” is like saying “You should undergo chemotherapy in case you have cancer”. Both are extremely traumatic experiences.”

    I hope they change the management and marketing team they have nothing to lose by doing it. Not doing it will cause downward spiral for AA.

    An analyst article from: http://airsoc.com/articles/view/id/4f6c888ac6f8fadf1b000004/is-american-buying-bigger-planes-an-analyst-wonders?ev=10&evp=tl gives a good insight regarding the matter. It would be helpful to deeply understand the issue regarding AA.

  16. Alexander :
    Bankruptcy is bad not only for pilots but for it’s employers as well. But sometimes the causes are mismanagement, stiff competition and market saturation. This dude is right:
    “It would be better if they didn’t. All parties should avoid it all costs. And in the case of the unions it would be “AT ALL COSTS”. To say “AA should file” is like saying “You should undergo chemotherapy in case you have cancer”. Both are extremely traumatic experiences.”
    I hope they change the management and marketing team they have nothing to lose by doing it. Not doing it will cause downward spiral for AA.
    An analyst article from: http://airsoc.com/articles/view/id/4f6c888ac6f8fadf1b000004/is-american-buying-bigger-planes-an-analyst-wonders?ev=10&evp=tl gives a good insight regarding the matter. It would be helpful to deeply understand the issue regarding AA.

    Correction: Bankruptcy is bad not only for pilots but for it’s EMPLOYEES as well. But sometimes the causes are mismanagement, stiff competition and market saturation.

    Type Error Sorry.

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