Should You Worry About an American Airlines Bankruptcy?

There has been a growing amount of rumor regarding a possible bankruptcy at American Airlines, with the rumors taking on a very tangible form on Monday.

American’s stock lost almost exactly one full third of their value on Monday, wiping almost $350 million off the company’s market valuation.  If you have a spare $664 million, you could now buy the entire company.

On the other hand, the market as a whole was tough on airlines on Monday.  Contrasting with a 2.4% drop in the Dow, a 2.9% drop in the S&P 500 index, and a 3.3% drop in the NASDAQ, the NYSE airline index dropped 9.8%.  Notable other losers included US Airways (-15.8%), Jetblue (-14.7%) and United (-11.7).  Even Southwest dropped 8.6%.

The big news surrounding AMR’s 33.1% drop seemed to be fears of a possible pending bankruptcy.  Let’s answer two questions – what would it mean to you if AA did declare bankruptcy, and why might they do this?

What Would an AA Bankruptcy Mean to You?

As you may already know, there are two main types of corporate bankruptcy – a Chapter 7 bankruptcy, where a company closes down for good (think the recent disappearance of Borders) and a Chapter 11 bankruptcy where the company ‘reorganizes’ – a polite way of saying ‘is able to walk away from most of its debts and even wipe out its current shareholder values too’.

Airlines generally do a Chapter 11 bankruptcy as a way to ‘clear out the deadwood’ they no longer want – airport leases they want to renegotiate by force or simply renege on, leased planes they’d like to walk away from, accumulated bills from suppliers they’d rather shaft than settle, and of course, their employment agreements with their workforce.

So we have a very good idea of what to expect when airlines go through a ritualistic Chapter 11 experience.  Most flights will keep operating, at least short term.  And – the question closest to most people’s thoughts – frequent flier miles and premium status stays in place, close to completely unchanged.

If AA does declare bankruptcy, and if by some bad chance they cancel some flights that you were booked on, you can ask your credit card company for a refund due to ‘failure to receive the goods paid for’.  The refund is usually given to you close to automatically.

If schedule changes make AA no longer the best carrier for you to concentrate your future flying on, you could take your premium Aadvantage status to other airlines and see what they’ll do to match it if you switch your business to them.  Maybe they’ll instantly match, or maybe they’ll set you up with a ‘challenge’ – a short term requirement to accumulate a certain amount of flying with them to qualify.

As for the frequent flier miles you already have, they are probably safe for the future (but unlike your status, can’t be transferred to another airline).  The reality is that frequent flier miles are such a trivial liability that the commercial ‘cost’ of zeroing out frequent flier accounts would eclipse the ‘saving’ many times over – airlines would rather carry forward the frequent flier miles and keep you hooked as a passenger.

Why AA Might Declare Bankruptcy?

When we think about a personal bankruptcy, we typically think about a ‘having too much debt’ type scenario.  While being able to wipe out a mess of accumulated debt is definitely a bonus for airlines, it seems that the more important value for them is in being able to cut down their operating costs and increase their potential profitability in the future.

Imagine if you could do a personal bankruptcy and come out the other end with a reduced monthly house payment, lower rates for your insurances, and less cost for groceries.  And imagine further that going through a bankruptcy would carry no social stigma whatsoever, and that your credit rating was unaffected.  Wow – what an amazing ‘gift’ that would be, right?

Welcome to the wonderful world of Chapter 11 corporate ‘bankruptcies’.  The preceding analogy reasonably accurately describes what airlines hope to achieve in a Chapter 11 bankruptcy.

In AA’s case, the primary reason for a bankruptcy might be to apply some brute force pressure to their negotiations with their employee unions.  According to this article, AA has $800 million in extra labor costs compared to its competing airlines, and that is the good news!  The article reports that current labor negotiations are stalled – AA of course seeks to reduce its costs down to something more in line with its competitors (most of whom renegotiated their labor costs down while cycling through Chapter 11 a few years ago, at a time when AA was under intense pressure to do the same thing, but didn’t).

But AA’s unions are not arguing over the size and scope of any givebacks.  Instead, they are actively seeking pay increases.  That’s a huge difference in perception between the two sides, and no wonder there is precious little sign of any positive settlement being reached.

Quite possibly AA is currently ‘negotiating in public’ by allowing rumors of its bankruptcy to swirl around its unions, enveloping them in fear and making them much more pliable at the negotiating table in private.

Or maybe after trying the honorable non-bankruptcy route, and finding themselves hugely disadvantaged as a result and with no clear solution in sight, the airline has simply accepted that in order to return back to a level playing field alongside its competitors, all of the largest of which have been through at least one bankruptcy in the last decade, AA needs to now do the same thing.

The simple fact of the matter is that AA is losing money while its competitors are making profits.  AA can’t really charge any more for its tickets than the amounts charged by competing airlines.  So if it can’t increase its revenue, its only alternative is to lower its costs, and if it can’t reduce them by ‘normal’ means, it may be left with no choice but to adopt the ‘nuclear’ option of Chapter 11.

Who Would Lose in an AA Bankruptcy?

All AA’s unsecured creditors must be feeling very anxious at present, because they’ll be one of the first groups to feel the bite of a Chapter 11 bankruptcy.  This exposure can create a slow but certain inevitability towards a Chapter 11 – if unsecured creditors stop extending credit and start demanding both cash up front for future transactions and also immediate payment of outstandings, that can sometimes push a company that was hovering on the edge on over to the bankruptcy filing.  Fortunately AA currently has plenty of spare cash, so it can withstand some drying up of credit.

A second group would be AA’s shareholders – hence the 33% drop in share price on Monday.

And a third group?  Employees – both present and past.  While Chapter 11 doesn’t give the airline carte blanche to ride roughshod over its employees and retirees, the unmistakable truth is that airlines do succeed in negotiating tougher agreements in a Chapter 11 than as a regular going concern.  This may be while AA is reportedly experiencing a mini-exodus of pilot resignations at the end of each month (when pilots can announce their intention to retire almost immediately if they so wish, cashing in part of their retirement benefits as a lump sum payout at the same time – retirement benefits that would be at risk in a bankruptcy).

Your Best Strategy For Now?

Simple.  Don’t fret.  Past airline Chapter 11 bankruptcies have been of almost no discernable impact to passengers, this one would be unlikely to be any different.

But, just in case, do make sure you’re paying for your airline tickets with a credit card.  Which you should be doing anyway as a matter of course.

Lastly – talking about bankruptcies – have you contributed to our 2011 Fundraising Drive yet?  🙂