Delta & Northwest file for bankruptcy: is it time to ground a major airline?

• Author: McQuaid, Kristina

1. INTRODUCTION II. "HOUSTON, WE'VE HAD A PROBLEM." III. "COME FLY WITH ME, LET'S FLY, LET'S FLY AWAY" IV. BANKRUPTCY: IS THE BAGGAGE REALLY LOST, OR IS IT AT ANOTHER GATE? V. SHOULD NORTHWEST AND DELTA MERGE? A. Antitrust Considerations: Clear for Takeoff? B. Domestic Mergers: Stuck on the Runway? C. International Mergers: Flying High? 1. Australia 2. The European Union VI. IMPACTS A. Are Unions Becoming Black Sheep Squadrons? 1. Conflicts Within the Labor Group Itself 2. Issues Between Unions and Management if a Merger Occurs B. Time to Earn Your Wings 1. Competition: The Bermuda Triangle 2. Customers 3. Suppliers C. Birds of a Feather Flock Together 1. Investors and Alliances 2. Alliances and Open Skies Agreements VII. CONCLUSION I. INTRODUCTION

   Prior to 1978, Congress chose to regulate the airline industry "to avoid the deleterious consequences of cutthroat and excessive competition, and thereby enhance economic stability, safety, and the sound growth and development of this young industry." (1) During the forty years of regulation, no major airlines filed for bankruptcy, (2) and no new airlines were created. (3) However, in 1978, Congress passed the Airline Deregulation Act, which forever changed the industry. (4) There have been polar views on deregulation's success from its inception to date. (5) However, one thing is certain: deregulation's goals have come at a high cost. (6) Since deregulation began in the United States, dozens of air carriers have been merged, taken over, or have simply gone out of business. (7)

   The airline industry has faced significant obstacles over the past few years. (8) Airline carriers are "caught in a squeeze between higher costs and lower revenues." (9) The trend commenced before September 11, 2001, but the terrorist attacks exacerbated the problems. (10) Despite a significant cash infusion after September 11th, (11) bankruptcies have been on the upswing. (12) On September 14, 2005, two more airlines became the latest casualties and filed for bankruptcy. (13) Atlanta-based Delta Air Lines, Inc. and Eagan, Minnesota-based Northwest Airlines Corp. filed for bankruptcy protection, becoming the third and fourth major U.S. carriers to enter Chapter 11 since the September 11th terrorist attacks. (14)

   In Parts II and III, this Comment will discuss problems in the airline industry and provide detail about Delta's and Northwest's bankruptcy filings. Further, Part IV will provide background information about bankruptcy law prior to the statutory change in October 2005. Part V will discuss one possible outcome of these bankruptcy filings, which is a merger between Delta and Northwest. Next, Part VI will evaluate the impact a merger would have on the two airlines, the domestic airline industry, and the international airline industry. Finally, this Comment will conclude with a recommendation that these two companies should merge during bankruptcy.

2. "HOUSTON, WE'VE HAD A PROBLEM." (15)

   There are several reasons why the airline industry is on a dismal flight path. (16) The terror attacks of September 11th have damaged the industry. (17) Further, bombings in Britain and Egypt have re-awakened terrorism fears. (18) However, it is naive to think that these are the only causes that have crippled the industry. (19) Fuel costs have skyrocketed, (20) which is the largest contributing factor in network carriers' cost structures falling short of sustaining profitability. (21) This fuel increase is extremely troublesome because most domestic carriers had inadequate fuel hedging programs, which left them exposed to the oil price shocks. (22)

   Another reason for the airline industry's turbulent outlook is that the money needed to keep up operations can only be borrowed at high interest rates. (23) Also, loans can be difficult to obtain from lenders because "after years of borrowing billions ... the carriers have few assets left to pledge as collateral." (24) Further, labor costs, which are the largest expenses for an air carrier, (25) are out of line with the market. (26)

   In addition to higher costs, the method of earning passenger revenue has changed. (27) Revenues are no longer primarily derived from the business traveler. (28) Instead, leisure passengers are an increasing component of revenue. (29) Further, these travelers are making their own bookings on the Internet and are shopping around for the best price. (30)

   Also, profit has declined due to excess numbers of available seats. (31) This overcapacity puts airlines in a dilemma. (32) To deal with the excess seat availability, airlines have lowered fares to keep customers, and any chance of increasing fares has been thwarted by other airlines. (33) Since the low fares do not cover the costs of providing the service, this cycle creates greater fiscal losses and perpetuates the problem. (34) This debilitating gap between rising costs and shrinking revenues has led many domestic carriers into bankruptcy. (35)

   While the domestic airline industry has been hit hard, the international airline industry has not been immune from problems either. (36) International carriers also face high fuel costs, and these prices are starting to take their toll on carriers in Europe and the Asia-Pacific. (37) The European airline market was down slightly in 2005 compared to 2004. (38) Even though the Asia-Pacific market made a gross profit of $1.5 billion (USD) in 2005, that number is down over 40% from 2004. (39)

   However, foreign airlines seem to be doing much better than U.S. carriers. (40) This is because foreign airlines have cheaper labor costs than the United States. (41) Additionally, airlines in Europe and Asia have been able to mitigate the impact of rising oil prices by passing on these costs to their passengers in the form of fuel surcharges. (42) Finally, foreign carriers have more pricing power since they tend to share routes with just one or a few significant rivals. (43) By comparison, U.S. airlines have cutthroat competition, (44) and some perceive bankruptcy as the best way to cut costs and remain competitive. (45)

3. "COME FLY WITH ME, LET'S FLY, LET'S FLY AWAY" (46)

   Delta and Northwest are considered legacy carriers (47) and have been "flying the friendly skies" (48) since 1928 and 1926, respectively. (49) However, in more recent times, those skies have not been so friendly for the two companies. (50) On September 14, 2005, both airlines filed for bankruptcy. (51) At that time, the current debt for Delta was $28.3 billion (USD), and for Northwest it was $17.92 billion (USD). (52) Both airlines have decided to "fly away" from responsibility by seeking bankruptcy court protection from their creditors. (53)

   Some of the listed causes for Northwest's filing included high operating costs, higher fuel costs, and a mechanics' strike. (54) Northwest's fuel bill was $3.1 billion (USD) for 2005 "compared to $2.2 billion [(USD)] for 2004 and $1.6 billion [(USD)] for 2003." (55) Also, Northwest's "[m]echanics went on strike in August rather than accept deep layoffs and pay cuts, and though the airline stayed aloft with replacements, it switched to a reduced fall schedule early and saw more delays and cancellations than usual." (56) In September 2005, Northwest first acknowledged some of the costs of the strike when it asked for permission to pay $55 million (USD) to vendors for services during its mechanics' strike. (57)

   For Delta, some of the blame for its financial woes falls on Hurricane Katrina. (58) Katrina hit Delta hard because of the airline's presence in the South. Specifically, the airline had to cancel flights to New Orleans, Louisiana and Gulfport, Mississippi. (59) However, JP Morgan analyst Jamie Baker, in his research note on Delta, placed the blame on management's inability to pursue asset sales, debt-for-equity exchanges, credit card processor replacement, and wage reductions, in light of dramatically higher fuel prices. (60)

   Whatever the carriers' ultimate reasons for their financial troubles, Delta and Northwest were both looking to bankruptcy as a way to relieve some of their high costs. (61) Since filing for bankruptcy, Northwest has sought to reject certain aircraft leases. (62) After its filing, Delta "asked a New York bankruptcy judge to allow it to abandon some properties and prevent utilities from turning off its power." (63) Further, Delta and Northwest have cut or are in the process of cutting their employees' jobs, pay, and benefits. (64)

4. BANKRUPTCY: IS THE BAGGAGE REALLY LOST, OR IS IT AT ANOTHER GATE?

   In 1978, Congress passed the Bankruptcy Act. (65) The purpose of the Bankruptcy Act is to allow financially troubled businesses to continue operating by giving them time to reorganize their finances. (66) Under Chapter 11 bankruptcy, a company continues to operate while creating a reorganization plan, confirmed by the court, that determines how its creditors will be repaid, and from what source. (67)

   According to Robert Crandall, a former CEO of American Airlines, bankrupt airlines enjoy competitive advantages over rivals not in bankruptcy. (68) A bankrupt airline can defer debt payments, (69) modify labor agreements, (70) and postpone pension contributions. (71) Crandall theorizes that a bankrupt airline can lower its financing and operating costs, thereby luring customers away from competitors by offering lower prices. (72) Similarly, Nigel Milton, Virgin Atlantic's government affairs manager, said, "Chapter 11 is a type of state aid. The playing field gets tilted more and more against US." (73) These lower prices have the effect of forcing nonbankrupt airlines to reduce costs and shrink their profit margins, perhaps bringing these carriers closer to bankruptcy themselves. (74)

   In addition, Chapter 11 bankruptcy reorganization allows the industry to retain more competitors than the market can handle. (75) The availability of Chapter 11 reorganization has caused overcapacity by keeping inefficient carriers in the...