Chapter 11 Has Unreported Consequences

Chapter 11 of the US Bankruptcy Code affords "protection" to the company whose application is accepted. Chapter 11 was designed by politicians, to give companies that couldn't meet expenses, an extended chance. Once under court protection, Chapter 11 companies don't have the day-to-day freedom to make decisions the way they did before they entered; but their creditors can't collect, either, unless and until the judge says so.

Employees get paid; creditors do not. That simple fact identifies the political reality: Chapter 11 is a "jobs" program, designed to curry favor with employees of companies that can't make it in the harsh marketplace. The way it's usually presented, Chapter 11 looks like a "second chance" for a struggling company. It prevents "jobs from being lost." It "keeps creditors at bay," while the bankrupt company sees if it can "return a good portion of the dollar to creditors, instead of just pennies."

Assuming those are all noble (if economically ignorant, and economically unjust) ideals, what else happens, when a company doesn't have to face the music? That part about keeping the company afloat while it restructures itself sure sounds good; but Chapter 11 still (although not as much as in past decades) impacts company image among consumers.

With revenues down, how is a Chapter 11 company supposed to make it? The "protection" explains things: without having to pay existing debts, including most interest, the company in Chapter 11, even with significant loss of revenue, often has more operating room than its non-bankrupt competition. "That's good," you say. "The struggling company needs a competitive advantage."

Here's where the unintended consequences come into play.

In an official press release yesterday, American Airlines, under CEO Don Carty (right), noted that that, while it's not yet publicly contemplating filing for Chapter 11, it faces unfair competition from airlines that already are operating under court protection. One particularly-telling sentence said the unthinkable: "The company cited pricing actions by low-cost and bankrupt carriers among the factors putting 'unrelenting pressure' on the company's financial situation." In other words, as United and US Airways don't have to pay their (prepetition) suppliers' debts and interest, American, operating in the clear, does. United and US Airways thus have more room to cut fares, making it possible to lure PAX away from American.

If United and US Airways were playing on a level field, American thus points out, those airlines would be forced to pay their debts, or go out of business. Since they are, momemtarily, "untouchable," American can't compete on price, all other things' equal. Thus, the responsible competitor, American Airlines, may well be forced into bankruptcy by the competitors that are being kept on court-ordered life support.

What if everybody did it?

Of course, US Airways and United's suppliers' not getting paid their just deserts will continue to have dire consequenses downstream. Creditors, from Boeing, to airports and cities, to caterers, still have to pay their bills -- except they now have to do it, without the money the Chapter 11 airlines owed them. This puts additional businesses at risk -- businesses that are most certainly not competing with United, or with US Airways. If more and more companies start feeling that their customer-companies are headed for Chapter 11, the credit and cooperation among companies will diminish, actually provoking more filings, as more companies take advantage of the courts.

It should be easy to see that, in the long run, Chapter 11 "protection" is not a good idea -- even for those workers whose jobs are temporarily "saved." Politicians, though, will continue to pander. Economists, with lower profiles, will continue to pull their hair out...

FMI: www.amrcorp.com