Most of news over the past two years about the United Airlines chapter 11 case has focused on the legacy airlines operating losses, its unfunded pension obligations, and its need to overhaul or reject its collective bargaining agreements. Here is a series of posts on those various issues.
So, United has established that a legacy airline can lose money for a long time while floundering in chapter 11. However, can United continue meandering in chapter 11 without aircraft? Look at this seemingly innocuous press release that United issued late this past Friday:

A U.S. federal bankruptcy court judge has blocked a group of creditors from repossessing up to 14 airplanes from UAL Corp.’s United Airlines, saving the bankrupt carrier tens of millions of dollars.
Judge Eugene Wed off issued a temporary restraining order Friday barring the group, represented by the Chicago-based law firm Chapman & Cutler LLP, from seizing up to eight Boeing 767s and six 737s.
The group of financiers, which controls about one-third of United’s fleet, had threatened to seize the planes as early as Dec. 1 because of an impasse over their leases.
United, the nation’s No. 2 airline, is seeking to lower aircraft operating costs by renegotiating its leases with creditors. However, it argued that the Chapman group was violating antitrust laws by renegotiating as a bloc instead of as individual leaseholders, forcing United to accept higher lease rates.

Well, you say, what’s so unusual about that? Secured creditors in chapter 11 cases are automatically stayed from repossessing their collateral until they petition the Bankruptcy Court to modify the automatic injunction under Bankruptcy Code section 362 to allow them to exercise their contractual rights. Isn’t the Bankruptcy Judge simply enforcing the stay against United’s aircraft lenders?
Not exactly. Aircraft collateral is treated differently under the Bankruptcy Code than other types of collateral (financial institutions that make aircraft loans lobby well in Congress). Under section 1110 of the Bankruptcy Code, the above-described TRO is on quite shaky grounds:

(a)(1) . . . , the right of a secured party with a security interest in [aircraft] equipment, . . . or of a lessor or conditional vendor of such equipment, to take possession of such equipment in compliance with a security agreement, lease, or conditional sale contract, and to enforce any of its other rights or remedies, under such security agreement, lease, or conditional sale contract, to sell, lease, or otherwise retain or dispose of such equipment, is not limited or otherwise affected by any other provision of this title or by any power of the court.

In plain English, that says “a bank that has aircraft collateral cannot be enjoined from repossessing and selling its collateral in a chapter 11 case.” Section 1110 goes on to provide that the only limitation on an aircraft lender’s collateral rights is during the first 60 days of the chapter 11 case and that the debtor must cure any defaults under its agreement with the aircraft lender if the debtor wants to continue using the aircraft that is collateral for the lender’s loans to the debtor.
Consequently, it looks like the financial institutions that control a third of United’s fleet have had enough. As United’s management, unions, and other parties-in-interest continue to fiddle while Rome burns, I wonder whether they have examined pro formas on operating an airline without a substantial portion of its aircraft fleet? Inasmuch as the Bankruptcy Court’s decision to approve a TRO in the face of section 1110 is almost certainly in error, United’s dithering parties-in-interest better get ready to deal with a few less aircraft sooner rather than later.

This Floyd Norris’ NY Times column does a nice job of explaining the developing debacle of Krispy Kreme, the share price of which peaked at $49.74 in the summer of 2003, but which has fallen as low as $9.35 recently. An earlier post on the company’s developing troubles may be reviewed here.
What happened? Easy. Most Krispy Kreme franchises don’t make money:

Krispy Kreme’s company-owned stores report an operating profit, but not one large enough to cover corporate overhead. The real profits have come from the company’s dealings with its franchise vendors. The franchises pay royalties of 4.5 percent to 6 percent of sales, plus 1 percent for advertising and public relations. And they must buy all their supplies from the parent – paying hefty markups that provide 20 percent profit margins for Krispy Kreme.
All that would be fine if the franchises were doing well. But many are not, and some are turning to Krispy Kreme as the lender of last resort. Some of these borrow from the parent and others sell their franchises back to it. One lucky operator had a deal that forced Krispy Kreme to buy at a price set in more optimistic times. In other cases, the parent bought for reasons the S.E.C. may be looking into, since its insiders held stakes in franchises the company purchased.
Until recently, it had been hard to tell how the franchises were doing. But the combination of additional investments in franchises and new accounting rules – imposed as a result of the Enron scandal – has forced the company to disclose more. In the quarter ended in October, the joint ventures lost $2.1 million after coming close to breaking even a year earlier.

The lesson of Krispy Kreme is simple, and it is the same one that the Boston Market bankruptcy of the 1990’s should have taught us. If the people who actually sell the product are not doing well, then neither is the enterprise.
Put Krispy Kreme on your bankruptcy watch list for 2005.

Two years into its aimless chapter 11 case, UAL Corp. finally requested that the Bankruptcy Court allow it to reject its existing labor contracts with six unions if the company cannot reach consensual agreements on modifications to the contracts by January, 2005.
Better late than never, but geez United, let’s get on with it.
In its motion, United disclosed that it needs an additional $725 million in annual savings from its 62,000 workers in order to maintain sufficient liquidity to avoid a default under its interim bankruptcy financing even though United employees provided wage cuts valued at $2.5 billion a year earlier in the case. United now needs to generate additional savings because the airline business has been hammered even further by a compbination of low ticket prices, competition from discount airlines, high fuel prices, and unfunded pension obligations.
Moreover, UAL used the filing to remind the Court that it must also reduce its pension liabilities in order to secure exit financing to fund a plan of reorganization in its chapter 11 case. Consequently, unless consensual modifications of those liabilities are obtained, United will request that the Court approve United’s termination of its four pension plans, which would foist a substantial portion of the unfuned pension liabilities onto the federal Pension Benefit Guaranty Corp., which is not exactly in great shape itself.
United’s proposals are meeting with angry opposition in its chapter 11 case from the various unions and the PBGC. As a result, it appears that United will probably be required to endure a prolonged court battle on its motion to reject the labor contracts. Under the Bankruptcy Code, United has to prove that the rejections are necessary to permit the company to reorganize, that they are fair, and that the company bargained in good faith with the unions.
Legacy airlines are doomed to failure in the current airline industry absent change that will allow them to compete with the discount airlines. Nevetheless, the glacial progress in United’s chapter 11 case reflects the difficulties involved in changing a legacy airline’s culture. Although perhaps not best for United and its various parties-in-interest, the best thing that could happen to the airline industry as a whole would be for the Bankruptcy Judge in United’s case to issue an order requiring United’s parties-in-interest to show cause why United should not be liquidated. Only that type of industry shattering event is likely to shake the intractable view of airline unions that the past largesse of the legacy airlines is sustainable in the future.
Meanwhile, in this Wall Street Journal ($) op-ed, three authors involved in airline industry/bankruptcy issues provide the following proposal for dealing with unfunded pension obligations of the various legacy airlines:

We believe that the airlines, airline unions and the administration should work together to propose to the Congress a new alternative to the “lose-lose-lose” Chapter 11 approach. This would present an airline and unions with the following new choice: First, management and a union would need to agree collectively to freeze an existing defined-benefit pension plan. Importantly for the PBGC, its liability as guarantor of the plan would be capped as of the freeze date and would decrease over time. Second, the unfunded liability of the frozen plan then would be amortized over a specified time period that would be longer than what current law allows. Here’s where compromise is needed — the PBGC will want a shorter period for the unfunded pension liability to be paid; the airlines will want longer. One thing is clear: The existing pension funding law, particularly the so-called deficit-reduction contribution provisions, so accelerate the funding of significantly underfunded pension plans as to make the freeze option unrealistic absent a longer time period to satisfy the unfunded liabilities. Finally, management and labor would negotiate and agree upon a new, replacement defined-contribution pension plan.

This NY Times article reports that CBS executives are smiling these days, and Dan Rather’s recent resignation as CBS anchorman does not really have much to do with it.
This is further confirmation that the mainstream television networks are really just entertainment venues, and that their news divisions have turned into just another entertainment show that they feel compelled to run for public relations purposes. Thus, so long as the news divisions are marginally profitable or do not lose much money, the networks don’t really care much about the quality of the product.
My sense is that this is not the way that Edward R. Murrow thought that television network news was going to develop.
Meanwhile, this editorial provides The Economist’s view of Mr. Rather’s resignation, including the following observation:

Mr Rather’s retirement epitomises two broader shifts of power. First, the old media are losing power to the new. And, second, the liberal media establishment is losing power to a more diverse cacophony of new voices.

Don’t miss Holman Jenkins, Jr.’s Business World column this week in the Wall Street Journal ($) in which he reviews the rather remarkable effects of the Sarbanes-Oxley legislation, which was Congress’ knee-jerk public relations reaction to the WorldCom and Enron scandals:

No wonder that the annual bill for Sarbox is going through the roof, with the latest estimates being about $6 billion for the Fortune 1000 alone. One investment banker estimates that a small company nowadays would have to generate $150,000 in free cash annually just to cover the additional paperwork before it can even consider going public. Then there’s upwards of $100,000 each to insure all who sit on its board, if any can be found. Oh yes, and the fact that audit fees, for the average company, have risen about 50% in a single year.
No wonder, too, that the number of companies alerting the SEC that their latest financial reports will be late doubled last quarter, adding to a backlog of late filers that recently topped 600. One strategic-investor type who sits on the boards of a number of companies called a few weeks back to gripe in detail about what all this was costing the economy. Under the SOX regime, something as slight as an anonymous letter alleging accounting irregularities can effectively deliver a company entirely into the control of outside auditors. Directors, so fearful about their own liability that they stop thinking about what’s good for the business and worry only about securing their own alibis, write a blank check with shareholders’ money to do whatever the auditor dictates.

And though Sarbox compliance has become a gravy train for auditors, Mr. Jenkins points out that it has come with a “Faustian Caboose:”

But, ahem, Sarbanes-Oxley has at least fixed a lot of real problems, right? Let’s recall that the Internet and telecom bubbles were occasioned by investors who weren’t interested in published financial accounts — they were interested in the speculative potential of new technologies and new business models.
Secondly, there was the problem of how company promoters and CEOs behaved in the presence of a stock market willing to throw money at such speculative endeavors. Neither of these issues is addressed by Sarbanes-Oxley. Nor does any legislative solution for the inherent risks and foibles of market capitalism suggest itself.
Sarbox, rather, is the last gasp of a corporate governance kludge in which auditors became, in the public’s eye, something they’ve never been in their own eyes: namely proof against fraud. In the audit industry’s eyes (or at least in its behavior), the mandatory audit is a welcome gravy train that has gradually revealed an unwelcome Faustian caboose. Whenever a company blows itself up in an accounting scandal, the accountants pay for their gravy train by serving as an additional set of deep pockets for trial lawyers to sue.

So rather than encouraging beneficial risk taking that spurs economic development and job creation, Congress gives us Sarbones-Oxley, which is nothing more than a regulatory straightjacket that could well chill markets in the long run. This is a common occurrence when our elected officials pass legislation to facilitate public relations for their re-election campaigns rather than to provide a real benefit for their constituents.

Don’t miss George Mason University law and economics whiz Henry G. Manne‘s brilliant Wall Street Journal ($) op-ed from yesterday in which he criticizes Eliot Spitzer’s latest assault on business. Dean Manne cuts through the fog of Spitzer’s public relations blitz to bear in on the true nature of Spitzer’s campaign against the big insurers:

In an era of general acceptance of deregulation and privatization, Mr. Spitzer has introduced the world to yet a new form of regulation, the use of the criminal law as an in terrorem weapon to force acceptance of industry-wide regulations. These rules are not vetted through normal authoritative channels, are not reviewable by any administrative process, and are not subject to even the minimal due-process requirements our courts require for normal administrative rule making. The whole process bears no resemblance to a rule of law; it is a reign of force. And to make matters worse, the regulatory remedies are usually vastly more costly to the public than the alleged evils.

Professor Manne goes on to point out that Marsh’s contingent commissions were as innocent as payola, which is widely misunderstood with regard to its market effect:

Nobel Laureate Ronald Coase once famously showed (Journal of Law and Economics 1979) how kickbacks in the so-called radio DJ payola scandal were really a legitimate, albeit superficially confusing, competitive device. Payola was essential, Coase explained, to preserving competition between record companies, and its demise was only sought by competitors who were injured by the practice — not by consumers. There are eerie similarities between the two situations.
If the Coasian analysis is correct — and no serious rebuttal has ever appeared — we may witness the demise of specialized insurance-brokerage firms like Marsh & McLennan in favor of more integrated insurance companies who will do their own marketing. This is already rumored to have begun. Or we may see insurance brokerage firms beginning to acquire and operate insurance companies. In either case we would be witnessing a decrease in market specialization with a commensurate loss of economic efficiency. Mr. Spitzer would have succeeded in making the industry less competitive and less efficient, and insurance buyers will eventually pay higher not lower premiums.

With his usual insight, Professor Ribstein succiently points out in this post that governmental regulation of payola is misguided because of the valuable market benefits that it provides:

The problem is that, whenever government interferes with the market, it can create more problems than it solves. When government banned payola . . , it blocked a practice that was, after all, getting more air time for new kinds of music. (In general, regulation hurts the newcomers more than it hurts the established players.) But it didn’t stop payola. . . .“[N]ew payola” (spot buys) arose in response to the banning of the old payola. The new payola, . . . creates a less informed market than the old payola.

Payola’s effect in making the music market less transparent is analogous to the effect of insider trading regulation. Insider trading, like payola, helps disseminate information. Regulation forces the trading underground, making markets less informed.

The criminalization of business practices exemplified by Spitzer’s tactics and most of the Enron-type prosecutions combines the worst elements of business regulation with overt miscarriages of justice. Although the prosecutions play well as superficial morality plays in the mainstream media, I fear that the damage being done to America’s business and justice systems will ultimately exceed even the tragic destruction of individual lives that has, and will continue, to occur.

One of the more interesting articles stories in today’s NY Sunday Times is this one regarding the travails of Ricardo B. Salinas Pliego, the chairman of TV Azteca, in trying to find an American law firm that would support his position that there is no duty to disclose to the market that he and a partner had turned a $218 million profit from discounting TV Azteca debt that they purchased from third parties and then selling it to the company at the full amount of the indebtedness:

The Securities and Exchange Commission is investigating whether Mr. Salinas Pliego or TV Azteca properly disclosed his personal financial interest in a deal involving the company, where he serves as chairman. . .
The investigation stemmed from reports about a dispute over the need to disclose that Mr. Salinas Pliego and a partner had turned a $218 million profit from buying company debt at a deep discount and reselling it to the company for full price. [A] lawyer from a prominent firm, Akin, Gump, Strauss, Hauer & Feld, took the unusual step of quitting as counsel to TV Azteca and reporting his dispute with management to the board of directors.

However, if one firm doesn’t agree with you, Mr. Salinas Pliego’s approach is “to try, try again”:

As it turns out, Mr. Salinas Pliego and his management team rejected the advice of two other American law firms on the same matter, according to a nearly final draft report of an internal investigation. The draft, which was provided to The Times, was compiled by Munger, Tolles & Olson, a law firm in Los Angeles that was hired early this year by a committee of independent directors of TV Azteca . . . Munger Tolles’s investigation found that the company’s managers withheld important information from their board, failed to correct a false public statement by Mr. Salinas Pliego and gave explanations for their actions that the law firm concluded were not credible.

Apparently, the Munger Tolles reports provides an entertaining account of how Mr. Salinas Pliego traversed from law firm to law firm in trying to find someone who agreed with his position that his profit on the company’s debt need not be disclosed:

[The report] traces TV Azteca’s journey from corporate law firm to corporate law firm in a search for lawyers sympathetic to its position. After Akin Gump backed away, it says, TV Azteca sought a second opinion from lawyers at Cleary, Gottlieb, Steen & Hamilton, a big New York firm. When Cleary Gottlieb also recommended disclosing Mr. Salinas Pliego’s financial interest in the transaction, the company turned to another firm, Hogan & Hartson. That firm advised disclosure, too.
But when lawyers from Munger Tolles, as part of their investigation, sought to speak to the lawyers from the three firms whose advice had been rejected, they were rebuffed.
(In a particularly absurd twist, the report said Akin Gump declined to make its lawyers available in part because TV Azteca had not yet paid its bills, but lawyers representing Akin Gump did tell the Munger Tolles investigators what the Akin Gump lawyers would have said if they had consented to interviews.)

And in a delicious twist, the Munger Tolles report has now required the company to hire yet another law firm to help it respond to the report:

After splitting with Akin Gump, TV Azteca hired yet another American law firm, Mayer, Brown, Rowe & Maw, to recommend responses to the Munger Tolles report. A recent company filing said the recommendations included the creation of nominating and audit committees and the adoption of a rigorous code of ethics. But it was left to the regulators to decide whether to punish Mr. Salinas Pliego and his team.

My sense is that TV Azteca’s legal fees will continue to be a rather large budget item for the near future.

New York-based investment firm Apollo Management LP announced on Friday that it has agreed to acquire Houston-based Goodman Global Holdings Inc. for $1.43 billion. Goodman Global is a maker of air conditioners and heating equipment and one of Houston’s largest privately-owned businesses.
Goodman Global manufactures brands such as Amana, Janitrol, GmC and QuietFlex, and it has factories in Houston, Fayetteville, Tennessee and Dayton, Tennessee. It employs about 4,000 employees, of which about 2,500 are in Houston.
Apollo has received debt commitments from J.P. Morgan Securities Inc., UBS Securities LLC and Credit Suisse First Boston to finance the deal, which will leave in place the senior management of Goodman Global. Moreover, the Goodman family will retain an unspecified “significant” investment in the company. Goodman Global President and Chief Executive Charles A. Carroll will retain his positions, and Goodman Global principal John B. Goodman will remain chairman.
The deal is expected to close the deal in the first quarter, subject to customary regulatory approvals.

Houston-based Continental Airlines — one of the city’s largest employers — announced Thursday that it is asking employees for reductions in pay and benefits effective Feb. 28 of next year as a part of a plan to reduce its annual costs by half a billion dollars.
Continental expects the savings to be generated from a combination of productivity enhancements, benefits changes and wage reductions with each employee group. The cuts would be in addition to $1.1 billion in annual cost savings and revenue enhancements that Continental announced previously this year.
However, even with the cuts, Continental does not expect to return to profitability unless there is a change in the current economic conditions that are depressing the airline industry. Continental has lost about $160 million through the first three quarters of this year and will likely lose more in the fourth quarter. All airlines have been coping with a glut of seats and high fuel prices over the past year, and traditional hub-and-spoke carriers such as Continental have been facing increased competition from discount airlines such as JetBlue Airways and Southwest Airlines. Although relatively healthy in comparison to the reeling legacy airlines, Continental is the last of the “big six” hub-and-spoke airlines to request such employee concessions after the terrorist attacks of 2001 on New York and Washington.
As a part of the plan, Continental President and Chief Operating Officer Larry Kellner agreed to cut both his base salary and annual and long-term performance compensation by 25% effective Feb. 28. Mr. Kellner will replace Gordon Bethune as chairman and CEO of Continental at the end of this year. Likewise, other top Continental management personnel will take similar reductions in compensation and benefits as a part of the plan.

Schlotzsky’s, the Austin-based sandwich franchisor that filed a chapter 11 case earlier this year, has proposed in its bankruptcy case that its assets be sold at an auction next week.
This proposal comes on the heels of a $88 million quarterly loss, large operating deficits as a debtor-in-possession, and tepid interest from reorganization investors. The auction sale will essentially liquidate the company, and almost certainly means that neither unsecured creditors or shareholders in the company will receive any dividend on their claims or equity interests.
Absent a “white knight” investor, restaurant reorganizations almost always fail. The margins are just too thin, and the competition so robust, for management to make enough headway from an operations standpoint in chapter 11 to persuade creditors to take a stake in a reorganized company that comes out of chapter 11 without substantial new capital.