US bankruptcy laws undermine competition among airlines

An editorial in the Financial Times has described as “living dead” US airlines that use bankruptcy protection to undercut their more successful competitors. In films of the zombie genre, the living dead return to consume the flesh of the healthy, the editorial said, noting that much the same is happening in the airline industry, where failed US carriers use Chapter 11 bankruptcy protection to undercut their more successful competitors, said the editorial that appeared on November 10.  

One of the latter, the editorial said, is British Airways which has accused the US bankruptcy procedure of propping up “the waking dead” carriers. The British airline’s concern is understandable, it said, noting that large parts of the US industry are in Chapter 11, including United Airlines, US Airways (for the second time in two years) and ATA, the 10th largest carrier. Delta Air Lines, the editorial said, has for the moment narrowly avoided Chapter 11 and American Airlines came dangerously close last year. “The idea of Chapter 11 is to allow a business that could be a going concern breathing space to reorganise. The management retains control and can tear up labour contracts, abandon pension obligations, shed unwanted assets and restructure debt,” FT said.
 
For airlines, much of the debt will be secured on the aircraft, and the creditors will often prefer to keep them flying. “Having used Chapter 11 to slash their employment costs, the carriers can cut their fares and attract passengers, who pay much-needed cash now for flights later. “What is good for business that is thus saved from collapse, however, can be devastating to better-managed companies that have not walked away from their obligations.” BA believes its Chapter 11 competitors are cutting fares on the competitive north Atlantic routes to generate short-term cash regardless of profitability.

Unlike them, it must still honour its pension obligations — indeed, must increase its contributions to reduce the pension fund deficit, the editorial said. BA says the Chapter 11 procedure is in effect a form of state aid that protects US carriers from competition. The term “state aid” is misplaced — there is no support from the government implied in this form of bankruptcy. But its effects on competitors are undisputed, with solvent US airlines also complaining about the low fares charged by carriers in Chapter 11. “Experience,” the editorial said, “shows that the pain inflicted on profitable airlines often procedures no lasting benefits for bankrupt carriers.”

Of the seven US airlines that filed for Chapter 11 in the early 1990s, only two — Continental and American West — re-emerged. Continental is held up as an example of success for the procedure, but it took two trips to the courts to restore its health. Nor has Chapter 11 helped in dealing with the real cause of the US industry’s financial problems, which is excess capacity. Instead it prolongs the agony by allowing airlines to keep flying on a business model that is fast becoming obsolete — spreading the misery to other, better-run carriers. Chapter 11, FT said, “should be an opportunity to restore failed airlines to profit — not to allow them to haunt healthy carriers at a time of structural change.” Bankruptcy judges must set tighter deadlines for restructuring to minimise the damage inflicted by the walking dead.