Since I appear in the bankruptcy courts on behalf of creditors (and only creditors – too many possibilities for conflicts of interest in trying to represent clients from both sides), I have a pretty good insight about how this works. Bankruptcy used to mean that a debtor cannot pay his bills so the court would take over his property, liquidate it, and divide up the proceeds amongst the creditors in proportion to the debts owed. The debtor would then be put out on the street with the clothes on his back, if that. Most bankruptcies were involuntary on the part of the debtor. Today, there are still involuntary as well as voluntary liquidation provisions, but the most common types of bankruptcies are either the voluntary Chapter 11 reorganizations, primarily used by ongoing businesses that get into financial difficulty, or Chapter 13, use only by individuals who propose to pay back a portion of the debts they owe according to a plan which meets certain criteria.
The American Airlines bankruptcy filing strikes close to home for me because several family members are employees of AMR, and my family was affected by a bankruptcy filing by the late, lamented Braniff International nearly 30 years ago.
American Airlines is the last of the so-called legacy airlines to file a bankruptcy. Other than Braniff, those airlines survived in some form as a result of merger and reorganization, and several actually became much stronger and sounder financially.
One thing that strikes many of us as odd, is that presently American has around $4 billion in cash, and has been paying its debts as they become due. Why, then, bankruptcy?
There was a time when bankruptcy was synonymous with failure. Indeed, having a bankrupt in the family was considered a disgrace, and something that was not talked about in public, or even to close friends. One of the reasons that bankruptcy caused Braniff’s ultimate demise was that, unlike the later airline filings, it ceased operations upon filing and attempted to reorganize without any meaningful revenue stream. But at the time Braniff believed that it had no choice, because no one would fly a bankrupt airline because of the perception that it was a failure, and could not provide the transportation service safely. Whether that was true at the time is speculation, but the way that the reorganization scheme and process under Chapter 11 of the bankruptcy code has evolved, the day-to-day operations of most businesses can remain unaffected. This is not true in every case, of course. Witness the Enron debacle of a decade ago. Bankruptcy nevertheless has become just another business strategy to use when financial adversity occurs.
The Chapter 11 reorganizations do not necessarily require that the bankrupt entity be insolvent. As matter of fact, that is not often the case. The purpose is to try to save a potentially viable business by giving it temporary relief from the claims of creditors in order to readjust its affairs and pay its debts in an equitable manner (“equitable” here meaning a reduced amount paid pro rata according to the amount each creditors owed).
One of the salient features of the Bankruptcy Code (Title 11 of the United States Code, for those who are interested) is that it allows debtors, or appointed trustees who take charge of the bankruptcy estate, to accept or reject contracts and leases. This allows corporate debtors to get out of onerous financial relationships which no longer make economic sense, without the usual consequences of breach of contract. Labor union contracts are often, and in American Airlines’ case, probably the targets of and reasons for a bankruptcy filing in the first place. The United States Constitution prohibits states from impairing the obligations of contracts, but gives Congress the power to enact uniform bankruptcy laws throughout the Union, which inherently impair contract obligations, as well as property rights (although with regard to property, Congress is restricted somewhat by the due process clause of the Fifth Amendment).
Quite a few sections of the U.S. Bankruptcy Code can be doubtless tied to special interest lobbyists. Regarding complex Chapter 11 cases, the concept that some business entities are “too big to fail” seems to rule. One bankruptcy specialist likened a Chapter 11 filing as akin to a snake shedding its skin – an apt metaphor in many cases. Many economists believe that the economy as a whole benefits from the existence and application of bankruptcy as it has evolved. Creditors, employees, and stockholders (or other equity interest holders) are the ones that take the hit when a large firm goes bankrupt. Usually, secured creditors at least get the value of their collateral, although quite often not without some effort. Thus, those who really benefit from bankruptcy are the lawyers, on both sides.