UK: United Airlines, US Airways, Delta, Northwest... US Chapter 11

Last Updated: 26 January 2006
Article by Peter Coles

Chapter 11 bankruptcy protection has been an all too common feature of the US airline industry over recent years. Reorganisation under Chapter 11 can help recovery and ultimate survival of the business but brings with it uncertainty and very limited debt recovery options for unsecured creditors.

Since 2001, the U.S. airline industry has lost over $30 billion and 23 airlines have sought bankruptcy-court protection. Two of the largest US airlines, Delta and Northwest, filed for bankruptcy on 14 September 2005, highlighting the deepening woes of an industry in turmoil. Delta and Northwest joined United Airlines and US Airways, which are seeking to emerge from bankruptcy reorganisation.

Chapter 11 bankruptcy cases in general

In most business reorganisations filed under chapter 11 of the Bankruptcy Code, the company's management hope to revitalise business by presenting a plan of reorganisation that will meet with the approval of its creditors and comply with the requirements of the code. Unless an independent trustee is appointed to operate the business, the debtor will generally have the exclusive right to file a plan for the first 120 days after the filing date of the case. After this period has expired (unless the court extends this exclusive period), any other party, including a creditor or the unsecured creditors committee, is allowed to file a plan.

The present management of the debtor will continue to operate the business as a debtor in possession unless the case is dismissed, the court orders that a trustee be appointed, or the case is converted to a liquidation proceeding (Chapter 7). The court will normally enter such an order only if the debtor is not making progress toward reorganisation. In most cases the court will have a hearing concerning the proposed action and all creditors will be notified.

During the course of the administration of a case, the United States Trustee will monitor the case by periodically reviewing the financial reports filed by the debtor, by investigating complaints made by creditors, by scrutinising all pleadings filed in the case, and by keeping apprised of the success of the debtor's current business activities in order to keep the case progressing toward the filing of a plan.

The bankruptcy code sets forth a priority scheme for creditors’ claims. In general, creditors whose claims are secured by assets of the estate are in a superior position. Should a debtor fail in its attempt to reorganise, a secured creditor may look to the liquidation of its collateral for payment of its claim. Conversely, all other creditors are dependent upon unencumbered assets of an estate for payment. The ability to generate sufficient unencumbered funds to pay these claims often involves a continuation of the debtor's business. The priority for payment of these claims is generally as follows: first, costs of administration (including professional fees and expenses), followed by certain wage and tax claims, and finally general unsecured obligations. By virtue of their last-in-line position, general unsecured creditors have the most at stake should a debtor's reorganisation fail.

Life as an unsecured creditor

Unsecured creditors typically include navigational air service organisations (e.g. Eurocontrol), airport and government authorities, caterers, maintenance organisations, repairers and overhaulers, ramp handlers, re-fuellers, spare engine lessors and freight warehousemen.

Significant considerations include: (1) the extent to which pre- and post-petition debts can be recovered, (2) whether participation on the unsecured creditors committee is necessary, (3) whether the debtor is prepared to treat unsecured creditors as critical vendors and (4) whether existing business terms are likely to be assumed or rejected by the debtor.

Any claims for payment on services rendered pre-petition – regardless of when the invoices fall due – are treated as pre-petition claims. Effectively, unless the debtor agrees to pay these pre-petition amounts, they will not be paid in full. That agreement might arise as a result of a determination by the debtor that it is in the best interests of the estate to treat an unsecured creditor as a "critical vendor" in which case it will be authorised to pay pre-petition obligations in the ordinary course of business based on its business judgment. Even if an unsecured creditor is not treated as a "critical vendor", it will likely be paid in full if its contract is "assumed" by the debtor pursuant to section 365 of the Bankruptcy Code.

"Assumption" means that both the estate and the non-debtor party to the contract must complete performance of the contract. "Assumption" is achieved by formally stating this or by agreeing to be bound by terms of the contract, subject to certain statutory conditions being met, including curing any outstanding defaults under the contract or "providing adequate assurance" that it will do so, and "providing adequate assurance of future performance" and obtaining consent of the bankruptcy court. Since assumption may represent the only mechanism for a creditor to recover the pre-petition debts owed under the contract, assumption is generally favoured over rejection. "Rejection" constitutes a breach of contract by the estate (even if a prior breach had not occurred) giving rise to a claim for damages, which means that the unsecured creditor will not be paid in full and will share pari passu with other unsecured creditors based on a recovery percentage determined at the end of the case.

The deadline for assuming or rejecting a contract is the date upon which the restructuring plan is approved by the bankruptcy court, unless that court sets an earlier deadline.

Post-petition payments for services rendered are given administrative expense status, which means they are necessary for the ongoing operations of the debtor and are paid ahead of any other creditors.

The purpose of an unsecured creditors’ committee is to represent the interests of the class of unsecured creditors by monitoring the debtor's operations during the bankruptcy case and by expressing its opinion as to the best means to achieve a successful reorganisation. The Committee is usually composed of the seven largest unsecured creditors, but any party may apply to become a member. To assist the Committee with its functions, the bankruptcy code allows the Committee to examine the debtor's officers and managers under oath, and to review the debtor's ledgers, accounting or tax approaches, salaries and benefits, and its general business practices. The Committee also has a right to be informed about the debtor's plans and progress toward reorganisation, and the code requires the debtor to meet with the Committee as soon as practical after the Committee is appointed.

If an unsecured creditor files a notice of appearance in the Chapter 11 case or files a proof of claim (in the event they are not paid), then it will be subject to the jurisdiction of the U.S. bankruptcy court. Enforcement proceedings in the U.S. or elsewhere will in those circumstances be a violation of the "automatic stay" against (other) proceedings that took effect when the debtor petitioned for bankruptcy; and exposes the unsecured creditor to damages and contempt proceedings in the United States.

The life of an unsecured creditor is not a happy one and brings into sharp focus the need for strict payment and terminating provisions in supply contracts. This is particularly important in today’s business environment as it can be very difficult for suppliers of goods and services to the airlines to enforce liens (contractual or common law) and seize property and other assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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